Good afternoon. My name is Chantelle, and I'll be your conference operator today. At this time, I would like to welcome everyone to the RH second quarter 2019 Q&A conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Allison Malkin of ICR, you may begin your conference.
Thank you. Good afternoon, everyone. Thank you for joining us for RH's second quarter fiscal 2019 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Jack Preston, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook for our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results.
Please also note that these forward-looking statements reflect our opinions only as the date of this call, and we undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements in light of new information or future events. Also, during this call today, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the investor relations section of our website at ir.rh.com. With that, I'll turn the call over to the operator to begin our Q&A session. Chantelle, we're ready for questions.
At this time, I would like to remind everyone, in order to ask a question, press star, then 1 on your telephone keypad. Please limit yourself to one question and one follow-up question, and then re-queue to ask any additional questions. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Tami Zakaria with JPMorgan. Your line is open.
Hi. Thanks for taking my question. Could you comment on the 3Q revenue guide and why revenue growth would step down to 5%-6% after over 8% the first half? Was there any revenue pull forward into 2Q that's part of the expected sequential deceleration?
Hey, Tami, it's Jack. You may recall that we have the sort of self-inflicted drags, in a sense, the decisions we made to exit certain revenue items. Those are two for the quarter. There's the impact of the drag being different. I think one of the other things you're seeing is we saw an outlet. You see all the outlet sales in our press release. There, we talked about the closure of the 500,000 sq ft distribution center last quarter. We've cycled most of that inventory out, so you're not going to see that benefit. That benefit was worth about 2 points in Q3. It was also a big drag on gross margins.
Got it. My follow-up question is, earlier this year you guided to $15 million-$20 million additional savings from the Home Delivery Initiative. Does that still hold, or are you seeing incremental savings that could come from this initiative?
Sure, Tami. I think at this time, what we guided was 15%-20%, with a third of the benefit in this year and two-thirds next year. At this time, we're holding to that. We're optimistic and looking forward to even better benefits there. For the moment, we are holding to that, and that is the timing.
Got it. Thank you so much.
Your next question comes from Steve Forbes with Guggenheim Securities. Your line is open.
Good afternoon. Maybe another question on the three Q guide, but this one really on sort of the gross margin outlook. The third quarter sort of, I guess, looks a little weaker than we were modeling, and the fourth quarter looks a little stronger. I don't know if there's sort of any shift in both margin and expenses because you sort of the same dynamic as you move down the P&L. Can you just talk about if there's anything to call out, sort of any idiosyncratic that's sort of impacting the model?
Really think it's advertising swinging around. Yeah. Nothing idiosyncratic, Steve. I think we didn't provide you quarterly flow, and I think a lot of times what happens is, unfortunately, the analyst community doesn't always get it right if we don't give you sort of the guidepost to where to go. When I look at it on the half, we're guiding 40.5%-40.8%, and it's up 140 basis points versus last year, versus what we did in the first half up 100 basis points. I think that's one way to look at it.
Right. Nothing idiosyncratic call out. Then maybe for you, Gary, because I didn't fully get to digest the whole release yet, but if you think about the comments around international opportunity last quarter, and I think during the pre-announcement. I don't know if you can help us as we start conceptualizing the international expansion opportunity. Can you update us on the timeline and maybe discuss sort of the infrastructure needs of the business for a successful transition into one or more international markets over the next few years here?
Yeah. Let's go back to your first question, because I think that there is confusion and has been confusion about sometimes how to landscape the business year-over-year, if you're not paying attention to it. The biggest thing year-over-year is we used to book advertising and advertise it to our catalogs and the curve of our catalogs, and now we book advertising based on when we mail the books. If you're trying to model the business, you could be kind of surprised to see we have how much of our advertising expense for the second half is in the third quarter.
Most is.
It's like 80%.
That's right.
Yeah. 80% of our advertising costs are hitting in the third quarter because of the timing of our books, and only 20% is hitting in the fourth quarter. You've got that kind of landscaping that can sometimes make the numbers look a little funny. I think if you just look at the second half, I believe we took the second half above everybody's numbers pretty meaningfully. How it exactly landscapes is going to sometimes be affected by different changes, like accounting policies and so on and so forth. As it relates to international, I could tell you, I don't know if I've ever been more excited about anything, any idea or any opportunity. We just actually just got back Sunday night from another trip overseas to look at opportunities and locations.
I think a couple of things becomes clear as you get closer to the opportunity and you kind of look at it at a micro and a macro level. There really is a complete void in the market for a concept like ours and for a higher end kind of dominantly positioned and assorted home business. In the U.S., retail is a lot more uniquely developed than, especially in all of Europe. We just see the opportunity as so significant. The fragmentation in our marketplace in Europe is exponentially greater than the fragmentation in North America. It hit us, gosh, several months ago, we went to the Maison, not the Maison show.
Salon
The Salone del Mobile in Milan. Shows that would generally be commercial attendees and B2B attendees are attended really by the open public and almost act like a pop-up store. I kind of stood back and looked at it and I said, "Wow, this is interesting. There's 500,000 people here shopping a commercial show." To give you a comparison, it would be like RH didn't have any stores open daily in America, and we popped up with a big store in New York City once a year, and 500,000 people came. There's no way you're going to get the whole market. It was really not just a business to business kind of environment. It was a consumer kind of interfacing with the business, not in a typical kind of retail environment. It just opened our eyes.
Again, we just got back from another trip, and we were through Europe and dealing with actual potential locations, and we've got multiple. We almost have too many really good options. The hard part is going to be about which ones to say no to and which ones to say yes to. The other thing I'd say is, I got two more things, is that we have to, in North America, I think what people don't realize is we have to drag kind of our, I hate to say ugly past forward with us, but in many ways it was ugly. If anybody picked up an 86-page catalog with a box of Oxydol Laundry Detergent that I carry around in my bag to kind of show people where we came from. We don't have to drag the past forward.
We have so many people in America who say, "Where do you work? What do you do?" Say, "Oh, Restoration Hardware." They go, "Oh, I bought this interesting knick-knack there," and they haven't shopped from us for 10 years or 20 years and whatnot. We don't have to create a forced reconsideration of our brand. We get to make a completely new impression. If you thought about going into a market, I mean, still today, most people, just where we live in the San Francisco Bay Area, there is no new expression of our brand. In most major markets, there is not a new impression of Restoration Hardware. We have an old legacy store from 25 years ago, right? That's the impression of the brand.
If I meet people here in the Bay Area, someone will say, "Oh, what do you do?" "Oh, I work for RH." "Oh, you do? Oh, gosh, I've been to your flagship store in Corte Madera," or, "I've seen your flagship store in San Francisco." Our store in San Francisco is 4,500 sq ft. Our store in Corte Madera is like 6,500 sq ft. I have to go, "Well, no, that's not really our flagship store." Sometimes people ask me, "Oh, so do you work at the flagship store?" I go, "No, I don't work there." I go, "I go there now and then." Really, still in America, maybe two things. One, it helped me see, in America, there's so many markets where people just don't really understand what we're doing because they can't see our assortment. This is a visual business.
It's not an intellectual business. Retail is first and foremost a visual business. If people don't like what they see, they don't even begin to start to intellectualize and think about whether they should buy it or whether they like it or not. People don't walk up to things that are visually not appealing to them and take another step. Today, we're visually trapped in so many markets in America, 25 years ago. That's what people see, unless they happen to get one of our source books or they happen to somehow go online. Even if you go online, it's only a one-dimensional experience. You have to click the website too many times to kind of see it and get it and understand the depth and breadth of assortment or the level of services and experiences that we can offer. That's a big piece.
I'd say in Europe, in the rest of the world, we get to make an incredible first impression. When you see what we're going to do, when we finally choose which of these locations we want and what we're going to do, I think it jaw-dropping. We seriously were sitting around thinking as a team. We opened New York and I'm sitting next to Eri, she's looking at me smiling right now because we were sitting there, Eri, IDP, and Dave, and Jack, and all of us were there and we're like "Oh, man, how do we top this?" A year ago when we opened New York City, wow, we did a good job here. Now what do we do? Now what?
It's like with the movie I used to watch with my kids, "Finding Nemo." If you've ever seen "Finding Nemo" with your kids, anybody who has kids, I watched it 100 times. The fish try to get out of the fish tank. They figure out how to get into a plastic bag and get out on the dock. They jump into the ocean. They're still in the plastic bag. They look at each other and they go, "Now what?" We had one of those now what moments. We just got back from Europe and saw some things that are going to make New York look like yesterday's news, seriously. I mean, incredible. This opportunity to make a first impression and to disrupt the market. We're trying to disrupt the market today in America. We've been disrupting the market.
In some ways, disrupting the market, creating a new market. We've been trying to create a new market with old physical presences. That's kind of crazy if you think about it. We had these old physical presences. We've been able to create a new market. We're here in Corte Madera. When I joined the company 18 years ago, the Corte Madera store did $2.5 million, now it does $20 million. When I joined the company, New York did $3.9 million. Now, it's tracking to do, what, $114 million, $112 million, something like that. That's kind of a really hard thing to do, to show up looking one way then try to get people to reconsider you when they've already judged you. In the rest of the world, we're not dragging that past forward with us. We don't have to have them reconsider us.
We get to make an entirely new first impression. The other headline thing that I think people can miss, if you look at history of retailers going internationally, for a long time, a lot of retailers didn't have a lot of success internationally. Even today, most people get massively de-leveraged when they go out and they roll internationally and look at the cost and the returns and sometimes get turned down. It's generally because it's not that the rest of the world is underdeveloped in retail. They're just underdeveloped in retail in certain categories. If you're someone like Home Depot and you go international, someone's done a Home Depot-like concept. If you're a discounter, they've got discount stores internationally. They've got all kinds of businesses. They don't have a business like ours internationally. There's nothing like us internationally.
The other point that ties into that is the potential for a business when you're selling commodities versus selling proprietary product is massively different. There's not too many American retailers where 75% of their business is outside the United States when they're fully penetrated in the United States. LVMH, Kering, Hermès, all the luxury brands, where we're evolving and positioning our brand to be like, 75% of their business is outside the United States. If you think about the right roadmap to look at and how to correctly dimensionalize the opportunity, you really have to look at not the mass market. You'll totally miss it. It's like looking at home sales and looking at total home sales that are affected by all kinds of units of homes that are $2-$400 or $500 or $600,000. That's not our customer.
It's like someone was trying to sell me digital advertising not too long ago and saying, like, "Why aren't you buying the word sofa? Why aren't you buying the word couch or bath hardware?" I said, "Because 96% of the world can't afford my sofa, my couch, or my bath hardware." It'd be like putting my store in the middle of a city that was massively populated with people that can't afford my goods. You wouldn't do that. When you look at the pattern of the luxury businesses, there's a lot of wealthy people, and wealthy people spend multiple times expansion more on the home. We think long-term, now that we've spent time thinking deeply about this, right?
Getting into it at a detail level, being boots on the ground, walking streets, walking stores, looking at it really from a customer's point of view, in the cities, in the countries, and talking to customers and talking to people that shop. I think the opportunity internationally probably could be 3x to 4x what we do in North America. That's how we think about it. Sorry, this is a really long answer, but you happen to catch me just coming back from a trip. We landed Sunday night and we've been doing recaps on this, and we just think the opportunity is huge.
The other thing is from a growth opportunity, today, if we go to transform a store from a legacy gallery to a new design gallery, we've got an opportunity to double the business at the retail level in a market, then get a lift in the direct side of the business. If you take a $15 million gallery, it can go to $30 million, then you take the other $15 million in the market and lift it 10%-20%, you can get another $2 million-$3 million, right? That's how you think about it. You take a market that was doing $15 at retail, $15 at direct, and the retail doubles to $30, and the direct lifts by 10%-20%, so lifts by $1.5 million-$3 million.
Say you get the upside on both ends, you're picking up 15 and three, you're picking up $18 million. The real piece of that, you really go at retail, you go from 15 to 30, right? Direct goes from 15 to 18. You really have a $50 million pickup, right? Not an $18 million pickup. If you just think about going into the U.K., for example, if you just look at the data and you look at the numbers, there's 68 million people in the U.K. with a demographic profile and wealth profile that kind of looks like California. Not too different, here or there, right? London looks a lot like New York, or Southern California with a secondary piece and kind of a little bit more fragmented. It's not really the next San Francisco.
68 million people with pretty similar demographic profile. California has 40 million people. We do $450 million in California, and we only have one new store that's not even the full big store, right? When we transform the real estate in California, it's going to be like a, I don't know, $700 million-$800 million market when it's at full maturity, when each of the galleries is open three years and we expand the assortments. You say California's like $700 million with 40 million people. 68 million people is, what is that, 60%, something like that, more than that. You take potential of market $700 million, $600 million, $700 million times 60%, it's like a $1.1 billion opportunity. We don't have opportunities like that in North America.
We're going to go into the U.K. and have a $1.1 billion opportunity with that demographic. Go in fresh, not drag the OxiClean or Oxydol Laundry Detergent into the market with us. Open galleries that could be our best and finest work ever. You can go into a market and do $250 million overnight. We don't have that kind of growth potential in North America. We have a lot. We doubled the company and get to $5 billion in North America, we think, today. Now we're looking at the landscape and saying there's another $15 billion to go get. You're not getting a lift on the piece you've already got. You're going after an entirely new market. It's a huge opportunity. A huge opportunity.
We get to go in with all our best thinking, not dragging old thinking from legacy stores, not dragging old supply chain infrastructures, not dragging any old technology, not dragging any bad habits. We get to go in with all our best work, so we're super excited about it. Sorry for the long answer.
Thank you, Gary.
You're like, "Oh, God, okay." There's no time for other questions. Sorry.
Thank you, Gary.
Your next question comes from Michael Lasser with UBS. Your line is open.
Good evening. Thanks a lot for taking my question. There's two questions on what's implied in the fourth quarter. We assume that half of the growth in the second quarter came from the increases in the outlets and increases in the RH N.Y. store. Is the difference between the 10% sales growth, recognizing that there are some nuances with what you are lapping from the year ago period, but is the difference between the 10% sales growth that you experienced in the second quarter and the 5%-6% that you're implying for the fourth quarter, basically that you won't get as significant a contribution from those two sources, the growth in N.Y. and the growth in outlet in the fourth quarter?
You are very good with math. Yeah. Really, you've got the outlet. We've been burning through the inventory. We closed a 500,000 square foot distribution center that was sitting on reverse logistics. We've talked about, I think, for the last 18 months, 24 months, how we are kind of redesigning the whole reverse logistics outlet business. Part of that was don't hold outlet inventory and close facility. The last thing you want to do is store second quality goods. A lot of retailers do, a lot of retailers are sitting out there with liabilities not moving through inventory or markdowns. We wanted to make it almost impossible in our company to sit on bad quality goods, because they're like tomatoes at the grocery store. They just don't get better with time.
Yeah.
They just really don't. They don't turn into antiques in our lifetime. We closed that facility. We burned down those goods. Those were close to about a point. Little more than a point. Those goods we're burning down. We have today, versus 18 months ago, 75% less outlet inventory, something like that. That channel is now really clean. We swallowed that margin. A lot of people are like, "Wow, is there more margin to expand here?" The outlets were massive dragging in the first half of the year. We've got lots of margin opportunity and expansion from that point of view. For those people that care about earnings growth, might only be me and a few others.
The earnings growth opportunity based on lapping the burn down of the outlet inventory, and we got rid of that distribution center that was holding a bunch of stuff that we didn't need.
Yeah.
That's a piece of it. New York, right, opened really big and we cycling New York. The timing of the new stores this year versus the timing of the new stores last year, kind of gives us a little temporal trough, if you will. Until the stores we're opening this year come on, what we've got is we had a different dynamic. We not only have the stores coming on a little later, that we're going to open in the second half this year, but we have stores that we thought we were going to open in 2019 that are going to now open in the first and second quarter of 2020, and they're going to open on top of no openings. Right? In the first half of this year, we had no openings. Right? Correct.
How many openings do we think we have in the first half next year? What do we have?
Three.
Three openings. Right. You've got these kind of three that are opening later, then you've got three that are opening on top. You're going to get, just like you see a little trough, you're going to see a spike in the first half next year, and you'll see our revenues kind of kick back up and grow. Then we start to kind of kick back up, and then really when we start to kick up is when you get in Q3 and Q4 of next year. We have some periods where we have up to seven, eight new stores on top of two comparatively year-over-year. Right. If you look at it right now as we go into Q3, and early Q4, we have a little bit of trough and timing, and then it kicks right back up.
Maybe that helps the hedge fund.
That helped a lot.
Yeah.
Two more quick questions on that. One, on that line of thinking, is because you won't get such a contribution or as meaningful a contribution to the growth from the outlets, that's why gross margins are expected to sharply inflect in the fourth quarter? The other question is just now that you've had time with RH Atlanta, RH Denver, RH Tampa, and those types of galleries have been in the market for quite some time, can you give us the sense for the shape of the growth profile many years later and how the returns for that class of initial openings are trending? Thank you.
Yeah, the returns are fantastic. Generally, our bigger stores are growing faster than our smaller stores. Some of them, right, market to market, you have different dynamics based on how housing markets, kind of more localized, regionalized economies are doing. There's also a whole another layer of opportunity with all of those kind of first and second generation galleries, is they don't have hospitality. We're looking at adding a restaurant to the rooftop in Denver. Billy Taubman and Bobby Taubman might be on the phone. Yes, guys, I'm going to ask you for tenant allowance to build the restaurant. You want these restaurants. Denver and Tampa both can have rooftop restaurants. One, we're massively happy. All those galleries that you've mentioned and all of our design galleries throw off massive cash, right?
The cash return profiles and the earnings return profiles on all of our big galleries, we're extremely happy with. Right? We don't have one that we thought, "Oh, look, that one's a mistake." We now think we can add hospitality, which not only adds that revenue, hospitality lifts the overall revenue of a gallery. We've got an opportunity to go back to a lot of the first generation galleries, and I think almost all of them, except for the smaller ones. Houston can't fit it, or maybe Greenwich, Connecticut, a few others. All the ones you mentioned, we actually already have conceptual designs for the restaurants in Atlanta, Tampa, and Denver. We've got a whole another layer of growth that we can go back and get in those markets. Look, those are the best positioned retail businesses.
Go into Denver, go into Tampa, go into Atlanta, and see if anybody's opened that looks like a competitor to RH. It's going to be a long time before you see anybody place that kind of bet. I think those galleries will continue to take market share over time as customers find them, as people cycle around into their buying cycle. They either bought a new home, remodeled the home, or it's refurnishing their home, which is a cycle of anywhere from five to 20 years. When it's their time to go shop and you become more top of mind in the market because of these physical presences. We're just going to continue to be relatively disruptive and take market share. I don't see anybody coming that's going to place the kind of bet.
They don't have the assortment, don't have the merchandising finesse we do, don't have the creative conceptualization to design or develop buildings and experiences like that. At least I haven't seen it. The Wayfair store sure doesn't look like that opened in Massachusetts.
Michael, as it relates to your gross margin question, certainly outlet has an impact. You may recall, we plan to exit the holiday business. That business overall has a lower margin in Q4. We will get the benefit of not having those low margin sales. That's another pickup for Q4.
Yeah. I think the other thing, the tone of the questions is all based on our guidance. I would just remind everyone to think about what was our original guidance in Q1 and what happened. What was our original guidance in Q2 and what happened? There might be a pattern.
Thank you very much. That's helpful.
Your next question comes from Oliver Chen with Cowen. Your line is open.
Hi, thank you. Inventory management, you've made nice progress in. What are your thoughts on a multi-year basis as you look to some of the newer concepts, and you manage breadth versus depth versus surprise and delight in terms of inventory management and working capital on a multi-year basis? As you think about, it looks like you've also made really nice progress with your home delivery and fulfillment. Would love your thoughts on what inning you are there and what's next in terms of just increasing the customer satisfaction and the vertical integration there. Thank you.
Yeah. That first one was a very good, what we'd call a multidimensional, fully integrated question. A lot of depth and breadth, but a lot of focus. A good one. This one could take a while. It's exactly what we think about. As you build any business, any brand, how do you dimensionalize it without diluting it? How do you elevate it versus just expand it? Because generally, when you expand something, a lot of times it kind of gets worse, versus just thinking about elevating. When people usually are trying to be additive, they're generally dilutive. When people try to do more, they mostly do less. That's very true with businesses. You have to be super disciplined and go through really just the absolute right filters.
One of the overarching filters we use here is that we say everything that we do has to render everything else that we do more rather than less valuable. Most of the time, when people do new things, it actually creates distractions. It renders other things less valuable. It's really hard, honestly, to use those kind of filters and just like you asked a beautiful question. It was multidimensional, yet fully integrated. It's like when brands start branching out and adding other brands a lot of times. Unless you've built such a clear and concise platform and methodology like Bernard Arnault has built with LVMH. To me, that's one of the hardest ones. He's made it look simple because he's got so many brands, different countries, different cultures, different people woven together in such an integrated way with such great harmony around luxury.
In businesses from alcohol to watches to apparel to Belmond and hotels and trains and so on and so forth. Just beautifully thought about and beautifully integrated, yet still kind of isolated in brand dimension and so on and so forth. Most of the time, businesses, the downfalls become in trying to get bigger, and the pressure on growth usually leads people to isolation and fragmentation. What happens is that isolation and fragmentation, you start doing completely different businesses and completely different brands. The problem is you can't split the people up. We're all made of lots of atoms and cells, but you can split an atom technically and scientifically. You can't do that with a human. They won't respond very well if you try to break down their cells. You only have so much talent in an organization.
You only have so many truly gifted people. The key is how do you elevate and amplify those people and not distract and dilute their efforts and their talent. You have to be really, really disciplined about building your thoughts and ideas in a completely integrated way versus an isolated way. When people work in isolation, you get a lot of people working really hard on all the wrong things. Not because they think they're working on the wrong things, it's just that they're in isolation, and they don't have all the information and the flow, and you just have a lot of discord versus harmony. One of the breakthroughs I think we had, and one of the best ideas we made is when we were working for, I don't know, five years on a completely separate brand.
I was kind of following an old path from what I did before, and I worked on West Elm for three years, and it launched right when I left Williams-Sonoma . Great business, great brand, and I think Williams-Sonoma 's got a really great model and built a great platform with a lot of leverage. The problem is every business is really pretty different. I think, no differently than the Gap that now wants to break apart. No differently than Limited Brands which was built kind of like the Gap with kind of multi-brand, multi-dimension and kind of ramped up, but then they got all kind of diluted, and I think because there's isolation and not integration, and you have discord and you don't have harmony. You can't have true focus in situations like business like that. Same thing here.
We had a whole team for five years. I don't know. We must've spent $25 or $30 million building a brand that honestly, I wish I could go sell it. If anybody wants to come here, it's not still set up in a room. We had it all set up. We had samples. We had everything. We thought we could kind of go underneath at RH and build a whole kind of another brand, another business, hit another market. We talked about time allocation. We talked about human capital and how we're going to allocate our time. When you really go through human capital allocation, what you realize, and what we always say, I would say, look, we can always raise more money. I don't know how to raise more time.
We can make a mistake financially, we can kind of clean up that mess, raise some more money. There's always ways to get capital. We always say human capital is exponentially more valuable than financial capital, because you can't get the time back. Anybody says they can save you time is like, I don't know how you save time. You either spend time or waste time. How you allocate your human capital in a company is so important. As we were going through a process and a debate on what was next, where we're going to focus our time, Eri's sitting next to me, she said to me, "Gary, you know." If I could do her voice the way she would, she'll kick me here if I say it, but like how hard it has been to get RH to where it is.
How do we build the next brand? It's an isolated thing. We can't build it in integration. What we can do in integration is we can kind of multi-dimensionalize RH and weave it together in a very integrated way and create a lot of harmony and where everything that we do in RH will render the rest of RH more valuable. Everything that we would try to do outside of RH, if we're allocating human capital towards that, is actually going to render RH less valuable because you only have so many great resources anywhere in an organization. So much talent, so much expertise, and people that have the scar tissue from getting knocked down 10 times and getting up 11. The ability to truly allocate human capital correctly, we think, is the winning formula, and we think doing that in a focused way.
We're debating here whether we do a whole investor day this fall sometime in October. Maybe news that comes on that, and if there's not, it's only because we're kind of too busy working, not because anything's wrong. We've got, I think, a really compelling, like your question, very clear, very multidimensional, yet beautifully integrated vision of where this business can go. We believe it can be one of the great ecosystems of all time. If you think about the great ecosystems, I think Apple built one of the great ecosystems of all time. Once consumers bought into that brand and that ecosystem, they had you on so many levels. They beautifully integrated. People almost forget that we used to carry around a camera. We used to carry around a video thing.
Not too long ago, I used to video my little twin girls with a little video camera. We used to carry around a phone. We used to carry around something, what they call a Walkman, music thing. You had all these kind of separate things. Apple really beautifully integrated all these disparate things into kind of an ecosystem of businesses and products that really changed the way people shopped and created an entirely new market. Everything they did rendered everything else that they did more valuable. Disney has created one of the great ecosystems of history. I mean, everything that they do renders everything else that they do.
The characters they develop, and the stories they tell, and the movies they make, and how that integrates and happens in the theme parks and how it gets communicated and how it gets licensed into the toy business and divisions, and it's all beautifully integrated. That's why I think they've stood the test of time and have performed so well. We happen to kind of exist in a kind of category of home goods that relates to the biggest part of the economy, which is the housing market, right? So if you stand back and think about kind of the bigger picture and what you might be able to build with the RH brand, with the head start that we have, and what an ecosystem that extends all the way through the actual largest part of the economy, right?
Think about getting small percentages of the biggest market in the world. At some point, I get too excited and I'll talk about the whole thing and then anyway. I think we can build one of the great ecosystems of history and one of the most focused, integrated businesses that anybody's ever seen. No different than our galleries and physical locations render our products more valuable. Our interior design business, embedding that into our galleries, renders our product and our galleries more valuable. Our hospitality business beautifully integrated into our galleries and into our experiences, renders our gallery, renders our products, renders our experience, even renders interior design more valuable because they can sit down and have a lunch catered into a room and create a beautiful meeting setting and feed a customer so they don't get hungry.
It's just thinking about weaving businesses together in a really thoughtful way where they all amplify each other and they all render each other more valuable. We think pretty deeply about those things, and I think what we're most excited about is I think we believe we can build one of the most admired brands in the world. From a financial point of view, we believe when we unveil this thinking, it will be pointed and we'll have the opportunity to create an entirely new market like a Disney, like an Apple, right? Be one of those brands that really stands the test of time for generations.
Gary, that's really helpful. Just a follow-up and our final question was, as you do think about global in your earlier comments, what are your thoughts about the flywheel and network effect, as well as sequencing the growth and thinking about supply chain? Awareness build can also be very difficult for U.S. brands historically. How might you approach a lot of the DNA of your merchandise is Belgian linen and that aesthetic. I'm just curious about how that will translate globally as you think about the product matrix.
Yeah. I think you kind of have to look at it country by country. I think the world is getting smaller, not bigger. Right? That's what the internet's doing. That's what social media and networks and connections are doing. My girl's now turned 17, but they've had friends in multiple countries through technology for years now that they've never met. I look at their ability to curate and see things and react to trends and know about brands, it's completely different. I don't think the ideas of the future don't exist in the past. The clues do, right? There's dots in the past you can kind of reference in the future, but you really have to kind of think about where it's going and not necessarily where it's been.
As we look forward and think about where the world is going and how brands can evolve in the world of tomorrow, we think that brands are gonna be more valuable, not less valuable. The world is so cluttered with choices, with information, with really bad visuals, right. I joked around because a consulting company called us feeble, right. My mom used to always tell me, "If you don't stand up for yourself, honey, no one else will." A lot of people take potshots at us because we say it's not about the internet, it's about the fact that the decay of retail is because people haven't really done anything to evolve retail environments, retail stores. It's not that we don't believe in the internet. We've got over a $1 billion business that's done online.
Really, what we're doing physically in the world, I really believe people are gonna look back in 20 years and 30 years and think that this is gonna be one of the relevant stories of how to build a brand. There's a lot of kind of followship in kind of humanity, right? Someone heads in a direction and they have some success or then everybody starts building a thesis around it, and then you have consulting companies talking about that success, and then you've got everybody kind of following the same direction, whether it's re-engineering or it used to be multi-channel retailing, then it was omni-channel retailing, then it was this and that, and then now it's customer centricity and put the customer in the middle or build everything around the customer. Well, that's interesting.
The customer doesn't know what they want unless you're selling dog food or stuff like that. If you're trying to lead customers and create brands, you better not be using focus groups because that's a good way to go backwards. Usually, all the dying brands are the ones who use the focus groups. We say, "Great brands don't chase customers chase great brands." Right? I think we're building a great brand. When we look forward and we think about international and we think about what we're doing, and we think about what we're doing with the product assortment and how we're going to beautifully integrate that, and how our brand is going to be more focused, more powerful, more clear, even though it's got more dimension to it. It'll be richer, but it won't have discord. It will have exponentially more harmony, right?
Like you think about RH New York. We basically tripled the size of our New York gallery. Think about what retailers in the world could take their store size and triple it, actually have it be more focused, more clear, more beautiful, more harmony, less discord. That's really hard to do. Throw a restaurant into it. Throw a barista bar and a wine terrace into it. Embed an interior design business into it, right? You're adding complexity, yet at the same time, you're creating clarity. That's super hard. When I look forward and I think about over the next couple of years as we're going to take the first few baby steps into Europe first and wherever second and we'll figure out how to sequence this. We've got a lot of ideas we're still debating.
I think we're going to enter these markets with such intention, such clarity, such purpose, with such a clear and compelling brand, that I think we're going to break through the clutter and create a new market. We're going to get people to shop for the home, to redesign their homes that aren't even thinking about it. That's how we built the business. There's people that walk into our galleries every single day that were maybe thinking about their home, or maybe they decided to walk in, but they see such a beautiful, inspirational space, and they see product displayed maybe the way they never would think about it in a home, and they become inspired, and then they might decide, "Hey, look, let's forget about the Caribbean or Hawaiian vacation this year.
Let's save that money and redo our living room or completely redesign our backyard. That's where you start to create a new market. I think awareness is really difficult for U.S. brands to build when you're selling commodities, right? If you're going in and you're now the fifth pet store in Europe or you're going to come in and sell TVs or you're going to come in and sell tools or lumber or you're a discounter. Got it. They got good people at all those businesses internationally. They don't have anybody like us out there. There's more people that are closer to our business here in the U.S. We think we're massively differentiated here. There's other people that sell furniture or home furnishings in a lifestyle kind of approach that aren't half bad. Over there, it's super mom and pop.
I just think that it's going to be very different for us versus you can't compare the way we're going to do it versus other businesses. Again, it's like the housing market. It'd be like counting the units of homes at $500,000 below or counting the homes that are $5 million and above. There's a lot less units, but there's a lot more dollars, right. The answer is in kind of the subtleties. I think we're going to enter these markets with more differentiation and uniqueness as a new brand entering a new country from a retail consumer point of view than the history of the world. I think there's going to be that much differentiation of how RH introduces our goods and our category, the kind of differentiation that no one's ever seen.
How different is RH N.Y. than every other home business in N.Y. City? How different is it? It's not close. Well, now take the next closest people, the next closest 10 people, and take them out of New York. How different is it? Exponentially different. Those next closest 10 people don't exist internationally. If that makes sense. It makes sense to us.
Yeah. It's very helpful. Sounds like.
Yeah
complexity and also balance. Thank you. Best regards.
Yeah.
Your next question comes from Zach Fadem with Wells Fargo. Your line is open.
Hey, good afternoon. Gary, it looks like you're now on track for about 240 basis points of operating margin improvement this year. Curious if we could bridge the gap here as you approach that mid-teens or higher target over time. How much is sales leverage? What, going forward, would you attribute to operating initiatives, things like home delivery and reverse logistics? As you reconcile those, maybe you could talk through the levers that you view as more near term, 1-2 year opportunities compared to those opportunities maybe further out.
I don't know if we can prepare a great ad hoc model granularly. I think you can pick up the last press release we did and look at the last letter I wrote. I think I listed five key points that where we're somewhere between 400 and 600 basis points more operating margin. I think if we look at it today, we clicked this thing up from low to mid-teens to mid to high teens operating margins. We've got a really clear line of sight to there. I think, it's 20% to 20-plus operating margins look very doable to us as we look out over the long term. Think about, start with, we're from a design gallery rollout, we're one-third penetrated. Take two-thirds of the market, put these new disruptive design galleries in the rest of the market, lift the sales to $5 billion.
Think about the next generation of design galleries are going to take a fraction of the capital. They're going to have a fraction of the depreciation. They're going to have better rent structures. The whole occupancy piece of the business has a lot of opportunity for leverage. We don't need to build new inventory teams or merchandising teams or overhead teams to support bigger stores, right? We need to make investments at the gallery level. We need to make investments in hospitality at the local level and so on and so forth to run those businesses. Think about adding, if you could just like today, right? We don't really need, I don't think, one more person at the headquarters level. If we just had all big galleries out in the market today, we wouldn't have to add a person corporately.
Take our company from $2.7 billion and take it to $5 billion and think about what advertising looks like, what SG&A looks like, what occupancy looks like if those new galleries have a completely different structure from rent, from depreciation perspective, from return on invested capital perspective. We didn't put out that we can be in excess of 50% ROIC as like, that's a dream. We have a five-year plan that shows it. It's a pretty conservative five-year plan, right? This is going to be like a cash machine, what we're building and the structure and the model that we built. Then as you look at the supply chain, we've made some big moves, right? We've simplified this thing and been able to focus and comparatively, if we had inventory turns today that we had just three or four years ago, right?
Three years ago, we would have $500 million more inventory in our system today. We basically have taken out $500 million of inventory in three years, three and a half years, something like that. That was us just looking under the hood, right? I don't want to make it sound that simple, but we've attracted new talent into the company. You'll hear more about some of the things that we're doing as we're coming, but we think there's lots of opportunity, lots of ways to amplify things with technology and systems. I always say, we say inside our company that systems don't simplify, systems amplify, right? People simplify. You can take a system and put it on a bad platform. You're just going to make that bad platform go faster. You're going to make the outcome you're going to amplify bad, right?
Systems can make a flywheel go faster. They're not the flywheel in a lot of cases. You have to first design the business process and the methodology and architect it, right? Then you can amplify it. We're architecting things, then we're going to be in the process of amplifying what we've architected. We think there's exponential opportunities to all of that through simplification and clarity and removing complexity, right? Creating harmony. In home delivery, we've just gotten started, like just gotten started. We've got an incredible new leader and Can I talk about ETF or when? You can. I can? Are your deals done? Everything's good? Okay. I could talk about it. I'm going to take the whole conference call with like four questions today. Fernando Garcia joined us as the President of Furniture Operations and Home Delivery.
Fernando is a young man compared to me. That came to America with a dream, with $5 in his pocket and what was your first job was in a Kmart, right? Cleaning. Got an opportunity to deliver furniture. Through that opportunity to deliver furniture, figured out how to save enough money, bought a truck, and off the back of one truck, built a company that spanned 26 states and controlled 550 trucks and drivers, and built one of the best logistics companies in America. We got a chance to meet Fernando, who's one of our providers. We both found that we were very much aligned in our vision and our values and what we wanted to do and the dent we wanted to make in the universe.
Fernando said, "Look, I think I can help you guys and be a part of it." Fernando's just completed selling his company and joining our company full time. He has been working with us part-time, which his part-time looks like everybody else's full-time. I can't imagine what his full-time looks like. The opportunities he sees because he's actually built it from the ground up, and he knows the model. He knows how to take the complexity of a business like that and simplify it, and his intellect, drive, and desire, and what he can do to help us take the learnings and what you see when you're really at the point of contact with a customer in the home and see those issues, and actually architect and engineer that all the way back to our factories, right?
Whether it's the design of the products, whether it's the packaging of the products, whether the way it's being handled in a distribution center, or whether should it even go through a distribution center. How the truck is designed, how the cab is designed, how you handle things in reverse logistics, how you look at the entire transportation network, what are all those opportunities? He came when we first met, he told me, "I've been trying to meet with you for three years, but I couldn't get a meeting with you because I think I know what you need." I said, "Well, really?" I didn't even know. We were doing a meeting here, and I was asking some questions on metrics, and nobody in the room knew the numbers.
I had the numbers on the tip of their tongue. I said, "Well, somebody in the company's got to know those numbers. Can we get those numbers right now? Can we call somebody?" They said, "Well, Fernando will know the numbers." I said, "Oh." I didn't think Fernando worked for us. They called Fernando. Fernando gets on a conference call, and this guy's like bang, bang on every metric, every detail, every input and output. I'm like, I write on a piece of paper. We're in a room. There's probably 20 of us in a room. I go, "We should promote him." Then they said, they write a note back, "He works for FGO.
He's one of our providers." I go, "Oh, okay." I write on another piece of paper, I said, "We should hire him." I hold that up in the room, they go, "He owns the company." It's like they're whispering, "He owns the company." I'm like, "Oh, shit." I'm thinking, "Well, maybe we should buy his company." We did not do that. Fernando had opportunities to sell his company and did quite well. It's the American dream. He'll write a book soon, where you'll be reading about this guy. When I sat down, he actually flew out the next week and offered to come out and just help us think through the problems we were trying to solve.
We got to spend a few days together, and I had a one-on-one with him, and I said, "Well, what really motivates you?" He said, "Oh, well, just being here and talking to you guys and this and that," he goes, "I've been trying to get a meeting with you for three years and haven't been able to get in the door." He goes, "I've got some ideas. I think I know what you need. I've got a little presentation here if you'd like to see it." I go, "Okay." He pulls out a whole beautifully laid out PowerPoint on a complete strategy that we ought to pursue that sounded to us exactly like what we ought to be pursuing.
He said, "Look, I think I've got an opportunity to sell my company and join your company, and I think we can make a huge difference together." Here he is, and I can tell you, in his first, I don't know, 30 days, what did we say, $15 million-$20 million or $15 million-$30 million?
15 to 20.
Yeah, $15 million-$20 million, which means it's always more than we tell you, right? His first couple of months, he was finding just huge opportunities to simplify and massive savings. He didn't come here and think he was going to find it all in the first two to three months, I guarantee you that. We think there's huge opportunities, and we're just getting warmed up here on so many levels. Again, take whatever we're doing here and whatever you think we might do here over the next five or seven years, then kind of 4x it, and that's what the global opportunity looks like. The global opportunity of this dimension of RH, when we unveil the entire ecosystem, you can 10x that. We're just more excited than we've ever been about the future.
I know everybody wants to kind of get into the weeds and the next quarter and the guidance and so on and so forth. We all know business, that there's some form of pattern recognition that's important and relevant and short-term information that's key. There's pattern recognition here that you should look at, and there's massive opportunities ahead of us in the future. There's exponential value creation that's going to come. We point out, I tell people, 10 years ago, LVMH stock was at $39 a share, right? 10 years later, it hit $390. I think people are going to look at 10 years ago, RH was whatever it's trading at today, $150 a share, $160 a share. 10 years from now, the stock could be $1,600 a share. We have lines to sites to stuff like that.
We're not going to get too caught up on the next quarter or this guide or did we go out there and guide really aggressive? I don't know. Did we guide aggressive in Q2? What happened in Q2? Did we guide aggressive in Q1? What happened in Q1? Think all of a sudden we're going to guide too aggressive in Q3 and Q4? No.
Thanks for that, Gary. Welcome. Welcome aboard, Fernando. Appreciate the time, guys.
Yeah. You can say hi to everybody, Fernando.
Hi, guys. Thank you.
Just in case you thought I was making you up. Let them know you're here.
Your next question comes from Brad Thomas with KeyBanc Capital. Your line is open.
Hi. Thanks for taking the question. Just to dovetail off of some of that opportunity on the delivery and reverse logistics side, could you talk a little bit more about the outlet strategy and how many you think you'll have at the end of the year, and what that may look like over two or three years, and how that'll fit into the business model?
Yeah. I think we now have the inventories at a level where they're kind of clean and moving. In our mind, the outlet ought to be like a really super simple flywheel, right? The stuff that gets returned or nicked or damaged ought to just spin. I don't know. Was it three, four years ago? We have, actually, the flip chart that we were mapping this thing out about three, four years ago is in exactly the same place. I'm looking over it, and we actually made a joke last night as we were kind of going through some details and planning, and we said, "Hey, look, there's the flip chart. Remember the famous meeting where we realized that the slowly turning inventory in the company was the outlet?" Which is hard to believe.
That should be the fastest turning part of the company because that inventory really rots quickly, and it's out of a box, and if it gets handled multiple times. We've simplified it, and we've got it to an okay place. Exactly the dynamics of the future of the outlet. The outlet will be responsive to the changes and improvements we make to the entire business versus the business being responsive to the outlet. Meaning that whole strategy should be triggered off a create rate, right? That's driven by returns or damages or what's happening. All of that is triggered off your quality, your packaging, your delivery experience, your customer experience, and so on. There's all these things that all kind of weave together that are all absolutely, actually completely integrated from product ideation to presentation, from concept all the way to customer.
You've got to kind of see that whole piece and understand all the pieces and integrate them beautifully together and not play Whac-A-Mole. What happens when organizations work in isolated ways, somebody makes an improvement over here, and look how much money I saved over here, and then they created one and a half times the cost somewhere else, and the whole company goes backwards. It takes a certain kind of people and a certain kind of culture to really work in a deeply collaborative way to build a really integrated methodology, where everything that you do renders everything else that you do more valuable. Just as we think about the brand, we think about the operating platform and every piece of our business. Capital structure, everything. We take the same kind of approach and view and deep thinking about it.
Again, we think that there's lots of opportunity. Exactly how many outlet stores and exactly where they should be, we have a lot more to learn before we can really know. We say inside our company that you have to listen, learn, and then lead, in that order, right? All of us have to continue to do a lot more listening, get close to the details, get close to the problems, get close to the opportunities, and learn and understand, and then be able to lead the organization forward. We say inside our company that the smartest people in the company are those people closest to the customer, and those of us that get farther and farther away from the customer usually get dumber and dumber. Which makes me the dumbest guy in the company, by the way.
The only way I can do my job is to spend time listening and learn. If I do those two things well, I can actually lead. We have a leadership culture here, not a management culture. You don't need to really listen and lead to try to manage people because you're just kind of arranging and organizing the status quo. If you want to lead people to a better outcome, you've really got to understand what the reality is today and get the kind of key insights. The organizations will tell you what we do smart and what we do dumb. Leaders have to listen so they can learn and then therefore lead. We've got a lot of listening to do and a lot of learning to do so we can lead.
By the way, you find out when you really build a culture like that, you never stop. You're never done. You're just never done. The opportunities get bigger and bigger and bigger, and the dots connect faster and faster and faster. Just when you thought you'd done something like RH New York and you say, "This took us 20 years of our life to get to this point. How the hell will we ever do anything better than this?" Within a year, you see something that could be exponentially better and more exciting and more valuable from an emotional value point of view, from a strategic value point of view, and from a financial value point of view.
That's great. If I could follow up on the Source Book launchings that you have here in the back half of the year. Could you just talk a little bit about the new Modern book and how you're continuing to grow that important line for the business?
We think, early stages, it's been our big focus. We went to the Salon Show in Milan really for the first time, and spent a lot of time there, and were able to kind of see the market in a whole new way and think about modern in a whole new way. We just got back from the Maison&Objet show last week. We were in Paris for the Maison&Objet show , and we were in the flea markets. The big headline and takeaway for the team is how much bigger modern can be and how that is continuing to evolve. I joke around a lot of times when people ask me, "So, where do trends come from?" In our business, I usually tell them the dead, right? What happens is, generations pass away, their belongings go into estate sales.
The estate sales feed the flea markets and the antique markets. The flea markets and the antique markets become inspiration for the reproduction markets. The reproduction markets are inspirations for the next level, broader markets, higher-end markets, and then, it gets into the broader and mass markets. That's kind of the evolution of home trends, right? The reason you've seen all this mid-century modern and all these products kind of develop, you've had a couple of things. You've had amplifiers here. You've had all the people that were at home buying ages, that were anywhere from 30 to 60 years old in the '50s and '60s, are kind of either aged out or died, right? Their belongings went into the estate sales.
They then went into the antique markets and flea markets, and depending on how valuable they were, and then they get picked up by the interior design market, and then they feed the reproduction market, and so on and so forth, right? The antiques of today, a lot of the ones kind of feed the products of tomorrow. Maybe I just gave an education to all my competitors, but that's kind of how it goes. It takes you years to figure that out, though. You've got to go to a lot of flea markets and go to a lot of stores to figure out, like, "Oh, that's how it happens.
That's why I'm here. The amplifiers to that, and I think I talked a lot about this when we launched RH Modern, is that you've got then these other kind of things that have happened at the same time. You've had a move to modern architecture. Most of the major architectural work that's been done around the world has been contemporary and modern. From the Bilbao in Spain from, what, 20 years ago, right, to Hudson Yards, go to every continent on Earth and look at the greatest new architectural work. Look at the Apple campus. We got back, we spent a day at Foster + Partners in London, Norman Foster's famous firm, incredible. They did Apple campus, and they're doing some of the greatest work in the world. It's all contemporary and modern, right? You look at the influences of the devices we carry.
I say that Apple is kind of the champion of the move to taking technology and making it so beautifully designed. That they created a movement in their own. They put a dent in the universe from a modern design point of view, and then the stores that they created, and the spaces they've created. We think that we're in a long upward trend for modern. Now, that could make some people go, "Oh my God, classic's going to go away." No, that's not going to happen because really, architecture kind of drives aesthetics and home buying, too. When we launched RH Modern, we had this epiphany, right, Dave? We remember that. We're looking at Modern, and it's like we launched Modern, and Modern was off to a great start, and Dave and I were down looking at real estate, and we were in Santa Barbara.
We go to our gallery, it was end of the day, early evening, and the whole team, they must have heard that we were going to be in town because all the designers, everybody, we had so many people there. We realized first that like, "God," like, "Who's doing the scheduling here? We have a dozen people in the store, and there's only a couple customers," about 7:00 P.M. Dave and I walked in and realized that they knew we were in town, and everybody showed up. We wind up, the store is getting ready to close. We had a meeting with them for about two hours, three hours. Walked the gallery.
We just launched RH Modern. We said, "So, how's the launch of RH Modern doing?" They kind of looked at us, and then they looked at each other, and no one kind of said anything. Someone said, "So, have either of you been to Santa Barbara?" We're like, "Yeah. We've been here quite a few times, and we're looking for gallery space and do a big, new, beautiful gallery here." They said, "Yeah, there's not a lot of modern architecture in Santa Barbara. It's all kind of classic and Spanish colonial and so on and so forth." People are coming in saying, like, "Yeah, this looks really great, but I don't know how it would fit in my home." You have to respect the fact that architecture does drive design vernacular. Right.
You're not going to see really hard, straight-edged modern goods inside probably a beautiful Montecito home in Santa Barbara. Otherwise, you'll have discord and not harmony, right? As the world is changing, if you look at the architectural movements, you look at the verticalization of cities and the movement back into cities and these high-rises and these condos that are being developed, and they're generally almost all modern, right? That's going to drive a trend. If you look at the data, and you look at the data around how many homes are modern and how many classic homes there are. You can take a classic home and a classic condo, and you can remodel it and give it a more contemporary point of view and create a transitional environment. It doesn't change overnight.
We like where the trend's going, and we also know that, look, the classic and kind of an updated traditional look is going to be here forever, because you're not going to bulldoze all the architecture in the world. When you think about markets, I tell the team, think about a couple of things. In our business, think about who's dying and what they're leaving behind, because it's going to probably start a trend. Think about what's being built and what the design vernacular is, and is there a trend that's happening. Look around at everything that is existing and every piece of existing architecture is going to have an influence on the potential and possibilities in our business and in our marketplace. We like how we're positioned.
We like that we were kind of out there with modern in a big way, even though we got out of the gate, people go like, "Oh, man, that launch of modern's got to cost us $20 million." We had some hiccups when we launched. That's R&D cost. That's nothing. Modern's a massive success. The business is significantly bigger than our five-year plan than when we launched it and will continue to be. We like our positioning around modern, we like our positioning around contemporary, we like our positioning around classic. We think we can bring our own unique point of view to just about any design vernacular and aesthetic and create beautiful environments and elevate people's lives by creating harmony. There's just a lot of potential that we see ahead of us.
Very helpful. Thank you, Gary.
Your next question comes from Brian Nagel with Oppenheimer. Your line is open.
Hi. Good evening. Thank you for taking my question. I'll keep it short, just because we're running out of time here. Gary, you spent a lot of time early in the conversation talking about a potential move overseas. The question I have is, are there any parameters yet how we should think about the timing of that, initial markets? To follow up on, I guess, another question, you have shown nice progress lately in EBIT margins. Would a move overseas, to some extent, weigh upon expenses or even capital in the near term?
Yeah, we're kind of fleshing all that out. How to think about the timing, well, let me give you some reality. We just got back on Sunday. We went to the Maison market and the flea markets. We had a merchandising trip. It was an integrated real estate trip. The whole team was kind of a cross-functional team that saw multiple locations, multiple opportunities. Dave and I are back on a plane. When are we going, Sunday or Monday?
To be determined.
To be determined. We got home Sunday. We're going to probably leave Sunday. We've got a whole cross-functional team, designers, architects, things like that, and we're going back to see locations and advance the project. We think that timing-wise, our projects are not little projects, right? We're not building a storefront inside a mall, and then filling in an empty box with some fixtures. We have real development projects. Nonetheless, the projects we're looking at are pretty inspiring spaces that are pretty far along. They're not ground-up builds. They're spaces that we would take over and adapt and then inhabit. We think we can move quickly, but at the same time, you want to move really thoughtfully here. As far as the infrastructure and capital, I don't think there's a whole lot of complexity to it, right?
We really run a direct-to-customer showroom platform business, right? What's our cash and carry in a big design gallery now, less than 1%?
1%.
Yeah. If you think about our business model, less than 1% of the goods is walking out of the store in a bag, like less than one. Pretty soon it might be zero. We don't have the same complexity from a cash and carry point of view. We're really like a direct business with these inspiring showrooms, and that's why I think our model is also so efficient. We don't have to spread inventory all over the place. We really just have floor models on display. We can architect the inventory in the most efficient way behind the demand and fulfill it really well. We have less markdowns because we run the business that way. We're finally getting rid of the last of holiday. We were talking on this last trip, we were saying, "Oh, remember when we were in all those shitty seasonal businesses?
We used to sell Halloween crap, and we used to sell Easter crap, and we used to sell Valentine's crap." All these businesses that had a four-week or six-week lifespan, and God forbid the vendor shipped it two weeks late, and now 90% of it is getting marked down, and your whole margin structure is screwed up. Not only that, you're massively polluting all your core businesses. People would tell us, like, "Oh, you should sell all this stuff. You have all these empty dining tables that you can put all these things on, and you can sell extra things." Like, go put a bunch of Halloween crap on top of a beautiful dining table and render it less valuable. Immediately render that dining table less valuable. That's why we don't have all that crap piled up in our stores. Right?
Our business, and the point of what I'm saying is our business is much simpler than a lot of people's business in a lot of ways, and then it's more complex in other ways. Right? Through the simplification of it all, I think we're creating a really capital-efficient model. We're doing fewer things really well. We're executing all those things really well. We have less waste, less complexity, less clutter, less waste. Right? As we have been thinking through international and how we can do it, again, it's like stores. We don't have to drag the past into the future. We don't have to dis-architect a supply chain that was built for a completely different business and didn't make sense for the business we're in.
We can take our very best thinking of today, advance that thinking into a market, and make a minimal capital investment. How many DCs did we have? Five or six buildings?
Four. Well, yeah, five furniture. Yeah.
Yeah. We have one and a half kind of today. It's going to be way simpler. What's been really hard and complex is actually taking what we had, whether it was image, brand, real estate, old stores, poorly architected processes and systems and infrastructures, and dis-architect it, redesign it, redo it. Think about it. We're changing all this stuff, right? When you guys think, "Oh, my God, they're redesigning their whole supply chain. Stuff's going to go really wrong. This is going to be really expensive. They're going to make a lot less money for a time." We had kind of one transition year where we went from a promotional model to a membership model that changed things. There was timing between when we took membership revenue and how we booked it to our P&L. We explained to everybody our earnings are going to go down.
This is what's going to happen. Nobody believed us. Stock went to 25. The people that were smart enough to buy at 25 are pretty happy today. We're doing all these big moves. We're moving really big rocks, really changing massive things in our company, and it's taking less capital. We've got higher earnings, higher margins, right? Why wouldn't that be the same in international? It will be. What we've got is we've got some startup costs to kind of train people, build culture. Do you got to build a DC? Yes. Are DCs hard to build? No. They're tilt-up walls, right? Concrete floors and skylights and things. It's not like building these galleries or developing these galleries. You've got are people delivering furniture in every country in the world? Yes. That's not entirely new. Will we do it better? Of course, we will.
To me, Europe and international in a lot of ways just looks like kind of some more stores. We're not changing anything about our brand. People go like, "Whoa, well, the homes in France are not as big, and they have smaller apartments." Well, that's why our sofas come in how many sizes? Like seven lengths and three depths. Yeah. Okay, buy a petite version of that. Buy a classic version of that. You got a bigger home? Buy the luxe version of that. Get it in nine feet, 10 feet, 12 feet, four feet. We've got the assortment. It's not like we got to build a new assortment here. Not like you go into a country, "Oh, they only like pink sofas. You don't have any." Yeah. We'll pass on that market. That one we'll give to Wayfair.
I'm sorry, I'm picking on them a little bit just because I saw the new store. Everybody was telling me, "Wayfair is getting into the retail business. Are you worried?" Go take a look at the store. I'm not worried.
Thanks a lot, Paul. I appreciate it.
Yeah.
Thank you.
Your next question is from Oliver Wintermantel from Evercore ISI. The line is open.
Hey, this is John-Paul. On for Ollie. Just a couple of quick ones, Gary. Any update on tariffs, sourcing efforts, conversation with vendors? For Jack, if you could just delve into the tax rate guidance that you changed for the year. Thank you.
Yeah. It's kind of what I've said. I think that there's certain things that are episodic, and they're distractions, but they're not necessarily strategic, right? There's implications of some strategic sourcing shifts that are going to happen with tariffs. Tariffs are more of a distraction, and they shouldn't take our focus off the big rocks and what we're doing and where we're going. The tariffs are a little rock. It's kind of distractive. Somebody dropped a little rock on our head, and oh, here comes another one. There's another little tariff, and it's like having apples falling on your head and thinking, well, I'm standing under a tree, but you can't see the orchard, right? You got to get up and look at the bigger picture. Look, long term, where does it all shake out? The numbers say the U.S. needs China, and China needs the U.S.
To what degree does China need the U.S., and what degree does the U.S. need China? The numbers would tell you that China needs the U.S. more than the U.S. needs China. If you've read "The Art of the Deal" and understand what's in the mindset of a guy that wrote that book and how he negotiates, whether you like that he negotiates in public and on Twitter or not is kind of irrelevant. You got to understand, when you have leverage, you should use leverage if you're negotiating. The U.S. has leverage with China. China's uncomfortable. U.S. is uncomfortable. Read the letter I wrote in our recent source book. Leaders have to be comfortable making others uncomfortable because you're leading people to places they've never seen, getting outcomes that have never been achieved before.
I think what we're going through from a tariff point of view is very important to the U.S. long term strategically. I'm perfectly comfortable being uncomfortable about tariffs because I think it's going to be really good for our country long term. Balancing trade with China is a really good thing. People that don't understand that don't understand math and economics and world power. I'm okay. Is it a distraction? Do I have to worry about like, oh, shit, I was going to do a convert and Trump tweeted about more tariffs, and our stock went down 12 points in one day, and we called off a convert or something like that? Yeah. Got it. That's inconvenient. It's a distraction. It's not strategic. The strategic nature of it is as it relates to the United States and our country's economy long term.
How it's relating to our business specifically, nothing different than what we report. We actually put out press releases when these things happen and tell you, look, has anybody seen a difference in our business or our performance or our profitability since all these tariffs have been launched? No. We keep telling you it's not an issue, it's not a problem. No different than the U.S. needs China and China needs the U.S. I like to say to our partners, and the people that produce our products, I go, look, we should be linked together and completely integrated. We're shopkeepers without factories, and you're manufacturers without stores. We're not really good in isolation, either one of us, right? We have to be integrated, and we have to have deep partnerships and relationships, and that's what we have.
We have really good partnerships and relationships all over the world, and in China. When you are playing for the long term and you've got deep, long relationships and you have real partners, you don't abandon your partner in times of trouble, right? That's not when you flee. We're not just like, hey, okay, let's just uproot and leave China. We've got great partners in China. We have great manufacturing partners. We have great relationships in China. We're getting great product out of China, great quality out of China. How do we get through difficult times? We work together as partners. We do the math. We figure out how to create a really good outcome, and we get through it. That's what we've done.
We've moved a little production where probably the only places we've moved production is where the relationship wasn't as good and the quality wasn't as good, or the long-term investment wasn't going to make sense. I think I said it on Cramer. I said the companies that are going to in a complex business like ours, where quality and manufacturing capability is so key, you're going to uproot and just try to take things to other countries and ramp up production? Get ready for the complexity and chaos and problems that comes with that. I'd rather deal with the math and some of the changes, we'll all get through this. We're not going to have an embargo on China. Don't underestimate what Trump might do and what moves he might make from a negotiating point of view. I think he's a master negotiator.
I don't think we're going to have the embargo, Cuban Missile Crisis thing happen here. There's not going to be an embargo on all the ships. Just got to get through some negotiation. I think it's going to work out for both countries really well. We're going to get back a little of what we've given up long term. I wouldn't want to be in China's position and have the cards China has versus the cards the U.S. has in this negotiation. When you have leverage, it's just a matter of time. We've been able to get through it. We're not really worried about it. If it really escalates for a short period of time, and panics everybody in a short period of time, it's going to be a distraction.
We'll look back a few years from now and go, "Yeah, that wasn't that big of a deal." I think the outcome will be good for our country.
Got it. Thanks, guys.
John, as it relates to taxes, I think one of the drivers of a changing tax rate is the exercise of employee stock options and the vesting of restricted stock units. Depending on that activity and the share price and the amount that our employees exercise, there's a certain benefit that flows through to us. That benefit can change quarter to quarter. Last year in particular, we saw some distinct variability in that. We had a tax rate last year of 16.8% effective, and in Q2 it was 4.4%. I think as we talked about in a couple of quarters ago, as we were preparing our outlook for this year, and there's just the noise of that low tax rate versus the activity and trying to project that employee activity quarter by quarter.
It doesn't help in terms of comparisons and looking at your earnings growth year-over-year. Now, we addressed that by picking a normalized tax rate, and we picked a quarter or two quarters ago, 26%, which is effectively our statutory tax rate. In essence, our marginal one. The problem with that, though, is that economically there is this activity. I think some of that activity in 2018 was pronounced, but we continue to get this benefit. This year.
It's a real benefit.
It's a real benefit, real cash benefit. This year, our outlook for the tax rate is 21%. In terms of EPS, if you think about that just in terms of our guidance, that math is $0.67. That's a material amount of earnings power that was being understated by our choice of 26%. We just want to make sure that investors and you have the most accurate view of what the earnings power of the business is. We're going with the 21% normalized tax rate for all four quarters. That again, I think that just takes a little of the confusion out with the variability that we were seeing last year.
Yeah. If you just take a simple multiple, what's our multiple now? About 15 or so. If you take our multiple and take 15 times $0.67, it's $10 a share. Why would we present the numbers to be worse for our shareholders? All we're trying to do is create comparability that makes sense to evaluate the health and growth of the business. We don't want to understate it. We don't want to overstate it. The tax rules change, and you've got some of these activities happening, and so we're just trying to create the best comparison for ourselves, for our investors, and for our shareholders. That's all.
There are no further questions. I'd like to turn the call back over to Gary for any closing remarks.
Great. Well, thank you everyone. I want to thank our people and our partners all around the world who have just worked so hard and passionately bringing our vision to life and generating these really extraordinary results. I couldn't be more proud. We just ended a quarter with operating margins of 14.9%. I don't know who the next closest competitor in our space is. Maybe the L2 people want to do a ranking on that. We've got really one of the best models in our industry, and we're just warming up. I think we've got the best people in the world, best team in the world. Not just inside this company, but outside this company. Our partners around the world are incredible, that we work with. We're proud to work through problems with them, whether it's in Europe or whether today it's in China.
We're about partnerships and we're about passion and vision. I can tell you, we've never had a greater view of the future and a more inspiring vision in the future. We're going to passionately pursue that vision. I think we're going to build one of the most innovative and inspiring brands the world's ever seen. Thank you for being a part of the journey and wanting to be interested in our story. We like talking about it. We'll talk to you next quarter. Thank you.
This concludes today's conference call. Thank you everyone for joining. You may now disconnect.