Good afternoon. My name is Chantelle, and I will 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 speakers’ remarks, there will be a question-and-answer. [Operator Instructions] 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 opinion only as the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during 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 the 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.

[Operator Instructions] Your first question comes from Tami Zakaria with JPMorgan. Your line is open.

Hi, thanks for taking my questions. So, could you comment on the 3Q revenue guide? And why revenue growth would step down to 5% to 6%? After over 8% in first-half, was there any revenue pull forward into 2Q that's part of the expected sequential deceleration?

Hi Tami, it's Jack. So, you may recall that we have the sort of self-inflicted drags in a sense the decisions we made to exit certain revenue items. And so that – those are 2%, 4% to the quarter. And that – so there's the impact of the drag being different. I think one of the other things you're saying is, we saw an outlet – you see all the outlet sales in our press release. And so there, we talked about the closure of the 500,000 square foot distribution center last quarter. And so, we've cycled most of that inventory out. And so, you're not going to see that, that benefit, and that benefit was worth about 2 points in Q3, and it was also a big drag on gross margins.

Got it. So, my follow-up question is, earlier this year, you’ve guided to $15 million to $20 million additional savings from the home delivery initiative. So, 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 million to $20 million, with third of the benefit in this year and two thirds next year. At this time, we're holding to that. I mean, we're optimistic in looking forward to even better benefits there. But 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 3Q 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. So, I don't know if there's sort of any shift in both margin and expenses because you sort of have seen the dynamic as you move down the P&L. Can you just talk about, if there's anything to call out, sort of idiosyncratic that’s sort of impacting the model?

The only thing is advertising is swinging around, yes.

Yes. Nothing idiosyncratic, Steve. It's – I think we don't – we didn't provide you quarterly flow, and I think a lot of times what happens is, the – unfortunately, the one asking me doesn't always get it right if we don't give you sort of the guideposts to where to go. And so, when I look at it on the half, we're guiding 40.5, 40.8, and that’s up 140 basis points versus last year versus what we did in the first half, up 100 basis points. So, I think that's one way to look at it.

Right. So, nothing idiosyncratic call out. And then maybe for you, Gary, right, I don't – I didn’t fully get to digest the whole release yet. But if you think about the comments around international opportunity last quarter, I think during the preannouncement, I don't know if you can help us right, as we start conceptualizing the international expansion opportunity? Can you update us on the timeline and maybe discuss sort of the the infrastructure needs of the business for successful transition into one or more international markets over the next few years there?

Yes. Let's go back to your first question, and 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. So, 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. And so, 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, it’s like 80%?

That's right.

Yes. 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. So, you've got that kind of landscaping that can sometimes make the numbers look a little funny, but I think if you just look at the second half, I believe we took the second half above everybody's numbers pretty meaningfully. So, what – how it exactly landscapes is going to sometimes be affected by different changes like county policies and so on and so forth. As it relates to international, I can 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. And I think a couple of things becomes clear as you get closer to the opportunity and 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. And in the U.S., retail is a lot more uniquely developed in – especially in all of Europe. So, we just see the opportunity as so significant. The fragmentation in our marketplace in Europe is exponentially greater than the fragmentation in North America. And we – it hit us several months ago. We went to the Salone Show in Milan. It shows that it would generally be commercial attendees and B2B attendees are attended really by the open public and almost act like a pop-up store. And it – I kind of stood back and looked at it and I said, “Wow, this is interesting. There's 500,000…

Thank you, Gary.

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 implying the fourth quarter. So, we assume that half of the growth in the second quarter came from the increases in the outlets and increases in the RH New York store. So, 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% to 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 New York and the growth outlets in the fourth quarter?

You are very good with math. Yes. What – I mean really, you've got the outlet. We've been burning through the inventory. But we closed the 500,000 square foot distribution center that was sitting on reverse logistics, is part of we talked about, I think, for the last 18 months, 24 months. We are kind of redesigning the whole reverse logistics outlet business and part of that was don't hold outlet inventory and close facility. The last thing I want to do is like store – second quality goods, a lot of retailers do and a lot of retailers are sitting out there with liabilities, not moving through inventory or markdowns. And so, we wanted to be make it almost impossible in our company to sit on bad quality goods, because they're like tomatoes at the grocery store. I mean, they just don't get better with time. They just really don't. They don't turn into antiques in our lifetime. So, we closed our facility. We burned down those goods. That gave us – those words that goes about a point, little more than a point. That – those goods are burning down. Outlet inventories are – we have today versus 18 months ago 75% with outlet inventory, something like that. And so that channel is now really cleaned. We've – we swallowed that margin, yes, I mean, a lot of people are like, wow, is there more margin to expand here? Well, I mean, the outlets were massive dragging in the first-half of the year. So, we've got lots of margin opportunity and expansion. From that point of view, for those people that care about earnings growth, I mean, might only be me and a few others. But the earnings growth opportunity based on lapping the burn down at the outlet inventory and we got rid of that distribution center that was holding a bunch of stuff that we didn't need. So, …

Yes.

…so that's the piece of it. And then New York, right, opened really big and recycling New York. And then the timing of the new stores this year versus the timing of the new stores last year, kind of gives us a little kind of temporal trough, if you will, like we – until the stores were opening this year come on. And then what we 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? So, 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? Where we have like…

Three.

…three openings, right? So, you've got these, kind of, three that are opening later, then you've got three that are opening on top. And so, 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. And 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, you can have – we have some some periods where we have up to seven, eight new stores on top of two comparatively year-over-year, right? So, if you look at it right now, as we go into kind of Q3 in early Q4, we have a little bit of trough and timing, and then it kicks right back up. So, maybe that helps to hedge fund.

Helps a lot. Two more quick questions on that. One on that line of thinking is, because you won't get such a contribution, or as meaningful as a contribution from – to the growth from the outlets. That's why gross margins are expected to sharply inflict in the fourth quarter. I mean, 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 sometime. Can you give us a sense for the shape of the growth profile many years later? And how the returns for those – that class of initial openings are trending? Thank you.

Yes. The returns are fantastic. And generally, our bigger stores are growing faster than our smaller stores. And – but some of them, right, market-to-market you have different dynamics based on how housing markets kind of more localized, regionalized economies are doing. But yes, there's also a whole another layer of opportunity with all of those kind of first- and second-generation galleries if they don't have hospitality. So, we're looking at adding 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. So – and you want these restaurants. But Denver and Tampa, both can have rooftop restaurants. We’re one we're massively happy. All those galleries that you've mentioned and all of our design galleries throw up massive cash, right? And 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 was a mistake. But we now think we can add hospitality, which not only adds that revenue, it – hospitality lifts the overall revenue of a gallery. So, 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. But all the ones you mentioned, we actually have – already have conceptual designs for the restaurants in Atlanta, Tampa, and Denver. And so, we've got to know a whole another layer of growth that we can go back and get in those markets. But yes, but, look, those are the best positioned retail businesses. There's no one, I mean, going to Denver, going to Tampa, going to 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 take – make place that kind of bet. So, I think those galleries will continue to take market share over time as customers find them, as people kind of cycle around into their buying cycle and it's their time to either bought a new home, remodeled a home or refurnishing their home, which is a cycle of anywhere from five to 20 years. When it's their time to go shop and you can have more top of mind in the market because of these physical presence – presences, we're just going to continue to be relatively disruptive and take market share. And I don't see anybody coming that's going to make the kind of bet, 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. I haven't seen it. I mean, the Wayfair stores sure doesn't look like that and that opened in Massachusetts, so.

And, Michael, as it relates to your gross margin question, certainly outlet has an impact. And then you may recall, we plan to exit the holiday business. So, that business overall has a lower margin in Q4. So, we will get the benefit of not having those low-margin sales. That's another pickup for Q4.

Yes. I think the other thing of this is – ton of the questions is all kind of based on our guidance, right? And 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's – 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 there. 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? And then 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.

Yes. That first of all, is a very good, what we call a multi dimensional fully integrated question, a lot of depth and breadth, but a lot of focus. So, a good one, this one could take a while. But it's exactly what we think about right, like, have you build any business, any brand? How do you dimensionalize it without diluting it? How do you elevate it versus just expand it, right? 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 and that's very true with businesses. So, you have to these super disciplined and go through really just the absolute right filters. I mean, one of the overall arching 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 and it renders other things less valuable. And it's really hard, it's really hard, honestly, to kind of use those kind of filters and just like, you asked a beautiful question is, kind of, it was multi-dimensional, yet fully integrated, right? It wasn't – it's like when brands start branching out and adding other brands a lot of times unless you're – you've built such a kind of clear and concise platform and methodology like; Bernardo knows built with LDMH. I mean, it’s me, that's like one of the hardest ones, but 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…

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, and how might you approach know 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?

Yes. Yes, I think when we – you kind of have to look at it country-by-country. I think the world is getting smaller, not bigger, right. And that's what the internet is doing. That's what social media and networks and connections are doing. And my girls now turned 17, but they've had friends in multiple countries through technology for years now that they've never met. But they – if I look at their ability to curate and see things and react to trends and know about brands, it's – yes, it's completely different. So, 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. And 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 going to be more valuable, not less valuable, that the world is so cluttered with choices, with information, with really bad visuals, right? I mean, for the most part, the Internet is a really good platform, like we, look, I joked around because of consulting company called this feeble, right. So, like my mom used to always tell me, if you don't stand up for yourself, honey, no one else will. So, yes, we – 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 $1 billion businesses online. But…

Yes, very helpful.

Yes.

It sounds like complexity and also balance. Thank you. Best regards.

Yes.

Your next question comes from Zach Fadem with Wells Fargo. Your line is open.

Hi, 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's going on and what going forward? Would you attribute to operating initiatives, things like home delivery and reverse logistics? And as you reconcile those, maybe you could talk through the levers that you view is more near-term one to two-year opportunities compared to those opportunities may be further out?

I – yes, I don't know if we can kind of prepare great [indiscernible], but 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 kind of key points that were somewhere between 400 and 600 basis points more operating margin. I mean, I think as we look at it today, we click this thing up from low to mid-teens to mid to high-teens operating margins. And we've got a really clear line of sight today. I think, it's 20 to 20-plus operating margins. Look, very doable to us as we look out over the long-term. Again, think about, start with we're from a design gallery roll out, we're one-third penetrated. So, we take two-thirds of the market, put these new disruptive design galleries and 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. So, the whole occupancy pieces of 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. But 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. Like, if we just had all big galleries out in the market today, we wouldn't have to add a person corporately. So take our company from $2.7…

You can.

I can, or your deal set, everything's good. Okay. So, I can talk about them. It might take the whole conference call with like four questions today. But Fernando Garcia has joined us as the President of Furniture Operations and Home Delivery. And Fernando is a young man compared to me, but that – came to America with a dream with $5 in his pocket and was your first job – your first job was in a Kmart, right, cleaning, and decided, got an opportunity to deliver furniture. And 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 and just – we got a chance to meet Fernando who's one of our providers. And 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. And, Fernando said, “Look, I think I can help you guys and be a part of it.” And Fernando has just completed selling his company and joining our company full-time and he has been been working with us part, which – his part time looks like everybody else's full-time. So, I don't can't imagine what his full-time looks like. But the opportunities he sees, because he's actually built it from the ground up. And he knows the model and 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…

$15 million to $20 million.

Yes, $15 million to $20 million, which means, it's always more than we tell you, right? So – but I know in the first couple of months, he's finding just huge opportunities to simplify and massive savings. And 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. So, we think there's huge opportunities and we're just getting warmed up here on so many levels. And again, I mean, take whatever we're doing here and whatever you think we might do here over the next five or seven years, and then kind of for exit, and that's what the global opportunity looks like. We – I mean, that the global opportunity of this dimension of RH when we unveiled the entire ecosystem, you can, like 10x that. And so, it’s – we're just more excited than we've ever been about the future. And I know, everybody wants to kind of get into the weeds and the next quarter and the guidance and so on and so forth. And we – look, we all know business, that there's some form of pattern recognition that's important and relevant and short-term information, that's key. And – but there's pattern recognition here that you should look at. And there's massive opportunities ahead of us in the future. And – but there's exponential value creation that's going to come. We point out, I tell people, 10 years ago, LDMH 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 its trading at today, $150 a share, $160 a share. 10 years from now, the stock could be $1,600 a share. And we have lines of sighs and stuff like that. So, we're not going to get too caught up on the next quarter or this guide or like, 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 – and welcome aboard, Fernando. I appreciate the time guys.

Yes. You can say hi to everybody. Fernando.

Hi, guys. Thank you.

Just in case you thought I was making you out. But I 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 about a little bit more about the outlet strategy? And how many of 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?

Yes. Not a – we – I think we now have the inventories at a level where there – what kind of clean and moving. And that, in our mind, the outlet ought to be like a really super simple flywheel, right? The stuff that gets returned or nicked, or damaged or did just spin. We – I don’t know, it was three, four years ago, and we have actually the flip chart that we were mapping this thing out that three, four years ago, isn't exactly the same place I'm looking over. And we actually made a joke last night, as we were kind of going through some details and planning. And we said, “Hi, look, like there's the flip chart. And there was a famous meeting, where we realized that the slowly turning inventory in the company was the outlet, which is like, hard to believe, right? 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.” So, we've simplified it. We've got it to – an okay place. Exactly, the dynamics of the future of the outlet, the outlet is – will be responsive to the changes and improvements we make to the entire business versus the business being responsive to the outlet, meaning that, the outlet is, that whole strategy is going to be – is – should be triggered off a create rate, right, that's driven by returns or damages or what's happening. And all of that is triggered off your quality, your packaging, your delivery experience, your customer experience. And so, 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…

That's great. And if I could get a follow-up on the source book launchings that you have here in the back-half of the year, could you talk a little bit about the new modern book and how you're continuing to grow that important line for the business?

Yes. We think early stages, I mean, that was a – 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 we're able to kind of see the market in a whole new way and think about modern in a whole new way. We – modern was – we just got back from the [indiscernible] Show last week. We were in Paris for the [indiscernible], when we were in the flea markets. And the big headline and takeaway for the team is how much bigger modern can be and how that – it’s continuing to evolve. And I joke around a lot of times people ask me, so, where did trends come from? And in our business like I usually tell them the dead, right? And 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, 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. And that's kind of the evolution of home trends, right? So, the reason you've seen all this mid-century modern and all these products kind of develop, you've had a couple of things like you've had amplifiers here. But 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? And so, 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…

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. So, I’ll keep it short, just because we are running out of time here, but with Gary, you spent a lot of time early in their conversation talking about potential move overseas. So, the question I have is, are there any parameters yet? How we should think about the timing of that initial markets. And then follow-up on, I guess, another question. You have shown nice progress late in the EBIT margins. Would a move overseas to some extent, way upon expenses or even capital in the near-term?

Yes. We're kind of flushing all that out. But how to think about the timing? Well, let me give you some reality. We just got back on Sunday. We saw that we went to the Amazon market and the flea markets, then we had a merchandising trip, and it was an integrated real estate trip. So, the whole team was kind of a cross functional team that saw multiple locations, multiple opportunities. And Dave and I are back on a plane, when are we going, Sunday or Monday?

To be determined.

To be determined. So, we got home, Sunday. We're going to probably leave Sunday. And we've got a whole cross functional team, designers, architects, things like that. And we're going back to see locations and advance of the project. So, 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 a – an empty box with some fixtures. We are – we have real development projects, but nonetheless, the projects we're looking at are pretty inspiring spaces that are pretty far along. They're not ground up builds. Their spaces that we would take over and adapt and then inhabit. So, 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 like a direct-to-customer showroom platform business, right? We don't really – what's our cash and carry in a big design gallery now less than 1%?

1%.

Yes. So, 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 1%. I mean, it pretty soon it might be zero. And so, we don't have the same complexity from a cash and carry point of view. We 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. And then we can architect the inventory in the most efficient way behind the demand. And to fill 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're talking on this last trip. We're saying, oh, remember, yes, remember, when we were in all those shitty seasonal businesses, we used to sell like, Halloween crap and we used to sell Easter crap and we used to sell like Valentine's crap. And like all these businesses that had like a four-week or six-week lifespan, and God forbid, the vendor shifted two weeks late and now 90% of it is getting marked down and your whole margin structure screwed up. And not only that, you're massively polluting all your core businesses, people are like, oh, you should sell all the stuff. And you have always empty dining tables that you can put all these things on and you can sell extra things. Like, they'll 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? And so, our business and what – 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? And – but through the simplification, have 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? And so, as we have been thinking through international and how we can do it like, again, it's like stores. We don't have to drag the past into the future. We don't have to, like disarchitect 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. Like, I think we used to have, how many DCs that we have, five or six like buildings?

Four. Well, yes five furniture. Yes.

Yes. Yes, we have like one-and-a-half kind of today and like it's going to be way simpler, like, it's – what's been really hard and complex is actually taking what we had, whether it was image, brand, real estate, old stores are poorly architected processes and systems and infrastructures, and disarchitect it, redesign it, redo it, like think about, we're changing all this stuff, right? And like you go – like when you guys think like, oh, my god, they're redesigning their whole supply chain, that's going to go really wrong. This is going to be really expensive. They're going to make less – a lot less money for a time, like we had kind of one transition year when we went from a promotional model to a membership model that changed things. There's timing between when we took membership revenue and how we booked it to our P&L. We explain 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 the 25 are pretty happy today. But 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 the DC? Yes. Are DCs hard to build? No. Like their tilt up walls, right? And concrete floors and skylights and things. It's not like building these galleries or developing the galleries. And then 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. And so, to me, Europe and international in a lot of ways just looks like kind of some more stores. And we don't change anything about our brand. People feel like, oh, well, they don't have 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 lanes and three depths. Yes, okay, by a petite version of that, by a classic version of that. You got a bigger home. Buy deluxe version of that, get it in 9 feet, 10 feet, 12 feet, 4 feet. Like how we – we've got the assortment. We can – it's not like we got to build a new assortment here. Not like you go into country, oh, they only like pink sofas, you don't have, yes. We’ll pass on that market. That one, we’ll give Wayfair. I'm sorry picking up a little bit, you guys 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 for the color. I appreciate it.

Thank you.

Your next question is from Oliver Wintermantel from Evercore ISI. Your line is open.

Hi, this is [indiscernible] for Oliver. Just couple of quick ones, Gary. Any update on tariff sourcing efforts, conversation with vendors? And for Jack, if you could just delve into the tax rate guidance that you changed for the year? Thank you.

Yes. It's kind of what I would have said, I think that, look, there's certain things that are episodic and there are distractions. But they're not kind of necessarily strategic, right? Like, there's implications of some strategic sourcing shifts that are going to happen with tariffs. But 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 in our head, and oh, here comes another one, there's another little tariff. And I mean, it's like, you got to kind of 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. And so, look, there's 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. Therefore, 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, not just kind of relevant, you get understand, like 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 – that has…

Got it. Thanks, guys.

So, John, as it relates to taxes, I think the – one of the drivers of changing tax rate is the exercise of an employee stock options and the vesting of restricted stock units. And so, 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. And a benefit changes 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%. So, I guess, 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 what the activity and trying to project that employee activity, quarter-by-quarter that just, it doesn't help in terms of comparisons and looking at your earnings growth year-over-year. Now, so we address that by picking a normalized tax rate, and we picked in a quarter or two quarters ago, 26%, which is effectively our statutory tax rate in essence are marginal one. The problem with that, though, is that economically, we do. There is this activity, and I think there some of that activity in 2018 was pronounced, but what we continue to get this benefit. And this year…

It's a real benefit.

…the real benefit, real cash benefit, which – so, this year, our outlook for the tax rate is 21%. And in terms of EPS, if you think about that just in terms of our guidance, that math is $0.67, and that's the material amount of earnings power that was being understated by our choice of 26%. So, we're just – we just want to make sure that investors and you have the most accurate view of what the earnings power of the business is. And so, we're going with the 21%, normal – normalized tax rate for all four quarters. And that, again, I think that just takes a little of the confusion out with the variability that we were seeing last year.

Yes. I mean, if you just take a simple multiple, I mean, I, which are multiple now about 15 or so, if you take our multiple intake 15 times $0.67, it's $10 a share. Why would we present the numbers to be worse for our shareholders? We're – all we're trying to do is to 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. But the tax rule has changed. 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. So, 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, like I couldn't be more proud, and we just ended the 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. But 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. And I can tell you, we've never had a greater are a greater view of the future and a more inspiring vision in the future and we're going to passionately pursue that vision. And I think we're going to build one of the most innovative and inspired and inspiring brands the world has ever seen. So, thank you for being a part of the journey and wanting to be interested in our story, we'd like – we like talking about it. So, we'll talk to you next quarter. Thank you.

This concludes today's conference call. Thank you, everyone, for joining. You may now disconnect.