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RH (NYSE:RH)
Q1 2018 Earnings Conference Call
June 11, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Catherine and I will be your conference operator today. At this time, I'd like to welcome everyone to the RH first quarter fiscal 2018 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 session. If you'd like to ask a question at that time, please press * and then the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key. And thank you, I would like to turn the call over to our host, Cammeron McLaughlin, RH Investor Relations. Cammeron, you may begin your conference.

Cammeron McLaughlin -- Investor Relations

Thank you. Good afternoon everyone. Thank you for joining us for RH's first quarter fiscal 2018 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Karen Boone, President Chief Financial Administrative 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 law, 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 FCC filings as well as our press release issued today for a more detailed description. Forward-looking statements reflect our opinions only as of the date of this call and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.

Also, during our call today we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will also 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 will turn the call over to the operator to take our first question.

Questions and Answers:

Operator

Ladies and gentlemen, just as a reminder that is * and then the number 1 if you would like to ask a question at this time.

Your first question comes from the line of Michael Lasser with UBS.

Michael Lasser -- UBS -- Analyst

Good evening, thanks a lot for taking my question. So, you're looking for a big acceleration in your topline growth over the next couple quarters. You'll benefit from having some of your new design galleries open. Can you give us the sense for what the underlying comparable brand comp is implied within the next few quarters of the top line guidance that you've outlined?

Karen Boone -- President, Chief Financial and Administrative Officer

Sure, this is Karen. For the comp, we're in Q2 through Q4. We expect a range of about 8% to 9% in Q2, about 5% to 7% in Q3, and about 4% to 7% in Q4. And that should line up pretty closely with the guidance table that we've included in the release. The reason it dissipates in the back half and gets smaller is because we expect the new stores to provide a greater contribution to total revenue. So that, therefore, is kind of the plug to get to the comp to total.

Michael Lasser -- UBS -- Analyst

And do you expect your membership growth during that same time to mimic what your brand comp growth should be?

Karen Boone -- President, Chief Financial and Administrative Officer

Yes, generally we expect membership to just translate to total growth, not outlet necessarily, but new store growth, even though it's not comp would have a membership correlation as would comp brand. So, in general, when sales are growing, memberships growing. As we've previously said, this was really not intended to be special -- just a loyalty program -- it was a new way and a different way to have a better promotional program.

Michael Lasser -- UBS -- Analyst

My follow-up question is on gross margin. You're guiding the 39% gross margin this year. That'd be 200 basis points higher than the highest gross margin that you've achieved in the last ten years or so. Is the delta -- that 200 basis points -- all related to the difference in the economic structure of your membership program versus the more promotional-oriented model that you've had in the past? And the reason why the question's important is because the market's gonna want to understand what the upside and the shape the gross margin's gonna look like as you roll in incremental topline dollars over the next couple of years.

Gary Friedman -- Chief Executive Officer

It's really a combination of everything we've outlined in the letter. I think we're pretty complete and articulate in what's driving it and what the bridge is to the load of mid-teens operating margins and beyond. It's everything from the power of the membership model, unique and proprietary product offering that allows us to get better margins than people that are selling other people's goods, our efforts to revolutionize physical retailing, and the work we've done thus far to rearchitect and redesign our operating platform which we're in the early innings of. There's a lot more good news to come there.

Michael Lasser -- UBS -- Analyst

Okay. I guess I was talking specifically --

Gary Friedman -- Chief Executive Officer

There's nothing -- there's no news outside of what I wrote in the shareholder letter.

Michael Lasser -- UBS -- Analyst

Okay. Thank you very much.

Operator

Your next question comes from the line of Peter Benedict with Baird.

Peter Benedict -- Baird -- Analyst

Hey guys, thanks for taking the question. First, just a quick clarification: On the converts, it looks like basically, all we've got here is now you're gonna pay them off in '19 and '20 and there's really nothing else to consider with those between now and then. Is that fair?

Karen Boone -- President, Chief Financial and Administrative Officer

Sure. We have included a share count table in one of the tables in the press release that shows kind of the illustrative examples of at different rising share prices the dilution that will come between now and then in our EPS but that's more of an accounting item. For GAAP purposes, we would have dilution all the way beginning at the lower strike crisis of 116 and 118 but because we have these economic bond hedges in place to actually deliver and offset that dilution we won't actually have true dilution until above the upper strike. So there is some accounting that will go on with our diluted shares calculation above the lower strike but we truly will not have dilution until we pack the upper strike.

Gary Friedman -- Chief Executive Officer

Yeah, the 172 and --

Karen Boone -- President, Chief Financial and Administrative Officer

172 and 189.

Peter Benedict -- Baird -- Analyst

Okay, that's helpful. You talked about leverage and where that's going I guess up to by the end of this year. Where do you guys envision being comfortable running the business? I don't know how far out you want to go -- 2021 or just in the next few years -- what's a good level of leverage you think the business should operate under?

Karen Boone -- President, Chief Financial and Administrative Officer

As we mentioned, we could be in a position to be at two times by the end of this year. Beyond that, we haven't really set a target. We think zero to two is probably a good range but it really depends on what the uses of cash are that we would have for any outstanding borrowings.

Gary Friedman -- Chief Executive Officer

I think as we said in the letter, we will continue to be opportunistic with the capital markets if there's the ability to have offensive cash on the balance sheet. We may think about that and pursue those options. But that wouldn't necessarily be leverage if you will; it would be cash getting on the balance sheet. No different than when we first did the two convertible notes. We kind of carried that cash for a while until we acquired waterworks and then significantly made a repurchase of our stock.

Peter Benedict -- Baird -- Analyst

Understood. And just one quick last one -- just around hospitality: Can you help us understand the size of that business? If not today, where you maybe see that as a percentage of the business as we move out a few years based on what you have planned? Thanks so much.

Gary Friedman -- Chief Executive Officer

We couldn't be more excited about the integration of hospitality into our business model. Not only does it drive significant incremental traffic to our galleries and brings in the right customer. We can see mathematically adding a significant bump to our revenues in the galleries that have hospitality. As we are evolving and learning and designing the business model for hospitality, we think hospitality will be incrementally profitable to the model, which besides the integrative benefit, which we really never had a plan for, quite honestly.

But I think the experience that we're designing, the incredible food and hospitality experience that Brendan and his team are bringing to life inside these pretty magnificent spaces we're creating, I think what surprised us is just how popular they're becoming. And so, as we think about it I think there could be a third maybe more of our galleries. A third to a half, long-term, it all depends. And what we like about it -- one of the great things about it -- it is a different business integrated into a retail business so this is all hard work to kind of thread these needs and get it to all work seamlessly.

I think we've found a model that's really unique and there are lots of things to like about it. It doesn't really impact our overhead or cost structure, you don't have inventory, and you have fast turns in the F&B business. We don't have to build another DC for those sales. We don't have to carry the inventory. It increases turns. It's got faster return on cash and so on and so forth. So lots of things to really like here, but we're still really early and we're still learning so much. I would just say it's just significantly beyond our expectations how this turned out. Our original vision was to have a really nice amenity inside our galleries because our customers spend so much time working with us designing their homes and the ability to have them have a place to have lunch or early dinner to keep them in the gallery -- we hoped it would drive some traffic or revenues. Take Chicago for example, there's a building in a residential neighborhood.

There's just a little sign on the building that has RH. There's no identification there's a restaurant in there, you have no idea walking by. And initially, our questions internally like, who's gonna really want to go to a furniture store to have dinner? So far, everything beyond our expectations and we're just in real learning mode and making a lot of adjustments and fine-tuning the model and now we're in a position to believe that this is gonna be meaningfully more incremental than we thought and we'll be a real business. I think we're gonna build several hundred-million-dollar hospitality platforms here.

Operator

Your next question comes from the line of Steve Forbes with Guggenheim Securities.

Steve Forbes -- Guggenheim Securities -- Analyst

Good afternoon. I wanted to focus on the customer insights that you are gaining from your RH members program, especially as it relates to the demographic appeal of the brand. Are there any learnings that make you rethink that $4 billion to $5 billion long-term opportunity as you think about how broad the brand can travel as it relates to just demographic -- whether it's age or income spread to so forth? Any insights would be valuable.

Gary Friedman -- Chief Executive Officer

Nothing particularly different than what we anticipated. So, I would say if you look at how we thought membership would translate and how it would impact the business we're just really happy that we're really directionally right with this. Again, it's relatively early -- the first couple of years of all of this.

The real key to membership -- we can all talk about customer data and customer insights and all this other stuff and I listened to so many retailers' conference calls and they're all talking about all this big data and all this customer data and insights. Well, we've all had the data on the customers, right? Even the retailers out there that have had credit cards for years they know everything they've got all this data, yet they can't grow their business over the last ten years. I think people sometimes put too much of a premium on these things.

For us, remember the objective here was to smooth out our business. To not run a chaotic, promotional business that we believed was massively distractive to leadership to try to run a business like that. You're not making high-quality decisions. It's enormously cost inefficient to manage inventory or manage the business. This was to really simplify and streamline our business. That was our major goal. We run a big direct business, right? We have data on our customers. I didn't expect all of a sudden to find out we're gonna have all new customers on membership. Honestly, that would've alarmed me. We know a lot about our customers. Do we know that much more?

I think what's happening -- look, our average transactions are going way up, we're getting great leverage, and we're spending more quality time with our customers. They're not all rushing in at the end of an event. You've got a store of 300 people and a staff and a team trying to serve everybody on the closing weekend of an event. Now our business has smoothed out we're getting significantly better service. We can staff the business better. We have a better relationship, and average orders are going up. Our interior design business, which is an important element that's linked to this is again really growing and becoming more and more important.

Every month that goes by we have more and more hundred-thousand-dollar interior design jobs. We just did a $900,000 job in Italy DP. We finished an install in Italy, we're working on a $1.3 million installation in Shanghai, and we're becoming a serious interior design firm. The membership is linked to that. But the real objective here for us was to move from a promotional model to this membership model to smooth out and streamline the business. And we thought there were massive cost deficiencies. And it's allowed us to reverse engineer the supply chain.

From our numbers, if you really look at the numbers at the end of this year, we would've planned to have $400 million more inventory than we're gonna have if you looked at our previous long-range plan. So, net-net, you guys are seeing that we're probably gonna take somewhere around $300 million of that but we would've had inventory growth. If you run the business on the same terms it's about a $400 million difference in inventory.

You couldn't run the inventory the way we're running it if you're running the crazy promotional model like we were. You just would always be buying wrong. So, you have that. So many things here that membership is unlocking all kinds of opportunity in the business. I tell you; the least important part is, "Do we know more about our customers?" We know a lot about our customers.

Steve Forbes -- Guggenheim Securities -- Analyst

As a follow-up there, Gary, you mentioned some international sales there. Can you update us on your thoughts around the international opportunity in general as it relates to having a footprint there, whether it be in London or other countries?

Gary Friedman -- Chief Executive Officer

Good question. We're really excited. We're shipping goods all over the world and we have customers that are really passionate about this brand. We keep getting more and more excited about the international opportunity. We just want to be really smart about it. It's complicated in a business like ours where I tell people a lot, when you're in the apparel business it's men's and women's, tops and bottoms, and accessories. Everything comes folded the same size it all comes in the same size box and nothing breaks in transit.

Our business is exactly the opposite of that. When you decide to all of a sudden take your business to another country you really got to think through all those aspects, the supply chain, and so on and so forth. And we've been working on that. We've done a lot of work on the real estate side. We think we're zeroed in on a location in London and possibly one in Paris. But our deals are not the simplest and easiest to do. These are pretty iconic locations that we think are perfect for the brand and if we can get them done we're kind of parallel pathing working through what the operational mechanics and how does that all translate.

As we know more and get closer to it, we'll be there, but clearly, there's a huge market opportunity here. The international opportunity may be as big or bigger than the US opportunity because the competition is -- there's really no competition internationally when we look at what we're doing. And we have all kinds of people that want to license it, franchise it, and we've just said no to everybody. We really believe we want to control our brand. So, for now, that's the path we're taking.

Operator

Your next question comes from the line of Matt Fassler with Goldman Sachs. Matt, your line is open.

Matt Fassler -- Goldman Sachs -- Analyst

Thanks a lot. Good afternoon and thanks for that color that you offered up in the letter. My first question relates to gross margin. The gross margin was substantially better than you had guided to at fiscal year-end, as is your guidance for the year. Can you give us a sense on this line item in particular what's really breaking your way above what you had initially expected? Because lots of the changes that you're speaking about have been in place for a number of months, so is it the mix of business, is it what the cleanliness of the inventory, dust your ability to sell at full price? Can you give us a sense if you could about the nature of the upside surprise here?

Karen Boone -- President, Chief Financial and Administrative Officer

Sure, Matt, so gross margin was really hitting on all cylinders in Q1 so we have been talking about is this skew rationalization in inventory optimization efforts and cycling through those was by far the biggest item. But peer point we did have very clean inventories. Now that we have the membership, we don't have a lot of variability in selling price.

We're having a lot of full price selling. But then the other things that also fall into gross margin for us are things like having a full quarter of the benefit of the DC's and the reverse logistics of not taking the outlet goods all the way back to the DC that's in transportation. There's just a lot of benefits of the way we're handling the goods and having zero DC's and the way we're really just -- the way we've kind of architected the platform, as Gary mentioned, just has a lot of efficiencies as it relates to the movement of goods, the storage of goods, the handling of goods, so it's kind of -- product was by far the biggest item. But within transportation and occupancy, there are also savings there.

Gary Friedman -- Chief Executive Officer

Yeah, and it's a little hard as Karen said. We're still in the very early stages of realizing the opportunities that we anticipated. So, trying to forecast that and trying not to get ahead of ourselves until they're ready. At one point earlier in the quarter, we got one of the roll-ups, Karen came to me and said, Gary, money's falling out of the trees. And it's true. I think the simplification of the backend of this business and the business being architected in a truly unique way that's custom to our business. Not like anybody else's architected an operating platform. We're really thinking deeply. We're bringing first principle thinking to everything. We're not looking at best practices. It's all next practices. I think the time and effort that this leadership team's putting in -- you're just seeing opportunities all the way through. I wish we could be more specific with all this but we took the learnings in Q1 and we tried to reproject the year and we've tried to be conservative projecting the year. We don't want to get ahead of ourselves. We're learning, you're learning, all good so far.

Matt Fassler -- Goldman Sachs -- Analyst

Super helpful. By the way, a quick follow-up: I know margin was really the big source of the upside surprise but you spoke about sales overseas and there's a point a couple three years ago where the oil markets and the tourist markets et cetera did start to weight on the business a bit. If we look at macro factors and listen to other companies, the oil markets are in better shape, tourism into the US seems to be in better shape. Are you feeling that at all? Is that a factor in the strengthening of your comparable brand -- sales from that that you can discern?

Gary Friedman -- Chief Executive Officer

Yeah, Matt, the market's that we mentioned before that are most impacted by oil that you would anticipate in Texas and as you kind of go up to Canada and look into Florida and then some of the ones tourists did not as much for us, right? But the oil markets -- we're seeing better performance out of the markets that would've been negatively impacted when oil dropped all the way down into the 20s, 30s, so. Oil will move those markets, there's just no getting around that. Logic prevails here.

Operator

Your next question comes from the line of Brad Thomas with KeyBanc Capital Markets.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

Thanks, good afternoon. Gary, in your letter you highlighted a number of things that the DeMonty's team are working on, like the supply chain and customer service, the in-home delivery, the call centers. I was hoping you could talk a little bit about the timeframe with which you hope to make maybe the most meaningful progress on this and maybe talk about what might just be more customer-facing versus the areas of what he's working on that are really contributing more meaningfully from a financial standpoint?

Gary Friedman -- Chief Executive Officer

I think we'll be prepared to kind of be more specific and give you a lot more color probably later in the year and maybe with our next quarter. DeMonty's just completely getting close to this with his team, making real changes, putting fresh minds in the business, and also just putting people in the supply chain that actually come from a customer perspective -- in a gallery and storage perspective that think about the business completely differently than a typical supply chain person might. We're just seeing opportunities that other people couldn't see and unlocking a lot of value. But we're so early on here. The moves we've made to consolidate the DC's from four to two. There's still more work and more opportunity there in the DC network design. In the outlet piece where we simplified the reverse logistics, that's the early work. There's a lot more work there. We're seeing benefits in outlet margins and other things but we think there's continued margin opportunity in outlets from minimal handling.

We think we're gonna turn the goods a lot faster by not transporting them as far. We still don't have outlet stores in every market by our galleries. There are still places where we have to take it somewhere cross state, still moving it too far. We're in the early innings of rearchitecting the outlet platform wherein the very beginning innings of rearchitecting the home delivery platform and network. Soon we'll have in the Bay Area the new model up and we'll have more to report there when we have real data. But one of the things that's really interesting, when I got here 17 years ago, in the Bay Area we actually did our own home delivery.

We insourced and did it ourselves and had the best metrics in the company. And it was that way for three or four years. And then, we decided to outsource it and then the metrics looked a lot worse. It's interesting, the guy that used to run it is still with us and now that we're listening to him, he's telling us, here's how we used to run it. Here's the metrics from 15 years ago. It's just that nobody believed it could be done. It's just bringing first principle thinking into the business.

Looking at things with fresh eyes, building up from what is truth, not speculating. And if you came into our offices you'd see on one wall kind of current state and then you'd see right across on the other wall a design of future state. I think the logic of looking at the fact that today -- today I would say we have a home delivery network design that almost looks like a DC network design.

For example, in the San Francisco Bay Area we pick the orders that are DC and Patterson, we drive the orders 20 minutes to our HDL in Tracy, and then we unload the goods after 20 minutes, take them out of their protective packaging, blanket wrap them which kind of protects the goods, and then we send drivers into traffic for two and a half hours to get to their first delivery in Marin or San Francisco or Palo Alto or Woodside.

And if you've ever driven a truck or been in a truck in stop and go traffic, you can only imagine the furniture banging around against each other with the blankets. Just a simple solution like, hey, why don't we put the home delivery and the delight centers near the customers? And why don't we send the goods at night not during the traffic? And why don't we leave them in the protective packaging? And then why don't we unpack it five minutes from the first delivery and so it's not getting banged around for two and a half hours? And by the way, what does the math look like when your drivers aren't sitting in traffic for two and a half hours before they make their first delivery and then have to drive back with the returns in two and a half hours? What if you just drop the return off in an outlet that's somewhere in the market where all the customers are instead of taking it into the middle of nowhere where there are no customers?

Maybe the turns will be better, maybe the margins will be higher, and maybe the teams will deliver twice as many orders on the same day. It's just bringing fresh eyes, fresh minds, first principles thinking, find out what the truth is, build it up from the truth, and don't hire a consultant that's gonna come in and tell you how everybody else is doing is because they may be doing it wrong. You're just seeing the very early stages of this. It is going to be so transformational. I think the model we're gonna build here is -- we wouldn't tell you mid-teens operating margins unless we really believed it. We believe this and it might be more than that. I think we're gonna build a model that is unlike anybody's seen. No different than the frontend.

Why do we build these spectacular galleries? When I inherited the business the average store volume here was $2.9 million a store. We have stores doing $60+ million. The same little boxes that were doing $2.9 million a store are now doing $15 million a store in the same square footage. It's just looking at things differently. But that same creativity, that same approach, the same cross-functional collaboration that helps us architect an integrated solution that is unlike anything anybody's ever seen is the same energy, creativity, cross-functional collaboration that is going into building the operating platform and we're having a blast.

We're finding things that we're like, oh my god. We feel stupid for doing it the other way for so long. But you couldn't be more exhilarated to find -- like every problem is an opportunity, right? The opportunities are enormous here. And I just think that we're just taking our own path and bringing fresh eyes and thinking and not having consultants come in and tell us the way that everybody else does it. That's not gonna get you ahead of anybody. We're gonna conceptualize a leapfrog operating platform and you're just seeing the beginnings of what I think is gonna unfold here over the next five years.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

That's great, very helpful Gary. If I could squeeze in a quick follow-up maybe for Karen on the sourcebooks: I know the interiors book is getting out meaningfully earlier this year than it did last year. Clearly, that should benefit I would think sales at least for Q3 from a timing perspective. How should we think about the other maybe P&L impacts from getting that sourcebook out earlier?

Karen Boone -- President, Chief Financial and Administrative Officer

Sure, so what's different is actually it's not just getting it in early, we're having two drops. So last year we had modern drop in the spring and an interiors drop in the fall and now we have two drops of interiors; one in the spring, one in the fall, and two drops of modern; one in the spring, one in the fall. So, it is -- there is an incremental advertising investment but in total, we're doing different things with circuit page counts and such that on the year, the ad costs shouldn't be that different.

And then with respect to the new accounting rules, we haven't tried to make it clear how that's going to shift significantly between quarters and put a table in the press release to try and show some of the variability between quarters. For example, in Q3 when the fall books go out, you'll see all of the expense hit in Q3, then Q4 will be massively improved because there isn't really any expense in Q4. So, there is some variability by quarters, but in total on the year, ad costs should be relatively consistent with last year.

Operator

Your next question comes from the line of Geoff Small with Citi.

Geoff Small -- Citi -- Analyst

Hi Gary and Karen, thank you for taking my questions. Gary, you just touched upon gallery productivity and I believe eight of your next generation galleries have now been open for more than a year or even from something like 18 months to about three and a half years. I'm just curious whether you can offer any color on the comparable sales growth you're seeing from those galleries relative to the company as a whole and also whether the marketwide lift in direct revenue from those new galleries has met or exceeded expectations?

Gary Friedman -- Chief Executive Officer

We continue to be extremely happy with our new galleries and we continue to fine-tune them. As far as the impact of the direct lift, the model's relatively similar and we've articulated before we expect a modest direct lift in the markets when we open the big galleries. The major lift is in the galleries themselves. And that will actually change the whole complexion of our sales over the next several years. So if you just think about a market where our sales at retail will lift by two to three X over a few year periods at retail and our direct business might lift by 10% to 30% over that period of time. You're gonna wind up with a business year.

It's funny, again, you study what other retails are doing and what people are excited about, and people get excited about their direct business growing faster than the retail business. I don't know why because the direct business makes less money in every retail company in the world. I'm positive of that. That's why you see declining operating margins. I'll tell you this, our business will go -- we were almost 50% retail, 50% direct. That was because we had significantly undersized retail stores.

When you really size the retail stores correctly, this model's gonna look like 65, 35, 75, 25. And quite honestly, we're kind of ambivalent where the sales fall. I can't influence whether someone's gonna place the order from home or their gonna place it in the gallery with an associate. We just want to kind of build the net, if you will, that we catch the customer right. We're aware the customer wants to interact -- or not even where the customer wants to react because how could they want to shop your gallery if there's not one there? So really, it's about where and how do you position the business to grow in the most productive way? How do you allocate capital in the most productive ways?

We look at a market and we try to size the gallery, size the circulation, think about the investment in advertising, think about all the things we're gonna do, and the investment in a market, and then how do we really optimize that market from a return on invested capital? We think we have the most exciting retail stores in the world today. They're only gonna become more productive over time, not less productive over time. We will only get smarter in how we merchandise them, how we market them. I think the fact that they're so unique and different that we're getting the share of traffic that others are not getting, we're becoming more important to developers and landlords. Just interesting fact. We now have a real proven concept. We have enough of these opened that developers now believe these will work. We've now layered on top of that a hospitality experience that is really terrific compared to anything else in a retail development. And that has developers excited because it drives traffic, not just to our galleries; it drives traffic to any development. I just think we're on the right track, we're on our track, and we couldn't be more excited about what's happening with our galleries.

Geoff Small -- Citi -- Analyst

Thank you, Gary, that's really helpful color. On the SGNA side, it looks as though spending came in above your expectations in the first quarter after adjusting for the accounting change. And I think you took up the plan for the year again after the adjustments presumably to spend behind a new -- sourcebook mailings was one component of that increase but I'm wondering what else is driving SGNA higher than you initially expected?

Karen Boone -- President, Chief Financial and Administrative Officer

Sure, so we do have a couple just investments this year. We are continuing to invest in hospitality. As Gary mentioned, we have three experiences this year so that's incremental start-up cost there plus just more openings than we had last year so we have more pre-opening costs. But then separate from that, we have two kinds of compensation things: One is incentive comp is higher than it was last year, obviously we didn't have the same strengths of our business that we have this year so we have higher incentives cost in our base. And then there are this other small incremental investment's modest in other areas. Things like our call centers and some of the changes that Gary mentioned in the release of opening a call center on our campus, for example. So, there are other modest SGNA investments in there.

Gary Friedman -- Chief Executive Officer

Yeah, that wasn't in our plan and we decided we needed to get the customer closer to us. Whichever way we can get closer to the customer, get out to the customer; bring the customer's voice into the hallways of our corporate campus here. So, we're making investments to just strengthen our ability to serve the customer. But I think, look, are we spending a little bit more money? Yeah, we might be. Are we making massively more money? Yes. Business is about investing. It's really not about spending. If we're investing more, we're making more. That's what we always ask at the table. What are we investing in? What do we expect to get from it? I think our numbers tell a pretty clear store that any incremental investments in SGNA that we're making are results of significantly better returns.

Operator

Your next question comes from the line of Adrienne Yih with Wolfe Research.

Adrienne Yih -- Wolfe Research -- Analyst

Good afternoon. Let me add my congratulations. Gary, I was wondering if you can give us an update on the RH delivery network, what you're doing there? And then also, can you talk about the quality of transaction -- either increase in order size, return rates lowered, that lead-time just from having cleaned up that inventory? And then for Karen, with regard to the warehouses with the skew rationalization, how many of those warehouses are now decommissioned so to speak? You talked about one of them being anniversary. And what, as we go forward, what can we see from the remaining warehouses? Thank you.

Gary Friedman -- Chief Executive Officer

Yes, I think the first question is an update on the RH delivery network, right? And I think I just talked about that, the simplification of that and the ability to kind of move home delivery and delight centers close to the customer so goods travel farther in the original package that gets it almost anywhere in the world undamaged. It's when you take that packaging off products what are you doing with it?

Adrienne Yih -- Wolfe Research -- Analyst

Timing of implementation or when we might see returns on --

Gary Friedman -- Chief Executive Officer

It's going to take several years to get through the whole country. So this is a long-term project. But the returns and benefits we believe are going to continue to be really good so as we learn we'll adjust. But we think there are tremendous benefits to make in lowering returns, lowering damage, lowering exchanges, getting orders to stick, being able to deal with a customer issue immediately as opposed to you make the delivery, a customer has an issue, and it goes into a process and a system and it gets back to the customer and could take days or weeks.

We can have a medic in a customer's house in 30 minutes in our new model. But it's going to take a long time to get this everywhere nationally. Some things we'll be able to go faster about. Just doing simple things like adding more routes, moving to seven-day deliveries, delivering when the customer wants the goods not when it's most convenient for the trucking company to deliver. All kinds of things like that. We'll be more specific with our plans here probably in the fall, sometime in September when we report second quarter. We'll take you through a more broader view of what we've learned and what we're doing. We're just at the early stages there.

Adrienne Yih -- Wolfe Research -- Analyst

I think I was referring more to the -- where you wanted to have your own employees, the RH employees?

Gary Friedman -- Chief Executive Officer

We have a bias for more control than less control but at the same time we have a lot of partners that are kind of raising their game and expressing very passionate about wanting to be our partner and wanting to integrate with us and work in a deeply collaborative way to provide a service that's not being offered in the industry. So there are people that can partner with us in the right way and can actually differentiate themselves great. People that can't differentiate themselves -- we're operating a business that really doesn't have a peer. We really don't. Who else is really at the kind of more luxury end of the market with scale? No one has that. But we can't have our goods on the trucks of the other people being delivered the same way. Our customer expects more. Our galleries are different. Our experience is different. Our home delivery experience has to be different. And we're just being very clear and transparent with our partners and a lot of them are stepping up so we're optimistic. It means a real focused commitment and investment into RH for them. We'll see who's game.

Karen Boone -- President, Chief Financial and Administrative Officer

And then Adrienne, with respect to the DCs, we used to have four furniture DCs and two of those closed last year in Q4 so our LA warehouse and then our Dallas warehouse -- those both closed in Q4 and then we still have two left, an east coast and a west coast, as well as our small parcel, our shelf stock facility in Ohio. So that's the structure and kind of plan for now. We'll continue to evaluate and see if there's opportunity but we don't have any immediate plans with any other of those warehouses.

Adrienne Yih -- Wolfe Research -- Analyst

Great. And then just one last one for Gary: When would the timing of the gallery in London potentially be?

Gary Friedman -- Chief Executive Officer

Too soon to tell. We've got to nail down the deal and so it's not that easy. Hopefully -- it's on the top of Dave's list. We think it's probably a $300 million or $400 million opportunity if you just look at the UK market. We think we could open one gallery and probably create a $200 million to $400 million business very quickly.

Operator

Your next question comes from the line of Daniel Hofkin with William Blair.

Daniel Hofkin -- William Blair -- Analyst

Good afternoon. I apologize if I missed this. I know you talked about your sales guidance by quarter the remainder of the year and within that, it sounded like the comp expectation was starting with Q2 some deceleration from that to Q4. Just curious what was driving that? It wasn't immediately obvious why you would expect comps to decelerate. Thanks.

Karen Boone -- President, Chief Financial and Administrative Officer

The real estate -- so when we open new stores those are non-comp so those are a bigger contribution to total revenue growth in the back half. So those are offsetting some of the -- we've given our total top line revenue guidance and if the new stores are contributing more, comp is there for less.

Daniel Hofkin -- William Blair -- Analyst

Okay, got it. Thanks.

Operator

Your next question comes from the line of Chuck Grom with Gordon Haskett.

Chuck Grom -- Gordon Haskett -- Analyst

I think [inaudible] sales were down 22% in the quarter. I mean, given the easier compares in the linear inventory, how should we expect this to trend for the balance of the year?

Karen Boone -- President, Chief Financial and Administrative Officer

Outlets were a two-point drag in Q1 and we expect a very similar drag in Q2 but by the time you get to Q3 and Q4, it should be more neutralized and roughly flat in Q3 and maybe down just under a point in Q4. So that's how that should landscape. And then skew rationalization -- and this is probably another point for Dan on that prior question -- skew rationalization, which was not in the outlets, it was just our core product that we were discontinuing, it was selling through the regular channels. That actually dissipated through the year too so that's another contributing factor to the comp. So, we have an easier compare if you will in Q2 than we do in Q4 when there wasn't that much skew rationalization left. In addition to the real estate lessening impact of skew rationalization is another factor at play in the sales cadence throughout the year.

Chuck Grom -- Gordon Haskett -- Analyst

Got it. And then just switching gears a little bit. I appreciate the margin bridge, the long-term guidance. I guess, is the expectation that some of the new businesses that you've kind of been holding back on over the past three years that they'd be relatively flat to margins going forward once you do start to roll those out?

Karen Boone -- President, Chief Financial and Administrative Officer

Those are basically the new businesses. We wouldn't expect those to be a significant impact, positive or negative to margins at this point.

Chuck Grom -- Gordon Haskett -- Analyst

Got it. Thank you.

Operator

Your next question comes from the line of Oliver Chen with Cowen and Company.

Oliver Chen -- Cowen and Company -- Analyst

Hi, thank you. Regarding the inventory, you made some really good progress. What are your thoughts about the breadth versus depth now? And it looks like you can continue to maintain great revenue growth with less inventory, which is encouraging. I'm just wondering where you are in the context of that strategy? And Gary, as you think more broadly, would you ever intersect hospitality with membership in terms of having a membership model within hospitality and/or think about shared workspaces? Just because a lot of the consumer model with millennials in the on-demand lifestyle is also shifting in that way as well. Curious on your thoughts.

Gary Friedman -- Chief Executive Officer

Let's start with the inventory. I think by the end of this year the inventory will be relatively close to optimized. And then I think we'll hit turns -- turns is measured internally the way we measure them getting up three-seven. Maybe we can run the turn to three-five to four depending on how we're buying or how much newness we're betting on. But I think we can maintain these high turns. It's just simplification of the DC network design and how we design the network. It's just going to be way more productive. And then obviously benefited by the consistency of membership -- smoothing out the business which allows you to buy it better. When you're wrong, you're not as wrong and so and so forth.

As we think more broadly, would we intersect membership and hospitality? It's funny, we get a lot of feedback from people and one of the things we're struggling with -- or I don't know struggling with, it's a good problem to have where we're now extrapolating what we're doing in these other restaurants and then saying, what does that look like on the rooftop in New York? And how are we gonna run that volume? We could have a $15 million restaurant on the rooftop of a retail store and how does that impact our business and how do we think about the inside of the restaurant? The outside people buying a $4 cup of coffee and have a business meeting for five hours on our outdoor furniture on a nice table? Many ideas.

And people saying, well, why don't you make it a members thing -- you have to be a member to eat at your restaurant and so and so forth? You could do that, at the same time what we really want people to do is discover the brand and discover RH because people don't go to furniture stores very often. If we all just step back and say, how often do you go to a furniture store? Not very often. And so, you miss the opportunity to inspire people, to give them ideas, to help them see their home in a new way. I like the openness of it. We can naturally edit it around price point and offering and attract the right people. But I like the incremental traffic.

There are the Soho House and other people that are doing what they're doing -- they're great at that. It's not really who we are. I never want to say never but I think obviously there's been a lot of discussion around how to think about membership and how does it integrate with hospitality or the other pieces of business. The thing about shared workspaces, I think the same way, I mean WeWorks is fantastic, they're doing a great job, they're the market leader. Could we do that? Sure. Soho House is doing that; other people are trying to do that, just like other people are trying to be the Soho House. No one is anywhere near as good as the Soho House. Other people are trying to do WeWorks -- no one, I don't believe anybody's gonna be as good at WeWorks as WeWorks.

We just want to really be great at RH. And we think if there are markets where there's an opportunity to be truly distinctive and differentiated, we will test those things. We believe that in hospitality, which is why we're testing a guesthouse in New York. We think that there's an opportunity to bring a product to the market that does not exist. It's not about -- people ask things like, "Oh, so you're gonna sell your furniture in your guest houses?" Nope. That's not what we're doing. We're gonna build a hospitality experience that does not exist; that's tailored to what we believe is fantastic and great and missing. And so, we'll learn. But we're not rushing out to get into a whole bunch of new businesses that we're not good at and we don't know a lot about. We really want to own this business.

Oliver Chen -- Cowen and Company -- Analyst

It's very helpful. On the strategy of simplify to amplify and thinking about customer centricity -- what are kind of the simple key metrics, you're looking at regularly just to judge yourself with this idea of customer centricity and being on top of satisfaction and the way in which people perceive or receive your brand?

Gary Friedman -- Chief Executive Officer

We're looking at all the metrics that everybody else is looking at and some that are unique and specific to us that -- I don't know if it's that important to talk about but the good thing about the retail business is you get a report card every day. We know how our sales are every day at what margin every day. We know the average order value every day. We know what they're buying every day. We know specific products they're buying every day. What finishes they're buying every day. There's plenty of metrics here that are important that we review and obsess about. I think it's not even so much about the metrics; it's your ability to draw the right insights.

There are a lot of people in the world that are great at reporting the news, not making the news. And it's really about being able to take data and turn it into insights and from those insights conceptualize new and better ways of running your business and I think if you look how we're running our business, we're running our business in a very unique way. We're pretty counter to almost everybody in the industry. People are shrinking the size of their stores and closing stores. We're building the biggest specialty stores the world's ever seen. People are eliminating catalogs; we're mailing inspiring sourcebooks that rival some of the best-produced magazines in the world. You look at how we merchandise and assort our business, just moving from promotional model to membership model. Just about every aspect we take we tend to be the others; we tend to be going the opposite direction.

Not because -- hey, we should go the other way -- but I would tell you most of the winners in the world when you really look at whether it's countries or businesses or cultures or individuals and so and so forth, the ones that tend to really win tend to be doing something unique because they have better insights than other people. It's not so much; do we have the right metrics? Everybody probably has similar metrics in this industry. Do you have the right insights, and from those insights can you conceptualize a better methodology and a better outcome that you can actually bring to life and execute to scale? Which is also hard to do. I don't know if I answered your question but that's how we think about it.

Operator

Ladies and gentlemen, I thank you for your questions. I would now like to turn the call over to Gary Friedman for our closing remarks.

Gary Friedman -- Chief Executive Officer

Thank you, everyone, for your interest in our brand. I would like to say congratulations to our people and our partners around the world who work so hard and bring their passion and energy to bring our vision and values to life each and every day. We spent a good 18 months marching through hell in this company and it's nice to get a taste of heaven on the other side. Thank you for believing everyone on the call and there's more good news to come. Thank you.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

Duration: 57 minutes

Call participants:

Cammeron McLaughlin -- Investor Relations

Michael Lasser -- UBS -- Analyst

Karen Boone -- President, Chief Financial and Administrative Officer

Gary Friedman -- Chief Executive Officer

Peter Benedict -- Baird -- Analyst

Steve Forbes -- Guggenheim Securities -- Analyst

Matt Fassler -- Goldman Sachs -- Analyst

Brad Thomas -- KeyBanc Capital Markets -- Analyst

Geoff Small -- Citi -- Analyst

Adrienne Yih -- Wolfe Research -- Analyst

Daniel Hofkin -- William Blair -- Analyst

Chuck Grom -- Gordon Haskett -- Analyst

Oliver Chen -- Cowen and Company -- Analyst

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