RH (RH) Earnings Call Transcript & Summary

Allison, is your line muted? My apologies. I believe we can proceed straight to the Q&A portion now.

Oh! No, that's fine. I'll get us started. Thanks. Good afternoon to all of you. We appreciate you being on this Q&A conference call for the third quarter of fiscal 2020. With me here today are Gary Friedman, our Chairman and CEO, and Jack Preston, our CFO. Prior to getting underway, I want to bring up our legal disclaimer — we will be making certain forward-looking statements today within the meaning of the, pardon me, federal securities laws, including statements regarding the outlook for our business and other matters referenced in the press release we issued today. A number of risks and uncertainties are involved in these forward-looking statements that could cause actual results to differ materially. For a more detailed description of the risk factors that may affect our results, please refer to our SEC filings, as well as the press release we issued today. Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events; also during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. Additional information regarding these non-GAAP financial measures and a reconciliation of this non-GAAP to GAAP measures can be found in today's financial results 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 begin our Q&A session. Operator, we are ready for questions.

Great. Thanks so much. Good afternoon; and I just have to say, wow. I mean, this really is a remarkable performance. So congratulations to everyone at RH. Gary, I guess my first question for you is, previously you've talked about two macro drivers that help the company. One, being high-end housing growth, and the second being strong stock market returns, and right now we have both. And looking at history, how long has the — what's the lag in terms of the effect, and obviously, we're seeing it kind of immediately today. But what has been the length of the positive impact on your business from that? And then my second question is, the sales galleries in Europe, what size are they going to be and how should we think about, I guess, the yearly sales contribution from each of those? Thanks so much and congratulations.

Thank you. Thank you. It's difficult to be specific about duration. I think it hinges on how severe the correction is in any of the markets. In particular, we've seen, as you know, with sharp stock market moves, sometimes consumers at the high end will pause. So it's hard for us to kind of give you a figure or range there; but I'd say, there's nothing different from how you might assume consumers would behave depending on how severe the changes are in a marketplace. I would say, we see a very healthy home market, right? And I've been asked recently about Keith, how do you feel about the cities you have galleries in that are consumers or moving out of some of the key dense cities because of the pandemic and there's a boom in the suburban housing market and the second home housing market. We are generally — I would just say, we're generally indifferent, because people moving and buying homes is just a good thing, right? We have galleries in every major market. So that will all kind of balance itself out and our key market galleries like New York tend to draw from the broader suburbs and everywhere, because it's where our best assortment is. But this — the uptick in the housing market and how long will that last? Again, we don't have a crystal ball. There's usually a longer tail there, because as anybody on the phone knows, if you've bought a new house or moved into a new house, it triggers a lot of spending on the home and it's not an easy job.

This is going to take a while. From the housing market shift alone, the tail we're seeing looks quite favorable, though it's tough right now to predict what the stock market will do and how it will interpret the next phase of the pandemic; we also can't easily grasp how the market will rotate through what people call the stay-at-home stocks versus the rest; and honestly, we make an effort not to fixate on matters beyond our influence. Still, when you consider the galleries in Europe and how their sales contribution ought to be viewed, our thinking is that it's clearly quite different when seen through the lens of the work involved. Take the U.S.: nearly every new gallery we open takes the place of one that already exists. That has a real upside, and yet there's also the angle that risk is minimal and we have plenty of precedent; we know of a gallery generating $18 million, and when we launch a new one featuring hospitality, typically somewhere between the first 12 months and 36 months, that figure will climb to double, $36 million, and in every one of those markets we possess a benchmark. When it comes to going international, though, no stores are being replaced. That leaves a degree of uncertainty on that side. And that can work against you, since guesswork increases and the data available shrinks. That said, we're fairly precise about what our U.S. expansion will produce, and even in fresh markets — when we launched in new U.S. locations, our performance predictions were fairly accurate. Internationally, then, we hold less data; the exact reaction is something we can't know. So that's a drawback. On the plus side, here's how to frame it: what you're opening isn't a market, it's a country, correct? So consider the U.K. as a starting point. California right now, roughly speaking, is directionally a $500 million market for the business, before accounting for all the gallery conversions. Down the road, likely a $700 million-plus market for RH, probably, as we keep broadening the assortments and turn into a more disruptive, dominant brand, which helps California over time — perhaps it approaches $1 billion, $800 million, though $700 million is easy to envision when you consider California's transformation. Now compare the U.K., with 68 million people, against California's 39 million — 39 million people. Demographics are comparable, wealth populations are comparable, and so forth, with density barely differing; so you launch a gallery in England, in London, or wherever, and our strategy there is rather distinctive. We're about to unveil an absolutely fantastic gallery — from an image standpoint, from an impact standpoint, from a conversation-starting standpoint — RH England, this stunning estate sitting on 73 acres in Oxfordshire, only five minutes away from Soho Farmhouse. People have referred to it as the coolest house in Great Britain. That said, it's somewhat removed from where the population centers are. It's going to generate a great deal of awareness for the brand, simply given the footprint and how unique the gallery is, and it's got a wonderful size of — I believe it's 50-something thousand square feet there, plus the three buildings. Then you've got a completely different one in central London, in Mayfair, correct, where we sit right in the middle of everything, framed by Savile Row and Burlington Gardens, and we're a block off New Bond Street, the Ralph Lauren flagship, and the large project that LVMH is doing. And nobody is going to — and all the affluent people, nobody will overlook us there. My sense is everyone will hear about us in Oxfordshire. How many will actually show up? Not certain; but the way to think about it isn't merely that you're always — you're unlocking the whole direct market, correct? And we've always been a brand. We used to call ourselves a direct centric brand. If you think about it — and it's amusing, since I just wrote about physical first strength. And at some — and that's — and some folks think, oh, he doesn't believe in the Internet, since he's building these large stores, these large galleries. But the way we even reached the point where we are today is that we accomplished that via the direct business, correct? When we began here, where these small stores existed and we had a small assortment, and there's simply no way to present our assortment within the 6,000 of selling or 7,000 square feet of selling; we had the average galleries, and we had a strategy we used to discuss as kind of the first leg as a public company and didn't discuss it as much when we reentered the public market. But we still discuss direct center growth. What we meant by that was, we said we were going to size the assortments to the potential of the market, not restrict them to decide to the store. And use the stores and the website to reach a far broader market; and through that, we managed to grow the company, a company that was on the verge of bankruptcy, in a very capital efficient manner; and that is going to kind of play through when you consider moving into new countries, correct? Here we began with 106 stores and we kind of right sized it down to what we think kind of it was 60, 70, whatever it ends up being as we optimize the footprint. I'm not sure we necessarily need to keep as many galleries in Europe, correct, since the Internet keeps getting better as a way to shop or to convert, right? So if your positioning is strong, you might not require as many brick-and-mortar locations. The thing is, at this point we understand what the physical stores accomplish. We know that in every market we can double the business, and from a retail standpoint too. So when you launch a gallery or two in England, again and the greater U.K., we launch a gallery in Paris, right? You're going to unlock all of France and larger portions of Europe. We're going to unlock your business to all the travelers. And so we aren't certain exactly how to think about that until we until we have a couple; but I would say the asymmetrical risk to the upside from how we think about our business, because we've been a company that had yeah before we are transforming our galleries when our galleries were undersized. Half of our business, 50%, was direct to customer, omnichannel, digital first, whatever you want to call it. We just call it online or on our website it's where it's transacted. And so we believe opening up markets is — opening up countries is a big deal, a really big deal; and that I think gives us asymmetrical risk to the upside, downside of maybe not having as much specific data, right? Like it would be like that's being the brand start today where kind of the awareness we have today and opening up California with a magnificent store in LA, right, at an incredible gallery, I don't know, call it in the Napa Valley or somewhere that people visit vacation and go to for weekends. So what does that do? We think it's some kind of a really good outcome would be our best use today.

That’s very helpful. Thank you very much.

Yeah.

Hey, everyone. I really appreciate you taking my question, and congratulations on the strong quarter. It's genuinely encouraging to see your cancellation rates sitting under where they were a year ago. Do you believe that can hold up going forward, or might there be some exposure given that supply is going to lag demand for a stretch longer than you'd earlier expected? Then, on a separate note, what's your current thinking around priorities for allocating cash? Your free cash flow is beginning to build, and with fewer big capital-intensive projects plus debt maturities, might we see faster buybacks, one-time dividends, or acquisitions? I'd just like to hear how you're looking at it. Thanks.

Yeah. Cancellation rates have now been lower for a number of quarters. So the pattern suggests there isn't exposure, correct? And I'd say there isn't exposure because, first, I don't believe we face much direct competition at our spot in the market; we're among the very few who carry higher-end luxury home furnishings; in most locations, it's a far longer wait for custom, and so on and so forth. And I think the customer requires the product, and I simply don't think anyone else has inventory, right? I mean, we're carrying the largest back orders in the company's history across my 20 years here now. So this kind of phenomenon is something I've never witnessed, right? Back orders at record highs alongside cancellation rates near record lows is something I've never witnessed, right? So, first, that shows you the customer likely lacks many alternatives, and whatever alternatives they believe they have also lack product ready to ship immediately. And they truly need the product, so in many instances they're compelled to wait, right? So you sort of think, gosh, if I don't place the order today, how long could I be waiting, right? How many additional weeks could the delay stretch? So the figures would show you across the recent quarters that exposure doesn't appear to be there. That isn't to say things can't shift. I simply can't identify any reason they would shift. So our confidence level for turning those orders into revenue is extremely, extremely high, right? We now have plenty of data and very, very steady back order patterns moving lower rather than higher, back orders have sat under where they were a year ago and they were low — which is why back orders, pardon me, cancellation rates are under a year ago and they're under where they were a year ago last year. And as back orders have climbed each quarter, right? Since you can't, when things clearly began rising, we weren't purchasing for ourselves, though we'd canceled orders—so when they climbed 20%, we purchased at 20%; then they rose 30%, and you—they're purchasing at 30%, then it hits 40%, and it's like, gosh, go ahead and purchase at 40%. Let me say, hold on a few more weeks, and then you say, fine, it appears to be a trend, so you purchase at 40%; thus we're on a compounded basis, and then they reached 47%, correct? So we sort of fell behind, right? So as we believed we'd begin catching up, we also—we actually dropped further back since demand kept speeding up, and you'd have expected cancel rates to be affected. Yet for the reasons I mentioned, I think they haven't been affected, and now I hold a more solid view that I don't think they will be; that doesn't mean we can't be mistaken on that, but that's our perspective as of today. And when we consider cash allocation priorities, look, we're in a world where things shift every day, right? Once more, we are—we just entered the State of California shelter-in-place orders, right? Retail is running at 20% capacity. The malls and shopping centers see less traffic than they've seen over the past few months. We just witnessed the harshest decline from the Black Friday to Cyber Monday selling seasons that we've ever witnessed; and talking with other retailers and leaders in the business, folks saw a huge drop during that stretch, like, we're sitting here saying, oh, like, we just orders is the tailwind finished and it just appeared that given the fact that the virus was spiking, people chose not to head out and shop and suddenly, once we get beyond Cyber Monday, our business began to ramp back up; so when you're in that sort of business circumstance with so many unknowns that we're in, whether you've got a headwind or tailwind, it doesn't—to me it doesn't really matter. I mean we have more optionality with the tailwind. And I—do I feel better being on this side of the table than maybe apparel folks or other folks had their business or restaurants and other folks had their business devastated? Yeah, of course choose the side we're on. But it doesn't mean you ought to adjust anything long-term. It means you ought to just sort of do your best day-to-day, week-to-week, month-to-month as new data comes in to make really good decisions for what you know and don't lose sight of your long-term vision and strategies that will create—that you believe will create significant shareholder value long-term. Also, I believe we've demonstrated it through the major choices we've made and by transitioning away from a promotional approach toward a membership one. Once more, when I spoke about having far too much assistance for heavy causes and remaining committed to that, and about overhauling our entire method of conducting business. That was a long-term perspective, and we refused to let short-term distractions pull us off course. We rebuilt and re-architected the company's whole operating platform, and there was plenty of short-term noise while we did it. We kept our attention on where — on how we might generate long-term value, and that hasn't shifted. That's the reason I wrote one of my lengthier shareholder letters in this instance, attempting to provide you with as much detail as possible about how — as transparently as we can about how we view the business, though things shift constantly. So in order to sort of hold a firm stance regarding what you'll do from a capital allocation standpoint, buybacks or M&A or other matters, like, we will always remain opportunistic. But I — it's simply difficult to sort of pledge to too many things right now. I mean, we felt quite sure we would open RH England, and then suddenly travel closes down in the U.K; and we can't go unless we quarantined for two weeks. And you can't dispatch your leadership team and other folks to go quarantine in a hotel for two weeks, to work two days and return. And so we simply decided, like, yeah, it's not a good time.

We had to decide to put money into distribution infrastructure, other investments, personnel, and things of that nature. And we said, look, taking a long-term perspective matters here. That perspective means everyone will still be around if we hold off until ‘22. We will be better prepared. We will perform at a higher level; we will gain more visibility. We will grasp what this looks like once the pandemic is behind us; so, at this moment, I would simply say there are too many moving parts to commit to any particular activity. Should the right thing come along with asymmetrical upside risk, where genuine opportunity exists, we will pursue those things. We've wrapped up a few minor purchases, which I think you'll spot in our filings, even though they don't really move the needle. Still, we're taking opportunities to do things that lift the brand and invest money into it, and that kind of activity will continue. As for making big share repurchases amid all this uncertainty? I doubt it. Not right now. My view is we should let some time go by, and it's really no different than — look, I think we're being quite wise not to take on debt immediately, and when the pandemic struck and our business fell off, it shifted by 50 points, correct? There's a common refrain that we're short on cash. That's the impression people have, and we actually looked into it. We built in a great deal of flexibility. We had many avenues available for bringing in capital. Borrowing costs would have been extremely steep. That capital would have come with a very hefty price tag, and it could have given us some flexibility. But there's just no reason to expose yourself to risk when you lack genuine, solid visibility. Take, for example, the view that repurchasing close to 60% of the company for $1.2 billion was a major gamble. To us, it wasn't a gamble at all, correct? The reason is that we had a firm grasp on what the outcome would be. We had a firm grasp that we would be — we design the supply chain. Between $400 million and $500 million comes out of inventory. We anticipated the outcome. Our assumptions were solid. Actually, I'd say our assumptions were genuinely strong. We understood our operations deeply, and we took certain steps that appeared risky to outsiders but struck us as having better odds of upside than downside. So right now, I think it's simply this — we're operating in a highly unpredictable period; we shared all the guidance we could, and I tend to view it this way — evaluate it across a two-year window, correct? The first half of fiscal '21 — sorry, fiscal '20 — declines, while the second half rises. The situation in fiscal 2021 is completely reversed. If you take those two years as a pair, the question becomes: after everything evens out, what sort of company do you believe you're running? Our belief is that this business is on track to rank among the genuinely exceptional companies, and that's precisely where we're focused. That's how I'd put it when describing our current mindset.

Understood. Many thanks, Gary, and I hope everybody enjoys the holidays.

Appreciate that. Best wishes for the holidays to you as well.

Good afternoon. Hey, Gary. Perhaps to begin, during the prior call, you discussed at length the reallocation of human and financial capital, correct? And I'm curious whether you might give additional context regarding the potential advantages there, right, as you work through those changes, and is the debut of RH Contemporary, right, along with RH Color perhaps an outcome of those efforts, or how would you characterize the potential advantages, right, of that strategic shift and the choice not to drop the sourcebook in the fall?

Sure. Look, the reason we held off on sending out the sourcebook in the fall comes down to this: inventory was already way behind demand. Putting it out would've just made things worse — we might not have been able to fill orders at all, and we'd have ended up with unhappy customers dealing with ads and everything else. So yes, we did sacrifice some revenue by skipping that mailing. If we had sent those books, would we have seen extra sales? Absolutely. Would backorders have gone up? They would have. Would customers have gotten more frustrated waiting? Without a doubt. So our view was that the smart play for the long haul wasn't trying to fine-tune operations while the pandemic was going on — figuring out how to redeploy our people and keep our eyes on the future. Instead, we redirected our hours and effort into different areas, and contemporary was one of those. We deliberately delayed launches that would have driven sales right now. It makes me quite optimistic that our main segments recovered to a 39% gain — 39% higher, without any books, without anything new. And remember, we're comparing against last year's book. When we compare to what we launched a year ago, we're still posting a 39% gain. Could that figure have been 48 or 52? Possibly, I can't say for sure. The tradeoff is that operations would have gotten sloppier, and letting things get sloppy isn't something anyone should want. I've been in charge of businesses like that before; this one has also operated in a disorganized, chaotic fashion previously. It's really no different than — anyone glancing at what lands in their email inbox can see plainly that during one stretch, hardly anyone was out there marketing. It seems like we're in a stretch where promotions are everywhere. My take is that plenty of folks in retail are throwing more promotions on the pile to keep things hot. In my view, that isn't a smart way to think long term, since you'll be facing all of that again next year when you're dealing with a cycle of tough comparisons. When I look toward the coming year, I actually feel quite optimistic. We're sitting on a cycle where demand is up 40. That figure might come in lower for this fourth quarter, given that we didn't send out the books and we lack the newness. Yet as we look to the coming year, there’s a great deal of fresh material headed our way, and our assortments will be carefully conceived and purposefully designed. We’ll be even more deliberate in our strategy, and we’ll have the ability to put money into other parts of the operation that lift the brand higher. So our outlook on the year ahead feels quite strong — barring any major shock. Sure, the market could tumble and the home category could collapse; still, on the whole, I’d say the upcoming year is coming together nicely thanks to choices we’ve already made. I’d say we’re genuinely thrilled. The pipeline holds an enormous number of new items — arguably more than we can handle. We need to stay rigorous regarding how we commit capital on the inventory side, on risk, on newness, yet what’s coming is a wealth of excellent newness; and I believe RH could, for a period, unlock a completely different tier of the market — one that for us bridges the distance between the sort of updated classics in interiors and the sharper, more modern edge, while adding aesthetics we simply hadn’t gone after before, done in a distinctly RH manner, through our own singular perspective — and I expect consumers will find that genuinely thrilling; plus we’ve brought aboard some extraordinary new talent on both the design and artisan fronts. I’m not sure whether anyone has seen the latest Architectural Digest. You’ll find a two page piece covering Alison Berger joining our platform with some remarkable new lighting concepts; and Alison ranks among today’s finest lighting designers and glass designers anywhere. I mean, yes, her work was sold only through Holly Hunt’s platform, and Holly Hunt has long been regarded as the premier high-end interior design showroom across the United States. And here you have somebody like Alison shifting over to our platform, sort of setting things right once more, correct? And — yet it comes down to the product, the individuals coming onto the platform, and the individuals joining the cause. There is simply enormous momentum behind our brand at present. On the human capital side, both within RH and beyond it, people are going to add to RH. In design, manufacturing, business acumen, merchandising strength, and so on and so forth; so I suppose the way to frame it is that a balance has to exist — not simply churning out the books with no newness and then recycling that into the following year. And not merely churning out the books, but churning out additional books, with greater unit volume, since you’ll have contemporary offerings and you’ll have this sort of rising momentum; now, what will the markets do? Do we believe some air will escape from demand? Is it our belief that — you can’t — anyone would be foolish to assume this sort of thing persists for a genuinely extended period at this level. For instance, our view is that it’s — you’re going to see it cycle. Normalization will occur. From where we sit, momentum will remain within the home business thanks to the long tail, and that kicks in whenever individuals purchase residences and relocate. Yet over the long term, if you simply consider the strategic actions we’re taking, those aren’t temporary. The pandemic is temporary, correct? What we’re doing is systemic and strategic, and these things will endure for a great while. That’s therefore what holds our attention. Among the actions we’re taking, the investments we’re making, these will lift the RH brand and make our brand worth more in the market — more wanted, more distinctive, more genuine. And these will carry enduring worth, since — look, our stock climbed $120 or $130 across the past 30 days, or roughly that. I mean — share prices will fluctuate. You’ll encounter, you know, the near-term matters are, you’re able to fixate on those and then you begin in some sense running your operation, correct? And a manager typically coordinates and arranges the existing state of affairs while attempting to safeguard what exists now. We’re builders in this place. Nobody here carries the title of Manager within this organization. We’ve got only leaders. And leaders bring individuals to places they’ve never visited, accomplishing what they’ve never accomplished, correct? And they construct things while constructing worth, and that represents our company’s culture. Were you to step inside our Center of Innovation, you would pass through a portal bearing the words, RH, the home of the extraordinary, the remarkable and the amazing, right, since that reflects our thinking, correct? What do we concentrate on that is extraordinary, remarkable and amazing? That’s the type of effort — that’s the type of concentration required to create one of the most admired brands in the world, and that is our DNA. That is our concentration. So everything else amounts in some sense to noise and distractions. What counts is those major actions and major investments set to keep transforming everything for an extremely long period.

Then perhaps a brief additional question for Jack. I’m not sure whether you could address what an appropriate expense level would be when we consider 2021, or perhaps you’d prefer to use the third quarter as a starting point and assist us in understanding which temporary elements were involved, correct, such as eliminating the sales organization and similar items, when we build our 2021 models?

Guidance isn’t something we provide. Our outlook was shared with you, and I believe it demonstrates our assurance regarding the company and the operating framework. Additionally, a few areas I aim to keep reinforcing include gross margin and product margin, which represent a significant portion of the narrative; and as we consider the future and our assurance about achieving the 25% margin within our outlook — our more extended outlook, I mean, that — these constitute the robust aspects of the narrative. Regarding particular items for 2021, providing them now isn’t something we can do. I’ll check with Gary to see if there’s anything more.

No. What I'm saying is, our expectation is that we'll see revenue increase by double digits while operating margins get wider. As the pandemic continues to unfold and the world gets back to something closer to normal for people, we'll learn more week by week and month by month about how folks will act and what will take place. But — from a cost standpoint, we won't overextend ourselves on SKUs, correct? And if we did — there's no way to know, so we're in a situation that's temporary in nature. You need to be shrewd about that; that's the reason we're confident margins will keep getting bigger, since we have solid control over expenses and clear visibility into the product pipeline and what we think the margin structure can be from a product standpoint, and that's the main lever. As for expenses, we've been quite disciplined here when it comes to investment; it's a — our culture tends to avoid spending money; our culture puts money to work depending on what we believe the return on that investment will be, what sort of return it will produce. So, provided we maintain that discipline and avoid growing complacent or arrogant because of the business trends occurring right now. We keep our edge. We stay unsatisfied, serious, critical, forever incomplete, forever in motion, and we'll keep doing excellent work; so I don't believe anyone else is providing you with significantly more information than what we're giving you today; so I think our — there's a great deal in the shareholder letter.

Thank you both. Happy holidays.

Happy holidays, Steve.

Hi there. Appreciate it. Evening to everyone. Could you fellas give us a sense of how large the opportunity in the outdoor furniture sector might be for your company? Then, for Jack, I'm attempting to grasp the link between deferred revenue and customer deposits on that balance sheet of yours — I think it's more than 60% higher versus a year ago — while your demand comp sits below that figure. Could you tie those two things together for us?

Sure. Well, look, outdoor — I'd describe the outdoor operation as being quite similar to the broader RH operation. Once you establish a brand such as ours, in many respects you're actually building a market. You're motivating folks to buy and put money into things, as opposed to other things they might have bought and invested in, based on whatever catches their eye. It's just like Apple built a brand-new market — they didn't examine the cellphone category and ask how large it was. Apple essentially created an entirely fresh market centered on smartphones and the iPhone. Nobody imagined it would sell in China. It wound up being the top-selling phone there. If you develop a genuinely strong product — and I don't mean merely one item, I'm referring to a completely integrated branded offering — you get the chance to build a new market, correct? To expand a market disproportionately, since you're introducing something that didn't exist previously, correct? I believe that's taking place in numerous areas, correct? Consider all those brands building new markets; so with outdoor, it's largely the same story. If you simply stepped back and asked, where can you purchase outdoor furniture? There aren't many stores selling outdoor furniture that face consumers, correct? They tend to sit off the beaten path in odd locations. You can recall the names — you've driven past them before — but if you asked about high-end outdoor furniture, where would you go? Where would you even lay eyes on it? Where would you even feel inspired to purchase it? Nobody truly showcases it, since it leans more seasonal by nature when it comes to the business peaks. I used to joke with people — you may recall this was known as Smith & Hawken, correct? They launched roughly 50 stores, then nearly went bankrupt. They gave it another attempt. I'd ask, why didn't Smith & Hawken turn a profit? And I'd say, gosh, well, I'm not sure, I'd say. Well, mostly they had to cover rent, correct? They paid rent on the ground for a highly seasonal business. If you examine our approach and what we've accomplished with rooftops and terraces and similar things, we — inside our new galleries we showcase somewhere between 20 and 30 outdoor collections, depending on the outdoor garden area and the rooftop area. In the outdoor furniture sector, no one interacts with the customer in that manner. Since we engage buyers that way given today's conditions, a fresh market is being established by us; and within outdoor furniture, we're building that fresh market with an extremely strong return on invested capital. Thus we genuinely appreciated that business and asked, well, why can't competitors pull that off. Well, competitors don't construct galleries on our scale. Consequently, their rooftops could never match ours in size, correct? They lack our command over real estate, plus they don't — replicating our approach is incredibly difficult, correct, and that's — and this is why the tangible aspect of our operation matters so greatly, correct? For instance, I'd argue that the — an online site is a store you cannot see, correct? It isn't visible to you. You don't walk past it. Someone must nudge you toward visiting it; whereas with these brick-and-mortar locations, folks drive past and notice — provided you're positioned well, you're in the — you'll remain perpetually in view, and you can showcase goods and classifications in manners impossible on the internet. In the online realm — and digitally, this is extremely egalitarian, correct? We — everyone gets an identically sized display, once more, perhaps, some shop could appear equally large as RH on the web. And I don't mean to reference Holly's home stores. No one is called Holly. That simply denotes a pricier regional furniture boutique that an individual operates. And — yet such enterprises cannot replicate us, which is precisely why we're so revolutionary. So when disruption hits you that way, you're capturing share. Yet even most — more crucially than capturing share, a fresh market is being created by you, and that's our perspective on it; and after that, Jack, perhaps you could weigh in on whether you …

Yeah.

…deposits and revenue.

Yes. I mean, clearly, given how strong the business is, the heavy demand, and the supply chain limitations we discussed, those represent the two items — two critical items — that you will observe expanding alongside customer deposits and, in a sense, deferred — the special order business we operate that increases those customer deposits. And then, as the business expands, you will naturally see growth in the deferred revenue balance. You are examining year-over-year. I would suggest you also look, in a sense, sequentially, at how Q2 to Q3 grew as well. That was roughly an 18% sequential build. So I think you will examine both, don’t misunderstand me. But I think regarding the impact from walking down from demand down to revenue growth, you kind of want to look at that sequential build; so, as I said, that was an 18% growth and very much expected relative to the trajectory of the business.

That’s a helpful way to frame it. I’ll take it one step at a time, then. My follow-up question is this: I’m curious whether you have a sense — and it’s likely more art than science — of how much of your revenue growth comes from buyers who are actually purchasing second homes, or from people who are leaving cities for bigger suburban homes?

Chuck, we’ve examined the data. The data shows exactly what we’d anticipate: suburban homes are seeing high growth rates, and second home markets are seeing the highest growth rates. Then, as Gary mentioned, there’s an exodus out of cities. So — but again, we’re in all these markets, and our customers, whether they own a primary home in an urban market and happen to be moving out there — it’s all ultimately good for our business. We haven’t dug into much more detail. But I think the trends, as I said, that hierarchy of second homes having the strongest growth, suburban very strong growth, and urban being the weakest of the three. Again, it’s kind of a firm grasp of the obvious, as we sometimes say. But I’m not sure, Gary, do you have anything else there?

No. No. I mean, take a look — our company has forever had its largest segment rooted in the suburbs, correct? That's where you find bigger houses, and those bigger houses come with additional bedrooms, additional living area, space for outdoor furniture, that kind of thing. So it's no shock that this represents the biggest chunk of what we do. Consequently, the suburban segment — which makes up a very substantial portion of our company — has a tailwind behind it, and as folks relocate there, that benefits us; yet once more — it's, we're aware of every piece of data available to us — we examine it. I'm not sure whether any of that data pushes us toward acting differently or anticipating differently. It's not as though there are markets where we say, oh my goodness, people are purchasing houses in that place and they're unaware of us, so let's hurry and launch a gallery or something of that sort. I mean, occasionally you encounter a spot, alright, we've spent years examining Palm Desert down in Southern California and it's absolutely booming. And our Chief Gallery Officer visited his grandparents during Thanksgiving. He told us we truly, truly need a gallery in that location and I thought, yeah, it's on the list. If you feel that strongly, go locate a site and we'll secure it fast. I mean — yet it isn't — it isn't like oh my goodness. That's going to alter things dramatically. It's likely just a minor note. Still, we're extremely well-positioned across North America to take advantage however the market shifts. We simply appreciate that the market is rising, correct? We're well-positioned to take advantage. Regardless of where people relocate within North America. I believe the sole spots where we lack a presence are Montreal and Hawaii. Let me think. So there are a handful of locations similar to those.

Naples?

Yes. Yes. Yes. We — yes. Naples isn't where we are.

Right.

Our intention is to have a presence in Naples, though even without being located there, our performance in that market is strong.

Understood. Many thanks.

Hello there. I appreciate you fielding my inquiry. Gary, could you describe for us the sorts of shopper actions you're observing that are fueling such robust increases in demand? What portion originates with first-time buyers as opposed to those returning, and what portion stems from bigger purchase sizes? Is there a pattern where people are increasingly purchasing furnishings for multiple rooms within their homes, and is that where you're noticing this powerful surge in demand?

Our interior design operation continues to expand and has been expanding, so you would anticipate that a significant initiative such as this would do that. Everything here has gotten a boost, in a sense. If anything changed, our outdoor category performed extraordinarily well early on, since I believe many individuals recognized they wouldn't be taking trips during the summer and would instead be spending far more time at home. Yet shopper actions are — they haven't — there's nothing surprising given demand of this magnitude; it involves — first-time buyers alongside increased spending by those already with us, and that sort of thing. The measurements don't lead us to consider acting in any substantially different way from our current approach. So — yes, yes, therefore we — our operation is — has been expanding when you consider purchase size and that sort of thing. That's — since we have transformed the company from a — from merely imagining that we sell merchandise to, or developing merchandise and imagining and selling environments. And the work involved in constructing a complete interior design infrastructure across the country — if you visit our latest galleries, you'll notice the committed office areas for our interior designers alongside the design affiliates, plus the conference rooms and the areas we've laid out — it will demonstrate that this is clearly an area we're putting money into. So — and we believe that is going to generate strategic differentiation for many years ahead. Every one of these investments will keep generating strategic differentiation and make our brand more valuable over the long run, and that's what gives us the greatest confidence. Examine all these elements and ask, how will this appear across the coming 10 years, which I attempted to show people and explained what's behind me. I'm checking — yes, nobody has altered the whiteboard, so it's the identical whiteboard. That's the way we approach the company. As I've consistently stated, whenever people inquire — have inquired of me previously, may I purchase your shares? And I always respond by posing the identical question back: are you an investor? Are you a trader? If you're a trader focused on near-term sporadic fluctuations in the equity markets or quarter-by-quarter sorts of matters, then please don't purchase our shares. It will be a volatile stock, since we're constructing something unprecedented; it's going to be misinterpreted. There will be times when it's priced too high and times when it's priced too low, and you're going to lose plenty of sleep at night. Yet if you're an investor who thinks in terms of years rather than days, well, this is among the finest spots to deploy capital. That's what I said a decade back, and that's what I said half a decade back. When you examine what we've delivered, you'd probably tell yourself, gosh, I sure wish I'd simply kept my RH shares. Consider who our largest stockholder is right now — Fidelity — and that group at Fidelity that has been around from the beginning has never let go of their position. They've kept 15% of our shares. At one moment it climbed to nearly 30%, since we repurchased stock at the company and they faced a restriction; they weren't permitted to own that much, though they would have wanted to. Even so, that team hasn't parted with any shares since the IPO. And I believe they're feeling quite pleased about having put money into a stock in the — back when we listed at $24 per share, and we'll keep putting money into something that appears to be a solid investment, despite the fact that it has swung wildly up and down, correct? Being among the company's largest shareholders, folks sometimes ask me on days when the share price performs very well, or when it performs very poorly; my response is, honestly, that's not something I dwell on. What matters is recognizing this as an investment for the long haul. This is a wonderful spot for your money. And I suspect the temperament and composition of our investor base would give you the very same answer. So…

Yes.

Yeah.

For my second question, stretches like this where things get disrupted tend to be great moments for figuring out how to run things a different way. You had those extreme cost pressures in Q3, and we know part of the SG&A drop came largely from the sourcebook. So can RH now run its model with less cost intensity and fewer labor hours, meaning we shouldn't assume the same labor expense going forward — and how would you approach putting some of those savings back into the business?

Look, the models will keep evolving, correct? Take one easy shift in what we do: we moved from a legacy gallery to a design gallery. That design gallery essentially doubles the business, you know, somewhere between 1 year and 3 years. Which means we won't mail any additional sourcebooks into that market. Normally we don't. Maybe we do a small splash, since a new gallery is opening and we want people aware of it. But at that level, our ad cost — the leverage there is enormous. I believe people occasionally overlook this in a model like ours, since they look at this big gallery and think, oh, that has to be expensive. It costs far more, and they fail to consider the dynamics of what takes place, because nobody — nobody has ever taken a truly productive legacy store the way ours are. And then simply altered the footprint and more or less doubled their business. I've never witnessed that. We can do it consistently, all across the country; so when you consider ad cost, that hands you huge leverage. When you face a temporary circumstance like the pandemic and you choose not to mail a book, are there lessons to take from that? Sure, but it's actually — it's somewhat tricky, like, as we reinvest and send the books out, we mail the same volume as last year. We send more e-mails. Should we mail less? What should we test? I mean, we'll examine plenty of data. We'll run the models. We're constantly hunting for ways to be more efficient, to optimize. At the same time, you don't want to under invest in the business at certain moments. So — but our model — again, throughout, consider doubling your revenue at retail, which is the largest portion of our business in a market, and what that does to the cost structure at corporate. What that does to the cost structure across all the other operating areas, our distribution centers and so forth? You'll get leverage. As we’re ascending that luxury peak — elevating quality, desirability, and pricing — that’s what creates leverage for us, correct? Then consider how we operate with a permanent sense of dissatisfaction toward whatever results we’re delivering today; that’s simply our DNA, always searching for ways to improve. Consequently, we’ll have our cost structure, and we’ve got numerous programs underway, numerous investments being made that we expect to generate strong returns, making the model leaner and more profitable. So be it through labor savings — well, labor savings isn’t really the main thing — it’s leverage within the business and the strategies we’re pursuing that are driving greater profitability, correct? And we’ve got plenty in motion that we’re confident will deliver that, plus our track record over the past several years. I recall declaring we’d reach roughly a 10% operating margin, and everyone reacted, oh, you can’t achieve a 10% operating margin; so I just want to note that we subsequently reached 11.4%, correct? And look, I recall reading analyst reports about the company saying 11.4% — nobody’s — like, it exceeds whoever else and it can’t be sustained, correct? They only generate half the revenues of that other business whose peak was 10% or something, and 11.4% can’t be sustained — then we achieved 14.1% operating margin, and again everyone said it can’t be sustained. Now we’re going to land at 21%, and 21% on let’s say 7% revenue growth — really the right way to step back and view the pandemic is to compress the entire year together. We’ll only have revenues increasing 7% while operating margins reach 21%. Does it truly matter how those revenues arrived throughout the year, or does it matter that with 7% revenue growth they achieved 21%? So I’m not sure if absent a pandemic, would we have reached 20% or would we have reached 22%? It’s not as though the pandemic, from a revenue perspective, has boosted our operating margin this year; it truly hasn’t. If anything, it has deleveraged our operating margin this year. It rendered us less efficient when you examine how events unfolded. Consider this: we’re producing approximately $80 million to $100 million in future revenue. We expended all the funds acquiring all those customers, assisting all those customers, completing all the design work, and we’re receiving zero revenues this year — that $80 million to $100 million. Insert that $80 million to $100 million into your model this year, and what would RH’s operating margin be? Because there wouldn’t be much additional cost, correct? Most of the cost already sits behind us. We’d have shipping and similar items. Yet when you examine what drops through on that, operating margins would exceed 21%, correct? That's the thing I pay attention to. Hold on a second. My operating margin sits at 7%. They reached 21%, right? I mean, they were — at 14% we considered them elevated, and at 11% we considered them truly elevated, yes. And after that it gets you thinking about, oh, what's their next stop? Like we — when we claimed a clear line of sight at 2020, it simply arrived before you anticipated, correct? We claim a clear line of sight at 25%; we do have a clear line of sight. We believe it happens across the coming several years, everything hinges on what's going to happen. If — look, if a recession doesn't hit us, if a recession does hit us, we will halt right there. It will be reset. It will take somewhat longer. But if it doesn't and if the economy simply keeps performing, like if we merely expand it 8% to 12% a year, we are going to do pretty good. If we speed up, like we believe next year it's going to be double digits, right? So that's 10% or over.

So we wouldn't be saying double digits unless we felt it was fairly close to a sure thing — we're not even counting on what happens in the back half of next year. Once we lap those figures, I don't think it will look the way it does now. Still, we can look forward and point out that everything we're doing creates upside. Some things will cycle forward. There are pluses and there are minuses. Take the revenue we lost at our New York restaurant — just add it back, and that's no small amount; that location does very high volume. Once vaccines reach there, folks will begin returning to restaurants. And by the way, when you consider all the foot traffic we lost at restaurants — do you think we operate those restaurants only for the restaurant business? Absolutely not. That traffic fuels business in our galleries for our brand. So when you say, oh, the restaurant business, I'm not sure — recent months ran about 70% below our plan. When that recovers, a great many people will be in RH Galleries, a great many people will be finding plenty of new products, a great many people will hopefully draw inspiration from our environment, and there will be something like tailwinds. But the key thing is, don't lose sight of things because of the pandemic. It's been a wild year — down in the first quarter, stores shut. Stores shut for part of the second quarter. Then everything suddenly rebounds. I sort of watched the whole thing unfold. Revenues rose 7%, so it seems like, all right, we're slightly short of our 8% to 12% growth, yet operating margins will be 21%. I truly like this model; it's a genuinely strong model. I wouldn't wager against this team. We've delivered what we promised quite consistently, and we've blown past people's expectations in a big way over recent years, ever since we transformed the whole company across so many dimensions, and now we've got something like a brand with no peer. And our DNA is just hugely dissatisfied; we get very excited for maybe a few minutes, then around here we get really intense about what comes next and making things great. So I just — I like the path we're on. And as a major shareholder here, I really like the coming 10 years, and I wouldn't have said that if it truly weren't up on the whiteboard behind me. My team isn't even smiling, right? We look at this. We're big thinkers. We take a long-term view. I know many of your customers are focused on the short term; that's fine. Just don't buy our stock. I mean, if someone's looking to hold just a single stock over the long haul, this is a solid option.

That’s really useful. Thanks a lot, and enjoy the holiday.

Thanks.

Hello. Good evening. Thank you so much. So, yes, I'd like to focus, I suppose, on the RH contemporary line. Perhaps we could receive slightly additional information regarding the vision and the strategy. Gary, your description was that it bridges the interior and modern lines within the ladder. My assumption is there's — what I would say is, a very high likelihood, you wouldn't dismiss it if you believed it would take sales from what already exists. So, yes, I'm simply sort of wondering what provides the assurance that you believe this will prove to be a solid incremental business regarding how it stands apart from the other lines. Yes, what's the right way for us to think about it?

The way I see it is we feel thrilled about it and you should feel thrilled about it. Since we don't feel thrilled about things we have no desire to purchase and that we — what I mean is we are — perhaps we feel too thrilled about it, correct? If anything, late last night as the selling area was like, okay; so let's ensure we are examining the whole Board here, since it truly is exciting. There is a great deal of genuinely new product and so we simply believe it will widen the aperture of the brand. And yes, we feel truly thrilled about how our teams can handle everything simultaneously and we continue to kick the can down the road regarding color. We have got — I believe we are beginning to zero in on RH color. It's a difficult one, correct? We are a neutral space brand. We are somewhat renowned for our look in point of view; as a matter of fact, we are so renowned for it, that people who enjoy color sort of despise our brand almost like it offends them that there isn't much color in our age. But that's fine. We inform people that, look, there isn't much color in humans, correct? We are also some form of a neutral color from light to dark, correct? And that's the reason neutrals represent the biggest part of the market, since most great design reflects human design. That's why it's familiar and comfortable with it and that's why you go, ah, because it reflects self; but we do believe there's a market for color. It isn't the biggest part of the market; but that will widen the aperture that we are in. So it's just no different than beach house and ski house widened our brand. People talk like relatively small introductions, writing small books, but a big conversation. I can't tell you how many people have said, oh, I have got your ski house book. It can't wait; we are doing it. We got your test book and so forth, so a lot of these things too. Again, we say internally if you want to be part of the conversation you have to create the conversation, correct? Plus, modern will spark a different discussion. Hue will spark a different discussion. You simply need to execute those items extremely, extremely effectively. Yet you ought to feel genuinely thrilled about it, since we feel genuinely thrilled about it. And it’s — precisely what shape does it take, well, I’m unable to state that. It’s what they say. It will appear quite new and new; though once more, we prefer to claim that which truly performs well is new yet recognizable, correct? Thus you cannot make things that are excessively out there. Those are intriguing but typically not applicable to your company and fail to sell effectively. Yet we believe it appears quite new. There’s a recognizability to it and there are kind of truly excellent historical design cues that render it recognizable. So when we obtain items that are new and recognizable they tend to be quite excellent.

Got it. I'm looking forward to seeing that once it's out. Let me ask one more thing quickly. Turning back to Europe — theoretically, I'm not sure. Do you believe that — obviously there's a ton of moving parts and it's really early. But is it possible that the profit contribution ends up being bigger than the U.S. at some point, once you've got a bit of scale, based on what you said about maybe running a less dense category strategy, plus the extra international exposure you'll likely get from being in those major capital cities?

Yes. Everything from our research and due diligence points to the potential for margins that are higher than the U.S. And many brands, as you're aware, enjoy better margins and greater profitability abroad than they do in the U.S. That happens because you gain a lot of leverage from your cost structure, correct, provided you build it properly and aren't too redundant. In our case, right, there's no need for us to create redundant buying organizations, inventory organizations, or anything of that sort. I mean, consider it. We don't operate any cash and carry — what does our cash and carry business look like these days?

Less than a 1%.

I’d say, 1%.

Yeah. You are right.

It’s almost zero…

It’s a zero…

Almost, right, like…

Yeah.

There’s essentially nothing we sell. It used to be around 1% or 2%, and at this point it’s close to zero. Yeah, we simply — yeah, the holiday merchandise is gone. The ornaments and all of that were eliminated; so yeah, once in a while somebody purchases a few towels or similar items and carries them out. Mostly, we don’t actually keep any inventory in our stores. So compared with other models, ours has been — is extremely simple. Like, a person might tell me, oh, well, Home Depot or Target or others didn’t perform that well in Europe or elsewhere — yeah. Well, first, those are types of stores, not brands, correct? They’re stores that sell brands belonging to other companies. The majority of high-end luxury brands perform very well around the world, correct? And if you’re the finest within your category and we think we are, then those brands tend to do — they typically do far better, by an exponential margin, than the rest. And so — and then — and it appeared quite strategic; honestly I was pleased that we allowed ourselves a bit more time on Europe, since we had additional time to consider matters such as this Curtis, the margin structure, the way we think about it, the pricing. All the various subtleties, and to truly, truly think hard about these moves we’re going to make in positioning the business properly, since everything we’ve examined and read and all the points of reference would indicate we ought to have higher profit margins in Europe. Of course there will be some short-term, some expense yet minor expense deleverage as you build up the infrastructure. But that could resolve itself fairly quickly given the broad based market you’ll address by opening and just — by opening it just in the U.K., in London and England and Paris, and a couple of these galleries, even considering Munich and Dusseldorf or Madrid and Brussels, and once just with that small footprint. You’re going to reach a massive audience, correct, thanks to the Internet and thanks to the online component of the business. And by positioning ourselves in these kinds of extraordinary locations and stores and environments that we’re considering, it’s going to be a great new learning. I mean, I really — as much as I really didn’t want to delay it, it was simply the right business decision to do it, because we are so eager to learn. But I think what you’re saying is directionally right. I think it should be based on other points of reference more profitable or at least as profitable as our U.S. business; but it should create leverage, correct? So the net-net effect should be overall RH margins going up.

Understood. I really appreciate the consideration, and enjoy the holidays.

Thanks. Same to you — happy holidays.

Operator?

Ally?

are we still connected to the operator?

is that our final question, or does the operator have…

We saw three…