RH (RH) Earnings Call Transcript & Summary

Thank you. Hello everyone, and we appreciate you joining us for this Q&A session about our fourth-quarter and fiscal 2020 results. Gary Friedman, our Chairman and Chief Executive Officer, is here with us, along with Jack Preston, our Chief Financial Officer. I'd like to start by noting our legal disclaimer: some of what we say today will be forward-looking under federal securities law, covering expectations for our business and other items discussed in the press release we put out today. Such forward-looking statements carry various risks and uncertainties, and actual outcomes could differ materially. For a fuller picture of the risk factors that could influence our results, please consult our SEC filings and the press release we issued today. Keep in mind as well that these forward-looking statements represent our views only as of today's call date, and we assume no duty to update them or make public any revisions to them should new information or later events arise. In addition, we might discuss non-GAAP financial measures on this call, which modify our GAAP results by removing the effect of particular items. Details about these non-GAAP financial measures, along with a reconciliation of the non-GAAP figures to the GAAP figures, can be found in today's financial results press release. You can also listen to this call as it happens through the Investor Relations area of our site, ir.rh.com. Having said that, I'll hand things over to Gary to kick us off.

Thank you. Good afternoon, everyone, and we appreciate you joining us. On today's call, we're going to try a somewhat different approach. Some of you have told us that you're often in a hurry and don't always get the opportunity to read through the letter before the call starts, given that only an hour passes between the release coming out and this call. The suggestion we received was to open by reading the letter aloud, so that all of you have the same grounding in what we've just communicated, and it may also raise and enhance how good the discussion is from here on. I'll start by going through the shareholder letter we just sent out to our employees, partners, and shareholders. We're marking the anniversary of one of the toughest years in recent memory, and now that we're beginning to glimpse light at the end of this deadly, disruptive virus's dark tunnel, we feel a deeper appreciation for our freedom and for life's simple gestures, such as a handshake or a hug. We also reach this turning point aware that we spent our time well, reimagining and reinventing ourselves yet again. When turmoil strikes, people usually move in herds, hunkering down and taking comfort in conformity. People who cover and dissect the news also appear comforted by repetition, attempting to squeeze it all into an expected outbreak-related stack of stories we've all been seeing. Us, as an example, got sorted into the "there's no place like home" stack. Other companies landed in the eCommerce is everything folder. Truthfully, either stack works well, since being in one means you're viewed positively, no matter whether you sit at the top or the bottom of it. My sense is that a lot of Wall Street folks run their portfolios in stacks, peering through reading glasses when what they actually require is both a microscope and a telescope — a microscope for hunting out the fine points and distinctions among those uncommon brands and companies that deserve a place in any such stack, and a telescope for spotting the chances they'll seize once this pandemic is behind us. We at team RH tend to go against the crowd, we can't stand the idea of hunkering down, and we certainly don't see ourselves as part of the pandemic pile. So we've come up with 4 straightforward headlines that don't need a microscope or a telescope — the 4 Ps that offer a glimpse of what you can expect from us next. While much of the world has been sheltering in place over the past year, we've used that time to reimagine and reinvent ourselves at a pace never seen before. Let me walk through those 4 Ps: our product; our performance; our prospects; and our people. Our product. Our goal is to assemble the world's broadest and most captivating assortment of luxury home furnishings. Thanks to the allure and rarity of our merchandise, amplified by our unique settings, we've secured substantial market share, and RH core demand grew 36% in Q4. The pace accelerated sharply — February brought a 73% increase, and in the opening two weeks of March demand rose 96%, all prior to any effect from the year-earlier shutdown of our galleries, restaurants and outlets. Adjusted gross margin rose 480 basis points for the quarter, 540 basis points across the year, and 1,210 basis points on a 3-year basis against fiscal 2017 — once again showing how desirable our exclusive assortment is and the pricing power behind our brand. The strategic separation we have established will keep expanding as we elevate and grow the RH brand further, launching RH Contemporary in 2021 along with RH Color, RH Couture and RH Bespoke across the coming several years. On top of that, we intend to introduce The World of RH this fall — a digital portal that showcases our products, places, services and spaces. We'll start animating the various pieces of our integrated ecosystem through rich content that, in our view, will strengthen the brand and forge a far deeper connection with our clients. Now to our performance. We keep building the industry's most productive operating platform and business model, as adjusted operating margins climbed 750 basis points to 21.8% from 14.3% a year earlier, achieved on revenue growth of just 8%. Let me repeat that. 750 basis points on revenue growth of only 8%. No one in the furniture and home furnishing market has ever posted an operating margin like it, and it stands more than 50% above our nearest competitor. Our ROIC of 53% in 2020 likewise places us in a league of our own. What we've delivered reflects a structural uplift rather than a temporary pandemic-driven swing from an unsustainable revenue bump. Keep in mind that essentially 100% of our core business is direct-to-customer, with under 1/10 of 1% coming from cash and carry in our stores, which amounts to little more than floor model sell-offs at season's end. That explains why our demand-to-revenue lag is so much longer than at other home furnishings retailers, who carry seasonal assortments and run large cash and carry operations. Another point to keep in mind: supply chain interruptions caused by the virus mean that about $150 million in demand that was created during 2020 will instead be recorded as revenue in 2021, despite the fact that the bulk of the selling expense required to generate that demand was already absorbed during 2020. If that revenue had been recognized in the prior year, adjusted operating margin would have reached 23%. I often quote Bernard Arnault, Chairman and CEO of LVMH, who has said that luxury goods represent the sole category where it is possible to earn luxury margins. With an adjusted operating margin of 21.8% in 2020, RH has now moved ahead of LVMH's operating margin, and we have clear visibility into an operating margin exceeding 25% across the next several years. Given net revenues of under $3 billion, imagine the leverage we ought to see once we scale. RH has also turned into one of the best-performing consumer stocks over the last ten years. From our IPO on November 2, 2012 at $24 per share, RH has beaten Apple, Amazon, Google, Facebook, Nike, Starbucks, LVMH, Home Depot, Hermes and nearly everybody else — except Tesla. Warren Buffett says time is on the side of a well-managed company. We think our results have proven that point and will keep proving it. Turning to what lies ahead, we finished 2020 with net revenues just shy of $3 billion, and in our view the numbers back the RH brand reaching $5 billion to $6 billion across North America and $20 billion to $25 billion worldwide. We expect that number to continue rising once you account for what hospitality and home building offer us, since we continue expanding the RH ecosystem through the launch of RH Guesthouses and RH Residences; our plan for entering Europe internationally remains on schedule, with RH England and RH Paris set to open in 2022. Our inaugural Guesthouse is set to launch in New York City this autumn, followed by a second Guesthouse in Aspen that will include our debut RH Bathhouse & Spa, arriving in autumn 2022.

Right now, we're in design development on our first RH Residences, which is part of the broader Aspen ecosystem, and we've already gotten several unsolicited offers to buy a home before anyone has even seen it. And to put down deposits and reserve a home — I mean, we haven't released anything. We've said nothing beyond the initial press release, and we could probably presell every home today. We think the revolutionary design of both the Guesthouses and the Residences could create entirely new markets within their respective industries, while also establishing RH as a thought leader and a maker of taste and place. We're also planning to launch 4 new Design Galleries in 2021, and every one of them will include a restaurant and wine bar: RH San Francisco, The Gallery at the Historic Bethlehem Steel Building; RH Dallas, The Gallery on Knox Street; RH Oak Brook, The Gallery at the Center; and RH Jacksonville, The Gallery of St. Johns Town Center. Now, on our people: in my view, no other team in this industry comes close to ours when it comes to resourcefulness — and it's not even a close contest. Tony Robbins describes resourcefulness as the ultimate resource — what matters isn't time, money or technology. Instead, it boils down to passion, persistence, vision and values. Starting from zero, we acquired a business that was close to bankruptcy—selling nostalgic discovery products with a $20 million market cap—and transformed it into the top luxury home brand globally, now worth over $10 billion. According to history, people will work for a dollar but will die for their beliefs. Within our company, we often say this is not merely our company—it is our cause. It genuinely reflects who we are and what we believe. Certain individuals advise not to take things personally. Such people are not our people, understand this clearly. To us, this is extremely personal. We hold the view that brands possessing greater control will grow more valuable. Our approach has consistently been to keep command of the brand all the way from the initial idea through to the end customer, and to stay away from middlemen whose commitment can never match our own. For that reason we have steered clear of partnerships, sponsorships, franchising and licensing, and our conviction remains that brands retaining greater control will grow more valuable over time. Taking the simple route when growing a brand rarely proves to be the wisest choice. The history of global expansion is filled with brands that placed their trust in others, only to spend decades afterward haggling over buyback rights once the harm had already occurred. None of this means there will be no cases where an exceptional partner can be found in a difficult country, yet such situations will stay uncommon as we take the RH brand across the globe. We're continuing to put money into owning more of how the customer experiences us, and RH In-Your-Home has been in test mode across Los Angeles and San Francisco, and the early numbers have us really pleased. As Fernando Garcia, our President of Furniture Operations and Home Delivery, puts it, RH In-Your-Home isn't some different or improved experience — it's one that's unique and memorable, because what we're doing is bringing the gallery to the customer — into our customers' homes. With furniture ambassadors watching over every detail, it leaves our customers with an impression that can last a lifetime. On top of that, a new furniture distribution center spanning 1 million square feet is set to open in Southern California this spring. With that new facility, we’ll be able to shorten delivery windows by seven to ten days for outdoor furniture and for special-order upholstery in most major markets. Everything points to 2021 being a really strong year. Yes, 2021 would certainly be a story of two halves, but given a booming housing market, a record stock market, low interest rates, the anticipated rebound in the economy and jobs market, along with the recent further acceleration in our demand trends, it feels more rather than less optimistic that it could actually end up being two very good halves. Although we anticipate ongoing difficulty getting vendors to increase output enough to satisfy demand, and we don't anticipate the ocean freight and port congestion problems clearing up in the near future, it's difficult not to project first quarter revenue growth of at least 50% along with an adjusted operating margin around 20%. Given the business's momentum, we feel confident stating that 2021 ought to deliver revenue growth between 15% and 20%, adjusted operating margin up 100 to 200 basis points, and ROIC above 60%. We've chosen yet again to push back when we send out our Source Books and the debut of RH Contemporary, moving both to fall 2021, so our manufacturing partners can catch up with rising demand patterns. That choice ought to help us deliver a solid second half too, since we've withheld fresh collections over the last year, and that will produce one of the biggest new product introductions we've ever had. Our RH Outdoor Source Book, containing 10 new collections, is set to arrive in homes beginning this week, while the digital Source Book and the new outdoor collections are live on our website as of today. This is the moment for our vision to define us, rather than a virus. Now that the pandemic's darkest period lies behind us, we should recall a rebirth—a period when we reinvented and reimagined ourselves yet again. A period in which what we achieved reset what was thought achievable for a home furnishings brand, and when our performance compelled the world at large to pull us out of the pandemic pile and recognize us for what we really are: a group of individuals who have no idea what can't be done. Now is the moment for our vision to define us, rather than a virus. Seize the day. All right. Operator, I'll hand things over to you now so we can begin the question-and-answer portion of the call.

Nice work on the impressive numbers — happy to be on this earnings call for the first time as a participant. Gary, the business has a lot of momentum right now. There's a lot of new product activity. You're growing the hospitality offerings, and the margin profile is well ahead of your initial expectations for the business. Given all that momentum, and considering how the world has shifted since the global pandemic, where have you become more confident about this business's long-term growth potential?

I don't think the pandemic has really changed anything for us. Honestly, I believe the situation hasn't shifted nearly as much as folks assume. Take our company as an example—it operates almost entirely as a direct-to-customer platform. From day one, we've remained channel-neutral, so it makes no difference to us where someone chooses to order. During the pandemic, orders moved from stores to online or essentially to our people, yet once our galleries reopened, things returned to what felt quite normal. I'm aware there's plenty of discussion suggesting this period will boost Internet growth by 10 points across the coming years. Whether that holds up remains uncertain. Honestly, that doesn't really matter to us—we truly have no preference regarding the natural migration between sales channels that will unfold across the coming decades; we saw it coming. We understood it was inevitable. Whether it happens or not makes no difference to us. Due to this channel migration, companies are rethinking their business models and shutting locations more quickly. That could be accurate, since their model wasn't designed with an independent view across every channel, whether strategically or financially. It may have been a legacy model built solely for a retail operation, and they entered direct-to-customer more recently, rushing online without strategically weighing all the consequences. We started this business two decades ago as a channel-neutral one. It's a platform that looks forward to the coming 20, 30, 40 years and says we could see where the world is heading. So whether it arrives there — whether the shift happens 5% or 10% quicker, with a bigger or slower move — we're entirely indifferent. Nothing about our real estate approach, our online approach, or any of our initiatives is altered by this. In the physical world we inhabit, we think excellent in-person experiences—let me stress excellent in-person experiences—will stay relevant. If anything, I think we'll end up more relevant once this pandemic passes, because I believe it has scared a fair number of people off from investing in the physical world. And it has simply driven many others to join the crowd—hurrying to turn themselves into an online business, hurrying to become a digital-first business, hurrying to become a digital-first business that retains a handful of stores. I'm not sure what everyone's in such a hurry about; the only spot we hurry toward is one we've already worked out, something we've pondered for ages and in great depth. So I'd argue the pandemic hasn't really altered our strategy in any basic way. The pandemic leaves us indifferent; our whole focus is on assembling the most compelling product assortment, shown on the most inspiring and immersive platform anywhere in the world, backed by the most incredible services available from anyone in this industry. And we believe those are the right priorities—rather than chasing shifts in the business. Frankly, that's very tactical. Oh, there's a shift to online, great. Should this be news to you at this point, you are very far behind.

Great. That's really useful detail. I just have a question about the margin outlook—the 100 to 200 basis points of expansion. How should we think about that in terms of gross versus OpEx leverage? And then, specifically on the growth side, you've had 2 strong years of product margin expansion. Do you expect that strength to carry on this year?

I'll let Jack take that one. Go ahead, Jack.

Yes. Well, as you mentioned, over the past two years or so, most of our margin growth has come from the gross margin line. So in fiscal '20, out of the 750 basis points of increase, almost three quarters came from gross margin. And so on balance, I think you'll see that same quality in margin improvement going forward. And while we aren't giving specific guidance on exactly what share of the $100 million to $200 million will come from gross margin, I'd describe it as at least half, if not more.

Yes. And let me add to what Jack said. When you pose that question, it gets me thinking about something that's probably not evident if you're outside this business — because people have watched us reposition the product, they've seen us take pricing — but I think what's probably unclear is that as this brand evolves and as we keep climbing up the luxury mountain, product quality will keep moving substantially, and pricing will naturally move along with the products, yet the value equation will become stronger, not weaker. As we become more sophisticated and develop stronger, more meaningful ties with the manufacturing partners who matter most to us — something that may not be obvious is this: once you lift prices and factor product margin into the picture, you also pick up leverage across the supply chain, correct? So that's likely just basic math that perhaps not everyone has put together, yet it's fairly straightforward once you think it through. And if you simply try to grasp the core of what Bernard Arnault said — "Only in luxury products can you have the ability to make luxury margins" — there's a plainness and a truth to it. Constructing something comparable to our model would be extremely difficult for anyone positioned in the middle of the market.

Great. Fantastic to hear that the momentum is carrying on. Gary, you and I have discussed demand creation before — how it isn't just one figure on the P&L anymore, such as a percentage of sales, but rather the combined effect of what you're investing in Aspen, London, RH 3, and so forth; it looks like RH is increasingly generating desire and a pipeline of future customers — people who want the RH lifestyle, right, along with everything that goes with it. So going forward, how should we view that advertising demand creation line on its own?

That's a very good question, and that's exactly the right lens. Creating one of the most admired brands globally, desired brands globally, whichever adjective fits, really, it demands a different route; it demands a different method of communicating. And I believe we're in a world where getting your message across gets harder and harder, since there's such a volume of information out there. I read a study, roughly a year back I think, that humans now consume 700%, 7x the information they did 20 years ago. What an amazing figure when you consider it — that compared with 20 years ago, we take in 7x more information thanks to these devices we carry and the sheer quantity of information, the number of platforms we communicate on, and how easily it reaches us. So the way to sort of cut through, right — Steve Jobs said something; if you watch his original YouTube clip, when he's wearing shorts and flip flops on a small Apple stage after he returned to Apple, and he was discussing — he was reintroducing the think — reintroducing Apple and launching the Think Different campaign. He told us we live in an extremely noisy world, and that it would be very hard for anyone to recall anything about any of us. He also stressed how essential it is — he talked about marketing as being tied to values, right, to what you deeply believe in, and to connecting with people through those values; and he brought up a few great brands, naming Nike as one of the great global brands. And he said, if you look at Nike, what they sell is a commodity. They sell tennis shoes, right? For the most part, they sell shoes. He also pointed out that in their ads, the shoe never comes up, the sole never comes up, the laces never come up — instead, what they talk about, what they honor, is outstanding athletes and outstanding athletic performance, correct? He then mentioned Apple's conviction that people, when sufficiently passionate, genuinely had the power to change the world. And through that Apple brand, the Think Different campaign — more than anything, that campaign centered on the product's absence, right? An iMac never appeared, and nothing from that campaign showed up. Nike barely enters your thoughts. Their brand was not built around any single shoe. We all recall the Jordan shoe, but the reason we recall it is Michael Jordan — not some particular shoe, correct? So when you consider the great brands, and you consider the way they were built and the way they conveyed a truly distinctive path — just step back for a moment. Tesla ranks as the fastest growing and most valuable car company anywhere in the world. Not once have they run a TV commercial. Consider that. People queue up to buy Teslas, right? So inside our company, for instance, we say we have no marketing department, and that might stun plenty of people. The rationale behind lacking a marketing department is that much of marketing ends up being cosmetic gloss, correct? It resembles taking a so-so concept and trying to disguise it, spin it, and make it appear superior to so-so. And pulling that off is really hard, correct? It's just really hard to pull off. And the absence of a marketing department stems from our view that, as we phrase it, our actions rather than our words define us, correct? Therefore we have a truth group. Previously, our truth group would approach me saying a reporter wanted to write a piece that would mention us, and I'd answer that this isn't what we believe—why would we want to be part of such a piece? That isn't our truth. Our work is our truth; we define ourselves through it, and we connect with people through it. That explains why launching a fully integrated, revolutionary ecosystem in a place like Aspen, where the wealthy and affluent vacation—visit and vacation and do something extraordinary there—you've got the attention of the right people. We're not going to make a lot of noise and draw attention to ourselves; we're just going to do some remarkable work. That's why I talk about scaling the luxury peak and the route we've chosen — every luxury brand originated at the summit, correct? Take any luxury brand you can think of, and it started at the top. That's not where we started. We didn't even begin at the base of the mountain, right? Our starting point was beneath the ground. We were essentially a company in bankruptcy. So we had to pull ourselves up from below the surface and then commit to making an ascent that no brand has ever attempted. Nobody has tried making this ascent before. The people up at the summit, frankly, aren't eager for you to complete that journey. You aren't a local. Their parties don't include you on the guest list. That means our work must be genuinely outstanding — so remarkable and so impressive that it forces a fresh look at our brand, and drives those at the peak to acknowledge us with a tip of the hat, you know? Essentially to say, well done; respect is something we have to win from them; as the familiar expression puts it, if you weren't born to royalty, you've got to earn it, correct? So the effort we're putting in, everything we're doing to establish this brand, we see it as the proper sort of work; our view is that if we deliver exceptional work that cuts through all the noise, it gives people something to talk about. And by the way, we issued a press release, just one page, about Aspen. I doubt I've ever gotten so many billionaires contacting me directly with notes asking, "What are you up to in Aspen?" Personally, I received 3 inquiries from people wanting to buy one of our homes. Our partner has fielded roughly 12 such requests. Not one person has laid eyes on a home. We haven't even released a rendering. At the end of the day, our focus is on spaces—design, architecture, living, and places. That's what we're all about.

So when we build incredible spaces and environments that spark inspiration, our belief is that this approach will stand out amid all the clutter—and it packs much more punch than just buying an ad and boasting about it. That explains why we avoid social media entirely. Why? We don't have an Instagram profile. We have no Twitter presence. None of those channels are something we use. Everybody constantly advises me that tweeting is essential, that a Pinterest profile is essential, that an Instagram profile is essential. You'll gain followers, they insist. Gary, they tell me, tweet and you'll accumulate loads of followers. My response is that thinking about tomorrow's tweet isn't how I want to spend my time. I don't want to dedicate my time to — I don't want a department whose job is deciding which images go on Instagram each day. And just so you know, for context, we aren't on Pinterest, Twitter or Instagram at all, yet among brands like ours we're the most pinned anywhere on earth. Among brands in our category, we get the most tweets worldwide, and among brands of our kind we're the most posted about on Instagram globally; that's why we're convinced it all comes down to our work; and that's why we're pursuing what we're pursuing. Also, as a result of the initiatives we're pursuing — including the inspiring galleries we're constructing — we're re-evaluating the model right now, and we're concluding that in these galleries, particularly those featuring restaurants that generate substantial foot traffic, we don't believe we need to allocate as much money toward mailing catalogs in that market, since we serve thousands of people each week. Consequently, when you consider our financial model along with the opportunities, leverage, and investments, the fact that we historically invested in a particular manner doesn't mean we ought to continue investing that way, because as we keep innovating, we're able to see around more corners; we have more data. We've gained additional insights. Sitting here today, I find myself asking: how long has it actually been since we sent out a Source Book? About a year, correct? Right, a year. Once we send the fall Source Books, it'll have been roughly 18 months since the last one went out, or thereabouts. I'm not certain — should we return to distributing Source Books two times per year? And should those mailings be as extensive — for instance, in markets where we've created those magnificent, architecturally significant spaces and places? What portion of that value counts toward marketing, really? I understand the point—if you're shutting locations that are kind of run-down and sit in a mall where every storefront is glass and the only thing above yours is a logo, that's a different situation. That isn't our approach, correct? We're taking another path. So that's the reason I say you shouldn't lump us in with the pandemic group, right? You can't group us alongside everyone else. If you do, you'll completely overlook what's really happening here. That was a long answer to your question, but it's one of the best questions I've had in a long time.

Gary, that's extremely useful. We always appreciate hearing your philosophy. Jack, one quick question, actually. This involves 73% and 96% demand growth — and then we get to the part where stores were closed. Why is there at least 50% revenue growth — is that from poor congestion or inventory shortages? It seems the gap between those 2 figures should be narrower.

Yes. Well, look, you'll see the same dynamics when it comes to supply chain constraints. And for the very reasons demand growth outpaced revenue growth in Q3 and Q4, we're — given how strong business is, you'll keep seeing that in Q1, plus possible acceleration thanks to demand's strength and acceleration.

Yes. And once more, the crucial phrase here is at least — it's at least, correct? So across the past few years, we've told you at least this many times: at least an 18% operating margin, and then at least 20%, and then — so our tendency is to sort of give you — we want to guarantee that no matter what happens, we will reach that at least; but generally we'll be at least fairly comfortably beyond it, and — though there are plenty of factors to sort of weigh. But at least signifies that we have more than that.

So Gary, I'd like to tack a question onto what Adrienne asked — maybe a little more specific. Thinking about the ecosystem you're in the middle of launching, I suppose there are really two questions. How significant a brand builder do you expect that to be for RH across, let's say, the coming 3 to 5 years? And as a stand-alone business, how much does it matter as a source of revenue and profit? Or would you say that first point carries more weight? How should we frame that?

Yes. Well, I believe it will do a great deal to strengthen the brand. And honestly, it's funny — had you asked me 5 or 7 years ago, back when we began working on this, I'd have said it would do a great deal to strengthen the brand; yet looking back now, I'd say that wasn't even any good at all. That was the work of 5 or 7 years ago, because we have a habit of continually improving things. And that's the wonderful part about merely having a vision for something rather than actually starting on it, right? You truly learn once you begin doing, and that's the moment your education really speeds up, you connect additional dots, and you can see around additional corners. As for what we plan to reveal in New York and Aspen, I doubt anybody has a clue about it. Honestly, I don't think so. It's — I've been fortunate in my life to have traveled since I was a relatively young man, journeying all over the world; and my career has been spent in design, whether at my previous — the company I formerly worked for, where we searched the globe for the best in design, the best hotels, the best locations to find inspiration, asking ourselves what we might come across. So I've seen a great deal, correct? I've been to nearly all the almond resorts anywhere in the world. I've visited so many locations, both personally and professionally. And someone asked me how long I've been working on the Guesthouse. I told them roughly 30 years, since that's how long it's been on my mind; that's how long I've been traveling to truly wonderful places and posing questions to myself such as, why don't they offer this? And why has nobody conceived of that? And why must it be this way? And I believe once you see what we've accomplished with the Guesthouse, there are simply things nobody has ever done in hospitality. And that's why people say much of the — most innovation worldwide originates outside, comes from outside industries rather than within them, right? Like, again, I return to Tesla. That individual had zero prior experience building automobiles—none whatsoever. Yet he went on to revolutionize the entire auto sector, and these days every manufacturer worldwide is racing to keep pace, scrambling to deliver electric vehicles, right? Opening a hotel is something we've never done, and we have no intention of beginning now. The reason being it isn't a hotel—it's a guest house. Making that distinction was essential for us. And if you check out the website launch in the west—the website launch—upon opening, the initial thing you'll see on that site reads: this is not a hotel, right? Since it truly isn't one. This represents a completely different way of conceptualizing that sort of experience. So my view is that when you create work of that nature, first, there's a good likelihood that the folks at the very top will offer their respect, because it's something they haven't encountered. Think about it this way — suppose we wanted to — if I went up to the peak of the luxury world and asked, alright, who resides there, who holds the largest estate? That's Bernard Arnault, correct? He controls the biggest luxury platform globally. I tell people internally, half-jokingly, that Bernard Arnault just acquired Belmont for $3 billion, right? It's like nobody believes we're going to impress Bernard Arnault. I promise you, once he lays eyes on this Guesthouse, he'll have no choice but to tip his hat — because nothing like it exists anywhere on the planet. That's exactly what will spark the conversation, isn't it? That's what will change the way people see the brand. A brand that started underground had to claw its way out of a grave and begin ascending a mountain no one has ever climbed. You just have to do things people can't even imagine. And I believe it all comes down to — it all comes down to building the brand; it all comes down to truth and respect, right? Our work is our truth, and I believe our work will earn respect; our truth will then be respected, and people will listen more closely. They'll pay greater attention to us. And then from that — the same applies to the homes we're building, the Residences we're building and other things you'll hear about, I mean — let me step back for a moment. Let me begin here. We had no knowledge whatsoever about restaurants, correct? A few years back, everyone said, you're going to open a restaurant, like what are you going to do? Who's going to run it? This isn't the same setup as before — we originally had a partner, but these days we handle everything in-house. As a fully integrated hospitality company, we currently operate 10 restaurants. When it comes to our restaurant volumes and the trajectory they're on — we never stop innovating and evolving, and the changes we've made over the past 18 months, or 12 to 18 months, aren't even visible yet thanks to the pandemic. Even so, aside from the 1 or 2 standout performers, our restaurant volumes will match the highest-volume restaurants anywhere. Once we're fully reopened and every seat in every restaurant is available, our volumes will be among the strongest. People used to say constantly that mall developers were eager to land a Cheesecake Factory since its locations brought in roughly $10 million apiece on average. Before long, in all probability, our own restaurants are going to hit that kind of volume. And that depends on more than just the count of guests coming through the door—it also involves what the typical guest spends, and that spending in turn influences who comes in, which keeps our audience aligned with the target consumer and the people we want to impress. Still, we're going to be a fairly strong restaurant company. When you look at the figures, the returns, and the margins our restaurants generate now, they're three times better than they were three years back. So that's something we do quite well. And I think what happens relates to the things you genuinely care about, right? Within our company, we discuss 3 lenses that guide every decision we make.

Our decisions rest on an idea's emotional worth, then its strategic worth, then its financial worth — in that sequence. If financial worth is all you chase, nobody truly buys into it; absent people willing to die trying to make it real, that money never shows up. When emotional worth runs high, though — when folks inside the company genuinely care, give a damn — they'll be knocked down ten times and rise eleven, and the effort, passion, and lessons learned shift the result. I've watched concepts with very high financial worth, very high strategic worth, very high emotional worth, real strategic worth, but only moderate financial worth become the company's biggest financial ideas, since the work ends up that strong. Conversely, I've watched the reverse. I've watched things with moderate emotional worth, comparatively high strategic worth, and extremely high financial worth — someone figured it was worth $500 million, and it ended up a $5 million idea, since nobody cared sufficiently. Achieving great work demands effort — for an extraordinary result, extraordinary effort is required. There are no shortcuts. Elon Musk got asked: Elon, you run 3 different companies — Tesla, Solar City and SpaceX — how? He replied, look, it's simple, just physics. The average executive might put in 40, 50 hours weekly, he said, while I put in roughly 150 to 160 hours weekly. I put in three times the hours of the average person, so I can do three times as much. And he said it's not — it's just very simple math. Spend time with the people in our organization and you'd discover we truly love what we do. Nobody can hold us back; we'll find a way or go down swinging, because this isn't merely a job for us — it's our life, and when you pour yourself into something like that, the outcome usually ends up exceeding what you first pictured by a wide margin. By "you" I mean us. So that leads me to this — if somebody asked, "Hey, do you figure you'll ever turn a profit on the Guesthouses?" my answer would be no. If — I put it this way: as long as I'm not losing a ton of money, it'll be a genuinely positive thing for the brand. Honestly, I think we — now, the way I see it, I believe this is going to work. To be honest, we haven't booked one room night so far, yet I genuinely can't wait to stay there myself — not just because I'm the one who built it, but since we've put so much thought into it, we'll be doing things no one in the hospitality business has ever attempted. Those ideas are truly strong, and the same holds for our residencies. We designed the one on Red Mountain — it's stunning, honestly that good. That comes from how much we care about it. These concepts have enormous emotional worth; and when something carries that much emotional value, people don't just give a day's effort. They deliver a week's work in a single day, and the results show it. At a broad level, my view is that these will lift the brand enormously — enormously — and increase its value; and my hope is that they'll also come with genuinely strong financial models. By the way, I feel greater clarity about the homes. To me the homes involve simpler arithmetic, I think, since I own homes and have purchased homes, and I'm the consumer; and I know what we're capable of building, what we can sell them for, and how much we can earn. And I believe we'll build an exceptional product. And I believe we'll earn a great deal of money in the home business, whether that's single-family homes, condominiums, or similar. Luxury apartments are a genuinely compelling category for us. You look around and there simply aren't any exceptional apartments anywhere — the design quality just isn't there. Now consider this: what if we offered fully furnished luxury units? How many people out there need to enter a market and reside there for one or 2 years, have no interest in purchasing a home, yet possess substantial wealth and want to inhabit a truly beautiful space? We believe that could be an outstanding opportunity. As for the Guesthouse concept, I'm not sure. We're pursuing things nobody has attempted before. For instance, we don't offer any meeting rooms, no weddings, nothing at all — no celebrations. It's extremely private. It excels at a handful of things more than anyone else globally, yet it doesn't cover everything. So everything hinges on the kind of room rate we're able to secure for these remarkable rooms and the incredible feeling of privacy and luxury we've built. So we'll find out shortly. We'll find out shortly, but we're enthusiastic about it.

Obviously, thanks for that really considered response, and hopefully once fall arrives we'll begin to see part of this face to face. Best of luck for the remainder of the year.

Right, we'll work out some way to pull off a bit of a — what we're kicking around is — nobody really knows how you throw a launch party inside a hotel with 10 rooms, correct? You can't simply have folks strolling through the corridors, correct? So then we figured — I was thinking I'd handle it this way — I may host a full week of sleepovers, correct, where people receive an invitation to sleep over. Yet my capacity is limited — suppose you put 2 people per room, multiplied by 10 rooms, that gives us 20 people each night. Even so that adds up to 100 people. If we line up the right influencers alongside the right crowd — and our plan is to, we believe, line it up with Fashion Week, and we believe Fashion Week is going to return, and everyone in New York would be back out in the Hamptons. We believe travel will be happening again by September; it might turn out to be the most spectacular coming out party anywhere; and a few of the who's who might fancy coming for a sleepover and getting a look at something nobody has ever seen, and we kick off the right conversation; though my guess is what we'll likely do during that week is stick around there for a stretch, and perhaps it's a smart moment to hold an investor meeting in New York and get everybody caught up and run a tour of the Guesthouse, most likely just before we genuinely open it to the public. Since after it's open, you can't walk anybody through the place, correct? Because privacy is the point. We can't be doing, hey, here's a bunch of Wall Street guys we're walking through here. Pardon, pardon, forgive us; we realize this is about privacy, just not today. So there will be a single opportunity to truly view it, and we'll need to make that happen prior to opening.

Congratulations on what was genuinely a phenomenal quarter. Looking ahead to the 100 to 200 basis points of EBIT margin expansion you're expecting in '21, where do you see the biggest opportunities? And beyond that, toward the 25%-plus longer term, what further opportunities come to mind after 2021?

Well, we did reference that 100 to 200 basis points, and we also provided a few reference points, right? We put it this way: "Hey, had that $150 million shipped this year, we'd have been at 23%." So to start — we're basically at 23%. And then we've got another 100 basis points — to bring you to 24%, which is 200 basis points above 21.8%, right, 2,200. So reaching that isn't hard at all. It doesn't take many moves. And part of it will hinge on just how much — where do revenues actually land here, we don't require much revenue to sort of get to where we're guiding you. If, for whatever reason, these revenue trends keep going, like — I mean, it's genuinely fascinating. I've never — this is — nothing like this have I ever witnessed. I mean, I lived through the Great Recession, I've lived through several recessions across my career. I've worked in the home category for, what is it, 34 years now. The other day Jack reminded me that I'd hit my 20th anniversary here — not that I'm fishing for congratulations from anyone, but I hadn't even noticed. He told me, "Oh, God, I'm sorry. I missed your anniversary." I hadn't realized the date myself; so that's 20 years here, and more than 14 at Williamson. All told, I've put in 34 years in the home business, and over that stretch I've seen plenty of cycles. And I have never seen anything quite like this. When we get news as good as this, my instinct is to play the pessimist inside the company. I'm usually the one saying whatever demand surge we're seeing at the moment isn't down to us and won't stick around, so don't shape the business around it — it's going to vanish. Well, it hasn't vanished yet. And I've talked with some quite sharp people who've given me various perspectives, along the lines of, look, Gary, here's one I think everyone ought to consider — it's really clever. This is based on analysis from someone highly credible, thoughtful, and sharp. Their view is that the migration happening in America right now — the pandemic-driven movement out of cities into suburbs or second-home markets — is significant. Incidentally, the suburban trend works very well for us, since 80% of our business is located in the suburbs. So the move to the suburbs isn't just a move to the suburbs — it means more square footage. In their assessment, that's a doubling or more of square footage for the consumer. I hadn't thought about that before. That point really grabbed me, and here's how their reasoning ran: they said, Gary, your customers who leave the cities might be in a 3,000 square foot apartment, and they're headed to a house of 6,000 to 10,000 square feet out in the suburbs; and in their city apartment they owned no outdoor furniture, and now all of them own outdoor furniture; and they've got large yards and lawns and pools, and so forth. So I'm just like, that stunned me, right? I truly hadn't considered it from that angle. The consumer's expansion in square footage hadn't occurred to me. They also mentioned that locating a contractor today is a massive issue — you might purchase a house, yet if it requires remodeling or any work, you'd be waiting six months for a contractor. So their view is — six months or more in certain markets. There's a genuine delay. And this individual holds the belief — they said it right to me, and I honestly didn't know what to say back. The thinking was that our business would speed up thanks to the lag—thanks to this enormous shift—right? That as the pandemic dragged on, more and more folks started relocating for good. I don't mean the ones who sort of flew back to their Hamptons place. That's a whole different thing, right? Take New York—anyone who was able to headed out to the Hamptons. Whoever owned a house was sitting in their Hamptons house, right? They moved there for the year. Anyone who could rent a Hamptons house rented one. When people were able to buy, well, they bought; but plenty of them are returning. Initially, everyone viewed it as something temporary. Then suddenly, how people wanted to live shifted in perception, and it might be more lasting. So this relocation trend could persist much longer and represent a significantly larger movement. Then you ask yourself: how long will it continue? Everything hinges on whether the move proves permanent, correct? For instance, considering our business, I'll share figures I've never really discussed before. Before the pandemic, our business was 80% suburbs, 10% second home markets, and 10% urban markets. When I refer to urban markets, I mean the city itself—correct? Beverly Hills isn't the city of Los Angeles, right? The city portion of Los Angeles is the vertical section known as Los Angeles City. We do have some vertical markets, like Manhattan or Chicago, that are truly vertical and include a good number of high-end homes, and we see substantial volume in those places. But almost everywhere else, suburban areas account for much more of our business. That makes sense. Those homes are bigger, with backyards and kids, and you usually get extra bedrooms, extra spaces, extra family rooms, and so on. Then the pandemic arrived and changed the picture, producing a surge in second home markets; and what that did to our figures, essentially, was move second home markets from 10% of our business up to 20%; they grew far faster than everything else, and this is a shift in percentage, correct? So 12% — 10% to 12%. Yes, 10% to 12%; and then the suburbs more or less held steady while cities dropped 2 points, to 8%. But consider our model, where 92% of our business — and this isn't where demand gets created, it's a shift in addresses; it's where the product was headed, right?

Looking at it, 92% of what we do is ideally positioned for whatever permanent change this pandemic creates. And I was trying to remember the figures from another study out there about the big shifts and moves — someone else had mentioned it to me. Every few years, you get a shift in one direction and then another, with people relocating — such as the huge migration into the suburbs during the '50s, '60s, and '70s. Or, during the last 10 to 15 years, there was movement back into cities, right — gentrification and all that urban redoing. But the shift that might be underway could genuinely last. That's the reasoning some folks have been sharing with me, and they believe this isn't temporary. In their view, far fewer people will go rushing back to the city; and they think the return to cities will involve a much younger consumer; and consumers aged 40, 50, 60 who left the cities will remain outside them. They don't expect them to return. And when I reflect on it, that turns out to be really positive for our business over the long term. Because it also means even the moves within a given place — not everyone, though. Consider this: suppose you relocated to the suburbs and, amid the pandemic frenzy, hurriedly acquired a second property — it almost feels like a film, doesn't it? The thinking was that everybody would abandon the cities, traffic would be jammed, and off you'd go. Yet the likelihood of securing the exact home you genuinely wanted at that time is quite low, correct? And I'm convinced a great many folks are leasing houses. I'm aware we're handling numerous rapid design installations — customers tell us they need the furniture within 2 weeks, you see. And luckily — that’s one of the benefits — here’s another plus, sort of a side note, but I believe it deserves a mention and to be shared with all of you, since we’re all attempting to figure out where matters are going and what is happening here — I considered this and wondered, what’s the reason our demand is truly speeding up at this moment? What is going on? And I think there is simply a backlog — that accumulated demand, just as folks were unable to find contractors, and now they can at last arrive. However, for everyone relocating who requires new furniture within a 30-day window—meaning they need it in two or three weeks—I believe we're now gaining an advantage since we actually carry furniture in stock. We're one of the few businesses that truly maintains inventory of this product, allowing quick delivery. That doesn't apply to every item, though. Special orders represent a significant share of our business, and right now we're dealing with backorders. Even so, these are precisely the moments when I think our model gives us an edge over a Wayfair, a Perigold, or any other online competitor—what I'd call a marketplace approach, where the operator isn't holding the inventory, right? That's part of the appeal of such an approach. It requires little capital and ought to deliver strong returns provided the earnings structure can be made to work. Yet hardly anyone has really asked: what's the built-in vulnerability of that approach? If you visit Wayfair and — and mostly we watch what they're up to at Perigold; we watch anyone who could be competing against us. And the sheer volume of out-of-stocks and the limited selection available there is astonishing, because their then — their vulnerability is this: you've got countless thinly funded little operators merely trying to peddle sh** through a platform of that kind in a marketplace. And they'll accept anyone, by the way. There isn't much of an approval process. If you'd like to sell something, at Wayfair. So you won't reach that many vendors that fast when your standards for who sells on your platform are genuinely high. It's impossible to speak with that many people. What that means is plenty of junior staff are greenlighting plenty of new vendors. But I look on there, and I'm acquainted with some of these people, like we know who the factories are across the globe. And once more, those folks have no money. Holding the inventory is beyond their means, right? So I think during prolonged episodes like this, we actually — I'd never considered it, but we actually do hold the inventory. If you needed to furnish your home next week, we could actually pull that off — provided you're located in a major market. That's a massive opportunity for us. But let me address the point about the 25% operating margin and what opportunities lie beyond '21. It's really just about scaling this thing, right? We've got plenty of strategies and initiatives that we see as margin-enhancing. While RH In-Your-Home begins as an investment, I believe it will generate a strong return on investment — and we have many initiatives like that. We continue refining our model with each new gallery. I'd expect their output to rise rather than fall. We're going to see a huge improvement in our restaurant segment. In Waterworks, compared with three years back, I'd say EBITDA is likely 12, 14 points stronger — maybe 15 points, roughly in that range. Right. And from there, you simply scale it up. Just — when I think about it, we're a $2.8 billion company with the potential to be so much bigger. And we've built a really smart, simple platform that scales. So the leverage as we scale — you think about, like, other — someone mentioned Sonoma to me last week, because they obviously had great results and a fantastic outcome. And I think they're doing a tremendous job. And — but they're already at $6.5 billion or something. What are they? $6.5 billion, $7 billion? Say, yes, $6.5 billion, right? Like, we're not even half the size of Williams-Sonoma, and we have the operating margins that we have today, right? It's really just about the math of scale — finding 20 basis points in roughly eight separate areas across the business. That's how you reach genuine leverage, right? Which is why we believe — yes, we have visibility into operating margins of 25%-plus today, and better. And honestly, every margin goal we've set for you, we've reached it far more quickly, sooner rather than later, right? So — yes. We wouldn't be this confident and this clear in telling you — if we couldn't see it and couldn't draw straight lines to the numbers. So we just keep learning as we go here.

And we tend to never be satisfied — we're constantly pushing forward. It's rare that we take even a moment to celebrate. That's not to say we never do. We get really excited, and for regular learners like us, we keep learning. So if you continue learning, you keep discovering more. And when you can see more, you end up never content with your current position — that's basically our culture, correct? I believe this team, and we've brought roughly 10 new senior leaders into our leadership group. We have — there are some individuals I can't discuss yet since we haven't made those ideas public. But we have international leaders — leaders in international supply chain. We have plenty of fresh talent in the room, and that also enables us to accomplish more. We've invested substantially in human capital here. So anyway, that was a long, rambling response — my apologies. But just a few — I figured some of those points might be useful; thinking through how to approach this pandemic was useful to me, like the shifts and the movement to the suburbs and how that could impact us and our square footage growth. I find square footage growth really fascinating because — you mentioned you might be selling 2 to 3x additional furniture simply because — to the same customer. And it's fascinating since our tickets are rising significantly, our average orders are climbing considerably, so it's actually unfolding that way.

Gary, you mentioned getting more control over the business. I'd like you to go deeper on that. What's your thinking there — which other areas would you like to have more control of? It might be manufacturing, it might be the whole design process, right, I think the RH In-Your-Home experience. I'd really like to hear your thoughts on a few of those control ideas.

Yes. Yes, so Steve, that's a good question. When we look at it strategically, right, our model is going to generate a lot of cash here. And what do we do with that cash? Obviously, there are several options for the money—putting it back into the company, repurchasing shares, issuing dividends, and so forth. Yet when you examine our model across a five-year horizon, you need to look ahead and ask yourself what the right moves are, and where the greatest chances to generate additional value lie. Among the most significant ones we're considering is the notion of owning a larger share of the brand. As we grow the luxury mountain, I think we're coming to see just how fragmented things are; and I've always enjoyed saying that goods of this caliber have never been produced at this scale. I think we should be taking more control over the product pipeline, whatever form that takes — manufacturing, sourcing, there are just so many aspects to it, raw material procurement included. For instance, most of our furniture uses 4 species of wood, right? I'm not sure — should we take positions in certain woods to gain a competitive advantage? What I mean is, first, sometimes it's simply about getting the raw materials. When you're a platform as large as ours in outdoor furniture, securing peak is one of the challenges. And should we actually own plants that make outdoor furniture, so we can get better access to raw materials and more control over them—that might hand us a huge edge over competitors. In other areas of the company, we've already run tests; we operate our own upholstery production facility in North Carolina. Its size is modest, yet the experience has taught us plenty, and we have ideas about it. But beyond that, consider this: as you move further up into the luxury tier, manufacturing scale keeps shrinking. It becomes what I'd describe as a workshop-style operation—extremely high-end, very couture and bespoke, perhaps. You mentioned putting out a bread crumb — but how do you actually scale that? How do you create a platform and grow it? Or just consider this: think about going global, right? Our products tend to be bulky and heavy, and shipping furniture around the world isn't especially efficient. It works today, and some countries are better at producing certain things than others. But I think technology will keep making the world smaller. Over the long term, I believe the competitive advantages between countries will shrink, and the world will become more neutral. It won't be so easy to find cheap labor or efficiencies in a single location where someone can manufacture that product. I think the world 10 years from now will look very different from today's world. So we ask ourselves: what's the right approach to building our platform? Should furniture for America be made in America, furniture for Europe be made in Europe, furniture for Asia be made in Asia? Is that the right model? So you build a supply chain that's country-centric, particularly where you expect your largest business segments to be, and you replicate manufacturing capabilities. And then you also avoid single points of failure. One lesson from the pandemic or something similar is that you have all this demand, and it's like you've got one person producing that, or tariffs come into play. And then all of a sudden, oh no, we produce all of that over there, and now 25% tariffs come into play. And you're stuck, right? The only thing you can do is negotiate and attempt to find some workaround. But consider this — simply because this predicament affected us, what does a global supply chain look like for a $25 billion brand? What ought that to look like? And incidentally, no one in our industry has constructed one, so I believe we have a chance to start entirely from a blank whiteboard and accomplish something that's never been done. And our capital structure allows us to invest — to invest so that we gain even greater strategic separation and capability than others. We sit at the premium end of the market, correct? That gives us considerable leverage in our operations. Selling the products we offer carries far more leverage than selling what competitors offer in the lower tiers. So indeed, we're examining every angle — supply chain and home delivery, manufacturing, raw material procurement and how you manage raw materials while gaining leverage there — but also leverage simply through accessibility. If a peak-season surge hits and we can't reach peak capacity, that leaves you crippled, correct? So yes. Throughout this, opportunities are going to exist, since there are strategic acquisitions we undertake that provide us with capabilities and similar things. How do you view capital allocation across the coming 10 years as we work to achieve our vision? It's the correct thing to consider. We're devoting considerable time to pondering all of that at present. And we — please continue. No, no. I was merely saying, we've already completed — with those, involving certain items I'm unable to disclose to you yet, but you'll learn of them shortly.

Okay, we're eagerly waiting for those. And — perhaps a brief follow-up: with the unsolicited offers that came in for the residences down in Aspen, it seems like it's gotten you thinking that the concept is larger — perhaps larger than what you first envisioned. But I'm curious whether those offers point to something bigger regarding the opportunity, maybe a faster ramp-up behind it, or where things stand in terms of thinking on the residences overall?

Yeah. I don't believe we need to hurry at this point. What I believe is we need to hurry when it comes to learning and figuring out the correct model. Building lovely homes and selling them, I don't think that will prove difficult for us. That I believe we're capable of. The question is, what's the correct model? How do you go about it? What do you — like — is it — is this a case where we're — suppose we choose to truly pursue this. Suppose we run some tests, and we go, wow, this genuinely works. And we've also received strategic inbound interest, from folks who'd like to partner with us and folks who saw the Aspen press release. CEOs of companies have been — getting in touch, asking whether we'd be interested in partnering to build RH homes jointly and forming a JV. And opportunities like that may exist, correct? There may be folks who possess what we lack at present — the capacity to source and lock in land, who understand how to construct homes at scale, yet lack our creativity, our taste, our style, and don't have our brand, so to speak. And so opportunities could arise where you see us partnering with a major home brand or buying one, I'm not sure, like if we become truly skilled at it. So there's not — there's plenty of optionality in this. I think we did — the wonderful part — I've told the team for years that we're involved in only 10% of the business; and at times people — newcomers would ask me, "What do you mean we're involved in only 10% of the business?" We're involved in 10% of business; typically, at the high end, people devote roughly 10% to furnishings for their house relative to what the house costs. So if you purchased a $10 million home, you'd devote about $1 million to furnishing it. You purchased a $5 million home, you'd devote on average $500,000 to furnishing it, right? And that's simply the math, $2 million, probably $200,000, that's broadly how the allocation breaks down. It isn't always exact, but directionally it's correct. So I've always said, like we're involved in 10% of the business; we don't sell the home. And in fact we're actually disadvantaged by being in the 10% of the business, because we're, frequently, furnishing genuinely poor architecture homes, like a half-designed home, a badly proportioned home; and so it doesn't even make our goods render as more valuable, right? Every one of our galleries is designed with real care, with balanced proportions that make the merchandise feel more valuable. Most of the residences we work on — and honestly, most residences in general — if you hop on Zillow, hop on Redfin, hop on whichever platform you prefer, just click around and count for me how many houses truly feature outstanding architecture versus how many have solid interior design. The count is remarkably low. Fewer than one out of a hundred, under 1%. So I really enjoy viewing this market through that lens. And whenever the situation looks like that — when the data tells that story — you have the opportunity to establish a new market, correct? An entirely new market can be built. That's precisely our big idea: it isn't merely about selling a house; it's about establishing a new market at the high end for residences that buyers genuinely desire on RH Home, because those homes are simply so well designed. Not merely furnished — I mean the architecture itself, the logic, the siding of the house, the landscape architecture, the pool, all of it, the entire package is simply so well designed; and on top of that, it's furnished incredibly. So you simply walk in and you just want to move in, correct? It's as though we save you time; and once more, those with greater wealth have less time. Those with more time have less money, correct? And at the high end, what are you able to sell? You can sell time value. People are willing to pay for time value. Plenty of people on this planet possess more money than time. They've built up wealth, and now they've reached my age. You're 63. You consider how much time remains for you, and you seek to purchase time value, correct? And I believe that's — if you asked, what are you truly going to sell? We're going to sell time value, and people will pay for that.

And Gary, I just want to say — as a sell-side analyst who has only had a buy rating on the stocks for the last 300 points — I don't want you spending your time thinking about what you're going to tweet later today either. So I just wanted to kind of put that out there.

Thanks, Anthony. That's good.

No worries. These are really more housekeeping-type questions, and probably aimed more at Jack than at Gary. Specifically, I was hoping we could get a bit of color on what's driving gross margin, what's driving SG&A leverage, and then just what your CapEx expectations look like for 2021.

Yes. Anthony, historically we've spoken about very strong results on the product margin side as it relates to gross margin, and so Q4 is no different from what we discussed in Q3. Roughly 3/4 of the pickup comes from our product margin, which involves a number of things we've discussed — climbing the luxury mountain, improving the quality of the product, cycling the rug business, running the rug business at a higher margin, among other things. The outlet business, as we discussed in MD&A in our filings, obviously reflects a lower promotional level. So that's where you're seeing the predominant amount of it. And then as far as CapEx for the year goes, you'll see in the 10-K when it's filed next week that the range we're giving is $250 million to $300 million. That's a little higher than this year. We ended up with what you might call adjusted CapEx — you need to look at it because a portion ends up being put in the op section of the cash flow. But this year, we ended up at $180 million. So the — and then what I'll say is, regarding the elevation of the CapEx — there are a number of development deals happening this year that we'll monetize in a future period, and then just finishing — one of those stores we're opening was on a land lease. So there are just a number of factors driving the higher CapEx this year, including starting to spend money internationally.

Gary, profitability has climbed sharply for a lot of companies in home furnishings, so do you figure this industry is simply earning better margins now as a structural matter? And how should all that shape the way we think about RH's profitability in the back half, where—given your tale of 2 halves—the second half brings some unusual factors and far tougher comparisons?

Sure. Yes. Good question. To get at that, I think you have to examine the revenue growth this business saw in 2020, right? That's the reason I raised the point—and I repeated it in the letter—that we reached 21.8% operating margin on 8% revenue growth, right? We picked up 750 basis points of margin expansion alongside 8% revenue growth — that's the first component, correct? So that's something you can more or less count on, right? It's not going anywhere, because it isn't tied to the pandemic. It has no connection to home furnishings tailwinds. 8% revenue growth — that's unrelated too; so the whole thing is structural. And by the way, it's approximately what we anticipated earning before the pandemic, okay? Our model indicated roughly 22% as what we calculated we'd generate, and then the pandemic hit. When it hit, what it really did was divide things into two halves. Did we make some optimizations in certain areas? We did, though our plan had anticipated somewhat stronger revenue growth. So—we still ended up right around that mark. So when you look at companies whose 2020 growth outpaced their historical pace, you have to wonder how much of that is sustainable? How much of the leverage persists? And then one really crucial factor for determining where everyone lands is the pricing and promotional makeup of the business, right? So we didn't turn less promotional; we are—we don't do promotions, right? All we have is discontinued items from the assortment. But we're not a promotional business, right? Looking at our sector, some companies have pulled back on promotional activity—which makes sense. They reduced those promotions, and demand or revenue could have been at a certain level. When conditions eventually change, will they be able to maintain that nonpromotional posture? I'm fairly sure some firms have gained 200 to 300 basis points in product margins, having previously relied heavily on promotions; now they don't need them since demand is up. For me, that's the unresolved question: how much revenue will stick? In other words, what portion of industry margins depends on elevated revenues—ours doesn't, since our top line never moved? To revisit that point, had that $150 million in revenue actually materialized during this year and we were sitting at a 23% operating margin—120 basis points within our model—we would have called it out to you. We would have described it as, from our perspective, something of a one-off and possibly not structural. Yet no part of our 2020 revenues received pandemic assistance. No portion of our product margin got pandemic assistance either; we weren't any less promotional than we had planned. Since we operate a membership model, the margin improvement you observed in our product represents genuine margin growth. It isn't necessarily temporary in any way. That's my take — or if you will — and the second thing I'd highlight is advertising, correct? So when you're examining — especially a company like Wayfair, and I don't mean to single out Wayfair. Honestly, initially I doubted Wayfair would survive. And I remember thinking, when I went through their S-1 during filing, I thought, yeah, this doesn't seem like a genuine business. But over time I've come to value and respect the platform Wayfair has built and how they can generate substantial revenue so fast. What I wonder about with Wayfair is, what is the true structural margin in the company? Take a company like Wayfair — right now I'd say you're basically snow-blind, correct? Consider that essentially every restaurant across America and most of the globe shut down, so anyone in the kitchen goods business saw a surge — people rushing out for toasters, pots, pans, and similar items, since dining out was no longer an option. Even households like mine — my daughters are off at college now, so I typically eat dinner out nightly. My partner and I eat out every single night. And she went out and essentially raided the stores. She said something like, "We have a completely new kitchen, right, since we'll be spending so much time at home, right?" So we ended up with all sorts of new items. She's making meals. She had never made meals before. And when I consider categories like that, I think those might not last. Plus, those are purchases she was going to make regardless of any discount, right? She'll purchase the cookware whether or not there's a sale. And so how promotions work in some of these businesses, in some of these categories, is very, very different, right? Take the early pandemic period—I was digging into all the data and visiting every company's site, and I made a joking remark about Wayfair listing sixty pages of toasters. That's accurate, and by now the count might be even larger—sixty pages of toasters is what we're discussing. My recollection is that forty or sixty of those pages had sold out, which shows how businesses like that saw a surge. Still, when I examine the industry and where we fit in it, I attempt to understand the nuances of which revenue arrived as a gift. To illustrate, we received a substantial amount of demand as a gift. But no revenue came as a gift—is that right? None of that went out the door. As a result, we reported 8% growth along with the 750 basis points — and then there's the advertising piece, excuse me. One has to factor in the advertising leverage a business such as Wayfair achieved, or other companies — every company, correct? Each of us picked up some advertising leverage. Take us: last year we bypassed a catalog cycle, a source book cycle. So let's estimate that at, I'm not certain, $40 million, roughly that figure, or $60 million?

Yes. For the full year, as will be shown in the 10-K, advertising came in $49 million lower, and that was < >.

Yes. So that’s $49 million less, which works out to a little under 1.5%, correct? So you’re asking, “Hey, Gary, can you really keep this up? You’ve got to put that advertising spending back into the model.” That’s a fair question. I don’t have a definite answer yet. I’m not certain, but it’s something we think about. Do we need to return to mailing a book two times a year? Can we send out fewer books? Our major galleries and our restaurant investments, bringing in more traffic and what do we need there? But I’d say those are the areas — revenue, the promotional structure and margin structure driven by promotions, and then the advertising component. So then obviously, when folks get a significant increase, they'll enjoy occupancy leverage and similar benefits, which could come back. So I'm unsure how durable the current margin structure across our sector really is. Everybody wants you to think it is. That's why I stressed the point about our own. Honestly, I'm pretty happy we posted just 8% revenue growth, since that keeps anyone from being blinded here, ourselves included, right? So I'm asking, do we essentially run a business with around a 22% operating margin today absent a pandemic? That's what we have. And how much of a pandemic lift will we see in ’21? If our revenues rise 15%, perhaps a bit, right, since we'll begin expanding internationally. Keep in mind that as we start expanding worldwide, we'll be entering market after market. Once we launch in Europe, we'll be able to accept online orders and deliver across the entire continent—so this isn't comparable to opening in a place like Sacramento, or launching a new location in Vancouver or Montreal. We're opening up an entire huge country. For us, Europe's volume should end up roughly comparable to that of the United States, right? That's significant. It would be like arriving in America with a brand that people already recognize. I noticed a few analysts—not sure if they're on the call right now—who seem to consistently publish unfavorable commentary about us. They're aware of who they are. Whatever they might claim—something like, "their New York restaurant is struggling"—as if to say, "they won't hit their fourth quarter numbers"—come on, seriously? In any case, one of their reports stated that we lack market awareness, that people simply don't know who we are. My reaction was: don't rely on some generic market awareness survey. The top 1% is our customer. A lot of the time, the heart of what we do is the upper half of the top 1%, thanks to brand awareness. Go to London, go to Paris, and talk to the top 1%, and they're all wearing the same labels — Rolex watches and the like. They eat at the same restaurants. They all take holidays in Saint-Tropez, Ibiza, St Barts, Aspen. Every one of them knows every other one, and every one of them knows us. So you want to know about brand awareness and why we're confident? Sure — because the people buying the other great luxury brands know who we are; we're the only high-end brand of our kind anywhere in the world. Everybody else is just a category player. They just sell couches, or they sell lamps, or they sell — we're unique in our category. So the chance for us, when you think about growth over the long run, comes when we start launching countries. That's like us showing up in America and being fairly well recognized as a — in the segment of the market you're going after and opening a gallery in New York and opening a gallery in L.A. or something like that. Maybe I can liken that to Paris and London, right? And then opening up the entire Internet to the whole market; and you go, you don't think of it in terms of stores. You don't think of it in terms of markets. Consider what the United States could produce if I operated locations in New York and L.A. — fantastic locations in New York and L.A. — and customers there recognized my brand. Then suddenly they've got a website, and for years I've wanted to purchase from them; and I've had to fly to America to buy things, locate a container shipping company and handle the shipping myself. I think there could be a rush on the house here once we go international. I think it's going to outperform anyone else's model that crossed the pond.

That helps. As a follow-up, I suppose we're all attempting to determine what sustainable demand looks like and when we'll actually know it. So could you take the clock or calendar back to last year? This year, February demand — and we're assuming that reflected core demand — is up 73% < >.

Last February it rose 8%. Right, February a year ago came in at 8%, up 8%.

And what did March look like, just to give us a bit of a read < >...

Okay, March — the stores — March — right; so last February we posted 8%. I believe we announced an 8% gain to everyone before everything went sideways. So February came in at plus 8%, and honestly that was pretty much in line with what we expected. And on top of that 8% from last year, the core business is now up 73%. During the first 2 weeks of March, one week I believe we were up 4% and the other week down 3%. So across those 2 weeks we were roughly flat, maybe up 1%. So measured against that flat first 2 weeks of March, we're up 96%, all right? So here's how to frame it: if you said, fine, neutralize that 8% from February, you'd tack 8 points onto the 73%, putting you at up 81% and 96%, so — if the goal is to kind of steady the 2 months, right? Then naturally — yes. Then we're lapping all those shuttered galleries, shuttered restaurants, and shuttered outlets. And keep in mind, our outlet business had no website when it closed. So outlets went to 0. Restaurants went to 0. In our core business, the RH core business, and in our contract business, we were still able to take orders and so forth. Obviously with contract, the further we got into the pandemic and the more people understood hotels and all of that would stay closed for a long stretch, that business got hit hard. And for a while our outlet business dropped to 0. And our restaurants, right, dropped to 0. So big — picture big year-over-year gains in our restaurant business, a big year-over-year gain in our outlet business, and a big year-over-year gain in our contract business, because hospitality is beginning to spend once more. They're essentially wagering on the recovery cycle now, right? So hotels are putting money back in, purchasing new outdoor furniture, that sort of thing.

So Michael, it's Jack. I think it'll — go ahead.

Do you figure maybe around May or June things will start opening up again? Then you'd have some fair comparisons, and at that point you'd get a feel for the business's run rate?