RH (RH) Earnings Call Transcript & Summary

Thank you. Good afternoon, everyone. We appreciate you being with us on this conference call covering the first quarter of fiscal 2021. With me on the line today are Gary Friedman, our Chairman and Chief Executive Officer, and Jack Preston, our Chief Financial Officer. Before we begin, I want to remind everyone about our legal disclaimer: we will make certain forward-looking statements today within the meaning of the federal securities laws, including statements regarding the outlook for our business and other matters referenced in the press release we issued today; these forward-looking statements carry a number of risks and uncertainties 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 issued today. Please also note that these forward-looking statements reflect our opinions only as of today's date, 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 these non-GAAP to GAAP measures can be found in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. With that, I'll turn the call over to Gary.

Alright, thank you all. We'll begin by walking through our shareholder letter, which covers both the results and the outlook, and after that we'll take your questions. To our people, our partners, and our shareholders: fiscal 2021 has gotten off to a very strong start, with first-quarter revenues rising 78% compared with a 19% decline a year ago. Total company demand grew 101% in Q1, and RH Core demand rose 109% — the strongest demand trends anywhere in our industry. We keep raising the bar on financial performance among home furnishings retailers, with adjusted operating margin climbing 1,260 basis points in the first quarter to 22.6%, compared with 10% a year earlier. Adjusted net income increased by 375%, while adjusted diluted earnings per share rose 285%, reaching $4.89 per share compared with $1.27 in the prior year. For the quarter, we generated $228 million in adjusted EBITDA and $136 million in free cash flow. As Q1 ended, total net debt stood at $382 million, with trailing 12 months adjusted EBITDA of $896 million. By the conclusion of this fiscal year, we expect to have no net debt. Now, regarding our raised fiscal 2021 outlook: reflecting current business trends, we are increasing our revenue growth projection for fiscal 2021 to a range of 25% to 30%, compared with our earlier forecast of 15% to 20%. Our adjusted operating margin is now projected at 23.5% to 24.3% — that's 170 to 250 basis points higher than the 100 to 200 basis points we previously guided, and ROIC should come in above 60%. Turning to the second quarter, we're looking for revenue growth of 35% to 37% with adjusted operating margin between 25.9% and 26.1%. Fiscal 2021 will certainly be a tale of 2 halves, but plenty of data points give us confidence that the momentum carries into the back half of 2021, and that growth picks up in fiscal 2022 and beyond. The factors at play here include a strong market for housing and renovations — each benefiting from delayed demand and lasting momentum — along with an all-time-high stock market, inexpensive borrowing costs, and multiple sizable sectors of our economy coming back online. Beyond all that, people shedding their masks may unleash consumer enthusiasm on the scale of the Roaring Twenties. Town & Country really nailed this mood with a recent magazine cover headline: "Remember Fun? Get Ready for the Comeback!" Add to that the biggest cycle of new product launches in the company's history, kicking off this fall, plus RH International's debut next year — and enjoyable times may indeed lie ahead. You can also take comfort in the fact that our business assumptions and risks have been stress-tested, and we feel sure about holding an adjusted operating margin north of 20% in virtually any economic downturn we could imagine. RH has risen as a luxury brand that produces luxury margins. Over many decades, we have built a brand and a business model alike that yield profitability leading the industry as well as robust returns on invested capital. We also share Bernard Arnault’s view: “Luxury goods are the only area it is possible to make luxury margins.” In fiscal 2020, RH’s adjusted operating margin reached 21.8%, surpassing that of LVMH, and we can now see a clear path to an adjusted operating margin above 25% during the next several years. Regarding our business model, people frequently miss how simple and low-risk what we’ve built really is. I figured it would be useful to point out several of its main characteristics. There is no seasonal inventory; we don’t sell seasonal categories such as Valentine’s Day, Easter, Halloween, Thanksgiving or Christmas. Another thing we avoid is holding inventory in collections or color palettes that are tied to spring, summer, fall or winter, which is common among many home furnishings and home improvement retailers. It took us years to eliminate those categories, and the reason was so we could avoid seasonal markdowns — that is what allows us to operate with margins that are substantially higher. Our fashion risk is limited. Fashion cycles like the ones seen in retail models that rely on frequent discounting are not what drives our business. The major trends underlying our business relate to architecture and the dead. Architectural trends typically move over decades rather than years. Take, for example, the view held by many that the recent modern movement began with Frank Gehry's 1997 launch of the Guggenheim Museum in Bilbao, Spain — the work of a legendary architect. We brought out RH Modern nearly twenty years later, in fall 2015, after enough modern houses and condominiums existed to form a critical mass, which gave rise to a substantial new market. Regarding the deceased: as generations die off, their possessions pass through estate sales, and those sales stock the antiques trade, which in turn drives the high-end interior design business, which then influences the upper-tier reproduction sector; from there, trends continue flowing downward. Should you wonder where the mid-century modern style came from, either run the numbers or stop by a graveyard. Membership. Moving from a promotional approach to a membership one, which is what we did back in 2016, simplified and streamlined how we operate, eliminating the disorder and expenses tied to a customer offering that's always in flux. Membership additionally deepened our relationships with customers, given that most of them rely on our interior designers when furnishing their homes. That moved us away from selling products toward selling spaces, which generated larger average orders and reduced what it costs to acquire customers, as RH has become their go-to pick for luxury home furnishings. Luxury positioning. We've seen that luxury brands are less exposed to economic downturns, since their customers might hold off on spending for a period but don't lose their ability to spend. On top of that, putting money into a home pays off more and more as buyers accumulate wealth and buy additional homes, and that drives greater sales, which brings down advertising expenses and yields a more profitable operating model. A powerful picture of what lies ahead. We entered this decade with that same powerful picture of what lies ahead, a team deeply committed to making it real, and the industry's strongest brand and business model. Our plan is to launch a remarkable quantity of new, creative approaches designed to elevate and expand the RH brand even more. As I also did in my most recent letter to annual shareholders, I'll describe the strategic separation we've put in place and the strategies we're following as we continue pursuing our aim of becoming one of the most admired brands anywhere in the world. Product elevation: within one brand, we've brought together the world's most comprehensive and compelling assortment of luxury home furnishings. Our goods show up across many collections, categories and channels that we control, and because they are so desirable and exclusive, we've been able to achieve revenues and margins that lead the industry. These brands are known by customers as RH Interiors, RH Modern, RH Beach House, RH Ski House, RH Outdoor, RH Rugs, RH Lighting, RH Linens, RH Baby & Child, RH Teen, and Waterworks. We'll keep pushing to raise the design and quality of what we make, and in 2021 we'll introduce RH Contemporary, backed by a 400-page source book, its own website, a national advertising push, and a standalone RH Contemporary gallery in the San Francisco Design District. Over the next few years we also intend to bring out RH Couture Upholstery, RH Bespoke Furniture, and RH Color. Gallery transformation.

By transforming our more established stores into multidimensional design galleries that simultaneously double retail revenue and profitability in every market, the RH brand should achieve $5 billion to $6 billion in North American revenues, with an adjusted operating margin in the mid-20s. Such compelling and disruptive physical experiences elevate the worth of our products while creating unmatched strategic differentiation and brand awareness, which lets us seize significant market share while investing less in advertising. This places our competitors in a tough spot, because they are closing or downsizing stores at the very moment we are building the largest specialty stores our industry has ever witnessed. Our galleries, we believe, are delivering a major competitive edge, enabling RH to bring in customers while keeping fixed costs lower than the variable digital ad expenses that storeless or store-shuttering brands face, which can shift from one day to the next. Simply stroll through a mall and you will see that the majority of retail shops are outdated, windowless boxes with no trace of humanity. Typically there is neither fresh air nor natural light. In nearly every retail store, plants perish, and if that is the case, such places cannot be healthy settings for people; that is precisely why we do not construct retail stores. We design uplifting environments where the boundaries between living and shopping, inside and outside, domestic life and hospitality grow indistinct—places full of clean air and daylight, featuring garden courtyards, parks on the roof, eateries and wine bars; environments that engage every sense; and settings impossible to duplicate on the internet. RH Dallas, launched in May of this year, has gotten off to an excellent beginning, and reservations at our rooftop restaurant are taken through August. We intend to launch 3 more design galleries during 2021, among them RH San Francisco, RH Oak Brook, RH Jacksonville, a standalone RH Contemporary gallery debuting in San Francisco, along with our inaugural RH Guesthouse, which opens in New York this autumn. Elevating the brand. We're starting to take the brand past the stage of curating and selling products and into conceptualizing and selling spaces. What we're doing is building an ecosystem of products, services, places and spaces that's designed to elevate our product and make it more valuable, while also establishing the RH brand as a thought leader, a taste maker and a place maker. At the heart of that ecosystem are our products, which include RH Interiors, RH Contemporary, RH Modern, RH Beach House, RH Ski House, RH Outdoor, RH Rugs, RH Lighting, RH Linen, RH Baby & Child, RH Teen and Waterworks. Next, consider the services we offer — RH Interior Design, RH Contract, RH Trade, and RH In-Your-Home. These enhance the value of what we sell and extend the brand into neighboring areas of business that strengthen the core. As an example, we believe RH Interior Design is by now the largest residential design operation in North America, and it has aided our transition from selling products to selling spaces. RH Trade partners with independent interior designers and design firms, working together on projects and serving as a support group that manages the logistics involved in large, intricate designs. RH Contract serves the hospitality and commercial sector, supplying design and logistics assistance for projects that are large in scale and high in volume. RH In-Your-Home improves how customers feel about the whole process, since Furniture Ambassadors oversee each part of your delivery—carrying the sales experience into the home and leaving a memorable, lasting impression. We are also exploring the possibility of expanding what we offer to include RH Architecture and RH Landscape Architecture, as people keep asking us how our galleries, garden courtyards and rooftop parks are designed. Our portfolio spans several concepts. RH Galleries are designed to elevate our products and brand, adding value. RH Restaurants extend the customer experience and drive high-quality incremental traffic to our Galleries. RH Guesthouses aim to create a new market for travelers seeking privacy and luxury within the $200 billion hotel industry. RH Residences offer fully furnished luxury homes, condominiums, and apartments with integrated services, delivering taste and time value to wealthy, affluent, time-starved customers. The venues we are developing—meant to inspire and elevate the brand—will initially feature Plane & Yacht Design and Charter. In that space, customers have the ability to tap into our design knowledge, browse our work online, and book our RH1 and RH2 aircraft, as well as RH3, our luxury yacht, which can be found in the Mediterranean and the Caribbean—places where wealthy, affluent individuals go to travel and vacation. Beyond that, we will be launching our first RH Bath House & Spa inside our Aspen Guesthouse, set to open in the second half of 2022, along with other exciting venues that we will be unveiling over the years ahead. Our view is that when immersive experiences are woven together this tightly, they inspire people to imagine, plan, eat, journey and reside within a world RH has carefully assembled — creating a feeling and bond that no other brand globally can match. That is what we call digital reimagination. We're digitally rethinking the RH brand and business model, inside and out. Internally, that means changing how we innovate, curate and bring together every dynamic part of our brand. Externally, it means bringing customers into the world of RH through a new digital portal that showcases our products, services, places and spaces. This has been a multiyear project, and it started internally last year when we reimagined our Center of Innovation & Product Leadership. That effort will introduce digitally integrated visuals and decision data designed to reinforce the creative process from product ideation through product presentation. Our external work gets underway this fall as we launch Phase 1 of The World of RH, our new digital portal. It will offer rich, immersive content along with simplified navigation and search functionality, all intended to improve the shopping experience and make our product and brand more valuable. We see an opportunity to achieve the same kind of strategic separation online that we have created with our galleries offline, rethinking what a website can and should be. Worldwide growth. We think RH could turn into a $20 billion to $25 billion worldwide brand as it stands today, and perhaps even bigger should certain parts of our ecosystem develop into substantial revenue sources. As we see it, the worldwide competitive landscape is more fragmented and more susceptible to disruption than North America's, and no scaled direct rival comes to mind that has RH's merchandise, operating infrastructure, or brand equity. Our overseas push begins in spring 2022 when RH England, The Gallery at Aynhoe Park, makes its debut — a 73-acre historic estate set out in 1615 by Sir John Soane, who is arguably among the most admired and renowned architects of his era. RH England will feature the Aynhoe Architectural Library, Aynhoe Organic Gardens, the RH Restaurant & Orangery, and the RH Champagne & Caviar Cellar, along with other unique experiences. If France's reopening timeline goes according to plan, we plan to launch RH Paris, The Gallery on the Champs-Elysees, in fall 2022. Guests will pass through imposing gates that are 18 feet tall, then proceed along a decomposed granite walkway bordered by towering hedges until arriving at a garden courtyard. Once there, they will see 18-foot brass doors and pass through a 6 — which leads into a 6-foot atrium, linked by brass staircases that traverse the space together with a glass elevator. At RH Paris there will be a restaurant that looks out over the gardens and draws inspiration from the Grand Palais, a Champagne and Caviar Bar that sparkles on the uppermost level, and a romantic garden on the roof where guests may enjoy an RH Bellini as they take in views of the Eiffel Tower.

Altogether, we've locked in 5 sites across Europe — London, Munich and Dusseldorf among them — and we're in the final stages of lease talks on another 5 sites, which should open over the coming 2 to 3 years. Scaling the luxury mountain while creating a peerless brand. Every one of the finest luxury names on earth — Hermes, Chanel, Louis Vuitton, Gucci, Cartier, Tiffany and the others — began at the summit of that luxury mountain. No brand has ever launched from the bottom the way we did and then completed the ascent to the top. Our belief is that RH can be the first to complete that ascent, fully aware that those already at the summit may not particularly want us there. The reality is we don't come from their neighborhood, and we aren't on their party guest lists. To complete the ascent, we recognize that our work must be so exceptional that it forces a reconsideration of our brand, compelling those at the summit to tip their hat in respect. This isn't an ascent suited to the faint of heart — it demands imagination, innovation and a great deal of persistence and perspiration; we must be willing to accept short-term pain to generate long-term gain, just as we did in shifting from a promotional to a membership model, elevating our products, transforming our stores, redesigning our operating platform, and running the business with a bias toward earnings rather than revenues as we constructed a financial model to support long-term, high-quality growth. We also recognize that the strategies we're pursuing — opening the largest specialty retail experiences in our industry while most others are shrinking their retail footprint or shutting stores; shifting from a promotional to a membership model while others orient their brands around price rather than product; continuing to mail inspiring source books while many are doing away with catalogs; and declining to join the herd in self-promotion on social media, instead letting our brand be defined by the design and quality of the products and experiences we create — all run directly counter to conventional wisdom and to the plan many in our industry are following. Our belief is that when you step back and consider, first, that we're creating a peerless brand; second, that we're crafting a customer experience impossible to replicate online; and third, that we hold total control of our brand from concept to customer, you come to see that what we're building is exceedingly rare in today's retail landscape and, we'd argue, will prove equally valuable. I want to thank the members of Team RH who embody our values and battle for a cause — a group building a culture of leadership rather than followship, one that aims to innovate rather than duplicate; a group whose people have the courage to keep climbing even when the air thins and the odds grow slim; people willing to be knocked down 10 times and rise 11, as they endeavor to plant the RH flag at the very summit of the luxury mountain. Carpe diem. We'll now take questions on the call.

Amazing work, team. Gary, can we somehow quantify how much categories like outdoor are contributing to overall sales growth? Perhaps the category's penetration in 2018 compared with where you expect '21 to finish. And are there other categories where you think you're seeing outsized growth right now? Those results are simply exceptional.

Yeah. Looking at our demand trends, I'd say everything is way up, correct? So — but outdoor ranks among our best-performing categories. I mean, at the high end today, we're the most dominant outdoor brand in the world and have the biggest business in the world at the high end for outdoor by multiples. So you'd expect us to dominate that category, even though lead times are really long, and we've been sold out for a good part of the past year.

Great. And are there any other categories you'd call out apart from outdoor?

Again, at — if you look at the core business with 109% demand growth in Q1, every one of them is up substantially. So across all categories, the business is strong.

Thanks. In the shareholder letter you published last week, you said, "We have to be willing to endure short-term pain to drive long-term gain." You brought up quite a few of the business's growing pains from recent years as well; I'm just wondering if there's anything ahead that you had in mind regarding the future outlook.

No. It's simply — it's the outlook of putting money in with a long-term perspective to build one of the most admired brands in the world, and that's not a road most people choose to travel. The bulk of the industry, you know, concentrates on copying things and shifting plenty of little stones; our own attention goes toward large stones that generate substantial value. Bringing those to reality can occasionally require several years. So, look—our guidance, as I see it, signals that nothing in the near term appears likely to disturb our results. When we consider where we'll be putting money over the coming years—whether that's international expansion, digital reimagination, product elevation, or any of the other major initiatives we're pursuing—all of it is already baked into our outlook and guidance. That said, every so often we may need to make a sizable investment that pushes the business even further ahead into the future, right? That's how we've ended up with an operating margin that's, I don't know, nearly double that of the next best player in our category.

Let me add my congratulations too. You're as eloquent as ever, Gary. Gary, my question, I think, has to do with the TAM opportunity — or more precisely, the $5 billion to $6 billion sales target for North America along with the $20 billion to $25 billion. You said this fits inside the company's current format. So could you tell me how many galleries back North America, and, more crucially, how many galleries back the business worldwide? And is the focus purely on home furnishings, with nothing in hospitality, B2B, and so on? I was hoping for a little more detail there, and then what I'd follow up with is this: as you open stores in other countries, in all those different cities and countries, are you doing anything around product market research or tailoring things for each individual marketplace? And should we assume every one of those stores brings in the same sales dollar, or is each one different?

Adrienne, that's quite a few questions rolled into one. Where should I begin? Let's see. The opportunity when it comes to the $6 billion in North America, $20 billion, $25 billion in the current format, how many galleries in North America and how many galleries internationally? That's a good question. In North America, we've traditionally talked about needing roughly 60 to 70 galleries to really cover the market there. Keep in mind that we constructed our American — we built our North American presence at the same time as we were reshaping the brand and reshaping the business, correct? So our footprint was fairly sensible, located across every major market and every major suburb, and so on. And essentially we consolidated and transformed, and now we're opening large design galleries that replace the earlier footprints. The question is whether you really need that many international galleries as the world keeps evolving and changing, right, as consumers grow more comfortable buying online without seeing products. That's somewhat unknown to us, I think. If there are no indications today that we should have fewer galleries in North America, we wouldn't penetrate the markets the way we penetrate them today with fewer galleries, as we do the math. So even though there's a kind of migration online, you really have to be careful in today's world not to look at the channels independently. I really would caution any retailer who's doing that. To me, judging a business that way seems unwise, since we are physical creatures inhabiting a physical world. The capacity to encounter brands physically and recognize them — to grasp their scale, their product range, their values, their quality, their taste and style — strikes me as essential. So my feeling is that we are expanding worldwide. Could we perhaps construct somewhat fewer galleries? Frankly, I doubt it. I don't think so. Replacing physical stores with online advertising looks to me like a bad call. Why would anyone choose a variable cost structure that might shift from one day to the next just to market a brand? Physical stores, after all, function as major three-dimensional brand-building statements that shoppers can engage with. They're able to feel the merchandise. They're able to engage with the brand. They're able to perceive the size and scale of things. They're able to grasp the taste, quality, and style, across all sorts of levels. Replacing that with some form of digital advertising or another ad format seems to me impossible — particularly when it isn't a fixed-cost format. From where we sit, sure, some of it is customers moving to online channels and so forth, yet even with a brick-and-mortar gallery there is just a natural drift toward digital. That isn't to say it changes everything—it just means that after someone knows your brand and has bought from you before, they might go home and finish a purchase having first viewed the item in a physical location. Anyone who assumes you can close a large number of stores and still hold onto the same share of the market is, to my mind, being naive. So when we look at this, we think our footprint is going to look a lot like North America. That's how we see it at the moment. We're looking into this — on the last call, I think I mentioned that our business basically breaks down as 80% suburbs, 8% to 12% second homes, and 8% in city, urban areas. And I'd expect that to be similar internationally. I don't think it would be wise to say all we need is a single store in the major European cities. I just don't believe we'd achieve the market share we have in North America; it's the same as being in a country or a city — you get a better grasp of the business. Consider Corte Madera, California. If you're at our Center of Innovation there, RH Marin at The Village at Corte Madera sits just four blocks away. These days that mall has no luxury retailer at all. Nordstrom — should you consider it luxury, which I don't — is the top brand store in the center. And if Apple counts as luxury in your book, fine, there's an Apple store; yet no other luxury retailer is present anywhere in that mall. We launched one of our large new galleries at that location. It includes a restaurant, and it will be a tremendous success. If we hadn't been there and lacked an existing store in that mall, we never would have understood what Marin County could offer. Our presence would have been far more limited. Now that our large gallery is complete, I'm confident other luxury brands will soon arrive as well. In fact, I hear Tiffany is currently locking in a location, and since LVMH has bought Tiffany, I think that picture will change. Regarding the merchandise, my sense is we'll wind up looking pretty similar. In my view, the world continues to contract. A lot of people tell me that European homes are smaller. That isn't really true. Certainly, are city dwellings somewhat smaller? Yes, city dwellings are somewhat smaller, and so are the urban demographics across North America. And every item we offer is available in every size. We sell sofas ranging from, what, 6 feet up to whatever — as many feet as you'd like, right? If you want 5 feet, we'll build you a 5-foot sofa. So our products are available in all sorts of sizes. I believe we have the assortment that suits the world. And I think the world is looking for RH. There's nothing comparable out there; and I believe our brand will resonate very well. So I've attempted to address all those questions. I'm not sure whether I overlooked anything. Yes.

Gary, you mentioned in the letter that you'd keep a 20% EBIT margin under any scenario you can imagine, and since I think we're all living in scenario land, I'm curious whether you could give us some color on how you're thinking about the possible paths for demand growth as we move into the back half. And could you put the downside scenario into context — the one you tested in the model — so we can better understand the flexibility you see, or that inherent right in the model that you have.

Sure, sure. Honestly, anything that climbs for reasons outside your control won't necessarily remain elevated. The real issue is the duration of that rise. What shape does it take as conditions shift and revert toward some baseline? That said, this isn't a fresh baseline. And I believe it's naive to ignore any of the models. Also, had you spoken with me four weeks ago, my outlook was considerably gloomier than it is now. One month on, my outlook is considerably brighter. There's more information available to us now, and with the team we've built, we're able to spot additional patterns and understand what's going on—not only from our internal figures and the shape of our demand trends, both as we look forward and in terms of what has already occurred and what we expect to occur, but also from conditions in housing, conditions in equities, conditions in the remodeling sector, and the demand that has built up and is waiting to be released. Consider those constructing houses: projects are stretching out longer. Tradespeople are hard to find. Homeowners can't get anyone to take on their remodeling jobs. So all of that tells us they haven't purchased their furniture so far, correct? In a sense, we're the final destination along that path. As a result, there's a certain amount of pent-up demand building up. Many signals suggest to us, when we consider our pipeline and examine it, that things appear quite strong as we look toward the remainder of this year and perhaps into the following year; and once we reach next year, we have some increases, correct? Starting in the latter portion of the second half of this year, we plan to launch a record quantity of new products. For the most part, that will speed up revenues in 2022, correct? A portion will go out during this year, though only a limited amount; when we assess it, we’re essentially looking at today’s patterns. We’ll see some benefit in the back half from recently opened locations and ones currently coming online, plus a bit from new product. But honestly, those efforts are really about positioning us for ’22. That leaves us carrying plenty of momentum into 2022, and at that point we begin expanding overseas. Moving into international markets is quite a different undertaking compared with opening a fresh gallery in North America, because most of our North American galleries function as replacements. Only a handful qualify as something else — Jacksonville, for instance, could be seen as a new market or as growth within the Florida market. Just a couple remain ahead of us where we aren't present — we aren't in Hawaii, and we aren't in Montreal. Whether there's anything beyond that, I honestly can't recall. We aren't...

Naples, maybe.

Naples. Yeah, one could argue that Naples is probably incremental, though it likely isn't fully incremental, because we already operate in a few of those countries. But we aren't in the United Kingdom, right? We aren't in France. We aren't in Germany. We aren't in the Netherlands. We aren't in Spain — I mean, the list goes on and on; so we'll be opening countries, and that's a very different dynamic, right? And it's not just opening countries with a handful of galleries. We're launching in various nations through a multi-dimensional digital portal that folks will be able to use—and the entire country will be able to access the brand. After that, we'll likely figure out our approach to cross-border sales before we've built up our footprint there, including delivery and similar logistics. It's possible we can extend our reach further across the continent. I'm confident some customers will want shipments sent to Russia and the Middle East, and so forth. We'll determine how to manage those situations. We won't formally inaugurate the European continent at the point when we open the initial few galleries. Operationally, it's a little complicated, and the upfront expense would be too high. So we'll kind of figure things out as we go. Still, that gives us an advantage. When you consider the downside scenario — which matters, and we've kept it in view ever since we started seeing this uptick — we asked ourselves how it would unfold. As of today, based on everything I can see and know right now, the remainder of this year looks fairly solid. Could the stock market collapse? I don't know. It might. Could housing activity decelerate? I don't know. Nobody really knows for certain. That said, my information is likely about on par with what you have, and the same holds in reverse—so essentially all of us are making guesses about what lies ahead, and any plan we put together will be off in some respects. What matters is whether our errors are smaller than our correct calls. At this point, I think the forecast we shared with you gets more right than wrong, correct? We also have a habit of leaning somewhat cautious when we project and leaving ourselves a bit of flexibility to maneuver; still, here's how I frame it. When we were constructing our models, we revisited the question and asked ourselves: what would a normal environment have resembled, correct? How would 2020, 2021, and 2022 have appeared in the company's long-term outlook? It would have shown roughly 10% growth for 2020 rather than 8%, since shipping was not possible for us, correct? So COVID didn't truly give us a lift last year. That's the point I attempted to make regarding revenue growth of only 8%, which yields operating margins of 21.8%. Thus it wasn't genuinely a COVID boost in the manner most other retailers experienced one; we carry no cash and carry product, correct? We don't — what do we sell, 0.1% of our sales depart the store with the customer? I can't think of any product we sell that a person would haul around in a bag unless they truly required a towel on that particular day. What we actually operate is a platform built for selling straight to the consumer. All of it ships to people's houses. A large share consists of custom orders. Delivery windows stretch out further, things like that. And these aren't products where you can suddenly throw a switch and announce, hey, we're up 40 and the factories are able to start shipping at that volume. So we're sitting on a sizable backlog that keeps rolling over. Well, that backlog remains; it's about the same magnitude, approximately $150 million on a forward-looking basis. Whether we'll clear all of it this year? We don't know. It all depends on what the trends show. Most likely not all of it will carry over into this year, since as we deliver those products, fresh backlog will accumulate. So we can't say precisely when things will fully settle down. Still, looking at our longer-range plan, we'd have described a typical pattern as roughly 10% growth, another 10%, then 13% to 14% in 2022 when we expanded internationally — and we'd expect a larger jump at that point. So when we assess it, we say: fine, we grew 8% rather than 10%. As for this year — well, you're familiar with the guidance. So next we ask ourselves: suppose 2022 unfolded the way our standard operations typically would — what would that roughly resemble? At that point we're effectively saying, let's return whatever boost COVID gave us. We've done the calculations on how much we received that we really shouldn't have. We subtract that figure — it's a specific amount, and you can work it out yourselves. After that we asked: what if things continue — remember, we're currently in the lengthiest period of economic growth the U.S. has ever recorded, with no downturn. Eventually, something is bound to occur—assuming it never will would be both naive and foolish. You have to prepare yourself. So we ask: what if a 20% economic decline hits in 2022? Consider that—it's a severe one, since it resembles 2008 and 2009, when we dropped roughly 15%. Remove that 20%, taken from the COVID boost. Strip out 20%, and we still hold an operating margin of 20%, just above it. What gives me confidence is precisely how strong our model is. Our model's strength is something I can stand behind when someone asks, "Should I buy your stock?" My answer is always the same. If you're a trader focused on the short term and only care about brief, one-off price swings, then our stock isn't for you. But if you're an investor thinking long term and plan to hold for at least 5 years, you stand to earn substantial returns — just like those who've held since our IPO. You've all seen those figures; the story has plenty of upside. This model is, without question, the strongest one in our sector. Nobody has anything even remotely comparable. It all gets somewhat obscured at the moment since certain companies are enjoying a big COVID-related boost, which makes their business and margins appear stronger. They aren't running promotions. Honestly, nobody is promoting anything these days. I mean, seriously — how could you possibly promote when demand looks the way it does and you can't even secure the inventory? The upside is that none of this touches us, because we have never done promotions, correct? So our margins stay what they are, correct? You can rely on our margins remaining exactly our margins. Would I assume that other companies' margins are going to stay where they are? Absolutely not.

When the home industry eventually gets back to something resembling normal, there's simply no chance that the folks who promoted before won't need to promote once more. Believing otherwise would be quite foolish. I'm just glad we shifted from a promotional approach to a membership approach quite a while back, since nothing on our end needs to change. Our margin structure stays exactly what it is. The one factor in that structure possibly giving us a slight boost during this stretch is that our advertising spending is lower. We reduced advertising because we couldn't obtain the merchandise. Had we kept that advertising expense, we likely would have driven more volume; yet spending on advertising and mailing catalogs makes no sense when inventory isn't available, correct? Doing so would amount to nothing but wasting money — striking the match and setting the cash ablaze — so we chose against launching new products and against advertising. And so my feeling is that once advertising investment comes back, we'll have the inventory and we'll see an additional lift on the top line; that's one more point I probably should have covered in the letter, now that I think about it. The reality is that we have — we've scaled back on advertising; so once we begin mailing catalogs again, that too will generate momentum for the business. That's the reason we feel today, Steve, quite confident about how we view the remainder of this year and what next year looks like; and we feel tremendously confident that if circumstances shifted and the home industry surrendered any COVID gains and you layer a recession on top of that and you give back another 20% of the business, we're going to land in the 20% range, and we're going to be positioned to play offense, capture plenty of market share, and do plenty of smart things that I don't think others will be capable of doing.

That was really helpful, Gary. I truly appreciate it. And just as a quick follow-up, it's kind of hard not to feel excited about RH International. So I'm just curious, as we're — what are we, under a year out, correct? What else has to get done to make sure the launch is smooth and seamless as you get ready for this grand opening?

Absolutely. Everything you'd imagine. I mean, we need to construct the operational platform from a distribution, logistics, and home delivery standpoint, which we're working on and building; we need to make the inventory investments and be in a position to obtain the inventory, which we're working on. And we couldn't have launched this year if we'd had no inventory, correct? So we had to push everything back by a year. Thank God, we did. We did, because we wouldn't have any goods to sell. So we need the inventory, so build the inventory. And you'll begin to see that reflected on our balance sheet as we build the inventory for international. And then we need to keep building the team. And the good news is — what's the latest poll? How many people from our organization want to work for us internationally?

Several hundred...

Yeah. Several hundred people have already raised their hands from America to go work over in Europe. So we have — and a number of those folks are from Europe itself. So there's a lot of enthusiasm among people who want to help us open up internationally. On top of that, we have a team that's — and we have a leader for international. And we're putting that team together. If you visit our Center of Innovation, you'll see a huge RH International room filled with maps, dots, cities, numbers, volumes, and populations—everything showing what we need to accomplish, where we need to go, and where we should launch home delivery versus where we shouldn't. So yes, we're addressing everything that needs to be done. The good news is that all of this is work we already do here, so nothing is truly new. It's just that in some cases—mostly—everyone speaks English, unlike 50 years ago. Also, the currency involved can differ somewhat, and similar variations come into play. That raises the issue of how the merchandise should be priced. The encouraging part, I believe, is that we examine this closely and review how competing brands set prices for their products. The margin upside may be larger than our original assumption. As a result, our confidence has grown, rather than shrunk, that once RH International starts scaling, it will add to margins instead of reducing them.

Hi, it's Tami. My first question relates to international openings. In your shareholder letter, I believe you said 10 locations would open altogether across the coming 2 to 3 years; so I'd guess the pace works out to 2 to 3 international launches annually over that 2 to 3 year stretch; does that therefore mean you intend to launch the same count of U.S. and international sites across the next couple of years? What I'm really after is this: what's your gallery opening pace over the next few years? And how does that divide between international and domestic?

Sure, sure. Appreciate the question, Tami. Incidentally, you seem to have had a crystal ball — your note arrived just before our announcement, and your projections come quite close to ours, so good job on those models. Regarding how quickly galleries open in North America, I'd say the pace will hold at roughly 3 to 5, or perhaps 4 to 6, depending on how these deals come together. On the international side, my view is that we have 2 in the first year, provided France opens and we can get the work done there. Paris should open either in the fall of next year, or, if COVID-related delays persist and prevent us from getting in to do the necessary work, that could push into the spring of the year after. Beyond that, we have the remaining locations. A number of them are considerably simpler to launch than others — they're less complicated. The initial handful are comparatively complex, and London is comparatively complex as well. Certain ones are less complex, since some have a smaller footprint and allow us to, in a sense, test things out and retain some flexibility. Our goal isn't to get tied down in every market across numerous nations, because if we err there, the error would stick with us forever. On a net basis for Aynhoe in England, the capital commitment will be fairly modest—we acquired the property, put some money in, and we'll arrange a sale leaseback. Paris will absorb more capital; that lease runs long-term. London will also take more capital, and we're further along, so to speak, in Mayfair, where we're essentially piecing together 4 buildings into a spectacular gallery. A number of our other sites are leased for less time, and we're putting in far less capital there, simply to get a read on the markets and on the country itself. The properties and structures are still remarkable. The wonderful thing about Europe, really, is that you find all these magnificent buildings. In the U.S., in North America, you have to hunt for a structure with stature, taste, style and fine architecture. Europe is full of them, so we're big fans of the buildings. We're quite fond of the real estate we're buying. We believe those are the correct locations, although we can't be sure. So we're eager to learn, and that's why we have some locations on shorter-term leases, which gives us flexibility. We'll put in less capital. We won't launch restaurants in every location, since that requires a larger capital outlay; instead we'll test and learn, and then we'll have the flexibility and mobility to make a bigger investment once we understand those markets better. On the consumer side, though, all of them are going to be spectacular. When we look at them, they're a bit smaller. Not every one will include the restaurant investment. Still, a lot of our galleries across North America — the legacy locations we've had for years — do huge volume and perform very well, and the new sites dwarf them in size. A number of these, I'd argue, resemble our 1.0 format galleries like Houston or Boston, where the footprint runs 15,000 to 25,000 square feet (20,000 included) instead of 50,000 to 60,000 square feet.

Gary, what it sounds like you're saying is that over roughly the past 20 years, RH has built a luxury brand unlike anything else that existed in home furnishing. At this point it has pricing power and ought to earn luxury margins, which we've watched you deliver over the last several years. And COVID let you speed that up — raising prices and reaching the margin level that fits, that suits a luxury brand in this market. Is there a scenario where, because of these unusual conditions, you haven't gotten a solid read on elasticity within your core customer segment — or on how big that core segment is — and that could shift once we're on the other side of this? So that's the first part of my question. Then the second part: who are the people in the demographic you've seen coming in and buying? What have they been purchasing over the last couple of months that's driving this level of growth?

Let me take the second question first. Honestly, it's kind of a core RH customer — the demographic buying from us isn't any different. There's simply more activity, more movement, more people relocating, more people going from cities out to suburbs, second homes, that kind of thing, and then more people simply refurnishing the homes they're already in, just because they've spent so much time there and really couldn't travel. So people are doing their outdoor spaces and similar projects. All of that has stayed strong. On COVID accelerating anything — it really hasn't accelerated a thing. Not in our case. Sure, this year it will give us a lift. But again, if you simply look back at last year and say on 8% revenue growth — 7.7% revenue growth — we had 21.8% adjusted operating margins, right? So that was below what we'd expected. We'd expected growth of 10% to 11%. And so our model is fairly clean if you trace it through 2020. Then this year you've got some lift. Obviously, we'll be up 25% to 30%. So the way I'd look at it is to model us out over 3 — if you model this at something like 10%, 10% and 13%, you'd be roughly in the right direction, give or take a point here or there; and then the question becomes, what is 2022? Is 2022 a giveback year, a flat year, because the COVID cycle ends and the focus on the home reverts? I mean, it could be. We have things that ought to make it a better year than that, given the fact that we haven't introduced new products. How long has it been now? 18 months at most?

It will be 2 years in the fall.

Alright, so it’ll be two years, okay, this fall, since we last brought out new products. Just think about that for a second. Two years with nothing new at RH. So we have a substantial backlog ready to launch this fall and next spring. The product pipeline alone for the coming 18 to 24 months is extremely dynamic, with new items across every category, right? Across RH Interiors, RH Modern—not only RH Contemporary but Interiors, Modern, Baby & Child, Teen, Beach House, Ski House—a great deal of new product is on the way, along with RH Couture upholstery, RH Bespoke furniture, RH Color, many things we’ve been developing. So that’s a major advantage for us. And then we’re expanding internationally, which is another big advantage, right? That is 100% incremental, right? It’s not simply transforming a gallery in a market already doing $15 million that will go to $30 million, or a $25 million market going to $50 million; these aren’t incremental markets—they’re incremental countries, and really you should think of it more as an incremental continent. Because eventually we’ll open enough galleries in Europe, we’ll have our infrastructure and home delivery sorted out, and then we’ll open up the entire continent. Whether or not we have galleries everywhere, we’ll be able to work that out. The key reason you can’t rush to open up the continent is that you have to sort out reverse logistics, right? You have to work out what you’re going to do with the returns. Because the last thing you want is to suddenly open up the country too soon and end up with a pile of returns in Russia or Copenhagen or places where you have no infrastructure, no outlet infrastructure, and no way to handle the goods—and you’ll just lose a lot of money every single day, right? So we’re just trying to be prudent about how we open up these countries, at what point we have the infrastructure in place and have worked it out—worked out how to handle returns, how to handle the back-end logistics, and how to wire that to change, which a lot of people don’t know. I mean both—but I’m public, so I’ll say it. I mean, we made—in our reverse logistics outlet business, we made—it’s roughly a $200 million business. We’ve had a $100 million difference in profitability in that business over the last 4 years. $100 million, okay? We know what it looks like when that business isn’t run well, and we know what it looks like when it is run well. And you figured it out across all the handling and transportation costs and everything that goes wrong there; so we just want to build a really great business and a really great model there. So we'll take it a bit easier. But if you consider our model and the COVID factor, there's going to be a modest COVID boost this year. Yet looking at the growth coming next year, whether it decelerates or not, given where we stand this year, that's sort of a solid position, since we have other elements that will offset it. The positive side is — and incidentally, we didn't actually make any price changes or hikes tied to COVID, correct? So we simply applied our usual sort of price increases, because that's our practice. As we — and since we possess pricing power and we're a luxury brand, we're able to pass along price increases in other segments of our business. And that's among the benefits you get when you're competing in the luxury space and you have exclusive product and you control the distribution, right? But I wouldn't claim our business has experienced a COVID effect apart from the leverage we'll gain from the large — from a substantial portion of the revenue that's going to land this year.

Congratulations on the impressive results. Perhaps I could move to the margin topic. With such a robust showing in the first quarter, has anything really shifted in how you think about what drives gross margin compared with SG&A for the full year, relative to the initial guidance you gave back in March? And then, specifically for the second half of the year, with the momentum on gross margin, could gross margin keep expanding?

I'm not sure — Jack, would you like to handle that?

Steven, I believe nothing has really shifted from what we told you last quarter. When you examine what has historically pushed our operating income margin higher, my view is that roughly three-quarters of it comes from gross margin and one-quarter from SG&A; and within gross margin, most of that — say three-quarters — comes from product margin and the steps we discussed around elevating design quality and raising the margin on the goods. That has stayed pretty consistent when we look at the model going back 4 or 5 years, as Gary described the evolution. This year, the comparisons will be a bit unusual given how 2020 unfolded. So clearly, with Q1 down 20% — 19% last year — Q2 flat, and the growth rates we have now, you're going to see some swings in what I'd call the margin deltas versus last year. One thing we were just examining — or that I personally like to examine — is that in the same way people look at 2-year growth rates, I would also look at margin changes on a 2-year basis versus '19. That formula I mentioned earlier holds on an ongoing basis, and I would expect that going forward; and then, to address that point, I think there's opportunity for gross margin to expand. I mean, that opportunity always exists. I think our — you know, our stance on how we communicate guidance and outlook numbers to you, and how our internal models are positioned. But it's something where we do well, we keep elevating the design, the quality and the luxury mountain, and I think you've seen the benefits of that, and I think that will keep accruing to us.