RH (RH) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the RH Second Quarter 2020 Earnings Conference Call.

(Operator Instructions)

Please be advised that today's conference is being recorded.

(Operator Instructions)

I would now like to hand the conference over to Ms. Allison Malkin.

Thank you.

Please go ahead.

Thank you.

Good afternoon, everyone.

Thank you for joining us for our second quarter 2020 Q&A conference call.

Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Jack Preston, Chief Financial Officer.

Before we start, I would like to remind you of our legal disclaimer.

That we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about our outlook for our business and other matters referenced in our press release issued today.

These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially.

Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results.

Please also note that these forward-looking statements reflect our opinions only as of the date of this call.

And we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.

Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items.

You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release.

A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com.

With that, I'll turn the call over to the operator to begin our Q&A session.

Operator, we're ready for questions.

(Operator Instructions)

Your first question comes from the line of Steven Forbes with Guggenheim Securities.

So Gary, you spoke in the letter, right, about the expectation for revenue growth to lag demand.

And I think it was 5% to 10% in the third quarter.

So I want to start there, right?

Just as we contextualize the build for the back half year given the current trends.

So I don't know if you can talk about like how much of the closure between this expectation in the 16% 2Q spread is due to demand being fulfilled, right, versus sort of a more natural closure in the spread between demand comp and revenue comp?

Because I think you did mention, right, that you expect to fulfill the majority of that demand over the next 3 quarters.

So any like sort of color that could help us walk or build it out over the 3 quarters as we think about fulfilling this unfulfilled demand over the next 3 quarters would be helpful.

Sure.

Thanks for the question, Steve.

And I'll try to add some color, and maybe Jack can fill in some pieces.

But if you kind of start back when we spoke to you last quarter, we expected revenue to kind of lag demand comps by about 10 to 12 points.

And what happened, the reason the gap got bigger and it got to 16 points is, in the second half of the quarter, our demand really accelerated and kind of ran away from our trends and our inventory flow.

So it built up a much bigger gap.

As you think about -- we're responding as quickly as I can.

As you look at the kind of demand builds month-over-month as we laid out in the letter, it's hard to plan for something like that.

You can start with a big picture and say, the pandemic hit in mid-March, mid- to late March.

And our revenues dropped by just about 40 points.

And in a 3-month period, a little over 3 months, our demand is -- went from 40 down to 40 up, right, roughly, just directionally.

So it's an 80-point swing.

And we responded very quickly to the down -- the downdraft.

Based on our analysis, we didn't know how long our galleries were going to be closed and what the impact was going to be, but we wanted to react quickly, and we did, and we were able to cut receipts and push out inventory.

And then as demand built, we thought, geez, it looked good coming back from down 40 to down 20 to down 10 to up 7, and then it just took off.

So if you start there, we're behind.

Then you compound that with the fact that the pandemic hit everybody, right?

It hit every country in the world.

It hit every one of our manufacturing partners in the world.

And they had dislocation, whether it's loss of workers or shutdowns, so on and so forth, whether it was in North America, whether it's in Asia, whether it's in Europe or South America.

So just now, I would say, we have relatively good visibility, if things don't change drastically from here.

I'm not sure, will demand continue to grow month-over-month.

I don't think so, but I don't know that it won't.

We're off to a pretty good start in the first 2 weeks of September.

And what's different about September year-over-year is, last year, we had a higher mix of, what we call, clearance inventory that we wanted to get rid of older goods.

So last Labor Day, we ran a kind of a labor day sale with clearance inventory, and we were able to liquidate goods and that gave us a lift.

So that kind of slowed down trends.

If you just think about the first 2 weeks, what will happen in the next several weeks?

Not sure.

Yes, we -- it's funny.

I've never spent so much time looking at our business kind of day-to-day, but it's changed so dramatically day-to-day, and we're learning.

So as we look at this second half, our expectations, if we look at expected inventory flow, we should start to catch up and close the gap.

And then we should start to shift over that gap, right?

So -- and have a positive.

So as I think about when do we kind of get caught up and watch through this, probably the end of the first quarter, maybe the second quarter of next year.

Yes.

I mean, our product is not that quick to be made and shipped.

So a lot of it can have lead times up to 6 months in some categories like rugs, 9 months.

And so what we're doing is trying to give you our best view of how we think this kind of demand will convert to revenue.

And well, I think, we'll be directionally right.

But as I like to say, every plan we have here is some degree of wrong.

The question is, is it more right than wrong.

And I think we'll be more right than wrong unless our demand trends changed dramatically.

I don't know, Jack, do you want to add to that?

Go ahead, Jack.

No, no, no.

I think that was great.

Well, maybe one for you is -- or either Jack or Gary.

If I think about the 2Q's gross margin, right, because this was clearly a focal point for us and investors heading into the quarter.

And as we think about raising the long-term guidance here, right, to 25% EBIT margins from '20 versus the [22%] you delivered.

What's the right gross margin profile for this business?

I mean, is there still a lot of opportunity as we think about whether it's delivery, right, damages or reverse engineering, the outlets, the whole supply chain, I mean where is the right margin profile for that long-term target as it stands today?

I don't know if you call it the right margin profile, or what we think about what's possible.

And I don't think anybody would have -- I don't think there's an analyst on the street that had us at 20% operating margins in the next 5 years.

So when you say what's right, there's -- we saw a path to [20%].

How quickly was it going to unfold?

A lot of it comes down to the desirability of your product when it relates to margins, right?

So we're seeing now, as we've transitioned -- and transitioned from a single-source rug relationship to a direct sourcing model in rugs.

We've got a very different business and a very different margin profile that's lifting the business.

We've talked to you guys about kind of annualizing the accelerated clearance of products through our Outlet division a year ago that dragged margins.

That's now washed through, and we're seeing what I'd call more normalized margins there.

I'd just start with -- if you think about that 21.8% or the 47.5%, we hit in margins today, we did that on -- even thinking about it from a gross margin point of view or operating margin point of view, we did that in flat revenues, right?

So what we're doing is what I wrote in the letter that we now expect that we will reach 20% operating margins in 2020 with 5% revenue growth.

What I was trying to do is give you a floor, right?

A floor for this year.

I don't think there's any way we'll go under 5% revenue growth, but I don't know if all the stores shut down again?

Who the hell knows, what can happen with this pandemic.

I mean, it seems like things are kind of getting better, not worse.

And so we think that consumers are used to wearing mask now, people are used to social distancing.

In many markets you see cases going down.

So we think we're pretty safe to say, I mean, you guys could do the math.

If you back into the math on 5% revenue growth for the year, it's about 18% in the second half, right?

So we kind of think today that seems like a floor.

And at that kind of revenue growth, we're comfortable with having 20% operating margins.

And if you just kind of step away from the pandemic and the whole -- all the things that are happening with COVID, I'm actually quite happy, to tell you the truth, that our revenues are flat this quarter because what it does is it helps get rid of the noise and helps us see our underlying business model and helps potential investors see and recognize the underlying business model that we've built here, right?

That we've invested in for the past 5 years kind of re-architecting the entire business model and kind of positioning the brand more as a luxury brand.

I think that there's opportunities in every part of the margin structure of the business.

We are at the early stages of elevating the product.

I mean, you'll hear more soon about some really important strategic moves we're going to do to continue to elevate the RH brand and position it as a luxury brand in the marketplace.

I think that is going to give us more product margin opportunity.

And that also can relate to shipping margin opportunity, right?

The product prices go higher, and you have the same cost structure moving product through the supply chain.

And the other thing that you've got to think about is we're still pretty early in the transformation of our real estate.

And when we transform a gallery in a market, we basically -- the first year or 2, I think, we have about a couple that went longer than 2 years, but the call it what first 1 year to 3 years and mostly 1 year, we doubled the revenues at retail in that market.

So you think about the -- just the leverage you're going to get in the occupancy side about the business, but also against the SG&A side of the business at a corporate level, right?

So we can see a pretty clear path that we feel pretty confident over the long-term that we now see an opportunity to get to 25% operating margin in the business.

And that assumes investments in international, and it assumes -- there'll be a little bit of a, I know, it's not going to be a complete straight line.

There'll be some quarters where we're opening a new DC internationally.

And it will be a drag for a little bit.

I don't think it will be enough of a drag to massively impact the company because we're not just opening the DC and having our revenue move a little.

We're open at DC in an entirely new continent, and I think we're going to see pretty fast revenue growth.

And so I think we'll see kind of that normalize very quickly.

But I'd say, if you think about since, I don't know, 2016, when we, as I said, when we launched Modern in the end of 2015, and I refer to it as proverbial -- you go public and you put a car in a racetrack and you're on the quarterly race track, and it kind of narrows your view.

And we were kind of a perfect public company, I think, for 13 -- 12 or 13 straight quarters.

And then we blew a tire.

And most companies blow a tire and bring the car into the pits and change the tire and fill up the gas and they go back on to the racetrack.

And we decided we were going to completely rebuild the whole car.

And we decided -- we knew it was going to -- we're going to take a lot of slack for it, and we refer to it as we were going to march through hell for a heavenly cause.

And we kept the car in the pits for, I don't know, 1.5 years.

And nobody really believed what we were working on.

And if we said -- well, people don't believe in what we're doing, what we do, and we raised $1.2 billion or something above that 60% of our company and brought an entirely new car under the racetrack, like with a jet engine.

And so we've now slingshot it past everybody in our industry, right?

A 20% or 20% plus operating margins, wherever it unfolds, we're going to have -- what I like is that 5% revenue growth would have -- we would have had a planned slightly higher than that.

So the fact that we're at 20% this year.

It just says that the underlying business model has a systemic shift.

It really has nothing to do with COVID at all, right?

There's going to be a lot of people that have a very temporal lift to their business.

And when this thing changes and kind of heads back to normal, there may not be anything systemic there.

We have a 20% operating margin floor now on basically flat to up 5%.

So now you think about the business growing at 8% to 12%, and over the next several years, you think about where you're going to get leverage and margin in that model.

If you think about continuing to take this brand up the luxury mountain and the kind of leverage that we'll get, the good key becomes -- it's 1 of the reasons why in the second half, right, we've decided not to mail our fall books because, quite frankly, one, we be mailing and possibly creating incremental demand we don't have product for.

The newness because the factories are behind would be late.

So that's costly to have back orders.

And we thought, let's take this time and focus on the next few really big moves.

So all that time and energy, it would take us to normally develop the seasons and develop the books and launch everything.

We're actually going to refocus that time to rebuild every category in the business, and we believe we can take the floor up there, right?

And if you think about it, if we really do our job well, there might be 10 or 20 comp in the core business just by going category by category, down to the detail and re-architecting the assortments, which you don't get a chance to do when you're kind of just running the business.

And so -- and then focusing their time on architecting the web portal, the world of RH, which we think will be a leapfrog and focusing our energy on launching -- launch in Europe.

So I think what's different about RH in a lot of ways.

And what's unique about us is we invest really with a long-term view.

And I think that's why we have one of the best-performing stocks since our public offering in 2012.

It's funny, I was doing an interview with someone for a magazine and clearly, this person was -- had been talking to a bunch of short sellers or non believers in our company.

I could just tell by the tone of the questions and I kind of said, like, " I can tell by your tone, you have a lot of sources that they're sharing their feelings with you."

And I said, "why don't we just start with some facts because a lot of times, when you think about a company like ours that invests with a long-term view, you have somewhat of a volatile stock over the short term. "

But it can really perform over the long-term, I said, "so why don't we move from feeling to facts?"

I said, "so here's a fact for you.

On November 2, 2012, our company went public at $24 a share.

It's increased.

I don't know where the stock will close tomorrow, but where it closed today, it's increased 14x in value in just under 8 years.

It's one of the best performances of a publicly traded company during that time period.

It's better than LVMH.

It's better than Home Depot.

It's better than Starbucks.

It's better than Nike.

It's better than Lulu Lemon and even better than Apple.

And depending on where our stock closes tomorrow, it's better than Amazon."

And I don't think anybody even recognizes that, right?

I don't think anybody stops to kind of motor up and look at the long term, and say, " What are they doing here? "

I think people get trapped in a short term view, quarter-to-quarter kind of microscope, and they can't see the bigger picture.

And we try to motor up and see the whole chessboard, right?

And we try to see all the moves.

And we like to say inside our company don't move until you see it, right?

And so for the most part, I'd say, since we brought the car, which is now a jet out of the pits in late 2016, early '17, I think, we've basically done everything we've told you we were going to do, right?

And we probably delivered -- now we're going to deliver 20% operating margins.

I mean, 5 years ahead of, I think, any analyst had us on Wall Street or 7 years ahead because it wasn't in anybody's model.

A lot of people had us at like 17%, 5 years from now, 18%.

We thought we were 2 to 3 years away.

And now it's kind of a reset, right?

We're saying we've got a new floor.

And we have a path to 25% operating margins.

We don't make stuff up here.

I mean, I can't give you every single little detail of the puzzle.

But I'd say, if you look at our past performance, and you look at the big picture, we're a company that 20 years ago, started this journey as a nearly bankrupt company with a $20 million market cap.

I don't know, tomorrow we'll probably be have a mark cap somewhere around $7 billion.

So we think we're a really good bet.

And I think people that take a long view and look at the big picture here and look at the facts versus their feelings?

I think they're going to be really happy they invested in RH if they want to hold the stock for 5 to 10 years because I think we'll be among the best performers in anybody's portfolio over that time horizon.

A little longer than you asked, but I thought I'd share the big picture view so.

Your next question comes from the line of Curtis Nagle with Bank of America.

Just a quick one on, so Gary, in the letter you cited evidence of some of your clients moving out urban center, buying second home, second or maybe even third homes.

Hard to imagine a company that's probably better positioned for that maybe over the next few years.

I guess, could you extrapolate a little bit more in terms of how much demand that's driving?

Maybe hard to know, but how sustainable that growth could be?

Yes.

We tried to articulate it in the letter.

And it's -- your guess is as good as ours, but we like the data we see.

I think that because the pandemic is lasting as long as it has, I just asked my doctor a few weeks ago.

I said, " How long do you think we're going to be wearing masks?

And he said, "at least 2 more years? "

I said, " Really?

2 more years?

He said, "yes, " you got to think about the math.

He said, "it's going to take -- we have 270 million people to have the antibodies or the vaccines to get to herd immunity, right?

And most likely, the vaccine is not going to come until the spring of '21.

It's going to take at least 18 months to move really fast to get 270 million that people to herd immunity.

So he said, we've got a new behavior shift.

He thinks that's going to last for a while.

I don't think any of us could conceptualize that early on, and now it starts to make sense, right?

And the data and the shifts of things, I'm surprised how quickly people responded to this pandemic from the activity in the home market.

How quickly people moved to buy second homes to get out of cities and so on and so forth.

And not -- I wouldn't say all out of cities, just get second homes to have somewhere to go to.

They still -- many of them still have their city home.

And then you have people that are moving to suburbs.

In fact, there's kind of new suburbs being formed.

I mean, I was talking to some people that there's a whole new view in how they think about suburbs and Silicon Valley.

So many of the people now that they're learning they can work remote more.

So they're moving, they're buying homes in Palm Desert.

And Palm Desert now is kind of getting recast from a retirement community to a suburb for many people, right?

Younger people move where they can get a bigger home, they could have more space.

There's a perception that there's less crowds than more safety probably and so on and so forth.

And who knows when we're all going to travel again.

I mean, that's our biggest question on international.

We can't go to Europe.

Yes, unless we want to go and quarantine for 2 weeks.

So I go like, how?

Is this going to completely snap back?

Is it -- there's got to be some real somewhat permanent changes in behavior.

How long did that last?

If you think about the kind of the home buying cycle and the home furnishing cycle, it's not a short cycle.

And I do think we're well positioned for it because of our assortment and our unique interior design ability where we can just come in and do someone's home.

We're doing more full projects than ever before.

We've people who're looking for a solution that saves them time.

And we can do that.

So -- so like I said in the letter, I think, we're going to have a higher water level in through 2021, but I don't know, I've never seen anything like this, right?

I mean, maybe the air comes out of the balloon sooner.

Or maybe there's just a permanent shift.

I mean, when you get people thinking about something -- I mean, this could create a whole new market for the home.

I mean, just think about this, how many people are not going out to dinner today or limited amount of people going out to dinner.

I read some stuff that open-table reservations are down 50%, somewhere in that direction.

I'm going out to dinner, I think, 80% less than I was.

We're going to people's home for dinner, people we know well.

And I think what happens when there's a shift like this, people go to other people's homes, and then they look at someone else's home, they go, "oh, their home is really much nicer than our home.

Honey, we got to redo our home because we can't have them over to our home yet, for dinner until we make our home better. "

You get -- it's the interesting thing about humans, right?

We kind of compare and contrast ourselves all the time, what we wear, what we drive, where we live, our home, the size of our home, all these little things, where we go, where did you go on vacation?

Oh I went to Capri.

Oh, yes, we went to Capri too.

All that kind of stuff that humans do.

And so I think this focus on the home and this amount of time people are spending in their home and that the entertaining focus now in the home could create a whole perception of home that you've got to kind of have a much better home.

And your home's got to be all furnished.

Then it's got to look a hell of a lot better.

And because you're just going to have more people over, and they're going to be spending more time there.

And so that could become just like a permanent shift.

But like I said in the letter, I don't know how to plan for that stuff.

I don't want to take too much risk because I'm not sure.

So we're going to invest very thoughtfully.

We're going to continue to let cost chase demand versus demand chasing costs.

We don't want to build a big cost structure based on 40% demand comps and have it go to 10.

And go, "oh, oh".

But I think that there's -- this is a lot longer than any of us here thought, and it feels more permanent, yes.

At least it feels like it's going to have a longer life.

But we don't know.

Yes.

So and we're good either way.

I mean, we like our business model long term, either -- if this is more temporal than systemic, whatever.

Got it.

No, understood.

And a thoughtful answer.

And maybe just a quick one in terms of the capital structure.

So you paid down the converts.

You guys, I don't know, I think you're running at [13] of average, something like that.

How do we think about that going forward?

Do you remain under leverage?

What does the capital structure look like given the explosion in margins?

Yes.

We're just going to have -- we're going to generate a lot of cash.

So the capital structure is going to look really good.

And but we'll -- as we said in the letter, we'll remain opportunistic as it relates to sources and uses of capital.

And you just -- there's always going to be some kind of opportunities in dislocated markets like this and whether they're short-term or more medium-term, we like to maintain optionality.

So -- but we'll see.

Again, like we'll see how long these rates last -- our model, just from an investment perspective, even though we're doing Europe, we've got.

Surprisingly, that the first several galleries are not going to be capital intensive, but one, just Central London, where we're kind of stringing together 4 buildings and making them into one, and that will be a bit more of a capital investment kind of like New York, but Paris is not a heavy capital investment.

RH England is not a happy capital investment.

The ones that follow that, we've got 2 more deals done and signed are not heavy capital investment.

So -- and then in the U.S., we're you'll see us start to ramp up.

There'll be more prototypes, which we've got that model now kind of fine-tuned and we'll have a less capital investment approach there.

And then if you think about the last couple of years, we had some heavy capital-intensive storage.

We had RH New York, we had just the development of the first few prototypes, right?

Those, as you're working on them for a long time and making a lot of changes, it's like developing a new iPhone or something, right?

It's -- that store is really like an R&D project.

So there's a lot of capital there.

RH San Francisco, a lot of capital.

Our first guest house in New York, again, it's like an R&D project.

That's a lot of capital.

You roll through that, and we don't have as many galleries that are capital-intensive galleries.

And then as we said in the letter, our performance is going to drive a new kind of credit profile in our company, which is going to make us a much more valuable development partner for any developer, right?

Like they'll get a better cap rate on our rent and our credit than they will on other tenants.

So that tends to allow us to get more TI, lower rents, so on and so forth, and it really helps us in our own development deals, because we can -- we should be able to get better cap rates.

No different than -- yes, we sold Minneapolis in the middle of the pandemic, right, like crazy.

First, if the other people walk away, they thought they were going to get a bigger price.

And we said like, walk away, I mean, this is temporal.

We're okay.

Then they came back and we closed at a 5.5 cap.

And I think initially, when we talked about that one, several years ago, I think, in New York, we were going to put a $1.8 million rent on it and sell it for $33 million.

And instead, we've decided to put a $1.4 million rent on it and sell it for $25.6 million, but the fact is we got a 5.5 cap.

And that was before we leapfrogged at 20% to 20% plus operating margins and the cash flow profile and the return of capital profile that you're going to see.

I mean, I think that there's a chance we'll exceed 50% return on invested capital this year.

That was a long-term target.

I didn't update that long-term target because it's like it starts to be selling math, what are we going to have like 75% return on invested capital, but it's going to be a really good model as we kind of flip over and don't have as many capital-intensive projects.

So -- and even -- like if you think about our second guest house that we're building in Aspen, that's a joint venture development.

It's a very capital-light guest house.

And we're able to kind of deal like that because we were already in construction and had the designs and plans for the first one.

So the development partner was like, got it, that looks amazing, okay, I'll cut this kind of deal.

In the very, very first one in New York, people thought we were nuts.

Like, what are you guys going to do?

And people still think we're nuts.

Because I think until they see it, then you'll get it.

But so, we like the capital profile of the business.

We like to -- what -- as we project the new cash flow model, the return on invested capital, the capital requirements of the business.

I think it looks like a model -- I honestly, I would have never imagined it would look this good.

I mean, I remember my early days here, like there's a lot of people sitting around the table to hear the whole time, right?

It's like we're like, okay, if we can get to a $1 billion and make 8%, if we can get there, like we'll have made it.

And so you'd have told me, hey, we would build the kind of leading luxury design platform in the world.

And we'd be at 20% plus operating margins and a cash profile.

The model like we have building the kind of galleries that we're building.

We're not building shitty little crappy retail stores.

I mean, we're developing buildings.

These are like, it'll look great 50 years from now.

So I mean, it's kind of kind of remarkable.

When we say inside our company, the thing I've learned in my career is that you can always monetize extraordinary remarkable and amazing work.

And it's hard to really monetize ordinary and unremarkable work.

And so the thing we've learned is that we just focus on doing really extraordinary, remarkable and amazing work.

We can always create a model in a business around that.

And I think people learned that with the iPhone, right?

Like if you think about when Apple invented the iPhone, the average phone, I think, in the country was $59, and it was the Motorola Razor.

Apple introduced at the time a $600 phone.

And it was $600 that for 4 or 6 months, and they lowered it $400.

But the point is it was like so much more.

And everyone thought, that will never work, that will never work.

Then it became really one of the best-selling phones in North America.

And then Arie said, " Oh, it will never sell in China.

You never sell a $600, $800 phone in China, " and then became bestselling phone in China.

And so one thing that we've learned over time, too, if you do extraordinary remarkable, amazing work.

You actually can create a new market.

And people, we've learned over time, consumers want better things.

I -- if you really do significantly better work, people will pay for it.

And we're learning that with Tesla, right?

I mean, look at -- I mean, and Tesla's performance as a new car company.

The guy never built the car before.

And, yes, but he built a remarkable car.

I mean, it's really extraordinary compared to anything else in the market and is creating an entirely new market.

And so I think what we're doing is similar to things like that.

We're kind of creating a new market for the high-end home consumer, and it's been a market that's been behind the iron curtain, if you will, of the true to trade design centers and showrooms that they lacked accessibility, they lack transparency, and they lack scale.

Think about that.

At the high end of the market, they lack accessibility.

You couldn't even go to them unless you had an interior designer or a resell license.

Like that's a good market to decide like, " Hey, I'm going to go compete in a market that lacks accessibility, and I'm going to become accessible "

Then it lacks transparency, meaning like, they'll walk in a showroom.

There's no prices.

You can't figure it out.

There's code.

They give designers discounts, they give other people discounts, we'll give you a discount, you got to bring in a designer.

So so convoluted.

And then they lack scale and the ability to put it all together, so you got to go to like 20 different showrooms to do your house.

And then we come along with something that's accessible and beautiful, and it's transparent, right?

We remove all the -- like who's getting a discount?

This is your designer?

Is it this person?

It's that.

And then by the way, we offer design services, so that helps.

And then we've got scale.

And we've integrated it all together where it delivers time value to a consumer.

And time is the ultimate luxury, right?

It's nothing is more important than the time.

I always tell people here, how we allocate our time is more -- is actually more important than how we allocate our capital.

As I can always go raise more capital.

But I can't -- I've never figured out how to get more time, right?

So I think what we've created is going to create this entirely, I think, we're going to creating an entirely new market for our business.

And then we're kind of now in this situation where, while there might be a systemic shift towards the home and a focus on the home.

If that happens, at the same time, we're kind of evolving into the brand we aspire to be, you could really get an upward spiral here.

But we don't need that to happen to create a lot of value.

If that happens, we'll be like supercharged.

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

Gary, just curious, you talked about sustaining that 20% operating margin goal, which is impressive.

Just wondering if you can contextualize that for us longer term in the light that you go down the path of building out RH residents.

And obviously, you're going down the path of RH guest houses.

Just how do we think about the margin structure over time as you continue down those avenues?

Do you view those channels as accretive, dilutive?

Do you think you can sustain the operating margin structure?

Yes.

I think we think about them from a couple of perspectives.

One is we think that they will elevate and render the RH brand more valuable.

So how do you build a high-end luxury brand.

I tell the team, all the great brands, mostly were born at the top of the luxury Mountain, Hermes and LVMH and Gucci and Channel and just name luxury brands, come top of mind.

They've always been a luxury brand.

We didn't start anywhere close to a luxury brand.

We had Oxydol, like laundry detergent on the cover of our catalog at $5.95, right?

And so we have to scale this luxury mountain, and you have to do things that create a forced reconsideration of the brand that elevate the brand in the right consumers' minds.

And so whether it's doing a, we think, an extraordinary experience that a guest house that's going to create an entirely new market for customers seeking privacy and luxury, or having RH 3, a luxury yacht that that you can charter in the Mediterranean and Caribbean, and not a lot of people can use that, but I guarantee you when we do the portal of RH, and you see it on our website, and you see our guest houses.

And you see the other things we're doing, the branding of that, right?

We don't have a marketing department in our company because we say marketing a lot of times is about putting lipstick on the pig, right?

People try to take an ordinary thing and dress it up and make it like seem better than it is.

And we say it's not what we say, it's what we do that defines us.

So we build our brand through our work, right?

We don't really run many ads, you might see a ad or 2 here or there in a home magazine like our digest or someone in...

But really, it's mostly our work.

Our galleries are our work and their extraordinary experiences.

Our source books are our work.

Our web portal will be another version of our work and how we communicate, what we do.

And I think the guest houses and the residences if done really well, [one though] when they'll elevate the brand, and they will help us climb the luxury mountain.

Because they'll -- I think, they'll be so extraordinary.

They force the very best people in those industries to tip their hat.

And again, I believe, we've learned that if we do extraordinary remarkable, amazing things, we generally can figure out how to monetize it and build the business model.

And today, even though we haven't opened a guest house, like the few people on the inside of the hospitality world that I've showed it to.

They're like, oh, my god, do you know how much you can get for those rooms?

Oh, my god.

And if they're half right, we're going to do really well.

But they're not just kind of a new business, thinking about it independently.

I have to think about all these things in not in isolation.

You have to think about them in integration and how they elevate and render the brand more valuable.

It's just like the mistake the department stores made over the years, if you listen to Stanley Marcus in the beginning Neiman-Marcus, he can tell you, like the restaurants were never supposed to be the leading profit driver in the company.

The restaurants were supposed to get the high end of female consumers to come to the store more often and walk you through the shoe department and buy really expensive shoes and other things.

And in an integrated fashion, the restaurants were very profitable.

But if you look at things in isolation, you can make a mistake and not see the bigger picture.

It's no different than, quite frankly, it blows my mind, how many retailers right now are talking about closing stores and just having a website, like I guarantee you, people start closing stores, their website traffic is going to plummet.

You're going to find out the cost of acquiring customers through digital marketing, the cost of marketing an invisible store online, good luck with that.

There's all the digital native brands are opening stores.

So these other elements, guest houses, residences, other things you'll hear about that we'll test and incubate, they're going to create a big conversation around our brand.

They're going to be extraordinary, extraordinary pieces of work in their industries.

And they will elevate the RH brand and render us more valuable.

And I think we will find, they will become real businesses in and of themselves, and if they are, right, the ecosystem gets bigger.

If not, we have a handful of them and they're tremendous examples of our work and they elevate our brand.

And but I think long term, we're going to probably find now that we've worked on them longer, I think, that we're going to find that they're businesses, and we won't do anything like that's going to destroy value here, right?

Like we don't want to -- all of a sudden try to build a 8% operating margin business, when we've got a 20% to 25% operating margin business, we'll just drag the whole thing down and kind of destroy value.

So the idea is, can we build things in an integrated way that lifts the whole margin profile of the business.

I mean that's what hospitality does in our current galleries.

If you looked at hospitality in isolation, you might think it's a drag.

If you really do the integrated math and look at how many people turn into purchasers, and then you integrate that and you take that extra flow through, and you look at it in an integrated way, it's a really good model.

But you have to do the math on all of it.

And so we'll test these and try these, and we'll learn more.

But I know one thing for sure, they will elevate the RH brand.

They will create a conversation at the highest end of the market.

And that's what's really hard to do.

No one's ever climbed the luxury mountain before.

Starting where we started ever.

I can't name one brand.

Most brands go down.

And so this just requires a different kind of effort.

You're not going to do it just running some ads in magazines and stuff like that.

It's really -- it's -- our work has to define us here.

It's the only way we'll earn the respect of the consumers of the very best brands in the world.

That's helpful.

And just as a follow-up.

Just thinking about the factors that have driven the demand improvement over the past several months.

Probably hard to answer, maybe it's not, but just curious if you've got a sense for how much of that's coming from some of your deurbanization movement versus the shift in second home markets versus just the overall housing market doing better.

Or the last bucket would be just the pandemic and people just being more hunkered down.

I'm just wondering if you can think about like the different drivers of the recent strength?

Yes, I think, it's all of the above.

I mean -- yes, it's all those things together.

I mean, again, we were, I think, we were running with that 8 or something before this pandemic.

Yes.

So we were running to up 8 before the pandemic, and then we went down 40, and now we're up 44 or something in core business or something like that.

But 47 in August, up 44, so 4 months to date in September.

I mean, yes, I mean, there's a big shift here.

The question is, how much of it is systemic and how much of it is temporal.

And the key is, I think, you've got -- you've got to play it with the expectations that it could be temporal.

Otherwise, you can kind of goof up your model.

So we're okay not trying to optimize everything in this market, right?

If this thing is temporal, you can like change your model and try to run after every sale and optimize this and put your head down in the weeds, and maybe you'll crank out another 3% to 5% of sales.

And -- but all of a sudden, you're focusing on the Little rocks and you just screwed up your model, right?

And then all of a sudden, the thing -- the air comes out of the balloon, and you're like, oh, now what?

You got to disarchitect your business and stuff and your cost structure.

So we're okay.

We're not chasing any sales.

We haven't put one thing on promotion.

We're letting some demand get away.

We know we're losing demand with the backorder rates we're running, right?

There's so -- but that's okay.

This is -- I don't want to be famous for, like, " hey, they did really great during that pandemic, didn't they?

Do you remember them?

"like, " Oh, my god, they had the best numbers during the pandemic.

What happened to them? "

"oh, yes, I think, long term, they kind of screwed up their model. "

Like we look at this as, yes, this is some kind of a temporal event that may have systemic long-term benefit to the home.

We hope it does, but if it doesn't, it's okay.

It's we're looking at our model very long term.

And that's what I love, the fact that, " Hey, our revenue is flat this quarter.

Thank God, so I don't have a zillion questions from everybody like, where was the margin?

How much was this?

And what's the leverage there? "

Like revenue is flat, and we have 21.8% operating margin.

And that's with 40 basis point drag from the pandemic.

That's a 90 basis point drag from Waterworks.

It's got an 80 basis point drag or something like that from hospitality because we're in start-up mode.

We've got another drag from some kind of onetime investments we're making.

So we could take those pieces and not else to see, yes, 25 down that road.

So stay down that road, don't get lost in the little rocks of the pandemic.

Yes.

Ride this way, the best we can.

But I don't think the business stays up 40%.

I don't.

It might stay here for a couple of years.

Yes.

Or maybe there's a new water line.

I don't know.

I mean, it's just hard to say.

It hasn't been that long.

I mean, never seen anything like it.

So I just don't want to overreact to it and goof up the last kind of decade of work.

So we're taking a very long-term view here.

We're not running around with our heads down, trying to manage the business from week to week.

We're not pulling any levers.

There's no promotions going on here.

Just trying to build the best brand of its kind in the world.

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

Congrats on all the momentum in the business and the bright outlook here.

My question was if you could share any color on how to think about some of the expenses and SG&A in the back half of this year?

On the one hand, I would presume, there's perhaps more sales coming from an e-commerce or a web order rather than in the stores, and that may benefit costs.

You're also not mailing the source book.

On the other hand, of course, knock on wood, the sales look really good.

So how should we think about expenses through the balance of the year?

Yes.

Look, we'll have, obviously, some savings in ad costs.

And we're not going to try to chase and optimize the revenue over the short-term here, we think we've got enough, and we're already chasing it from a supply point of view.

So we think we're going to -- making the right decision to -- it's not like we're not mailing the book and not doing anything.

We're not mailing the book, and we're going to invest our time and energy and resources and make investments in other areas that we think will have real long-term benefit to the business.

Versus mailing into this, doing a lot of work and maybe getting a little extra bump or no bump, mailing into it just not having the goods, or if the already customer already optimized.

So -- and by the way, the other thing that we want to learn is, I don't know, maybe the books aren't as productive anymore as we think.

So let's take this time and test our way kind of out of it and back into it, and we'll get some new fresh data that says, " Hmm maybe when we launch the portal and maybe because we're building all these big new stores, we can mail less books, " and so there's lots of motivation about kind of testing and learning for the long term.

So -- but we're making a lot of investments in long-term growth, making a lot of investments in international, making a lot of investments to elevate and expand the product.

You probably read, if you haven't read, we've made a small acquisition of a business that we disclosed.

So we're not saying much about it from competitive reasons.

But that we think is going to elevate us and the talent -- the acquisition is going to continue to help drive our kind of product capabilities.

So that's what we're focused on.

And then we want to really do our best work at introducing the brand internationally in Europe because that opens a whole door, right?

If we start to demonstrate that this brand can work without a long, long ramp up.

Like if our brand can be introduced internationally and actually ramp anywhere near a market, a normal market that we haven't been in, say, like Canada, when we've opened galleries there and stuff.

That just means that we can that will lay the tracks for the brand being $20 billion globally without really anything else working, right?

So again, I kind of think about it, if we can prove ourselves internationally, and we can, over a several year period, kind of ramp-up in England and in France and in throughout Europe and Spain and other places, Germany and so on and so forth.

That probably is going to be a really good indicator of what's going to happen as we move across to Asia and Australia and South America and other parts of the world.

And the world, what we feel good about our timing is that the world is exponentially getting smaller, right?

The visualization that happens on the Internet through all the platforms and social media and Pinterest and everything else like the world is getting smaller.

The world is adapting the same taste and style and so on and so forth.

So I think that really -- all of this is really going to benefit great global brands.

So we're investing in all those things.

And despite the investments, again, we think we'll do quite well from a profitability and margin performance perspective.

And Brad, it's Jack.

I'll just add quickly.

As Gary was talking about with -- as we think about the 20% model as a floor with an implied sort of 5% revenue increase.

You can do the math also and what that implies for H2 op income, and that's 22.2% with 700 basis points, right?

That's -- again, that's just the implied math of the floor we were guiding.

We're not telling you how that split between gross margin and SG&A.

Obviously, we're not guiding.

But naturally, as you've alluded to on the source books, that benefit would naturally on the SG&A side, come more in Q3 than it would in Q4, given that's when the mailing would occur.

So I just wanted to leave...

That's a good point, yes.

add that from a timing perspective as you think about the quarters.

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

Great content and color.

Gary, as you were talking about sort of brand building, although some of these very high end brands.

When you look at many brands, global brands, they have a line that's called demand creation.

And so when you think about your catalogs as being sort of 3.5%, 4% of sales, you almost have the luxury of having another 600 basis points or so in all of these different areas like RH 3 and [art, wine] and guest house and hospitality, right, to build that.

And so I guess my question is, is that the right way to think about it?

How much could you bring that demand creation up through as a percent of sales because now you have the luxury of this extra margin.

And then to your point on the catalogs, could the catalogs ever turn from content only product only and be a physical manifestation of sort of the world of RH in sort of a lifestyle content magazine.

So there's a couple of my questions.

Yes, you look from work here.

Our whole leadership team is in the room, by the way.

Yes, I was like, yes, okay, you think like we think.

So yes, correct, on all of it.

Yes.

So exactly how we think about it.

Okay.

And then so if that's the quick answer.

One quick, very small thing, actually 2 quick housekeeping then.

I know it's a small initiative, and you have so many bigger initiatives now.

But where are we with RH Color?

And then secondarily, what percent of transactions that you're running currently have interior decorating services attached to them?

Yes.

We don't give the interior design percentage to an investor base that we don't.

Yes, it's a big part of our business.

But yes, we don't give it for just some competitive reasons right now.

And then like where is Color?

Color is probably ask me that question next quarter.

We have a series of off sites and time we're spending just to evaluate all of our kind of key value-driving strategies and initiatives.

And we have a pretty long list of opportunities.

And it's how many can we do at one time?

How do we sequence them?

What's the emotional strategic and financial value of each one of them.

And that's how we kind of allocate our time and human capital and financial capital.

So we're excited.

I mean, I actually -- it's kind of a gift to tell you to say, like, you know what, just don't mail the book right now.

Don't do all that work.

Like just have everybody stop and let's take all our talent in this organization and kind of really see the board, really put things in the right order and really focus on kind of the next few big rocks that can kind of change everything again.

I really believe that if we use our time wisely over the next 6 months that we can really step change the core business from just a comparable sales point of view.

Yes, like if you really need to get all the leadership to focus, including me, right?

So -- and we've got so many things to work on in so many opportunities.

And we've also brought in a lot of new talent.

And we have a lot more kind of capacity to do more.

But it takes everybody together and to really focus to move the big rocks.

Otherwise, people are working really hard in all these little rocks and they're kind of ranging and organizing things.

And at the end, it doesn't really move the needle that much.

But in the just short time, we have started to focus in kind of a couple of the categories, I think, if you were sitting here with kind of our senior leaders of kind of product, I think, everybody's eyes really wide open, and we think, wow, there's a lot of opportunity here.

And then not only just the product itself, but then the physical manifestation of that product in the marketplace, we've got ideas and opportunities to do things.

Today, we're -- I'd say we're exceptional at presenting the product physically in an integrated fashion.

We're a little hard -- we're kind of hard to shop by category today, right?

You go to one of our big galleries and you try to shop for lighting.

Try to shop for -- you got to kind of walk the whole place.

And we don't even have the whole assortment in organized way.

And again, the web helps you there and the books help you there.

But people still really want to see the goods.

So we've got a lot of ideas around, doing different physical manifestations of categories in a way that we think can also be massively disruptive.

I don't know maybe I should throw one out for everybody a bone.

So they think about it, like, most likely, this one will come.

I'll talk about one that we're a little further along in our thinking just to kind of give you the idea.

Look, we think -- if you go to any of our regular galleries, legacy galleries, any of our legacy galleries.

They show one collection of outdoor furniture on the floor for 6 months of the year, right?

And then if you go to our big design galleries, we show 20 to 24 collections year around, somewhere around there.

But they're not all in the same place.

Some are on the rooftop, some are around in garden patios, some are on terraces.

And we have now, what do we have 45 collections or somewhere like that.

By next year, we might have 60, 70 collections of outdoor furniture.

We've got a concept we're working on that could come to life, yes, faster than slower.

Actually, I like saying it because it gives us a faster deadline.

So everybody is looking at me here in this room, they're going like, okay, here he goes.

Now we've got to get this done really fast.

So we're working on a concept called RH Oasis.

And it's going to be a freestanding outdoor furniture experience like nothing in the world.

It will be mind blowing.

And we will own the category of not only outdoor furniture, but shade and fire and heat and textiles and things presented in a way, in an environment that you can't even imagine.

And I think it will be massively disruptive and accretive to our business.

And if you kind of think about that and you think about like, well, gosh, is there something you can do?

Is there RH illumination?

Is there RH under foot?

Is there RH [picture upholstery?] Is there are RH (inaudible)?

Is there -- like, I can go on and on, right?

And Eri's is going, "oh (expletive), here, he goes, like the whole change. "

But you can all of a sudden start to imagine an RH Compound of this beautifully integrated experience with these isolated experiences around the categories that allow you to shop both ways and allow us to express our brand in a way, no one's ever seen.

And so we've got these things that we're working on that we're testing.

And that's why we have to put everything in perspectives.

Like, well, where is RH Color come in?

Well, like we got a whole bunch of things like that to choose from and how many can you do at 1 time, in what order?

How do you do it really well, like I got someone in the room looking down at me, saying, are you going to tell them about that?

If I tell them about that, they'll think we're really crazy.

Like she's looking down at me right now.

But like another big idea, but we're not short of ideas here.

And the key is we're all short of time, and it's just how do we allocate our time.

And I love the fact that right now, this pandemic in some ways, has given us the permission to reallocate our time in a dramatically different way.

And I think we'll be more right than wrong as we measure the outcome of how we allocated our human capital over the next 6 to 12 months.

And we might find that, wow, there's real breakthroughs here, and we might be spending our time to like, who knows?

Maybe we might find out 2 years from now, 3 years from now, we're mailing 2/3 less books that we just don't need as many books, and they can be different, like you said, express total lifestyle differently.

And lots of different ways to do it.

I mean, the good news is we're kind of always unsatisfied, always on the move.

We're always innovating.

We're always learning.

We're getting smarter and smarter.

And I think we'll keep finding better ways to do what we do.

So lots of things in the horizon.

Like I gave you a little peak into the future.

Now you guys are going to ask me in every conference call, like when's RH (inaudible) coming, when's RH (inaudible) coming?

When is this coming?

When's that coming?

But there's going to be a lot coming over the next 5, 10 years.

Like we're not going to run out of ideas here.

Our next question comes from the line of Michael Lasser with UBS.

2 quick ones and maybe for Jack.

Number one, can you provide an explicit breakdown of where the gross margin expansion came from in the second quarter?

And then I have a quick follow-up.

Well, we -- beyond what Gary already mentioned in the letter because we did talk about 490 basis points of product margin.

And so the rest would be shipping expense and occupancy expense, which we got a little leverage on each of those.

And we're not going to go into much more detail than that.

And did that just come from fewer promotions and discounting that occurred in the second quarter?

Yes, partly that.

I mean -- but partly higher-quality product that's commanding the higher margins and (inaudible) all the things that we've talked about.

Cycling of the outlet, cycling of the rug transition.

So and that's about -- those 2 are about a little over 1/3 of it, right?

A little less than half?

That's right.

And the rest is just higher margins across the business, right, across all the categories.

Yes, that's helpful.

And my follow-up is, so you're on this path to 20 -- mid-20s margin over time.

Is there a scenario where you would take -- your margin would take a step back if you accelerated some of these investments?

Or do you think, from here, you can continue to seeing margin expansion year-over-year, even while you do make these investments?

We think we can do it even while we're making those investments because we keep doing it while we're making -- we've been making investments.

And I think the key is, I think, maybe there's a time we say, look, we've got so many really good ideas now.

We're going to invest even more, and we're going to have a flat year.

We might have a year that's a little down, I don't know, maybe.

We'll tell you when we get there.

I mean, we will make really good long-term decisions.

Like we're not going to, all of a sudden become a company that gets to 20% operating margin and starts managing quarter-by-quarter and go into the downward spiral that a lot of companies do because they start quote-on-quote "protecting their brand ", right, instead of building their brand.

And they hit what I call the death curve.

They're really smart and inventive and innovative while they're building their brand.

And then they build something that's valuable and then they start to protect it and everybody starts playing defense instead of offense, and that's when you just go into that death curve.

And you start shrinking because you start playing massive -- you play more defense than you do offense.

So look, if it's right for us to run flat margins or slightly down margins to make an investment to kind of leapfrog the company by hundreds of basis points.

Of course, we'll do that.

Like you'd have to be a short-term thinker.

I like -- I'm not trying to get out of this company or sell this company.

It's like none of us are.

We're -- this is our life, not just our job.

So we're going to make decisions like we own 100% of the company.

We're not going to, all of a sudden, play small ball try to play quarter-by-quarter, year-by-year predictable margin improvement.

We could have, by the way, I could have not let this thing slingshot to 20.

I could have said like, " Oh, let's like spend a bunch more money here.

So we grow 100 basis points a year or 150 basis points a year. "

Like that's like dumb.

Like we're going to find big moves and big leapfrogs, and we're going to make those big moves and big leapfrogs because you know what they do?

They lead you to the next big move and big leapfrogs.

So we're going to keep playing our game.

And again, if you look at us over time, I kind of shared with you, go do the math.

Go look at November 2, 2012 and look at our stock.

It went public at 24, and look where it is today.

And go, look up every 1 of those other brands that I would tell you, most people, I'd say, "Hey, how do you think these companies did over the last 7.5 years compared to us? "

Everybody, you ask, that hasn't done the math would say, "Oh, those companies did better than RH. "

None of them did better than RH, right?

And the only way to keep that kind of performance alive is to continue doing what we're doing and not play -- not get down into the little rocks, not let our view contract and start playing a quarterly or yearly game.

We're going to -- 10 years from now, 5 years from now, 10 years from now, I think, our shareholder is going to be really happy.

If I start playing like quarter-to-quarter, year-by-year, oh, my God, we -- operating margins might be down 100 basis points this year.

Let's not invest in that extraordinary idea.

Let's not do that.

Like, I think, this is dumb.

Yes.

So we're going to play the game with a long-term view.

It's worked for us thus far, and I think it'll continue to work for us.

We want to get better.

We're going to have to take bigger risks.

We're going to have to be more inventive, more innovative than we've ever been before, right?

You're either striving to get better, or you're allowing yourself to get worse.

There is no such thing as staying the same.

That's why I've said in the beginning, like someone pulled out my first video.

We were watching it the other night.

When I said if you want to know about our company, put down your spreadsheets and go to Melrose, go to L.A. or go to Atlanta, and maybe you'll see what we see.

And also fall in love, right?

And it's because you have to kind of -- this is so different, you've see it to believe it, right?

But we've got to get better at doing what we do.

We got to get more courageous, not less courageous.

We've got to take more risk, not less risk.

Otherwise, the whole thing is going to -- it's going to go into a downwards spiral, it's going to become boring.

We're going to lose our passion here.

And you're going to be like all the stiffs in the department store industry.

Like they haven't done one innovative thing in the last 25 years.

Why?

It's because like they're managing the business.

They're not leading.

They're not building.

So we're not going to be scared to kind of take risk to kind of have our margin like delever by a year.

Thank God, we did what we did in 2016 and '17.

Your next question comes from the line of Cristina Fernández with Telsey Advisory.

I wanted to ask about the demand trends you're seeing, I mean, it seems like it's a very good opportunity to attract new customers to RH.

Can you talk about whether you're seeing an increase in new customers?

Or is a lot of the demand coming from existing members or reactivated customers that perhaps had shopped before but not recently?

Yes.

Let me say, I think, the numbers would indicate we're seeing a lot of new customers, right?

There's an acceleration in new customers, there's acceleration in existing customers.

But you can't run-up 40 demand, 47 demand without new customers.

So there's people that all of a sudden, again, the home has become more of a focus.

It's more important -- there's more people buying second homes, moving.

There's an uptick in the home building market?

Yes.

And hopefully, this means that, again, it sets a new level of importance on the home, possibly indefinitely.

That's helpful.

And then my follow-up, can you talk about the performance of the 2 new stores that you opened this quarter?

And then on the -- on your letter, you mentioned you couldn't provide opening guidance for galleries, just given all the changes, but maybe update on what's going on there?

And when do you think you could resume some of the store openings in 2021.

Yes.

Well, one, Charlotte and Marin -- we're really happy with both.

It really is pretty extraordinary.

Marin, it's not performing as well as Charlotte because the restaurant we opened, and the restaurant was opened for 3 days, and we had to close the restaurant.

The restaurant has been closed, what, for 1.5 months, 2 months, something like that.

It's really great for everybody that's kind of -- we haven't opened for our associates.

So we're feeding our people, and it's -- so we keep our team engaged and alive and people are -- get to eat there, but our customers can't, and that drives a lot of extra traffic and extra revenues.

But in spite of that, Marin is really performing well.

Charlotte is kind of off the hook, right?

Like -- and what we're finding in some of these, I don't know, if we can talk to Charlotte as a secondary market?

Yes.

I mean, some of these markets like Charlotte and Columbus, like extraordinary lifts, I mean, lifts like way better than we've expected.

And I think that we're even more differentiated and unique in markets like that because even the great brands, if you look at the luxury brands, my sense is they probably underinvest in those kind of markets because they don't understand them.

And there's -- I think there's a lot of wealth in many of the markets.

And my sense is that brands tend to under invest.

And so we built our prototype in both Charlotte Marin, but you think about Charlotte and Columbus, the lists are extraordinary.

I mean, way beyond our expectations, not a little beyond, way beyond.

So it really is making us rethink the -- just the focus and investments in some of these markets because they're very home centered in a lot of these markets, in Columbus and Charlotte and places like that.

And so -- but we couldn't be happier with how the new galleries are performing.

And then as far as the guidance, '21, we'll open new galleries in '21.

We just -- things are moving around.

We've had some of the developers of -- they froze their capital outlets, which is a lot of our TI and stuff for a few months.

And we've lost time.

It's hard to get things into local municipalities and get approvals right now.

You're doing Zoom meetings and we're trying to get RH Morristown approved in New Jersey, which is a 5.5 acre of state with a historic home, and we're developing multiple buildings and gardens and food and beverage offering stuffs, so it can be extraordinary gallery.

It's just that -- it's hard to -- without physical meetings and town meetings trying to do the stuff on Zoom is just taking forever.

So we've got a bit of a slowdown on things.

And -- but we will have new galleries in 2021.

I think we -- it's just too hard to commit to a number because some things are going to get kicked into 2022 and things that were 2022 are going to probably get kicked into 2023 because just everything is kind of backed up.

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

It's Max on for Oliver.

Can you provide any updates on timing in Europe?

Where are you in the process of just planning where the DCs are going to be and then the new gallery openings?

It seems like maybe it's also been pushed out a little bit.

So any color there would be great.

And then we have a follow-up.

Yes.

Nothing's pushed out in Europe right now.

The initial gallery that we planned to open, RH England, which we plan to launch with -- we still believe we can open it tentatively in the kind of early summer and of '21.

And that's anticipating if we're to be able to travel over there soon.

But -- and the team is identifying distribution and logistics solutions and where we're going to be and whether the DC is kind of be in Belgium, or it's going to be in the Netherlands or it's going to -- do we open one in the U.K.?

And we've got all the optionality teed up, and the team's done a very good job of creating the options and doing the math and thinking about it short term, long-term as we think about the investments, and we've got to kind of ramp up being able to -- we've got to place the orders, and we've got to get goods, and they've got to be there by April, May, so we can open in June as kind of our target.

Maybe we can open as early as May, but I think it's going to be more like June.

But a lot of it's just going to depend on the virus and what does travel look like and what is local restrictions look like as far as gatherings and shopping?

And are we going to have a second wave of the viruses?

Are things going to slow down or shut down or anything, like we just don't know.

So we [systemically] 2021, that's when we were always going to open that first gallery.

We're targeting, I think, 2022, we would have Paris ready to go and maybe another one.

And then my sense is, Central London is just a more complex job that might take longer, it might be 2023.

But we'll see.

It all depends.

It's like just getting approvals right now and things like that are the difficult thing and understanding construction time lines and stuff.

So -- but so far, there's no real change.

The only questionable -- questionable one would -- can we get RH England open in '21?

There's still some questions because we just can't travel right now, and there's things we can't do.

Got it.

That's very helpful.

And then on the new opening pipeline, obviously, no guidance, we just discussed that.

But can you remind us how many of those galleries are planned to be capital-light and then with that in mind, just any sort of framework we should think about longer-term CapEx, where it could be versus, let's say, the last several years?

I don't know if -- I think, you're going to see more capital-light than less capital light.

We don't have that many bespoke projects on the dock that's doing that right now.

There's New Jersey...

New Jersey is bespoke, but New Jersey is basically capitalized the development deal.

So we -- New Jersey were -- yes, we're buying it, we're building it.

it's a development deal where we're going to sale leaseback.

Yes.

We'll do a sale leaseback, we'll get 100% of our capital back out of New Jersey.

So I think about those as capital light.

I mean we have a little bit of capital we're putting upfront or taking some construction loans, and we'll get all of our capital back immediately after we sell it.

So -- but I'm just trying to think, we -- most of our big capital jobs.

I mean, the one on the horizon I'm thinking about is London, depending on what we do in Orange County, that will probably be a little more capital-heavy because it's going to be a kind of a new spectacular gallery.

Miami could be (inaudible).

Miami.

Miami, yes, Miami, if we -- yes, we have an opportunity to do a deal, we've been trying to do for 7 or 8 years.

And now since it's coming looks like it might be coming back, which would be extraordinary.

But even there, I think it's going to -- you've got some of these things that might look capital heavy, but they're like New York, right?

They're going to pay back in 2 years.

So but going forward, I would say, that if you think about the real estate pipeline, it will have a better return on invested capital in the next 5 years than it had in the last 5 years.

Your next question comes from the line of Tami Zakaria with JPMorgan.

I have 2 quick modeling ones.

So you mentioned COVID-19-related costs were about 40 basis points of drag in the second quarter.

That's right.

So any guidance on what we should expect for the rest of the year related to that?

And then could you remind us how much was the annualized savings from the headcount reduction you did back in April?

Tami, I'll take that.

Look, from a COVID perspective, clearly, with the reopening activity in Q2, there's probably the bigger hit is going to be then with the 40 basis points.

And so as I think about the rest of the year, it's some amount less than that.

And then as far as the headcount savings, look, we -- as Gary talked about, we went from demand being down 40 to demand being up 40.

You have an 8-point swing in our business.

And so in some ways, those savings and we're making investments from here.

So the bulk of those savings are sort of behind us in Q1.

Some -- we got some in Q2, but we're in investment mode, given the trajectory of the business.

Got it.

That's super helpful.

And then lastly, another quick one.

Regarding the world of RH.

When do you expect that to be up and running?

I think it's probably more like spring of '21 somewhere around there.

Your last question comes from the line of Seth Basham with Wedbush Securities.

It's Seth Basham with Wedbush.

My question is really around some of the sequencing of all these great investments that you're planning.

You've got a really bad connection.

Yes.

You've got a really bad connection.

We can't understand you on this end.

It's like Darth Vader almost.

We can't.

Yes.

No, you've got a really bad connection.

So you're talking about sequencing of the investments we're making?

Yes.

If you can just try a little bit more color on how do you manage the execution risk associated with that, that would be excellent.

So how we manage execution risk with the investments we're making?

Yes.

Again, we spend a lot of time deeply thinking about where we allocate our human and financial capital.

And we think about investing in things that have a much greater asymmetrical risk to the upside.

So I don't see any massively elevated level of risk in the investments we're making, the one where we obviously have the less -- the least amount of experience and data is in the international expansion.

So but I think we've got that appropriately handicapped, and we're moving at a good pace that's going to allow us to kind of learn and improvise and adapt and overcome.

So but I don't -- the level of capital that we're putting into the European expansion is, if you had asked me 3 years ago, I would have said we were probably going to be putting in 2 or 3x more capital than we are.

So that brings the risk level down quite a bit.

And the fact that we were able to get a handful of these deals that were ex Abercrombie & Fitch flagship locations, where they've put in a massive amount of capital rebuilding the buildings, putting in the HVAC and the electrical and all the kind of infrastructure, and they built beautiful.

I mean, anybody who's seen some of the Abercrombie & Fitch locations are unbelievable.

So we've got a handful of those that are going to put us in a more of a capital-light perspective because we can just take out the fixtures and do some interior architecture.

The outside of the buildings are spectacular.

And then we got some capital building a restaurant either on a rooftop or terrace or things like that, that are not significant capital.

So that's what's giving us a pretty high level of confidence in -- that we've mitigated a lot of risk.

All right.

I will now hand the call back to Gary Friedman, Chairman and CEO, for any closing remarks.

Great.

Well, thank you, everyone, for your time and interest in the organization.

I do want to thank our people and partners of RH in the U.S. and all around the world, just your extraordinary efforts to just improvise through this period

and adapt and overcome the challenges and bring our brand to life in new and innovative ways and connect with our customers in new and innovative ways and connecting with each other in new and innovative ways.

I think it's been extraordinary to watch and is making us -- made us all so proud.

And I'd say, look, the next 10 years for this organization, the opportunities ahead of us are just extraordinary.

And if anybody takes a look at what we did in the last 20 years, with no capital and basically trying to dig ourselves out of a grave, you think about what this organization is going to do with the knowledge we've acquired,

the capital structure we have, the experience and the passion we have and the love we have for what we do.

We couldn't be more excited about what's next.

So thank you, everyone.

We appreciate your leadership, and we appreciate your partnership.

Thank you.

Thank you, ladies and gentlemen, for joining RH Second Quarter 2020 Earnings Conference Call.

Have a great day.

You may now disconnect.