RH (RH) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the RH Fourth Quarter and Fiscal Year 2019 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 your speaker today, Allison Malkin, Investor Relations.

Thank you.

Please go ahead.

Thank you.

Good afternoon, everyone.

Thank you for joining us for our fourth quarter and fiscal year 2019 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 the outlook for our business and other matters referenced in our press release issued today.

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

Please refer to our 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) The first question is from Michael Lasser of UBS.

So it's a two-parter.

If you look at the low to mid-40% run rate decline that you experienced in closing your stores, do you think that there's a realistic run rate beyond this?

You guys know a realistic run rate to kind of model the business as long as those stores are closed?

And given the dynamics, how should we think about the profitability of the business if this run rate continues?

Sure, Michael.

First, let's just say, I think we're way too early to comment on any realistic run rates.

I think we've had -- what have we been, closed for 11 days now?

Right.

Yes.

Yes, 11 days.

So I wouldn't necessarily commit to anything.

We're in such a time of change and uncertainty.

It's -- this is a time where things are changing not weekly, not daily, but changing hourly.

If you just step back and think for a second, the President of the United States on Friday, I believe, said that the country will reopen on the 12th.

The President of the United States on Sunday said the country's now going to be closed through the end of April.

There are so many things changing right now.

The important thing is to pay attention at what's changing.

The important thing, I think, right now is to quiet the noise.

It's not a time to rush.

It's not about the amount of decisions you make.

It's about the quality of the decisions you make, and we believe it's a time to do less and think more so we can do more, and just kind of try to motor up and see the whole board, if you will, from a chess point of view, and try to take the most recent data and information that's available and try to establish patterns and try to look ahead.

But look, 2 weeks ago, a little over 2 weeks ago, nobody knew every store in the country was going to be closed.

So this is an unimaginable time to be leading a business, to be leading a company.

And we're not going to kind of rush to try to figure everything out.

I don't think you can.

I think you've got to kind of look at kind of the big picture and make the right, big decisions right now.

And everything that we put in our press release, everything we wrote in the letter is what we can see and what we know today.

Beyond that, it would just be unwise to comment beyond anything that we've already said.

Okay.

And in your letter, you did mention you're planning to pay down the $300 million in this summer.

Can you give us a sense for what the burn rate, what the cash burn rate of the business looks like, so we can get -- have a better understanding of the liquidity of the business, especially as the stores are closed and it's facing some pressure?

Yes.

Again, I -- we're not going to comment beyond what we've commented in the letter.

We feel confident just based on what we know today and what we see, and we're taking the appropriate actions and deferring capital and reducing costs.

And we're in a position where we're confident to say that we can pay down the $300 million of convertible notes in cash, just as we planned to before.

So nothing different there.

Your next question comes from Steven Forbes of Guggenheim Securities.

I wanted to focus -- just thinking about times now, right?

So I just sort of wanted to focus on the efforts of the design team broadly right now that the stores are closed.

So Gary, I don't know if you can expand on how they're interacting with your customer base today, what successes are you seeing on the back of those efforts.

And whether you think those efforts have helped to alleviate some of the stress on the business more recently.

Sure.

Sure.

First, I'd say that the amount of innovation that's being generated by our people across every part of our company has been extraordinary over these past couple of weeks.

And we're doing daily conference calls, including the weekends.

I don't know, Jack, would we have an 8- or 9-hour conference call with leaders across the country yesterday and Saturday?

And this is such an important time to kind of listen, learn and then lead because we like to say in this company that the smartest people are those that are closest to the customer.

And those of us who have gotten farther away from the customer generally get dumber and dumber, and that makes me the dumbest guy in the company.

So the only way to lead people through any time is to first listen, then learn and then lead.

And I'm just so impressed by the amount of innovation that's happening across our country.

We're reimagining RH live and in the moment.

And particularly from a gallery point of view, not having a physical location and trying to imagine how do you work with people and how do you continue -- not only continue, how do you -- just reimagine how you interact with customers, how you do interior designing and so on and so forth.

How do we market to our customers?

What should we be marketing now?

What are the -- what is the most valuable?

Because everybody is bombarded with communication, just start right there, that the amount of news people are consuming today, the amount of information just trying to stay up and stay up to date and just stay safe is basically overwhelming.

And so communicating in a typical way is, we believe, fruitless.

So we try to imagine -- reimagine how we're communicating, how we're working with the consumers.

If you go to our website, you can get a sense for what we're doing.

The whole front of the website starts with a letter from me addressing the current situation, letting everybody know our galleries are closed and letting everyone know that we say our doors may be closed, but our hearts and minds are open.

Our design team is here to help in any way we can.

We set up virtual appointments using FaceTime, Hangouts, Skype, Zoom, or call -- it's like we're live innovating, improvising, adapting and overcoming.

And the demand that our teams are generating during this time is -- I think it's extraordinary.

And we're learning hourly and daily.

So this is -- if you look back and think about the really big important moves this company and this brand has made in its history, they were -- the most important moves we made, the biggest transformational steps we've taken have been in the times of most uncertainty.

And I believe, as I articulated in the letter, this will be no different.

So I think Winston Churchill said, "Never let a good crisis go to waste." And for our culture, this is probably when we're at our best.

So I think you're going to just see an evolving, changing effort and an upward spiral in how we just run our business that is not just -- that's not going to just define the short-term and this period but is that -- there are going to be different ways to kind of lead our business and run our business forever.

I think no different than this virus is going to forever change this country and the world.

This time is going to forever change our company and our way of doing business and, in many ways, elevate our culture.

So yes -- so I think it's one of our great strengths is we really do have the largest interior design firm in North America today, residential interior design firm, and having that is a true strategic differentiator and strength.

And we also have a large B2B business in our contract and trade side of our business that are -- both have similar attributes of being -- can operate in a B2B direct way with the customer.

And we're leveraging all our assets and all our knowledge right now and learning daily.

So -- and it's what I tell the teams that, look, right now, just a headline, it's going to get worse before it gets better.

But make no mistake, it will get better.

So how much worse it gets?

We're all doing our -- coming up with our own assumptions and modeling all the different possibilities and downsides.

I think the greatest risk for our industry is if governments decide to kind of describe -- if they change the essential business descriptions on warehousing, transportation and service aspects that deal with the supply chain and logistics, I think as long as we can run the direct side of our business, we're very confident.

I think for everybody in our industry, if that gets redefined, if how governments describe business functions that today they define as essential, if that changes and everybody's warehouses change and transportation and delivery changes, if everything stops, you've got an entirely new ball game.

And of course, if you're smart, you have to model all of that and understand what does that look like.

But that also has implications on the entire system of the United States, right?

Like every port would have to shut down.

The movement of containers would have to shut down.

Every distribution center in the world would back up.

Every port would become inoperable, and the shipping industry worldwide would shut down, right?

So that, to me, is the greatest risk any of us in this industry face because I think almost everybody today has some sort of online business and some way to interface with customers.

So we, on the other hand, have had a direct business that at one point was 50% of our business, and it's come down some as we opened these bigger galleries as we expected.

But we're a very capable direct-to-customer business not only through our website but through our contract and trade business and hospitality business and so on and so forth.

So -- and when I say hospitality, I mean hospitality contract business, not our hospitality, food and beverage business.

So at this current moment, and again, things can change all the time, we're -- I've never been in a leadership position like I've been doing what I've been doing for quite a long time.

I'm not a young guy anymore, but I have never seen a time where things are changing this rapidly from day-to-day, moment-to-moment.

And so I think the important thing for everybody is pray for peace, plan for war, try to see the whole board, be patient, don't move until you see it.

I think there's more risk in this environment by rushing to make decisions and making the wrong decisions for the short term that can be devastating from a strategic point of view.

So this will get worse, but it will get better.

And the key is how do you navigate through this period.

And we have data, right?

We've seen the curves in China.

We're not so sure how good the data in China is.

And look, it's very different in China.

You see videos of people getting off buses and planes and being sprayed down like cattle, right?

So that's probably not going to happen in our country.

So the curves may be somewhat different.

But even in countries like Italy and Spain and where they've had really bad breakouts, you can see the curves start to flat, and you can see things starting to change.

And you can -- this is temporal.

The question is, is it a month?

Is it 2 months?

Is it 3 months?

Is it possibly longer than 3 months?

Does it go through midsummer?

But at some point here, it changes.

The question is how do you optimize your business through this time?

And how do you position yourself?

How do you navigate to survive during this time?

And how do you position yourself to thrive on the other side of this?

And that's what we're thinking about.

And then Gary, just a quick follow-up on that, right, sort of thinking about getting ahead.

I guess do you envision any potential future supply chain disruption, right, given the global reach of the virus?

Or what are you sort of doing to get ahead of, whether it's more back orders or just disruption in the global supply chain?

Sure.

Sure.

So the biggest piece of the disruption has already happened on our end of the business, and that really dealt with China and Asia, the broader business that we source out of Asia.

And that is pretty much back to normal.

It's actually 100% back at actual orders.

Yes.

100% back.

And so the challenge becomes -- and then if you look at it more globally, we've got a pretty big business coming out of Italy.

We're the biggest importer of Italian bedding in the world.

We've got some furniture and upholstery coming out of Italy.

We've got -- and so we'll have some disruption there.

That's not a big percentage of our business.

The bedding side of the business, we're -- we've got relatively good back stock situations.

And so we don't think that will be massively material as long as the curve flattens in Italy and things come back in the next several months.

But most of our -- and then really, what's going to happen in the U.S.?

We still have a relatively good portion of our business, especially if it deals with upholstery and special order business happening in the U.S., some coming out of Mexico.

But I think the biggest challenge is behind us.

The Asia challenge, the virus has been relatively well controlled out of Vietnam.

We're -- all of our Asian factories are back to 100%.

So the key becomes, how do you -- as you think about our manufacturing platform, it's a true strategic advantage for our company, right?

I've always said that furniture of this quality has never been made in these quantities before.

So we've built, in partnership with all of our key partners, built the manufacturing platform.

And the key is how do you not let the virus create any permanent damage.

And I think it -- again, it's working in partnership.

It's no different than in the real estate world, right?

There's some people sending letters out there that are saying -- announcing they're paying no rent.

Well, how do you like to be a landlord on the other side of that letter?

When a letter hits the public press and you just make a declaration, you're paying no rent.

That's not really a partnership, right?

Just going out and canceling orders is not how you build partnerships.

This is not how you solve problems, and the great companies are built on great partnerships.

And their -- the business is built in a very integrated way.

And so from a supply chain point of view, the key for us is to recognize we have a problem.

There's business dislocation.

The demand is down.

It may stay down throughout the year.

And most likely, at this point, we believe it will.

Will it stay down at 40%?

No.

Will stores reopen in the next month, 2 months, 3 months?

Yes.

Is it 1 month or is it 3 months?

That's unknown.

Do they come up in staggered order?

Most likely.

So what those scenarios look like.

And then is it down after it's down 40% to 45% for a while?

Is it down 25% for a few months?

Then is it down 20%?

Then is it down 15%?

And you get back to down 10% by the end of the year?

I think some of that depends on how promotional people decide to get and so on and so forth.

But the key becomes, go back to the supply chain and our partnerships, is there's product that is being manufactured today.

There is product that's been manufactured over the last several weeks, that's being finished today.

There's product that's on the water today.

How do we handle that product in partnership?

How do we share the pain in partnership?

How do we not try to create another enemy?

We already have an invisible enemy, the virus.

We don't need to create more enemies today.

We need to build better partnerships and greater relationships because that's where the opportunity is going to exist on the other side of this, when things do return to normal.

And so it doesn't matter if it's the supply chain.

It doesn't matter if it's the real estate partnerships we have, if it's the manufacturing partnerships we have, the design partnerships we have, the partnerships we have inside and outside the company today.

It's the time for people to come together and work together to solve problems and imagine new ways of doing business not only through this short time.

This is -- the opportunity becomes reimagining new and better ways of running our businesses together forever.

And so it's kind of disheartening, honestly, when I see some of the behavior that's happening.

Some of the people are making proclamations about not paying rent or canceling all orders.

Great, good for you.

Those are not -- that's not a strategic way to navigate a business in a time like this.

The -- only partnerships will overcome the problems.

Your next question comes from Curtis Nagle of Bank of America.

Gary, yes, sorry about that.

In a small apartment and on mute, so...

No worries.

We've all been there.

Trying to keep the noise out.

But anyway, first, just a quick one for Jack, what the current revolver availability is.

I think it's around $600 million, but that may not be the case.

And then for you, Gary, I may be getting a little ahead of myself here.

But kind of thinking about when the dust clears and things normalize and the macro environment hopefully gets better.

Thinking about, I guess, kind of competitively, you guys are in a pretty decent capital position.

How would you say, I guess, your most direct competitors are positioned in terms of liquidity and capital structure and that kind of thing?

And when things do get better, do you think there could be an opportunity for maybe more market share gains?

Or is it just -- maybe that's not the appropriate thing to think about right now.

Sure.

Let me take that question.

Then I'll give it back to Jack, give it over to Jack to answer the question about the credit facility and availability.

Look, I've been through significant downturns.

We went through the Great Depression, and I think our operating margin going into the Great Depression was 7% or something like that, 5% to 7%.

And I know how difficult that was to survive.

We just reported operating margins of 14.3%.

We had talked about on the last call and in the last press release of having at least 200 basis points of operating margin expansion opportunity in 2020, right, prior to this virus.

So if you just do the simple math, if we guided -- yes, we just reported 14.3%, and we said we had at least 200 basis points of margin expansion.

You get to 16.3% if you get the least.

If you say, "Hey, there was more than that," you could take a more optimistic view and say, "Hey, this company before this happened probably had an operating margin in the kind of higher teens, if you will, somewhere above 16.3%," because we obviously wouldn't have given you kind of 200 basis points at least, unless we had more than that.

So I look at it this way.

I'd say, I'm going into a difficult time like this.

This team has navigated really difficult times with operating margins of 7%.

What does it look like with operating margins of 17%?

It looks a heck of a lot better.

And it -- what it does is it clearly opens up the aperture of potential opportunities.

The key is, again, how do you navigate the short term so you can set up the right strategic view and the strategic moves that can happen?

How do you put yourself in a position to see the opportunities that are going to kind of unveil themselves in times like this?

And so the market share gains for us long-term are going to be massive.

If you think about the fact that we're, for the most part, most of our key manufacturing partnerships were, I don't know, on average 50% to 80% of their business and call their other 50% -- 20% to 50% is probably mostly individual stores, mom-and-pops, smaller regional players that don't have our operating model, don't have our distribution platform, don't have our capital structure, don't have all the resources of a company like this.

And so the opportunity is for us to become bigger and more important, to be just more integrated with all of our key partners everywhere.

The same thing -- it's no different than a real estate point of view, like what the opportunities are.

We -- I think probably 3 to 5 years ago, when we started building these big galleries, everybody thought those will never make money.

If you read 80% of the analysts' reports that are being written 3 to 5 years ago, "How are they going to possibly build money?

Friedman's building mansions for his ego," all kinds of crazy stuff written.

Now I think people realize that we weren't trying to build mansions.

It wasn't about magic.

There was nothing about gut instincts.

It's all about math, and it was all about logic.

And so we have probably arguably one of the most exciting retail experiences and one of the most productive and profitable physical environments in our industry today.

And so through this dislocation, there's going to -- for a period of time, there's going to be a lot less players.

There's going to be a lot of people that are handicapped or on crutches financially.

And there's going to be, I think, even more opportunity for RH to become more important with the most important partners.

There's going to be more opportunities to present themselves through the dislocation.

We don't know exactly what's the longer-term impact to the economy.

Are we going to be in a recession that's down 10% or down 20%?

Is it going to be greater than that?

But there's going to be all kinds of opportunities.

And the key is just kind of don't do anything right now.

Like we said, like, look, just don't do anything in our company to make things worse.

Let's not rush and accidentally like kind of screw anything up or hurt anything right now.

It's a time for deep thinking.

It's a time for real objectivity.

It's a time for listening and learning and seeing the bigger moves, right, seeing what others can't see so we can do what others can't do.

And that's why, honestly, right now, we haven't taken markdowns at all.

We're not promotional at all.

In 2008 and 2009, with 7% operating margins, like we had to pull levers immediately.

We're not pulling any levers today.

We think we are uniquely positioned.

We think we have a brand that is -- in many ways, doesn't have a real peer in the industry.

We don't mean that in an arrogant way.

We think if you just stand back and take a look at what we do and how we do it, the offer we have and how we present it, there's not anybody really like us.

We think we've got incredible physical environments that when people -- by the way, like what is the potential slingshot effect here?

When people, who are cooped up, I don't know how you guys feel, like I mean today, I'm in our office with Jack and Dave, and the rest of our teams are calling in, and Jack and Dave and I are all about 15 feet apart.

We haven't sprayed each other with Lysol yet, but we've been so cooped up.

And people are going to want to get out.

People are going to be dying to get out.

Spring is coming.

The weather's going to be nicer.

Hopefully, the virus subsides and people are going to want to get out.

What kind of physical environment do you think is going to do better when people want to get out?

I think one that's got magnificent architecture, that's got rooftop parks, that's got integrated hospitality, that's got -- that's inspiring from an interior presentation and design point of view, I used to think -- I think what's just happened, everybody's forced to spend so much time at home.

Like if you spend as much time at home as I have been spending, the last couple of weeks, then you start looking around and going like, "Oh, my God, there's so many things that I wish were different about my house.

Oh, my God, I can't believe -- like I need to update my sofas, or I need to update these pillows.

Or, God, my window treatments, it's probably time for a refresh." And by the way, I think the home, because of what is transpired here because of this virus, it's going to become even more important.

And the way people live at home and having an inspiring place to live at home, so whether it's something like this that happens or just the fact that, it's like -- I also think about things like how many vacations are being canceled right now?

How many people are really going to travel to Europe or Hawaii or wherever they were going to go, South America, Africa?

How many people are going to be traveling this summer?

I think a fraction of the number of people that traveled last summer.

I know just personally, I mean our plans are all changing.

But how many people are going to be inspired to kind of reimagine their home and create a permanent kind of escape and a reimagined home that feels more like an environment that you would go to when you're on vacation.

How many people are going to -- and by the way, that's what I think our galleries feel like.

Our galleries feel like a vacation from real life.

And so many opportunities and things that I think that set up an opportunity for us to think about RH reimagined.

What are all the different things we can do?

What are all the advantages we have today?

How would we swing the pendulum so far to the other side to not see incremental change but to see true leapfrog moves?

Because we're in a position to do that.

We're in a position to invest.

We're in a position to partner in ways that nobody else can.

We -- we're passionate about doing great work, and I think times like these get people to kind of focus more and think about what's really important.

And I think you can't escape that your home is really important, that the relationships you have with your family are really important.

Your friendships are really important.

And where you're going to spend your time over the course of the next year to 2 while this virus is still probably somewhat alive in this world, you're going to probably spent a hell of a lot more time in your primary residence, second home, somebody else's home.

And I think that all creates a potential tailwind for us.

But short term, we've got to get through here and now.

And we've got to make sure we, as everybody else do, as everybody else does, we have to live to fight another day.

And we have to make a lot of tough, short-term decisions and make those decisions in the context of a strategic view of the future and not screw anything up here by moving in haste and being driven by fear.

So we say the facts remove the fear.

What do we know?

What are the facts?

What's the data?

How do we think about it?

How do we recognize the right patterns?

And how do we set up the next 20 moves?

If you like plain chess, if you've ever seen the movie Searching for Bobby Fischer?

If you haven't, we're all locked down right now at home.

I'd encourage everybody to watch that movie.

It's about a young boy who plays chess named Josh, and he's trained by a street player and a Russian master.

And it gets to the point -- we use it as kind of a leadership training movie in our company.

And the final game, if you can actually just Google and pull up the YouTube of the final game, Searching for Bobby Fischer, it's all about don't move until you see it, right?

Don't -- see the whole board, don't move until you see it and see the big moves.

And if we see those and we make those moves correctly, I think we're going to redefine ourselves in a way that's exponentially greater than we did in '08 and '09.

That's exponentially greater than when we redefined ourselves in '16 and '17 when we decided to pull the car in the pits after our kind of rocky start with RH Modern.

And we decided to move from a promotional model to a membership model that allowed us to re-architect the entire operating platform of the business and elevate the brand.

And I think the global opportunities we're going to have in an environment like this are incredible.

And so it's a lot.

It's like we're -- we don't have a really great script here right now.

So just like things are kind of evolving, we're giving you our live time evolving thoughts.

So I'll turn it over to Jack.

Curtis, so as far as the revolver availability, so the $600 million is the full line size.

But as a reminder, it is an asset-based loan.

So it depends how much inventory and other collateral we have.

And in the 10-K that will be filed momentarily, you will see that we ended the year with $322 million available.

And then as we sit today, it's $308 million available.

Your next question comes from Chuck Grom of Gordon Haskett.

Well, you've really done a really good job streamlining your cost structure, which I'm sure you're really happy about now.

I'm just wondering if you guys could dive a little bit deeper into the components of your cost structure, both cost of goods sold, SG&A.

I guess a little bit, maybe a little bit of color on how much of those costs are fixed versus variable.

What do you think you can flex down?

Would you pay or continue to pay your employees if the stores are going to be closed for beyond the April 30 deadline?

Just any color on that one would be helpful.

There's not too much detail outside of what's communicated in our financial filings.

If you think about us being shut down, while our stores are shut down, we have a relatively high percentage of our people that are engaged and working because of our interior design business and because of the direct nature of a lot of our transactions.

So we're connected.

We're reaching out.

We're operating.

Will we have to -- if things remained closed and stay as is in the current environment, do we have to kind of redesign our cost structure?

Of course, we do.

Is it as significant as other industries and other businesses?

I don't believe so.

I just saw the news about Macy's today and businesses that really rely on traffic much more than we do.

Remember, we have a lot of galleries that are -- they're very unusual places.

Start with Chicago, it's 6 blocks from any other retail store.

It's in a residential neighborhood.

It's in the Gold Coast.

We had to get the city to rezone the entire neighborhood for 1 day and approve us and zone it back so there wouldn't be another retailer in there because we said we don't build retail stores.

We build inspiring spaces.

And so our business is much more destination.

I think that plays in our favor.

It's not that walk-in traffic is not important.

Of course, it is.

Like people have -- want to interact with the goods.

They want to feel the environment and be inspired by the space.

And then there's people that are just visiting, that are coming in for a bite to eat and coming into our restaurant and all of a sudden, they're in this inspiring space that makes them reimagine their home and connects with them.

So look, there's -- I've had people ask me, "So is this an opportunity to kind of become a real direct business and start digital advertising and be like Amazon?" And I said, "No.

Not at all." You want to really change the cost structure of the business, start wasting a lot of money on digital advertising.

That's a -- there's nothing -- there's no advantage to having that as the base of your cost structure.

And so we -- short term, there's going to be dislocation, but we also are going to have a lot of people working through a lot of parts of our company.

So we're not going to -- it's not going to be like Macy's or some of these other places where the vast majority of the people are furloughed.

We're going to have to make intelligent decisions.

That's, by the way, why we've waited.

It's another one of those decisions of don't move until you see it.

Extending the length of time that we are paying our people and extending full benefits, it is -- one, it's good for them.

It allows them to get -- to understand if possibly there are some furloughs here, what does that mean?

It's -- to them, we're very open and transparent with our people right now.

The -- it's good for us.

We're getting organized and smarter.

We're getting the information about all the stimulus support for businesses and for people during these times, and we just want to think this through and get more data.

It's -- so we think we're going to weather this storm very well.

It's clearly going to be very different, vastly different in the short term, less different in the medium term and more normal in the long term.

But we'll come out of this a reimagined RH and I believe a vastly different and significantly better brand and business, no different than any other time we've faced like this.

Okay.

Great.

And then I guess my follow-up would be, there's been some bad points out there signaling weakness on the coast but relative stability in the inner part of the country.

Just curious on what you're seeing across the U.S. And then as a follow-up to that, year 1, New York City now in the books.

I guess could you speak to any bigger picture learnings that you have, good or bad?

What do you think you could apply to future openings?

Yes.

I don't think that there's vastly different business dynamics on the coast than there is in the Midwest today.

That's not what we're seeing.

We're seeing relatively similar impact across the country because the biggest impact to the business is the closure of our physical locations.

So that has been a relatively democratic decision and a consistent impact across the country.

So look, do we expect things to get worse in New York before they get better?

Of course.

And then if you go back and look at New York in a bigger picture, what are the learnings after year 1?

One of the learnings are we probably have the opportunity to do more business in markets than less business.

And as we think about designing physical experiences, New York was the first store we embedded a visible interior design team, interior design business into the physical gallery.

You're going to see that happening in all of our new galleries.

The hospitality experience on the rooftop, which started, I think our first one is Palm Beach, right?

Starting with Palm Beach, it was the only place we stopped construction for 9 months.

It was the only place we couldn't figure out where to put a restaurant.

We were scared to do it because it was on the fourth floor.

And we thought, "What if nobody goes up there?" New York, again, reinforced that a hospitality experience on the rooftop is economically viable.

It's more economical to build it that way.

And that's why you're going to see, because of Palm Beach and New York and a few of the others that we recently opened, you're going to see restaurants on rooftops.

We think it's a great experience for consumers to give some beautiful views and beautiful environments to eat amongst, in a glass box, looking out in a beautiful rooftop garden.

And other aspects that -- other things we've learned from New York but -- and it gives us a lot of confidence thinking about what we should do internationally in some of the other very important cities.

When you think about the potential in New York and the volume we're doing with just 1 store in New York, should we have a second store in New York?

Should we have some kind of a unique environment in the Upper East Side and some kind of reimagined brownstone or home?

What should we do in London and Shanghai and other big cities and metropolitans like that?

So -- yes, and the new galleries that we have coming are -- all reflect our most recent data and learnings and have evolved.

Even our, what we call -- in fact, we want to stop calling it a prototype, right, because a prototype means everything's stagnant and doesn't evolve, and that's just not our culture.

So we say innovation is at the core of what we do, and we're always trying to reimagine everything we do and make things better all the time and say we're always unfinished and on the move.

So I'm not going to talk about our prototype, but I'll talk about it as our -- the most recent iteration of our Design Galleries.

They are an integration of all of our best thinking and learnings from all of our experiences, good and bad, that we've built so far.

So we think they're going to continue to get better and more productive.

And then as we think about different bespoke experiences, they integrate our best learnings just in new and better ways and sometimes set up an opportunity to learn something we haven't learned before.

I think when everybody sees what we're going to do in New Jersey, it's just incredible.

It's almost mind-blowing.

We decided to not take an anchor position at the Short Hills Mall.

We decided to purchase a 5.5-acre piece of property in Morristown, New Jersey.

In the township in New Jersey, we've taken a historic home that was on the property.

We're adding kind of 2 buildings to the property, the most beautiful exterior gardens that you've ever seen, an entrance that's somewhat like Versailles-like and things that you've just never seen that we've never done that I think is going to be the most inspiring destination in the State of New Jersey, if not on the East Coast.

And people will come from everywhere.

And why do we have the confidence to do things like that?

Because we keep learning from our successes, and we keep learning from our shortfalls.

And we continue to connect the dots and reimagine what's possible here.

Again, I mean what we're going to do in New Jersey, which I think is just -- again, it's one of the most exciting things anybody has ever seen in our industry.

It's a combination of what we learned in Chicago, of going off the beaten path and going into a very high demographic area that doesn't necessarily have high traffic but has high prestige and integrating businesses in new and unique ways.

There's learnings from RH Yountville there as far as gardens and connecting spaces and integrating hospitality in a unique way.

There's learnings from Palm Beach there, where we've got incredible gardens and experiences as you pull up and where -- how you park your car and how you enter our compound.

Because we said when we did Palm Beach that the key -- we're actually in West Palm Beach, and the joke was that a lot of people from Palm Beach Island don't go to West Palm Beach.

And we said, "Well, all these people kind of fly in and they come in from the airport, whether they're on their private jet or just flying in, and then they go to their compound." And they kind of stay in their compound.

And if they come out of their compound, they might go to a friend's compound or go to a restaurant in Palm Beach.

So we thought we have to build the most inspiring compound in that whole area and that whole region so that, that customer feels comfortable leaving their compound and coming to our compound.

And so it's a complete walled-in compound.

You pull up your car in front of a 14-foot wall of falling water.

We valet park you.

You're in this amazing experience.

And so when you see what we're doing in New Jersey, it's 5.5 acres.

It's like a beautiful estate and these unbelievable gardens.

So what you're going to see coming from us, like our best work is ahead of us, not behind us.

A lot of people thought like when our operating margins got to 11%, everybody said, "Oh, that's it.

That's it." The former leading company peaked out at operating margins of 10.5%, and they've slid backwards.

And these guys hit 11%, they probably stretched ourselves too far.

And here we are at 14.3%.

And I just told you, if we didn't have a coronavirus scare here, we'd be much higher than 16.3%.

And this company is going to continue to innovate.

It is going to continue to reimagine the future and invent, and we're going to continue to get smarter and stronger.

So this is -- it's just a temporal -- it's a really -- it's an unimaginable time.

It's like it's scary for everyone.

It's heartbreaking to know that there are so many people being infected by this virus and people dying from this virus.

We've never had anything like this in the United States.

We live in a country that has never been invaded in our lifetime, right?

Like this is an invasion.

It's like a war.

We've never experienced this.

We've never experienced lockdowns.

We've never went through things like this, but it will pass.

And it will get worse before it gets better.

But it will get better.

So -- and we're going to continue to let our vision and let our values guide us and leverage the hearts and minds of all of our people and ignite the human spirit inside everything we can control inside our company.

And I think what you're going to see in the future from us is going to be extraordinary.

Your next question is from John Baugh of Stifel.

Gary, really quickly.

The RH being down 40% since closing, is that a shipment number or an order number?

Can you give clarity on that, please?

Yes, that's demand.

Yes, that's demand.

Demand leads shift.

So I'm giving you the -- what, 11 days since we've been closed, Jack, 12 days?

Today is day 13.

So day 13.

Okay.

Orders, essentially orders placed written...

Yes, thank you.

And then quickly, my follow-up.

The commentary around exploring debt is sort of an opportunity-offensive maneuver.

And is that really the case?

Or might it be something to just shore up the cash position given we just don't know what the future is?

What was the question, John?

Well, I think the letter speaks to it.

It's about the liquidity.

Is it offensive or defensive?

I mean...

Oh, it says offensive.

Yes.

Yes.

So you view as an opportunity to maybe make a real estate deal or do something?

It's not an effort to shore up the liquidity position?

No, no.

Our liquidity is fine.

It's -- as you have seen us in the past, we're relatively opportunistic.

Your next question is from Oliver Chen of Cowen and Company.

It's Max on for Oliver.

So first, can you maybe update us on the size of your direct business at this point?

And what have those trends been over the past few weeks?

And then can you remind us where your DCs are located in the U.S.?

And then we have a follow-up.

Yes, we really don't report our channel separately.

We run the business in an integrated way.

We're not too concerned where the customer transacts.

Clearly, there's only one place for them to transact today.

So that's where it all goes.

But if you just -- if you step back and just did the simple math and said, what were we last quarter, 60-40, somewhere around there?

That's right.

Yes.

So our business was 60-40.

60%, retail, 40%.

Yes, yes, yes.

And used to be 50-50.

So it's all happening in the -- through the direct channel today, kind of, but really being facilitated by our retail teams, a big part of it by our retail team.

So it's kind of irrelevant exactly what's happening.

Like -- so we look at the data that we think is really important that we can impact, in effect, so where it lands, where the customer places the order, we place the order for the customer, somewhat irrelevant to us right now and has been for quite a while.

And then as far as where our DCs' located, we have our furniture DCs, one in Patterson, California and another one on the East Coast in Baltimore, Maryland.

And then we have a small parcel facility in Ohio.

Yes.

And I'd say, just look, if you stand back and just, again, take a high-level view of this and say, there's so many people over the last 10, 15 years that have spoken about their retail business versus their direct business and their direct business is more profitable than the retail business.

So the retail business is more profitable than the direct business.

And people get lost in all that noise and they get lost in how they're allocating costs and they build silos inside their company.

And a lot of people have thought, like, why are you guys so ambivalent about this?

Why don't you care more?

Other people seem to care so much more about you.

It's just because we see it differently, and we care about the integrated outcome.

And I think that's why we have operating margins that are basically 2x our next closest competitor today and growing.

So if I tell you it's not important to us, there's probably a reason.

And it's because there's a more important way to look at your business.

Got it.

And then just zooming out a little bit.

Can you just update us how was RH Ski House and RH Beach trending before the slowdown?

And at this point, do you expect RH Color to likely be pushed back into 2021?

Yes.

Yes.

Yes.

So we just said we're going to defer all new business launches.

It's not a time to -- you never, in the direct business, mail a book into the wind.

It's just not a good thing.

It's been my history.

It's the worst time to invest because you have no flexibility.

You mail a book into the wind right now, it's all reverse leverage because the data would tell you, you can't make that significant of a difference and change the consumer behavior when there has been a kind of some kind of action of epic proportions that's changed consumer behavior.

It's just too expensive to change that behavior right now.

So yes, we're pushing that back.

We're also reevaluating all of our ad costs, evaluating what, if any, books we should be mailing right now?

How should we be allocating capital right now?

How should we be allocating advertising right now?

And by the way, I would tell you this, that the data would say that our source books are significantly, significantly a better allocation of capital than digital advertising.

What I'd be worried about is if I was just a massively disproportional online business today and I had to rely on digital advertising, and I didn't have direct catalogs.

Like that's a disaster.

Here we are, primarily a retail-based business with a very strong direct business that operates in an integrated way, and our main channel just stopped.

But I can tell you this, that even with the channel stopped, right, we're closed, we still are interfacing from a retail way.

And that's what I feel very good about.

We haven't done anything from a price point of view.

We haven't added one promotion.

We haven't done one promotional e-mail since this all started.

What we've done differently is try to do things that are high quality, value-add and brand elevating.

So I think the e-mails that we sent out, the way we've quickly kind of redesigned the website and the way we're operating is in a very high-quality way that is -- it's a way to elevate the brand.

One of our teammates on one of our conference calls said, we were talking about how we're going to navigate through this crisis and we were talking about possibly would we promote, would we not promote, what do we do.

And you can't commit to anything right now because we don't know how bad this is going to get.

And you can't let inventory back up too much.

I mean the good thing is we don't sell perishable inventory.

We don't have any seasonal inventory.

None, none, right?

We don't have any Easter goods.

We don't really have any summer goods.

We, don't have any color palette goods.

We get the least amount of seasonal risk of anybody in our industry, right?

Go look through people's catalogs right now, go walk retail stores.

If you want to think about how to define risk right now, go peek in the windows of retail stores, go look at other people's catalogs, go on their website and look at how much Easter stuff they have, look at how many Easter plates they have, look at how many bunny candlesticks they're selling, look at all the other tchotchke crap, right?

And ask yourself, "How well is that going to do once the stores reopen and we're past Easter?" That's a disaster, right?

If you want to think about short-term risk or want to think -- that stuff's a disaster.

So you look at a business like ours or go look at anybody selling any kind of perishable goods, disaster right now.

Selling any kind of fashion goods in apparel, the spring season is a disaster.

How people even get rid of the goods when the stores are closed?

The inventory is in the stores.

Are they going to pack up all the stores?

Are they going to box up those goods and send them somewhere else?

What, you can't send them anywhere else, there's nowhere to sell them.

Ross just closed stores and said they're not taking goods.

Like there's Ross and T.J. Maxx and everybody, like, just do the math going through the logic train.

Like, where do all those goods go?

How much are you going to have to sell those for?

I mean you want to talk about fire sale.

We have no fire sale risk.

We have possibly inventory backing up, right, and inventory backing up that we will either hold in-country and wherever there's warehouse space that's less expensive.

We will slow down manufacturing.

We will hold it in our DCs.

And yes, we will lower our order rates and then our -- then we'll adjust inventories.

And if we can navigate through this without having to do anything to permanently impact our new model, right, which is the best model in our industry by far, that's what we're going to do.

If I take a hit on the top line, let's say, I don't go chase an extra $100 million in revenue by promoting the business and making a longer-term decision that I'm not going to get into the game and I'm going to protect the integrity of the brand, that's key.

I mean, one of our team member's going to tell you, I said, we were talking about this topic.

It's like, geez, Gary, I hope we hold our ground and don't get back on crutches because he says it's really hard to scale the luxury mountain on crutches.

Because we're trying to scale the luxury mountain, right?

We're trying to position this brand as one of the most admired brands in the world like Hermes, like a Chanel, like a Louis Vuitton, like the great brands.

There is no really great brand for the home worldwide at a luxury level.

And everything we have to do -- everything we should be doing is focusing on climbing that luxury mountain and not compromising and elevating the brand, not just expanding the brand.

It's easy to expand.

And then a lot of time through expansion, you have erosion.

It's very hard to elevate.

The people that are top of the luxury mountain, they were born there.

They look at someone like no one's ever made the climb up the luxury mountain.

No one's ever started where we were and climbed that mountain.

And by the way, they don't want you to make that climb.

You're not from the neighborhood.

We didn't grow up -- we're not necessarily worthy.

We don't get invited to their parties.

What we have to do is things that are so extraordinary.

We have to have such extraordinary parties, they want to be at our party.

We have to build such extraordinary stores.

They look and dream that, one day, that their stores could be as inspiring as ours.

We have to do work that is -- that creates a forced reconsideration of our brand.

And it's just so important for us today based on where we're going, based on becoming one of those handful of truly admired businesses that stand the test of time, that are generational businesses.

It's not about the short term.

Short term, we'll navigate through this.

Long term, it's a strategic move.

So even like how's Beach House doing, how's Ski House doing?

Before, they were doing fine, but they're a little test.

It's not like it's not a big deal.

It's like the last thing on my radar, how Beach House and Ski House are doing.

Those are just new little business categories that they tested well.

They were -- Ski House, we mailed it basically in Q4.

So you have to invest all the advertising costs and the launch costs onetime.

You can't amortize cost anymore, so all the costs went into Q4, with very little revenue Ski House in Q4.

Most of it is going to roll over into Q1 and stuff like that.

But those are small, little pieces.

The key is what are the big moves right now.

How do you navigate through this short-term time?

How do you not make strategic mistakes?

How do you continue to focus on elevating the brand?

How do you not all of a sudden jump back on the crutches and try to climb the luxury mountain in crutches?

How do you outthink everybody and position ourselves that when we come out of this terrible time, not just economically, but socially, terrible time, one of the worst times that this nation in this world has had to go through outside of probably the last world war?

And how do you come out of this in a way that you're really ready for the brighter days?

So yes.

And Color, of course, is going to be pushed back.

It was like, yes, of course.

I don't know, is it pushed back to '21, it is pushed back to '24?

Irrelevant, irrelevant to the bigger picture.

It's the big strategic moves right now.

It's the big things that can lead to leapfrogs that create strategic separation that render our brand more valuable.

That's all that's important right now.

Your next question is from Seth Basham of Wedbush Securities.

I know the big picture is really what we're focused on, but we're also thinking about some of the near-term options that you have.

You talked about potentially cutting CapEx.

Could you give us a sense of how your CapEx budget is formulated for this year?

What types of things that you could consider cutting for starters?

Look, it's -- in the last downturn, we cut CapEx to $2 million.

We can cut CapEx to whatever we want to cut it to.

Right now, we're stopping everything, okay?

Does that mean everything will be stopped when things start to become back to normal?

No.

But have we stopped everything right now?

We've stopped everything outside of -- we're finishing Charlotte, right, because we're, what, about a month away from finishing Charlotte?

So we're month away from finishing Charlotte.

Our partner in the development has guaranteed that they're going to continue to fund the tenant allowance, and so we're going to keep going.

But yes, we're managing the business with a bias for cash right now, managing business for cash as we should be.

We're deferring all capital right now, basically all capital.

I'm trying to think of anything besides Charlotte we're spending money on.

We stopped everything in the company.

Will we keep everything stopped for the whole year?

I doubt it.

I doubt it's like stores are going to be closed for the rest of the year.

I think our -- we have capital plan with somewhere around $150 million net.

Jack, somewhere around that?

Original.

Yes, original plan.

We've spent some in the first quarter.

But we can save the vast majority.

If we wanted to, we could probably save 80% to 90% of that?

Yes.

Yes, probably 90% of that, somewhere around there directionally.

So that gives us a lot of flexibility.

The ad costs we were planning to spend in the first half, we're going to only spend a fraction of the ad cost.

So once we have the all clear and physical stores reopen again, and we're back running and we see what those trends are like, that changes everything, right?

That changes everything as we think about capital allocation, be in a position to realize opportunities.

So it's balancing, playing short-term defense while you're developing offensive plans, right?

But yes, so we get lots of control.

Like right now, everything stopped, except for one store.

Your next question is from Peter Benedict of Baird.

I'll be quick.

Most of my questions have been answered here.

But -- so just following up on that.

So you can obviously take your marketing down, you can take the CapEx way down.

Just curious, how do we think about SG&A?

If you take out marketing, that remaining bucket, how much of that is truly variable?

And then we can kind of think about how we might be able to manage that other bucket.

But just what percentage, I guess, of SG&A after marketing is truly variable?

Yes.

We don't disclose that.

But we -- a lot of things are variable in times like these.

Yes.

Some things are more variable in the short term versus the long term.

But in times like this, it's unprecedented, and we clearly are prioritizing cash.

Yes.

Everything is negotiable right now, right?

Everybody's got to think about partnerships and priorities and how to get through this time so.

The next question is from Adrienne Yih of Barclays.

Gary, I wanted to step back a little bit and talk about your R&D network kind of pre the transformation.

So before, you had invested sort of kind of fixed salary, R&D, innovation and design talent.

And now that the global network, I want to say it's a little bit more variable, but it's sort of globally going around and creating a group of talent that you can pick from and sort of kind of ebb and flow depending on how you need that skill set and when you need that skill set.

Can you talk about that and help us understand exactly what the changes are there?

Sure, sure.

We think about us as it's like the Apple App store, right?

Apple has the best developers in the world developing applications or, in this case, even music, right, developing music.

The main platform for music, the main platform for apps today is the Apple platform.

Why?

They're the best platforms, right?

And so when you think about our industry and you think about goods that are targeted to the high-end luxury market, we're the best platform in the world.

And so even more so now, I think there's going to be -- it's going to tilt our way.

There's going to be even more people that want to develop for our platform because we're going to be even more viable.

We're going to be even more disruptive.

We're going to take even more market share.

But when you think about the cost structure and how that works, it's all amortized into the goods, right?

And so if people are designing, developing ideas for us that we don't like and we don't pick, there is no cost.

So it's a true advantage.

We don't really have a big design team here.

We've got only one or two technical designers inside the company that work with our partners on some specifications and quality and engineering.

But for the most part, 95% of the development cost sits outside our company, is amortized in the product.

It's either built into the cost of goods from the perspective of -- at an artisan manufacturing level, design level or it's someone we're paying a certain royalty or design fee on the goods.

And so it's all built into the cost of goods.

So the flexibility there, when you think about it versus other people doing what we do, is massively more flexible and truly more powerful, right?

Because I used to say that, in my career, I was most influenced in my time with The Gap where I saw Mickey Drexler transform The Gap from a $300 million business to a $15 billion, the leading global apparel company in the world, right?

And that was Mickey Drexler and Les Wexner, really, were the pioneers and the inventors of vertically integrated retailing as we know it today.

And that model was super powerful.

And there is a lot to like about that model.

What I learned not to like about the model and what gave us the idea was when we saw Apple.

I remember someone asked me to go to the CSC, is that what they call it?

CES.

Yes, CES.

CES show.

I had a friend that was in technology, you should come with me, you'll learn a lot about technology.

And I live here in the Bay Area, right?

So I've got a lot of friends that are in technology.

I used to be in YPO and a lot of the key leaders in that space during the last 10, 20 years, I got to know relatively well.

And if you'll go -- come to Las Vegas, come see this.

And I was an Apple fan for a long time.

And I say, "Well, great.

Is Apple going to be there?

Can I get to see all the new Apple stuff or listen to Steve Jobs?" And they said, "No, no." Because they said, "Everybody comes." And I said, "Oh, great." "Apple doesn't come.

It's the only company that doesn't come." And I said, "Oh, really, what do they do?" And they say, "Well, they do their own conference." And I started off kind of looking at Apple through a different lens and noticed that when they launched the App Store, how all the best developers were developing for Apple.

And then whoever gets the dregs was like BlackBerry and all the rest, right, like the Android platforms and stuff like that.

So the light bulb went off for us here, and we said, look, Apple has built the best platform, right?

They built the best platform and their platform creates the most leverage for all the best developers and designers, right?

And maybe we're doing this wrong, and maybe we had to turn this model that served me very well, right, that I learned from the very best in the industry and turn this upside down.

And because, realistically, we have these big design teams and they would design all this product, and honestly, I never liked more than about 3% of what anybody showed me.

And so I just thought, like, wow, we spent so much money and energy and we're developing all this product and have samples coming from all over the world, and I hardly like any of it.

And so when the lightbulb went off, we said, like, that was really happened.

And also right around 2008 and 2009, and we said, "Look, why don't we turn this upside down?

Why don't we not have a design team?

Why don't we just have some really great curators, people with great taste and style that had a really great eye?" And we'll never get all the best designers in the world working here in Corte Madera.

Like, the best people generally in every industry are entrepreneurs.

A lot of them are working for themselves, and their independence and control is paramount to them.

And so we said, like, why don't we build the best platform in the world and have people design for the best platform.

And instead of being a design-driven company, we'll be a curation being -- driven company?

And not only curating product, but curating product people, ideas and inspiration.

And then really, the true talent differentiating factor in our company will be that building that platform and attracting the very best people.

But the hidden talent, which people miss about us, is our ability to integrate, right?

It's integrating all of those people, those products, all those ideas and inspiration in a way that when it all comes together, it has its own unique point, an RH point of view that really differentiates and defines us.

But when you think about it from a financial model point of view, it's massively, massively more powerful and more efficient.

And serves you well in all times, whether it's times like this or other times.

Like, we don't have a big, massive design team that we've got to cut or that's sitting there not really productive.

And by the way, here's an interesting thing.

Of all the products that were presented, for the most part, we still don't like more than 5% of what we see.

But we don't incur all that waste inside our company.

That makes sense.

Your next question is from Brad Thomas of KeyBanc Capital Markets.

Just a couple of housekeeping questions here from me.

I guess, when we think about a new world where revenues are likely down here, can you give us a sense of maybe where you could bring inventory levels down to?

Can you bring that down much lower from here, particularly with the made-to-order nature of a lot of the products?

And then how should we think about working capital, in general, in a world where sales are declining?

Yes, that's a really good question.

It's something that we're kind of talking about and kind of studying.

So we believe we pushed inventories down to about as tight as we could be and we saw, in the fourth quarter, we saw back orders kick up.

And not only higher backorders, we had missed demand in the company.

And so we thought, okay, we obviously -- I think we pulled out, on an apples-to-apples basis, about $500 million out of our inventory.

If you looked at our kind of 4-year, 5-year plan back about 3, 4 years ago, we have about $500 million less inventory than we plan to have prior to us redesigning the operating platform in the supply chain.

And we are trying to find, okay, where is equilibrium, where is the most optimal way that we can run inventory?

So we think we pushed it a bit too far in Q4.

We gave up some demand in sales.

It probably cost us, I'd say, somewhere in the neighborhood of $20 million or so.

And that's fine.

There's cost to learning and cost to optimizing.

And so now it's -- when you think about this period, you've got some -- you've got to kind of deal with the immediate problem that's happening.

And the immediate problem is we have a lot less demand, and we've already bought into that demand.

And you can't cripple your partners by just saying, "Oh, I'm just cutting all those orders and you deal with it." I mean that's no way to have great partners for the long-term and going forward.

So we're right now in live discussions with everybody around the world.

Like, we don't say, like, "Hey, I have a problem at RH, and you have a problem.

It's we have a problem." How are we going to deal with it.

And I'm sure -- I'm sure what will come out of this is an entirely new way to think about the supply chain, an entirely new way to think about how to flow goods, entirely new way to think about.

If this is what happens during times like these, right, when you have pressure, that's when you can turn coal to diamonds.

And I don't know exactly the answers yet.

We're in live discussions right now, dealing with the short-term issues, dealing with the cash flow issues, not so much on our end today, not yet.

If and -- we don't know how long this is going to be, but there's clearly, in our partner side, there's going to be issues.

They have a lot of independent customers around the world, a lot of smaller players that have no choice than to cancel all their orders.

So how do we work in partnership; how do we become more important partners and more valuable partners to these key people, many of them the very best in the world at what they do.

And so an opportunity for us to become more important than less important.

And we'll get our inventories -- I think if things play out directionally how we might imagine, I would say we'll be heavy on inventories throughout the year, and we'll probably be able to get inventories recorrected by this time next year.

Yes, but you're going to have to work through, just work through this kind of issue that's been created.

You can't make this issue go away.

Anybody says that they are going to be able to cut all the orders and it's not going to be an issue is full of (expletive).

It's impossible right now.

Your next question is from Tami Zakaria of JPMorgan.

I know it's getting late in the East Coast, so I'll ask a very quick question.

So you have mentioned prior to the dislocation in the business in March demand in core RH business was up 8% in February.

So how much of that was driven by back order fulfillment versus core growth?

And did that include a 4% drag from lower outlet sales like you're planning?

No, that didn't include the core -- that's just the core RH business, right?

So that's not inclusive of the outlet business.

So that's why we characterize the outlet business separately.

And so how much of that was from back orders?

0. That was demand, right?

So that was order generation, that was demand.

And the reason we put that in, just to give you a point of reference of how our core business had kind of recovered post the elimination of holiday, right?

So the -- I mean, the fourth quarter businesses were -- business was influenced a lot of taking the holiday business out, taking other promotions out that we had characterized in previous press releases and discussions with everyone.

And what we had is we had greater-than-anticipated collateral damage that related to the elimination of holiday.

So if you think about it, where we kind of missed our forecast here was there was more kind of attached business through the traffic and activity in the peak weeks of holiday and the peak weeks of January, when all of that kind of Christmas stuff goes on sale, all the ornaments, all the decor, all the gifting stuff all goes on sale.

You have incrementally more traffic going to the web and incremental means more traffic going to the stores.

And what we are able to analyze post elimination of holiday is that there was more attached product; meaning, someone coming to the website or coming into a gallery, and they were buying sale Christmas ornaments or sale other tchotchkes and stuff like that, that they might have seen some sale dining chairs, they might have seen some sale bedding, they might have seen some sale other things.

So the elimination of that traffic and the connected possible other transactions, which I refer to as the collateral damage, was greater than we thought.

So that cost us a portion of the business.

And then the other biggest piece of the miss was just -- we just ran the inventories too tight.

We took out a lot of inventory, as you know.

I think going into the fourth quarter, wasn't inventories down 24%?

24% at the end of Q3, and we ended up the year down 18%.

Yes.

So down 24% going into Q4, and we ended up down 18%.

And that was on top of down last year and so on and so forth and prior third year down.

And so we just ran it too tight.

And nothing strategic and easy things to correct.

We don't have to transition out of holiday again.

So the important point about the update is, hey, post holiday in February, the core business rebounded to plus 8%.

The outlet is a completely different story.

And let me make sure everybody's got this in the right context.

You'll remember last year, we had higher than normal outlet sales because we closed the distribution center in Q4 of '18, and we decided to accelerate the liquidation of that inventory through our outlets.

That's what we did.

So we ran very high outlet sales in Q1, Q2, Q3, Q4.

And not as high in Q4 year-over-year, but the first 3 quarters very high.

And that obviously was a lift to total business, and it was a drag to margins, right?

And so the way to think about it this year is we burn down outlet inventories to the lowest levels in the history of the company.

We started the year without a lot of outlet inventory.

Obviously, we'll be creating some outlet inventory right now because returns and exchanges right now have -- that usually go straight to the outlets and get liquidated or backing up because the outlets are closed.

So we'll have a position where you've got a little bit more inventory.

But really, this year is about now -- it's now you cycle those high sales.

You're not going to have the sales, but you're not going to have the inventory drag.

So operating margins for the entire company would have been up around 100 basis points or more because of that shift in the mix of the business, right?

So the outlet business, in my mind, I always kind of put it off to the side because it's really a channel we're liquidating returns and damages and trying to deal with sometimes bad bets from an inventory point of view.

And that -- and so it's an integrated piece of our business.

It's going to -- yes, it's going to affect top line to a degree, plus or minus.

And the margins -- but year-over-year, last year was an anomaly, this year is another anomaly.

It's just swinging one way or the other.

So last year, sales were up, operating margins were down.

If we didn't have -- if we had a normal outlet situation last year, our operating margins in the company would have been in the mid 17.3% to 17.5%.

And not -- excuse me, not 17.3% to 17.5%.

15.3% to 15.5%, yes, because we were 14.3%.

So it cost us about 100 to 120 basis points of operating margin last year.

So this year would have been more normalized.

Operating margins, that's why we could comfortably say we had at least 200 basis points of operating margin expansion because, on a pro forma basis, we really had a company that, last year, that looked like 16.5% to 17%, not 14.3%.

And so -- and that's why when I look at the situation we're in now, and I say -- people ask, "How do you feel about going into this?" And I go, "Well, geez, I mean, comparatively to the last really difficult situation from a business point of view and economic point of view, is a great recession, it's leading the company that had operating margins in the 7% range.

And now really, we've got a business that's in the 17% range." So I feel terrible about the health impact and the destruction this virus is going to cause socially and from a humanitarian point of view.

But from a business point of view, we've never been in a better position to take advantage of a dislocation economically.

Your next question comes from Anthony Chukumba of Loop Capital Markets.

Gary, in light of everything that's going on, I know one of the things you're very excited about or are very excited about is your own expansion into Europe, which I think will be a real home run for you.

Is it safe to assume that everything that's going on right now is going to push that back or is it too early to tell at this point?

Too early to tell.

I think we'll all be a lot smarter in about 2 or 3 months.

So as far as we're concerned right now, we're not really spending capital there yet.

We're finalizing leases and doing some architectural work and development work and so on and so forth.

So there's work that's all going on.

But we've got flexibility as it relates to that.

And for some reason, there's later cycle developments in the U.K. or other things that force us to push things back.

A lot of flexibility.

I think that the little bit of data that everybody has, mostly related to China, would say that the world is going to be on the other side of this issue, at the latest, by the end of the summer.

And so the question is, does -- we reenter the cold months, does this -- is this like a flu, does it reappear?

And is there another infection cycle to go through?

We don't know that, right?

Nobody knows that.

But I have a lot of faith and hope based on what I hear from people that are in the biotech field here, obviously, San Francisco and the Bay Area's the epicenter for a lot of that, a lot of that industry.

And what I hear from people that I respect is that the ability to develop drugs and vaccines and things are going to happen very fast.

And so my sense is this could get dragged on all year.

We could have a long slog of a year that turns into a recession.

And it could be that 2020 is -- becomes -- and it's interesting from one sense.

You say 2020 should -- is perfect eyesight.

It becomes probably the least clear year that we've seen in a long time.

And that things, really, in 2021, you have a real sense of clarity of where you're going.

But in 2020, in some ways, it's a year to manage the business for cash, it's a year to position yourself for the long term and a year to kind of see the opportunities that are going to exist on the other side of this and position yourself to be opportunistic and optimistic when we start to get through the worst part of this.

But it doesn't change anything strategically, right?

It doesn't change our opportunity in Europe.

Maybe changes a little bit of timing on things.

It doesn't change the opportunity globally.

What it does is it sets up opportunities globally, right?

From a real estate point of view, there's going to be a lot of good real estate deals post this.

There's going to be a lot of opportunities that happen post this.

There's going to be capital, access to capital is going to only get better.

And so we see more opportunities than less.

Our biggest issues right now is how do we navigate through this in the most elegant and humane way as it relates to all of our people, all of our partners here and around the world.

We're a very connected company.

It's not just our team members that are here in RH, and it's not just the partners at the senior level of manufacturing companies all over the world and their partners, it's all of their people that are going to get impacted by this.

We're all connected here and as well as with our customers.

And so from just a social humanitarian point of view, how do you do what's right?

How do you solve those problems?

How do you -- as best you can, how do you try to create a sense of hope and try to ignite the human spirit in the world in a time when that's what people need?

That's why we say, in our company, by chasing our hopes and dreams, we inspire others to chase theirs; by fearlessly fighting for what we believe in, we encourage others to do the same.

And it's the time to play our game and to shine our light, if you will.

But it's time to have edge and it's the time to demonstrate empathy.

And speaking of demonstrating empathy, I commend you and the rest of the leadership team are forgoing your sellers during this very difficult time.

Keep up the good work.

There are no further questions at this time.

I will turn the call over to Gary Friedman, CEO, for closing remarks.

Great.

Well, thank you, everybody, for your time.

I do want to make sure I just thank our teams and our people and partners, customers and shareholders all around the world, but specifically, our team that just had an extraordinary year and fought hard to get to where we are not just this past year, but over this past decade and for some people that have been with me here through the past 20 years to get to where we are today.

And this is the most difficult and challenging time I've ever led a team through, and it's a time for all of us to kind of come together and to band together and to get all the brains in the game and the egos out of the room and do what's right, not just from a business and financial point of view, but do what's right from a human point of view.

And we all have a lot of decisions to make.

We all face the same challenges right now.

And it's a time for purpose and it's a time for partnerships.

And we'd like to say that profits follow purpose.

And the key thing for us, long term, is to live and breathe our values and let profits follow purpose.

If we do the right thing, we will all get through this together on so many levels.

So thank you for your time.

Thank you for your patience, and thank you for your understanding today.

And we'll talk to you soon.

Thank you.

This concludes today's conference call.

Thank you for your participation.

You may now disconnect.