Rh (RH) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the RH Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that this 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 are ready for questions.

[Operator Instructions] Your first question comes from the line of Steven Forbes with Guggenheim Securities. You may now ask your question.

Good evening. So, Gary, you spoke in the letter, right, about the expectation for revenue growth to lag demand by, 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 here given the current trends. So I don’t know if you can talk about, how much of the closure between this expectation and 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 three quarters. So, any, like sort of color that could help us walk or build that out over the three quarters as we think about fulfilling this unfulfilled demand over the next three quarters will 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, recently the gap got bigger and it got to 16 points 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 are responding as quickly as I can. As you look at the, kind of demand build month-over-month as we laid out in the letter, it’s hard to plan for something like that. It started 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 three month period, little over three months, our demand 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 draft and based on our analysis, we didn’t know how longer our galleries were going to be closed and what the impact was going to be, but we wanted to react quickly and we did we were able to cut receipts and push out inventory. And then, as demand builds, we thought, Jesus, 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 are behind. And 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 dislocations, whether it’s block to workers or shutdowns, so on and so forth, whether it’s 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 am 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 are off to a pretty good start in the first two weeks of September and what’s different about September year-over-year is, last year, we had a higher mix of what you call, clearance inventory that we wanted to get rid of older goods. So, last Labor Day, we ran a kind of Labor Day sale with clearance inventory and we are able to liquidate goods and that gave us a lift. So, that’s kind of slowed down trends. If you just think about the first two weeks, what will happen in the next several weeks, I am not sure. We – it’s funny I’ve never spent too much time looking at our business kind of day to day. But it changed so dramatically day to day and we are learning. So, as we look at the second half, our expectation is that 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 refill. If I think about when do we kind of get caught up and wash through this, probably the end of the first quarter, maybe the second quarter of next year. I mean, our product is not that quick to be made and shipped. So, a lot of it can have lead times up to six months in some categories like we are obviously nine months. And so, what we are doing is, trying to give you our best view of how we think this kind of demand will convert to revenue and 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 it more right than wrong, and I think, will be more right than wrong unless our demand trends change dramatically. I don’t know, Jack, do you want to fill in? Yes.

Go ahead, Jack.

No, no, I think that was great.

Oh, yes. Well, maybe one for you, or either Jack or Gary, if I think about 2Q gross margins, right, 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 the 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 diverse engineering, the whole supply chain, where is the right margin profile for that long-term target as it stands today?

I don’t know if we caught 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 is an analyst on the street that has a 20% operating margins in the next five years. So, when you say what’s right, it’s this, there is – 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 are seeing now as we have transitioned and – transitioned from a single source rug relationship to direct sourcing model in rugs. We got a very different business and it’s 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 are seeing, what I would call more normalized margins there. I’d start with, if you think about the 21.8 or the 47.5 we hit in margins, 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 are doing is, when 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 is any way we will go under 5% revenue growth, but I don’t know all the stores shutdown again, who the hell knows, what can happen with this pandemic. I mean, it seems like things are kind of getting better not worst. And so, we think that consumers used to wearing masks now. People are used to social distancing. In many markets you see, cases going down. So, we think we are 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 are 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 am actually quite happy to take through 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 built here, right, that we’ve invested in for the past five years kind of re-architecting the entire business model. And kind of positioning the brand more as a luxury brand. I think that there is opportunities in every part of the margin structure of the business. We are at the early stages about elevating the product. I mean, you’ll hear more soon about some really important strategic moves we are going to do 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 shifting margin opportunity, right. If the product prices go higher, same cost structure moving products through this supply chain. The other thing that you’ve got to think about is, we are 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 two, I think we have a couple that went longer than two years, but, first one year to three years, and mostly one year, we double the revenues at retail in that market. So, you think about the just the leverage you are going to get in the – side of 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 will be a little bit of a kind of – it’s not going to be a complete straight-line. There will be some quarters where we are 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 are not just opening the DC and having our revenue move a little. We are opening a DC in an entirely new continent and I think we are going to see pretty fast revenue growth. And so, I think we’ll see kind of that normalize very quickly. But I’d say, you just think about since, I don’t know, 2016 when we – as I said, when we launched Modern in the end of 2015 and I’d refer to it as – you go public. And you put a car in a race track and you are on the quarterly race track and it kind of narrows your view and we were kind of 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 gaps and they go back kind of on the race track. And we decided we were going to rebuild the whole car. And we decided – we knew it was going to – we are going to take a lot of flag for it and we refer to it as we were going to march to help for a heavenly cause. And we kept the car in the pits for, I don’t know, a year-and-a-half. And nobody really believed what we were working on and we said is, what people don’t believe and what we are doing, what we do and we raised $1.2 billion or something, bought back 60% of our company and brought an entirely new car under the race track, like with a jet engine. And so, we’ve now sling shoted past everybody in our industry, right. 20% or 20% plus operating margin wherever it unfolds, we are going to have – I mean, what I like is that 5% revenue growth, we would had a plan slightly higher than that. So the fact that we are at 20% this year. Just as at the underlying business model has this systemic shift. It really has nothing to do with COVID at all, right. There is 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%. Over the next several years, you think about where you are going to get leverage in margin in that model, if you think about continuing to take this brand up to the luxury mountain and the kind of leverage that will get – the key become – it’s one of the reasons why in the second half, right, we decided not to mail our call books. Because quite frankly, one, we’d be mailing and possibly creating incremental demand, we don’t have product for it. The newness because the factories are behind would delay. 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 the time and energy it would take us to normally develop the seasons and develop the books and launch everything, we are actually going to refocus that time to rebuild every category in the business and we believe we can take the floor up there, right. If you think about it, if we really do our job well, there might be 10 or 20 comps 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 are kind of just running the business. And so, and then, focusing our time on architecting the web portal, the world of RH which we think will be a leapfrog and focusing our energy on 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 stock since our public offering in 2012. It’s funny I was doing interview with someone for a magazine and clearly this person was – have been talking to a bunch of short sellers or non-believers in our company, I could just tell by the tone of a question. Then I kind of said, you know, like I can tell by your tone, you have a lot of sources that are 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 as a long-term, I said, so why don’t we move from feelings to facts. I said, here is the fact for you. On November 2, 2012, our company went public in $24 a share. It’s increased, and I don’t know where the stock will close tomorrow, but where it closed today, it’s increased 14 times in value in just under eight years. It’s one of the best performances as a publicly traded company during that time period. It’s better than LDMH. It’s better than Home Depot. It’s better than Starbucks. It’s better than Nike. It’s better than Lululemon and even better than Apple. And it’s depending on where a 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 – but 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, - since we brought the car which is now a jet out of the pit in late 2016 early 2017, I think we’ve basically done everything we’ve told you we were going to do, right. And we’ve probably delivered now, we are going to deliver 20% operating margins. I mean, five years ahead of, I think any analyst had us – Wall Street or seven years working anybody’s model, lot of people had it like 17% five years from now, 18%. We thought we were two to three years away. And now, it’s kind of a reset, right. We are saying we got a new floor and we have a path to 25% operating margins. We don’t mix step 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 are 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 at, we have a market cap somewhere around $7 billion. So, we think we are 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 are going to be really happy they invested in RH if they want to hold the stock for five to ten years, because I think we’ll be among the best performers in anybody’s portfolio over that time horizon. It’s a longer answer than you asked, but you know, what I shared is a big picture view, so.

Thank you, guys.

Your next question comes from the line of Curtis Nagle with Bank of America. You may now ask your question.

Good afternoon, guys. Thanks very much for taking the questions. Just a quick one on, Gary, in the letter you cited evidence of some of your clients moving out urban centers, buying second homes – 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 more in terms of how much demand that’s driving, maybe hard to know, but how sustainable that growth could be?

Yes. We try to articulate it in the letter and it’s – your guess is as good as ours, but that we like the data we see. I think that because this pandemic is lasting as long as it has, I just asked my doctor few weeks ago, I said how long do you think we are going to be wearing masks and he said, at least two more years. I said, really two more years? He said, yes, you got to think about the math. He said, it’s going to take, when he said 270 million people that 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 2021. It’s going to take at least 18 months to move really fast to get 270 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, I think, I am 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 that I won’t say, all out of city, just get second homes to have somewhere to go to. They still – many of them still have their city home. And then, people that are moving to suburbs, in fact, there was kind of new suburbs being formed. I mean, I was talking to some people that there is a whole new view in how they think about suburbs in Silicon Valley. So many of the people that they are learning they can work remote more. So they are moving, they are buying homes in palm desert. Palm desert now is kind of getting recapped from a retirement community to a suburb for many people, right. Younger people move where they can get a bigger home, they can have more space. There is a perception that there is less crowd than more safety probably and so on and so forth. And who knows, when we are all going to travel again. I mean, that’s our biggest question on international. We can’t go to Europe unless we want to go and quarantine for two weeks. So, I go like, is this going to completely snap back, is this – there is got to be some real somewhat permanent changes in behavior, how long does that last? If you think about the kind of the home buying cycle and home furnishing cycle, it’s not a short cycle. And I do think we are well positioned for it, because of our assortment and our unique interior design ability where we can just come in and do someone telling, we are doing more full projects than ever before. People are looking for a solution that save some time. And we can do that. So, like I said in the letter, I think we are going to have a higher water level and through 2021, but I don’t know. I’ve never seen anything like this, right. I mean, maybe that the air comes out of the balloon sooner or maybe there is – it’s a permanent shift I mean, when you get people thinking about something, 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 stat that open table reservations are down 50% somewhere in that direction. I am going out to dinner. I think 80% less than it was. We are going to people’s home for dinner, people we know well and I think what happens when there is 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 for dinner until we make our home better. You get, 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 do you go on vacation. Oh I went to Pepperie, oh, yes, we went to Pepperie too. All that going to stuff that humans do. And so, I think that focus on the home and this amount of time people that spend on the home is that the entertaining focus now on the home could create a whole perception of home that you’ve got to kind of have a much better home. And your home is got to be all furnished and it’s got to look a hell of a lot better. And because, you just going to have more people over and you are 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 am not sure. So we are going to invest very thoughtfully. We are going to continue to let cost chase demand versus demand chasing cost. We don’t want to build a big cost structure based on 40% demand comps and have it go to 10% and go. So, but I think that there is – this is a lot longer than any of us here thought and it feels more permanent. At least it feels like it’s going to have a longer life, but we don’t know. So, and we are good either way. I mean, we like our business model long-term, either if this more temporal than systemic, whatever.

Got it. No, understood and thoughtful answer. Thank you. 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 are wanting at 1, 3 leverage, something like that. How do we think about that going forward? Do you remain underleveraged? What does the capital structure look like in the explosion in margins?

Yes, we are 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 as we said in the letter, we’ll remain opportunistic as it relates to sources and uses of capital and just there is always going to be some kind of opportunities and dislocate in markets like this and whether they are 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 are doing Europe, we’ve got surprisingly the first several galleries are not going to be capital-intensive but one. Just central one and where we are kind of screening together four 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 as heavy capital investment. RH England is not as heavy capital investment. The ones that follow that, we got two more deals done and signed are not heavy capital investments so. And then in the U.S., we are – you’ll see us start to ramp up. There will 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 have some heavy capital-intensive stores. We had RH New York, we had just the development of first new prototypes, right. Those – because we are working on them for a long time and making a lot of changes just like developing a new iPhone or something, right. That store is really like an R&D project. So, there is a lot of capital there. Or in San Francisco, a lot of capital. Our first guesthouse 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 on our company, which is going to make us a much more valuable development partner for any developer, right. That’s like, they’ll get a better cap rate on our rents and our credits 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 home development deals, because we can – we should be able to get better cap rates. No different than – we sold Minneapolis in the middle of the pandemic, right, that’s crazy. First, with the other people walk away that’s out there we are going to get a big, bigger price than we said, like walk away, hey, I mean, this is temporal. We are okay. Then they came back and we closed at a 5.5 cap. And I think initially when we – I talked about that one several years ago, I think in New York, we were going to put out $1.8 million rent on it and sell it for $33 million and said, we’ve decided to put $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 leapfrog to 20% or 20% plus operating margins and the cash flow profile and the return on capital profile that you are going to see, I mean, I think that there is a chance we’ll exceed 50% return on invested capital this year. And that was a long-term target. I didn’t update that long-term target, because I was like – you start this silly math when we are 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 you think about our second guesthouse that we are building in Austin, that’s a joint venture development and it’s a very capital-light guesthouse. And we are able to kind of deal like that, because we were already in construction and have 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. And the very, very first one in New York, people felt we were nuts, like, what do you guys going to do? And people still think we are nuts. I think until say they see it and then you’ll get it. But, so, we like the capital profile of the business. We like what the – as we project the new cash flow model, the new 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, in my early days here, it was a lot of people sit around the table here the whole time, right, just like, we were like, okay, if we can get to a billion dollar to make 8%, if we can get there like we’ll have made it. And so, you would have told me, hey, we would – I mean, okay, build that kind of leading luxury design platform in the world and we’d be at 20% plus operating margins and a cash flow profile model like we have building the kind of galleries that we are building. We are not building shitty little crappy retail stores. I mean, we are developing buildings. These are like, look great 50 years from now. So, I mean, it’s kind of remarkable. When we say inside our company, the thing that 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, is we just focus on doing really extraordinary remarkable and amazing work, we can always create a model and a business around that. And I think people learn that with the iPhone, right. Like if you think about when Apple incented the iPhone. The average phone I think in the country was $59 and it was the Motorola Razor. Apple introduced it at the time of $600 phone. And $600 for six months and they lowered it to $400. But the point is, there was like so much more and then we thought, that will never work, that will never work, then it became really one of the best selling phones in North America, and then everybody said, oh, they don’t never sell in China. You’ll never sell a $600, $800 phone in China and the it became the best selling 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. If you really do significantly better work, people will pay for it. We are learning that with Tesla, right. I mean, look at Tesla’s performance is that new car company. The guy never built a car before, but he built a remarkable care I mean, it’s really extraordinary compared to anything else in the market and it’s creating an entirely new market. And so, I think what we are doing is similar to things like that. We are 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 two of the trade design centers and showrooms that they lacked accessibility, they lacked transparency, and they lacked scale. Think about that. At the high end of the market, they lacked accessibility. You couldn’t even go to them unless you had an interior designer or a retail license. Like that’s a good market – I am going to go from market that lacks accessibility and make them accessible. And then it lacks transparency, meaning that they’ll walk in a showroom. There is no prices. You can’t figure it out. There is codes. They give designers discounts. They give discounts. Won’t give you a discount. The guy bringing a designer so, so convoluted and then I think 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 that – like whose getting a discount, your designer, is it this person, is that. And then by the way, we offer design services. So, that helps. And then, we’ve got scale. And we’ve integrated it altogether where it delivers time, value to consumer and time is the ultimate luxury, right. It’s nothing is more important than time. I would tell people here, how we allocate our time is more – is actually more important than how we allocate our capital, because I can always go raise more capital, but I can’t – I’ve never figured out how to get more time. Right, so – so I think what we created is going to create this entirely – I think we are creating an entirely new market for a business and then we are 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 are kind of evolving into the brand we aspire to be, you could really get an upwards file here. But we don’t need that to happen to create a lot of value. If that happens, we’ll be like super charged.

Thanks very much guys. Appreciate it.

Yes.

Your next question comes from the line of Chuck Grom with Gordon Haskett. You may now ask your question.

Hey, thanks. I was just curious when you talk about sustaining that 20% operating margin goal, which is impressive. Just wanting if you can contextualize that for us longer term in the light that you go down the path of building out RH residence and obviously you are going down the path of RH guesthouses. Just how do we think about the margin structure over time as you continue down those avenues? Or do you view those channels as accretive, dilutive? Do you think you can sustain the operating margin structure? Thanks.

Yes. I think we think about it 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 those high-end luxury brands? I tell the team, all the great brands mostly were born at the top of the luxury mountain, LDMH and Gucci and Canoe and just to name luxury brands come top of mind. They have always been a luxury brand. We didn’t start anywhere close to a luxury brand. We had Oxydol laundry detergent on the cover of our catalog 595, right. And so we have to scale this luxury now, I mean, you have to do things that create a four, three consideration of the brand that elevate the brand in the right consumers’ mind. And so, whether it’s doing a – we think an extraordinary experience that a guesthouse that’s going to create entirely new market for customers seeking privacy and luxury, or having RH3 luxury yacht that you can charter in the Mediterranean and Caribbean and I mean, not a lot of people can use that. But I guarantee when we did the portal of RH, and you see it on our website and you see our guesthouses and you see the other things we are doing, the branding of that, right. The – we don’t have a marketing department in our company, because we say marketing lot of times putting lipstick on the pig, right. People try to take an ordinary thing and dress it up and make it like clean 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 and like to ad or two here or there in a home magazine like Digest or someone in. But really it’s mostly our work. Our galleries are our work and the extraordinary experiences our stores looks are our work, our web portal will be another version of our work and how we communicate what we do and I think the guesthouse is and the residence is, if done really well, what knows that they’ll elevate the brand and they will help us climb the luxury mountain, because I think that will be so extraordinary, the 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 guesthouse like the few people in the inside of the hospitality world that I have showed it to, they’ve gone like, oh my god, do you know how much you can get for those rooms, oh my god. And if they are half right, we are going to really well. But they are not just kind of a new business thinking about it independently , you have to think about all these things in – not an 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 visited Stanley Markets in the beginning of markets, and 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 female consumers to come to the store more often and walk 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 difference than quite frankly it blows my mind how many retailers right now is talking about closing stores and just having a website, right. I guarantee you people start closing stores, their website traffic is going to plummet. And it’s going to find out the cost of acquiring customers through digital marketing. The cost of marketing and invisible store online, good luck with that. There is all the digital native brands are opening stores. So, these other elements, guesthouses, residences, other things you’ll hear about that will test and incubate, they are going to create a big conversation around our brand. They are 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 itself and if they are, right, the ecosystem gets bigger. If not, we have a handful of them and they are tremendous examples of our work and they elevate our brand and – but I think long-term we are going to try and find, now that we’ve worked on them longer. I think that we are going to find that their 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 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 look at hospitality and 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 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 the 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 are not going to do it just running some ads and magazines and stuff like that, it’s really – 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 – but just curious if you can give us a sense for how much of that’s coming from some of the deurbanization movement versus the shifts in the second home markets versus just the overall housing market than better the last buck will be just the pandemic and people just being more hunkered down. I am just wondering, if you can think about like the different drivers of the recent strength.

Yes. I think it’s all of the above. Yes, it’s all those things together. I mean, again, we were – that’s eight or something before this pandemic. Yes, so we are running it up eight before the pandemic and then we went down 40 and now we are up 44 something in the core business or something, but 47 in August, up 44 for month to-date in September. I mean, yes, I mean, there is 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 to play it with the expectation that it could be temporal otherwise you can kind of goof up your model. So, we are okay, not trying to optimize everything in this market. Right, this thing is temporal. You can like, change your model and try to run after every sale and optimize it 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 are focusing on the little rocks and you just screwed up your model, right, and then all of sudden things the air comes out of the balloon and you are like, oh, now what, you got to disarchitect your business and stop your cost structure. So, we are okay. We are not chasing any sales. We didn’t put one thing on promotions. We are letting some demand get away. We know we are losing demand with the backwater race we are running. You are right there 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. Did you - do you remember them, like, oh my god, they had the best numbers during the pandemic. What happened to them? Oh, yes, long-term, they kind of screwed up their model, like we look at this is, this is some kind of a temporal advance that may have systemic long-term benefit to the home. We hope it does, but if it doesn’t, it’s okay. We are 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 resilient 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 in the pandemic that’s a 90 basis point drag from water works. It’s got an 80 basis point drag or something like that, hospitality confirmed start-up mode. We’ve got another drag from some kind of one-time investments we are making. So we can take those pieces and that helps us see, yes, 25 down that road. So stay down that road. Don’t get lost in the little rocks to the pandemic. Ride this wave 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. Maybe there is a new water line, I don’t know. I mean, I guess, this is hard to say. It hasn’t been that long. I mean never seen anything like it. So, like, don’t want to overreact to it and goof up the last kind of decade of work. So, we are taking a very long-term view here. We are not running around with our heads down trying to manage the business from week-to-week. We are not pulling any levers. There is no promotions going on here. Just trying to build a – build the best brand of its kind in the world.

Great. Good luck. Thank you.

Thank you.

Your next question comes from the line of Brad Thomas with KeyBanc Capital Markets. You may now ask your question.

Hi. Thanks for taking my question. 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 is perhaps more sales coming from in ecommerce or web order rose than in the stores and that may benefit cost. You are also not mailing the source book, on the other hand, of course, knock on wood. The sales book is pretty good. How should we think about expenses to the balance of the year? Thank you.

Yes. We will have obviously some savings in ad cost. And we are not going to try to chase and optimize the revenue over the short-term here. We think we’ve got enough and we are already chasing it from a supply point of view. So we think we are going to making the right decision to – it’s not like we are not mailing the book and not doing anything. We are not mailing the book and we are 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 the customer already optimized. So, and by the way the other thing that we want to learn is, I don’t maybe the books aren’t as productive anymore, as we think. So let’s take this time and test our way kind of add it and back into it and we’ll get some new fresh data that says, maybe when we launch the portal and maybe because we are building all these big new stores. We can mail less books. And so, there is lots of motivation about kind of testing and learning for the long-term. So, but, we are making a lot of investments in the long-term growth. Making lot of investments in the international, making a lot of investments to elevate and expand the product. You’ve probably read, if haven’t read, we made a small acquisition of a business that we disclosed. So we are not saying much about it for competitive reasons. But that we think is going to elevate us and the talent and the acquisition is going to continue to help drive our kind of product capabilities. So, that’s what we are 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 where we opened galleries, that just means that we can – that will lay the tracks to 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 then 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, Australia and South America and other parts of the world. And the world is what we feel is 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 interest and everything else like, the world is getting smaller. The world is adapting the same pace 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 are investing in all those things and despite the investments, again, we think we’ll again do quite well from a profitability and margin performance perspective.

And Brad, it’s Jack. I’ll just add quickly. Gary was talking about with – if we think about the 20% model, at the floor, it implies sort of 5% revenue creep. You can do the math also on what that implies for H2 op income and that’s 22.2% with 700 basis points, right. Again, that’s just the implied math of the forward guiding. We are not telling you how that’s split between gross margin and SG&A, obviously we are not guiding, but naturally as you alluded to the sourcebooks that benefit would naturally I am going to see inside come more in Q3 than it would in Q4 given that’s when the mailing would occur. So I just want to...

That’s a good point, yes

Add that from a timing perspective when you think about the quarters.

Great. Very helpful. Thank you, Gary. Thanks Jack.

Yes. Thank you.

Your next question comes from the line of Adrienne Yih with Barclays. You may now ask your question.

Great. Thank you. Great content and color. Gary, as you were talking about sort of brand building, some of these were 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% to sales, you only have the luxury of having another 600 basis points or so in all of these different areas like RH3 and guesthouse 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 to as a percent of sales, because now you have 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 our age and sort of the Lifestyle Content Magazine. So those are couple of my questions. Thanks.

Yes, you got some work here. Our whole leadership team is in the room by the way. Yes, it was like, yes, okay, you think like we think. So, yes, it’s correct on all of it. Yes, so, exactly how we think about it.

Okay. And then, so if that’s we get, one quick very small thing, I have actually two 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 are running currently have interior decorating services attached to them? Thanks so much.

Yes, we don’t give the interior design percentage.

We have given it. But we don’t.

Yes. Yes. Just a big part of our business. But we are not giving it just for competitive reasons right now. And then, like, whereas color, color is probably, ask me that question next quarter. We have a series of off sites and time we are 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 are excited. I mean, I actually – it’s kind of a gift to say like, you know what this, don’t mail the book right now. Don’t do all that work like this have everybody stopped 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 these – 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 six months that we can really step change the core business from a – just a comparable sales point of view. Like, if it’s you need – you really need to get all the leadership to focus including me, right. So, and we got so many things to work on 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 have kind of a range in organizing things and it – at the end it doesn’t really move the needle that much. But in the short time, we started to focus and on a couple of the categories, I think, if you are sitting here with kind of our senior leaders or kind of product, I think everybody’s eyes are really wide open and we think, well, there is 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 got ideas and opportunities to do things. Today, we are – I’d say, we are exceptional at presenting the product physically in an integrated fashion. We are a little hard – kind of hard to shop by category today, right. You go to one of our big galleries and try to shop for lighting, you try to shop for – you got to kind of walk the whole place. And we don’t even have the whole assortment in an organized way and yes, the web helps you there and the book helps 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. Maybe I should throw one out to everybody a bone so they could think about it like, most likely, because – I’ll talk about one that we are a little farther and long in our thinking just to kind of give you the idea, like, 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 six months of the year. Right, and then you go to our big design galleries, we show 20 to 24 collections year round somewhere around there. But they are not all in the same place. Some are on the roof top, some around in garden patios, some are on terraces, and we have now, what we have 45 collections, somewhere like that, by next year, we might have 60, 70 collections of outdoor furniture. We have got a concept we are working on that could come to life faster than – actually, I like saying it, because it gives us a faster deadline. So, everybody is looking at me here in this room. They are going to like, okay, here it goes. So, now we’ve got to get to spend really fast, but we are 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 in not only outdoor furniture, but shade and fire and heat and textiles and things presented in a way in an environment where 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, there is something you can do, is there RH Illumination, is there RH – is there RH Chair Upholstery, is there RH Furniture, is there, it’s like I think go on and on, right. And everybody is going, oh, here is he goes, like the whole things. But you know, you can all of a sudden start to imagine an RH Compound, this beautifully integrated experience with these isolated experiences around the categories that allow you to shop both ways and allows to express our brand in a way no one has ever seen. And so, so we’ve got these things that we are working on, that we are testing and that’s why we have to put everything in perspective like, where is RH Color come in. Well, like we got a whole bunch of things, like you choose from, how many can you do at one time in what order. How do you do it really well, like, I guess, someone in the room looking down at me, saying that you are going to tell them about – if I tell them about that we think we are really crazy, like they are just looking down at me right now. But like another big idea, but we are not short of ideas here and the key is we are all short of time and it’s just how do we allocate our time and I’d love the fact that right now this pandemic in some ways is giving us the permission to reallocate our time in a dramatically different way and I think will be more right than wrong as we measure the outcome of how we allocated our human capital over the next six to 12 months. And we might find that, well, there is real breakthroughs here and we might be spending our time, like we, who knows, maybe we might find out two years from now, three years from now. We are mailing two-thirds less books that we just don’t need as many books then they can be different like you said, expressed all the lifestyle differently. Lots of different ways to do it, I mean, the good news is, we are kind of always unsatisfied, always on the move, we are always innovating, we are always learning. We are 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.

Thanks.

Like that will peak into the future, 90 days and ask me in every conference calls, like, yes, RH – is coming, when is RH Illumination is coming, when is this coming, when is that coming. But there is going to be a lot coming over the next five, ten years, like we are not going to run out of ideas here.

Thanks, so much. Congrats to the whole leadership team. I mean, what you are creating is really remarkable. I had to say that.

Thank you. Thank you.

Yes.

Your next question comes from the line of Michael Lasser with UBS. You may now ask your question.

Good evening. Thanks a lot for taking my question. It’s two 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, beyond what Gary already mentioned in the letter, we did talk about 490 basis points of product margin and so the rest would be shipping expense and occupancy expenses which we got a little leverage on each of those. And we are not going to go into much more detail than that.

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 commanding higher margins and all the things that we’ve talked about, cycling of the outlet, definitely the cycling of the rug transition.

So, and that’s about, those two were about a little over a third of it, right, little less than half.

That’s right.

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

That’s helpful. And my follow-up is, you are on the path to 20 – mid-20s margin over time. Is there, is this an area where you would take – your margin would take a step back if you accelerated some these investments or do you think from here you can continue to see margin expansion year-over-year, even while you do make these investments?

We think we can do it even while we are making those investments, because we keep doing it while we are making – we’ve been making investments and I think the key is, I mean, maybe there is a time we say, look, we’ve got so many really good ideas now. We are going to invest even more and we are going to have a flat year. We might have a year that’s a little down, I don’t know, it maybe. We’ll tell you when we get there. I mean, we will make really good long-term decisions, we like, we are not going to all of a sudden become a company that gets to the 20% operating margin and starts managing quarter-by-quarter and go into the downwards spiral that a lot of companies do because they start “protecting their brand” right, instead of building their brand. And they – what I call the death curve. They are really smart and inventive and innovative, while they are building their brand and then they built something that’s valuable and then they start to protect and everybody start to playing defense instead of offense and that’s when you just go into the death curve. And you start shrinking because you start playing massive – you play more defense than you do offense. 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, that could be short-term thinker. I am like – I am not trying to get out of this company or sell this company. It’s like, none of us are. We are – this is our life. It’s not just our job. So we are going to make decisions like, we own a 100% of the company. And we are not going to all of a sudden play small ball, and try to play quarter-by-quarter, year-by-year predictable margin improvement. We could have by the way could have not let the things swing shot to 2020. I’d kind of say it like, oh, let’s like spend a bunch more money here, so we grow a 100 basis points a year, 150 basis points a year, that’s like done. Like we are going to I mean, we are going to find big moves and big leapfrogs and we are 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 are 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. If I look at November 2nd 2012, and look at our stock went public at $24, look where it is today and go look up every one of those other brands, that I would tell you most people I say, hey, how do think these companies did over the last seven and a half 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 are 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 are going to – ten years from now, five years now, ten years now I think our shareholders are going to be really happy. If I start playing like quarter-to-quarter and year-by-year, oh my god, operating margins might be down 100 basis points this year. But let’s not invest in that extraordinary idea. Let’s not do that. Like, this is dumb. So, we are going to play the game with a long-term view. It’s worked for us thus far and I think it will continue to work for us. We want to get better. We are going to have to take bigger risk. We are going have to be more inventive, more innovative than we’ve ever been before. Right, you are even striving to get better. You are allowing yourself to get worse. There is no such thing that stay in the same. That’s why I said in the beginning, like someone pulled out my first video, since we are watching it the other night, when I said, if you want to know our better company, put down your spreadsheets and go to Melrose, go to LA or go to Atlanta and maybe you’ll see what we see and also fall in love, right. And because you have to kind of – this is so different. You have to see it to believe it, right. But we got to get better at doing what we do. We got to get more courageous not less courageous. We got to take more risk, not less risk, otherwise the whole thing is going to – it’s going to go into a downward spiral. It’s going to become boring. You are going to lose our passion here and it’s 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 they are like they are managing the business. They are not leading. They are not building. So, we are not going to be scared to kind of take risk to kind of have our margin hit or like delever by a year. I think that’s we did what we did in 2016 and 2017.

Understood. Thank you very much.

Yes.

Your next question comes from the line of Cristina Fernandez with Telsey Advisory. You may now ask your question.

Yes. Hi, good afternoon. I wanted to ask about the demand trends you are seeing and then it seems like it’s a very good opportunity to attract new customers to RH. Can you talk about whether you are seeing an increase in your customers or is lot of the demand coming from existing members or reactivated customers that perhaps shop before but not recently?

Yes, and we said, the numbers would indicate, we are seeing a lot of new customers, right. This is an acceleration in new customers. This acceleration in existing customers, but you can’t run up 40 demand 47 demand without new customers, so. After these people that all that within the home is become more of a focus, it’s more important as more and more people buying second homes, moving – uptick in the homebuilding market. And hopefully this means it, 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 two new stores that you opened this quarter? And then on your letter you mentioned you couldn’t provide opening guidance for galleries should 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, we show and rendered our – we are really happy with both – really pretty extraordinary. Marine, it’s not performing as well as Charlotte because the restaurants we opened and the restaurant is open for three days and we have closed the restaurants. The restaurant has been closed about for a month and a half, two months, something like that. It’s really great for everybody that’s – we haven’t open for our associates. So we are feeding our people and so we keep our team engaged and a lot of people 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 Marine is really performing well. Charlotte is kind of off the hook, right, like and what we are finding in some of these – I don’t know if you take Charlotte is 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 have expected and I think that we are 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 under invest in those call it markets, because they don’t understand them. And there is – I think there is 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 and Marine. But you think about Charlotte and Columbus, the lifts are extraordinary. I mean, way beyond our expectations, not a little beyond, way beyond. So, it really just making us rethink the – this is the focus and investments on some of these markets, because they are 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 this guidance 2021, we’ll open new galleries in 2021. We just – things are moving around. We’ve had some of the developers of – they froze their capital outlets, which lot of our TI and stuff for a few months. We’ve lost time, it’s hard to get things into local municipalities and get approvals right now. Doing Zoom meetings and we are trying to get RH Morristown approved and New Jersey which is a 5.5 acre stake with a historic home and we are developing multiple buildings and gardens and food and beverage offerings. It would be extraordinary galleries. So it’s hard to – without physical meetings and town meetings trying to do 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 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 kicked into 2023. If this just everything is kind of backed up. Go ahead. Thank you.

Your next question comes from the line of Oliver Chen with Cowen and Company. You may now ask your question.

Hey guys. Thanks, a lot. 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 is pushed out in Europe right now. The initial gallery that we plan to open RH England which we plan to launch with – we still believe we can open it tentatively in the kind of early summer end of 2021. And that’s anticipating – we are to be able to travel over there soon. But and the team is identifying distribution and logistics solutions and where we are going to be and whether the DC is going to be in Belgium or it’s going to be in Netherlands or it’s going to – do we open one in the UK. We got all the optionality heat up and team has 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 a 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 is 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 going to depend on the virus and what is 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 or things going to slowdown, shutdown or anything, we just don’t know. So, we said tentatively 2021 that’s when we are always going to open that first gallery. We are 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 like just getting the approvals right now and things like that are the difficult thing and understanding construction timelines and stuff. So, but – so far there is no real change. The only questionable one was, can we get RH England open in 2021. There is still some questions because we just can’t travel right now and there is 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? Thank you.

I don’t know for – one I think you are going to see more capital light, than less capital light. We don’t have that many bespoke projects on the dock to do it. Right now.

New Jersey.

New Jersey, bespoke – New Jersey is basically capital light. It’s a development deal. So, we – New Jersey, yes we are finding…

New Jersey is a development deal where we are going to be doing a sale leaseback.

Yes. We’ll do sale leaseback. We’ll get a 100% of our capital back out of New Jersey. So, I think about those as capital light and we have a little bit of a capital we are putting upfront there taking construction loans and we’ll get all of our capital back immediately after we sell it. So, but I am just trying to think- with most of our big capital jobs, I mean, the one on the horizon I am thinking about is London. Depending on what we do in Orange County, that will probably be a little heavy – more capital heavy because it’s going to be at kind of new gallery.

Miami could be.

Miami, yes, Miami, if we have an opportunity to do a deal, we’ve been trying to do for seven or eight years and now it’s been coming – most likely 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 are like New York, right, they are going to payback in two 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 five years than it had in the last five years.

Got it. Thank you so much.

Yes.

Your next question comes from the line of Tami Zakaria with JPMorgan. You may now ask your question.

Hi. Thank you so much for taking my question. I have two quick modeling ones. So you mentioned COVID-19 related costs were about 40 basis points of drag in the second quarter. 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?

Hey, Tami, I’ll take that. Look, from a COVID perspective, clearly, with the reopening activity in Q2 there is 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. An eight point swing in our business and so, in some ways those savings and we are making investments from here. So, the bulk of those savings are sort of minus in Q1 and some in Q2. But we are 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 2021, somewhere around there.

Got it. Great. Thank you so much.

Thank you.

Thanks, Tami.

Your last question comes from the line of Seth Basham with Redbush Securities. You may now ask your question.

Hi. Good evening. It’s Seth Basham with Redbush. My question is really around the sequencing of all these – that you are paying …

You got a really bad connection. Yes. You’ve got a really bad connection. We can’t understand you on this end.

Like exacerbated almost.

Yes, no, you’ve got a really bad connection.

Okay.

So, you are talking about the sequencing of the investments we are making?

Yes. [Indiscernible] more dollar and how you are managing execution risk associated with that, that would be excellent.

So, how we manage execution risk with the investments we are 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 much greater asymmetrical risk to the upside. So, I don’t see any massively elevated level of risk in the investments we are making. The one where we obviously have the less – the least amount of experience in data is, in the international expansion. So, but well, I think we’ve got that appropriately handicapped and we are moving at a good pace that’s going to allow us to kind of learn and provide and adapt and overcome. So, but I don’t – the level of capital that we are putting into the European expansion is, if you would ask me three years ago, what I would have said we are probably going to be putting in two or three times 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 and 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’ve built beautiful. I mean anybody who have seen some of this Abercrombie and Fitch locations, they 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’ve got some capital building restaurants, either on the roof top 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.

Thank you.

Alright. 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 connects 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 it’s making us – made us all so proud. And say, look the next ten 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 to trying to dig ourselves out of the 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.