Ladies and gentlemen, thank you for standing by. And welcome to the RH Third Quarter 2020 Q&A 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] As a reminder, today’s call is being recorded. I would now like to turn the call over to your host, Ms. Allison Malkin of ICR.

Allison, are you on mute? Sorry. I think we are ready to go right into Q&A.

Oh! No. It’s okay. I will start. Thank you. Good afternoon, everyone. Thank you for joining us for our third quarter fiscal 2020 Q&A conference call. Joining me today are Gary Friedman, Chairman and CEO; and Jack Preston, CFO. 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, excuse me, 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 this non-GAAP to GAAP measures in today’s financial results released. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. With that, I will turn the call over to the operator to begin our Q&A session. Operator, we are ready for questions.

Thank you. [Operator Instructions] Our first question comes from Adrienne Yih of Barclays. Your line is open.

Great. Thank you very much. Good afternoon. And I just have to say, wow. I mean, this is a really remarkable performance. So congratulations to everybody at RH. Gary, I guess, my first question for you is, in the past you have mentioned two macro drivers that benefit the company. One, being kind of high-end housing growth and the second being robust stock market returns to where the market that we have both. And based on the historical perspective, how long have the -- what’s been the lag in terms of the effect, and obviously, we are seeing it sort of immediate today. But what’s been the duration of the positive impact to your business from that? And then my second question is, the sales galleries in Europe, what size will they be and how should we think about, I guess, the annual sales contribution of each of those? Thank you very much and congratulations.

Thank you. Thank you. It’s hard to be specific on duration. I think it depends on severity of correction in any of the markets. Particularly we have seen, as you know, with sharp stock market moves sometimes will pause consumers at the high end. So it’s hard for us to kind of give you a number or range there. But I’d say, there’s nothing different than how you might assume the consumers would behave depending on the severity of the changes in a marketplace. I would say, we see a very healthy home market, right? And I have been asked recently about Keith, how do you feel about the cities you have galleries in that are consumers or moving out of some of the key dense cities based on the pandemic and there a boom in the suburban housing market in the second home housing market. We are generally -- I would just say, we are generally indifferent, because people moving and buying homes is just a good thing, right? We have galleries in every major market. So that will all kind of balance itself out and our key market galleries like New York tend to draw from the broader suburbs and everywhere, because it’s where our best assortment is. But this -- the uptick in the housing market and how long that will last? Again, we don’t have a crystal ball. There’s usually a longer tail there, because as anybody on the phone knows, if you have bought a new house or moved into a new house and it triggers a lot of spending on the home and it’s not an easy job.

Yeah.

It takes a long time. So we think that the tail from just the housing market move looks pretty good. It’s hard to say today what’s going to happen with the stock market and how the market is going to read what happens next in the pandemic. It’s hard for us to understand how the market will cycle through the stay-at-home stocks, as they call them versus others. And we just -- we try not to get too focused on those things we can’t control. But as you think about the galleries in Europe and how you should think about that the sales contribution. We think it’s very different obviously from the perspective of work. If you think about the U.S., when we opened a new gallery almost all of them are replacing an existing gallery. So there’s something very good about that and there is -- yet from the perspective that there’s little risk and we have a lot of history. We know we have a gallery that’s doing $18 million and we open a new gallery that has hospitality generally in the first 12 months to 36 months. It will double to $36 million and we have a point of reference in each of those markets. But when you think about opening it internationally, we are not replacing any stores. So you have a bit of an unknown on that end. But -- and that can be a negative, because there’s more guesswork and there’s less data to use. Again, we are relatively very accurate on understanding what’s going to happen with our expansion in the U.S. and even where we have hit new markets so we opened in the U.S. we are relatively accurate in predicting the performance. So we had less data internationally. We don’t know…

That’s very helpful. Thank you very much.

Yeah.

Thank you. [Operator Instructions] Our next question comes from Max Rakhlenko of Cowen and Company. Your line is open.

Hey, guys. Thanks a lot for taking my question and congrats on the nice quarter. So it’s really good to see that your cancel rates are below last year. Do you think that that could remain the case over the coming or could there be some risk as supply will trail demand for a bit longer than you previously anticipated? And then just separately, how are you guys thinking about cash allocation priorities at this point? Your free cash flow is starting to ramp and with fewer major capital heavy projects, as well as debt maturities, do you think we could see accelerated share repurchase, special dividends M&A? Just want to hear your thoughts on that? Thank you.

Yeah. The cancel rates have been down for several quarters now. So the trend would indicate that there’s not a risk, right? That the -- and I think there’s not a risk because, one, because I don’t think we have a lot of direct competition at our -- where we are in the market. We are one of the few people that stock higher end luxury home furnishings. In most places, it’s a much longer wait time custom, etcetera, etcetera. And I think that the consumer needs the product and I just don’t think anybody else is in stock, right? I mean, we are running the highest back orders in the history of the company since I have been here 20 years now. So I have never seen this kind of phenomenon, right? I have never seen back orders at all-time highs and cancel rates at almost all-time lows, right? So, one, is that tells you the consumer probably doesn’t have a lot of other choices, what choices they perceive they have, also don’t have product to ship right away. And they really need the product, so they are, in many cases, forced to wait, right? So you kind of go, God, if I don’t order it now, how long might I wait, right? How many more weeks might the delay be? So the numbers would tell you over the last few quarters that there doesn’t look like a risk. That doesn’t mean things won’t change. I just don’t see any reason for them to change. So our degree of confidence of converting the orders to revenues is very, very high, right? We have a lot of data now and very, very consistent back orders trends lower not higher, back orders have been below a year ago and they were…

Got it. Thanks a lot, Gary, and happy holidays to everyone.

Thank you. Happy holidays to you.

Thank you. Our next question comes from Steven Forbes of Guggenheim Securities. Your line is open.

Good afternoon. Hey, Gary. Maybe to start, on the last call, you talked a lot about the reallocation of human and financial capital, right? And I wonder if you can provide more context around the potential benefits here, right, as you digest those moves and is the launch of RH Contemporary, right, and RH Color like a result of these efforts or how do you sort of speak to the potential benefits, right, of that strategic change and not dropping the sourcebook in the fall?

Sure. Well, not dropping the sourcebook in the fall was a decision based on the fact that inventory was chasing demand massively and we were only going to create a greater pressure and possibly not satisfied, just have customers frustrated with ads and so on and so forth. So we give up topline in by not mailing a book? Sure, we did. If we were to mail the books, would there have been incremental toplines? There would have. Would there been higher backorders? There would have. Would there have been more frustrated customers in wait times? There would have. And so we thought the right long-term move was not to try to chase this kind of optimize the business in this time of the pandemic, like, how to shift our human capital and focus on the longer term. And so we reallocated our time and energy towards other things contemporary being one of them. We held back newness, right, that would have been generating demand today. I feel really good that demand in the core businesses bounce back to what is up 39, right? Up 39 with no books, right, with no newness. So we are up against last year’s book. We are up against last year’s newness and we are still up 39. And so could we been 48 or 52? I don’t know, maybe. But our business would have been messier. And it’s never good to kind of create a messy business. I mean, I have run those before. This company has run in a messy way before in a chaotic way. It’s no different than -- it’s pretty clear if you just look at the emails you receive in your inbox is that there is a period where very few people were promoting. Now it looks like…

And then maybe just a quick follow-up for Jack. I don’t know if you can sort of speak to what’s the right level of expenses as we look out to 2021 or if you just want to sort of based on the third quarter here and maybe help us conceptualize what some of the transitory factors were, right, like the removal of the sales structure and so forth as we think about our 2021 models?

We don’t give guidance. We gave you our outlook and I think it reflects our confidence in the business and the sort of operating structure. And look, some of the things I look to continue to strengthen in gross margin and product margin, like that is a strong part of the story. And when we look out and our confidence to reach the 25% margin in our outlook -- our longer term outlook, I mean, that -- those are the strong elements of the story. As far as like specific elements in 2021, we are not in a position to provide at this time. I will look at Gary if there’s anything else.

No. I mean, what we believe we are going to have a double-digit revenue growth and expanding operating margins. We will know more each week, each month as the pandemic kind of plays out here and the world returns to some kind of a more normalized environment for people, how people are going to behave and what’s going to happen. But -- we are not going to get out over our SKUs from a cost point of view, right? And if we had -- you can’t tell, so we are in kind of a temporal environment. You have got to be smart about that. So that’s why we feel confident that the margins will continue to expand because we have got a good handle on expenses and we have a good line of sight into the product pipeline and what we believe can be the margin structure from a product point of view, which is the key lever. And expenses, we were pretty disciplined around here from an investment point of view. It’s a -- we tend to have a culture that doesn’t spend money. We have a culture that invests money based on what we think the return with that investment, what kind of return will that generate. So, as long as we keep that discipline and we don’t become complacent or arrogant, based on business trends that are happening today. We keep our edge. We continue to be unsatisfied, serious, critical, always unfinished, always on the move and we will continue to do great work. So I don’t think there’s any other people that are giving you much more data than we are giving you today. So I think our -- the shareholder letter has a lot in it.

Thank you both. Happy holidays.

Happy holidays, Steve.

Thank you. Our next question comes from Chuck Grom of Gordon Haskett. Your line is open.

Hey. Thanks. Good evening. Can you guys put into some context how big of an opportunity the outdoor furniture market could be for you guys? And then, for Jack, just trying to understand the connection between deferred revenue and customer deposits in your balance sheet there, I believe over 60% year-over-year and then your demand comp, which is lower than that. Just wondering if you could connect those two dots for us?

Yeah. I think, look, outdoor, I’d say, outdoor business is a lot like the general RH business. I think when you build a brand like ours you in many ways are creating a market. And yeah, you are inspiring people to purchase and invest versus other purchases and investments they may have made based on what they see. And no different than Apple created a new market, they didn’t look the cellphone market, and say, how big -- I mean, Apple create an entirely new market around smartphones and the iPhone. Nobody thought it would sell in China. It became the bestselling phone in China. When you create a really good product and not just a single product, I am talking about a full integrated branded proposition. You have an opportunity to create a new market, right? To disproportionately expand a market because you are putting something out there that wasn’t there before, right? And I think that’s happening in many places, right? And look at a lot of brands that are creating new markets. So in outdoor, it’s much of the same. If you just stood back and said, where do you go buy outdoor furniture? There’s not a lot of consumer facing outdoor furniture stores, right? They are kind of out off the beaten trail kind of in weird places. You can come up with the names you have driven by them before. But if you said it’s the high-end outdoor furniture, where do you go? Where do you even see it? Where do you even get inspired to buy it? It’s -- no one really presents it, because it tends to be more seasonal in nature as far as the peaks of the business. I used to joke around and tell people is what -- you might…

Yeah.

…deposits and revenue.

Yeah. I mean, obviously, with the strength of the business and the high demand and the supply chain constraints we talked about, those are the two items -- two key items that you are going to see that grow with customer deposits and sort of deferred -- the special order business that we have that grows those customer deposits. And then as the business grows, naturally you are going to have a growth in the deferred revenue balance. You are looking year-over-year. I would have you look sort of sequentially sort of where Q2 to Q3 grew as well. That’s a -- that was like an 18% sequential build. So I think you are going to look at both, don’t get me wrong. But I think as far as impact from walking down from demand down to revenue growth, you kind of want to look at that sequential build. So, like I said, that was an 18% growth and very much expected relative to the trajectory of the business.

That’s a good color. I will look at it sequentially then. And then just my follow-up would be just wondering if you guys and it’s probably a little bit more art than science. But just any sense for how much of your revenue growth is coming from consumers who are actually buying second homes and/or people who are shifting out of cities into larger suburban homes?

We have looked at the data Chuck. Look the data is what exactly we would expect that that suburban homes are -- have high growth rates, second home markets have the highest growth rates. And then you have as Gary talked about an exodus out of cities. So -- but again we are in all these markets and our customers whether they have a primary home in an urban market and happen to be moving out there. It’s all at the end f the day good for our business. We haven’t gone into much more detail. But I think the trends, like I said, that hierarchy of second home having strongest growth suburban very strong growth and urban being the weakest of the three. Again, it’s kind of a firm grasp of the obvious as we say sometimes. But I am not sure, Gary you got anything else there?

No. No. I mean, look our business has always been our biggest part of our business is a suburban market business, right? It is where more large homes are, where those large homes have more bedrooms, more living space, outdoor furniture space, so on and so forth. And no surprise it’s the largest part of our business. And so the suburban market which is significantly large part of our business is -- has tailwind and as people move into it. That’s good for us. But its’ again -- it’s we know all the data we have got -- we look at it. I don’t know if any of it tells us to do anything differently or expect anything differently. There’s not like markets we go, oh, My God, they are buying homes there and they don’t know about us or let’s rush to open a gallery or stuff like that. I mean, some place you go, okay, we have been looking in Palm Desert in Southern California for years and it’s on fire. And the staff who is our Chief Gallery Officer went to see his grandparents over Thanksgiving. And he said we really, really need a gallery there and I felt yeah, it’s on the list. You feel strongly about it, go find a location and we will get it then quickly. I mean -- but it’s not like -- it’s not like oh my God. That’s going to change so much. It’s just probably a little mark. But we are really well-positioned in North America to capitalize based on any way it shifts within the market. We just like that the market is up, right? We are well-positioned to capitalize. No matter where they are moving in North America. I think the only places like we were not represented in Montreal and we are not represented in Hawaii. I am trying to think. So there’s a couple of places like that.

Naples?

Yeah. Yeah. Yeah. We -- yeah. We are not in Naples.

Yeah.

We plan to be in Naples, but we do great business in Naples even though we are not there.

Got it. Thanks very much.

Thank you. Our next question comes from Michael Lasser of UBS. Your line is open.

Good evening. Thanks a lot for taking my question. Gary, can you give us a flavor of the customer behavior that you are experiencing that drive this strong demand growth? How much is coming from new customers versus repeat customers and how much is coming from larger basket? Are you seeing a trend of customers who are more often buying furniture more than one room in their house and that where you are seeing a strong demand growth?

Our interior design business keeps growing and has been growing and so you’d thinking a big move like this. It’s kind of everything’s lifted here. If something shifted, we had outdoor was off the charts in the beginning because a lot of people I think realize you are not going to travel for the summer and spend a lot more time at home. But the consumer behavior is -- it hasn’t -- it’s no different than what you’d expect with demand like this. It’s a -- new customers to higher spend from existing customers, and so on and so forth. The metrics don’t make us think about doing anything meaningfully differently than what we are doing. So --yeah, yeah, so, we -- our business is -- has been growing if you think about size of basket and so on and so forth. It’s -- because we have moved the business from a -- from just conceptualizing selling product to or creating product and conceptualizing and selling spaces. And the efforts behind building an entire interior design platform on a national scale, if you go into our new galleries and you see the dedicated office space for our interior designers and the design affiliates and the meeting rooms and the space we have designed, it will tell you that that obviously is something we are investing into. So -- and we think that’s going to be create strategic separation for a long time to come. All these investments we will continue to create strategic separation and render our brand more valuable long-term and so that’s what we feel best about. Look at all these pieces and say, what will this look like over the next decade, which I tried to give people a view at and told you what’s sitting behind…

Yes.

Yeah.

My follow-up question are these periods of disruption are always an opportune time to learn how to operate differently, given the extremes on the cost side in the third quarter and recognizing that some of the SG&A decline was from mainly in the sourcebook. Is RH now able to operate its model less cost intensively with a lower amount of labor so we shouldn’t necessarily expect the same amount of labor expense moving forward and how would you think about reinvesting some of that back in the business?

Well, the --look, the models are going to continue to evolve, right? When -- look, if you just take a simple move in our model and say, hey, we went from a legacy gallery to design gallery. And that design gallery will essentially double the business, right, over in one year to three years. So we are not going to mail any more sourcebooks into that market. We generally don’t. We maybe do a little splash, because we are opening a new gallery so people are aware of it. But our ad cost at a -- at that level, right, the leverage is massively. And I think people sometimes miss that in a model like ours, right, because they see this big gallery and they go, oh, it must cost a lot of money. It’s much more expensive and they don’t think about the dynamics of what happens, because no one -- like no one’s ever taken a really productive kind of a legacy store like we have. And then been able to just change the footprint and basically double their business. I have never seen it before. Consistently, across the entire country, we can do that. And so, when you think about ad cost, that gives you big leverage. When you have a temporal situation like this with the pandemic and you make a decision to not mail a book, are there things we can learn there? Yeah, but it’s really -- it’s a little tricky, like, as we go to reinvest and mail the books, we mail as much as last year. We do e-mail more. Do we mail less? Do we -- what do we test? I mean, we are going to look at a lot of data. We are going to run the models. We are…

That’s very helpful. Thank you very much and have a nice holiday.

Thank you.

Thank you. Our next question comes from Chris, excuse me, Curtis Nagle of Bank of America. Your line is open.

Hi. Good evening. Thanks very much. So, yeah, I want to turn I guess for the RH contemporary line. Maybe just get a little more detail in terms of the vision and strategy. Gary, you described it as bridging between the interior and modern lines in the ladder. I am guessing there’s -- I guess, what I’d say is, an extremely strong chance, you wouldn’t rule it out if you thought it would cannibalize existing business. So, yeah, I just kind of curious what gives the confidence you think that this is going to be a good incremental business about how it’s out of the other lines. Yeah, how should we think about it?

I think about it is we are excited about it and you ought to be excited about it. Because we are not excited about things that we don’t want to buy and that we -- I mean we are -- we might be too excited about it, right? If anything last night late as selling area like, okay. So let’s make sure we are looking at the whole Board here, because it is really exciting. There’s a lot of really new product and so we just think it’s going to open the aperture of the brand. And yeah, we are really excited about how our teams can do everything at once and we keep kicking the can down the road at color. We got -- I think we are starting to zero in on RH color. It’s a tough one, right? We are a neutral space brand. We are kind of famous for our look in point of view. In fact, we are so famous for it, that people that like color kind of hate our brand almost like it offends them that there’s not a lot of color in our age. But that’s okay. We tell people that, look, there’s not a lot of color in humans, right? We are also some form of a neutral color from light to dark, right? And that’s why neutrals is the biggest part of the market, because most great design is a reflection of human design. That’s why it’s familiar and comfortable with it and that’s why you go, ah, because it’s a reflection of self. But we do think that there’s a market for color. It’s not the biggest part of the market. But that will open up the aperture that we are in. So just no different than beach house…

Go it. Excited to see it when you release it. Just as a quick follow up. Going back to Europe, I don’t know in theory. Do you think that the -- I know there are a lot of moving pieces here and its super early. But do you think that perhaps the profit contribution could be higher than the U.S. at some point in time, when do you get a little bit scale, given the comments you made about perhaps having a less dense category strategy [ph] and the additional international exposure you guys are probably going to see from being in these major capital cities?

Yeah. All our research and due diligence would say the potential is for higher margins than the U.S. And a lot of brands as you know have higher margins and higher profitability outside the U.S. than they do inside the U.S. And that’s because you are getting a lot of leverage off your cost structure, right, if you set it up well if you are not overly redundant. And for us, right, we don’t have to set up any kind of redundant buying organizations or inventory organizations or things like that. I mean think about it. We don’t have any cash and carry, what is our cash and carry business these days?

Less than a 1%.

I’d say, 1%.

Yeah. You are right.

It’s almost zero…

It’s a zero…

Almost, right, like…

Yeah.

We don’t really sell anything. It used to be like a percent or 2% and now it’s almost zero. We just -- yeah, we have gotten rid of the holiday stuff. We got rid of the ornaments and everything. So, yeah, every once in a while, someone buys some towels or something like it and walks out with them. For the most part, we don’t really inventory anything in our stores. So our model has -- is very simplistic versus other models, like, someone’s saying to me, like, oh, well, Home Depot or Target or other people didn’t do so well over in Europe or other -- yeah. Well, one, those are kind stores, not brands, right? They are stores selling other people’s brands. Most high-end luxury brands work really well globally, right? And if you are the best in your kind of category and we believe we are, then those brands do -- they usually do exponentially better than others. And so -- and then -- and it seemed very strategic, I actually liked that we gave ourselves a little bit more time on Europe, because we had more time to think about things like this Curtis, the margin structure, how we think about it, the pricing. All the different nuances and really, really think deeply about these moves that we are going to make in positioning the business correctly, because everything we have looked at and read and looked at points of references would say, we should have higher profit margins in Europe. Now there’s going to be some short-term, some expense yet minor expense deleverage as you ramp up the infrastructure. But that might take care of itself relatively quickly because of the broad based market you are going to address by opening and just -- by opening it just in the U.K., in London and England and Paris, and a couple of these galleries, even looking at Munich and Dusseldorf or Madrid and Brussels and once just with that little footprint. You are going to get a massive audience, right, because of the Internet and because the online component of the business. And by positioning ourselves in these kind of extraordinary locations and stores and environments that we are looking at, it’s going to be a great new learning. I mean, I really -- as much I really didn’t want to delay it, it was just the right business decision to do it, because we are so anxious to learn. But I think what you are saying is directionally right. I think it should be based on other points of reference more profitable or at least as profitable as our U.S. business. But it should create leverage, right? So the net-net effect should be overall RH margins going up.

Got it. Thanks very much for the thought and happy holidays.

Thank you. Happy holidays to you.

Operator?

Ally?

Operator?

We have got our last question or is the operator…

We saw three…

No. There…

Three more.

There’s two more.

Two more? Okay.

Two more.

We lost our operator?

Brad Thomas, your line is open.

Hi, Gary and Jack. Can you hear me?

We can hear you.

Hi, Brad.

Great. Hey. It’s Brad Thomas with KeyBanc. Thanks for making time for my question here. Just hopefully a quick one just on how to think about 4Q? I know there’s not specific guidance. But if you go back the last four years the fourth quarter has been your highest order for operating margin of any quarter and so just trying to understand some of the seasonal dynamics. Gary, I think you also reference that if sales for the full year come in growing about 7% that that might get you to 21% operating margin, which maybe pushes that 4Q operating margin closer to 20%. Just trying to understand if there’s any puts or takes that we should be aware of to make this 4Q different than what we have seen the last few years seasonally?

Yeah. Well, I mean, Jack can give you some highlights.

Yeah.

But one of the big ones is, Q3 has helped by not mailing a book. Hard to say exactly how much because we would have got more revenue. We expect revenues to slow a bit based on the fact that we don’t have the books and so you don’t have the ramp of the books and we are at record kind of out of stocks and things like that. So we are taking a conservative view and I think in the fourth quarter as we should. But -- I think the landscaping is a little hard to look at historically, because there has been so much change, change in demand trends, change in margins, you have things cycling through like when -- when the outlet business, how the outlet business cycles in and out and how the rug business cycles quarter-to-quarter, puts and takes that may have distorted past orders in past times. So -- and then we have things like -- we generally have a much bigger bonus accrual in Q4 and other things like that where we are having really good years and that can distort things. So, yeah, I don’t Jack if you want to?

Yeah. One thing I will add, as you think about the 21% in 2020 and as we talked about that as sort of floor number, that 7% growth rate. So that it does imply about 20% growth for revenue, as Gary mentioned, that is a slight deceleration from the 25 points in Q3. And then margin wise, to get the year at to ‘21, obviously that implies just shy of ‘21 for Q4, and I think, Gary spoke to that. You can’t look at the same sequential trends because Q3 has the advertising benefit. And so, I was going to make similar comments on the cycling, right? So like the rug business, we had talked about it as a sort of -- when you think about when we started clearing that out and put the new product on. The biggest benefits are going to be through this quarter. We will still get some benefit in Q4 and then once you come into next year. That will be fully cycled. And our outlet will have a different dynamic. But directionally I think those are some of the pieces.

That’s really helpful color. Thank you. If I could squeeze in one more housekeeping just around the merchandising newness for next year, any more color on maybe the magnitude. What percentage of products you may refresh or maybe new in 2021 and how that compares to what you normally change out or would like to normally change out?

I will just say year-over-year it will be a -- it will be a meaningful increase year-over-year.

Thank you so much. Hope you all have a great holiday.

Great. Thank you, Brad.

Thanks, Brad.

Happy holidays to you.

Thank you. Our next question comes from Tami Zakaria of JPMorgan. Your line is open.

Hi. Thank you so much for taking my question. I just have one longer term question. I think in your press release you spoke of 10% to 15% annual sales growth potential in the future with mid-20s operating margins. So what’s really driving that optimism of 10% to 15% versus 8% to 12% that you have been speaking out prior to this trend? Do you need all the new businesses to come to life, like, the Yard and RH Residences business to come to life to get there or can you get to that 10% to 15% with the existing home furnishings business alone?

Yeah. First, let me kind of characterize that, what -- I gave you kind of our internal view of what’s possible, right? Not necessarily our guidance and we are obviously going to always have a view internally of what can happen. I’d start with you, if you just kind of thought about -- if you take the belief that, hey, RH is building one of the dominant -- one of the kind of premier luxury brands in its space in the world and if it performs like other luxury brands and you think about the -- just the market at a global level, it would imply that 25% of our business should be kind of in the U.S./North America and 75% of our business should be outside of the U.S. And we believe we can be $5 billion to $6 billion long term in North America. That would imply that we would be a $20 billion to $24 billion global brand as architected today. The yacht is a brand elevating conversation, right? There’s -- some people that are spending money like everybody else on digital marketing, doing things that nobody talks about. We mentioned a yacht and a lot of people are talking about it, right? And when you see it on our website in the world of RH where 30-odd million people will see it every year, it’s going to be a pretty cool thing and a pretty big conversation for a pretty minor investment, right? And so it’s not it’s not about how many people are going to be on the yacht. It’s about how many people are going to appreciate the design, the creativity, the taste and style of the yacht and how many people are going to be aware of it and talk about that yacht, right? And so, yeah, the yacht is not a big growth story, the yacht conversation, right? The ads probably say we do want to be part of the conversation. You got to create the conversation. You want to climb the luxury mountain and you want people at the highest end of -- at this top of the mountain to talk about you, do things that they are interested in. Do -- be places where they spend their time. If you are in something in hospitality whether it’s a yacht or a guest house, do something that forces the very highest people at taste level of wealth influence force them to tip their hat that you did such great work that you earn their respect that think you create a forced reconsideration of your brand, right? So -- but the growth like if you just said, hey, we are going to get to the number is like $7.4 billion to $11.5 billion?

$11.5 billion. Yeah. $7.4 billion to $11.5 billion

$7.4 billion to $11.5 billion is like maybe half way to our global potential. So it’s -- for us to have a goal of saying, hey, can we grow this thing at 10% to 15%? We could. We could maybe grow faster. It depends on how much risk. It depends on how quickly you can go without putting risk into the work, right? I mean we are -- furniture of this quality has never been made in these quantities. So we have to build this supply chain and the platform to be able to do this, right? But -- I mean the thing that gives me confidence about that is it from where -- we have been to where we -- to where we are. We have learned that supply chases demand. If you create demand, people will figure out how to supply that demand, because there’s opportunities for people to benefit economically, right? And so we believe we will create a market at the higher end. We think that market is a potential for probably $20 billion to $25 billion globally and 10% to 15% annual sales growth could be possible. I wouldn’t plug it into your models. But if you wanted to look at an upside model of what might potentially could be if we start opening countries and opening countries is exponentially more valuable opening stores in North America that could accelerate our growth rate, right? We have people knocking down the door here, trying to partner with us with our brand, wanting to partner with us in China, partner with us in the Middle East, partner with us in Europe, partner with us in South America, partner with us in Mexico. Like, there is not -- I don’t think there’s a country unrepresented as far as…

Got it. Got it. That’s very helpful as always. Thanks, Gary.

Thank you. Happy holidays.

You too.

Thank you. Our final question comes from the Seth Basham of Wedbush Securities. Your line is open.

Hi. Good evening, Seth Basham here. Thanks for taking my question. The first question is just around understanding product margin in the quarter. Now product margin expansion certainly drove the majority to gross margin expansion. But could you help us understand how much of the revenue mix shift away from hospitality and outlet helped increase gross margins in the third quarter?

From a product margin point of view our hospitality margin is like quite good. You obviously have a higher mix of employment. But we are also operating the restaurants at very low levels of productivity and we are keeping people employed, right? So we actually got a pretty big drag from the restaurant…

Overall to the business.

Overall…

Slight -- a slight lift in the margin to -- very slight.

Very slight.

In the sales margin?

There’s not enough sales.

Yeah. There’s not enough sales to make a…

Yeah. Yeah.

… big impact.

Yeah. Yeah. So…

Yeah. But…

Yeah. And then the outlet, yeah, we have kind of given you directionally that’s year-over-year that’s been a big driver because we redesigned and re-conceptualized the whole reverse logistics business.

Yeah. Yes. So, of that 530 basis points of product margin, essentially half are in our core business, with some of that still related to the rug cycling as we talked about. And then half is from outlet. And that -- those are the big pieces of the factors.

Yeah. But inside the core business I think every category has got positive product margins, right?

That’s correct.

Yeah.

Very helpful. Thanks. And then…

Yeah.

…one item that -- one area that we haven’t really discussed much on this call is the interior design architecture and landscape architecture opportunity. Could you just give us an update on your rollout plan associated with that business?

Well, interior design is out there, right. It’s a -- I think today we must be the biggest residential interior design firm in North America, if you look at the work that we do and the projects that we do. And architecture -- and landscape architecture, we will begin to test that. I gave you a bigger vision for that, how it’s going to be within the world of our age. But we were going to move more quickly. We have pushed some of the plans out a bit because of the pandemic. But we are looking at testing our first kind of freestanding architecture interior design, the landscape, architecture, studio in a design district that will support many of our galleries in a market. So we will -- the way to think about it is where you see today if you have been into one of our new galleries. One of our prototypes where kind of the back part through -- if you look through the staircase is big glass wall with desks and it’s right next to our design affiliate. We are all -- our interior designers have their offices and that says right now RH interior design. Long-term, we believe it will say, long -- RH architecture, interior design and landscape architecture. And I think about that the galleries because they are a manifestation of great architecture, great interior design and great landscape architecture. We will have the only consumer-facing business of its kind like that. Most architects don’t have an office that anybody sees and most architects’ offices aren’t in great architecture necessarily. Landscape architects, like where do you find one, like, interior designers, again, not a consumer-facing business. So inside these big magnificent galleries that are an example of all those disciplines, it only makes…

That’s helpful. Just to clarify Gary, I know you don’t charge for the in your design services now unless I am mistaken. But do you plan to charge for those in the future and I presume that you plan to charge for the architecture and landscape architecture design services?

Yeah. Yeah. For sure the architecture and landscape architecture design services, how we think about the interior design piece work, we are still noodling with that. We believe at some point, we will probably charge to that. But we may not need to. I am not, I am not sure honestly. I mean I go back and forth on that one all the time, like, so more to come, but we will develop there more. But I think as we test this and kind of get our arms around it and we are going to -- we will probably start it here locally. I guess, I could say, we are thinking of doing right. Yeah, I mean, we could -- I reserve the right to change our mind, I think, I am assuming. But we -- our plans for opening a beautiful new gallery in San Francisco at the historic Bethlehem Steel Building, it’s really spectacular when everybody can travel again and come up to San Francisco. Let us know we will get you a seat at the restaurant spectacular restaurant. It will be the first restaurant with our -- we are actually testing our new guesthouse concept and menu there. It will be kind of a dual restaurant. We will have a live fire cooking component to it. That’s really great. But we are in this spectacular gallery in San Francisco, rooftop park, views of the bay and the city and so on and so forth. And we have this is -- as you know if you have been in San Francisco, we -- one of the great learnings for us is when we took this amazing little building in the heart of The Design District that was the Ed Hardy Antique Gallery and he built this charming palladium building. And we went into this center of the design district and said we got to put our brand among the very best. Remember the headline in the local San Francisco paper was There Goes the Neighborhood Change Store Going into the Design District, right? So we did pretty good work. We opened a beautiful gallery there. I think we see the people’s expectations and it became really fantastic for bid we -- that gallery is like $20 million.

Correct.

Yeah. Something like that. In 4,500 square feet.

Right.

Incredibly, it was one of our best real estate moves ever. We bought a little building I think for $3.5 million. But we have this charming building with a beautiful garden courtyard and we have learned so much being in that building and we could sell the building for $10 million or something. And we are thinking -- we are right in the center the design district. Why don’t we take that building and turn it into the first kind of freestanding RH architecture interior design and landscape architecture studio, right? And right in the heart of the design district, face the customer there in the heart of the design district and then face the customer in our galleries and use this as our first ecosystem for the services platform right here in our backyard. We can go there. We can listen and learn, very visible, use it as a lab and we think that will really accelerate our learnings. So that’s what we will do with it. Exactly when we start? Not sure yet. We have got a lot of big rock for moving in different parts of the business right now. And just want to make sure we do this one well. And we have a team in place that can really positioned this well and make a great first impression as we entered the services business. But that’s what you can expect from us. I think we will -- now that I have said it, what I like is that we are committed to it, right? It kind of -- we have been talking about it but now, we are committed. So it will happen. But if it works, I think, it just opens up another aperture business for us, right? If all of a sudden we become the architect for people’s homes, you are just going to sell them a lot more furniture and lighting and accessories and blubs [ph] and bath hardware and all the things we sell.

I get it. Very exciting. Thank you very much and happy holidays.

Thank you.

Thanks, Seth.

Thank you. I am showing no further questions. I’d like to turn the call back over to management for any closing remarks.

Great. Well, thank you, everyone. I want to especially thank our people and our partners around the world who have worked so hard through these challenging times to continue to elevate our brand and bring our vision to life each and every day. And also our thoughts and prayers go out to everyone who’s suffering through this pandemic, especially of people who have been infected by this virus and have family members and loved ones impacted. And thanks to all the people on the frontlines that are just working to keep us safe and get us through this. And this is -- it’s been a -- just a very mixed feelings, right, from our company, you -- again, when there’s so many people suffering and your business is doing well and you are getting the tailwind, it’s hard to really feel that good when other people are having the opposite experience. So we just hope that we get through this very soon, that the world will continue to evolve and improve and we will be here for the long-term. But we want to thank everyone for their hard work, their leadership, their imagination and their perspiration in bringing this to life. And all our frontline teams that is in our galleries, it’s in our call centers, it’s in our distribution centers and delivering our products into our customer’s homes. They have had to walk a fine line, right, and being on the frontlines, and especially want to thank those teams who have represented our company and our brand so well through these challenging times. So we wish everyone a wonderful holiday and a safe holiday and here’s to getting to the other side of this and back to bright and sunny days for everyone on this planet. Thank you.

Thank you. Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating. You may have a great day. You may all disconnect.