RH

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 speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that this conference is being recorded. If you require any further assistance, please press par zero. I would now like to hand the conference over to Ms. Alison Malkin. Thank you. Please go ahead.

Alison Malkin Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter 2020 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Jack Preston, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about our outlook for our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. With that, I'll turn the call over to the operator to begin our Q&A session. Operator, we're ready for questions.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press Thank you for your time.

You spoke in the letter about the expectation for revenue growth to lag demand. I think it was 5% to 10% in the third quarter. So I want to start there 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 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 sort of color that could help us walk or build it out over the three quarters as we think about fulfilling this unfulfilled demand over the next three quarters would be helpful.

Sure. Thanks for the question, Steve. And I'll try to add some color and maybe Jack can fill in some pieces. But if you kind of start back when We spoke to you last quarter. We expected revenue to kind of lag demand comps by about 10 to 12 points. And what happened, the reason the gap got bigger and it got to 16 points is in the second half of the quarter, our demand really accelerated and kind of ran away from our trends and our inventory flow. You know, so it built up a much bigger gap. As you think about, you know, we're 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, you know, it's hard to plan for something like that. You can start it with a big picture and say, you know, the pandemic hit in mid-March, mid to late March, and our revenues dropped significantly. by just about 40 points. And in a three-month period, a little over three months, our demand went from 40 down to 40 up, roughly, just directionally. So it's an 80-point swing. And we responded very quickly to the downdraft. And based on our analysis, we didn't know how long our our galleries were going to be closed and what the impact was going to be but we wanted to react quickly and we did and we were able to cut receipts and push out inventory and then as demand built we thought geez it looked good coming back from down 40 to down 20 to down 10 to up 7 and then it just took off so if you start there were behind. Then you compound that with the fact that the pandemic hit everybody. It hit every country in the world. It hit every one of our manufacturing partners in the world. And they had dislocation, whether it was loss of workers or shutdowns, so on and so forth, whether it was in North America, whether it was in Asia, whether it was in Europe or South America. So Just now, I would say we have relatively good visibility if things don't change drastically from here. I'm not sure will demand continue to grow month over month. I don't think so, but I don't know that it won't. We're off to a pretty good start in the First two weeks of September, and what's different about September year over year is, you know, last year we had a higher mix of what I call clearance inventory that we wanted to get rid of, older goods. So, you know, last Labor Day we ran a, you know, kind of Labor Day sale with clearance inventory, and we were able to liquidate goods, and that gave us a lift. You know, so that... kind of slowed down trends. If you just think about the first two weeks, what will happen in the next several weeks, not sure. It's funny, I've never spent so much time looking at our business kind of day to day, but it's changed so dramatically day to day and we're learning. So as we look at this second half, our expectations, if we look at it and so forth. So, as 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. Our product is not that quick to be made and shipped. A lot of it can have lead times up to six months. In some categories, like rugs, nine months. What we're doing is trying to give you our best view of how we think this demand will convert to revenue. I think we'll be directionally right, but As I like to say, every plan we have here is some degree of wrong. The question is, is it more right than wrong? And I think we'll be more right than wrong unless our demand trends change dramatically. I don't know, Jack.

Thank you. Yep. Go ahead, Jack. No, no, no. I think that was great. Oh, yeah.

Perfect. Yeah. Well, maybe one for you is, We're either Jack or Gary. If I think about the 2Q gross margin, right, because this was clearly a focal point for us and investors heading into the quarter. And as we think about raising the long-term guidance here, right, to 25% EBIT margins from 20 versus the 22 you delivered, what's the right gross margin profile for this business? I mean, is there still a lot of opportunity as we think about whether it's, you know, The reverse engineering, the outlets, the whole supply chain. Where is the right margin profile for that long-term target as it stands today?

I don't know if you'd call it the right margin profile. We think about what's possible. I don't think there's an analyst on the street that had us at 20% operating margins in the next five years. So when you say what's right, 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 margin. So we're seeing now, as we've transitioned and transitioned from a single source rug relationship to a direct sourcing model in rugs. We've got a very different business and a very different margin profile that's lifting the business. We talked to you guys about kind of annualizing the accelerated clearance of product through our outlet division. A year ago, that dragged margins. That's now washed through, and we're seeing what I'd call more normalized margins there. I'd start with, if you think about the 21.8 or the 47.5 we hit in margins today, we did that on, even thinking about it from a gross margin point of view or operating margin point of view, we did that on flat revenues. So what we're 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, a floor for this year. I don't think there's any way we'll go under 5% revenue growth, but I don't know, if all the stores shut down again, Who the hell knows what can happen with this pandemic? I mean, it seems like things are kind of getting better, not worse. And so we think that consumers are used to wearing masks now. People are used to social distancing. In many markets, you see cases going down. So we think we're pretty safe to say, I mean, you guys could do the math if you back into the math on and so on. So we kind of think today that seems like a floor. And at that kind of revenue growth, we're comfortable with having 20% operating margins. And if you just kind of step away from the pandemic and all the things that are happening with COVID, I'm actually... I'm quite happy to tell you the truth that our revenues are flat this quarter because what it does is it helps get rid of the noise and helps us see our underlying business model and helps potential investors see and recognize the underlying business model that we've built here, that we've invested in for the past five years, kind of re-architecting the entire business model. positioning the brand more as a luxury brand. I think that there's opportunities in every part of the margin structure of the business. We are at the early stages of elevating the product. You'll hear more soon about some really important strategic moves we're going to do to continue to elevate the RH brand and position it as a luxury brand in the marketplace. I think that is going to give us more product margin opportunity and that also can relate to shipping margin opportunity, right? As the product prices go higher and you have the same cost structure moving product through the supply chain. The other thing that you've got to think about is We're still pretty early in the transformation of our real estate. And when we transform a gallery in a market, we basically, you know, the first year or two, I think we have a couple that went longer than two years, but call it in the 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're going to get in the occupancy side of the business, but also against the SG&A side of the business at a corporate level. So we can see a pretty clear path that we feel pretty confident over the long term that we now see an opportunity to get to 25% operating margin in the business. and that assumes investments in international and it assumes there'll be a little bit of a, it's not going to be a complete straight line. There'll be some quarters where we're opening a new DC internationally and it'll be a drag for a little bit. I don't think it'll be enough of a drag to massively impact the company because We're not just opening to D.C. and having our revenue move a little. We're opening to D.C. in an entirely new continent, and I think we're going to see pretty fast revenue growth. And so I think we'll see, you know, kind of that normalize very quickly. But, you know, I'd say, you know, if 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, you know, the I refer to it as proverbial you go public and you put a car on a racetrack and you're on the quarterly racetrack and it kind of narrows your view and we were kind of the perfect public company I think for 12 or 13 straight quarters and then we blew a tire and most companies blow a tire and bring the car into the pits and change the tire and fill up the gas and they go back on the racetrack and we decided We were going to rebuild the whole car. We knew we were going to take a lot of flack for it. We referred to it as we were going to march through hell for a heavenly cause. We kept the car in the pits for, I don't know, a year and a half. Nobody really believed what we were working on. We said, if people don't believe and what we're doing, what we do. And we raised $1.2 billion or something, about 60% of our company and brought an entirely new car onto the racetrack, like with a jet engine. And so we've now slingshotted past everybody in our industry. 20% or 20% plus operating margins, wherever it unfolds, we're gonna have what I like is that 5% revenue growth we would have had a plan slightly higher than that so the fact that we're at 20% this year just says that the underlying business model has this systemic shift it really has nothing to do with COVID at all there's going to be a lot of people that have a very temporal lift to their business and when this thing changes and kind of heads back to normal, there may not be anything systemic there. We have a 20% operating margin floor now on basically flat to up 5%. So now you think about the business growing at 8% to 12%. Over the next several years, you think about where you're going to get leverage and margin in that model. You think about continuing to take this brand up the luxury mountain. and the kind of leverage that we'll get. The key becomes, it's one of the reasons why in the second half we decided not to mail our fall books because quite frankly, one, we'd be mailing and possibly creating incremental demand we don't have product for. The newness because the factories are behind would be late, so that's costly to have back orders. and we thought let's take this time and focus on the next few really big moves. So all that time and energy it would take us to normally develop the seasons and develop the books and launch everything, we're actually going to refocus that time to rebuild every category in the business and we believe we can take the floor up there. And 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're kind of just running a business. 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 on launching Europe. So I think what's different about our age in a lot of ways and what's unique about us is we invest really with a long-term view. And I think that's why we have one of the best performing stocks since our public offering in 2012. It's funny, I was doing it interview with someone, you know, for a magazine. And, you know, clearly this person was, had been talking to a bunch of short sellers or non-believers in our company. I could just tell by the tone of the questions. And I kind of said, you know, like, I can tell by your tone, you know, you've, you know, 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 over the long term. So why don't we move from feelings to facts? Here's a fact for you. On November 2, 2012, our company went public at $24 a share. 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 of a publicly traded company during that time period. It's better than LVMH. It's better than Home Depot. It's better than Starbucks. It's better than Nike. It's better than Lululemon. And even better than Apple. And it 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? You know, I think people get trapped in a short-term view, quarter to quarter, kind of, you know, microscope, and they can't see the bigger picture. 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 you know so for the most part I'd say since we brought the car which is now a jet out of the pits in 2000 late 2016 early 17 I think we've basically done everything we've told you we were going to do right and we've probably delivered, now we're going to deliver 20% operating margins. I mean, five years ahead of I think any analyst had us on Wall Street or seven years ahead because it wasn't in anybody's model. A lot of people had us at 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're saying we've got a new floor and we have a path to 25% operating margins. We don't make stuff up here. I can't give you every single little detail of the puzzle, but I'd say if you look at our past performance and you look at the big picture, we're a company that 20 years ago started this journey as a nearly bankrupt company with a $20 million market cap. I don't know, tomorrow we'll probably have a market cap somewhere around $7 billion. We think we're a really good bet. And I think people that take a long view and look at the big picture here and look at the facts versus their feelings, I think they're going to be really happy they invested in RH if they want to hold this stock for 5 to 10 years because I think will be among the best performers in anybody's portfolio over that time horizon. A little longer answer than you asked, but I thought I'd share the big picture view.

Thank you, Gary.

Our next question comes from the line of Curtis Nagel with Bank of America. He may not ask a question.

Good afternoon, guys. Thanks very much for taking the question. Just a quick one on, so, you know, Gary, in the letter you cited, you know, evidence of, you know, some of your clients moving out of urban centers, buying second home, second or maybe even third homes, you know, hard to imagine a company that's probably better positioned for that, you know, maybe over the next few years. I guess, could you extrapolate a little bit more in terms of how much demand that's driving, you know, maybe hard to know, but, you know, how sustainable that growth could be?

Yeah, you know, we tried to articulate it, you know, in the letter and, you know, it's, you know, your guess is as good as ours, but we like the data we see. I think that because the pandemic is lasting as long as it has, I just asked my doctor, you know, a few weeks ago, I said, how long do you think we're going to be wearing masks? And he said, at least two more years. I said, really, two more years? He said, yeah, you've got to think about the math. He said, it's going to take, we have to have 270 million people to have the antibodies or the vaccines to get to herd immunity. And most likely the vaccine is not going to come until the spring of 21. It's going to take at least 18 months to move really fast to get 270 million people to herd immunity. So he said, we've got a new behavior shift he thinks that's gonna last for a while. I don't think any of us could conceptualize that early on and now it starts to make sense, right? And the data and the shifts of things, I'm surprised how quickly people responded Thank you very much. and how they think about suburbs in Silicon Valley. So many of the people now that they're learning they can work remote more. So they're moving, they're buying homes in Palm Desert. And Palm Desert now is kind of getting recast from a retirement community to a suburb. and so on and so forth. And, you know, who knows when we're all going to travel again? I mean, you know, that's our biggest question on international. We can't go to Europe, you know, unless we want to go and quarantine for two weeks. So, you know, I go like, huh. is this going to completely snap back? There's got to be some real somewhat permanent changes in behavior. How long does that last? If you think about the home buying cycle and the home furnishing cycle, it's not a short cycle. I do think we're well positioned for it because of our assortment and our unique interior design ability where we can just come in and do We're doing more full projects than ever before. People are looking for a solution that saves them time. And we can do that. So like I said in the letter, I think we're going to have a higher water level through 2021. But I don't know. I've never seen anything like this, right? I mean, maybe, you know. The air comes out of the balloon sooner, or maybe there's just a permanent shift. When you get people thinking about something, this could create a whole new market for the home. 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'm going out to dinner every I think 80% less than I was. We're going to people's home for dinner, people we know well, and I think what happens when there's a shift like this, people go to other people's homes and then they look at someone else's home and they go, oh, their home's really much nicer than our home. Honey, we gotta redo our home, because we can't have them over to our home yet for dinner until we make our home better. it's the interesting thing about humans we kind of compare and contrast ourselves all the time what we wear, what we drive, where we live our home, the size of our home all these little things where we go, where did you go on vacation oh I went to Capri oh yeah we went to Capri too all that kind of stuff that humans do and so I think this focus on the home and this amount of time people have spent on the home and 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's got to be all furnished and it's got to look a hell of a lot better because you're just going to have more people over and you're going to be spending more time there. And so that could become just like a permanent shift. But like I said in the letter, I don't know how to plan for that stuff. I don't want to take too much risk because I'm not sure. So we're going to invest very thoughtfully. We're going to continue to let cost chase demand versus demand chasing cost. We don't want to build a big cost structure based on 40% demand comps and have it go to 10 and go, uh-oh. But I think that 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. And we're good either way. You know, I mean, we like our business model long term, you know, either if this is more temporal than systemic, whatever.

Got it. No, understood. And a thoughtful answer. Thank you. And maybe just a quick one in terms of, you know, the capital structure. So it paid down to converse. You know, you guys, I don't know, I think you're running at one three leverage, something like that. How do we think about that going forward? Do you remain under leveraged? What does the capital structure look like given the explosion in margins?

We're going to generate a lot of cash. The capital structure is going to look really good. As we said in the letter, we'll remain opportunistic as it relates to sources and uses of capital and there's always going to be some kind of opportunities in dislocated markets like this and whether they're short term or more medium term we like to maintain optionality but we'll see again we'll see how long these rates last our model just from an investment perspective even though we're doing Europe we've got you know surprisingly that the first several galleries are not going to be capital intensive but one you know just central London where we're kind of stringing together four buildings and making them into one and that'll you know that'll be a bit more of a capital investment kind of like New York but Paris is not a heavy capital investment RH England is not a happy capital capital investment uh The ones that follow that, we've got two more deals done and signed, are not heavy capital investments. And then in the U.S., you'll see us start to ramp up. There'll be more prototypes, which we've got that model now kind of fine-tuned, and we'll have a less capital investment approach there. And then if you think about the last couple of years, we had some heavy capital investments. Intensive Stores. We had RH New York. We had just the development of the first few prototypes. Because you're working on them for a long time and making a lot of changes, it's like developing a new iPhone or something. That store is really like an R&D project. There's a lot of capital there. RH San Francisco, a lot of capital. Our first guest house in New York, again, it's like an R&D project. That's a lot of capital. you roll through that and you know we we don't have as many galleries that are capital intensive galleries and then as we said in the letter you know our performance is going to drive a new kind of credit profile in our company which is going to make us a much more valuable development partner you know for any developer right you know that like they'll get a better cap rate on our rent and our credit than they will on other tenants. So that tends to allow us to get more TI, lower rents, so on and so forth. And it really helps us in our own development deals. Yeah, because we should be able to get better cap rates. No different than, we sold Minneapolis in the middle of the pandemic, right? Like crazy. First, the other people walked away. They thought they were going to get a bigger price, and we said, like, walk away. I mean, this is temporal. We're okay. Then they came back, and we closed at a 5.5 cap. And I think initially when we talked about that one several years ago, I think in New York, we were going to put a $1.8 million rent on it and sell it for $33 million, and instead we decided to put a $1.4 million rent on it and sell it for $25, $26 million. but the fact is we got a 5.5 cap and that was before we leapfrogged to 20% or 20% plus operating margins and the cash flow profile and the return on capital profile that you're going to see. I think that there's a chance we'll exceed 50% return on invested capital this year. That was a long-term target. I didn't update that long-term target because it's like it starts to be silly math what are we going to have like 75% return on investment 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 and even like you think about our second guest house that we're building in Aspen that's a joint venture development it's a very capital like guest house and we're able to kind of cut a deal like that because we were already in construction and had the designs and plans for the first one. So the development partner was like, got it. That looks amazing. Okay, I'll cut this kind of deal. You know, the very, very first one in New York, you know, people thought we were nuts. You know, like, what are you guys going to do? And people still think we're nuts. They think until they see it, then you'll get it. But so, yeah, we like to capital profile the business. We like to, what the, it gives, we project the new, cash flow models and return on invested capital, the capital requirements of the business. I think it looks like a model. Honestly, I would have never imagined it would look this good. I remember my early days here, there's a lot of people sitting around the table that were here the whole time. We were like, okay, if we can get to a billion dollars and make 8%, if we can get there, we'll have made it. If you'd have told me, hey, we would have we're going to build the leading luxury design platform in the world and we'd be at 20% plus operating margins and a cash profile model like we have building the kind of galleries that we're building. We're not building shitty little crappy retail stores. We're developing buildings. These are going to look great 50 years from now. It's kind of The thing I've learned in my career is that you can always monetize extraordinary, remarkable, and amazing work. It's hard to really monetize ordinary and unremarkable work. The thing we've learned is that 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 invented the iPhone, the average phone, I think, in the country was $59 and it was the Motorola Razr. Apple introduced, at the time, a $600 phone. And, you know, it was $600 for four or six months, and they lowered it to $400. But the point is, it was like so much more. And everybody thought, that'll never work, that'll never work. Then it became... really one of the best-selling phones in North America. And then Eri said, oh, that'll never sell in China. It'll never sell a $600, $800 phone in China. And then 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. And we're learning that with Tesla, right? I mean, look at Tesla's performance as a new car company. Guy never built a car before. But he built a remarkable car. 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're doing is similar to things like that, where were 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 to-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 resale license. That's a good market to decide. I'm going to go compete in a market that lacks accessibility and I'm going to become accessible. Then it lacks transparency. Meaning, go walk in a showroom. There's no prices. You can't figure it out. There's codes. They give designers discounts. They give other people discounts. Won't give you a discount. You've got to bring in a designer. It's so convoluted. And then they lack scale and the ability to put it all together. So you've 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. We remove all the like who's getting a discount? Is it your designer? Is it this person? Is it that? And then by the way we offer design services so that helps and then we've got scale and we've integrated it all together where it delivers time value to a consumer and time is, you know, it's the ultimate luxury, right? Nothing's more important than time. I always tell people here, you know, how we allocate our time 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, you know, so I think what we've created is going to create this entirely, I think we're going to create an entirely new market for our business, and then we're kind of now in this situation where, wow, there might be a systemic shift towards the home and a focus on the home. If that happens at the same time, we're kind of evolving into the brand we aspire to be, you could really get an upward spiral here. But we don't need that to happen to create a lot of value. If that happens, we'll will be like supercharged.

All right. Thanks very much, Gary. Appreciate it.

Yep.

Your next question comes from the line of Chuck Grom with Gordon Haskett. He's going to ask your question.

Hey, thanks, Gary. Just curious, you talk about sustaining that 20% operating margin goal, which is impressive. Just wondering if you can contextualize that for us longer term. in the light that you go down the path of building out RH residents and obviously you're going down the path of RH guest houses. Just how do we think about the margin structure over time as you continue down those avenues? Do you view those channels as accretive, dilutive? Do you think you can sustain the operating margin structure? Thanks.

Yeah, I think we think about them from a couple of perspectives. One is we think that they will – elevate and render the RH brand more valuable. So, you know, how do you build a high-end luxury brand? You know, I tell the team, you know, all the great brands mostly were born at the top of the luxury mountain. Hermes and LVMH and Gucci and Chanel and, you know, just name luxury brands come top of mind. They've always been a luxury brand. We didn't start anywhere close to a luxury brand. We had Oxidol laundry detergent on the cover of our catalog at $5.95. So we have to scale this luxury mountain, and you have to do things that create a forced reconsideration of the brand, that elevate the brand in the right consumer's minds. And so whether it's doing a... we think an extraordinary experience that's a guest house that's going to create an entirely new market for customers seeking privacy and luxury or having RH3 luxury yacht that you can charter in the Mediterranean and Caribbean and not a lot of people can use that but I guarantee you when we do the portal of RH and you see it on our website and you see our guest houses and you see the other things we're doing The branding of that, right? You know, we don't have a marketing department in our company because we say, you know, marketing a lot of times about putting lipstick on the pig, right? People try to take an ordinary thing and dress it up and make it, like, seem better than it is. And we say it's not what we say, it's what we do that defines this. So we build our brand through our work, right? We don't really run many ads. You might see an ad or two here or there in a homepage. You know, a magazine like Art Digest or someone. But really, it's mostly our work. Our galleries are our work and they're extraordinary experiences. Our source books are our work. Our web portal will be another version of our work and how we communicate what we do. And I think the guest houses and the residences, if done really well, one, they'll elevate the brand and they will... help us climb the luxury mountain because I think they'll be so extraordinary. They force the very best people in those industries to tip their hat. And again, I believe we've learned that if we do extraordinary, remarkable, amazing things, we generally can figure out how to monetize it and build a business model. And today, even though we haven't opened a guest house yet, like the few people in the inside of the hospitality world that I've showed it to. They're like, oh my God, do you know how much you can get for those rooms? Oh my God. And if they're half right, we're going to do really well. But they're not just kind of a new business thinking about it independently. You have to think about all these things not in isolation. You have to think about them in integration and how they elevate people and render the brand more valuable. It's just like the mistake the department stores made over the years. If you listen to Stanley Marcus in the beginning, even Marcus, he'd tell you 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 different than, quite frankly, it blows my mind how many retailers right now are talking about closing stores and just having a website. I guarantee you, people start closing stores, their website traffic is going to plummet. You're going to find out the cost of acquiring customers through digital marketing The cost of marketing an invisible store online, good luck with that. All the digital native brands are opening stores. These other elements, guest houses, residences, other things you'll hear about that we'll test and incubate, they're going to create a big conversation around our brand. They're going to be extraordinary, extraordinary pieces of work in their industries. they will elevate the RH brand and render us more valuable. And I think we will find they will become real businesses in and of themselves. And if they are, the ecosystem gets bigger. If not, we have a handful of them and they're tremendous examples of our work and they elevate our brand. but I think long term we're going to probably find now that we've worked on them longer I think we're going to find that they're businesses and we won't do anything that's going to destroy value here we don't want to all of a sudden try to build an 8% operating margin business when we've got a 20-25% 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 business that's what hospitality does in our current galleries if you looked at hospitality in isolation you might think it's a drag if you really do the integrated math and look at how many people turn into purchasers and then you integrate that and you take that extra flow through and you look at it in an integrated way it's it's a really good model but you have to do the math on all of it and so we'll test these and try these and we'll learn more but I know one thing for sure they will elevate the RH brand they will create a conversation at the highest end of the market and that's what's really hard to do no one's ever climbed the luxury mountain before starting where we started ever I can't name one brand most brands go down and so this just requires a different kind of effort. You're not going to do it just running some ads and magazines and stuff like that. 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.

Just as a follow-up, just thinking about the factors that have driven the demand improvement over the past several months. Probably the hard answer, maybe it's not, but just curious if you've got a sense for how much of that's coming from some of the de-urbanization movement versus the shift in second home markets versus just the overall housing market doing better, or the last bucket would be just the pandemic and people just being more hunkered down. I'm just wondering if you can think about the different drivers of the recent strength.

Yeah, I think it's all of the above. Yeah, it's all those things together. I mean, again, you know, we were running, what, up eight or something before this pandemic? Yeah, so we were running up eight before the pandemic, and then we went down 40, and now we're, you know, up 44 or something in core business or something. You know, about 47 in August, up 44, so four months to date in September. I mean, yeah, I mean, there's a big shift here. The question is, How much of it is systemic and how much of it is temporal? And the key is, I think you've got to play it with the expectation that it could be temporal. Otherwise, you can kind of goof up your model. So we're OK not trying to optimize everything in this market, right? If this thing's temporal, you can Thank you very much. We're not chasing any sales. We haven't put one thing on promotion. We're letting some demand get away. We know we're losing demand with the backorder rates we're running. But that's okay. I don't want to be famous for like, hey, they did really great during that pandemic, didn't they? Do you remember them? Like, oh my God, they had the best numbers during the pandemic. What happened to them? Oh, yeah, they, you know, long-term, they kind of screwed up their model. Like, we look at this as, you know, this is some kind of a temporal event that may have systemic long-term benefit to the home. We hope it does, but if it doesn't, it's okay. You know, we're looking at our model very long-term, and, you know, that's what I love, the fact that, hey, our revenue is flat this quarter. Thank God. So, you know, I don't have a zillion questions from everybody like, where was the margin? How much was this? And what's the leverage there? Revenue is flat and we have 21.8% operating margin. And that's with, you know, 40 basis point drag from the pandemic. That's a 90 basis point drag from Waterworks. You know, it's got an 80 basis point drag or something like that from hospitality because we're in startup mode. You know, we've got, you know, another drag from some kind of one-time investments we're making. So, you know we could take those pieces and that else let's see yep 25 down that road so stay down that road don't get lost in the little rocks of the pandemic you know you know like ride this wave the best we can but you know I don't think the business stays up 40% I don't it might stay here for a couple of years. Maybe there's a new water line. I don't know. It's just hard to say. It hasn't been that long. I've never seen anything like it. I just don't want to overreact to it and goof up the last decade of work. We're taking a very long-term view here. We're not running around with our heads down trying to manage the business from week to week. We're not pulling any levers. There's no promotions going on here. We're just trying to 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 KeyBank Capital Markets. He's going to 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's perhaps more sales coming from an e-commerce or a web order rather than in the stores, and that may benefit costs. You're also not mailing the source book. On the other hand, of course, knock on wood, The sales look pretty good. So how should we think about expenses for the balance of the year? Thank you.

Yeah, we'll have obviously some savings in ad costs. You know, we're not going to try to chase and optimize the revenue over the short term here. We think we've got enough and we're already chasing it from a supply point of view. So we think we're going to, you know, making the right decision to It's not like we're not mailing the book and not doing anything. We're not mailing the book and we're going to invest our time and energy and resources and make investments in other areas that we think will have real long-term benefit to the business versus mailing into this, doing a lot of work, and maybe getting a little extra bump or no bump, mailing into it and just not having the goods or the customer already optimized. And by the way, the other thing that we want to learn is, I don't know, maybe the books aren't as productive anymore as we think. So let's take this time and test our way kind of out of it and back into it, and we'll get some new fresh data that says, hmm, maybe when we launch the portal, and maybe because we're building all these big new stores, we can mail less books. And You know, so there's lots of motivation about kind of testing and learning for the long term. So, but, you know, we're making a lot of investments in long term growth, making a lot of investments in international, making a lot of investments to elevate and expand the product. You know, you probably read, you know, if you haven't read, you know, we made a small acquisition of a business that, you know, we disclosed. so we're not saying much about it from competitive reasons but that we think is going to elevate us and the talent and the acquisition is going to continue to help drive our product capabilities so that's what we're focused on and then we want to really do our best work at introducing the brand internationally in Europe because that opens a whole door, right? If we start to demonstrate that this brand can work without a long, long ramp up, like if our brand can be introduced internationally and actually ramp anywhere near a market... a normal market that we haven't been in, say like Canada when we opened galleries there and stuff. That just means that we can, that'll lay the tracks for the brand being $20 billion globally without really anything else working. So again, I kind of think about if we can prove ourselves internationally and we can over a several year period kind of ramp up in England and in France and throughout Europe and Spain and other places, Germany and so on and so forth. That probably is going to be a really good indicator what's going to happen as we move across to Asia and Australia and South America and other parts of the world. and the world you know what we feel good about our timing is that the world is exponentially getting smaller right the visualization that happens on the internet through all the platforms and social media and Pinterest and everything else like the world is getting smaller the world is adapting the same taste and style and so on and so forth so I think that really you know all of this is really going to benefit great global brands so So we're investing in all those things. And despite the investments, again, we think we'll do quite well from a profitability and margin performance perspective.

And Brad, it's Jack. I'll just add quickly, as Gary was talking about, as we think about the 20% model as a floor with an implied 5% rev increase, you can do the math also what that implies for H2. and that's 22.2% with 700 basis points. Again, that's just the implied math of the floor we were guiding. We're not telling you how that splits between gross margin and SG&A. Obviously, we're not guiding, but naturally, as you alluded to on the source books, that benefit would naturally on the SG&A side come more in Q3 than it would in Q4, given that's when the mailing would occur. So I just wanted to at least add that from a timing perspective as you think about the quarters.

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

Yep, thank you.

Your next question comes from the line of Adrienne Yee 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 a la some of these very high-end brands, when you look at many brands, global brands, they have a line that's called demand creation. and so when you think about your catalogs as being sort of 3.5%, 4% of sales, you almost have the luxury of having another 600 basis points or so in all of these different areas like RH3 and wine and guest house and hospitality 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 the luxury of this extra margin and then to your point on the catalogs could the catalogs ever turn from content only, product only and be a physical manifestation of sort of the world of RH in sort of a lifestyle content magazine so there's a couple of my questions, thanks

Yeah, you've got to come work here. Our whole leadership team is in the room, by the way. Yeah, it was like, yeah, okay, you think like we think. So, yeah, correct on all of it. Yeah, so that's exactly how we think about it. Okay.

And then so if that's the quick answer, one quick very small thing, 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're running currently have interior decorating services attached to them? Thanks so much.

Yeah, we don't give the interior design percentage, do we? Yeah, it's a big part of our business. But, yeah, we don't give it just for competitive reasons right now. And then, like, where is Color? Color is... probably ask me that question next quarter we have a series of off-sites and time we're spending just to evaluate all of our key value driving strategies and initiatives 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 in human capital and financial capital. So we're excited. I mean, actually, it's kind of a gift to say, you know what, just don't mail the book right now. Don't do all that work. Just have everybody stop and let's take all our talent in this organization and kind of really see the board, really put things in the right order and really focus on kind of the next few big rocks that can kind of change everything again. I really believe that if we use our time wisely over the next six months that we can really step change the core business from just a comparable sales point of view. You really need to get all the leadership to focus, including me. We've got so many things to work on and so many opportunities. We've also brought in a lot of new talent and we have a lot more capacity to do more. It takes everybody together and to really focus to move the big rocks. Otherwise, People are working really hard on all these little rocks, and they're kind of arranging and organizing things, and at the end, it doesn't really move the needle that much. But in the short time, we have started to focus on a couple of the categories. I think if you were sitting here with kind of our senior leaders of kind of product development, I think everybody's eyes are really wide open and we think, wow, there's a lot of opportunity here. And not just the product itself, but then the physical manifestation of that product in the marketplace. We've got ideas and opportunities to do things. Today, I'd say we're exceptional at presenting the product physically in an integrated fashion. were a little hard, kind of hard to shop by category today. You go to one of our big galleries and you try to shop for lighting, you try to shop for, you've got to kind of walk the whole place. And we don't even have the whole assortment in an organized way. And yeah, the web helps you there and the books help you there, but people still really want to see the goods. So we've got a lot of ideas around doing different physical manifestations of categories in a way that we think can also be massively disruptive. Maybe I should throw one out, throw everybody a bone so they think about it. Most likely this one will come. I'll talk about one that we're a little farther along in our thinking just to kind of give you the idea. 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. And then if you go to our big design galleries, we show 20 to 24 collections year-round, somewhere around there. But they're not all in the same place. Some are on the rooftop, some are around in garden patios, some are on terraces. And we have now, what do we have, 45 collections, somewhere like that. By next year, we might have 60, 70 collections of outdoor furniture. We've got a concept we're working on that could come to life faster than slower. Actually, I like saying it because it gives us a faster deadline. Everybody's looking at me here in the room. They're going like, okay, here he goes. Now we've got to get this done really fast. So we're working on a concept called RHOASIS. and it's going to be a freestanding outdoor furniture experience like nothing in the world. It will be mind-blowing. And we will own the category of not only outdoor furniture but shade and fire and heat and textiles and things presented in a way in an environment that you can't even imagine. And I think it will be massively disruptive and accretive to our business and if you kind of think about that and you think about like, well, gosh, is there something you can do? Is there RH illumination? Is there RH underfoot? Is there, you know, RH couture upholstery? Is there RH bespoke furniture? Is there, you know, like I can go on and on, right? And everybody's going, oh shit, here he goes, like the whole thing. But, you know, you can all of a sudden start to imagine an RH compound, you know, of this beautifully integrated experience with these isolated experiences around the categories that allow you to shop both ways and allow us to express our brand in a way no one's ever you know seen and so you know so we we've got these things that we're working on that we're testing and and that's why we have to put everything in perspective like well where's RH color come in well like we got a whole bunch of things like that to choose from and it's how many can you do at one time in what order? How do you do it really well? I've got someone in the room looking down at me saying, are you going to tell them about that? If I tell them about that, they'll think we're really crazy. Nisha's looking down at me right now. It's like another big idea. We're not short of ideas here. The key is we're all short of time. It's just how do we allocate our time? I love the fact that right now this Thank you very much. We might find out two years from now, three years from now, we're mailing two-thirds less books that we just don't need as many books. And they can be different, like you said, express the whole lifestyle differently. Lots of different ways to do it. The good news is we're kind of always unsatisfied, always on the move. We're always innovating. We're always learning. We're getting smarter and smarter. And I think we'll keep finding better ways to do what we do. So... Lots of things in the horizon. I gave you a little peek into the future. Now you guys are going to ask me on every conference call, like, yeah, when's RH Underfoot coming? When's RH Illumination coming? When's this coming? When's that coming? But there's going to be a lot coming over the next five, ten years. We're not going to run out of ideas here.

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

Thank you. Thank you.

Yep. Your next question comes from the line of Emika Lasser with UBS. Give me the asker question.

Good evening. Thanks a lot for taking my question. It's two quick ones, and it may be for Jack. Number one, can you provide an explicit breakdown of where the gross margin expansion came from in the second quarter? And then I have a quick follow-up.

Well, we – beyond what Gary already mentioned in the letter because we did talk about 490 basis points of product margin. And so the rest would be shipping expense and occupancy expense, which we got a little leverage on each of those. And we're not going to go into much more detail than that.

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

Yeah, partly that. I mean, but partly... Higher quality product that's commanding higher margins and all the things that we've talked about.

Cycling of the outlet, cycling of the rug transition.

And that's about, those two are about a little over a third of it, right? A little less than half?

That's right.

And the rest is just higher margins across the business, right? Across all the categories. That's helpful.

And my follow-up is you're on this path to mid-20s margin over time. Is there a scenario where your margin would take a step back if you accelerated some of 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're making those investments because we keep doing it while we've been making investments. I think the key is maybe there's a time we say, look, we've got so many really good ideas now. We're going to invest even more, and we're going to have a flat year. We might have a year that's a little down. I don't know. Maybe. We'll tell you when we get there. I mean, it depends. we will make really good long term decisions we're not going to all of a sudden become a company that gets to 20% operating margin and starts managing quarter by quarter and go into the downward spiral that a lot of companies do because they start quote unquote protecting their brand instead of building their brand and they hit what I call the death curve they're really smart and inventive and innovative while they're building their brand and then they they build something that's valuable and then they start to protect it and everybody starts playing defense instead of offense and that's when you just go into the death curve. 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. You'd have to be a short-term thinker. I'm not trying to get out of this company or sell this company. It's like none of us are. This is our lives, not just our job. So we're going to make decisions like we own 100% of the company. We're not going to all of a sudden play small ball and try to play quarter by quarter, year by year, predictable margin improvement. We could have, by the way, I could have not let this thing slingshot to 20. I could have said like, oh, let's like spend a bunch more money here so we grow 100 basis points a year or 150 basis points a year. That's like dumb. We're going to find big moves and big leapfrogs and we're going to make those big moves and big leapfrogs because you know what they do? They lead you to the next big move and big leapfrog. So we're going to keep playing our game and again, if you look at us over time, I kind of shared with you, go do the math. Go look at November 2nd, 2012 and look at our stock, 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'd say, hey, how do you 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. And the only way to keep that kind of performance alive is to continue doing what we're doing and not get down into the little rocks, not let our view contract and start playing a quarterly or yearly game. We're going to, you know, 10 years from now, five years from now, 10 years from now, I think our shareholders are going to be really happy. If I start playing like quarter to quarter, year by year, oh my God, operating margins might be down 100 basis points this year. Let's not invest in that extraordinary idea. Let's not do that. You know, like, it's just dumb. You know, so... We're going to play the game with a long-term view. It's worked for us thus far, and I think it'll continue to work for us. We want to get better. We're going to have to take bigger risks. We're going to have to be more inventive, more innovative than we've ever been before. You're striving to get better. You're allowing yourself to get worse. There is no such thing as staying the same. That's why I've said in the beginning, like someone pulled out My first video, you know, we were watching it the other night when I said, you know, if you want to know about our company, you know, put down your spreadsheets and, you know, go to, you know, go to Melrose, go to L.A. or go to Atlanta, and maybe you'll see what we see, you know, and also fall in love, right? And, you know, because you have to kind of, this is so different, you have to see it to believe it, right? But we've got to get... Better at doing what we do. We've got to get more courageous, not less courageous. We've got to take more risk, not less risk. Otherwise, the whole thing is going to go into a downward spiral. It's going to become boring. We're going to lose our passion here. And you're going to be like all the stiffs in the department store industry. They haven't done one innovative thing in the last 25 years. Why? Because they're managing the business. They're not leading. They're not building. We're not going to be scared to take risks, to have our margin de-lever by a year. Thank God we did what we did in 2016 and 2017. Understood. Thank you very much. Yes.

Your next question comes from the line of Christina Fernandez with Telsey Advisory. Give me now ask your question.

Hi, good afternoon. I wanted to ask about the The demand trends you're seeing, I mean, it seems like it's a very good opportunity to attract new customers to RH. Can you talk about whether you're seeing an increase in new customers or is a lot of the demand coming from existing members or reactivated customers that perhaps had shopped before but not recently?

Yeah, I mean, I think the numbers would indicate we're seeing a lot of new customers, right? There's an acceleration here. In new customers, there's acceleration in existing customers. But you can't run up 47 demand without new customers. So there's people that all of a sudden, again, the home has become more of a focus. It's more important. There's more people buying second homes, moving. There's an uptick in the home building market. And hopefully this means that, again, it sets a new level of importance on the home. and 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 just given all the changes, but maybe update on what's going on there and when do you think you could resume some of the store openings in 2021?

Yeah, well, one, Charlotte and Marin were really happy with both. Yeah, it really, you know, pretty extraordinary. Marin, you know, it's not performing as well as Charlotte because the restaurant we opened, and the restaurant was open for three days, and we had to close the restaurant. The restaurant's been closed, what, for a month and a half, two months, something like that. It's really great for everybody that's, you know, kind of, we have it open for our associates, so... we're feeding our people so we keep our team engaged and alive and 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 Marin's really performing well. Charlotte is kind of off the hook great and what we're finding in some of these I don't know if you can tell Charlotte's secondary market yeah I mean some of these markets like Charlotte and Columbus, like extraordinary lifts. I mean, lifts like way better than we've expected. And I think that we're even more differentiated and unique in markets like that because even the great brands, if you look at the luxury brands, my sense is they probably under invest in those kind of markets because they don't understand them. And I think there's a lot of wealth in many of the markets and my sense is that brands tend to under invest. And so, we built our prototype in both Charlotte and Marin, but you think about Charlotte and Columbus, the lists are extraordinary. I mean, way beyond our expectations, not a little beyond, way beyond. So, it really is making us rethink what we're doing. just the focus and investments on some of these markets because they're very home-centered in a lot of these markets in Columbus and Charlotte and places like that. But we couldn't be happier with how the new galleries are performing. And then as far as the guidance 21, we'll open new galleries in 21. We just... Things are moving around. We've had some of the developers, they froze their capital outlets, which was a lot of our TI and stuff for a few months, and we've lost time. It's hard to get things into local municipalities and get approvals right now. You're doing Zoom meetings, and we're trying to get RH Morristown approved, and New Jersey, which is a five and a half acre estate with a historic home, and we're developing multiple buildings and gardens and, you know, food and beverage offering stuff. It would be an extraordinary gallery. It's just that, you know, it's hard without physical meetings and town meetings. You know, trying to do stuff on Zoom is just taking forever. So we've got a bit of a slowdown on things, but, you know, we'll – We will have new galleries in 2021. I think it's just too hard to commit to a number because some things are going to get kicked into 2022 and things that were 2022 are going to probably get kicked into 2023, you know, because just everything's kind of backed up. Yeah, it doesn't affect anything. Yeah, go ahead. Thank you.

your next question comes from the line of Oliver Chen with Cohen and Company can we 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 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

Yeah, nothing's 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 of 21. And that's anticipating we're going to be able to travel over there soon. And the team is identifying Distribution and Logistics Solutions and where we're going to be and whether the DC is going to be in Belgium or it's going to be in Netherlands or do we open one in the UK? We've got all the optionality teed up and the team's done a very good job of creating the options and doing the math and thinking about it short-term, long-term as we think about the investments. We've got to kind of ramp up being able to, we've got to place the orders and we've got to get goods and they've got to be there by April, May, so we can open in June as kind of our target. Maybe we can open as early as May, but I think it's going to be more like June. But a lot of it's just going to depend on the virus and what does travel look like and what does local restrictions look like as far as and all of those people. So, you know, we're going to have gatherings and, you know, shopping and, you know, are we going to have a second wave of the viruses? Are things going to slow down and shut down or anything? You know, we just don't know. So, we said tentatively 2021, that's when we were always going to open that first gallery. You know, we're targeting, I think, 2022. We would have Paris ready to go and maybe another one. 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. Just getting approvals right now and things like that are the difficult thing and understanding construction timelines and stuff. So far there's no real change. The only questionable thing Questionable one would, can we get RH England open in 21? There's still some questions because we just can't travel right now and there's things we can't do.

Got it. That's very helpful. And then on the new opening pipeline, obviously, no guidance. We just discussed that. But can you remind us how many of those galleries are planned to be capital light And then with that in mind, just any sort of framework we should think about longer term, CapEx, where it could be versus, you know, let's say the last several years.

Thank you. I don't know. One, I think you're going to see more capital light than less capital light. We don't have that many bespoke projects on the. on the docket, do we do that right now? New Jersey's bespoke, but New Jersey's basically capitalized the development deal. So we, you know, New Jersey, we're buying it, we're building it.

It's a development deal where we're going to do a sale lease back.

Yeah, we'll do a sale lease back. We'll get 100% of our capital back out of New Jersey. So I think about those as capitalized. Maybe we have a little bit of capital we're putting up front or taking construction loans and we'll get all of our capital back immediately after we You know, we sell it. But I'm just trying to think. Most of our big capital jobs, I mean, the one on the horizon I'm thinking about is London. Depending on what we do in Orange County, that will probably be a little more capital heavy because it's going to be kind of a new spectacular gallery.

Miami could be, depending.

Miami, yeah, Miami, if we... We have an opportunity to do a deal we've been trying to do for seven or eight years and now it looks like it might be coming back, which would be extraordinary. But even there, I think you've got some of these things that might look capital heavy, but they're like New York. They're going to pay back in two years. But going forward, I would say 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.

Yep.

Your next question comes from the line of Tammy Zacharia with JP Morgan. Can you ask her 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, Tammy, I'll take that. Look, from a COVID perspective, clearly, you know, with the reopening activity in Q2, there's, you know, 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, you know, it's some amount less than that. And then as far as the headcount savings, look, you know, as Gary talked about, we went from demand being down 40 to demand being up 40. You have an 80-point swing in our business. And so in some ways, those savings, and we're making investments from here. So the bulk of those savings are sort of behind us in Q1. We got some in Q2, but we're in investment mode given the trajectory of the business.

Got it. That's super helpful. And then lastly, another quick one regarding the world of RH. When do you expect that to be up and running

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

Got it. Great. Thank you so much.

Thank you. Thanks, Sarah. Your last question comes from the line of Zed Basin with Redbush Securities. You may now ask your question.

Good evening. It's Zed Basin with Redbush. My question is really around some of the sequencing of all these great investments that you're planning to use.

You've got a really bad connection. Yeah, you've got a really bad connection. We can't understand you on this end. I sound like Darth Vader almost. We can't. Yeah, no, you've got a really bad connection.

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

Yeah, if you could just provide a little bit more color and how you manage the execution risk associated with that, that would be excellent.

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

Yeah, again, we spent a lot of time deeply thinking about where we allocate our human and financial capital, and we think about investing in things that have a much greater asymmetrical risk to the upside. So I don't see any... massively elevated level of risk in the investments we're making. The one where we obviously have the least amount of experience and data is in the international expansion. But I think we've got that appropriately handicapped and we're moving at a good pace that's going to allow us to learn and improvise and adapt and overcome. But I don't The level of capital that we're putting into the European expansion is, if you had asked me three years ago, I would have said we were 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 & Fitch flagship locations where they put in a massive amount of capital rebuilding the buildings, putting in the HVAC and the electrical and all the kind of infrastructure. And they built beautiful. I mean, anybody who's seen some of the Abercrombie & Fitch locations, they're unbelievable. So we've got a handful of those that are going to put us in more of a capital-like perspective because we can just take out the fixtures and do some interior architecture. The outside of the buildings are spectacular. And then we got some capital building a restaurant, either on a rooftop or terrace or things like that that are not significant capital. So that's what's giving us a pretty high level of confidence that we've mitigated a lot of risk. Thank you.

All right. I will now hand a 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 improvised through this period and adapt and overcome the challenges and bring our brand to life in new and innovative ways and connect with our customers in new and innovative ways and connecting with each other in new and innovative ways. I think it's been extraordinary to watch and it's made us all so proud. And I'd say, look, the next 10 years for this organization, The opportunities ahead of us are just extraordinary. And if anybody takes a look at what we did in the last 20 years with no capital and basically trying to dig ourselves out of a grave, you think about what this organization is going to do with the knowledge we've acquired, the capital structure we have, the experience and the passion we have and the love we have for what we do. you know 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