RH

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 listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question at that time, please press star then 1 on your touch-tone telephone. As a reminder, today's call is being recorded. I will now turn the call over to your host, Ms. Alison Naukes of ICR.

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

Oh, no, it's okay. I'll 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 federal securities laws. including statements about the outlook for our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinions only as of the date of this call. and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results 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. Thank you.

Again, ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch-tone telephone. One moment for questions. Our first question comes from Adrian Yee of Barclays. Your line is open.

great thank you very much and you know 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 you know in the past you've mentioned two macro drivers that benefit the company one being kind of high-end housing growth and the second being robust stock market returns so we're in a market that we have both and based on the historical perspective you know how long have the you know what's in the lag in terms of the effect obviously we're seeing it sort of immediate today but what's been the duration of the positive impacts 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 you know of each of those thank you very much and congratulations thank you thank you

You know, it's hard to be specific on duration. I think it depends on severity of correction in any of the markets. You know, particularly we've seen, as you know, with sharp stock market moves, you know, it sometimes will pause consumers at the high end. So, you know, 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've been asked recently about, geez, how do you feel about the cities you have galleries in that consumers are moving out of some of the – and the suburban housing market and the second home housing market. We're generally, I would just say, we're generally indifferent because people moving and buying homes is just a good thing, right? And 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 the uptick in the housing market and how long that will last, we don't have a crystal ball. There's usually a longer tail there because as anybody on the phone knows, if you've bought a new house or moved into a new house and it's it triggers a lot of spending on the home and it's not an easy job. 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 gonna happen with the stock market and how the market's gonna 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. 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 the sales contribution, we think it's very different obviously from the perspective of if you think about the U.S. when we open a new gallery almost all of them are replacing an existing gallery so there's something very good about that and 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 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 internationally we're not replacing any stores so you have a bit of an unknown on that end and that can be a negative because there's more guesswork and there's less data to use. We're relatively very accurate on understanding what's going to happen with our expansion in the U.S. and even when we have new markets that we open in the U.S., we're relatively accurate in predicting the performance. So we have less data internationally. We don't know exactly what the reaction will be. And so that's a negative. I'd say on the positive, the way to think about it is you're not opening a market, you're opening a country, right? And so I think about it from the perspective of the UK, just if you start there, you know, California today you know call it directionally you know five directionally 500 million dollar market for the business without all the gallery conversions you know longer term it's probably a 700 billion dollar plus market for RH you know probably as as we continue to expand the assortments and become a more disruptive dominant brand called California Long Term. Maybe it's close to a billion, 800 million, but it's easy to see 700 million as you think about transforming California. We'll take the UK at 68 million people versus California, 39 million people. You've got similar demographics, similar wealth populations and so on and so forth. Little change in the density. You open a a gallery in England, London or whatnot. And we've got kind of a unique strategy there. We're opening a really terrific gallery from the image and impact and kind of conversation point of view of RH England, which is this magnificent estate on 73 acres in Oxfordshire. It's five minutes from the Soho Farmhouse. It's been called the the coolest house in Great Britain. And, you know, but it's, you know, it's kind of out from the population. It will create a lot of awareness of the brand, you know, and just because of the footprint and the uniqueness of the gallery. And it's, you know, and it's got a great size. It's about, I think we're 50 something thousand square feet there in the three buildings. and then you have a very different one in central London at Mayfair where we're right in the heart of it and we're framed by Saville Row and Burlington Gardens and we're a block off New Bond Street and the flagship Ralph Lauren and the big project that LVMH is doing and all the wealthy people, no one will miss us there. I think everybody will hear about us in Oxfordshire. How many people will go? Not sure but the way to think about it is is not just as a gallery, you're opening up the entire direct market, right? And we've always been a brand, we used to refer to ourselves as a direct-centric brand. If you think about, yeah, and it's funny because I just wrote about physical first, right? And it's not that, it's not like people think, oh, he doesn't believe in the internet because he's building these big stores, these big galleries. But the way we got to even... be where we are today is we did that through the direct business. When we started here, we had these little stores and we had a little assortment and there's no way you could show our assortment in the 6,000 square feet of selling or 7,000 square feet of selling we had in the average galleries. And we had a strategy that we used to talk about in our kind of first leg as a public company and didn't talk about it so much when we reentered the public market, but we used to talk about direct center growth. And what we meant by that is we said we were going to size the assortments to the potential of the market, not limit them to the size of the store, and use the source case and the website to reach a much broader market. and by doing that, we were able to grow the company, a company that was on the edge of bankruptcy in a very capital efficient way. And that is gonna kind of play through when you think about moving into new countries, right? Here, we started with 106 stores and we kind of right-sized it down to, we think, I don't know, 60, 70, whatever it'll end up being as we optimize the footprint. and many more. So when you open up a gallery or two in England, in greater the UK, when we open up a gallery in Paris, you're going to open up all of France and greater parts of Europe. You're going to open up your business to all the travelers. So we're not sure exactly how to think about that until we have a couple, but I'd say the The asymmetrical risk to the upside from how we think about our business because we have been a company that had, before we were transforming our galleries, when our galleries were undersized, 50% of our business was direct-to-customer, omni-channel, digital, first, whatever you want to call it. We just call it online or on our website. It's where it's transacted. And so we believe opening up markets, opening up countries is a big deal, a really big deal. And that, I think, gives us asymmetrical risk to the upside of maybe not having as much specific data, right? Like it'd be like being the brand store today with kind of the awareness we have today and opening up California with a magnificent store in L.A., and an incredible gallery, I don't know, call it in the Napa Valley or somewhere that people visit and vacation and go to for weekends. So what does that do? We think it's some kind of a really good outcome would be our best use today.

That's very helpful. Thank you very much.

Yep.

Thank you. Again, if you'd like to ask a question, please put a star than one. Our next question comes from Max Relinko of Cowan & Company. Your line is open.

Hey, guys. Thanks a lot for taking my question, and congrats on a 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 months, or could there be some risk as supply will trail demand for a bit longer than you previously predicted? anticipated. And then just separately, how are you guys thinking about cash allocation priorities at this point? Your free cash flow has started 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 get 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? And I think there's not a risk because, one, because I don't think we have a lot of direct competition at 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, et cetera, et cetera. And I think that the consumer needs the product and I just don't think anybody else is in stock, right? I mean, we're running the highest back orders in the history of the company since I've been here 20 years now. So I've never seen this kind of phenomenon, right? I've never seen back orders at all-time highs and cancel rates at almost all-time lows, right? So, one, 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're many cases forced to wait. So you kind of go, if I don't order it now, how long might I wait? 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 the orders to revenues is very, very high, right? We have a lot of data now and very, very consistent. Back orders have trended lower, not higher. Back orders have been below a year ago and they were low, not by backwards, cancel rates below a year ago and they were below a year ago last year. And as back orders have increased every quarter, right? Because you can't, You know, when health centers, our business started trending up, you know, we weren't buying for up, right? We'd canceled orders and they started trending up 20% and we were buying for 20%. All of a sudden they went up 30% and then you start buying for 30, then they go 40%. And you're like, God, do I even buy for 40? Let me ask, wait a few more weeks. And then you go, okay, it looks like a trend. Then you buy for 40%. So we've, on a compounded basis, you know, then they went up to 47%, right? So we kind of got behind, right? So as we thought we would start catching up, we actually fell behind because the demand continued to accelerate. And you would have thought that cancel rates would be impacted, but for the reasons I stated, I believe that they haven't been impacted. And now I kind of have a more firm view that I don't believe they will be. Doesn't mean We won't be wrong about that, but that's our view today. As we think about cash allocation priorities, we're in a world where things are changing daily. We just went into, in the state of California, shelter-in-place orders. Retail is operating at 20% capacity. The malls and the shopping centers have less traffic than they've had in the last few months. We just saw the most severe drop-off of the Black Friday to Cyber Monday selling season that we've ever seen. In discussing with other retailers and leaders in the business, people saw a massive fall-off during that period. We're sitting here going, uh-oh, do we adjust orders? Is the tailwind over? And it just seemed that based on the fact that the virus was spiking, people decided not to go out and shop. And all of a sudden, once we got past Cyber Monday, our business started to ramp back up. So when you're in kind of a business situation With so many unknowns that we're in, whether you have a headwind or tailwind, for me, it doesn't really matter. I mean, we have more optionality with the tailwind. Do I feel better being on this side of the table than maybe apparel people or other people who have their business or restaurants and other people who have their business devastated? Yeah, of course, you choose the side we're on, but it depends. It doesn't mean you should adjust anything long term. It means you should just kind of do your best day to day, week to week, month to month as new data comes in to make really good decisions for what you know and don't lose sight of your long term vision and strategies that you believe will create significant shareholder value long term. and I think we've proven based on big decisions we've made and from moving from a promotional model to a membership model. When I talked about having to march through hell for a heavenly cause and staying true to that and transforming our whole way of doing business, that was a long-term view and we didn't let short-term noise distract us. We redesigned and re-architected the entire operating platform of the company. a lot of short-term noise as we were doing that and we stayed focused on how we could create long-term value and that hasn't changed and that's why if I wrote one of my longer shareholder letters here tried to give you as much detail as we could as transparent as we can how we're seeing the business but things are changing all the time so to kind of have a strong view about what you're going to do from a capital allocation point of view with buybacks or you know M&A or other things like we're always going to be opportunistic um but you know I it's it's just hard to kind of commit to too many things today I mean we we were we were pretty certain we were going to open RH England I you know and all of a sudden travel shuts down in the UK and we can't go unless we quarantine for two weeks and you know you can't send your leadership team and other people to go quarantine in a hotel for two weeks uh you know to work two days and come come back and you know so we just decided like yeah not a good time we had to make a decision to commit to um you know distribution infrastructure and other investments and people and so on and so forth and we just said like yeah like look it's important that we take a long-term view here the long-term view is like it's everybody will still be there if we wait to 22. We'll be more prepared. We'll do a better job. We'll have more visibility. We'll understand what this looks like on the other side of the pandemic. So, you know, right now I'd just say too many moving parts to be committed to kind of any kind of specific activity. If the right Thank you. Thank you. make significant share buybacks with all the uncertainty? I don't think so. Not right now. You know, I think let's let things pass. And, you know, it's no different than, look, I think we're very smart at not raising debt right away. You know, when all of a sudden this pandemic hit and our business went down, our business moved 50 points, right? And everybody's like, Do you have enough cash? What does this look like? And we researched it. We created a lot of optionality. We had a lot of choices to raise capital. The interest rates would have been really high. It would have been very expensive money. And, you know, it might have bought us some optionality. But, you know, you just don't need to take risks without having real clear visibility. I mean, some people thought we took a big risk buying back, you know, almost 60% of the company spent $1.2 billion. We didn't see it as risky because we understood what was going to happen. We understood we were going to re-architect the supply chain and take $400 to $500 million out of inventory. We knew what would happen. We had really good assumptions. I say we knew. We had really good assumptions. We knew our business really well and we made some moves that to other people looked risky to us, had more asymmetrical risk to the upside. And so right now, I think it's just, we're in a really uncertain time. We gave you as much forward-looking information as we could. I kind of look at this as, look at this over a two-year period, right? Fiscal 21 is a, excuse me, Fiscal 20 is a is a down first half, up second half. Fiscal 21 is just the opposite. I'd look at the two years together and say, what kind of company do you think you have when you balance it all out? We think this is a company on its way to being one of the great companies. And that's what we're focused on. So that's how I'd characterize it. are frame of mind today.

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 as you digest those moves. Is the launch of RH Contemporary and RH Color a result of these efforts? How do you speak to the potential benefits of that strategic change and not dropping the source book in the fall?

Sure. Well, not dropping the source book 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 satisfy, you know, just have customers frustrated with us and so on and so forth. So did we give up top line in By not mailing books, sure we did. If we would have mailed the books, would there have been incremental top lines? There would have. Would there have been higher back orders? There would have. Would there have been more frustrated customers and wait times? There would have. And so we thought the right long-term move was not to try to chase this kind of, you know, but 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 you know it bounce back to what it was up 39 right you know up 39 with no book right with no newness so we're up against last year's book we're up against last year's newness and we're still up 39 and and so could we have been up 48 or 52 I don't maybe but you know our business would have been messier and it's never good to kind of create a a messy business I mean I've run those before this company's run in a messy way before it you know in a chaotic way it's just no different than yeah it's pretty clear if you just look at the emails you receive in your inboxes that there was a period where very few people were promoting now it looks like a period of a lot of promotions and so my sense is there's a lot of people in the retail business that are you know trying to fuel the fire with increased promotions I think that's a I think that's not a good long-term view because then you're up against all that next year when you've got a cycle, these difficult comparisons. I look ahead next year and I go, I feel really good. We've got a cycle demand up 40. Maybe the fourth quarter will be less than that because we didn't mail the books and we don't have the newness. But next year, we're going to have a lot of newness and we're going to have really thoughtful constructed and architected assortments and we'll even be more strategic and we've been able to make investments in other elements of our business that will elevate the brand and so we feel very good about next year unless something big happens, unless we have a stock market crash and the bottom falls out of the home and the home business. But for the most part, I like how next year is shaping up because of the decisions we've made. I think we're very excited. I think it's a tremendous new product in the pipeline. Almost too much. You've got to make sure we're being disciplined about our investments from an inventory point of view and our risk on newness, but it's a lot of great newness. And I think our age contemporary is going to open up an entirely, another new layer of the market, right, for us. You know, it's going to bridge the gap between kind of the kind of class, updated classics of interiors and the more, you know, the harder edge, modern, and fill in with some aesthetics that we just hadn't pursued before in a very RH way, right, through our Thank you so much for joining us. lighting designers and glass designers in the world today. I mean, she's sold exclusively on Holly Hunt's platform, which Holly Hunt's been known as the best high-end interior design showroom in the United States. And to have someone like Alison come over to our platform, kind of tips things again. But it's about the product and the people joining the platform, the people joining the cause. There's just a lot of momentum in our brand today from a human capital point of view, both inside and outside RH that are going to contribute to RH. From design, manufacturing, business intellect, merchandising capability and so on and so forth. I guess the way to think about it is there's going to be a balancing of not mailing the books and not having any newness and then cycling around next year and not just mailing the books but mailing more books with more newness because you're going to have contemporary and and you're going to have this kind of upward momentum. Now, what will happen to the markets? Do we think some air is going to come out of the demand? Do we think, you know, these, you can't, it'd be foolish to think like this thing lasts for a real long time, you know, not at this level. Like we think it's, you know, you're going to cycle it, it's going to normalize, there's going to still be momentum in the home business from our point of view because of long tail and that happens when people buy homes and move. but long-term, if you just think about the moves we're making strategically, those are not temporal. The pandemic is temporal, right? The moves we're making are systemic and strategic and they're gonna last a long time. So that's what we're focused on. What are the moves we're making, the investments we're making that are gonna elevate the RH brand and render our brand more valuable in the marketplace, more desirable, you know, more unique, more authentic, and that are going to have a lasting value. Because it's, you know, look, our stock went up, what, $120 or $30 in the last 30 days or something like that. Like, you know, the stock is going to move around, you know, you're going to have, like the short-term stuff is, you get too focused on that and you start kind of managing your business and managers generally arrange and organize the status quo and try to protect the present we're builders here we don't have anybody with the title of manager in this company we only have leaders and leaders are taking people somewhere that they've never been doing things they've never done and they're building things and they're building value and that's the culture of our company. If you walk in our center of innovation, you'd walk through a portal that says RH, the home of the extraordinary, the remarkable and the amazing because that's how we think. What are we focused on that's extraordinary, remarkable and amazing? That's the kind of work, that's the kind of focus you have to have to build one of the most admired brands in the world. And that's our DNA. That's our focus. So all the other stuff is kind of noise and distractions. The important things are the big moves and the big investments that are going to continue to change everything for a very long time.

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 at the 2021 or if you just want to sort of baseline the third quarter here and maybe help us conceptualize what some of the transitory factors were, right, like the removal of the silver spokes or so forth as we think about our 2021 models.

Steve, you know 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. Look, some of the things I look to, continued strength in gross margin and product margin. That is a strong part of the story. And when we look out and our confidence to reach a 25% margin, in our outlook, our longer-term outlook. I mean, those are the strong elements of the story. As far as specific elements in 2021, we're not in a position to provide those at this time. I'll look to Gary if there's anything else.

No, I mean, look, we believe we're going to have double-digit revenue growth and expanding operating margins. We'll know more each year you know 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 you know how people are going to behave and what's going to happen but you know we're not going to get out over our skis from a cost point of view right and You can't. We're in kind of a temporal environment. You've got to be smart about that. That's why we feel confident that the margins will continue to expand because we've got a good handle on expenses and we have a good line of sight into the product pipeline and you know what we believe can be the margin structure from a product point of view which is the key lever and expenses we've you know we're pretty disciplined around here you know from an investment point of view it's 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 what that investment will kind of 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, curious, critical, always unfinished, always on the move. We'll continue to do great work. I don't think there's any other people that have given you much more data than we're giving you today. I think the shareholder letter has a lot in it.

Thank you both. Happy holidays. Happy holidays.

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. They're up, I believe, over 60% year over year, and then your demand come, which is lower than that. Just wondering if you could connect those two dots for us.

Yeah, I think it's, you know, 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, you know, you're inspiring people to purchase and invest, you know, versus other purchases and investments they may have made, you know, based on what they see. And No different than Apple created a new market. They didn't look at the cell phone market and say how big... I mean, Apple created an entirely new market around smartphones. The iPhone, nobody thought it would sell in China, became the best-selling phone in China. When you create a really good product and not just a single product. I'm talking about a full integrated branded proposition. You have an opportunity to create a new market, to disproportionately expand a market because you're putting something out there that wasn't there before. And I think that's happening in many places. You can 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 huh where do you go buy outdoor furniture you know there's not a lot of consumer facing outdoor furniture stores right that you know they're kind of out off the beaten trail kind of you know kind of in weird places. You can come up with the names you've driven by them before. But you said it's high-end outdoor furniture. Where do you go? Where do you even see it? Where do you even get inspired to buy it? 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 I used to tell people... is what, you know, you might remember a business called Smith & Hawkins, right? And they, you know, they opened like 50 stores and then almost went bankrupt and they took another go at it. And I'd say, you know, why didn't Smith & Hawkins make any money? And they'd say, geez, we don't know. I said, well, you know, for the most part, they had to pay rent. and they paid ground floor rent for a very seasonal business. And if you look at our strategy and what we've done with rooftops and terraces and things like that, in our new galleries we present somewhere between 20 and 30 outdoor collections depending on the outdoor garden space and the rooftop space. Nobody faces the customer like that in the outdoor furniture business. And because we're facing the customer like that in this environment, we're creating a new market. And we're creating a new market in outdoor furniture at a very high return on invested capital. So we really like that business. and you say, well, why can't other people do that? Well, other people don't build galleries as big as we do. So their rooftops can never be as big or they don't control the real estate like we do. And they don't, you know, very hard to emulate what we're doing, right? And that's, you know, and why the physical nature of our business is so important, right? Like I always say, you know, that, you know, a website is an invisible store, right? You don't, see it, you know, pass it. You have to be prompted to go to it. Physical stores, people drive by, they see, you know, if you're in the right locations, you're in the, you're going to be constantly visible and you can present, you know, products and categories in ways that you can't online. You know, where the online, an online business is very democratic, right? Everybody has the same size screen. You know, you know, Holly's Home Store can look as big as RH online. I don't want to say Holly's Home Store. It's nobody named Holly. It just refers to a higher-end local furniture specialty store that someone's running. But those kind of businesses can't do what we do, and that's why we're so disruptive. So when you're disrupted like that, you're taking share, but even more importantly than taking a share, you're creating a new market. And that's how we think about it. and then Jack, you can comment on if you understand the 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, you know, two key items that you're going to see that grow with customer deposits and sort of deferred, you know, the special order business that we have that grows those customer deposits. And then as the business grows, you know, You know, naturally, you're going to have a growth in the deferred revenue balance. You're looking year over year. I would have you look sort of sequentially sort of where Q2 to Q3 grew as well. That was like an 18% sequential build. So, you know, I think, you know, you're going to look at both, don't get me wrong, but I think as far as, you know, 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%. and very much expected relative to the trajectory of the business.

That's a good call. We'll look at it sequentially then. And then just my follow-up would be just wondering if you guys describe 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've looked at the data, Chuck. Look, the data is what exactly we do expect, that suburban homes 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. But again, we're 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 of 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 you know very strong growth and urban you know being the weakest of the three again it's kind of a firm grasp the obvious as we say sometimes but I'm not sure Gary you got anything else that yeah no I mean look our business has always been our biggest part of our business is the suburban market business right if it's just where more businesses

large homes are, where all 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 a significantly large part of our business, has a tailwind. And there's people moving to it. That's good for us. it's again it's we know all the data we've got it we you know we look at it I don't know if any of it tells us to do anything differently or to expect anything differently you know there's not like markets we go oh my god they're buying homes there and you know they don't know about us or let's rush to open a gallery or stuff like that I mean you know some some place you go okay we've been looking in palm desert in southern California for years and it's on fire you know and you know Steph who you know is our chief gallery officer you know went to see his grandparents over Thanksgiving and he said we really really need a gallery there and go yeah it's on the list you know if you feel that strongly about it you know Go find a location and we'll get it done quickly. It's not like, oh my God, it's going to change so much. We're really well positioned in North America to capitalize based on any way it shifts within the market. We just like that the market's up. We're well positioned to capitalize no matter where they're moving in North America. I think the only place like we're not represented in Montreal and we're not represented in Hawaii. I'm trying to think. So there's a couple of places like that.

Naples.

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

Got it. Thanks very much.

Thank you. Our next question comes from Michael Lassa 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're experiencing to drive this strong demand growth? How much is coming from new customers versus repeat customers, and how much is coming from larger baskets? Are you seeing a trend of customers who are more often buying furniture from more than one room in their house, and that's where you're seeing this strong demand growth? Well, our interior design business keeps growing and has been growing. And so you'd think in a big move like this, you know, it's kind of everything's lifted here. You know, some things have shifted. We had, you know, outdoor was off the charts in the beginning because a lot of people, I think, realize they're not going to travel for the summer. And, you know, they spend a lot more time at home. You know, but the consumer behavior is, It's no different than what you'd expect with demand like this. New customers to higher spends from existing customers and so on and so forth, the metrics don't make us think about doing anything meaningfully differently than what we're doing. Yeah, so our business has been growing. If you think about size of basket and so on and so forth, because we've moved the business from just conceptualizing selling product to are kind of creating products, conceptualizing and selling spaces and the efforts behind building an entire interior design platform, you know, in a national scale. If you go into our new galleries and you see the dedicated office space for our interior designers and the design ateliers and the meeting rooms and the space we've designed, it will tell you that that obviously is something we're investing into. So, you know, and we think that's going to be, you know, create opportunities strategic separation for a long time to come. You know, all these investments 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 try to give people a view at and told you what's sitting behind me and I'm looking, yeah, no one's changed the whiteboard, so same whiteboard. You know, that's how we think about the business. Like I've always said, you know, when people ask, you know, ask me in the past, should I buy your stock? And I always say, ask the same question, I say, you know, are you an investor or are you a trader? You know, if you're a trader and you're focused on, you know, short-term episodic swings in the stock market or, you know, quarter to quarter kind of things like don't buy our stock. It's going to be a volatile stock because we're building something people haven't seen before. It's going to be misunderstood. It's going to get overvalued and undervalued and you're going to not sleep a lot at night. But if you're an investor and you take a long-term view, I think it's one of the best places to put capital. I said that 10 years ago and I said that five years ago and If you look at our performance, you know, you'd say, hey, boy, I wish I just hung on to RH stock. You know, if I look at, you look at our biggest shareholders for today is Fidelity and the team at Fidelity who's been there the whole time. has held our stock. They've held 15% of our stock. At one point, you know, it went up to almost 30 because we bought back out the company and they had a restriction and we couldn't hold that much. But, you know, they would have liked to. But that team has not sold their stock at all since the IPO. And I think they feel pretty good that they, you know, they invested in a stock in the, you know, when we went public at 24 and, you know, and continue to invest in what looks like a good investment, even though it went crazily up and down. I'm one of the biggest shareholders in the company, and people ask me on days when the stock does really well or stock does really bad. I say, look, don't think about that. If you think about this is a long-term investment, this is a great place to invest. And I think the character and the makeup of our shareholder base would tell you the same thing. So, yeah.

My follow-up question is these periods of disruption are always an opportune time to learn how to operate differently.

And given the experience on the cost side in the third quarter and recognizing that some of the SC&A decline was from not mailing the source book, 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, look, the model's going to continue to evolve, right? If you just take a simple move in our model and say, hey, we went from a legacy gallery to a design gallery, and that design gallery will essentially double the business in one to three years. We're not going to mail any more source books into that market. We generally don't. We maybe do a little splash because we're opening a new gallery so people are aware of it. But our ad cost at that level leverages massively. and I think people sometimes miss that in a model like ours because they see this big gallery and they go, oh, it must cost a lot of money, it must be more expensive and they don't think about the dynamics of what happens because no one's ever taken a really productive kind of legacy store like we have and then been able to just change the footprint and basically double their business. I've never seen it before. you know consistently across the entire country we can do that and so when you think about ad costs like 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 you know it's like as we go to reinvest and mail the books Thank you for joining us. Your revenue at retail, which is the biggest part of our business, you know, in a market and what that does to the cost structure at corporate, what does the cost structure against all the other operating areas, our distribution centers and so on and so forth, you're going to have leverage. When you think about kind of climbing the luxury mountain as we are and taking quality up and desirability up and prices up, that's going to give you leverage, right? and then you think about just kind of being consistently unsatisfied with whatever today's performance is, which is our culture, you're always looking at how to do things better. And so throughout the cost structure and we've got all kinds of initiatives going, all kinds of investments we're making that we think will have really good returns that will make the model more efficient, more profitable. So, yes, whether it's labor savings, it's not so much labor savings, it's leverage on investments and strategies we're doing that are making the business just more profitable. right so and we have a lot of things happening that we believe will do that and you know our history right over the last several years I mean I remember when we said we were going to kind of be 10% operating margin it was like oh you can't be 10% operating margin and then we hit 11.4 right and what I remember reading reports you know on the company 11.4 no one's like it's higher than you know whoever and and it's unsustainable, right? They only have half the revenues of this other company that their high was 10% or whatnot. And 11.4 is unsustainable. Then we hit 14.1% operating margin. And it's like, it's unsustainable. Now we're gonna be at 21% and 21% on, call it 7% revenue growth. Like really the way to stand back and think about the pandemic is like mush the year altogether. We're only going to have revenues up 7% and operating margins are going to be 21. Does it really matter how those revenues came over the course of the year? Or does it matter that on 7% revenue growth, they hit 21? So I don't know. If we didn't have a pandemic, would we have hit 20 or would we have hit 22? It's not like the pandemic from a revenue point of view has enabled our operating margin this year. It really hasn't. If anything, it's deleveraged our operating margin this year, made us less efficient when you look at how things are happening. Think about this. We're generating roughly $80 to $100 million of future revenue. We spent all the money engaging all the customers, helping all the customers, you know, doing all the design work. And we're getting no revenues this year, that 80 to 100 million. Put that 80 to 100 million in your model this year, and what would the operating margin for our HP? Because there wouldn't really be much more cost, right? Like most of the cost is already behind us. We would have had, you know, shipping and stuff like that. But, you know, you look at the flow through on that, you go operating margins would be higher than 21, right? Like, you know, that's what I focus on. I focus on, wait a minute, on 7% operating margin, they hit 21. They were, we thought they were high at 14. And we thought they were really high at 11. And then it starts to help you think about, like, oh, where are they going next? Like, when we said we had a clear line of sight at 20, It just came sooner than you expected, right? We say we have a clear line of sight at 25. We have a clear line of sight. We think it's over the next several years. All depends what's going to happen. If, look, we don't go into a recession. If we go into a recession and stuff, right, it'll be a reset. It'll take a little longer. But if we don't, and if the economy continues to just perform, like if we just grow it, you know, 8% to 12% a year, we're going to do pretty good if we accelerate like we think next year is going to be double digits right so that's 10 or over you know and so we wouldn't tell you double digits if we didn't really think it looked pretty certain even you know like not not expecting the trends in the second half of next year you know we we think when we anniversary those numbers it's not going to look like this. But we can look ahead and say, here's all the things we're doing that will create upside. Here's what's going to cycle forward. Here's the pluses and minuses. I mean, if you just take the lost revenues in our New York restaurant and add those back, it's not a little. That was a very high volume restaurant. And once the vaccines get out there, We're going to start going back to restaurants. By the way, if you think about all the traffic we lost in restaurants, do you think we run the restaurants just for the restaurant business? Of course not. All that traffic drives business in our galleries to our brand. And so when you go, oh, the restaurant business today, I don't know, what's the last few months, we're down like 70%, right, to our plan. When that comes back, there's going to be a whole lot of people in RH galleries, a whole lot of people discovering a lot of new product, a whole lot of people hopefully being inspired by our environments. And there's going to be kind of tailwinds here. But the real point is, don't get lost in the pandemic. It's a crazy year, right? Down in the first quarter, doors closed, doors closed part of the second quarter. Things all of a sudden swing back. I kind of wash it all away and go, revenue's up seven. Looks like, okay, we're a little behind our eight to 12% growth, but operating margins are going to be 21. I really like this model. You know, this is a really good model. Like, I wouldn't bet against this team. You know, we've done what we said we were going to do very consistently and we've exceeded people's expectations massively over the last few years since we transformed the entire company on so many levels and now we've got kind of a brand with no peer and we have a DNA that's just massively unsatisfied. We get super excited for like a few minutes and then we're really intense around here about like what's next and, you know, making things great. So, you know, I just, I like the path we're on. And, you know, as a big shareholder here, you know, I really like the next 10 years. And I wouldn't have told you that if it really wasn't on the whiteboard behind me. My team's all nodding and smiling, right? Like we look at this. We are big thinkers. We look at a long-term view. And so, you know, I know you have a lot of customers that are real short-term focused. Okay. You know, like, tell them don't buy our stock. Like, if they want to, you know, if they want to own one stock with a long-term view, it's a good place. That's very helpful. Thank you very much, and have a nice holiday. Thank you.

Thank you. Our next question comes from Curtis Nagel of Bank of America. Your line is open.

Good evening. Thanks very much. So, yeah, I want to turn, I guess, to the Arch contemporary line. Maybe just get a little more detail in terms of the vision and strategy. Gary, I think you described it as bridging between the interior and modern lines in the letter. I'm guessing there's, I guess what I'd say is an extremely strong chance you wouldn't roll it out if you thought it can't mobilize the existing business. So, yeah, just kind of curious what gives the confidence

do you think this is going to be a good incremental business how it's out of the other lines how should we think about it I think about it if we're excited about it then you ought to be excited about it because we're not excited about things that we don't want to buy and that we might be too excited about it if anything last night late I was Telling Eri, like, okay, let's make sure we're looking at the whole board here because it is really exciting. I mean, there's a lot of really new product. And so, yeah, we just think it's going to open the aperture of the brand. and yeah we're really excited about about color too we just can't do everything at once and we keep kicking the can down you know down the road on color we've got I think we we we are starting to zero in on our each color it's it's a tough one right we're a neutral space brand um you know we're kind of famous for our look and point of view in fact we're so famous for it that you know people that like color kind of kind of hate our brand almost like because they 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're all some form of a neutral color from light to dark, right? And that's why neutrals is the biggest part of the market because, you know, most great design is a reflection of human design. That's why it's familiar and you're comfortable with it. And that's why you go, ah, because it's a reflection of self, right? 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 of the brand. So, you know, just no different than Beach House and Ski House opened up the aperture of the brand. And, you know, people talk like, you know, relatively small introductions, right? And small books, but a big conversation. I can't tell you how many people have said, oh, I've gotten your Ski House book. I can't wait. What are we doing? Oh, we got your Beach House book and so on and so forth. So a lot of these things too, We say internally, if you want to be part of the conversation, you have to create the conversation. Contemporary is going to create another conversation. Color is going to create another conversation. You just have to do these things really, really well. You should be really excited about it because we're really excited about it. What exactly does it look like? I'm going to I can't say that. They're remarks. It's going to look very new and fresh but again we like to say the things that really do well are fresh yet familiar. So you can't do things that are too far out there. Those are interesting but generally not relevant to your business and don't sell well. But we think it looks very fresh. There's a familiarity to it and there's kind of really great historic design references that make it familiar. So when we get things that are fresh and familiar, they're usually really good.

Got 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 it's super early, but do you think that perhaps the profit contribution could be higher than the U.S. at some point in time when you get a little bit of scale, given the comments you made about perhaps having a less dense gallery strategy 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 a higher profitability outside the U.S. than they do inside the U.S., and that's because you're getting a lot of leverage off your cost structure, right? If you set it up well, you know, if you're 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 business. What is our cash and carry business these days? Less than a percent. Yeah, you're right. It's almost zero almost, right? Like, we don't really sell anything you know it used to be like a percent or two and now it's almost zero we just yeah we've gotten rid of the holiday stuff we got rid of the ornaments and everything so again every once in a while someone buys some towels you know or something and walks out with them for the most for the most part we we don't really inventory anything in our stores so 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 of stores not brands right they're they're stores selling other people's brands uh most high-end luxury brands work really well globally right and if you're the best in your in your kind of category and we we believe we are um then those brands do they usually do exponentially better than others and so and then you know instead of just being very strategic I actually like that we gave ourselves a little bit more time on Europe because we had more time to think about things like this Curtis the you know the margin structure how we think about it the pricing you know all the all the different nuances and really really you know think deeply about these moves that we're going to make and positioning the business correctly because everything we've 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, minor expense deleverage as you ramp up the infrastructure, but that might take care of itself relatively quickly because of the the broad-based market you're going to address by opening it just in the UK and in London and England and Paris and a couple of these galleries even looking at Munich and Dusseldorf or Madrid and Brussels and ones like just with that little footprint you're going to get a massive audience because of because of the internet and because of the online component of the business. And by positioning ourselves in these kind of extraordinary locations and stores and environments that we're looking at, it's going to be a great new learning. I really didn't want to delay it. It was just the right business decision to do it because we're so anxious to learn. But I think What you're 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 effect should be overall RH margins going up.

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

Thank you. Happy holidays to you.

Operator?

Valerie?

Operator? Is that our last question or is the operator the one? We still have three.

No, there's two more. Two more?

Okay. Two more.

We lost our operator.

Pardon, Mr. Thomas, your line is open.

Hi, Gary, Jack, can you hear me?

You can hear you.

Hey, Brad. Great. Hey, it's Brad Thomas with KeyBank. Thanks for making time for my question here. Just, you know, 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. So just trying to understand some of the seasonal dynamics. You know, Gary, I think you also referenced that if sales for the full year come in growing about 7%, that that might get you to a 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 that make this 4Q different than what we've seen the last few years seasonally.

Yeah, well, I mean, Jack can give you some highlights, but one of the big ones is, you know, Q3 is 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're at record kind of out of stocks and and things like that. So, you know, we're taking a conservative view on, I think, in the fourth quarter as we should. But, you know, I think, you know, the landscaping is a little hard to look at historically because there's been so much change, you know, 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, how the rug business cycles quarter to quarter, puts and takes that may have distorted past quarters and past times. And then we have things like, we generally have a much bigger bonus accrual in Q4 and other things like that when we're having really good years and that can distort things. So I know, Jack, do you want to?

Yeah, one thing I will add, as you think about the 21% in 2020, as we talked about that as sort of a 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 you know to get the year at 20 to 21 obviously that implies just just shy of 21 for Q4 and I think you know Gary spoke to the you know you can't look at the same sequential trends because Q3 has the advertising benefit and so you know I was going to make similar comments on the cycling right so like the rug business you know we had talked about as a sort of When you think about when we started clearing that out and putting the new product on, the biggest benefits are going to be through this quarter. We'll still get some benefit in Q4. And then once you get into next year, that'll be fully cycled. Outlet will have a different dynamic. But directionally, I think those are some of the pieces.

That's a really helpful color. Thank you. If I could squeeze in one more housekeeping just around the merchandising aspect. 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 would just say year over year, it will be a meaningful increase year over year.

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

Great. Thank you, Brad. Happy holidays to you.

Thank you. Our next question comes from Tammy Vitara from JP Morgan. 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've been speaking of prior to this print? Do you need all the new businesses to come to life, like the yacht and the RH residence and 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 what I gave you, kind of our internal view of what's possible, right? Not necessarily our guidance, and we're obviously going to always have a view internally of what can happen. I'd start with if you just kind of thought about, you know, if you take the belief that, hey, RH is building one of the dominant, you know, one of the kind of premier organizations luxury brands in its space in the world. And if it performs like other luxury brands and you think about just the market at a global level, it would imply that 25% of our business should be kind of in the US slash North America and 75% of our business should be outside of the US. And we believe we can be five to six billion long-term in North America, that would imply that we'd be a 20 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. you know we 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 The tastes and style of the yacht and how many people are going to be aware of it and talk about the yacht, right? And so, yeah, the yacht is not a big growth story. The yacht is a conversation, right? The yacht is what we say. If you want to be part of the conversation, you've got to create the conversation. You want to climb the luxury mountain and you want people at the highest end of – at the top of the mountain to talk about you, do things that they're interested in. do, you know, be places where they spend their time. You know, if you're going to do something in hospitality, whether it's a yacht or a guest house, do something that forces the very highest people at taste, level, wealth, affluence, influence, force them to tip their hat that you did such great work that you earned their respect, that they, they, you create a forced reconsideration of your brand, right? So, so, uh, but the growth like if you just said hey we're going to get to the numbers is like 7.4 to 11.5 7.4 to 11.5 is like maybe halfway 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. Depends on how much risk. It depends on how quickly you can go without putting risk into the work, right? I mean, we're, you know, furniture of this quality has never been made in these quantities. So we have to build the supply chain and the platform to be able to do this, right? But, I mean, the thing that gives me confidence about that is that from where we've been to where we've to where we are, you know, 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 believe that market has a potential for probably 20 to 25 billion globally and 10 to 15% annual sales growth, right? could be possible. I wouldn't plug it into your model, 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 than opening stores in North America, that could accelerate our growth rate. We have people knocking down the door here trying to partner with us with our brand. One of the 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. I don't think there's a country that's unrepresented as far as people knocking on our door wanting to take our brand globally. We could go faster. It might mean less control. And we believe brands with more control will become more valuable. If you look at history and you look at all the great brands, they're all buying back their business from partners because they believe they can run the business better and there's greater returns. So we're gonna learn from that history. We're gonna probably go slower and with more control. And we're gonna try to retain as much control of our brand as we possibly can. I mean, today we have 100% control of our brand. Nobody presents our products but us. Nobody sells our products but us. Nobody uses our brand or our marks but us. And we think that's going to be more and more important in a world of marketplaces and kind of what I call messes, right? you know I think any of these brands I mean you look for the right model look at what Hermes is doing look at what Chanel's doing look at what the LDMH brands are doing look at the people that didn't put their brands out in marketplaces that were very discerning about what they've done that the investments that they've made they've taken you know you look at the great brands they've taken more and more control of their distribution you look at the brands that didn't make those investments and what happened to them and I don't have to name them, but you know who they are. The value has been significantly diminished because there's brands that had too much of their distribution was controlled by department stores. Department stores is a decaying platform. Can you imagine if you built a great brand and your distribution platform was predominantly department stores? and you don't have control of your distribution channel. I mean, I think what Arnaud and, you know, the Kearing Group and, you know, the Chanel teams and other people who have invested over the past 10 to 15 years to take control of their distribution, that's why they're the brands they are today. Good news is we're not in any department stores. We're not in any, nobody's got any control of this brand but us. and so we love that positioning and we think it may mean we go slower with higher quality and that's okay. That's okay. The world is only going to get smaller. It's not going to get bigger, right? The internet and communications and technology is bringing the world together. English is going to become the language and it's so much So every decade, it's exponentially easier to operate internationally. And that just is going to grow faster. I would say 10% to 15%. Is there probably people on the long side of this business that have that model? Probably. Should it be a secret that, geez, the RH team thinks that they might be able to grow this at 10% to 15%? We think we can probably do that. Is that what we're going to guide you? No. Not until we're more confident. There may be a time we're sitting here and that becomes the guidance. There may be a point that we're sitting here in a few years after we've got more data and proof of concept globally that the number could be 15% to 20%. I don't know. It's not unreasonable if you think that the size of the market for just the core business. Everything else is gravy. Do I think the yacht business is going to be meaningful from a taste and style and image and conversation point of view? Yes. For a revenue point of view? No. We will do revenues. I think we've got multiple charters lined up. It's like we unfortunately had to cancel seven charters on the boat this past summer because of the pandemic but there's a lot of demand for our boat but that's irrelevant from a revenue point of view do I think things like guest houses could be meaningful long term? They might be I think the work is that good I think what it's evolved into is something extraordinary beyond what my initial vision or expectations for it were. And I think it's become that because we control everything. Not some third party, you know, it's not Marriott using our brand, you know, and you have a bunch of bureaucrats with no taste, you know, kind of screwing up your brand. It's not some other, you know, little hotel company that's just, you know, doing a revenue share thing with you. We have total control of this thing. do I think RH Residences could be a big idea? I really do. I'm fascinated with it. I'm fascinated with selling spaces because when I go on Zillow and I go on Redfin and I look at the level of taste the design I see crappy architecture I see non-existent interior design and I'm like man people with a lot of money don't have The ability or access to make their home look amazing. Like, why doesn't everybody have an incredible, inspiring home, especially if you can afford it? Why? Because it's really hard to do and there's nowhere to do it. And by the way, why wouldn't you buy homes that are fully furnished, that are perfect, that you just like, you know, you buy it and give you the key and you move in. you don't have to spend a year or two or three or four or five or never get your home done most people just never finish it like so like you know Eri said to me a long time ago like like hey they don't sell you a car without an interior you know sit there and try to figure out the interior car yeah you get to pick the color you want tan you want black you want you know so I just think that I'm fascinated with the fact that there's so little great architecture Such little great design. I mean, start in any market you want. Like, you want to go to Marin right now. I think the most expensive house is $43 million. Just click down and tell me what you think of the architecture, the landscape architecture, the interior design, the furnishings, the taste, the style. It could be massive. Could be massive. If you said like, hey, is there an acquisition we make someday? I don't know. maybe we buy one of the big home builders and we infuse them with great taste. Now I'm not saying we're going to do that, but you know, if you want to think big, you know, I mean, there's like, I think we can create an entirely new market for, for residences, whether they're condominiums or homes or single homes and communities and, and things like that. And you'll hear more about this. Yeah. We'll, we'll, you know, we, we are pursuing opportunities and, in the spaces and places part of our strategy. And you'll hear about our first tests of our residences. But whether it's home condominiums, whether it's luxury rentals, huge opportunity. The market's full of crap out there. It's a massive opportunity.

Got it, got it. That's very helpful information. as always. Thanks, guys.

Thank you. Happy holidays.

You too. Thank you. Our final question comes from Seth Vachon of WebBush Securities. Your line is open.

Hey, good evening. Seth Vachon 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 of gross margin expansion, but could you help us understand how much the revenue mix shift away from hospitality and outlet helped increase gross margins in the third quarter?

From a product margin point of view or hospitality margins, like, you know, quite good. You obviously have a higher mix of employment, but we're also – operating the restaurants at very low levels of productivity and we're keeping people employed. So we've actually got a pretty big drag from restaurants overall to the business.

A slight lift in the margin, but very slight. Very slight.

It's not enough sales. Yeah, it's not enough sales to make a big impact. Yeah, so... And then the outlet, yeah, we've kind of given you directionally, that's year over year, that's been a big driver because we redesigned and reconceptualized the whole reverse logistics business.

Yes, of the 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. Those are the big pieces of the 530.

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

Very helpful. Thanks. And then 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 plans associated with that business?

Well, interior design is out there, right? And it's, you know, I think today we must be the biggest residential interior design firm, you know, in North America. If you look at the work that we do and the projects that we do. Architecture and landscape architecture will begin to test that I gave you a bigger vision for that, how it's going to be within the world of RH. But we were going to move more quickly. We pushed some of the plans out a bit because of the pandemic, but we're looking at testing our first kind of freestanding architecture, interior design and landscape architecture studio in a design district that will support many of our galleries in a market. So the way to think about it is where you see today, if you've been into one of our new galleries, one of our prototypes where kind of the back part, you look through the staircase, there's a big glass wall with desks and it's right next to our design atelier. where all of our interior designers have their offices. And that says right now RH Interior Design. Long-term, we believe it will say RH Architecture, Interior Design, and Landscape Architecture. And I think about the galleries because they are a manifestation of great architecture, great interior design, and great landscape architecture. We'll 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. You know, landscape architects, like where do you find one? Like, you know, interior designers, again, not a consumer-facing business. So inside these big, you know, magnificent galleries that are an example of all those disciplines, It only makes sense that people would go, oh, I can't tell you how many times people are in our galleries that ask us who the architect is. How many people ask us, oh, who did the landscape architecture? Who did the landscaping here? They obviously know we did the interior design. So we think there's an opportunity to continue to elevate and amplify the core business by expanding our services business which is a very capital light business if you think about it, right? It's not a lot of capital to make the investment to add those services and those services don't face the consumer in a very compelling way. And there are things that we already do really well, right? We now do almost all of our architecture internally, right? Very little externally. We have a great internal architecture team We do all of our landscape architecture internally. We do all of our interior design internally. And so they're competencies of our company, and it's just building out the teams kind of market by market, right? And just as we did with interior design, I see it no differently than interior design. It'll take us several years to kind of do it, and we'll learn and we'll roll it out. But we've set up kind of the galleries, the new galleries, to accept those businesses. Now, we may need support offices behind the scenes. We'll interface with the customer there. We'll catch them there. We'll consult with them there. We'll make the initial connection. But we probably will need some office space to support those businesses. But that office space can be anywhere, right? It's not high-cost real estate. You're not paying premium retail real estate for the back-of-house offices. We do all of our meetings in the galleries, but we might have to house more team members doing the production work on the architecture or the landscape architecture and things like that. So we think it's very logical for us to pursue the services side of the business. And we think we're really well positioned to capitalize on it. And we have the confidence, right? It is what we do.

that's helpful just to clarify Gary I know you don't charge for the interior design services now and unless I'm 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 uh how we think about the interior design piece we're still noodling with that we we uh

We believe at some point we'll probably charge for that. But we may not need to. I'm not sure, honestly. I mean, I go back and forth on that one all the time. So more to come. Our thoughts will develop there more. But I think as we test this and kind of get our arms around it, and we'll probably start it here locally. I guess I could say what we're thinking of doing, right? I reserve the right to change our mind. Our plans, we're 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 out to San Francisco, let us know. We'll get you a seat at the restaurant. It's going to be a spectacular restaurant. It'll be the first restaurant with our – we're actually testing our new guest house concept and menu there. It'll be kind of a dual restaurant. We'll have a live fire cooking kind of component to it that's really great. But we're going to have 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 – as you know, if you've been in San Francisco, one of the great learnings for us was 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 to the center of the design district and said we got to put our brand among the very best. I remember the headline in the in the local San Francisco paper was there goes the neighborhood, you know, chain store going into the design district, right? So, you know, we did pretty good work. We opened a beautiful gallery there. I think we exceeded people's expectations. And it became really fantastic for business. That gallery does like 20 million, right? Yeah, something like that in 4,500 square feet. Incredibly, it was one of our best real estate moves ever. We bought the little building that things were, three and a half million bucks. But we have this charming building with this beautiful garden courtyard and we've learned so much being in that building. And yeah, we could probably sell the building for 10 million bucks or something. And we're thinking, you know, we're right in the center of 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'll do with it. Exactly when we start... Not sure yet. You know, we've got a lot of big rocks we're moving in different parts of the business right now and just want to make sure we do this one well. And, you know, we have a team in place that can, you know, really position this well and make a great first impression as we enter this services business. But that's that's what you can expect from us I think well now that I've said it what I like is that we're committed to it right I kind of we've been talking about it but now we're we're committed so it will happen but but if it works I think there's it just opens up another aperture of business for us right if all of a sudden we we become the architect for people's homes you're just going to sell them a lot more furniture and for lighting and accessories and rugs 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'm showing no further questions. I'm going to try to call back over to management for an closing remark.

Great. Well, thank you, everyone. I want to especially thank 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 the people you know who have been infected by this virus and have family members and loved ones impacted and you know thanks to all the people on the front lines that are you know just you know working to keep us safe and get us through this and you know it's been just a very you know mixed feelings, right? Like from our company, when there's so many people suffering and your business is doing well and you're 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, you know, will continue to evolve and improve, and we'll 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, that's in our call centers, that's in our distribution centers, and delivering our products into our customers' homes, they've they've had to walk a fine line, right? And being on the front lines and, you know, especially want to thank those teams who have represented our company and our brand so well, you know, through these challenging times. So we wish everyone a wonderful holiday and a safe holiday. And, you know, here's to getting to the other side of this and, you know, 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