Restoration Hardware Holdings Inc. (RH) Q3 2020 Earnings Call Transcript

Restoration Hardware Holdings Inc. (NYSE: RH) Q3 2020 earnings call dated Dec. 09, 2020

Corporate Participants:

Gary Friedman — Chairman and Chief Executive Officer

Allison Malkin — Investor Relations, ICR

Jack Preston — Chief Financial Officer

Analysts:

Adrienne Yih — Barclays — Analyst

Max Rakhlenko — Cowen and Company — Analyst

Steven Forbes — Guggenheim — Analyst

Chuck Grom — Gordon Haskett Research Advisors — Analyst

Michael Lasser — UBS — Analyst

Curtis Nagle — Bank of America — Analyst

Bradley Thomas — KeyBanc Capital Markets — Analyst

Tami Zakaria — J.P. Morgan — Analyst

Seth Basham — Wedbush Securities — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the RH Third Quarter 2020 Q&A Conference Call. [Operator Instructions] I will now turn the call over to your host, Ms. Allison Malkin of ICR.

Gary Friedman — Chairman and Chief Executive Officer

Allison are you on mute?

Sorry. I think we’re ready to go right into Q&A.

Allison Malkin — Investor Relations, ICR

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.

Questions and Answers:

Operator

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

Adrienne Yih — Barclays — Analyst

Great. Thank you very much. And I just have to say wow. I mean this is a really remarkable performance. So congratulations to everybody at RH. Gary, I guess my first question for you is in the past you’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, how long have the — what’s been 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 impact to your business from that?

And then my second question is the sales galleries in Europe, what size will they be and how should we think about, I guess, the annual sales contribution of each of those? Thank you very much and congratulations.

Gary Friedman — Chairman and Chief Executive Officer

Thank you. Thank you. It’s hard to be specific on duration. I think it depends on severity of corrections in any of the markets. Particularly we’ve seen as you know with sharp stock market moves, it sometimes will pause consumers at the high end. So hard for us to kind of give you a number or a 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, gees how do you feel about the cities you have galleries in that are consumers are moving out of some of the key dense cities based on pandemic and there is a boom in 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. We have galleries in every major markets. So that will — 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, it is 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 is usually a longer tail there because anybody on the phone knows that if you bought a new house or moved into a new house and it triggers a lot of spending on the home and it’s not an easy job. It takes a long time. So we think that the tails from just the housing market move looks pretty good. It’s hard to say today what’s going to happen with the stock market and how the market is going to read what happens next in the pandemic. It’s hard for us to understand how the market will cycle through the stay-at-home stocks, as they call them, versus others. And we just — we try not to get too focused on those things we can’t control.

But as you think about the galleries in Europe and how you should think about the sales contribution, we think it’s very different obviously from the perspective of where — if you think about the US when we opened a new gallery with all of them replacing an existing gallery. So there is something very good about that and from the perspective that there is little risk and we have a lot of history, right.

We know we have a gallery assuming [Phonetic] $18 million and we opened 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 is more guesswork and there is less data to use.

Again we’re relatively very accurate on understanding what’s going to happen with our expansion in the US. And anything when we have kind of new markets that we opened in the US we’re relatively accurate in predicting the performance. So we had 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 are not opening a market, you’re opening a country, right. And — so I think about it — I think about it from the perspective of the UK. Just if you start there California today call it directionally $500 million market for the business without all the gallery conversions longer term probably it’s $700 million plus market for RH probably as we continue to expand the assortments and become a more disruptive dominant brand. California long term, maybe it’s close to $1 billion, $800 million. But it’s easy to see $700 million as you think about transforming California. We’ll take the UK as 68 million people, right, versus California 39 people — 39 million people. We’ve got similar demographics, similar wealth, populations and so on and so forth. Little bit change in the density. So you open 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 image and impact and kind of conversation point of view. 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 coolest house in Great Britain. But it’s kind of out from the population. It will create a lot of awareness of the brand.

And just because of the footprint and the uniqueness of the gallery and it’s got a great size. I think we’re 50,000-something square feet there with the three buildings. And then you have a very different one in Central London in Mayfair, right, where we’re right in the heart of it and we’re framed by Savile Row and Burlington Gardens and we’re block up New Bond Street and the flagship Ralph Lauren and the big project that LDMH is doing. And no one is going to — and all the wealthy people know it necessary. 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 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 — and it’s funny because I just wrote about physical first, right, and Aspen and it’s not that — people think, oh, he doesn’t believe in the Internet because he is 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, right. When we started here with these little stores and we had a little assortment and there is 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 re-entered the public market. But we still 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 and not limit them to the size of the store. And use the store 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 going to kind of play through when you think about moving into new countries, right.

Here we started with 106 stores and we kind of rightsized it down to we think 60-70 whatever it will end up being as we optimize the footprint. I don’t know if we have to have as many galleries in Europe, right because the Internet continues to be a better and better tool to shop or to convert, right. And so — so if you’re well positioned you may not need as many physical stores. It’s just that today we know what the physical stores do. We know we can double the business in every market from retail point of view. So when you open up a gallery or two in England again and greater the UK, we opened up a gallery in Paris, right, 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 asymmetrical risk to the upside from how we think about our business because we have been a company that had — before we are transforming our galleries when our galleries were undersized, 50% of our business was direct to customer, omnichannel, digital first, whatever you want to call it. We just call it online or on our website as words transacted.

And so we believe opening up markets is — opening up countries is a big deal, a really big deal. And that I think gives us asymmetrical risk to the upside, downside of maybe not having as much specific data, right. I could feel like that’s been the brand [Technical Issues] today with kind of the awareness we have today. And opening up California with a magnificent store in LA, right, at an incredible gallery, I don’t know, call it in the Napa Valley or somewhere that people visit in vacation and go to for weekend. So what does that [Technical Issues] we think it’s some kind of a really good outcome in our best view today.

Adrienne Yih — Barclays — Analyst

That’s very helpful. Thank you very much.

Gary Friedman — Chairman and Chief Executive Officer

Yeah.

Operator

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

Max Rakhlenko — Cowen and Company — Analyst

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 anticipated? And then just separately how are you guys thinking about cash allocation priorities at this point? Your free cash flow is starting to ramp and with fewer major capital-heavy projects as well as debt maturities, do you think we could see accelerated share repurchase, special dividends, M&A? Just want to get your thoughts on that. Thank you.

Gary Friedman — Chairman and Chief Executive Officer

Yeah. The cancel rates have been down for several quarters now. So the trend would indicate that there is not a risk, right. And I think there is not a risk because — one, because I don’t think we have a lot of direct competition at our — where we are in the market. We are one of the few people that stock higher-end luxury home furnishings. In most places it’s a much longer wait time, custom etc., etc. And I think that the consumer needs the product and I just don’t think anybody else is in stock, right. I mean, we are running the highest back orders in the history of the Company since I’ve been here 20 years now. So I’ve never seen this kind of phenomenon right. I have ever seen back orders at all-time highs and cancel rates at almost all-time lows, right.

So, one is that tells you the consumer price doesn’t have a lot of other choices. What choices they perceived they have also don’t have product to ship right away and they really need the product. So they are in many cases forced to wait, right. So you kind of go if I got — if I don’t order now how long might I wait, right. How many more weeks might the delay be. So the numbers would tell you over the last few quarters that there doesn’t look like a risk. Then that’s mean things won’t change. I just don’t see any reason for them to change. So our degree of confidence of converting the orders to revenues is very, very high, right. We have a lot of data now and it’s very, very consistent.

Back orders have trended lower, not higher. Back orders have been below a year ago and they were low, and not by backwards, assuming cancel rate below year ago and they are below year ago last year and as back orders have increased every quarter, right, because you can’t — when I will say our business started trending up we weren’t buying for [Indecipherable] trending up 20% and we’re buying for 20% also then they went up 30% and the new — they are buying for 30% and then it got 40%, you are like, go, do I even buy for 40%. Let me ask, wait a few more weeks and they go, okay, it looks like it’s trending, you buy for 40% on a compounded basis. Then they went for 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 there haven’t been impacted. And now I kind of have a more firm view that I don’t believe they will be. Does it mean we won’t be wrong about that, but that’s our view today.

And as we think about cash allocation priorities, look, we’re in a world where things are changing daily, right. Again, we just went into in the State of California shelter-in-place orders, right. Retail is operating at 20% capacity. The malls and the shopping centers have less traffic than they have 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. And in discussing with other retailers and leaders in the business people saw a massive fall off during that period. Like we’re sitting here going, oh, oh, like can 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 have passed Cyber Monday our business started to ramp back up. So when you’re in a kind of a business situation with so many unknowns that we are in whether you have a headwind or tailwind doesn’t — for me, it doesn’t really matter. I mean we have more optionality with the tailwind.

Am I — do I feel better being on this side of the table than maybe apparel people or people have their business or restaurants and I feel a lot of their business devastated, yeah, of course you choose the side we’re on. But 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 will create — that you believe will create significant shareholder value long term. And I think we’ve proven based on big decisions we made and from moving from a promotional model to a membership model. And when I talked about having a march to help 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. And a short-term noise as we are doing that and we stayed focused on where — how we could create long-term value. And that hasn’t changed and that’s why I wrote one of my longer shareholder letters hare, 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 M&A or other things we’re always going to be opportunistic. But it’s just hard to kind of commit to too many things today. I mean we were pretty certain we are going to open RH England. And I will send travel checks down in the UK and we can’t go unless we quarantine for two weeks. And you can’t send your leadership team and other people to go quarantine in a hotel for two weeks to work two days and come back. And so we just decided like, yeah, not a good time. We had to make a decision to commit to distribution infrastructure and other investments and people and so on and so forth and we’ve said like, yeah, flip 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 will be more prepared, we’ll do a better job, we’ll have more visibility, we will understand what this looks like in the other side of the pandemic.

So right now I’d just say too many moving parts to be committed to kind of any kind of specific activity. If the right thing comes along that have asymmetrical risk to the upside that there is real opportunity. We’ll do those things. We’ve made some small acquisitions, I think you’ll read about in our filings they are not really material, but we’re taking opportunities to do things that will elevate the brand and invest in the brand and we’ll continue to do things like that. Were we going to make significant share buybacks, with all the uncertainty, I don’t think so. Not right now. I think let’s let things pass and I think it’s no different than — look, I think we are very smart if not raising debt right away. We — when also as pandemic hit and our business went down, our business moved 50 points, right. And everybody is like do you have enough cash is what this look like and we researched it, we created a lot of optionality, we have a lot of choices to raise capital. The interest rates would have been really high, would have been very expensive money and it might have bought us some optionality. But 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 almost 60% of the Company at $1.2 billion. We didn’t see it as risky right because we understood what was going to happen. We understood we are going to re-architect the supply chain. It takes $400 million to $500 million out of inventory.

We knew what would happen. We had really good assumptions. So I’d 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 it 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. Tried to — I kind of look at this as look at this over a two-year period, right. Fiscal ’21 is — excuse me, fiscal ’20 is 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 would characterize our frame of mind today.

Max Rakhlenko — Cowen and Company — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Thank you. Happy holidays to you.

Operator

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

Steven Forbes — Guggenheim — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Sure. Not dropping the source book in the fall with the decision based on the fact that inventory was chasing demand massively and we were only going to create a greater pressure and possibly not satisfied, just have customers frustrated with us and so on and so forth. So did we give up top line in by not mailing book, sure. If we were to mail the books would there have been incremental top line, 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 optimize the business in this time of the pandemic, 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 bounce back to what it was up 39, right, up 39 with no books, 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 so could we have been up 48 or 52, maybe, but our business would have been messier. And it’s never good to kind of creative a messy business. I mean I have run those before. This Company was run in a messy way before in a chaotic way. It’s just no different than — it’s pretty clear if you just look at the e-mails you receive in your in boxes that there is 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 trying to fuel the fire with increased promotions. I think that’s — I think that’s not a good long-term view because then you’re up against all that next year when you’ve got to cycle these difficult comparisons. I look at next — I hadn’t next year ago, feel really good.

We’ve got a cycle demand of up 40. Maybe the fourth quarter will be less than that, because we didn’t mail the book. So we don’t have the newness, but next year we’re going to have a lot of newness. And we’re going to really thoughtful constructed and architected assortments and that will 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 of next year — about next year, unless something big happens, unless we have a stock market crash and the bottom falls out of the home — the home business. But for the most part I like how next year is shaping up because of the decisions we made. I think we’re very excited. I think tremendous new product in the pipeline, almost too much. You got to make sure we’re being disciplined about our investments from an inventory point of view in our risk, our newness, but it’s a lot of great newness and I think RH Contemporary is going to open up an entirely another new layer of the market, right, that’s for us. It’s going to bridge the gap between kind of the — kind of class — updated classics of interiors and more 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 own unique point of view.

And I think it’s going to be really exciting to the consumer. And we’ve got some tremendous new talent from a design and artisan point of view coming onto the platform. I don’t know if anybody has picked up the new Architectural Digest but you’ll read a two-page article about Alison Berger coming under a platform with some incredible new lighting designs. And Alison is one of the great lighting designers and glass designers in the world today. I mean she sells exclusively on Holly Hunt’s platform which Holly Hunt has been known as the best high-end interior design showroom in the United States. And you have someone like Alison come over to our platform kind of fits things again right. So this is 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. merchandizing capability and so on and so forth.

So I guess the way to think about it is, there is going to be a balancing right of kind 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, right, and with more newness because you’re going to have Contemporary 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 these — you can’t — it would be foolish to think like this thing lasts for a real long time, not at this level. Like we think you’re going to cycle it’s going to normalize. There is 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 going to 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 going to elevate the RH brand and render our brand more valuable in the marketplace, more desirable, more unique, more authentic and that are going to have a lasting value because it’s — look our stock went up $120 or $130 in the last 30 days or something like that. The stock is going to move around, 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 right and managers generally arrange and organize the status quo and try to protect the present. We are 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 they’ve never been, doing things they’ve never done, right and they’re building things and they’re building value and that’s the culture of our company. If you walked in our center of innovation you’d walk through a portal that says RH, the home the extraordinary, the remarkable and the amazing, right, because that’s how we think, right. What are we focused on that’s extraordinary, remarkable and amazing, that’s the kind of work — that’s 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.

Steven Forbes — Guggenheim — Analyst

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

Jack Preston — Chief Financial Officer

So if 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 and look some of the things I like to continued strength in gross margin and product margin like that is a strong part of the story. And when we look out and are confident to reach 25% margin in our outlook, our longer-term outlook, I mean those are the strong elements of the story.

As far as like specific elements in 2021, we’re not in a position to provide it at this time. I’d look to Gary if there’s anything else.

Gary Friedman — Chairman and Chief Executive Officer

No, I mean, look we believe we’re going to have a double-digit revenue growth and expanding operating margins. We’ll know more each week, each month as the pandemic kind of plays out here and the world returns to some kind of a more normalized environment for people, how people are going to behave and what’s going to happen. But we’re not going to get out over our skis from a cost point of view, right. And if you can’t that we’re in kind of a temporal environment, you’ve got to be smart about that. So 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 what we believe can be the margin structure from a product point of view which is the key lever and expenses we’re pretty disciplined around here from an investment point of view. 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 — 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 and we’ll continue to do great work. So I don’t think there is any other people that are giving you much more data than we’re giving you today. The shareholder letter has a lot in it.

Steven Forbes — Guggenheim — Analyst

Thank you both. Happy holidays.

Gary Friedman — Chairman and Chief Executive Officer

Happy holidays, Steve.

Operator

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

Chuck Grom — Gordon Haskett Research Advisors — Analyst

Hey. Thanks. Good evening. Can you guys put in just 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 are up I believe over 60% year-over-year and then you’re demand comp which is lower than that. Just wonder if you could connect those two dots for us.

Gary Friedman — Chairman and Chief Executive Officer

Yeah, I think look outdoor — I’d say outdoor business is a lot like the general RH business. I think when you build a brand like ours you in many ways are creating the market. And you’re inspiring people to purchase and invest versus other purchases and investments they may have made based on what they see. And no different than Apple created a new market. They didn’t look 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, right, to disproportionately expand the market because you’re putting something out there that wasn’t there before, right. And I think that’s happening in many places, right, and look at a lot of brands that are creating new markets.

So in outdoor it’s much of the same. If you just sit back and said where do you go by outdoor furniture, there is not a lot of consumer facing outdoor furniture stores right. There are kind of out off-the-beaten trail kind of in weird places, you can come up with the names you driven by and before. But if it’s high-end outdoor furniture where do you go, where do you even see it. Where do you can get inspired to buy it? It’s no one really presenting, it tends to be more seasonal in nature as far as the peaks of the business. Yeah, I used to joke around to tell people here is what you might remember a business called Smith & Hawken right. And they opened like 50 stores and then almost went bankrupt and they took another go at it.

And I’d say why didn’t is Smith & Hawkins make any money and since we don’t know I said will for the most part, they had to pay rent right 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 we’ve — in our new galleries we present somewhere between 20 and 30 outdoor collection 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 in this current environment we’re creating a new market and we’re creating new marketing outdoor furniture at a very high return on invested capital. So we really like that business.

And you say why can’t other people do that. Well, other people don’t build galleries as big as we do. So their rooftops never be as big or they don’t control the real estate like we do and they don’t — it’s very hard to emulate what we’re doing, right. And why the physical nature of our business is so important, right. Like I would say that a website is an invisible store right. You don’t see it, you don’t pass it, you have to be prompted to go to it. And these physical stores people drive by, they see if you’re in the right locations, you are in the — you’re going to be constantly visible and you can present products and categories in ways that you can’t online where the online — in online this is very democratic, right. Everybody has the same size screen. Holy’s home store can look as big as RH online. I don’t want to say Holy’s home starts, nobody named Holy, it just refers to a higher end local furniture specialty store that someone is running. But those kind of businesses can 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 most more importantly than taking share you’re creating a new market and that’s how we think about it. And then Jacking will comment on [Indecipherable] deposits and revenue,

Jack Preston — Chief Financial Officer

Yeah, I mean obviously with the strength of the business and the high demand and the supply chain constraints we talked about, those are the two items, two key items that you are going to see that grow with customer deposits and deferred — the special order business that we have that grows those customer deposits.

And then as the business grows, 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’s a — That was 18% build. So I think you’re going to look at Bob, don’t get me wrong, but I think as far as impact from walking down from demand down to revenue growth to come and look at that sequential build. So like I said, that was an 18% growth most and very much expected relative to the trajectory of the business.

Chuck Grom — Gordon Haskett Research Advisors — Analyst

That’s a good color looking at it sequentially then. And then just my follow-up would be, just wondering if you guys inspiring 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?

Jack Preston — Chief Financial Officer

We’ve looked at the data, Chuck. Look the data is what exactly we would expected that suburban homes have high growth rate. Second home markets have the highest growth rates. And then you have, as Gary talked about, an exodus out of cities. But again we are in all these markets and our customers, whether they have a primary home in a urban market and happen to be moving out there, it’s all at the end of day good for our business.

We haven’t gone into much more detail but I think the trends like I said, that hierarchy of second home having strongest growth, suburban very strong growth and urban being the weakest of the three kind of a firm grasp of the obvious as we say sometimes. But I am not sure Gary if you have got anything else there.

Gary Friedman — Chairman and Chief Executive Officer

No, no. I mean, look our business, okay, has always been our biggest part of our business is just the suburban market business, right. It’s just where more large homes are, where those large homes have more bedrooms, more living space, outdoor furniture space so on and so forth and no surprise is the largest part of our business. And so the suburban market, which is significantly large part of our business has tailwind and there is people moving to it.

That’s good for us. But it’s — again it’s — we know all the data we’ve guided. We will look at it. I don’t know if any of it tells us to do anything differently or to expect anything differently. There’s not like markets we go, oh my god, they are buying homes there and they don’t know about us. So let’s rush to open a gallery or a stuff like that. I mean some place you go okay, we’ve been looking in palm desert Southern California for years and it’s on fire and that staff who is our Chief Gallery Officer went to his grandparents over Thanksgiving and said we really, really need a gallery there. And unless you feel as strongly about it, go find a location will give them quickly, I mean it’s not like — it’s not like oh, my god. They are going to change so much despite a little mark there.

We’re really well positioned in North America to capitalize based on anyway it shifts within the market. We just lighted the markets up, right. We’re well positioned to capitalize, no matter where they’re moving in North America. I think the only place like we were not represented in Montreal, and we’re not represented in Hawaii. I’m trying to think. So there is a couple of places like that.

Jack Preston — Chief Financial Officer

Naples.

Gary Friedman — Chairman and Chief Executive Officer

Yeah, yeah. We’re not in Naples.

Jack Preston — Chief Financial Officer

Yeah.

Gary Friedman — Chairman and Chief Executive Officer

We plan to be in Naples. But we do great business in Naples, even though we’re not there.

Chuck Grom — Gordon Haskett Research Advisors — Analyst

Got it. Thanks very much.

Operator

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

Michael Lasser — UBS — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Well, our interior design business keeps growing and has been growing and so you would be thinking a big move like this. It’s kind of every things listed here. Something have shifted. We had outdoor was off the charts in the beginning because a lot of people I think realized they are not going to travel for the summer and they spend a lot more time at home. But the consumer behavior hasn’t — it’s no different than what you would expect with demand like this. It’s been new customers, higher spends from existing customers and so on so forth the metrics don’t make us think about doing anything meaningfully differently than what we’re doing.

So our businesses has been growing. If you think about size of basket and so on and so forth it’s because we moved the business from just conceptualizing selling product to creating product to conceptualizing the selling spaces and the efforts behind building an entire interior design platform on a national scale. If you go into our new galleries and you see the dedicated office space for our interior designers and the design affiliates and the meeting rooms and the space we’ve designed it will tell you that obviously is something we’re investing into. And then we think that’s going to create strategic separation for a long time to come. 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 in over the next decade, which I, try to give people a view at and told you what’s sitting behind me and I am looking. Yeah, no one’s changed the whiteboard, so same whiteboard. That’s how we think about the business.

I have always said people ask [Indecipherable] buy your stock, and I always say ask the same question, are you an investor or are you a trader. If you’re a trader and you’re focused on short-term episodic swings in the stock market or 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 nights. Yeah, 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, we are, you’d say, hey, wish I just hang on RH stock.

If I look at — you look at our biggest shareholder today is Fidelity. And the team at Fidelity who has been there the whole time has held our stock. They have held 15% of our stock. At one point it went up to almost 30% because we bought that back at the Company and they had a restriction that we can hold that much. But they would have liked. But that team has not sold their stock at all since the IPO and I think they feel pretty good that they have invested in stock when we went public at 24 [Phonetic] and continued to invest and it looks like a good investment. Even though it’s went crazily up and down, right. I’m one of the biggest shareholders in the company and people ask me on days when the stock does really well. If stock does really bad it’s like look I don’t think about that. If you think about this as a long-term investment this is a great place to invest.

And I think the character in the makeup of our shareholder base would tell you the same thing. So — yeah.

Michael Lasser — UBS — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Look the model is going to continue to evolve, right. Just take a simple move in our model and say, hey, we went from a legacy galleries to a design gallery. And that design gallery will essentially double the business over in one to three years. We’re not going to mail anymore Sourcebooks into that market. We generally don’t. We maybe do a little splash because we’re opening the new galleries of people are aware of it. But our at cost at that level right leverages massively. And I think people sometimes miss that in a model like ours, right, because they see this gallery and they go home, that’s cost a lot of money and much more expensive and they don’t think about the dynamics of what happens, okay, because no one’s ever taken a really productive and a legacy store like we have and then able to just change the footprint and basically double their business.

I’ve never seen it before consistently across the entire country, we can do that. And so when you think about ad cost 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 the book, are there things we can learn there. Yeah, but it’s really — it’s a little tricky. I’d like as we go to reinvest and mail the book we mail as much as last year, we do mail more, do we e mail less, do we — what do we test. I mean there’s going — we are going to look at a lot of data. We’re going to run the models. We’re always looking for opportunities to be more efficient to optimize. You also don’t want to under-invest in the business sometimes. So — but our model — again, all the way through, you think about doubling your revenue at retail, which is the biggest part of our business, in a market and what that does to the cost structure at the corporate, with that cost structure against all the other operating areas, our distribution centers and so on 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 a — kind of being consistently unsatisfied with whatever today’s performances is, which is our culture, you’re always looking at how to do things better. And so, it’s 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, yeah, whether it’s labor savings, it’s not so much labor savings. It’s leverage on investments [Phonetic] and strategies for doing that are making the business just more and more profitable. Right? So — and we have a lot of things happening that we believe will do that. And 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. Everybody was like, oh, you can’t be 10% operating margin. Like — and then we hit 11.4%, right? And what — I can remember reading reports on the Company, oh 11.4%, no one’s like it’s higher than whoever and it’s unsustainable, right? They only have half the revenues of this other company that their high was 10% or whatnot. And this 11.4% is unsustainable and we’d be — we hit 14.1% operating margin, and it’s like — everybody is like, it’s unsustainable.

Now, we’re going to 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 mushed 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 we would hit 22%? It’s not like the pandemic, from a revenue point of view, has enabled our operating margin this year. It really has it. If anything, it’s deleveraged our operating margin this year. Made us less efficient when — you look at how things are happening.

I think about this, we’re generating like roughly $80 million to $100 million of future revenue. We spent all the money like engaging all the customers, helping all the customers, doing all the design work and we’re getting no revenues this year, that $80 million to $100 million. Put that $80 million to $100 million in your model this year, and what would the operating margins for RH be? Because there wouldn’t really be much more cost, right? Like most of the cost is already behind us, we would had shipping and stuff like that, but you look at the flow through on that you go operating margins would be higher than 21%, right? Like that’s what I focus on. I focus on — wait a minute, I’m 7% operating margin, they hit 21%. They were — we thought they were higher 14%. 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 we — 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, if we don’t go into a recession. If we go into recession and stuff right, there, it will be reset. It will take a little longer, but if we don’t, and if the economy continues to just perform like if we just grow at 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 — hand her [Phonetic] over. And so, we wouldn’t tell you double digits if we didn’t really think it looks pretty certain. Even, like — not expecting the trends in the second half of next year, we think when we anniversary those numbers, it’s not going to look like this, but we can look ahead and say, here is all the things we’re doing, that will create upside. Here’s what’s going to cycle forward, and 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. If that was — it’s the very high volume restaurant. And once the vaccines get out there, people are going to start going back to restaurants.

By the way, if you think about all the traffic we launched 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 — I don’t know within the last few — I think 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. Whole lot people discovering a lot of new product. Whole lot of people, hopefully, be inspired by our environments. And there’s going to be kind of tailwinds here. But the real point is, like don’t get lost in the pandemic, right? Like it’s a crazy year, right, down in the first quarter, stores closed, stores closed part of the second quarter. Things all of a sudden swing back. I kind of wash it all away and go, revenues up 7%. Looks like, okay, we are a little behind our 8% to 12% growth, but operating margins are going to be 21%.

I really like this model. This is a really good model. Like it’s — I wouldn’t bet against this team. 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’ve transformed the entire Company on so many levels. And now we’ve got a 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 making things great. So, I just — I like the path we’re on.

And as a big shareholder here, 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 is all nodding and smiling, right? Like, we look at this. We are deep thinkers. We look at a long-term view. And so, I know you have a lot of customers that are real short-term focused. That’s okay. Like, don’t buy our stock. Like, if they want it — if they want to own one stock with a long-term view, it’s a good place.

Michael Lasser — UBS — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Thank you.

Operator

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

Curtis Nagle — Bank of America — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

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 — I mean, we’re — we might be too excited about it, right? If anything last night late as selling area like, okay. So, 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, we just think it’s going to open the aperture of the brand.

And we’re really excited about Color, too. We just can’t do everything at once and we keep kicking the can down the road at Color. We got — I think we are starting to zero in on RH Color. It’s a tough one, right? We’re a neutral space brand. We’re kind of famous for our look and point of view. In fact, we’re so famous for it that — people that like Color kind of hate our brand almost, like it offends them that there’s not a lot of color in RH. 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 most great design is a reflection of human design. That’s why it’s familiar and comfortable with it and that’s why you go, ah, because it’s a reflection of self. But we do think that there is a market for Color. It’s not the biggest part of the market. But that will open up the aperture of the brand.

So, just no different than Beach House and Ski House opened up the aperture of the brand. And people talk like relatively small introductions, right, small books, but a big conversation. I can’t tell you how many people have said, oh, I’ve got your Ski House book, I can’t wait. We were doing, wow, we got your Beach House book 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, right? And Contemporary is going to create another conversation. Color is going to create another conversation. You just have to do these things really, really well. But you should be really excited about it because we’re really excited about it.

And it’s — what exactly does it look like? I mean, I can’t say that. And that was their remarks. Yeah. It’s going to look very new and fresh. But again, we like to say the things that’s really do well are fresh, yet familiar, right? 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 is a familiarity to it and there is kind of really great historic design references that make it familiar. So, when we get things that are fresh and familiar, they are usually really good.

Curtis Nagle — Bank of America — Analyst

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 US at some point in time when you get a little bit 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?

Gary Friedman — Chairman and Chief Executive Officer

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

Jack Preston — Chief Financial Officer

Less than a 1%. [Speech Overlap] Yeah. You’re right.

Gary Friedman — Chairman and Chief Executive Officer

It’s almost — it’s at 0% almost, right? Like we don’t really sell anything. It used to be like a 1% or 2%, and now it’s almost 0%. We just — yeah, we’ve gotten rid of the holiday stuff. We got rid of the ornaments and everything. So, yeah, every once in a while someone buys some towels or something like — and walks out with them. For the most part, we don’t really inventory anything in our stores. So, our model has — is very simplistic versus other models, like, someone’s saying to me, like, oh, well, Home Depot or Target or other people didn’t do so well over — in Europe or other — yeah. Well, one, those are kind of stores not brands, right? They are stores selling other people’s brands.

Most high-end luxury brands work really well globally, right? And if you’re the best in your kind of category and we believe we are, then those brands do — they usually do exponentially better than others. And so — and then — and it just seems 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 margin structure, how we think about it, the pricing. All the different nuances and really, really 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, yet minor expense deleverage as you ramp up the infrastructure, but that might take care of itself relatively quickly because of the broad-based market you are going to address by opening and just — by opening it just in the UK, 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, right, 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 are looking at, it’s going to be a great new learning. I mean, I really — as much I really didn’t want to delay it, it was just the right business decision to do it, because we’re so anxious to learn. But I think what you are saying is directionally right. I think it should be based on other points of reference, more profitable or at least as profitable as our US business. But it should create leverage, right? So the net-net effect should be overall RH margins going up.

Curtis Nagle — Bank of America — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Thank you. Happy holidays to you.

Jack Preston — Chief Financial Officer

Operator?

Allison Malkin — Investor Relations, ICR

Valerie?

Jack Preston — Chief Financial Officer

Operator?

Gary Friedman — Chairman and Chief Executive Officer

Is that our last question or is the operator…

Jack Preston — Chief Financial Officer

We saw three…

Allison Malkin — Investor Relations, ICR

No. There [Speech Overlap]

Gary Friedman — Chairman and Chief Executive Officer

Three more.

Allison Malkin — Investor Relations, ICR

There’s two more.

Gary Friedman — Chairman and Chief Executive Officer

Two more? Okay.

Jack Preston — Chief Financial Officer

Two more. We lost our operator?

Operator

Pardon, Mr. Thomas. Your line is open.

Bradley Thomas — KeyBanc Capital Markets — Analyst

Hi, Gary and Jack. Can you hear me?

Gary Friedman — Chairman and Chief Executive Officer

We can hear you.

Jack Preston — Chief Financial Officer

Hey, Brad.

Bradley Thomas — KeyBanc Capital Markets — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

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

Jack Preston — Chief Financial Officer

Yeah.

Gary Friedman — Chairman and Chief Executive Officer

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

So, yeah, I don’t know, Jack, do you want to add something?

Jack Preston — Chief Financial Officer

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, to get the year at — to 21%, obviously, that implies just shy of 21% for Q4. And I think Gary spoke to the — you can’t look at the same sequential trends because Q3 has the advertising benefit.

And so, I was going to make similar comments on the cycling, right? So like the rug business we had talked about 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 year, that will be fully cycled. Outlet will have a different dynamic. But directionally, I think those are some of the pieces.

Bradley Thomas — KeyBanc Capital Markets — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

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

Bradley Thomas — KeyBanc Capital Markets — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Great. Thank you, Brad.

Jack Preston — Chief Financial Officer

Thanks, Brad.

Gary Friedman — Chairman and Chief Executive Officer

Happy holidays to you.

Operator

Thank you. Our next question comes from Tami Zakaria from J.P. Morgan. Your line is open.

Tami Zakaria — J.P. Morgan — Analyst

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 margin. So, what’s really driving that optimism of 10% to 15% versus 8% to 12% that you’ve been speaking of prior to this trend? Do you need all the new businesses to come to life, like the Yacht and the RH Residences business to come to life to get there? Or can you get to that 10% to 15% with the existing home furnishings business alone?

Gary Friedman — Chairman and Chief Executive Officer

Yeah. First, let me kind of characterize that what — I gave you kind of our internal view of what’s possible, right, not necessarily our guidance. And we’re — obviously, you can always have a view internally of what can happen.

I’d start with — if you just kind of thought about — if you take the belief that, hey, RH is building one of the dominant — one of the kind of premier luxury brands in its space in the world. And if it performs like other luxury brands, and you think about the — just the market at a global level, it would imply that 25% of our business should be kind of in the US/North America and 75% of our business should be outside of the US, right? And we believe we can be $5 billion to $6 billion long-term in North America. That would imply that we’d be a $20 billion to $24 billion global brand as architected today.

The Yacht is at a brand-elevating conversation, right? There is some people that are spending money like everybody else on digital marketing, doing things that nobody talks about. We mentioned a Yacht and a lot of people are talking about it, right? And when you see it on our website in the world of RH, where 30-odd million people will see it every year, it’s going to be a pretty cool thing and a pretty big conversation for a pretty minor investment, right? And so, it’s not about how many people are going to be on the Yacht. It’s about how many people are going to appreciate the design, the creativity, the taste and style of the Yacht and how many people are going to be aware of it and talk about the Yacht, right?

And so, yeah, the Yacht is not a big growth story. The Yacht is a conversation, right? The Yachts would probably 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 — be places where they spend their time. If you’re going to — it’s not something in hospitality, where there’s a yacht or 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 earn their respect that they — you create a forced reconsideration of your brand, right? So — but the growth, like if you just said, hey, we’re going to get to — what’s the numbers, that was like 7.4% to 11.5%.

Jack Preston — Chief Financial Officer

The 11.5%, yeah. 7.4% to 11.5%.

Gary Friedman — Chairman and Chief Executive Officer

Yeah. 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 — 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 to we are, we have learned that supply chases demand. If you create demand, people will figure out how to supply that demand because there’s opportunities for people to benefit economically, right? And so, we believe we will create a market at the higher end. We believe that market has a potential for probably $20 billion to $25 billion globally and 10% to 15% annual sales growth could be possible.

I wouldn’t plug it into your models, but if you wanted to look at an upside model of what might potentially could be if we start opening countries, and opening countries is exponentially more valuable than opening stores in North America, that could accelerate our growth rate, right? I mean, we have people knocking down the door here, trying to partner with us, with our brand, wanting to partner with us in China, partner with us in the Middle East, partner with us in Europe, partner with us in South America, partner with us in Mexico. Like there is not — I don’t think there’s a country that’s unrepresented as far as people like 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 going to learn from that history. We’re going to probably go slower and with more control. And we’re going to 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? Like just I think any of these brands — I mean, you look for the right model, look at what Hermes is doing, look at what Chanel is doing, look at what the LVMH 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 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. I mean, their — the value has been significantly diminished because there is brands that had — too much of their distribution was controlled by department stores. Department stores is a decaying platform. Imagine if you were — you built a great brand and your distribution platform with predominantly department stores, and you don’t have control of your distribution channel. I mean, I think what Arnault [Phonetic] and the Kering group and 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. We — 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. It’s — and it’s so much different. Every decade, it’s exponentially easier to operate internationally. So — and that just is going to grow faster.

So, I just think that — could you — if you were — 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. From a revenue point of view? No. We will do revenues. So I think we’ve got like — we have 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 is a lot of demand for our boats, but that’s irrelevant from a revenue point of view. Do I think things like guesthouses 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. It’s not Marriott using our brand, and you have a bunch of bureaucrats with no taste kind of screwing up your brand. It’s not some other little hotel company that’s just doing a revenue share thing with you. We have total control of the segment.

Do I think RH Residences could be a big idea? I really do. I’m fascinated with it. So 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 I think it’s really hard to do and there’s no one 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 buy, they just give you the key and you move in. And 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 Eri said to me a long time ago, like, hey, they don’t sell you a car without an interior. You’re sitting there and trying to figure out the interior of your car. Yeah, you get to pick the color, you want tan, you want black, you want — so I just think that I’m fascinated with the fact that there is 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, it 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 homebuilders and we infuse them with great taste.

Now, I’m not saying we’re going to do that. But if you want to think big, I mean, there is like I think we can create an entirely new market for Residences, whether they’re condominiums or homes or single homes and communities and things like that. And you’ll hear more about this. We are pursuing opportunities in the spaces and places part of our strategy. And you’ll hear about our first tests of RH Residences. And — yeah. But whether it’s home condominiums, whether it’s luxury rentals, huge opportunity. The market is full of crap out there. Like it’s a massive opportunity.

Tami Zakaria — J.P. Morgan — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Thank you. Happy holidays.

Tami Zakaria — J.P. Morgan — Analyst

You too.

Operator

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

Seth Basham — Wedbush Securities — Analyst

Hi. Good evening. It’s Seth Basham here. Thanks for taking my question. The first question is just around understanding product margin in the quarter. Now, product margin expansion certainly drove the majority of your 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?

Gary Friedman — Chairman and Chief Executive Officer

From a product margin point of view, our hospitality margin is like 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, right? So, we’ve actually got a pretty big drag from the rest [Speech Overlap]

Jack Preston — Chief Financial Officer

Overall to the business.

Gary Friedman — Chairman and Chief Executive Officer

Overall to the business.

Jack Preston — Chief Financial Officer

A slight lift in the margin to — but very slight in the product margin.

Gary Friedman — Chairman and Chief Executive Officer

Very slight. It’s so small. There’s not enough sales.

Jack Preston — Chief Financial Officer

Yeah. There’s not enough sales to make a big impact.

Gary Friedman — Chairman and Chief Executive Officer

Yeah. Yeah. Yeah. So…

Jack Preston — Chief Financial Officer

Yeah. But…

Gary Friedman — Chairman and Chief Executive Officer

Yeah. 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.

Jack Preston — Chief Financial Officer

Yeah. So 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.

Gary Friedman — Chairman and Chief Executive Officer

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

Jack Preston — Chief Financial Officer

Absolutely.

Gary Friedman — Chairman and Chief Executive Officer

Yeah.

Seth Basham — Wedbush Securities — Analyst

Very helpful. Thanks. And then one item that — one area that we haven’t really discussed much on this call is the interior design architecture and landscape architecture opportunity. Could you just give us an update on your rollout plans associated with that business?

Gary Friedman — Chairman and Chief Executive Officer

Well, interior design is out there, right? And it’s — I think today, we must be the biggest residential interior design firm in North America if you look at the work that we do and the projects that we do. Architecture and landscape architecture, we’ll 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 we’ll — if — the way to think about it is where you see today, if you’ve been to one of our new galleries, one of our prototypes, where the kind of the back part through — you look through the staircase is a big glass wall with guests in, and it’s right next to our Design Atelier, where all 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 will have the only consumer-facing business of its kind like that. Most architects don’t have an office that anybody sees and most architect’s offices aren’t in great architecture necessarily. Landscape architects, like where do you find one? Like interior designers, again, not a consumer-facing business.

So, inside these big magnificent galleries that are an example of all those disciplines, it only makes sense that people would go, oh, I try to — 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 is 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.

So — 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’d see it no differently than interior design. It will 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 office. 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? We — it is what we do.

Seth Basham — Wedbush Securities — Analyst

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?

Gary Friedman — Chairman and Chief Executive Officer

Yeah. Yeah. For sure, the architecture and landscape architecture design services. How we think about the interior design piece, we’re still noodling with that. 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. Like — 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’re going to — we’ll probably start it here locally. I guess, I could say we’re thinking about doing it, right?

Like, yeah — I mean, and we could — I reserve the right to change our minds [Indecipherable]. But we — 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 you come out to San Francisco, let us know, we’ll get you to see the restaurant. It’s going to be a spectacular restaurant. It will be the first restaurant with our — we’re actually testing our new guesthouse concept and menu there. It will 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 a 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, we — 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 and Peak Gallery, and he built his 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 local San Francisco paper was, there goes to the neighborhood. Chain store going into the Design District, right? So, 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. We — that gallery does like $20 million — something like that in 4,500 square feet incredibly. It was one of our best real estate moves ever. We bought the little building, I think, for $3.5 million. But we have this charming building, which is beautiful garden courtyard, and we’ve learned so much being in that building and we could probably sell the building for $10 million or something. And we’re thinking, 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. 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 we have a team in place that can really position this well and make a great first impression as we enter this services business. But that’s what you can expect from us. I think we’ll — 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 committed, so it will happen. But if it works, I think it just opens up another aperture of business for us, right? If all of a sudden, we become the architect for people’s homes, you’re just going to sell them a lot more furniture and lighting and accessories and rugs and bath hardware and all the things we sell.

Seth Basham — Wedbush Securities — Analyst

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

Gary Friedman — Chairman and Chief Executive Officer

Thank you.

Jack Preston — Chief Financial Officer

Thanks, Seth.

Operator

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

Gary Friedman — Chairman and Chief Executive Officer

Great. Well, thank you, everyone. I want to especially thank our people and our partners around the world who have worked so hard through these challenging times to continue to elevate our brand and bring our vision to life each and every day. And also our thoughts and prayers go out to everyone who’s suffering through this pandemic, especially people who have been infected by this virus and have family members and loved ones impacted. And thanks to all the people on the front lines that are just working to keep us safe and get us through this.

And it’s been just a very mixed feelings, right? Like from our Company, you — again, when there are 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 will continue to evolve and improve and — yeah, 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 front line teams that is in our galleries, is in our call centers, is in our distribution centers and delivering our products into our customers’ homes. They’ve had to walk a fine line, right, and being on the front lines. And especially, I want to thank those teams who have represented our Company and our brand so well through these challenging times.

So, we wish everyone a wonderful holiday and a safe holiday. And here’s to getting to the other side of this and back to bright and sunny days for everyone on this planet. Thank you.

Operator

[Operator Closing Remarks]