Ladies and gentlemen, thank you for standing by, and welcome to the RH Second Quarter 2020 Earnings Conference Call. I would now like to hand the conference over to Ms. Allison Malkin. Thank you. Please go ahead.
Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter 2020 Q&A conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Jack Preston, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about our outlook for our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results.
Please also note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the investor relations section of our website at ir.rh.com. With that, I'll turn the call over to the operator to begin our Q&A session. Operator, we're ready for questions.
Ladies and gentlemen, as a reminder, if you would like to ask a question, please press star then the number one on your telephone keypad. Please be advised to limit your question into one and one follow-up question. One moment for your first question. Your first question comes from the line of Steven Forbes with Guggenheim Securities. You may now ask your question.
Good evening. Gary, you spoke in the letter, right about the expectation for revenue growth to lag demand, but I think it was 5%-10% in the third quarter. I want to start there, right? Just as we contextualize the build for the back half here given the current trends. I don't know if you can talk about how much of the closure between this expectation and the 16% 2Q spread is due to demand being fulfilled, right, versus sort of a more natural closure in the spread between demand comp and revenue comp. Because I think you did mention, right, that you expect to fill the majority of that demand over the next three quarters.
Any sort of color that could help us walk or build it out over the three quarters as we think about fulfilling this unfulfilled demand over the next three quarters would be helpful.
Sure. Thanks for the question, Steve, and I'll try to add some color and maybe Jack can fill in some pieces. If you kind of start back when we spoke to you last quarter, we expected revenue to kind of lag demand comps by about 10- 12 points. What happened, the reason the gap got bigger and it got to 16 points is in the second half of the quarter, our demand really accelerated, and kind of ran away from our trends, and our inventory flow. It built up a much bigger gap. As you think about where we're responding as quickly as I can. As you look at the kind of demand builds month-over-month, as we laid out in the letter, it's hard to plan for something like that.
If you start with a big picture and say, the pandemic hit in mid to late March, and our revenues dropped by just about 40 points. In a three-month period, a little over three months, our demand went from 40 point down to 40 point up, right, roughly, just directionally. It's an 80-point swing. We responded very quickly to the downdraft and based on our analysis, we didn't know how long our galleries were going to be closed and what the impact was going to be, but we wanted to react quickly and we did, and we were able to cut receipts and push out inventory. As demand built, we thought it looked good coming back from down 40 point to down 20 point to down 10 point to up 7 point, and then it just took off. If you start there, we're behind.
You compound that with the fact that the pandemic hit everybody, right? It hit every country in the world, it hit every one of our manufacturing partners in the world, and they had dislocation, whether it was loss of workers, forced shutdowns, so on and so forth, whether it was in North America, whether it was in Asia, whether it was in Europe or South America. Just now, I would say, we have relatively good visibility if things don't change drastically from here. I'm not sure. Will demand continue to grow month-over-month? I don't think so, but I don't know that it won't.
We're off to a pretty good start in the first two weeks of September, and what's different about September year-over-year is, last year, we had a higher mix of what I call clearance inventory that we wanted to get rid of, older goods. Last Labor Day, we ran a kind of Labor Day sale with clearance inventory, and were able to liquidate goods, and that gave us a lift. That kind of slowed down trends, if you just think about the first two weeks. What will happen in the next several weeks, I'm not sure. It's funny, I've never spent so much time looking at our business kind of day to day. It's changed so dramatically day to day, and we're learning.
As we look at this second half, our expectations, if we look at expected inventory flow, we should start to catch up and close the gap, and then we should start to shift over that gap. Right? Have a positivity. As I think about when do we kind of get caught up and wash through this, probably the end of the first quarter, maybe the second quarter of next year. Our product is not that quick to be made and shipped, so a lot of it can have lead times up to six months, in some categories, like rugs, nine months. What we're doing is trying to give you our best view of how we think this kind of demand will convert to revenue.
I think we'll be directionally right, but as I like to say, every plan we have here is some degree of wrong. The question, is it more right than wrong? I think we'll be more right than wrong unless our demand trends change dramatically. I don't know, Jack, do you want to fill in?
Thank you.
Yep. Go ahead, Jack.
No, I think that was great.
Oh, yeah. Perfect. Yeah. Well, maybe one for you is, or either Jack or Gary. If I think about the 2Q gross margin, right? Because this was clearly a focal point for us and investors heading into the quarter. As we think about raising the long-term guidance here to 25% EBIT margins from 20% versus the 22% you delivered, what's the right gross margin profile for this business? Is there still a lot of opportunity as we think about whether it's delivery damages or the reverse engineering, the outlets, the whole supply chain? Where is the right margin profile for that long-term target as it stands today?
I don't know if you'd call it the right margin profile or we think about what's possible. I don't think there's an analyst on the street that had us at 20% operating margins in the next five years. When you say what's right, we saw a path to 20%. How quickly was it going to unfold? A lot of it comes down to the desirability of your product when it relates to margin, right?
We're seeing now, as we've transitioned from a single source rug relationship to a direct sourcing model in rugs, we've got a very different business and a very different margin profile that's lifting the business. We've talked to you guys about kind of annualizing the accelerated clearance of product through our outlet division. A year ago, that dragged margins. That's now washed through and we're seeing what I'd call more normalized margins there. I'd start with, if you think about the 21.8%, or the 47.5% we hit in margins today, even thinking about it from a gross margin point of view or operating margin point of view, we did that on flat revenues, right?
What we're doing is, when I wrote in the letter that we now expect that we will reach 20% operating margins in 2020 with 5% revenue growth, what I was trying to do is give you a floor. A floor for this year. I don't think there's any way we'll go under 5% revenue growth, but I don't know. If all the stores shut down again, who the hell knows what can happen with this pandemic? It seems like things are getting better, not worse. We think that consumers are used to wearing masks now. People are used to social distancing. In many markets, you see cases going down. We think we're pretty safe to say. You guys could do the math. If you back into the math on 5% revenue growth for the year, it's about 18% in the second half. Right?
We think today, that seems like a floor. At that kind of revenue growth, we're comfortable with having 20% operating margins. If you just step away from the pandemic and all the things that are happening with COVID, I'm actually quite happy, to tell you the truth, that our revenues are flat this quarter. Because what it does is it helps get rid of the noise and helps us see our underlying business model and helps potential investors see and recognize the underlying business model that we've built here. That we've invested in for the past five years, re-architecting the entire business model and positioning the brand more as a luxury brand. I think that there's opportunities in every part of the margin structure of the business. We are at the early stages about elevating the product.
You'll hear more soon about some really important strategic moves we're going to do to continue to elevate the RH brand and position it as a luxury brand in the marketplace. I think that is going to give us more product margin opportunity, and that also can relate to shipping margin opportunity. As the product prices go higher and you have the same cost structure moving product through the supply chain. The other thing that you've got to think about is we're still pretty early in the transformation of our real estate. When we transform a gallery in a market, we basically, the first year or two, I think we have a couple that went longer than two years, but call it first one year to three years, and mostly one year, we double the revenues at retail in that market.
You think about just the leverage you're going to get in the occupancy side of the business, but also against the SG&A side of the business at a corporate level. We can see a pretty clear path that we feel pretty confident over the long term that we now see an opportunity to get to 25% operating margin in the business. That assumes investments in international, and it assumes there'll be a little bit of, it's not going to be a complete straight line. There'll be some quarters where we're opening a new DC internationally, and it'll be a drag for a little bit. I don't think it'll be enough of a drag to massively impact the company, because we're not just opening a DC and having our revenue move a little.
We're opening a DC in an entirely new continent, and I think we're going to see pretty fast revenue growth. I think we'll see that normalize very quickly. I'd say, if you just think about since, I don't know, 2016, as I said, when we launched Modern in the end of 2015, and I refer to it as proverbially, you go public and you put a car on a racetrack. You're on the quarterly racetrack, and it kind of narrows your view. We were the perfect public company, I think, for 12 or 13 straight quarters, and then we blew a tire. Most companies blow a tire and bring the car into the pits and change the tire and fill up the gas, and they go back out on the racetrack. We decided we were going to rebuild the whole car.
We knew we were going to take a lot of flak for it, and we referred to it as we were going to march through hell for a heavenly cause. We kept the car in the pits for, I don't know, a year and a half. Nobody really believed what we were working on, and we said, "Well, people don't believe in what we're doing, what we do," and we raised $1.2 billion or something, about 60% of our company, and brought an entirely new car onto the racetrack, like with a jet engine. We've now slingshotted past everybody in our industry. At 20% or 20%+ operating margins, wherever it unfolds, what I like is that 5% revenue growth, we would've had a plan slightly higher than that.
The fact that we're at 20% this year just says that the underlying business model has this systemic shift. It really has nothing to do with COVID at all. There's going to be a lot of people that have a very temporal lift to their business. When this thing changes and heads back to normal, there may not be anything systemic there. We have a 20% operating margin floor now on basically flat to up 5%. Now you think about the business growing at 8%-12% over the next several years. You think about where you're going to get leverage and margin in that model. You think about continuing to take this brand up the luxury mountain and the kind of leverage that we'll get.
One of the reasons why in the second half, right, we've decided not to mail our fall books because quite frankly, one, we'd be mailing and possibly creating incremental demand we don't have product for. The newness because the factories are behind would be late. That's costly to have back orders. We thought, let's take this time and focus on the next few really big moves. All that time and energy it would take us to normally develop the seasons and develop the books and launch everything, we're actually going to refocus that time to rebuild every category in the business, and we believe we can take the floor up there. Right?
If you think about it, if we really do our job well, there might be 10 or 20 comp in the core business just by going category by category, down to the detail and re-architecting the assortments, which you don't get a chance to do when you're kind of just running a business. Then focusing our time on architecting the web portal, The World of RH, which we think will be a leapfrog, and focusing our energy on launching Europe. I think what's different about RH in a lot of ways, and what's unique about us is we invest really with a long-term view. I think that's why we have one of the best performing stocks since our public offering in 2012.
It's funny, I was doing an interview with someone for a magazine, and clearly this person had been talking to a bunch of short sellers or non-believers in our company, and I could just tell by the tone of the questions, and I kind of said, "I can tell by your tone you have a lot of sources that are sharing their feelings with you." I said, "Why don't we just start with some facts?" Because a lot of times when you think about a company like ours that invests with a long-term view, you have somewhat of a volatile stock over the short term, but it can really perform over the long term. I said, "Why don't we move from feelings to facts?" I said, "Here's the fact for you. On November second, 2012, our company went public at $24 a share.
It's increased I don't know where the stock will close tomorrow, but where it closed today, it's increased 14 times in value in just under eight years. It's one of the best performances of a publicly traded company during that time period. It's better than LVMH. It's better than Home Depot. It's better than Starbucks. It's better than Nike. It's better than lululemon, even better than Apple. Depending on where our stock closes tomorrow, it's better than Amazon. I don't think anybody even recognizes that, right? I don't think anybody stops to kind of motor up and look at the long term and say, "What are they doing here?" I think people get trapped in a short-term view, quarter-to-quarter, kind of microscope, and they can't see the bigger picture. We try to motor up and see the whole chessboard, right?
We try to see all the moves. We like to say inside our company, "Don't move until you see it." Right? For the most part, I'd say since we brought the car, which is now a jet, out of the pits in late 2016, early 2017, I think we've basically done everything we've told you we were going to do. Right? We've probably delivered. Now we're going to deliver 20% operating margins. Five years ahead of, I think, any analyst had us on Wall Street or seven years ahead because it wasn't in anybody's model. A lot of people had us at 17%, five years from now, 18%. We thought we were two to three years away, and now it's kind of a reset, right? We're saying we've got a new floor, and we have a path to 25% operating margins.
We don't make stuff up here. I can't give you every single little detail of the puzzle. I'd say if you look at our past performance and you look at the big picture, we're a company that, 20 years ago, started this journey as a nearly bankrupt company with a $20 million market cap. I don't know. Tomorrow we'll probably have a market cap somewhere around $7 billion. We think we're a really good bet. I think people that take a long view and look at the big picture here and look at the facts versus their feelings, I think they're going to be really happy they invested in RH if they want to hold this stock for five to 10 years, because I think we'll be among the best performers in anybody's portfolio over that time horizon.
A little longer answer than you asked, but I thought I'd share the big picture view.
Thank you, Gary.
Your next question comes from the line of Curtis Nagle with Bank of America. You may now ask your question.
Good afternoon. Guys, thanks very much for taking the question. Just a quick one on Gary Friedman, you cited evidence of some of your clients moving out of urban centers, buying second homes. Second or maybe even third homes. Hard to imagine a company that's probably better positioned for that maybe over the next few years. I guess, could you extrapolate a little bit more in terms of how much demand that's driving, maybe hard to know, but how sustainable that growth could be?
Yeah, we tried to articulate it in the letter, and your guess is as good as ours, but we like the data we see. I think that because the pandemic is lasting as long as it has. I just asked my doctor a few weeks ago, I said, "How long do you think we're going to be wearing masks?" He said, "At least two more years." I said, "Really? Two more years?" He said, "Yeah, you got to think about the math." He said, "We have to have 270 million people to have the antibodies or the vaccines to get to herd immunity." Right? Most likely the vaccine is not going to come until the spring of 2021. It's going to take at least 18 months to move really fast to get 270 million people to herd immunity. He said, we've got a new behavior shift.
He thinks that's going to last for a while. I don't think any of us could conceptualize that early on. Now it starts to make sense, right? The data and the shifts of things. I'm surprised how quickly people responded to this pandemic from the activity in the home market. How quickly people moved to buy second homes to get out of cities and so on and so forth. I wouldn't say all out of cities, just get second homes to have somewhere to go to. Many of them still have their city home. You have people that are moving to suburbs. In fact, there's kind of new suburbs being formed. I was talking to some people that there's a whole new view in how they think about suburbs in Silicon Valley.
Many of the people now they're learning they can work remote more, so they're moving, they're buying homes in Palm Desert, and Palm Desert now is kind of getting recast from a retirement community to a suburb for many people, right? Younger people move where they can get a bigger home, they could have more space. There's a perception that there's less crowds and more safety probably, and so on and so forth. Who knows when we're all going to travel again. That's our biggest question on international. We can't go to Europe unless we want to go and quarantine for two weeks. I go like, huh, is this going to completely snap back? There's got to be some real, somewhat permanent changes in behavior. How long does that last?
If you think about the home buying cycle and the home furnishing cycle, it’s not a short cycle. I do think we’re well positioned for it because of our assortment and our unique interior design ability, where we can just come in and do someone’s home. We’re doing more full projects than ever before. People are looking for a solution that saves them time. We can do that. Like I said in the letter, I think we’re going to have a higher water level through 2021, but I don’t know. I’ve never seen anything like this, right? Maybe the air comes out of the balloon sooner, or maybe there’s just a permanent shift. When you get people thinking about something. This could create a whole new market for the home. Just think about this. How many people are not going out to dinner today?
Limited amount of people going out to dinner. I read some stat that OpenTable reservations are down 50%, somewhere in that direction. I'm going out to dinner, I think 80% less than I was. We're going to people's home for dinner, people we know well. I think what happens when there's a shift like this, people go to other people's homes, they look at someone else's home, they go, "Oh, their home's really much nicer than our home. Honey, we got to redo our home because we can't have them over to our home yet for dinner until we make our home better." It's the interesting thing about humans, right? We kind of compare and contrast ourselves all the time. What we wear, what we drive, where we live, our home, the size of our home, all these little things. Where we go.
Where'd you go on vacation? Oh, I went to Capri. Oh, yeah, we went to Capri too. All that kind of stuff that humans do. I think this focus on the home and this amount of time people have spent on the home and that the entertaining focus now on the home could create a whole perception of home that you've got to kind of have a much better home, and your home's got to be all furnished, and it's got to look a hell of a lot better because you're just going to have more people over, and you're going to be spending more time there. That could become just like a permanent shift. Like I said in the letter, I don't know how to plan for that stuff. I don't want to take too much risk because I'm not sure.
We're going to invest very thoughtfully. We're going to continue to let cost chase demand versus demand chasing costs. We don't want to build a big cost structure based on 40% demand comps and have it go to 10% and go, uh-oh. I think that this is a lot longer than any of us here thought, and it feels more permanent. At least it feels like it's going to have a longer life. We don't know. We're good either way. We like our business model long-term. If this is more temporal than systemic, whatever.
Got it. Understood, a thoughtful answer, thank you. Maybe just a quick one in terms of the capital structure. You paid down the converts. You guys I think are running at 1.3 leverage, something like that. How do we think about that going forward? Do you remain under leveraged? What does the capital structure look like given the explosion in margins?
Yeah. We're going to generate a lot of cash. The capital structure's going to look really good. As we said in the letter, we'll remain opportunistic as it relates to sources and uses of capital. There's always going to be some kind of opportunities in dislocated markets like this, and whether they're short-term or more medium-term, we like to maintain optionality. We'll see. Again, we'll see how long these rates last. Our model, just from an investment perspective, even though we're doing Europe, surprisingly, the first several galleries are not going to be capital intensive, but one. Just Central London, where we're kind of stringing together four buildings and making them into one, and that'll be a bit more of a capital investment, kind of like RH New York. Paris is not a heavy capital investment. RH England is not a heavy capital investment.
The ones that follow that, we've got two more deals done and signed, are not heavy capital investments. In the U.S., you'll see us start to ramp up. There'll be more prototypes, which we've got that model now kind of fine-tuned, and we'll have a less capital investment approach there. If you think about the last couple of years, we had some heavy capital-intensive stores. We had RH New York. We had just the development of the first few prototypes. Because you're working on them for a long time and making a lot of changes, it's like developing a new iPhone or something, right? That store is really like an R&D project. There's a lot of capital there. RH San Francisco, a lot of capital. Our first guest house in New York, again, it's like an R&D project. That's a lot of capital.
You roll through that, and we don't have as many galleries that are capital-intensive galleries. As we said in the letter, our performance is going to drive a new kind of credit profile in our company, which is going to make us a much more valuable development partner for any developer. They'll get a better cap rate on our rent and our credit than they will on other tenants. That tends to allow us to get more TI, lower rents, so on and so forth, and it really helps us in our own development deals because we should be able to get better cap rates. No different than we sold Minneapolis in the middle of the pandemic. Like crazy. First, the other people walked away. They thought they were going to get a bigger price, and we said, "Walk away. This is temporal.
We're okay. They came back, we closed at a 5.5 cap. I think initially when we probably talked about that one several years ago, I think in New York, we were going to put a $1.8 million rent on it and sell it for $33 million, instead we decided to put a $1.4 million rent on it and sell it for $25.6 million. The fact is we got a 5.5 cap, that was before we leapfrogged to 20% or 20%+ operating margins and the cash flow profile and the return on capital profile that you're going to see. I think that there's a chance we'll exceed 50% return on invested capital this year. That was a long-term target. I didn't update that long-term target because it starts to be silly math. What are we going to have, 75% return on invested capital?
It's going to be a really good model as we kind of flip over and don't have as many capital-intensive projects. Even if you think about our second guest house that we're building in Aspen, that's a joint venture development. It's a very capital light guest house, and we're able to cut a deal like that because we were already in construction and had the designs and plans for the first one. The development partner was like, "Got it. That looks amazing. Okay, I'll cut this kind of deal." The very first one in New York, people thought we were nuts. Like, "What are you guys going to do?" People still think we're nuts, I think, until they see it, then you'll get it. Yeah, we like the capital profile of the business.
As we project the new cash flow model, the new return on invested capital, the capital requirements of the business. I think it looks like a model. Honestly, I would've never imagined it would look this good. I remember my early days here, there was a lot of people sitting around the table that were here the whole time, right? We were like, "Okay, if we can get to a billion dollars and make 8%, if we can get there, we'll have made it." If you'd have told me, "Hey, we could build a leading luxury design platform in the world, and we'd be at 20%+ operating margins and a cash profile model like we have building the kind of galleries that we're building." We're not building shitty little crappy retail stores. We're developing buildings.
These are going to look great 50 years from now. It's kind of remarkable. We say inside our company, the thing I've learned in my career is that you can always monetize extraordinary, remarkable, and amazing work. It's hard to really monetize ordinary and unremarkable work. The thing we've learned is that if we just focus on doing really extraordinary, remarkable, and amazing work, we can always create a model and a business around that. I think people learned that with the iPhone, right? If you think about when Apple invented the iPhone, the average phone, I think in the country was $59, and it was the Motorola Razr. Apple introduced it at the time, a $600 phone. It was $600, I think, for four or six months, and they lowered it to $400.
The point is, it was so much more, and everybody thought, "That'll never work." Then it became really one of the best-selling phones in North America. Then everybody said, "Oh, that'll never sell in China. You'll never sell a $600, $800 phone in China." Then it became the best-selling phone in China. One thing that we've learned over time, too, if you do extraordinary, remarkable, amazing work, you actually can create a new market. People, we've learned over time, consumers want better things. If you really do significantly better work, people will pay for it. We're learning that with Tesla, right? Look at Tesla's performance as a new car company. Guy never built a car before. He built a remarkable car. It's truly extraordinary compared to anything else in the market, and it's creating an entirely new market.
I think what we're doing is similar to things like that. We're kind of creating a new market for the high-end home consumer, and it's been a market that's been behind the Iron Curtain, if you will, of the to- the- trade design centers and showrooms that they lacked accessibility, they lacked transparency, and they lacked scale. Think about that. At the high end of the market, they lacked accessibility. You couldn't even go to them unless you had an interior designer or a resale license. That's a good market to decide, "Hey, I'm going to go compete in a market that lacks accessibility, and I'm going to become accessible." It lacks transparency, meaning go walk in a showroom. There's no prices. You can't figure it out. There's codes. They give designers discounts. They give other people discounts. Won't give you a discount.
You got to bring in a designer. Convoluted. They lack scale and the ability to put it all together, you got to go to, like, 20 different showrooms to do your house. We come along with something that's accessible and beautiful and it's transparent, right? We remove all the, like, who's getting a discount? Is it your designer? Is it this person? It's that. By the way, we offer design services, that helps. We've got scale, and we've integrated it all together, where it delivers time value to a consumer. Time is the ultimate luxury, right? Nothing's more important than time. I always tell people here, how we allocate our time is actually more important than how we allocate our capital.
I can always go raise more capital, but I've never figured out how to get more time, right? I think what we've created is going to create an entirely new market for our business. We're kind of now in this situation where while there might be a systemic shift towards the home and a focus on the home, if that happens at the same time, we're kind of evolving into the brand we aspire to be, you could really get an upward spiral here. We don't need that to happen to create a lot of value. If that happens, we'll be supercharged.
All right. Thanks very much, Gary. Appreciate it.
Yep.
Your next question comes from the line of Chuck Grom with Gordon Haskett. You may now ask your question.
Hey, thanks. Gary, just curious, you talk about sustaining that 20% operating margin goal, which is impressive. Just wondering if you can contextualize that for us longer term in the light that you go down the path of building out RH Residences and obviously you're going down the path of RH Guesthouse. Just how do we think about the margin structure over time as you continue down those avenues? Do you view those channels as accretive, dilutive? Do you think you can sustain the operating margin structure? Thanks.
Yeah, I think we think about them from a couple of perspectives. One is, we think that they will elevate and render the RH brand more valuable. How do you build a high-end luxury brand? I tell the team, all the great brands mostly were born at the top of the luxury mountain. Hermès and LVMH and Gucci and Chanel and just name luxury brands come top of mind. They've always been a luxury brand. We didn't start anywhere close to a luxury brand. We had Oxydol laundry detergent on the cover of our catalog at $5.95, right? We have to scale this luxury mountain, and you have to do things that create a forced reconsideration of the brand, that elevate the brand in the right consumer's minds.
Whether it's doing a, we think, an extraordinary experience, that's a RH Guesthouse that's going to create an entirely new market for customers seeking privacy and luxury, or having RH THREE, a luxury yacht that you can charter in the Mediterranean and Caribbean, not a lot of people can use that, but I guarantee you, when we do The World of RH, and you see it on our website and you see our RH Guesthouses, and you see the other things we're doing, the branding of that, right? We don't have a marketing department in our company because we say, marketing a lot of times is about putting lipstick on the pig, right? People try to take an ordinary thing and dress it up and make it seem better than it is. We say, it's not what we say, it's what we do that defines us.
We build our brand through our work, right? We don't really run many ads. You might see an ad or two here or there in a home magazine like Architectural Digest or someone. Really it's mostly our work. Our galleries are our work and their extraordinary experiences. Our source books are our work. The World of RH will be another version of our work and how we communicate what we do and, I think the RH Guesthouse and the RH Residences, if done really well, one, they'll elevate the brand, and they will help us climb the luxury mountain. I think they'll be so extraordinary, they force the very best people in those industries to tip their hat. Again, I believe we've learned that if we do extraordinary, remarkable, amazing things, we generally can figure out how to monetize it and build a business model.
Today, even though we haven't opened a guest house, like the few people in the inside of the hospitality world that I've showed it to, they're like, "Oh my God, do you know how much you can get for those rooms? Oh my God." If they're half right, we're going to do really well. They're not just kind of a new business thinking about it independently. You have to think about all these things not in isolation. You have to think about them in integration and how they elevate and render the brand more valuable. It's just like the mistake the department stores made over the years. If you listen to Stanley Marcus in the beginning, and Neiman Marcus, he'll tell you, the restaurants were never supposed to be the leading profit driver in the company.
The restaurants were supposed to get the high-end female consumers to come to the store more often and walk through the shoe department and buy really expensive shoes and other things. In an integrated fashion, the restaurants were very profitable. If you look at things in isolation, you can make a mistake and not see the bigger picture. It's no different than, quite frankly, it blows my mind how many retailers right now are talking about closing stores and just having a website. I guarantee you, people start closing stores, their website traffic is going to plummet. They're going to find out the cost of acquiring customers through digital marketing, the cost of marketing an invisible store online. Good luck with that. All the digital native brands are opening stores.
These other elements, guest houses, residences, other things you'll hear about that we'll test and incubate, they're going to create a big conversation around our brand. They're going to be extraordinary pieces of work in their industries, and they will elevate the RH brand and render us more valuable. I think we will find they will become real businesses in and of themselves. If they are, the ecosystem gets bigger. If not, we have a handful of them, and they're tremendous examples of our work, and they elevate our brand. I think long-term, we're going to probably find, now that we've worked on them longer, I think that we're going to find that they're businesses. We won't do anything that's going to destroy value here.
We don't want to all of a sudden try to build an 8% operating margin business, when we've got a 20%-25% operating margin business. We'll just drag the whole thing down and kind of destroy value. The idea is, can we build things in an integrated way that lifts the whole margin profile of the business? That's what hospitality does in our current galleries. If you looked at hospitality in isolation, you might think it's a drag. If you really do the integrated math and look at how many people turn into purchasers and then you integrate that and you take that extra flow-through and you look at an integrated way, it's a really good model. You have to do the math on all of it. We'll test these and try these, and we'll learn more.
I know one thing for sure, they will elevate the RH brand. They will create a conversation at the highest end of the market, and that's what's really hard to do. No one's ever climbed the luxury mountain before, starting where we started, ever. I can't name one brand. Most brands go down. This just requires a different kind of effort. You're not going to do it just running some ads in magazines and stuff like that. Our work has to define us here. It's the only way we'll earn the respect of the consumers of the very best brands in the world.
A couple things. Just as a follow-up, just thinking about the factors that have driven the demand improvement over the past several months, probably a hard answer, maybe it's not, but just curious if you've got a sense for how much of that's coming from some of the de-urbanization movement versus the shift in second-home markets versus just the overall housing market doing better. The last bucket would be just the pandemic and people just being more hunkered down. I'm just wondering if you can think about the different drivers of the recent strength.
Yeah. I think it's all of the above. Yeah. It's all those things together. Again, we were running, what, up eight or something before this pandemic?
Up 8%.
Yeah. We were running it up 8% before the pandemic, then we went down 40%, and now we're up 44% or something in core business or something. 47% in August, up 44% so far month to date in September. There's a big shift here. The question is, how much of it is systemic and how much of it is temporal? The key is, I think you've got to play it with the expectation that it could be temporal. Otherwise, you can kind of goof up your model. We're okay not trying to optimize everything in this market. If this thing's temporal, you can change your model and try to run after every sale and optimize this and put your head down in the weeds, then maybe you'll crank out another 3%-5% of sales.
All of a sudden you're focusing on the little rocks, and you just screwed up your model. All of a sudden, the air comes out of the balloon and you're like, "Oh, now what?" You've got to dis-architect your business and stuff and your cost structure. We're okay. We're not chasing any sales. We haven't put one thing on promotion. We're letting some demand get away. We know we're losing demand with the back order rates we're running. That's okay. I don't want to be famous for like, "Hey, they did really great during that pandemic, didn't they? Do you remember them?" Like, "Oh my God, they had the best numbers during the pandemic. What happened to them?" Oh, yeah. Long-term, they kind of screwed up their model.
We look at this as this is some kind of a temporal event that may have systemic long-term benefit to the home. We hope it does, but if it doesn't, it's okay. We're looking at our model very long-term. That's what I love, the fact that, hey, our revenue was flat this quarter, thank God. I didn't have a zillion questions from everybody like, "Where was the margin? How much was this? What's the leverage there?" Revenue was flat, we have 21.8% operating margin. That's with 40 basis points drag from the pandemic. That's a 90 basis points drag from Waterworks. It's got an 80 basis points drag or something like that from hospitality because we're in startup mode. We've got another drag from some kind of one-time investments we're making.
We could take those pieces and that helps us see, yep, 2025 down that road. Stay down that road. Don't get lost in the little rocks of the pandemic. Ride this wave the best we can. I don't think the business stays up 40%. I don't. It might stay here for a couple of years. Maybe there's a new water line. I don't know. It's just hard to say. It hasn't been that long. Never seen anything like it. I just don't want to overreact to it and goof up the last kind of decade of work. We're taking a very long-term view here. We're not running around with our heads down trying to manage the business from week to week. We're not pulling any levers. There's no promotions going on here. We're just trying to build the best brand of its kind in the world.
Great. Good luck. Thank you.
Thank you.
Your next question comes from the line of Brad Thomas with KeyBanc Capital Markets. You may now ask your question.
Hi. Thanks for taking my question. Congrats on all the momentum in the business and the bright outlook here. My question was, if you could share any color on how to think about some of the expenses and SG&A in the back half of this year. On the one hand, I would presume there's perhaps more sales coming from an e-commerce or a web order rather than in the stores, and that may benefit costs. You're also not mailing the source book. On the other hand, of course, knock on wood, the sales look pretty good. How should we think about expenses through the balance of the year? Thank you.
Yeah. We'll have, obviously, some savings in ad cost. We're not going to try to chase and optimize the revenue over the short term here. We think we've got enough, and we're already chasing it from a supply point of view. We think we're making the right decision to It's not like we're not mailing the book and not doing anything. We're not mailing the book, and we're going to invest our time and energy and resources and make investments in other areas that we think will have real long-term benefit to the business. Versus mailing into this, doing a lot of work and maybe getting a little extra bump, or no bump, mailing into it and just not having the goods or is the customer already optimized?
By the way, the other thing that we want to learn is, I don't know, maybe the books aren't as productive anymore as we think. Let's take this time and test our way kind of out of it and back into it, and we'll get some new, fresh data that says, "Hmm, maybe when we launch the portal and maybe because we're building all these big new stores, we can mail less books." There's lots of motivation about kind of testing and learning for the long term. We're making a lot of investments in long-term growth. Making a lot of investments in international, making a lot of investments to elevate and expand the product. You probably read, if you haven't read, we've made a small acquisition of a business that we disclosed.
We're not saying much about it from competitive reasons, but that we think is going to elevate us and the talent in the acquisition is going to continue to help drive our kind of product capabilities. That's what we're focused on. Then we want to really do our best work at introducing the brand internationally in Europe, because that opens a whole door, right. If we start to demonstrate that this brand can work without a long ramp-up. If our brand can be introduced internationally and actually ramp anywhere near a normal market that we haven't been in, say like Canada, when we've opened galleries there and stuff, that'll lay the tracks for the brand being $20 billion globally without really anything else working, right.
Again, I kind of think about if we can prove ourselves internationally, and we can, over a several-year period, kind of ramp up in England and in France and throughout Europe and Spain and other places, Germany and so on and so forth. That probably is going to be a really good indicator of what's going to happen as we move across to Asia and Australia and South America and other parts of the world. What we feel good about our timing is that the world is exponentially getting smaller, right? The visualization that happens on the internet through all the platforms and social media and Pinterest and everything else, the world is getting smaller, the world is adapting the same taste and style and so on and so forth. I think that all of this is really going to benefit great global brands.
We're investing in all those things and despite the investments, again, we think we'll do quite well from a profitability and margin performance perspective.
Brad, it's Jack. I'll just add quickly, as Gary was talking about with as we think about the 20% model as a floor, with an implied sort of 5% rev increase. You can do the math also. What that implies for H2 op income, and that's 22.2% with 700 basis points. That's just the implied math of the floor we were guiding. We're not telling you how that splits between gross margin and SG&A. We're not guiding. Naturally, as you've alluded to on the source books, that benefit would naturally, on the SG&A side, come more in Q3 than it would in Q4, given that's when the mailing would occur. I just wanted to at least.
Jack, that's a good point, yeah.
add that from a timing perspective as you think about the quarters.
Great. Very helpful. Thank you, Gary. Thank you, Jack.
Yep, thank you.
Your next question comes from the line of Adrienne Yih with Barclays. You may now ask your question.
Great. Thank you. Great content and color. Gary, as you were talking about brand building, a la some of these very high-end brands. When you look at many brands, global brands, they have a line that's called demand creation. When you think about your catalogs as being sort of 3.5%, 4% of sales, you almost have the luxury of having another 600 basis points or so in all of these different areas like RH THREE and art and wine and RH Guesthouse, and hospitality to build that. I guess my question is that the right way to think about it? How much could you bring that demand creation up to as a percent of sales? Because now you have the luxury of this extra margin.
Then to your point on the catalogs, could the catalogs ever turn from content only, product only, and be a physical manifestation of sort of The World of RH in sort of a lifestyle content magazine? There's a couple of my questions. Thanks.
Yeah, you got to come work here. Our whole leadership team's in the room, by the way. Yeah, it was like, yeah, okay. You think like we think. Yeah. Correct on all of it. Yeah. It's exactly how we think about it.
Okay. If that's the quick answer, one quick very small thing. Actually two quick housekeeping. I know it's a small initiative, and you have so many bigger initiatives now, but where are we with RH Color? Secondarily, what percent of transactions that you're running currently have interior decorating services attached to them? Thanks so much.
Yeah, we don't give the interior design percentage, do we?
We've given it at Investor Day, but we don't-
Yeah. It's a big part of our business. Yeah, we don't give it just for competitive reasons right now. Where is Color? Color is Probably best ask me that question next quarter. We have a series of off-sites and time we're spending just to evaluate all of our kind of key value-driving strategies and initiatives, and we have a pretty long list of opportunities, and it's how many can we do at one time? How do we sequence them? What's the emotional, strategic, and financial value of each one of them? That's how we kind of allocate our time and human capital and financial capital. We're excited. It's kind of a gift to tell you the truth, to say, "You know what? Just don't mail the book right now. Don't do all that work.
Just have everybody stop and let's take all our talent in this organization and kind of really see the board, really put things in the right order, and really focus on kind of the next few big rocks that can kind of change everything again. I really believe that if we use our time wisely over the next six months, that we can really step change the core business from just a comparable sales point of view. You really need to get all the leadership to focus, including me, right? We've got so many things to work on and so many opportunities, and we've also brought in a lot of new talent, and we have a lot more kind of capacity to do more. It takes everybody together, and to really focus to move the big rocks.
Otherwise, people are working really hard on all these little rocks and they're kind of arranging and organizing things, and at the end, it doesn't really move the needle that much. In this short time, we have started to focus on a couple of the categories. I think if you were sitting here with kind of our senior leaders of product, I think everybody's eyes are really wide open and we think, "Wow, there's a lot of opportunity here." Not just the product itself, but then the physical manifestation of that product in the marketplace. We've got ideas and opportunities to do things. Today, I'd say we're exceptional at presenting the product physically in an integrated fashion. We're a little hard to shop by category today, right?
You go to one of our big galleries and you try to shop for lighting, you got to kind of walk the whole place. We don't even have the whole assortment in an organized way. Yeah, the web helps you there, and the books help you there, but people still really want to see the goods.
We've got a lot of ideas around doing different physical manifestations of categories in a way that we think can also be massively disruptive. I don't know, maybe I should throw one out, throw everybody a bone so they think about it. I'll talk about one that we're a little farther along in our thinking, just to kind of give you the idea. We think if you go to any of our regular galleries, legacy galleries. Yeah. Any of our legacy galleries, they show one collection of outdoor furniture on the floor for six months of the year. Right. Then if you go to our big design galleries, we show 20 to 24 collections year-round, somewhere around there. They're not all in the same place. Some are on the rooftop, some are around in garden patios, some are on terraces.
We have now, what do we have, 45 collections, somewhere like that. By next year, we might have 60, 70 collections of outdoor furniture. We've got a concept we're working on that could come to life faster than slower. Actually, I like saying it because it gives us a faster deadline. Everybody's looking at me here in the room. They're going like, "Okay, here he goes. Now we've got to get this done really fast." We're working on a concept called RH Oasis, and it's going to be a freestanding outdoor furniture experience like nothing in the world. It will be mind-blowing. We will own the category, not only outdoor furniture, but shade and fire and heat and textiles and things presented in a way, in an environment that you can't even imagine. I think it will be massively disruptive and accretive to our business.
If you kind of think about that and you think about like, well, gosh, is there something you can do. Is there RH Illumination. Is there RH Underfoot. Is there RH Couture Upholstery. Is there RH Bespoke Furniture. I can go on and on, right. Everybody's going, "Oh, shit. Here he goes." Like the whole thing. You can all of a sudden start to imagine an RH compound of this beautifully integrated experience with these isolated experiences around the categories that allow you to shop both ways and allow us to express our brand in a way no one's ever seen. We've got these things that we're working on, that we're testing, and that's why we have to put everything in perspective. It's like, well, where's RH Color come in. Well, we got a whole bunch of things like that to choose from.
Yeah.
It's how many can you do at one time? In what order? How do you do it really well? I've got someone in the room looking down at me saying, "Are you going to tell them about that?" If I tell them about that, they'll think we're really crazy. Misha's looking down at me right now, it's like another big idea. We're not short of ideas here. The key is we're all short of time, and it's just how do we allocate our time? I love the fact that right now, this pandemic, in some ways, has given us the permission to reallocate our time in a dramatically different way, and I think we'll be more right than wrong as we measure the outcome of how we allocated our human capital over the next 6- 12 months.
We might find that, wow, there's real breakthroughs here, and we might be spending our time. Who knows? Maybe we might find out two years from now, three years from now, we're mailing two-thirds less books, that we just don't need as many books, and they can be different, like you said, express the whole lifestyle differently, and lots of different ways to do it. The good news is we're kind of always unsatisfied, always on the move. We're always innovating, we're always learning. We're getting smarter and smarter. I think we'll keep finding better ways to do what we do. Lots of things in the horizon.
Great. Thanks.
I gave you a little peek into the future. Now you guys are going to ask me on every conference call like, "Yeah, when's RH Underfoot coming? When's RH Illumination coming? When's this coming? When's that coming?" There's going to be a lot coming over the next five, 10 years. We're not going to run out of ideas here.
Thanks so much. Congrats to the whole leadership team. What you're creating is truly remarkable. I had to say that.
Thank you.
Yep.
Your next question comes from the line of Michael Lasser with UBS. Please ask your question.
Good evening. Thanks a lot for taking my question. It's two quick ones, and it may be for Jack. Number one, can you provide an explicit breakdown of where the gross margin expansion came from in the second quarter? I have a quick follow-up.
Well, beyond what Gary already mentioned in the letter, because we did talk about 490 basis points of product margin, and so the rest would be shipping expense and occupancy expense, which we got a little leverage on each of those, and we're not going to go into much more detail than that.
Did that just come from fewer promotions and discounting that occurred in the second quarter?
Yeah, partly that. Partly higher quality product that's commanding higher margins and all the things that we've talked about. Cycling of the outlet. Yeah. The cycling of the rug transition. Those two are about a little over a third of it, right? A little less than half?
That's right.
The rest is higher margins across the business. Right?
Across all the categories.
Yeah.
That's helpful.
Yeah.
My follow-up is, you're on this path to 20%, mid-20% margin over time. Is there a scenario where your margin would take a step back if you accelerated some of these investments? Do you think from here, you can continue to see margin expansion year-over-year, even while you do make these investments?
We think we can do it even while we're making those investments, because we keep doing it while we've been making investments. I think the key is Maybe there's a time we say, "Look, we've got so many really good ideas now. We're going to invest even more, and we're going to have a flat year. We might have a year that's a little down." I don't know. Maybe. We'll tell you when we get there. We will make really good long-term decisions. We're not going to all of a sudden become a company that gets to 20% operating margin and starts managing quarter- by- quarter and go into the downward spiral that a lot of companies do because they start, quote unquote, "protecting their brand," instead of building their brand. They hit what I call the death curve.
They're really smart and inventive and innovative while they're building their brand, then they build something that's valuable, then they start to protect it, and everybody starts playing defense instead of offense. That's when you just go into the death curve. You start shrinking because you start playing more defense than you do offense. Look, if it's right for us to run flat margins or slightly down margins to make an investment to kind of leapfrog the company by hundreds of basis points, of course we'll do that. You'd have to be a short-term thinker. I'm not trying to get out of this company or sell this company. None of us are. This is our life, it's not just our job. We're going to make decisions like we own 100% of the company.
We're not going to all of a sudden play small ball, try to play quarter by quarter, year- by- year, predictable margin improvement. We could have, by the way, could have not let this thing slingshot to 20%. I could have said, "Oh, let's spend a bunch more money here so we grow 100 basis points a year or 150 basis points a year." That's dumb. We're going to find big moves and big leapfrogs, we're going to make those big moves and big leapfrogs because you know what they do? They lead you to the next big move and big leapfrog. We're going to keep playing our game. Again, if you look at us over time, I kind of shared with you, go do the math. Go look at November second, 2012 and look at our stock. It went public at $24.
Look where it is today. Go look up every one of those other brands that I would tell you, most people I'd say, "Hey, how do you think these companies did over the last seven and a half years compared to us?" Everybody you ask that hasn't done the math would say, "Oh, those companies did better than RH." None of them did better than RH. Right? The only way to keep that kind of performance alive is to continue doing what we're doing and not get down into the little rocks, not let our view contract and start playing a quarterly or yearly game. 10 years from now, five years from now, 10 years from now, I think our shareholders are going to be really happy.
If I start playing like quarter-to-quarter, year- by- year, oh my God, operating margins might be down 100 basis points this year, let's not invest in that extraordinary idea. Let's not do that. It's just dumb. We're going to play the game with a long-term view. It's worked for us thus far, and I think it'll continue to work for us. We want to get better. We're going to have to take bigger risks. We're going to have to be more inventive, more innovative than we've ever been before, right? You're either striving to get better or you're allowing yourself to get worse. There is no such thing as staying the same.
That's why I've said in the beginning, someone pulled out my first video, we were watching it the other night, when I said, "If you want to know about our company, put down your spreadsheets and go to Melrose, go to L.A. or go to Atlanta, and maybe you'll see what we see and also fall in love, right?" This is so different, you have to see it to believe it, right? We got to get better at doing what we do. We got to get more courageous, not less courageous. We've got to take more risks, not less risks. Otherwise, the whole thing's going to go into a downward spiral. It's going to become boring, and we're going to lose our passion here. You're going to be like all the stiffs in the department store industry.
They haven't done one innovative thing in the last 25 years. Why? It's because they're managing the business. They're not leading. They're not building. We're not going to be scared to take risks, to have our margin de-lever by a year. Ooh. Thank God we did what we did in 2016 and 2017.
Understood. Thank you very much.
Yeah.
Your next question comes from the line of Cristina Fernández with Telsey Advisory. You may now ask your question.
Yeah. Hi, good afternoon. I wanted to ask about the demand trends you are seeing. It seems like it's a very good opportunity to attract new customers to RH. Can you talk about whether you're seeing an increase in new customers, or is a lot of the demand coming from existing members or reactivated customers that perhaps had shopped before, but not recently?
Yeah. I think the numbers would indicate we're seeing a lot of new customers, right? There's an acceleration in new customers, there's acceleration in existing customers. You can't run up 47 demand without new customers. There's people that all of a sudden, again, the home has become more of a focus. It's more important. There's more people buying second homes, moving. There's an uptick in the home building market. Hopefully this means that, again, it sets a new level of importance on the home, possibly indefinitely.
That's helpful. My follow-up, can you talk about the performance of the two new stores that you opened this quarter? On your letter, you mentioned you couldn't provide opening guidance for galleries just given all the changes, but maybe update on what's going on there, and when do you think you could resume some of the store openings in 2021?
Well, one, Charlotte and Marin, we're really happy with both. Pretty extraordinary. Marin, it's not performing as well as Charlotte because the restaurant, we opened, and the restaurant was open for three days, then we had to close the restaurant. The restaurant's been closed, what, for a month and a half, two months, something like that. It's really great for everybody. We have it open for our associates, so we're feeding our people, so we keep our team engaged and alive, and people get to eat there, but our customers can't. That drives a lot of extra traffic and extra revenues. In spite of that, Marin's really performing well. Charlotte is kind of off the hook great. What we're finding in some of these, I don't know if you'd call Charlotte a secondary market.
Some of these markets like Charlotte and Columbus, extraordinary lifts. Lifts way better than we've expected. I think that we're even more differentiated and unique in markets like that because even the great brands, if you look at the luxury brands, my sense is they probably under-invest in those kinds of markets because they don't understand them. I think there's a lot of wealth in many of the markets, and my sense is that brands tend to under-invest. We built our prototype in both Charlotte and Marin. You think about Charlotte and Columbus, the lifts are extraordinary. Way beyond our expectations. Not a little beyond, way beyond. It really is making us rethink just the focus and investments on some of these markets because they're very home centered in a lot of these markets, in Columbus and Charlotte and places like that.
We couldn't be happier with how the new galleries are performing. As far as the guidance, we'll open new galleries in 2021. Things are moving around. We've had some of the developers have froze their capital outlays, which was a lot of our TI and stuff for a few months and we've lost time. It's hard to get things into local municipalities and get approvals right now. You're doing Zoom meetings and we're trying to get RH Morristown approved in New Jersey, which is a 5.5 acre estate with a historic home, and we're developing multiple buildings and gardens and food and beverage offerings stuff. It'll be an extraordinary gallery. It's just that it's hard without physical meetings and town meetings. Trying to do this stuff on Zoom is just taking forever. We've got a bit of a slowdown on things.
We will have new galleries in 2021. I think it's just too hard to commit to a number because some things are going to get kicked into 2022, and things that were 2022 are going to probably get kicked into 2023, because just everything's kind of backed up. Yeah, it doesn't affect anything.
Your next question.
Yeah, go ahead. Thank you.
Your next question comes from the line of Oliver Chen with Cowen and Company. You may now ask your question.
Hey, guys. Thanks a lot. It's Max on for Oliver. Can you provide any updates on timing in Europe? Where are you in the process of just planning where the DCs are going to be and then the new gallery openings? It seems like maybe it's also been pushed out a little bit. Any color there would be great. We have a follow-up.
Yeah. Nothing's pushed out in Europe right now. The initial gallery that we plan to open, RH England, we still believe we can open it tentatively in the early summer end of 2021. That's anticipating we're going to be able to travel over there soon. The team is identifying distribution and logistics solutions and where we're going to be and whether the DC is going to be in Belgium or it's going to be in Netherlands or do we open one in the U.K.? We've got all the optionality teed up, and teams have done a very good job of creating the options and doing the math and thinking about it short-term, long-term as we think about the investments.
We've got to kind of ramp up being able to place the orders, and we've got to get goods, and they've got to be there by April, May, so we can open in June is kind of our target. Maybe we can open as early as May, but I think it's going to be more like June. A lot of it's just going to depend on the virus, and what does travel look like and what does local restrictions look like as far as gatherings and shopping, and are we going to have a second wave of the virus? Are things going to slow down and shut down or anything? We just don't know. We said tentatively 2021, that's when we were always going to open that first gallery. We're targeting, I think, 2022, we would have Paris ready to go and maybe another one.
My sense is Central London is just a more complex job that might take longer, might be 2023. We'll see. It all depends because just getting approvals right now and things like that are the difficult thing, and understanding construction timelines and stuff. So far, there's no real change. The only questionable one, can we get RH England open in 2021? There's still some questions because we just can't travel right now, and there's things we can't do.
Got it. That's very helpful. Then on the new opening pipeline, obviously, no guidance, we just discussed that. Can you remind us how many of those galleries are planned to be capital light? Then with that in mind, just any sort of framework we should think about longer term CapEx, where it could be versus, let's say, the last several years. Thank you.
Yeah, I don't know. One, I think you're going to see more capital light than less capital light. We don't have that many bespoke projects on the docket, do we, Dan, right now?
There's New Jersey.
New Jersey is bespoke. New Jersey's basically capital light. It's a development deal.
Exactly
We're buying it, we're building it.
It's not capital light. It's a development deal where we're going to do a sale and leaseback.
Yeah, we'll do a sale and leaseback. We'll get 100% of our capital back out of New Jersey. I think about those as capital light. We have a little bit of capital we're putting up front or taking construction loans, and we'll get all of our capital back immediately after we sell it. I'm just trying to think. Most of our big capital jobs, the one on the horizon I'm thinking about is London. Depending on what we do in Orange County, that will probably be a little more capital heavy because it's going to be a new spectacular gallery.
Miami could be, depending.
Miami, yeah. Miami, if we have an opportunity to do a deal we've been trying to do for seven or eight years, now all of a sudden it looks like it might be coming back, which would be extraordinary. Even there, you've got some of these things that might look capital heavy, but they're like New York, right? They're going to pay back in two years. Going forward, I would say that if you think about the real estate pipeline, it will have a better return on invested capital in the next five years than it had in the last five years.
Got it. Thank you so much.
Yep.
Your next question comes from the line of Tami Zakaria with J.P. Morgan. You may now ask your question.
Hi. Thank you so much for taking my question. I have two quick modeling ones. You mentioned COVID-19 related costs were about 40 basis points of drag in the second quarter.
That's right.
Any guidance on what we should expect for the rest of the year related to that? Could you remind us how much was the annualized savings from the headcount reduction you did back in April?
Hey, Tami, I'll take that. Look, from a COVID perspective, clearly, with the reopening activity in Q2, probably the bigger hit's going to be then with the 40 basis points. As I think about the rest of the year, it's some amount less than that. As far as the headcount savings, look, as Gary talked about, we went from demand being down 40% to demand being up 40%. You have an 80-point swing in our business. In some ways, those savings, and we're making investments from here. The bulk of those savings are sort of behind us in Q1. We got some in Q2, but we're in investment mode given the trajectory of the business.
Got it. That's super helpful. Lastly, another quick one regarding The World of RH. When do you expect that to be up and running?
I think it's probably more like spring of 2021, somewhere around there.
Got it. Great. Thank you so much.
Thank you.
Thanks, Sara.
Your last question comes from the line of Seth Basham with Wedbush Securities. You may now ask your question.
Hi. Good evening. It's Seth Basham with Wedbush. My question is really around some of the sequencing of all these great investments that you're planning.
You've got a really bad connection. Yeah. You've got a really bad connection. We can't understand you on this end. You sound like Darth Vader almost. We can't. Can you try-
Can you hear me any better?
Yeah, no, you've got a really bad connection.
Okay.
Can you guys make out what he's saying?
You're talking about sequencing of the investments we're making?
Yeah. If you could just provide a little bit more color on how you manage the execution risk associated with that would be excellent.
How we manage the execution risk with the investments we're making.
Yeah. Again, we spent a lot of time deeply thinking about where we allocate our human and financial capital, and we think about investing in things that have a much greater asymmetrical risk to the upside. I don't see any massively elevated level of risk in the investments we're making. The one where we obviously have the least amount of experience and data is in the international expansion. I think we've got that appropriately handicapped, and we're moving at a good pace that's going to allow us to kind of learn and improvise and adapt and overcome. The level of capital that we're putting into the European expansion is If you had asked me three years ago, I would have said we were probably going to be putting in two or three times more capital than we are. That brings the risk level down quite a bit.
The fact that we were able to get a handful of these deals that were ex-Abercrombie & Fitch flagship locations, where they put in a massive amount of capital, rebuilding the buildings, putting in the HVAC and the electrical and all the kind of infrastructure. They built beautiful Anybody who's seen some of these Abercrombie & Fitch locations, they're unbelievable. We've got a handful of those that are going to put us in a more of a capital light perspective because we can just take out the fixtures and do some interior architecture. The outside of the buildings are spectacular. Then we got some capital building a restaurant, either on a rooftop or terrace or things like that are not significant capital. That's what's giving us a pretty high level of confidence in that we've mitigated a lot of risk.
Thank you.
All right. I will now hand the call back to Gary Friedman, Chairman and CEO, for any closing remarks.
Great. Well, thank you everyone for your time and interest in the organization. I do want to thank our people and partners of RH in the U.S. and all around the world. Your extraordinary efforts to improvise through this period and adapt and overcome the challenges and bring our brand to life in new and innovative ways and connect with our customers in new and innovative ways and connecting with each other in new and innovative ways. I think it's been extraordinary to watch, and it's made us all so proud. I'd say, look, the next 10 years for this organization, the opportunities ahead of us are just extraordinary.
If anybody takes a look at what we did in the last 20 years with no capital and basically trying to dig ourselves out of a grave, you think about what this organization's going to do with the knowledge we've acquired, the capital structure we have, the experience and the passion we have and the love we have for what we do. We couldn't be more excited about what's next. Thank you, everyone. We appreciate your leadership, and we appreciate your partnership. Thank you.
Thank you, ladies and gentlemen, for joining RH second quarter 2020 earnings conference call. Have a great day. You may now disconnect.