RH

Ladies and gentlemen, thank you for standing by and welcome to the RH Third Quarter Fiscal 2022 Earnings Conference Call. I would now like to turn the call over to Alison Malkin of ICR. Alison Malkin, please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for a Third Quarter Earnings 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 the outlook of 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 filing 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 opinion 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. 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 Gary.

Great. Thank you, Allison, and thank you, everyone, for joining us today. I will start with our prepared remarks from our shareholder letter to our people, partners, and shareholders. We're pleased to report better-than-expected results for the third quarter with net revenues of $869 million versus $1.006 billion a year ago. and up 28% versus third quarter 2019, net revenues of 678 million. Gross margin contracted 50 basis points in the third quarter, primarily due to fixed occupancy due leverage partially offset by an increase in product margins as we continue to resist promoting the business. As previously mentioned, widespread discounting continues across our industry, and while it's been almost two years since we've deployed a promotional email, we've been receiving two sale emails per day from many home furnishings retailers. Although the stark contrast in strategy may lead to a short-term risk of market share loss, we believe there's certain long-term risk of brand erosion and model destruction for those who choose the promotional path. It's that discipline and long-term thinking that has enabled us to set new standards for financial performance in the home furnishings industry And our results now reflect those of luxury brands as we delivered 20.8% adjusted operating margin in the third quarter, also exceeding our outlook despite the dramatic slowdown in the housing market. Our results are inclusive of investments related to the launch of RH Contemporary, the opening of our first RH Guesthouse, the development of RH International, and the rollout of RH In Your Home. which led to approximately 200 of the 640 basis points of adjusted SG&A deleverage in the quarter. Additionally, we experienced adjusted SG&A deleverage due to lower revenues versus a year ago. Our business generated $102 million of adjusted free cash flow in Q3, ending the quarter with $12.5 billion in cash on our balance sheet, $2.5 billion in cash on our balance sheet, Total net debt of $375 million and trailing 12 months adjusted EBITDA of $1 billion. Fiscal 2022 outlook. As noted in our previous shareholder letter, we expect our business trends will continue to deteriorate as a result of accelerating weakness in the housing market over the next several quarters and possibly longer due to the Federal Reserve's anticipated monetary policy and the cycling of record COVID-driven sales and backlog reductions. Based on our current trends, we now expect fiscal 2022 revenue growth of negative 3.5 to negative 4.5% versus our prior outlook of negative 3.5 to negative 5.5 and adjusted operating margin in the range of 21.5% to 22% versus our prior outlook of 21 to 21.5%. While we expect the next several quarters to pose a short-term challenge as we cycle the extraordinary growth from the COVID-driven spending shift and shed less valuable market share, we believe our long-term investments will enable us to continue driving industry-leading results. RH business vision and ecosystem, the long view. We believe there are those with taste and no scale and those with scale and no taste. And the idea of scaling taste is large and far-reaching. Our goal to position RH as the arbiter of taste for the home has proven to be both disruptive and lucrative as we continue our quest to build the most admired brand in the world. Our brand attracts the leading designers, artisans, and manufacturers, scaling and rendering their work more valuable across our integrated platform, enabling RH to curate the most compelling collection of luxury home products on the planet. Our efforts to elevate and expand our collection will continue with the introductions of RH Couture, RH Bespoke, RH Color, RH Antiques and Artifacts, RH Atelier, and other new collections scheduled to launch over the next decade. Our plan to open immersive design galleries in every major market will unlock the value of our vast assortment, generating revenues of $5 to $6 billion in North America and $20 to $25 billion globally. Our strategy is to move the brand beyond curating and selling product to conceptualizing and selling spaces by building an ecosystem of products, places, services, and spaces that establishes the RH brand as a global thought leader, taste, and placemaker. Our products are elevated and rendered more valuable by our architecturally inspiring galleries, which are further elevated and rendered more valuable by our interior design services, and seamlessly integrated hospitality experience. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our galleries into RH guest houses, where our goal is to create a new market for travelers seeking privacy and luxury in the $200 billion North American hotel industry. Additionally, we are creating bespoke experiences like RH Yongeville, an integration of food, wine, art, and design in the Napa Valley, RH1 and RH2 are private jets, and RH3 are luxury yachts that is available for charter in the Caribbean and Mediterranean for the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design, and landscape architecture. This leads to our long-term strategy of building the world's first consumer-facing architecture, interior design, and landscape architecture services platform inside our galleries, elevating the RH brand and amplifying our core business by adding new revenue streams while disrupting and redefining multiple industries. Our strategy comes full circle as we begin to conceptualize and sell spaces, moving beyond the 170 billion home furnishings market into the $1.7 trillion North American housing market with the launch of RH Residences, fully furnished luxury homes, condominiums, and apartments with integrated services that deliver taste and time value to discerning, time-starved consumers. The entirety of our strategy comes to life digitally with the World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Our authority as an arbiter of taste will be further amplified when we introduce RH Media, a content platform that will celebrate the most innovative and influential leaders for shaping the world of architecture and design. Our plan to expand the RH ecosystem globally multiplies the market opportunity to $7 trillion, one of the largest and most valuable addressed by any brand in the world today. A 1% share of the global market represents a $70 to $100 billion opportunity. Our ecosystem of products, places, services, and spaces inspires customers to dream, design, dine, travel, and live in a world thoughtfully curated by RH, creating an emotional connection unlike any other brand in the world. Taste can be elusive. And we believe no one is better positioned than our age to create an ecosystem that makes taste inclusive. And by doing so, elevating and rendering our way of life more valuable. Climbing the luxury mountain and building a brand with no peer. Every luxury brand, from Chanel to Cartier, Louis Vuitton to Laura Piana, Harry Winston to Hermes, was born at the top of the luxury mountain. Never before has a brand attempted to make the climb to the top. nor do other brands want you to. We are not from their neighborhood, nor invited to their parties. We do have a deep understanding that our work has to be so extraordinary that it creates a forced reconsideration of who we are and what we are capable of, requiring those at the top of the mountain to tip their hat in respect. We also appreciate this climb is not for the faint of heart. And as we continue our ascent, The air gets thin and the odds become slim. We believe the level of work we have introduced this year, inclusive of our contemporary, the world of RH, RH San Francisco, RH 1, 2, and 3, as well as the opening of our first RH guest house in New York, begins to demonstrate the imagination, determination, creativity, and courage of this team and our relentless pursuit of our dreams. I mentioned at the start of this year that in over two decades leading our age, I've never been more excited about our future and I've never been more uncertain about the present. Although my uncertainty regarding the short-term has expanded due to the complete collapse of the luxury housing market, my excitement for our long-term opportunity has grown exponentially as I believe the investments we're making to elevate and expand our product and platform will once again be transformative. As we look forward to 2023, we will introduce the largest collection of new product in our history across RH interiors, modern, contemporary, outdoor, beach and ski house, baby and child and teen, baby child and teen. To amplify this historic launch, we will once again unveil a revolutionary new gallery design as well as redesign and remodel all of our current galleries. We'll be introducing RH to the UK and the rest of Europe this spring summer in the most inspiring and unforgettable fashion with the introduction of RH England, the gallery at the historic Ainho Park, a 16th century, 73-acre estate that will feature three restaurants, the Rangerie, the Conservatory, and the Terrace, plus the Ainho Architectural Library and the Deer Park. inclusive of the largest herd of white deer in Europe with a viewing from the Grand Lawn. We are also under construction on RH Paris, the gallery on the Champs-Élysées, scheduled to open in 2024, and RH London, the gallery in Mayfair, scheduled to open in 2024-25. We've also secured locations in Milan, Madrid, Munich, Dusseldorf, and Brussels, some which will also open in 24 and 25. RH also announced today the following acquisitions and hires to accelerate the brand's transformation and climb up the luxury mountain. The acquisition of Dimitri & Co., a to-the-trade custom upholstery atelier, and the hiring of Dimitri founders Donna and David Feldman to create RH Couture Upholstery. The acquisition of the business of Juke, Inc., a to-the-trade custom bespoke furniture workroom, and the hiring of Joseph Ju to create RH Bespoke Furniture. The hiring of Marco Russell, former editor-in-chief of Architectural Digest and El Decor, to create RH Media, an editorial content platform that will celebrate the most innovative and influential people and ideas that are shaping the world of architecture and design. Today's announcement, plus our previous acquisition of Waterworks, firmly plants four RH flags at the very top of the luxury mountain and clearly states our intention of establishing RH as an arbiter of taste and design. These brands and businesses, thoughtfully integrated and amplified on what we believe will be the world's most innovative and dynamic global design platform, will begin to fundamentally change the landscape of the luxury home furnishings market and the to-the-trade design industry. As we approach the holidays and new year, I would like to express our gratitude to all of our people and partners around the world for your contributions and commitment to our cause and for bringing our vision and values to life. It's not easy striving to become the most inspiring brand of the world, and it's surely not for the faint of heart. It takes courage to lead rather than follow. It takes collaboration to build a brand that can break through the clutter in this world. It takes teamwork to reach the top of a mountain no one else has attempted to climb. 20 years ago, we began this journey with a vision of transforming a nearly bankrupt business with a $20 million market cap and a box of Oxidol laundry detergent on the cover of the catalog into the leading luxury home brand in the world. The lessons and learnings, the passion and persistence, the courage required, and the scar tissue developed by getting knocked down 10 times and getting up 11, leads to the development of the mental and moral strength that builds character in individuals and forms cultures and organizations. Lessons that can't be learned in a classroom or by managing a business. Lessons that must be learned by building one or by reaching the top of the mountain.

Happy holidays, Team RH. Heartbeat Dean. Ready for questions.

The floor is now open for your questions. To ask a question at this time, please press star 1 on your telephone keypad. If at any point you would like to withdraw from the queue, please press star 1 again. You will be provided the opportunity to ask one question and one further follow-up question.

We will take a moment to render our roster.

Our first question comes from the line of Sibion Gottman from Morgan Stanley. Please proceed.

Hey, good afternoon, everyone. I wanted to ask a question about written orders in the third quarter. I don't know if you'll comment, but if you use that run rate as a proxy for the business, does that get worse? And then my question is that we now, since you've beat in the third quarter, we have a slightly steeper slope to the fourth quarter. Is that less backlog? Is it more macro risk? What's changing from third down to fourth?

Maybe starting with the second part, Simeon, in the beat in Q3, I think most of that I would characterize as just timing of sales from Q4 to Q3, not necessarily, some of that is obviously relieving backlog faster than expected, but we had expected to relieve that backlog and continue to do so throughout the year. So look, I think on the year, we're still talking about about 3.6 billion in sales. I don't think our sort of You know, numbers change materially in terms of that outlook. Slightly steeper, sure, but it's not, you know, kind of a rounding error in a sense, you know, with all due respect. But, you know, I think it's pretty consistent, you know, with what we've talked about before and simply that just Q3 said some pull forward of sales from Q4 and a little bit of faster backlog release.

Okay, and then as a follow-up, maybe more for Gary, knowing that you're going to continue to invest for the future and still be somewhat responsible here for the near term. Question is, are you looking at prioritizing things differently? Does anything get sacrificed? Love to hear how you think about this, especially as the year keeps on evolving with the Fed still tightening.

Yeah, well, how do you define responsible?

I'm serious.

I don't know. Yeah, I'm trying to understand the question. I think we're communicating what we're doing. We believe everything we do is responsible. So I don't quite know how to answer that.

Well, maybe there's the second part, which is, you know, is anything getting sacrificed, meaning are some of your longer-term investments putting on pause or no, and maybe that's just the right way to look at it.

We're not putting any longer-term investments on pause. I mean, we're playing for the long-term, so we're not doing irresponsible things that other people are doing, like promoting their business and selling, sending, I don't know, 30 emails to a customer a week with sale signs, so You know, that I think might be irresponsible. You know, but I guess it depends on your strategy. If your strategy is, you know, to stand for price, then maybe that's an okay strategy. Our strategy is to stand for design and quality and innovation. So, you know, it's positioned the company around product, not price. You know, so I think we've been really consistent with our strategy. And when you think about priorities, we reprioritize all the time here. You know, we like to say, you know, you've kind of got to get going. Are we strategically right? Are we directionally right? We believe we're strategically and directionally right. We believe if we make the right long-term investments, you know, and build this business for the long term, we'll become, you know, one of the few brands in the world that exists over a long-term period of time. So that's unusual in our industry. you know, most people build a concept and then they roll out 300 or 500 stores. And at the end of 10 years, it's an old concept. So we like not to get old and we like to continue to reinvent the business. And, you know, whatever the cycles are, if you look at it for us, if you look back at history, you know, since I joined in 2001, you know, there was a recession at that time and you know, we elevated the product and kind of transformed the brand. We did the same thing in 2008 and 9, you know, the financial crisis. We went through another cycle again in 15, 16, 17, when we made the move to membership and re-architected the back end. We also introduced modern and, you know, continue to evolve and make the brand relevant and make sure we're leading the industry. And we think the work that has begun with the introduction of RH Contemporary, which will triple in size next year from an assortment point of view. And the introductions we're gonna make across the entire portfolio, plus the new gallery design that we're gonna unveil and we'll go through and remodel and redesign all of our current galleries and refresh all of those. as well as the platform we're building globally for the brand, is going to once again transform RH and put us in a position where we create massive strategic separation. We're comfortable being the others and going the other way. A lot of people are hunkering down right now. you know and slowing down we're kind of speeding up you know we're more excited less fearful i think we saw this coming um we this is not a game that's the first time we've seen it it's just different um but you know our moves over the last 22 years have been very consistent you know i think we're pretty disciplined in the things we do they're unusual you know when We were opening 50 to 60,000 square foot stores. The rest of the industry was closing stores and shrinking footprints and, you know, trying to move all their business online. Now everybody's opening stores. I don't know. Maybe we're just a little bit ahead of everybody else.

Okay. Thank you very much. Happy holidays. Thank you. Happy holidays to you.

Our next question comes from the line of Stephen Zacon from Citi. Please proceed.

Great, good afternoon. Thanks for taking my question. I wanted to focus on RH Guesthouse. The last time you were on the call, you talked about some of the initial interest. How has that performed the first three months that it's been open? What are some of the early learnings for the hotel, and do you see opportunity to open more of these concepts going forward?

Yeah, I mean, we just opened. We think it's extraordinary. The feedback we're getting from our guests is incredible. The feedback we're getting on the restaurant has been incredible. And so, you know, we're just in early learning period. You know, we're not, you know, I mean, it's the first time we've ever done this. So far, we're really excited. You know, we're going to be opening our campaign and caviar bar soon. We've got our feet under the ground, you know, underneath us on our new live fire restaurant. And, you know, so we couldn't be more excited about it. You know, I mean, the feedback from our guests, you know, A lot of people are saying, gosh, how am I going to be able to get in long-term? Because it's just not that many rooms. But we're excited. There's going to be learnings here that will help us evolve and make Aspen better and so on and so forth. So this is just very early, big test. It's kind of a small thing in a very big organization that if it becomes a big thing long-term, great. But right now, it's really positioned to be something that helps redefine the brand and have people look at us differently. So I think it demonstrates the kind of creativity and passion and attention to detail to do something extraordinary. People from the hospitality industry have come and seen it. and toward it, you know, luxury CEOs that have come in toward it, you know, said they haven't seen anything like it anywhere in the world. So we just let it kind of unfold here.

Okay, great. Very helpful.

The other question I had was on gross margin. So it's the first quarter the business has seen a decline, you know, obviously on occupancy deleverage. But as we look forward, Is that the likelihood that you probably see gross margin decline again in the fourth quarter? How should we think about the trajectory from here?

Yeah, I think when you look at the sequential change in our absolute sales, so when we went from revenue in Q2 of $992 million and gross margin of $52.8 million and go into $869 million in Q3 and a $49.7 million, As Gary mentioned, a lot of that is docked CT leverage. So if you think about Q4, there's a further sequential decline, right? Q4 is a smaller quarter for us. So at the midpoint of the guide, we're at 789. So if you do, if you just, we're not guiding gross margin, but if you do sort of like similar sort of math and transposition of numbers going from Q3 to Q4 as you did from Q2 to Q3, you'd naturally see a gross margin decline built into that because, again, the absolute sales are lower than Q3. So it's just math. I mean, directionally, probably 100 basis points-ish. But again, we're not officially guiding gross margin. It's just a directional number. I would just say, look, if you look at the housing industry and track the housing industry, and if you track the performance of home furnishings retailers against past housing downturns, that would tell you things are going to get worse before they get better here. you know, the housing industry is in a free fall. Like the National Association of Realtors, you know, just reported that housing demand was down 37% in October. You know, we've never, at least in my lifetime, I've never seen interest rates rise so quickly. I don't think anybody on the phone has either. And the impact on the housing market, especially when you look at it versus the housing market that was overinflated and run up by COVID, you're going to have some wild swings here. And it's happening first to the luxury market if you look at the numbers and if you track the last nine months or the reporting on Redfin, I think the luxury housing market started going down in the Q4 of last year. and the luxury housing market went up faster and higher, and the luxury housing market is going to go down faster and lower, you know, and that's just an outcome, and, you know, and so, you know, the question is, you know, there's going to be people that wrote it up, and they're going to try to stay up, and they're going to promote their business, and I think they're going to break their models, and you know, next thing you know, you got to send out a thousand emails next year too. And you're just in a, you know, what I call the downward spiral. You know, we're, you know, we're in the ditch. And so, you know, we kind of expected from the beginning that this COVID list wasn't anything that we manufactured. And generally when that happens, those kinds of things go up and then they go down, you know, and you try to stay focused on the long-term, but we're not going to try to break our model and promote the business in a period. We have people that are in our industry right now that have some pretty good sales. Their whole website is 30% to 40% off. If I put our whole website 30% to 40% off, we'd change the sales trend by 50 points. The problem is you're just gonna have a much less productive business because doing more volume and lower margins and all that volume also creates costs that are inefficient through a model. I've already run companies like that. So yeah, we have a different model. Someone asked me the other day, hey, what if you're wrong on your long-term view? What if the market's not 25 billion?

I go, okay, what if it's not?

What if it's half that? What if it's 12 and a half billion? And we have 30% EBITDA. I don't know, that directionally looks like some other people, like Hermes and people like that. I mean, their EBITDA is higher than that, but we'd be in a zip code where this company would be worth a lot of money. And so, you know, whether we become 12 billion or 25 billion, it's, you know, not really what's most relevant is do we get there? And do we become really the first, you know, integrated luxury home brand in the world? And, you know, and that's just going to be a different path than anybody's taken because no one's ever done it. So, you know, you know, there's going to be some ups and downs here, but you know, the housing market's been a free fall, you know, and, and it's, it's going to get worse before it gets better. You know, you know, so far we've been more right than wrong about that, you know, because, you know, we don't really try to lead our business based on hope. We, you know, we, try to run our business the best we can based on facts and math and logic and patterns.

And so I may not sound really optimistic right now, short-term. I'm not. I'm super optimistic long-term. So if you want to play a short-term stock, don't play ours. You want to invest for the long-term, This is a good place to put your money. Duly noted. Thank you. Happy holidays. Happy holidays.

Our next question comes from the line of Max Reclenko from Cohen. Please proceed.

Great. Thanks a lot. So the way that you're seeing your margins play out over the past couple of quarters with upside, both 2Q and 3Q, does that give you more confidence in keeping at least 20% EBIT margins next year if the environment remains challenging? And then just more broadly, how are you thinking about the durability and margin power of the business today, given some of the moves that you've made recently?

It depends on our, you know, that always depends on your,

investment and your investment timing. You know, our underlying, you know, core business, if we wanted to, yeah, we can crank it all back and stay at 20. You know, I'm not sure that's a long-term priority. You know, I don't know how, you know, how bad this market's going to get. And And we don't want to promote the business over the short term to try to create some short-term outcome that's going to be irrelevant two quarters after that. So there's going to be a lot of decisions to make. It's a really difficult environment for those of us in the home industry, and especially if you're at the higher end. You know, it's more challenging and for some people it's not intuitive, but you've got to think about it. We have the greatest migration of people moving from cities to suburbs in the history of America, you know, during COVID and to second home markets. The people that did that could afford to do that. The people that moved the most and bought the most homes were the luxury customers that had the capability to do that. That's why, you know, the luxury market went up so high and the housing market, you know, the luxury housing market benefited most. And we're going to have a flip side here. So, you know, look, we didn't, all that extra money we made during COVID, we didn't waste it, you know. And on the flip side, you know, if we have a bigger give back, that's okay. If you look at every home furnishings, retailer and look at where their operating margins were in 19, you know, when they entered COVID and where they exited in 21. We had the highest operating margins going into COVID amongst all home furnishings retailers, and we exited with even higher margins than anybody else. We picked up, you know, more margin than others. We had more strategic separation. So, and I believe as we should, our consumer moved more, our consumer had more urgency and, you know, and, you know, and in some cases where other people promoted, maybe they got a little bit more top line than us, but we just didn't promote. But, you know, like trying to act like, oh, this is a surprise. You know, like, I mean, the Fed pumped so much money into the economy. They created inflation. They held interest rates at such low levels, they made it easy for people to buy homes. Now we're on the other side of that. Quantitative easing, interest rates are up, we've got inflation. Who's seen this game before? Anybody on this phone? Not unless you were in the market in 1975 to 1982. This is a whole new ball game that no one's even seen. We're trying to just look at the patterns and look ahead and say, what's the best way to play this, where we come out and we really are positioned for the next five to 10 years, not the next two to three quarters, or even the next five or six quarters. That's not relevant long-term. Relevant long-term is, What's the next five to 10 years going to look like? And what are the decisions we're making today that are going to impact that vector, right? That tilts us slightly more up, you know, and over the long term makes a big, big difference. So that's how we're focused. You know, we're not managing this business. We're leading this business somewhere bigger and brighter. And, you know, our journey is, It's going to be a little longer. It's going to take a little longer. So, you know, there's going to be people that have patience, and there's going to be people that don't have patience. We have patience. You need patience if you really want to be extraordinary in this world.

Got it. That's very helpful.

And then can you just separately speak to the customer reception to contemporary? How is that going compared to your expectations? And then just any updates on the timeline of the rollout to other galleries?

Yeah, we're very happy with the initial response. We wish we could get more product faster. It's two things. A lot of it got impacted by the supply chain backup, which are now just kind of all coming unlocked. But also, almost all of the new products, is really new product that has never been made at scale before. So one of the things that is going to happen to us during cycles, this happened to us in 08, 09, when we kind of transformed the assortment in the business. It happened to us in 15, 16, when we moved to modern, and it's happened to us now. When we make these big moves, and they're generally every seven or eight years, because those are kind of the big cycles in our business. I mean, trends can last 10 to 15, But there's generally, you know, I think every brand needs a major refresh every seven or eight years. And so ours just happened to be timed to economic downturns. And, you know, a lot of that is coincidental, quite frankly. In 15-16, it wasn't really an economic downturn week. created somewhat of a downturn when we moved to membership, because that, you know, was a kind of a year transition to do that. But, you know, when you bring in this much new product that the world hasn't seen before, that no one's ever scaled, you know, Travertine furniture, you know, or Burlwood, you know, scale, you can see pieces out there at antique stores, or, you know, some retailers have a piece or two, a couple pieces. they don't have collections with 130 SKUs. And no one's out there making that stuff at scale. So we are going to constantly, for the rest of time, have to continue to build the supply chain capability that enables us to invent. I mean, if you're going to invent something new, and scale something new, it means it hasn't been done before. So it can take longer. It's going to be bumpier. And it's the difference between leading a business, managing a business, invention and innovation versus duplication. So, and, you know, I think we're going to go through the same thing with contemporary. It's taken longer to scale this stuff. I mean, we just got back from the quarries in Italy, you know, meeting some of the best families and quarry owners and building partnerships for stone. And so we can, you know, make stone furniture at scale and we can have better economics and a better supply chain. We, I mean, I don't know, two weeks ago, we went around the world. We were in Penn State. for 10 days. I think we were in seven countries or something like that. And, you know, in the factories and meeting with the factory owners and talking about scaling, not only, you know, what they're scaling up now, but what's coming next, which is, I mean, you've just seen the first little introduction of contemporary. When you see what happens next year, it's, It's extraordinary and revolutionary. I mean, I think it's going to be, you know, we're just going to own this entire kind of aesthetic and look and, you know, be no different than, you know, how we approached 08, 09, you know, when we took kind of the European, Belgian kind of aesthetic and, you know, we went out there and owned it and did it at scale. And it became kind of the RH look in the industry. And then, you know, we didn't just dabble in modern. You know, we launched with a 450-page book or something like that. 545-page book. Yeah, 545-page book. And you have bumpiness on getting the supply chain up, you know, on both of those, by the way. But we wind up, you know, building a billion-dollar business out of modern. I think contemporary is going to be the most extraordinary thing we do. So, you know, you've seen like the first kind of, the first course of the meal. So there's, you know, call it a four course meal. And, you know, next year there'll be two more big courses and, you know, there'll be another big course in 24. And by 24, I think we'll have it rounded out. But it's going to be, I think it's going to be the most extraordinary thing we've ever done. So we're really excited about it. Wish we had more goods right now. Wish we could roll it out to more galleries right now um but so far every gallery we you know we put it in there's been really good response and uh you know we're really excited about getting into more galleries awesome thanks a lot gary uh jack allison happy holidays everyone speak soon happy holidays max

Our next question comes from the line of Curtis Nagel from Bank of America. Please proceed.

Great. Thanks very much for taking it. So maybe kind of one longer-term question and then a quick model one. So first, Gary, I'd love to talk about the acquisitions and kind of how much they step up your high-end trade into your design business for us kind of a little less than a no and how big an opportunity from a revenue perspective you could see. And then just as a follow-up, I just wanted to clarify that comment you kind of loosely made about 20% margin next year if you pull back on investments. Maybe I misheard, but just if you could clarify what you were talking about there.

Yeah, I think, yeah, if you think about the high-end design and trade, how big is the revenue opportunity? The people at the very top of the mountain own the most homes. Not only do they own the most homes, the homes are more expensive. On average, someone spends about 10% of the home cost on furnishings, decor, and art. So when they buy nicer homes, they buy nicer furniture. They furnish the whole house. They have multiple houses. And so that's the most lucrative part of the business. It'll be the most profitable part of the business. It has the most leverage. You make the most money there. So we think it's really important strategically. And we went out and met who we believed had the best reputation and quality and design in upholstery. and the same in kind of case goods and furniture. And, you know, they're big believers of trying to scale this level of quality and design. And so, you know, we're really excited about it. It's going to take a while. We've got to, you know, get it up and going and test it and see how it goes. We've got to figure out exactly how it's integrated. But in the long term, Yeah, I would just say probably today, right now, there's, you know, a bunch of people in the high-end trade industry that just kind of said, you know, WTF, you know, and then like now what, you know, is going to happen. And, you know, so this is a big move for us strategically. But we've got to build capability. You know, there could be other acquisitions. you know, to build capability here. And, you know, you think about, you know, the investments we're making building a media platform and a content editorial platform that will, you know, position the brand as an authority in the industry. You know, not speaking about ourselves, speaking about the people who are really, you know, shaping the world of architecture and design. You know, we want to become an authority and a voice in that. So you don't really do that by talking about yourself. You do that by talking about other people. And so, yeah, we're just going to, you know, we're taking a different path and going to build a different market and we're going to continue to evolve and change. I mean, not too different. If you think about Apple, right? I mean, Apple, I mean, they started pretty high up with a $400 phone or something. We started at, what's the latest Apple phone? Like $1,100 or something like that? $1,200. Yeah, I mean, they kind of created a high-end market for phones. But I think the average phone back then was like $69, a Motorola Razr or something. So I think, you know, one, we're not just going after a market and how big is the revenue opportunity there. We're also going to create a market because that product, at that level of the market, it's not accessible. You can't go into those showrooms. The goods aren't priced. you know, you're kind of blind and, you know, you have to go through, you know, go through a middle person to even, to have access to quality of, you know, that quality and that design. So, you know, we think it's going to be a big unlock just starting to make that level of quality and design available. We think we will grow the market. We think it will be a big, big plus to our brand, you know, to get us into those customers' main rooms. I think today we mostly play in, you know, the family room, the second bedrooms. I don't know if we get that customer's living room, master bedroom, main house. You know, I think there's, you know, it's just going to open up a lot of opportunities. But, you know, a lot to test, a lot to learn, a lot to figure out. We've thought about it for a long time. We worked on this for a long time. You know, and today we decided to tell you officially that we're doing it.

Before everybody else knows.

Yeah. We're super excited about it. The talent, it's also, what I'd say is it's a talent acquisition too. I mean, these people are just incredible. Incredible. Incredible culturally, creatively, you know, entrepreneurially, you know, just incredible, incredible talent. We've all, you know, in a short time, we've been together. We've learned, you know, from each other. And, you know, they've rendered us more valuable. I think we've rendered them more valuable. So it's kind of an upward spiral.

Yeah, you know, for sure. Some really impressive resumes there. And then just going to the follow-up question, Gary, comment you made about, you know, could have 20% margins if you pulled back or something like that. I may have misheard, but just wanted to clarify that.

Yeah, the underlying model, you know, like the underlying model, I think we've always said it can withstand at 20% down, you know, and probably hold, you know, the margins around 20%. So, you know, that doesn't necessarily mean that's what we're going to do, you know, that we're going to pull back investments when we should be investing. So, you know, right now, again, I don't think the idea here, I don't think it's strategic to go, hey, let's have 20% operating margins in 2023. You know, I don't think a lot of people get up in the morning and go, you know, go to work and fight for 20% operating margins. They get up and they go fight to do incredible, inspiring work that they think is going to create great long-term opportunity. And if we didn't have a whole lot of things to do, if we didn't have a lot of great ideas that we're pursuing right now, yeah, I might say, hey, you know what? We don't have anything that's really that big worth investing in, so let's let's, here we go. Let's hit 20% operating margin. Let's make that the, you know, the goal, you know, but we have some incredible stuff we're working on. The most exciting stuff we've ever worked on by far. And, you know, the kind of stuff that you're so excited, you just don't even, you can't sleep. You know, you can't even go home. You're just so excited. And, you know, we have groups of people that here have been all through all kinds of hours, like figuring stuff out because the work is is really that special so um you know so we're investing in that work because we think that work will you know change the vector and we'll change everything and uh we'll create massive strategic separation so um we're we're not really looking at i i wouldn't say you know if you said hey gary's your focus on financial outcome in 2023 not really our focus is on creating a leapfrog in 2023 and 2024 that when we come out of this cycle that people look around and go, where did they go? That we've just made such a leapfrog that we're so much farther ahead of everybody else on every level. And that will create big returns. And we know how to create big returns. We've built the best model in the industry. So we're going to do things that make the model better. But you can't do that by not investing and go, okay, we're 20. Let's hang on. Let's do less. That's the downward spiral. That's the long-term death spiral.

And that's not the game we play. Understood. Thanks very much, and happy holidays.

Our next question comes from the line of Jonathan Matsutsuki from Jefferies. Please proceed.

Great. Good afternoon, and thanks for taking my questions. Gary, you mentioned 2023 will mark the largest introduction of new products in company history. So how should we be thinking about your source book strategy next year? How are you thinking about mailings relative to maybe, you know, this past year? given all the new product launching, and should we be planning for elevated source book costs? That's my first question. Thanks.

Yes, you should. And probably a big advertising campaign, because I think it's the best work we've ever done. So we're going to shout from the rooftops. Gotcha.

And then, you know, my follow-up question on supply chain, Can you help us understand the cadence of how supply chain cost tailwinds may flow into gross margin next year? The reason I ask is I think 70% of your cost of goods sold is sourced from Asia. So how should we be thinking about the timing once we're on the other side of elevated inbound container rates next year? Any color there would be helpful. Thanks.

Hey, John. So we're kind of getting some of that already. If you think about the ocean freight contracts, they reset roughly June 1. So that's where we saw the initial burden of those much higher rates, as we've talked about on various calls. But I would say every month since then, we have actualized a number lower than contracted. And the way you achieve that, obviously, you're not always going on contract at the spot rate level. So you're going out in the spot market. And those rates have been coming down. There's excess availability, especially along certain Asia-Pacific routes. And so while we initially saw a margin structure from the higher rates in, I would say, the first four or five months, we're at a point now where we, like this last month, we're lower than we were for the sort of contracted rates for the prior year. And if you think about our turn, call it two, three times, depending on the product category, And a lot of our business special orders, there's an immediate impact on that. But the part that's stocked, I mean, we felt the pressure and we're kind of now getting into some of the initial tailwinds. And that's reflected in our guidance. But we expect, honestly, as we look at it and we think about what's happening with supply chain, I think there's there's probably more to come there, more opportunities.

And so those are starting and we'll continue to see this in the next year, we believe. That's helpful. Best of luck for the rest of the year. Thank you. Thank you.

Our final question comes from the line of Michael Lasser from UBS. Please proceed.

Good evening. This is Atul Maheswari on for Michael Lasser. Thanks a lot for taking our questions. Gary, your stock buybacks slowed quite a bit this quarter. The question is, why did you go slow on buybacks so much? Was it because of the M&A, or has anything fundamentally changed about how you view buybacks in the current landscape, given you still have over $2 billion of cash in the balance sheet?

Yeah, look, I think that the housing market has collapsed. And it's went down pretty viciously as interest rates have went up. And so I think Simeon's first question was about being responsible. So we're not going to necessarily change the world through a buyback strategy. you know, you're going into kind of a storm that you haven't seen before. You don't want to sail, you know, or let's say you're not in a sailboat, but you're in a boat. You don't want to spend all your fuel, you know, before you can see the shore and run out, you know, and be floating around out there. So, yeah. There's lots of examples of people who went out and spent a lot of money on buybacks and went bankrupt. Bed Bath & Beyond will probably be the next one that does. They're pretty famous for how much stock they bought back. I don't know exactly how this housing market is going to play out. I don't know if the housing market is going to... Almost always, The housing market is in a recession. I mean, if somebody doesn't think that, I'd love to just do a Zoom and put our numbers up for you. But, you know, the luxury housing market has trailed down since last September, right? It was down eight, down 16, down 17, down 16, down 12 in January, down 13 in February, down 15 in March, down 18 in April. down 18 again in May, down 21 in June, down 24 in July, down 28 in August. And, you know, the new numbers will come out for the next quarter and we'll know how far it goes down, but the odds are it could be down 35, it could be down 40. So when we start seeing trends like that, you know, I don't know how it comes all apart. Did anyone see 2008 coming because the way the market reacted, it didn't seem like it, right? And nobody sees the big implosions. And, you know, we're not greedy. Again, we're not going to accomplish our goals here based on a buyback. So we're spending our, you know, we'd rather just go, look, Where is the world going right now? We've never pumped this many trillions of dollars into the economy. Interest rates have never accelerated this fast. Inflation hit numbers that we haven't seen in 40 years. It seems like Powell kind of sounds relatively confident when he's up there, but He's the guy that raised interest rates way too slow. You know, he's the guy that didn't start easing. I mean, he should have raised interest rates and not let the housing bubble happen. You know, housing prices went up from 2020 to 2022 by 45%. You know, that's never happened except in the 70s.

The two-year period, housing going up 45%.

And so I don't want to sit here and have all kinds of debt and not have any clarity of what it looks like out there. So let's let the storm become clear. Let's make sure we can see the shore. Does that mean, oh, Maybe the stock runs a little bit and we buy a little less. We're not here spending all our time trying to figure out how to optimize a buyback. We think our stock's undervalued today. Could it get worse? I think business will get worse before it gets better. Will our stock get worse before it gets better?

I don't know. But I haven't been here for 22 years.

But, you know, spent all my time thinking about that. We've got much more exciting things to focus on. When we have a better view of the shore, then we'll make the right decisions.

That's fair, Gary. Thank you for that. And as a related follow-up, at this point, how much visibility do you have on some of the planned gallery openings in Europe and even the U.S. over the next 12 to 18 months? And if the macro does turn for the worse, would you look to maybe delay some of the openings until when the macro stabilizes so as to get the most customer attention to some of the great work that you and your team have been doing?

Yeah, it's a little tough to do that because once you're in construction, you know, if you stop, you're just going to make a gallery cost twice as much, you know, and you're still paying rent and, you know, you're still, have costs. I don't think we've ever opened a gallery that doesn't make money. Our new galleries, I anticipate, will do well. If business goes down 30%, 70% of the people still buy. All our galleries are really productive in the company today. Again, we opened a little lower, and then it just means when we come out of this, those galleries have big comps. We don't try to time things like that. If we were a company that had 5% to 8% operating margin, or even 10% or 12% operating margin, and you hit a downturn like this, you know, that could be sustainable and it pulls, you know, pulls you down and, you know, you might have a cashflow problem. Yeah, then you're going to make decisions like that. We're not going to have a cashflow problem. You know, so why would we stop building stores that we know are strategic and are going to make a lot of money? You know, so that doesn't make sense to me. Maybe other people have to do it because they have a cashflow problem. We're not going to let ourselves have a cashflow problem. That's why we haven't, deployed $2 billion buying our stock back yet. Because I don't know, you know, does Powell and his team know what to do? Or are they just tinkering around? They haven't seen this before? And is, you know, someone going to make some calls here and we go into a ditch? You know, it's not going to be a subprime thing, but it could be something else. Nobody saw, nobody's seen any of these big things coming except for one or two people. You know, the guy in the big short, you know, he got it. Maybe a few others. But most people don't get it right. And right now, I've never seen more confusion. You read the headlines of the, you know, top papers in the world. And I mean, who's saying what? Who thinks? I mean, you know, the KPMG consulting group. They think housing prices are going to drop 20% next year. Goldman Sachs thinks housing prices are going to drop 7.5% next year. The National Association of Realtors think housing is going to go up 1.2%. Prices are going to go up 1.2% next year. Generally, people speak from a place of self-consideration. If you're a realtor, you need to sell houses to make money. So you're going to have the rosiest outlook. If you're a banker, you don't want transactions to stop. You don't want the banking industry to slow down. And if you're a consultant, you don't mind telling everybody the bad news because people hire you when they're all screwed up and panicking. So maybe they're You know, they're the ones that are going to tell you the worst case. I don't know, but that's a big spread, don't you think? Housing prices are going to go up 20, go down 20, or they're going to go up one. That sounds like everybody's on the same page. You know, so it's just a lot of uncertainty right now. But one thing I'm certain of, the housing market is collapsing. at a level I haven't seen since 2008. I haven't seen this kind of drop since 2008. So go look at, you know, how far housing dropped in 2008 and 2009, because these numbers look just like that.

That sounds ominous. Thanks for that, Gary, and happy holidays. Thank you. Thank you.

And we do have one final question from Seth Basham from Wedbush Securities. Please proceed.

Thanks for taking my question. First, Gary, I'm sorry I jumped on late, but if you already addressed this, but we noticed in our work that you're partially rolling back some price increases on select products. We've also seen a higher level of clearance on your website. Can you characterize that relative to your pricing and brand strategy?

Sure, sure.

Well, you know, as Jack mentioned, freight costs are coming down, raw material costs are coming down, pricing is coming down, and we're not going to not want to have a good value in the marketplace. So, of course, we'll adjust pricing as our pricing comes down. And Sales are down. So did we plan for sales to be down this far? No. Did we think the housing market was going to collapse this fast? No. Did we think interest rates were going to go up this fast? No. So do we have more inventory than we'd like? Yes. Should we be accelerating the things that we don't want to have in our assortment long term that we're clearing out because we have new product coming in? Of course. Will we have more than normal? Of course we will. That shouldn't surprise anyone. It's the retail business. You have new product coming in, you've got to get rid of old product. So you mark it down. If your sales are down, you've got more old product. So you're going to mark it down a little faster. Otherwise, your DC can't process it. So yeah, that's all that's happening. And if, you know, prices go up, raw materials go up, shipping goes up, like everything that happened to COVID, you're going to take your pricing up. The customer, consumer's going to understand it. It's, you know, it's, well, no, but they're also going to understand when things come down. And so, you know, our whole business, we look at everything through a lens of design, quality, and value in that order. If the design's not beautiful and inspiring, nobody buys it. If the design's great, then they get closer to the product and they assess the quality. If they love the design and they believe it's really good quality, it's great quality, then they look at the price. And then the consumer makes the decision. For that design and that quality, is this a good value and do I buy it?

We try to guess where that best point is. Sometimes we're right, sometimes we're wrong.

So we adjust pricing all the time. We're never going to price anything exactly right, and we're never going to buy it exactly right.

As it relates to your clearance strategy, Gary, is the primary channel of clearance through your full-price stores and website as opposed to your outlets?

Oh, yeah, yeah. You want, like, we've got way more galleries with way more people coming into them, right? And so, and we have a website, you know, our full-price website is where we have the most traffic. So you don't want to move product out of that channel right away. You know, like we have, you know, we would, you know, you'd just back up inventory really fast. I mean, this isn't the luxury apparel business where they just throw it in a dumpster and burn it. You know, this is furniture. We're never going to run it exactly like the luxury apparel people or the luxury jewelry people and stuff like that. I mean, you know, our business, we can't throw away the product. And, you know, it's just got a different thing. We're going to have a different kind of outlet clearance model all the time. Something comes back as a return. You can't take it back at the store. You can't put it back on a shelf. You know, I mean, once it goes on a truck and it's out of the box, you got to take it somewhere so you have outlets. Because the customer doesn't like it or it's got a tiny scratch or, you know, that you can't fix or something's wrong, you've got to figure out what to do with it. But, you know, when you have plans to say, okay, you know, here's the collections, here's the things that are going to be going out that you're going to be marking down and your demand falls, pretty, you know, pretty rapidly, you know, that, you know, that's going to change your pricing strategy. It has to, because you've got inventory that's on order that's coming in. Got it. So, you know, bulky goods like ours, you know, you better keep that inventory moving because, you know, Fernando's sitting here, you know, if we don't, we don't, you know, move the inventory, He'll have to figure out where to put it, and we might not like what he does with it.

Okay. Lastly, if I may, a point of clarification. Did you say earlier that you could do 20% operating margins next year if you pulled back on a lot of investments? So with this tough macro investment environment, should we think of 20% as the high watermark for next year?

Well, I think it all depends where demand goes, what happens to the housing market. What's going to happen with interest rates, inflation in the housing market? How long of a downturn are we in? Does the downturn get worse? If housing falls off at a greater rate, just demand's going to go down. Our business is tied down. to the housing market because if you look at our business, it's tied to events. Someone bought a new home, they're remodeling a home, or they are redecorating their home. The core of our business is not like the person that goes, yeah, I need some new bedding. Our business is tied to those three things. If people are not buying homes, if people are not remodeling a home, and by the way, when people remodel a home, they're generally buying a home to live in, our customer is, while they're remodeling. So that's actually kind of good for our business. But if the real estate activity stops, it hurts our business. So if you have a 20% downfall in the housing market, two out of 10 people didn't buy a home. You know, if it's 30%, three out of 10 people didn't buy a home. And then, you know, or didn't move and, you know, or not, you know, remodeling the activities. I mean, what is it? Mortgage applications were down 47% in October. That's just the number. I'm not the doomsday guy. That's just the number. You know, and we look at these numbers. So mortgage applications down 47% isn't good for the outlook of our industry.

It's the highest print yet. So next year is like a month and a half away.

That slowdown, they don't buy a house and they buy the furniture the next day. So there's a whole tail to all this stuff. And, you know, so how it cycles through, you know, I just don't know where it's going yet. I don't think anybody does. I think anybody who tells you they think they know where the housing market's going, you know, I don't know who's been right yet.

This is not, by the way, for the housing market point of view, there is no soft landing.

We're way beyond a soft landing. This is a really hard landing or a crash landing. And it's looking more like a crash landing in the housing market. It's looking like 08, 09. And if that sounds like whatever Aaron said, like I'm going to pessimist or whatever. Yeah, you know, ominous or whatever, you know, okay. Okay, maybe I'm a truth teller and I'm not a BSer. But sometimes the truth isn't what everybody wants to hear. But it's just the truth.

It's the facts. You guys can read that. Yeah. Understood. Thank you for your candor and happy holidays. Happy holidays.

That does conclude today's questions. I would now like to turn the call over to Gary Friedman for closing remarks.

Great. Thank you, everyone. Well, as we said in our letter, we really want to thank all the people and partners, all the world that contribute to our cause, our shareholders for believing in us. And we just wish everybody a happy, happy holiday. And we look forward to speaking with you in the new year. Thank you.

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.