RH

Hello and welcome to the Q3 2023 RH Q&A conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. We please ask that you restrict yourself to one question and one follow-up, and you may re-queue for further questions. If you would like to ask a question during this time, simply press star 1 on your telephone keypad. If you would like to withdraw your question, again, press star 1. I'll now turn the conference over to Alison Malkin. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for our third quarter fiscal 2023 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 issue 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 issue 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. 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 Gary.

Great. Thank you, Allison. Good afternoon, everyone. As we usually do, we'll start with our shareholder letter and open the call to questions. To our people, partners, and shareholders, net revenues of $751 million were at the midpoints of our guidance to the quarter. An adjusted operating margin of 7.3% was slightly below expectations due to higher than anticipated expenses, including international openings, as well as costs related to our pending acquisition of the New York guest house property and unsuccessful efforts to secure the iconic One Ocean Drive Miami Beach location. While pleased with improved demand trends generated from the launch of our new RH interiors and RH contemporary collections, we experienced increased headwinds in early October when mortgage rates peaked above 8% and the Hamas invasion of Israel triggered the war in the Middle East. With 82% of homeowners having mortgages below 5% and 62% below 4%, We continue to expect the existing housing market to remain frozen until interest rates and or home prices fall meaningfully. Additionally, the home furnishings market has become increasingly promotional, and we believe that it will create a mixed shift towards the clearance products, pressuring gross margins. In light of the current market, We're delaying the mailing of our RH Modern Sourcebook until the first quarter of 2024, when we believe demand trends will likely be more favorable. As a result, we are narrowing our revenue guidance range for the year to 3.06 billion to 3.08 billion, and now expect adjusted operating margin to be in the range of 13.6 to 14%. As mentioned, we are in contact That contract to make an opportunistic purchase of the New York guest house property for approximately 58 million scheduled to close in the fourth quarter. The building was appraised at 85 million last September, when the federal funds rate was half the level it is today, we believe, controlling the outcome of this one of a kind property is in our best interest, however. we will be poised to take advantage of any opportunity to do a failed lease back with the appropriate investor when the commercial real estate market rebounds in the future. Product elevation. We expect our demand trends to accelerate through the first half of 2024, and as our product transformation unfolds, in stocks improve, we complete the reset of our galleries and introduce our new modern NRH outdoor source books in the first quarter of next year. We anticipate our inflection point will peak in the second quarter of 2024 as our new collections fully ramp and we begin another cycle of source book mailings, completing, transforming, and refreshing the entire brand over a 12-month period. We believe our latest collections reflect a level of design and quality inaccessible in our current market and a value proposition that will be disruptive across multiple markets. positioning RH to gain market share throughout fiscal 2024. While the product transformation of this magnitude will be margin dilutive in the short term, we believe it will become margin accretive over the long term as selling rates stabilize and allow for supply chain sourcing efficiency.

Platform expansion.

Our plan to expand the RH brand globally, address new markets locally, and transform our North American galleries represents a multi-billion dollar opportunity. As discussed last quarter, we introduced RH to the UK this past summer in a dramatic and unforgettable fashion with the opening of RH England, the gallery at the historic Ainho Park, a 17th century 73-acre estate that is a celebration of history, design, food, and wine. We had a spectacular turnout for our opening event, and the global press coverage the brand received was multiple times greater than any gallery we had ever opened. Due to RH England's countryside location, we expect the majority of the revenues to be driven by our interior design and trade businesses, which are dependent on building books of business and high-value repeat clients like interior design firms and hospitality projects. The quote book and demand continue to build monthly, despite the seasonal nature of the location. Our first UK interior sourcebook was in home in October, and our next contact planned to be our RH Modern and RH Outdoor sourcebooks in the first quarter of 2024. In November, we opened two new international galleries, RH Munich and RH Dusseldorf. The response to our opening event was beyond our expectations, with Munich hosting over 900 chic attendees, roaming three floors with Cipriani Bellini and Vesper Martini. And traffic in both galleries has been strong since opening. Although RH England is our most unique and spectacular gallery to date, and the only one with a hospitality component in Europe, all three are architecturally impressive, multi-level expressions of the RH brand. only to be outdone by even more impressive teams in each location. While many retailers boast of a capital-like franchise or licensing approach to international expansion, we believe the only way to build a brand and optimize the business globally is to invest into and control the brand in the same manner we do locally, with people who live and breathe our values because it's their values, people who will lead our cause and build our culture because it's their cause, and it's their culture. We believe when you aspire to be the very best in the world, there are no shortcuts, and greatness can never be delegated nor licensed or franchised. Our next international openings include RH Brussels, the gallery on the Boulevard de Waterloo, and RH Madrid, the gallery on the Plaza Marqués de la Salamanca in the first half of 2024, followed by RH Paris, the gallery on the Champs-Élysées in the fall of next year. RH Paris is one building from the corner of the Avenue Montaigne, known as one of the most exclusive and luxurious arteries in the capital and the chosen home of the major haute couture brands such as Chanel, Dior, Vuitton, Celine, Saint Laurent, and many others. We believe the space we've designed for this location will position RH as a placemaker and pacemaker in the luxury fashion capital of the world. RH Paris will be a six-floor jewel box connected by a dramatic, ornate scissor stair and a central glass elevator that will whisk you up to the fifth floor and rooftop champagne and caviar bar, where you can take in views of the Eiffel Tower while enjoying our innovative menu featuring the finest Petrosian caviar. You can also visit the second floor and dine in our dramatic atrium restaurant, inspired by the Grand Palais, with an onyx carved bar, floors, walls, and tables, looking out into the beautifully landscaped courtyard with 30-foot ivy-covered walls. It's like dining in a secret garden, erasing the noise and chaos of the outside world. Mark your calendars for early September. RH Paris will be an opening party you won't want to miss. We are also under construction in London and Milan in inspiring spaces that will celebrate the heritage of the historic structures and will integrate full expressions of our hospitality experiences. Our current plans call for opening both galleries in 2025. We're also anticipating gaining local approval soon for RH Sydney, the gallery in Double Bay, with plans to open in late 2025 or early 2026. Regarding our North American transformation, we opened RH Indianapolis, the gallery at the Dahan Estate, one of the most accurate palladium-style villas ever built in the United States. The estate spans 151 acres and over 60 rooms, overlooking a 35-acre lake, and represents one of the largest, most inspiring, and immersive physical expressions of our brand to date. With construction delays pushing RH Cleveland into the first quarter of next year, Our plan now includes opening five North American design galleries in 2024, inclusive of RH Palo Alto, RH Cleveland, and RH Raleigh in the first half of next year, and RH Montecito and RH Newport Beach in the second half. We also believe there's an opportunity to address new markets locally by opening design studios in neighborhoods, towns, and small cities where the wealthy and affluent live, visit, and vacation. We have several existing locations that have validated this strategy in East Hampton, Johnsville, Los Gatos, Pasadena, and our former San Francisco gallery in the Design District, where we have generated annual revenues in the range of $5 to $20 million in 2,000 to 5,000 square feet. We have secured our first new location for a design studio in Palm Desert and should open in the first half of 2024. We have identified over 40 locations that are incremental to our previous plans in North America and believe the results of these design studios will provide data that could lead to opening larger galleries in those markets. VRH 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 case 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 introduction of RH couture upholstery, RH bespoke furniture, 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 products to conceptualizing and selling spaces by building an ecosystem of products, places, services, and spaces that establishes the Arch 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. 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 Johnstville, an integration of food, wine, art, and design in the Napa Valley. RH1 and RH2 are private jets. and our H3, our luxury yacht, that is available for charter in the Caribbean and Mediterranean for the wealthy and affluent to visit in 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 who are shaping the world of architecture and design. Our plan to expand the RH ecosystem globally multiplies the market opportunity to $7 to $10 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. Never underestimate the power of a few good people who don't know what can't be done. For the past 23 years, we've heard others tell us what can't be done, and for the past 23 years, we've failed to listen. We avoided bankruptcy while being accused of lunacy. While others have been shrinking and closing stores, we've been building the largest and most inspiring spaces in the world. When Wall Street didn't think our stock was worth buying, we bought 60% of the shares ourselves. When everyone told us we should be working from home, we were in the center of innovation, working on rebuilding our new home, our brand, and it's almost ready for prime time. From the largest product transformation in our history to the most inspiring and unusual retail experiences in the world. From couches to caviar, beds to bellinis, architecture to airplanes, homes to hotels, I should say guests. From Pittsburgh to Paris, Los Angeles to London, Boston to Brussels, Miami to Munich, and San Francisco to Sydney, soon the world will be within our reach. Never underestimate the power of a few good people who don't know what can't be done, especially these people. Onward, Team RH. RPDM, Gary. Operator, I'll now open the call to questions.

Thank you. If you have a question, please press star 1 on your telephone keypad. If you wish to remove yourself from the queue, simply press star 1 again. One moment, please, for your first question. Your first question comes from the line of Simeon Goodman of Morgan Stanley. Your line is open.

Hi, everyone. Hi, Gary, Jack. Good afternoon. I want to ask about contemporary. I know it's early. I think some of the research was that it shouldn't cannibalize other aesthetics. I don't know how much data you have on it yet, but is that fair and how sales are progressing? And then I don't think, can you just remind us, you never touch pricing on contemporary. I know we talked about changing some pricing on some items, but I don't think it ever related to the new collection. Thanks.

Yeah, we reviewed kind of pricing and our value equation throughout the brand, so everything was touched. I mean, if you look at the contemporary brand, the contemporary book, this remailing of the book, it's got a very high new content. So, but all the products kind of been, I don't think there's anything we didn't reprice. So, yeah. Yeah. But look, the contemporary book got in mid-October, early to mid-October. It kind of hit right as the war was breaking out and interest rates peaked. So, it's hard to kind of see the initial reaction to it. You know, there's collections, like any collection, there's collections that are selling really well. Some are selling good, some not so well. You know, I feel very confident that, you know, the overall mailing of contemporary is going to be incremental, you know, as we believe interiors has been and as we believe modern will be and as we believe couture upholstery will be and bespoke furniture will be and everything we do, you know, stuff like that. So, look, we couldn't be more excited. We're sailing into probably one of the biggest headwinds any of us have experienced in the housing market. While it's not the great recession of 2008 and 2009, it is from a housing point of view. It's that bad. So, you're laughing really big down numbers in the housing market, and they're still down. You know, so, you know, you've got a little lift in the new home market, but that's only 10% of the market. So, you know, we've got to, you know, as I said, you know, in this latest shareholder letter, and I said last time, we'll continue, we should continue to see our business inflect, you know, through the rest of this quarter and into, you know, through the first half of next year and hit an inflection point, I think, kind of mid-late to second quarter. And that'll be despite kind of the housing market, unless there's something where there's another gap down. But it seems that they've got inflation somewhat under control. It seems like the Fed's becoming more confident. And if we can start to see a move in interest rates, and the easing in interest rates, the federal funds rates and the mortgage rates that'll help. While mortgage rates went down a little, you still have an affordability issue with 82% of the people with mortgages at 5% or under and 62%, 4% or under and 25% are under 3%. So that's the biggest issue facing the market today. And that's why we don't have inventory. There's not inventory in the housing market and why prices aren't coming down because there's not inventory. You know, some pricing come down here or there in some markets. But, you know, the good news for us is, you know, we're just taking a long view. We're trying to position the brand and the business, you know, for the next big run. And, you know, I think we're going to be. meaningfully better position than anybody else in our sector. You know, not by a little, by a lot. You know, it's like when this housing, you know, we'll outperform, you know, the market and the competition, I think, over the, you know, the next period. You know, we gave some market share back, you know, during, you know, the post-COVID period. We haven't been... promotional like everybody else got. Everybody got on the other side of COVID and everybody got promotional, even though people say they're not promotional or they're not doing site-wide promotions or whatever the language is, you know, just on people's websites. You know, it's a very promotional environment out there and has been. And I think what you're seeing now is the people that got promotional are now going to lapse their promotional stance and they have to go up against that. So that was the lever post-COVID for people to, you know, turn on the promotions, lift the business. Now everybody's cycling that. And, you know, I think you're going to see people's, as you're seeing it, people's businesses inflecting downwards in this environment and our businesses inflecting upwards and it will continue to do so.

Can you, as a follow-up, can you talk about your own inventory position, the ratio of, I don't know, discounted or clearance items? Because you mentioned the shifting to that could weigh on margin. And if you have stuff that needs to be cleared or contemplated to be cleared, does it make sense to tactically move it out of the way to make way for all the new product that's coming?

We are. We just don't want to lead with clearance and lead with pricing. I mean, we'll have a few emails that go out there that talk about, you know, end of year products. you know, end of year sales to, you know, to, to deal with the, uh, with the clearance goods and stuff like that. We'll, and we'll be aggressive pricing those goods. So we, you know, get the inventories clean and, um, you know, turn inventory into cash. Uh, we don't want it sitting around on the balance sheet. So, um, yeah, you'll see it takes the, you know, the appropriate, uh, action here. And, um, yeah, so that, you know, but, nothing we wouldn't normally do. We would still want to lead with promotions or start to, you know, turn the business back in that direction. We're almost to the other side of this thing. I can't believe, you know, maybe we've got another six to 12 months, but I think, you know, you get to the second half of 24, unless, again, unless they haven't got inflation under control, I think we're going to see, you know, take an easing approach. I would be surprised if they left interest rates at these levels the entire year next year. But nonetheless, even if they do, you're going to see us perform pretty well in any environment just based on the work we've done and what's in the pipeline and the plans we have. I mean, they're all very big moves. This is by far the biggest product transformation in the history of our industry. It's multiple times bigger than anything we've ever done.

Your next question comes from the line of Steven Zaccone of Citi. Your line is open.

Great. Good afternoon. Thanks for taking my question. I wanted to ask on operating margin, and I wanted to talk about, ask in particular about the ability to protect the operating margin. You know, we're now at a level that's below 2019, you know, granted the macro is challenging, but can you just talk through your comfort with protecting operating margin? What are some levers that you can pull if the macro deteriorates further into next year?

Yeah, I mean, you know, we're not, we don't have a strategy to protect operating margin. I mean, we're, you know, you're comparing it to 2019. Are you kidding me? No, like, why would you do that? It's nothing like 2019. We're in the biggest housing downfall that anybody's seen.

You know, so... There's massive, massive inflation since that time. Yeah. On so many items of P&L costs.

Yeah, yeah, yeah. So that's not where I'd be focused. You know, like, I mean, you can focus there. You'll just miss everything that's going to unfold here, you know, if you want to focus on that. I mean, we're investing for the next cycle.

We're investing for the long term.

We're not trying to protect the operating margin a point or two. I mean, it's... If that's going to get people really fired up about the long-term strategy of this company, it's probably the wrong shareholders.

And Steve, just one thing to comment about, again, you mentioned lever, but just more of a point of a tailwind is that, you know, that we have elevated Markdown activity this year, that as we cycle through that next year, that, you know, that could unveil itself as a tailwind next year.

So we'll talk more about that in March, but, you know. That's one aspect that's positive.

Yeah. I mean, the operating margins are going to be fine. So the cash flow is going to be fine. We didn't buy back $2.2 billion per stock because we think the model has a problem. We're going through the biggest transformation in this entire industry. And so you want to think about what's going to be on the other side of that, not what's the operating margin in the next quarter or two, whether that bounces around at point or two.

As the biggest shareholder in this company, that's not what I'm worried about. Okay, fair enough.

Follow-up then on just the promotional aspect to the furnishings industry. How long do you think that lasts? Is that something that continues for the next couple of years, or is it something that probably is finished by the end of 2024?

Oh, you mean just the broader industry?

Yes. Yeah, no, I think the broader industry is back to pre-COVID, you know, pricing and promotions, and it'll be there forever now. Once you turn that on, you can't go back. So, you know, maybe the emails look different or they call them different, but, you know, you go look at the websites. I mean, go – I mean – you're getting pelted with sale emails and have been for over a year. And that's why, you know, as I said, that's why everybody's now cycling that. And, you know, so, you know, there's easy business. We could have turned on promotions over the last year on the other side of COVID and moved our business 15 to 20 points. It just would have permanently created a different model. And so, you know, look, some people are, promoting and cutting ad costs. Some people are doing a lot of different things and hoping they have a massively different model. There might be people that come out of this thing with a slightly better model. Maybe there's some things they learned. Maybe they don't have to spend as much in ad costs. Maybe this or that. It's not really people that we compete with that I'm too concerned with. I'm more focused on you know, what we are doing and what our big strategies are and, you know, how this business is going to be positioned, you know, for the next, you know, five years. And, you know, and we really like what I see. I think this is the best work we've ever done. You know, so what you're going to see unfolding over the next several quarters and not just, it won't stop there. While I say that the inflection point, you know, will peak in Q2, that's just based on on what's in the pipeline. What's coming on the next cycle likely will create higher and higher peaks, right? Because we're creating an entirely new foundation for the business, you know, a stronger, bigger, better foundation for the business. You know, where we got arrogant around pricing during COVID and, you know, we had all the, you know, the price increases from, the tariffs and then the supply chain, you know, raw materials goods going up, you know, we're just a lot stronger and we're going to play a very aggressive, you know, game because we can't. We have the scale to buy bigger than other people. We have the scale to get better pricing. We have the platform to prevent it. And so, you know, where I think we've, we lost the market share because we were, you know, slow to kind of ramped back up the product development and marketing of the business post-COVID. We rebuilt those muscles where we were arrogant from a pricing point of view. There's no arrogance anymore. There's just an incredible competitive focus to win. The market's going to do what the market does. I don't know if I was... You know, all the people that are out there that have been promoting this past year, what are they going to do? Stop promoting? Their business will go down 15 or 20 points. Yeah, you know, try not promoting the furniture business when you've been promoting. Like, it just doesn't work. You have to go through a whole year cycle like we went through when we moved to membership. You know, that's a painful thing to do. And You know, you have to be someone who owns a lot of the company like I did. Otherwise, you're going to be a CEO that's under attack by activists. You know, you go through a transition like that. So, you know, there's people that say, oh, we're going to do like an RH membership model. Good luck with that. You know, they're not easy things to do. You know, we spent three years planning that and transitioning the business and the model. But, you know, to stop promoting when you've been promoting, you're back on that promotional drug.

You can't just get off it.

Your next question comes from the line of Chris Horvers of JPMorgan. Your line is open.

Thanks. Good evening. So a couple of follow-up questions on the gross margin. So once we get past holiday, do you think it'll be clean to start 24? And is it fair to say that the vast majority of the non-fixed-cost leverage in gross margin was clearance. And to your comment, Jack, is there any reason why you wouldn't get that back? Presumably with all the newness, you wouldn't expect a lot of markdowns.

Yeah, look, I think transition out. Yeah, look, starting there, we're going to be in a better position than, you know, let's say the start of the quarter. But I think we'll be going through, continuing to sell through the markdown goods, you know, by the end of the first half.

Yeah, I mean, we'll always have some level of markdowns, right? But what you want to think about, what does the overall mix look like? So the mix is going to be, you know, a heavier markdown mix, you know, in Q4, and you'll have some of that move into Q1. It'll probably lighten up, and it'll lighten up in Q2 as we sell down. And you're going to have, as the quarters go, you're going to have a higher mix of new, you know, higher margin product. Yeah, so what I said in the letter, you know, over the short term, it's margin. The transformation we're making is margin dilutive. But long term, it's margin accretive. You know, it's mixed shifts. as the inventory rebalances.

Got it.

One of the questions we also get from investors is trying to think about there's a lot going on with all the new galleries and the accelerations of the books, the source books back to what it was pre-COVID. As you think about what's implied here, the third quarter SG&A dollars, is that the right base? I guess said another way, is there any reason advertising steps up again next year? And if you think about the complexion of the openings next year with more international, are we just sort of naturally raising the expense base, given those two factors?

Yeah, I mean, when it's the appropriate time to guide, next year we'll guide next year. So we're not guiding next year right now. But, look, there's always going to be certain startup costs, right, when you're ramping up new countries and things like that, you know, and investments to get the galleries up and running, to get people trained, to get restaurants opened. to get the home delivery network set up and operating and people trained, and then you'll cycle those things, right? So, you know, are we going to have some cycles to get around as we open different countries? Yeah, sure. But once, you know, business is ramped, you know, you cycle those things. So, yeah, I don't know. we have a lot of confidence in long-term margin, you know, of the business and the model. So, you know, I don't think there's any reason why this, you know, why this, you know, business and brand doesn't get back into the, you know, 20% range as, you know, we cycle through. I mean, you're not going to get there in one of the worst housing markets. This is, I mean, you know, we compare the exact numbers to 2008 and 2009, but this is this is, if it's not the worst, it's the second worst in my career. And I think I've been doing this as long as anybody leading a company in this industry. You know, there might be some people that have been doing it longer than me. I don't know too many, but I haven't seen a market like this, you know, and how to navigate through a, you know, a housing market downturn like this. You know, so, you know, I can't remember when people were, you know, locked into low interest rates and they can't step up because, you know, different interest rates. So you got to kind of look beyond this kind of temporal time. I can't believe that we're going to be in this lockup like this forever. Like, could it go through 24?

It could. So what?

You know, it doesn't change the long term, you know, and we're you know, the good thing is we've now cycled around. So we didn't bite on the promotional, you know, drug like everybody else did. So we gave away some market share because we didn't do that. But at the same time, we've sharpened our value proposition at regular price, and we're going to be tough to compete with, you know, even if people go on sale. You know, people don't They just don't have the buying power, the platform to present it that we do. And so, you know, I wouldn't want to be on the other side of this big move we're making.

And Chris, you know, you asked about Q3 being a base.

You know, we don't look at it as a single quarter as a base.

You've heard me talk about if you're going to try to read some trends on a base, then, you know, look for a full four quarters given the cadence of advertising timing. Yeah, you can't just use a quarter.

Yeah, I mean, we used to be able to mail a book and we amortized it over, you know, six or 12 months. Now you mail a book and, you know, The day you drop it is the day the ad costs it. So, you know, and obviously, you know, the book's more valuable than that single period. But, you know, there's just an accounting rule change that, you know, is going to make a business like ours kind of lumpy, right? From, you know, quarter to quarter based on, you know, the ad costs hitting when the book drops. No amortization of the ad costs, which doesn't make sense.

You're not going to get all the sales that week.

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

Great. Thanks very much. Just kind of a quick one, more of a clarification than anything else. So just in the share letter, there was a comment about reaching kind of a peak inflection point in Second quarter of next year, is that in terms of kind of a ramp? Is that demand trends, you know, flow through revenue? If you could specify that a little bit more for me, that would be really helpful. I'd appreciate it.

Yeah, yeah, that'll be, you know, that'll be demand trends, you know, which will turn into revenue. And, you know, there's going to be just continued step-ups. You know, there's going to be step-ups as we get in stock. There's going to be step-ups as we finish the gallery transformation. You know, anytime you have big moves like this, you're going to have some things, some collections that are just wildly better than you could have thought. And you're not going to have, you know, we have a collection here that is the best collection in the history of RH by probably 40%. We're not going to catch up on the inventory until March, April, somewhere around there. You know, so, you know, there's, and we, you know, you've got all these imbalances when you have this much newness. So you've got to kind of right size all that. You've got to get in stock because, you know, because things like that and other collections and things are selling so well, you can't even put them in the stores, right? So you've got too much demand. So you've got to fill the demand. So, you know, some of the products that you're planning to transform the galleries with now is blown out. And then you've got to let, you know, the manufacturing base, you know, just get their legs underneath them with all this newness, right? And, you know, they're going to get more efficient, you know, and things are just, the flywheel is going to be running. You know, we will then have, you know, we're going to have the second round of the book mailings, which is going to have another Well, I mean, modern is going to be massively new. But then, you know, all the books will remail in the first half. You know, modern, because we're pushing a little later, may go, you know, in the third quarter. But all those books will have another probably an average 20% to 40% more newness based on what's in the pipeline. You know, so it's like we usually have 15% to 20% newness. And so, you know, basically the entire brand is going to transform, and the assortment is going to expand on top of that. And so you've just got to kind of, you know, get it all dialed in, get all the inventory balanced, you know, get everything set. You know, some things you planned you're going to put in the galleries, in the retail galleries. and all of a sudden the demand doesn't look good, and you're like, let's swap that out with something else. And so, you know, you're reading and reacting to real data now. And so we like what we see in the data. You know, we like what we have in the pipeline. We like when we, you know, we dimensionalize all the trends and all the data and say, what does this all look like three months from now, six months from now, when this happens, that happens, that happens. And, yeah, that's when we think we'll – or for this big transformation, that's when we should start to reach peak inflection.

Got it. And then just a follow-up for Gary. Comments in Germany were interesting, right, a lot stronger. It sounded like something you'd expected. I don't think you put a ton of marketing behind it. So what drove it? I mean, you know, at least from seeing online, you know, the great locations, you know, beautiful – exteriors, all the rest of it. But in terms of just this response, what's resonating and, you know, anything you could say in terms of just, I don't know, I guess the potential relative to some of the, I guess the average size in terms of revenue for U.S., if you could size that, unless it's too early.

Yeah, I think, you know, I think just in general, we're in highly populated, you know, shopping areas, right? So, you know, in Dusseldorf, we're on the main shopping boulevard, you know, dead center across from Chanel, you know, a few doors down in Hermes, you know, just the main luxury shopping street, and we're dead center. You know, so there's a lot of people walking by and a lot of people walking in. In Munich, we're right in one of the key hearts of town where there's a lot of people. And you really can't compare those to what we did in England, right? Like I've said since the beginning, England, we didn't do England through a lens of commerce first. We did it through a lens of conversation first. How do we create the right conversation with the brand? How do we make the right first impression? How do we do something that's so extraordinary? You know, it gets high-end luxury consumers to look at us differently, think about us differently. You know, so England is really a, you know, it's a big brand investment, but there's not a lot of people, there's no one walking by that store. Not a single human is walking by. You got to drive there. It's an hour and... 45 minutes out of London. I mean, the business is built. We just, we just closed our today. We closed our, you know, they get sale. Yes. It's 330,000 for what? And the French house, the French house, but you know, so you know, the book of business is building the design business with our, you know, our internal interior designers is building with our trade clients is building, you know, all those pieces of business are building nicely. And what's funny, I really thought, oh shit, this time of the year, it's going to, it's going to go slow because it's, you know, the weather's not that nice out there right now. And, you know, it's not like you're walking around the grounds unless you've got some heavy coats and, you know, some rubber boots and stuff. So, but, but our, our demand and our, and our book of business and everything is building still most over a month. And, Yeah, so the brand's just, you know, it's going to take a while for the brand to just, people know we're here and know who we are and what we're doing. And, you know, remember, people only buy furniture really every, you know, kind of five to 20 years, right, depending if you bought another new home or what you did. So, you know, you don't generally just go out to furniture stores, you know, unless there's a need. So, yeah. you know, what, you know, RE Chinglin just doesn't have the traffic of, you know, the locations that we have in Germany. And so this is just our first look at the locations in Germany. And we like what we see. We like, you know, the people that are coming in, you know, they're starting to engage our designers. They're starting to learn about the brand. Some know about the brand. Some have lived in America and now live in Germany. And, you know, some have Yeah. Telling us at the opening part of Munich, you know, at a couple, how they shift their own, been shipping their own containers to Munich. And now they're so excited we're here, you know, they're, yeah. And, you know, so we had a lot of fans. I mean, what I was, I think, beyond my expectation was just the excitement for the brand and the quality of people that were at the opening events. Yeah. It was, I mean, it was as good as you could have expected. And so, you know, that, again, that's, again, like creating another conversation, those people telling their friends and others, you know, you just, you know, let that, you know, start building. And, you know, I would expect these countries are going to probably have pretty big compounding comps for the first three years. know much bigger you know like in in america when we open a new store even if we're not in a market we're already in that market we're our age like we can open in milwaukee you know next month and we don't have a gallery there but we do millions of dollars in milwaukee people are shopping from us you know online they know the brand uh and so you know when we open in the place Like that, you know, people are lined up, ready to shop. There's people that have been shopping. They're ready to place transactions and place orders. And you have immediate demand. I think in these new countries, you know, people are going to come in and get to know us. And, you know, we'll start working on, you know, they'll get to know the brand. We'll start working on design projects. And, you know, and then people will get familiar with, you know, who we are, what our prices are, you know, how we compare. and start to interact with us. But it'll happen faster in Germany than it did in England. You know, like there's just not that much traffic. I mean, we did catch, you know, the back half of the summer. And so, you know, we did have some really high quality traffic out there. You know, but I think, you know, what I'm amazed by in RH England is that the demand is building, you know, into the slow season. I'm like, huh. That's interesting. So we like that. And we've only mailed one book, and not to that many people. So just learning about how you invest in marketing and advertising and building the brand, it's going to be a lot to learn here for us. But we like what we see. I mean, I'm pleasantly surprised how the business is continuing to build in RH England. I'm really happy with just the initial turnouts for the events and then the amount of traffic just coming into the galleries, you know, just exploring and coming to see us. You know, so, you know, the demand, you know, if that's happening, the demand will then start building, right?

So we'll see.

But, you know, we're going to know a lot more every quarter.

you know, every six months, every year here. Your next question comes from the line of Max Reklimko of TD Cowan.

Your line is open.

Great, thanks a lot. So, in the letter you noted being pleased with improved trends from the launch of interiors and contemporaries. Just curious if you could frame the uplift in the context of revenues down 13 and change. And then how should we think about the magnitude of growth in the next couple quarters from those two collections? And bigger picture on contemporary. Gary, what's your latest thinking around how large this collection can become?

Yeah, you know, it's funny. You know, we...

We don't primarily look at it, you know, it's really, what we look at is kind of one giant assortment packaged in different vehicles, right, that allows it to break through and, you know, present an aesthetic and so on and so forth to the consumer. But it's not like we sit here and go, how's contemporary doing? How's interiors doing? How's this? We say... how's the furniture, you know, the upholstery business doing? And we're looking at every sofa in the entire assortment, whether it's interiors, contemporary, modern, you know, so it's not so much the books from how we manage the business. The books is how we present it to the consumer. We look at the entire RH assortment, right? And then we're looking at you know, the books they're in and, you know, how we're going to adjust and what's working and what's not working and, you know, so on and so forth. So, you know, when you think about it, maybe from the way you're thinking about it, okay, will that, you know, will that assortment, you know, when you parse it out, how big will it be? It depends on how big we make that book, how big we make that assortment, you know, how many things we put into contemporary or how many things that wind up going into interiors and how many things go into modern, you know, because you've got some things that, you know, that the lines are blurred. We could put it in almost any of the three books. You know, so I think about the way I think about this today is RH is going through a massive product transformation. It's the biggest thing they've ever done. How does the whole thing look? And as the whole assortment gets out there, interiors, contemporary, modern, outdoor, right? As the books get out there, as the products get into the galleries, as we get in stock, what does that total assortment look like and how is it performing versus the old assortment.

We think it's going to be meaningfully accretive. Got it.

That's helpful. And then, no, that's great. And then, I guess, can you speak to the phasing of the new products to galleries and your confidence of completion by the end of first half of 24? And then, specifically, will all the galleries be touched? Will some get more newness than others? Or how should we just think about the totality of the in-gallery resets?

You mean the resets, of course.

Oh, the floor sets. Yeah, I think, you know, they're being done in stages, you know, as we're ramping up inventory. And it depends, again, is that, you know, if you're ramping up – if all of a sudden you have – some really high performing collections, you're just not going to be able, you're going to have to fill demand and not put the goods in the galleries, right? You're gonna have to wait. And so I'd say we're going to get, I don't know, 90%. in stock in Q1 or something. As far as completion of the four sets, probably a March timeframe.

Yeah.

It wouldn't be the end of the quarter, but as of where we're at today, it's probably a March. Yeah. And some galleries will get, you know, prioritized versus others. And yeah, I think it's, you know, I think we'll be in really good shape by the end of Q1, going into Q2. And then I think, by mid to end of Q2. That's why I say that should be our kind of inflection point. I mean, based on all the numbers we're looking at today, you know, we don't have data on modern yet. We won't until we mail that, you know, so that'll have, you know, same kind of challenges, lots of new product. We're going to, with any new product, when you don't have data, you're going to be a hundred percent wrong with your inventory investment. Like I've been doing this a long time. I've never seen anybody buy a new product exactly right. So you're going to be a little overbought, underbought, a lot overbought, you know, underbought. You know, because you just don't, you know, you don't have exact signs. You don't have any trends on any of the newness. So, you know, it takes a few quarters to kind of, you know, get the trends, you know, you know, read the trends right, make the adjustments you need to, get the on orders corrected, you know, make less of this, make more of this, and, you know, let the factories get adjusted, you know, as they're ramping up on a lot of new products. So yeah, but, you know, that'll all work itself out. Again, I just think about this as like, you know, the next couple of quarters will be meaningful. If we're sitting here you know, the end of Q2, and we didn't get the inflection point we needed, that would surprise me. You know, that we think we're going to get. It's not a little one. You know, it's going to be meaningful.

It's going to keep building. You know, as all these things happen.

In stocks, gallery sets, you know, modern, outdoor. and then a recycling and remailing of those books with more newness, right, with probably 30 to 40% more newness. And then you'll have some adjustments with that 30 to 40%, but that'll be much smaller compared to what we're doing today.

Your next question comes from the line of Stephen Forbes of Guggenheim Securities. Your line is open.

Hey, Gary, Jack. It might be a repetitive question, on the product transformation. But, you know, Gary, I was really just hoping you can, you know, if there's anything you can give us or speak to, whether it's sort of what you're seeing now or even a reference point back in history on sort of prior product transformation cycles that can help us contextualize, like, what the potential magnitude of the inflection on the horizon is. And, you know, whether we can reference sort of peak demand, you know, during COVID or Is there anything that helps us think through, you know, really what should we be expecting behind this product transformation?

I think it's all going to depend on what, you know, what the macro is doing in the housing market.

Yeah, so the housing market stays where it is.

I mean, again, let us guide you next year, you know, like you'll get a better sense, you know.

You know, we'll have a little bit more data.

But, you know, I just say generally I'd be surprised if anybody's outperforming us when we get to Q2 of next year.

I'd be shocked. Now, maybe someone will shock me. I don't think so. We will anxiously await that.

And then just a quick follow-up, the 70 new collections that were referenced sort of in past calls, where are we today with the number of collections that are out? And how many will be launched by spring next year, by fall next year? What's sort of the pipeline look like?

Yeah, there's more than 70 now. You know, so, yeah, we'll have probably – When modern, you know, with modern hitting and outdoor hitting, it will probably be somewhere between 70 and I'd say up to 90. And, you know, with more in the pipeline. And we have a whole other book we're working on, you know, that we haven't announced yet. So you'll hear about that, that we think is going to be meaningful. And it's not bespoke. It's not couture. It's something we haven't talked about. And that's going to be a whole new big thing. So, you know, so we're working on that, too. Yeah, so just a lot's coming, Steve. Buckle up.

Your next question comes from the line of Michael Lasser of UBS. Your line is open.

Good evening. Thank you so much for taking my question. Gary, why do you think you are losing market share? And if it's an issue with pricing, how much more do you think you need to lower prices in order to stabilize or gain market share?

Yeah, I don't think we're, well, I mean, did you miss the whole first part of this conference call? And I'd be like, I can repeat myself. You know, one, the transformations in the early stages, the goods aren't in stock. They're not in the galleries yet. We haven't been through a full mailing cycle. And I don't believe, you know, I think we've massively closed the gap. I think we're gaining market share in a lot of people today. And, you know, there might be a few people out there, you know, that are outperforming us at a demand point of view. I mean... they may not outperform us, you know, in the next quarter or two. I'd say there's going to be an inflection very soon here, you know, and so what do we have to do with everything I just said? You know, so I don't think you want me to repeat myself, do you? Like, you know, I don't think we've got to lower our prices anymore. I don't think we've got to, you know, the goods just got to get in stock. We've got to get the galleries reset, you know, and we've got to go through, you know, the next cycle and,

you know, we'll be off to the races.

My follow-up question is on the degree to which your P&L this quarter benefited from lower freight and transportation costs. Was that more significant? Could you, A, quantify it, and, B, was it more significant than the P&L had experienced in the second quarter? Thank you very much.

Michael, we've talked about this a few quarters now. Given our turn and the way Fernando and his team attacked ocean freight, where the bulk of the increases in costs had occurred through the pandemic, those turned over last year.

We peaked in May as far as the highest contracted rates we've ever seen.

And then every month thereafter, it's been a decline.

And now many markets were back to or close to 2019 levels, right, Fernando? So, you know, as far as, you know, kind of any kind of, you know, product margin impact from freight rates, I mean, we're, for the most part, cycled through that, given our... Yeah, we're not really seeing a benefit right now. I know other people are. I think they got stuck, you know, in longer contracts with bad freight rates than we did.

Yeah, we were just more nimble at accessing the spot market.

and taking advantage of the decline in ocean freight rates that really began last June, I think, June, July. So I wouldn't say there's any really that's quantifiable, or if it is, it's de minimis for Q3.

Your next question comes from the line of Jonathan Matuszewski of Jefferies. Your line is open.

Hey, Gary. Hey, Jack. Thanks for taking my questions.

The first one was just a follow-up on RH England. You know, great to hear the demand continues to build. A while ago, Gary, you mentioned the 50 to 250 range for first-year revenues was possible. Obviously, the backdrop has changed a lot. But, you know, what you've seen in the first six months and the sequential trends, how should we think about, you know, what you're internally expecting for an annualized first year volume? And I appreciate it's more about, you know, conversation than commerce, but just trying to think about how it's annualizing versus expectation. Thanks.

Yeah, you know, I don't know if we had any real expectations. You know, when people said, like, what could it be? Could it be, you know, I said, I don't know, it could be $50 million, it could be $250 million. And that's, you know, I think about it as, you know, we're going to keep kind of marketing the brand, right? To forget about RH, you know, that gallery. Think about that country, you know, and, you know, what will our investments in marketing do to the direct business? What will the brand recognition do? You know, how does it build? You know, when do you get to... you know, certain run rates. I just think it's super early for us to know because we didn't open a typical store, right? If we would have opened in London first, it'd be massively different. You know, we opened in the countryside. We tried to do something, you know, super inspiring and something the world's never seen. And so, you know, make an investment. It's like, it's just I wouldn't get too focused on this gallery, right? You know, you're going to try to draw a conclusion of this one. It's not going to tell us, you're not going to get the right answer from this one, right? This is really a brand investment and to create the right first impression and the right conversation. You know, London is going to be coming around the corner. We're looking at other locations in other parts of England. And we're going to be investing in marketing, right? And not just books, but other types of marketing to drive the online business. But we're just in the early stages of all that. You know, just like I'm telling you, don't get too obsessed with RH England. From that telling us what the market's going to be for us, I'm not too obsessed about that because it'd be the wrong place to...

draw conclusions from?

You know, like, has anybody opened a store like that in the world in any category?

Somebody named something similar to that. Let's think about that.

Like, if you've seen it, if you've been there, you know, anybody on the call, you know, if you haven't, take a look at the pictures. Have you ever been to a retail store

like that? No.

So if you try to draw too many, we're not going to really do another one like that, right? You know, so don't, you know, like we've got other things like seeing how, you know, how does Germany build? That's a lot more normal. We're on streets where there's a lot of people walking by, driving by, you know, so on and so forth. It's just a different, you know, there are two different objectives and goals and visions, right? You know, and strategies for the two. They serve two different purposes. So, you know, did I think RH England, you know, like there's a number I always had, you know, and yeah, it's a modest number. And, you know, but, you know, it's like what you don't know is, okay, when you open up a brand to an entire country like England, How does that go? How does it grow?

What marketing do you have to do, you know, beyond RE Chingling? We're still learning.

So, you know, we're not in a hurry to jump to any conclusions on any of this. We're really happy with the work we've done, with the team we have, you know, with the initial, you know, feedback we're getting from consumers and the kind of people that are coming and, you know, and all that looks directionally right. So, you know, over time, it'll all take care of itself.

Yeah, just, you know, England's its own thing.

There's nothing like it in the world. That's why we did it. To get people to see something they've never seen, think about our brand in a different way, have people at the highest levels of the economic ladders who are shopping the best luxury brands in the world and stuff look at us differently, think about us differently. Yeah, so they're all long-term, you know, things like that. It's really a long-term investment. It's like a guest house. Yeah, we opened what we believe is the highest quality hotel experience in New York City, if not one of the best in the world. I'm not looking at that thing to really tell me, am I going to roll out a lot of guest houses? No, I'm just trying to communicate differently about a brand to build something that no one's ever built before. It's like somebody just wrote a report that I thought was one of the most comprehensive reports written about our company, went all the way back to the very beginning, wrote about everything, wrote about RH Music when we had a record label and we did a concert at the Greek Theater and we did performances in all of our new, you know, new galleries. And we had RH Contemporary Art and we owned the Rain Room, you know, the most exhibited art exhibit in the history of the MoMA New York and the history of the LACMA New York. And, you know, I remember being at the Goldman Conference and, you know, someone asking me about RH Music and, you know, this and that. And like, you know, and I said, you know, it's just a different way of communicating. I could go run ads and, digitally or in print or do anything. And, you know, like, I don't know, how do you really measure those returns? If it was that easy, you know, if everybody had really great data on digital advertising, don't you think everybody would have a really high performing business? They don't. They don't know how much to spend. They don't know what they're getting for any of it. You know, Google and other people try to give you great things to you know, make you spend more money. Oh, look, look what you're going to find out. Like they clicked on your name. Like, you don't know if they clicked on your name because they came in your store, you know, or how they got there. You know, it's, you know, but it's just a different way of communicating and building a brand. If you're going to build something unlike anything anybody's ever done, you don't take the same path as them. But we got here and we did things like RH Music and we had, three artists for, I don't know, three years. And, you know, we produced albums and we did concerts and we did other things. And I think people thought it was really cool and it made our brand look different and that people think differently about us. Like, who are those people? You know, and we did art, contemporary art, and we had the rain room. Yeah. First piece of art we brought, but became the most attended exhibit in the history of the world. I mean, we're not always going to get it right, but I'll tell you,

anybody who's been to RH England thinks differently about RH and thinks about, huh, you know, those are pretty interesting people. And yeah, we're trying to build something special.

It's just, it's not a game plan to anybody else's running because they're all running the same game plan for the most part. We're running a different one. So at different times, it's,

Going to be hard to look at, hard to model, hard to understand. But that's how it should be, by the way.

Great.

Thanks, Gary. And then just a quick follow-up on product. A lot of discussion about disruptive pricing ahead. And just kind of curious how you're able to achieve that while preserving margins. So, you know, any color you could give us on how the materials or the finishes or the sizing of pieces in the new collection is going to be evolving would be helpful. Thanks.

Yeah, I mean, well, it's just, it's because of our scale and buying power and confidence. And, like, if you look at, you know, you look in our source books or you look online and you look at the Jacob chair, for example. And if you go look at it everywhere else and look at the pricing and you look at our pricing and you look at our assortment and you look at our presentation, you might have an ankle biter here or there and someone just bought 20 chairs and they're not making any money and they're going to match our pricing. But there's no one that can really buy as much as we can. No one that can present it on a platform as big as ours and mail as many books as we do and get behind it. And a lot of people don't place the financial bets we do on product. We do that very well. That we got to where we are. So if you... I mean, we've got people who are selling their version of the Jacob chairs, and they pulled it off their website because their price was so embarrassing. And they already own the inventory at a much higher price, and now they don't know what to do. So they're probably sending it to an outlet. And they know who they are. They're probably listening to this call. And, you know, if you look at anybody selling the Jacob chair, you know, whether it's the cane Jacob chair, the upholstered Jacob chair, the leather Jacob chair, the dining chairs, the lounge chairs, I wouldn't want to be competing with us in that chair. And the margins are as high as anything else that we have. So it's not necessarily a lower margin when you think of disruptive pricing.

Your next question comes from the line of Seth Bashan of Wedbush Securities. Your line is open.

Thanks, all, and good afternoon. My question is also around the product transformation. Understanding there's a ton of newness and a lot going on here, but as we think about modeling it, you mentioned that's going to be margin dilutive near term. Will that switch to accretion as the sales inflect in the second quarter, or is there a longer ramp to the margin accretion? Yeah, it should.

It should.

All right. That's reassuring. And then the second question I have is just regarding the ramp in Europe and understanding those galleries will take longer to ramp as the brand awareness is more limited than the U.S., but how should we think about the ultimate margins in ROIC of those new European galleries putting Irish England aside?

Um, yeah, you know, it's, it's not that many, you know, like we're, we're just going to, we're going to get them open. You know, we're going to learn a lot. We're going to focus on how do we build our business in these different countries and what kind of marketing investments they take and what they look like. I, you know, I, it's not, you know, it's not like you start with saying like, what's I don't know, I've never sold anything in Germany. Like, what's it going to cost to build the brand, to have people come, you know, to build up the design book and, you know, the trade book and everything else? You know, so, again, it's the handful of galleries, right? It's 10, all together, I think we've got 10, 9 or 10? 10, yeah, because we do... Sydney and yeah, the two and Madrid and stuff, you know? So, yeah.

So, you know, we're going to get them open and we're going to start learning and we're going to, you know, make all kinds of adjustments and get some things right and get some things wrong and work really hard to make it great. But, you know, I like how we're starting. I mean, like we, we look, you know,

you go into Germany, we look really good. I mean, the galleries look great. The teams are fantastic. All right. People are coming in. So it was really encouraging being, being in Munich, uh, you know, getting a, a really good feel for it. So, um, yeah, I mean, obviously very different than England. Yeah. And, uh, you know, so, and we didn't have to spend much capital, you know, in those two galleries.

We,

Yeah, we took over, you know, a couple of the Abercrombie & Fitch flagships and refitted them. And, yeah, we didn't have to build them like some of the other ones. You know, or like even in R.H. England where, you know, we had to rebuild it. So, yeah, so they're, you know, they're all going to have different kind of ROSC dynamics to them. But it's really how does it all blend out? What does it look like? you know, year two, year three, you know, as it ramps, once you cycle some of the initial investments to get home delivery up and going and, you know, all the investments we have to make. But the real big key, you know, I'd say is like, is going to be the inflection of the U.S. business. That's the key, right?

That's the big thing to focus on.

These things, you know, they're going to kind of take their own path and, uh, and we'll learn and we'll make adjustments. But, uh, you know, when we're getting these open, I don't, I don't mean to minimize it. I mean, it's just, I think it's kind of unrealistic to have really specific goals for these, you know, we just want to be directionally right. And then we'll refine it and, and, you know, learn and continue to improvise and, uh,

you know, and improve everything. But, you know, we're, our big focus is to inflect, you know, the U.S.

business and, you know, the North American business and, you know, get back to taking market share and, you know, getting our margins back to historical levels. And we're going to, you know, for part of it to get to historical levels, you know, and, in operating margins in the, you know, 20% range, we're going to need the housing market to, you know, unfreeze here and kind of return to a somewhat normal housing market.

And that could take, you know, another 12 months. You know, I don't know.

Your next question comes from the line of Peter Benedict of Beard. Your line is open.

Oh, hey, guys. Happy holidays. Yeah, follow up on that comment there, Gary. Just so I was going to ask you about the conditions you thought were required to get you back to that 20%-ish operating margin. Clearly, you know, an unfreezing of the housing market. I was thinking more, is there a revenue level or scale in a business around $3 billion now, given, you know, the cost increases across the P&L just post-pandemic? Like, is there a revenue level that you think is required to maybe support that?

That was kind of my first question.

Yeah, we know that answer, but I don't know if we want to say that right now. I mean, you know, like I think it'll – I mean, clearly it's still not higher than today.

We've said that the margin, you know, will – both gross margin and operating margin will naturally lever as we build back the revenue.

But we're not ready to give you that number.

Okay, got it. No, fair enough. Another question was just around the membership fee. I just noticed you took that up to $200. Just curious the rationale behind that decision that I think just happened here maybe in the last month or two. So that's my second question.

Thank you. Yeah, we just had plans to, you know, bump it up a bit.

So...

It's a natural progression of our business.

You know, when we started membership at $100 and for years we didn't move it, but the AOV of the business had increased.

And so when we first moved it to $150, you know, we talked about that we were kind of, you know, we might see a more regular cadence of increases. So I would just say this is just part of that and then reflects the sort of average order value of our business continuing to creep up.

And so it's membership as a percentage of that is one way we look at it.

And our last question comes from the line of Brad Thomas of KeyBank Capital Markets. Your line is open.

Hey, thanks so much. Gary, I was hoping we could talk a little bit more about the outlook for Gallery when we look at what you've done in Indianapolis and what you were working on for Miami, really pushing the boundaries here of what's going on in the U.S. I think the letter referenced 40 additional markets you're looking at. I was wondering if you could just expand a little bit more on what you think the U.S. gallery network looks like 10 years from now with this continuing evolution.

Um, but you know, something like Indianapolis is an opportunistic move, right? Uh, an incredible home and the state came on the market. We bought it for 14.5 million is that we bought it for you. Yeah. Yeah. It's, it's in our joint venture. Um, uh, you know, so, uh, you know, so we, we, you know, own 50% of it. Uh, and you know, it's just an opportunity to get something like that for a $14.5 million investment. And, you know, what we put into it was, you know, pretty minimal versus what our normal investment was. So we had this incredible experience for the, you know, experience for the customers, you know, at a lower investment rate than we'd make, you know, and a lower occupancy cost than we would expect to have. So, you know, that was just a that's kind of a one-off great outcome. I mean, we're always looking for things like that to come up, but I wouldn't say that's like you're out looking, you know, you're not really looking for something like that. Like that just, they just kind of happened. So, you know, I think, you know, You know, that's just an opportunistic move. But, you know, what does it look like 10 years from now? We have 35 legacy galleries.

You know, we'll have, you know, more and more of those converted. We'll also go back to the existing design galleries. We've talked about certain ones that are going to have the next iteration, like a Houston, for example, will have a big gallery. Los Angeles at some point.

Yeah.

For example, that in North America will continue. And the 40, you know, Gary talks about the design markets of the 40 and the logic there.

So that's a whole kind of different animal, I guess, in terms of adding to the store base.

Yeah, and we may learn in some of these, you know, smaller kind of, you know, what we refer to as a design studio. It's really in Palm Desert, it's like a design office, right? It's really enabling entrepreneurs, you know, interior designers that, maybe don't want to work in a retail gallery, and, you know, where there's market opportunities to do something to improve art and have a more dominant interior design presence, we think that's really good for the RH brand. You know, so some of these will look a lot less like a small store. They'll look a lot more like an interior design office with, you know, a couple of small presentations to the product, but really a real office for an interior designer to work with clients in a highly professional way and attract entrepreneurial people that want to run their own interior design business. And we've become a platform that can support them and allow them to do what they really want to do. So we may, for example, like in the first one that we got in Palm Desert, How big is that?

It's like 3,000 feet.

Yeah, it's like 3,000 feet. We're also looking to probably do a 10,000 to 20,000 square foot gallery there, probably 15,000 to 25,000, call the range, in that market. And we'll have both of those locations. One's really a true interior design office. But that gallery that we'll build probably won't have the same dedicated space for interior design that we might have in one of our big galleries, where we have interior design embedded into the gallery. So this gives us more flexibility, reach more markets, activate the interior design business, which is a growing part of what we do. And I think we're going to learn a lot of these where there's opportunities for even bigger stores. if we're right on this transformation that we're, you know, that we're kind of, you know, that began here and we're right around about how the business is going to inflect, you know, that's just going to meaningfully take up your volumes and all these markets makes all the occupancy models look different, right?

And allows you to access different things and invest in different ways. So, you know, we're going to,

I'm sure we're going to have an even new view in the second half of next year. As our baseline performance improves, it changes your economic outlook from a real estate point of view.

That's great. Thank you, Gary.

There are no further questions at this time. I will now turn the call over to Gary Friedman, Chairman and CEO, for closing remarks.

Great. Well, thank you, everyone. We appreciate your interest. We wish you all a happy holiday. And I would say to Team RH, we just can't tell you how much we appreciate the energy and the commitment and passion you bring to our business and to our brand. You are the heart and soul of this company. You are the ones that interface with our consumers every day. Thank you for making us so proud and especially the teams that just brought our international galleries to life. I mean, just incredible, you know, what we've done. We were in Germany, what, just two weeks ago or 10 days ago. And you walk in, you interface with the people, you look at the gallery, you'd think it was in North America. You know, I mean, and to be honest, you know, at the very beginning of this and to be executing at that level and to have that quality of people and, you know, that energy in the galleries was just gives me and the team here a great deal of confidence of what we can do globally with this brand. So we wish everyone a wonderful and happy holiday and, you know, wish for peace in the Middle East, and hopefully this world becomes a more peaceful place very soon. So happy holidays, everyone.

This concludes today's conference call. You may now disconnect. Thank you. Thank you. Thank you for watching. Thank you. Thank you. Thank you Hello and welcome to the Q3 2023 RH Q&A conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. We please ask that you restrict yourself to one question and one follow-up, and you may re-queue for further questions. If you would like to ask a question during this time, simply press star 1 on your telephone keypad. If you would like to withdraw your question, again, press star 1. I'll now turn the conference over to Alison Malkin. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for our third quarter fiscal 2023 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 issue 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 issue 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. 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 Gary.

Great. Thank you, Allison. Good afternoon, everyone. As we usually do, we'll start with our shareholder letter and open the call to questions. To our people, partners, and shareholders, net revenues of $751 million were at the midpoints of our guidance to the quarter. An adjusted operating margin of 7.3% was slightly below expectations due to higher than anticipated expenses, including international openings, as well as costs related to our pending acquisition of the New York guest house property and unsuccessful efforts to secure the iconic One Ocean Drive Miami Beach location. While pleased with improved demand trends generated from the launch of our new RH interiors and RH contemporary collections, we experienced increased headwinds in early October when mortgage rates peaked above 8% and the Hamas invasion of Israel triggered the war in the Middle East. With 82% of homeowners having mortgages below 5% and 62% below 4%, We continue to expect the existing housing market to remain frozen until interest rates and or home prices fall meaningfully. Additionally, the home furnishings market has become increasingly promotional, and we believe that it will create a mixed shift towards the clearance products, pressuring gross margins. In light of the current market, we're delaying the mailing of our RH Modern Sourcebook until the first quarter of 2024, when we believe demand trends will likely be more favorable. As a result, we are narrowing our revenue guidance range for the year to $3.06 billion to $3.08 billion, and now expect adjusted operating margin to be in the range of 13.6% to 14%. As mentioned, we are in contract to make an opportunistic purchase of the New York guest house property for approximately $58 million. scheduled to close in the fourth quarter. The building was appraised at $85 million last September when the federal funds rate was half the level it is today. We believe controlling the outcome of this one-of-a-kind property is in our best interest. However, we will be poised to take advantage of any opportunity to do a failed lease back with the appropriate investor when the commercial real estate market rebounds in the future. Product Elevation We expect our demand trends to accelerate through the first half of 2024, and as our product transformation unfolds, in stocks improve, we complete the reset of our galleries and introduce our new modern NRH outdoor sourcebooks in the first quarter of next year. We anticipate our inflection point will peak in the second quarter of 2024 as our new collections fully ramp and we begin another cycle of sourcebook mailings. completing, transforming, and refreshing the entire brand over a 12-month period. We believe our latest collections reflect a level of design and quality inaccessible in our current market and a value proposition that will be disruptive across multiple markets, positioning RH to gain market share throughout fiscal 2024. While the product transformation of this magnitude will be margin dilutive in the short term, We believe it will become margin accretive over the long term if selling rates stabilize and allow for supply chain sourcing efficiency.

Platform expansion.

Our plan to expand the RH brand globally, address new markets locally, and transform our North American galleries represents a multi-billion dollar opportunity. As discussed last quarter, we introduced RH to the UK this past summer in a dramatic and unforgettable fashion with the opening of RH England, the gallery at the historic Ainho Park, a 17th century 73-acre estate that is a celebration of history, design, food, and wine. We had a spectacular turnout for our opening event, and the global press coverage the brand received was multiple times greater than any gallery we had ever opened. Due to RH England's countryside location, we expect the majority of the revenues to be driven by our interior design and trade businesses, which are dependent on building books of business and high-value repeat clients like interior design firms and hospitality projects. The quote book and demand continue to build monthly, despite the seasonal nature of the location. Our first UK interior sourcebook was in home in October, and our next contact planned to be our RH Modern and RH Outdoor sourcebooks in the first quarter of 2024. In November, we opened two new international galleries, RH Munich and RH Dusseldorf. The response to our opening event was beyond our expectations, with Munich hosting over 900 chic attendees, roaming three floors with Cipriani Bellini and Vesper Martini. And traffic in both galleries has been strong since opening. Although RH England is our most unique and spectacular gallery to date, and the only one with a hospitality component in Europe, all three are architecturally impressive, multi-level expressions of the RH brand. only to be outdone by even more impressive teams in each location. While many retailers boast of a capital-like franchise or licensing approach to international expansion, we believe the only way to build a brand and optimize the business globally is to invest into and control the brand in the same manner we do locally, with people who live and breathe our values because it's their values, people who will lead our cause and build our culture because it's their cause, and it's their culture. We believe when you aspire to be the very best in the world, there are no shortcuts, and greatness can never be delegated nor licensed or franchised. Our next international openings include RH Brussels, the gallery on the Boulevard de Waterloo, and RH Madrid, the gallery on the Plaza Marqués de la Salamanca in the first half of 2024, followed by RH Paris, the gallery on the Champs-Élysées in the fall of next year. RH Paris is one building from the corner of the Avenue Montaigne, known as one of the most exclusive and luxurious arteries in the capital, and the chosen home of the major haute couture brands such as Chanel, Dior, Vuitton, Celine, Saint Laurent, and many others. We believe the space we've designed for this location will position RH as a placemaker and pacemaker in the luxury fashion capital of the world. RH Paris will be a six-floor jewel box connected by a dramatic, ornate scissor stair and a central glass elevator that will whisk you up to the fifth floor and rooftop champagne and caviar bar, where you can take in views of the Eiffel Tower while enjoying our innovative menu featuring the finest Petrosian caviar. You can also visit the second floor and dine in our dramatic atrium restaurant, inspired by the Grand Palais, with an onyx carved bar, floors, walls, and tables, looking out into the beautifully landscaped courtyard with 30-foot ivy-covered walls. It's like dining in a secret garden, erasing the noise and chaos of the outside world. Mark your calendars for early September. RH Paris will be an opening party you won't want to miss. We are also under construction in London and Milan in inspiring spaces that will celebrate the heritage of the historic structures and will integrate full expressions of our hospitality experiences. Our current plan calls for opening both galleries in 2025. We're also anticipating gaining local approval soon for RH Sydney, the gallery in Double Bay with plans to open in late 2025 or early 2026. Regarding our North American transformation, we opened RH Indianapolis, the gallery at the Dahan Estate, one of the most accurate palladium-style villas ever built in the United States. The estate spans 151 acres and over 60 rooms, overlooking a 35-acre lake, and represents one of the largest, most inspiring, and immersive physical expressions of our brand to date. With construction delays pushing RH Cleveland into the first quarter of next year, Our plan now includes opening five North American design galleries in 2024, inclusive of RH Palo Alto, RH Cleveland, and RH Raleigh in the first half of next year, and RH Montecito and RH Newport Beach in the second half. We also believe there's an opportunity to address new markets locally by opening design studios in neighborhoods, towns, and small cities where the wealthy and affluent live, visit, and vacation. We have several existing locations that have validated this strategy in East Hampton, Johnsville, Los Gatos, Pasadena, and our former San Francisco gallery in the Design District, where we have generated annual revenues in the range of $5 to $20 million in 2,000 to 5,000 square feet. We have secured our first new location for a design studio in Palm Desert and should open in the first half of 2024. We have identified over 40 locations that are incremental to our previous plans in North America and believe the results of these design studios will provide data that could lead to opening larger galleries in those markets. VRH 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 case 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 introduction of RH picture upholstery, RH bespoke furniture, 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 products to conceptualizing and selling spaces by building an ecosystem of products, places, services, and spaces that establishes the Arch 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. 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 Johnstville, an integration of food, wine, art, and design in the Napa Valley. RH1 and RH2 are private jets. and our H3, our luxury yacht, that is available for charter in the Caribbean and Mediterranean for the wealthy and affluent to visit in 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 self-space, 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 who are shaping the world of architecture and design. Our plan to expand the RH ecosystem globally multiplies the market opportunity to $7 to $10 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. Never underestimate the power of a few good people who don't know what can't be done. For the past 23 years, we've heard others tell us what can't be done, and for the past 23 years, we've failed to listen. We avoided bankruptcy while being accused of lunacy. While others have been shrinking and closing stores, we've been building the largest and most inspiring spaces in the world. When Wall Street didn't think our stock was worth buying, we bought 60% of the shares ourselves. When everyone told us we should be working from home, we were in the center of innovation, working on rebuilding our new home, our brand, and it's almost ready for prime time. From the largest product transformation in our history to the most inspiring and unusual retail experiences in the world. From couches to caviar, beds to bellinis, architecture to airplanes, homes to hotels, I should say guests. From Pittsburgh to Paris, Los Angeles to London, Boston to Brussels, Miami to Munich, and San Francisco to Sydney. Soon the world will be within our reach. Never underestimate the power of a few good people who don't know what can't be done, especially these people. Onward, Team RH. RPDM, Gary. Operator, I'll now open the call to questions.

Thank you. If you have a question, please press star 1 on your telephone keypad. If you wish to remove yourself from the queue, simply press star 1 again.

One moment, please, for your first question.

Your first question comes from the line of Simeon Goodman of Morgan Stanley. Your line is open.

Hi, everyone. Hi, Gary, Jack. Good afternoon. I want to ask about contemporary. I know it's early. I think some of the research was that it shouldn't cannibalize other aesthetics. I don't know how much data you have on it yet, but is that fair and how sales are progressing? And then I don't think, can you just remind us, you never touch pricing on contemporary. I know we talked about changing some pricing on some items, but I don't think it ever related to the new collection. Thanks.

Yeah, we reviewed kind of pricing and, you know, our value equation throughout the brand, so everything was touched. I mean, if you look at the contemporary brand, the contemporary book, this remailing of the book, it's got a very high new content. So, but all the products kind of been, I don't think there's anything we didn't reprice. So, yeah. Yeah. But look, the contemporary book got in mid-October, early to mid-October. It kind of hit right as the war was breaking out and interest rates peaked. So, it's hard to kind of see the initial reaction to it. You know, there's collections, like any collection, there's collections that are selling really well. Some are selling good, some not so well. You know, I feel very confident that, you know, the overall mailing of contemporary is going to be incremental, you know, as we believe interiors have been and as we believe modern will be and as we believe couture upholstery will be and bespoke furniture will be and everything we do, you know, stuff like that. You know, so look, we couldn't be more excited. We're, you know, we're sailing into the, you know, probably one of the biggest headwinds any of us have, you know, experienced in the housing market. You know, while it's not the great recession of 2008 and 2009, it is from a housing point of view. You know, it's that bad. So, you know, you're laughing, you know, really big down numbers in the housing market, and they're still down. You know, so, you know, you've got a little lift in the new home market, but that's only 10% of the market. So, you know, we've got to, you know, as I said, you know, in this latest shareholder letter, and I said last time, we'll continue, we should continue to see our business inflect, you know, through the rest of this quarter and into, you know, through the first half of next year and hit an inflection point, I think, kind of mid-late to second quarter. And that'll be despite kind of the housing market, unless there's something where there's another gap down. But it seems that they've got inflation somewhat under control. It seems like the Fed's becoming more confident. And if we can start to see a move in interest rates, and the easing in interest rates, the federal funds rates, and the mortgage rates settled out. While mortgage rates went down a little, you still have an affordability issue with 82% of the people with mortgages at 5% or under and 62%, 4% or under, and 25% are under 3%. So that's the biggest issue facing the market today. And that's why we don't have inventory. There's not inventory in the housing market. And why prices aren't coming down because there's not inventory. You know, you have some pricing coming down here or there in some markets. But, you know, the good news for us is, you know, we're just taking a long view. We're trying to position the brand and the business, you know, for the next big run. And, you know, I think we're going to be meaningfully better position than anybody else in our sector. You know, not by a little, by a lot. You know, it's like when this housing, you know, we'll outperform, you know, the market and the competition, I think, over the, you know, the next period. You know, we gave some market share back, you know, during, you know, the post-COVID period. We haven't been promotional like everybody else got. Everybody got on the other side of COVID and everybody got promotional, even though people say they're not promotional or they're not doing site-wide promotions or whatever the language is, you know, just on people's websites. You know, it's a very promotional environment out there and has been. And I think what you're seeing now is the people that got promotional are now going to lapse their promotional stance and they have to go up against that. So that was the lever post-COVID for people to, you know, turn on the promotions, lift the business. Now everybody's cycling that, and, you know, I think you're going to see people's, as you're seeing it, people's businesses inflecting downwards in this environment, and our businesses inflecting upwards, and it will continue to do so.

As a follow-up, can you talk about your own inventory position? the ratio of discounted or clearance items, because you mentioned the shifting to that could weigh on margin. And if you have stuff that needs to be cleared or contemplated to be cleared, does it make sense to tactically move it out of the way to make way for all the new product that's coming?

We are. We just don't want to lead with clearance and lead with pricing. I mean, we'll have a few emails that go out there that talk about end-of-year products you know, end-of-year sales to, you know, to deal with the clearance goods and stuff like that. And we'll be aggressive pricing those goods. So we, you know, get the inventories clean and, you know, turn inventory into cash. We don't want it sitting around on the balance sheet. So, yeah, you'll see us take the, you know, the appropriate action here. And, you know, so, you know, but nothing we wouldn't normally do. We would still want to lead with promotions or start to, you know, turn the business back in that direction. We're almost to the other side of this thing. I can't believe, you know, maybe we've got another six to 12 months, but I think, you know, you get to the second half of 24, unless, again, unless they haven't got inflation under control, I think we're going to see, you know, take an easy approach. I would be surprised if they left interest rates at these levels the entire year next year. But nonetheless, even if they do, you're going to see us perform pretty well in any environment based on, you know, just based on the work we've done and what's in the pipeline and the plans we have. I mean, they're all very big moves. This is by far the biggest product transformation in the history of our industry. It's multiple times bigger than anything we've ever done.

Your next question comes from the line of Steven Zaccone of Citi. Your line is open.

Great. Good afternoon. Thanks for taking my question. I wanted to ask on operating margin and I wanted to talk about, ask in particular about the ability to protect the operating margin. You know, we're now at a level that's below 2019, you know, granted the macro is challenging, but can you just talk through your comfort with protecting operating margin? What are some levers that you can pull if the macro deteriorates further into next year?

Yeah, I mean, you know, we're not, we don't have a strategy to protect operating margin. I mean, we're, you know, you're comparing it to 2019. Are you kidding me? Like, why would you do that? It's nothing like 2019. We're in the biggest housing downfall that anybody's seen.

You know, so... We've experienced massive, massive inflation since that time.

Yeah. On so many items of P&L costs. Yeah, yeah, yeah. So that's not where I'd be focused. You know, like, I mean, you can focus there. You'll just miss everything that's going to unfold here, you know, if you want to focus on that. I mean, we're investing for the next cycle.

We're investing for the long term.

We're not trying to protect the operating margin a point or two. I mean, if... If that's going to get people really fired up about the long-term strategy of this company, it's probably the wrong shareholders.

And Steve, just one thing to comment about, again, you mentioned lever, but just more of a point of a tailwind is that, you know, that we have elevated Markdown activity this year, that as we cycle through that next year, that, you know, that could unveil itself as a tailwind next year.

So we'll talk more about that in March, but, you know. That's one aspect that's positive.

Yeah. I mean, the operating margins are going to be fine. So the cash flow is going to be fine. We didn't buy back $2.2 billion per stock because we think the model has a problem. We're going through the biggest transformation in this entire industry. And so you want to think about what's going to be on the other side of that, not what's the operating margin in the next quarter or two, whether that bounces around at point or two.

As the biggest shareholder in this company, that's not what I'm worried about. Okay, fair enough.

Follow-up then on just the promotional aspect to the furnishings industry. How long do you think that lasts? Is that something that continues for the next couple of years, or is it something that probably is finished by the end of 2024?

Oh, you mean just the broader industry? Yes.

Yeah, no, I think the broader industry is back to pre-COVID, you know, pricing and promotions, and it'll be there forever now. Once you turn that on, you can't go back. So, you know, maybe the emails look different or they call them different, but, you know, you go look at the websites that, I mean, go, I mean, you're getting pelted with sale emails and have been for over a year. And that's why, you know, as I said, that's why everybody's now cycling that. And, you know, so, you know, there's easy business. We could have turned on promotions over the last year on the other side of COVID and moved our business 15 to 20 points. It just would have permanently created a different model. And so, you know, look, some people are, promoting and cutting ad costs. Some people are doing a lot of different things and hoping they have a massively different model. There might be people that come out of this thing with a slightly better model. Maybe there's some things they learned. Maybe they don't have to spend as much in ad costs. Maybe this or that. But it's not really people that we compete with that I'm too concerned with. I'm more focused on you know, what we are doing and what our big strategies are and, you know, how this business is going to be positioned, you know, for the next, you know, five years. And, you know, and we really like what I see. I think this is the best work we've ever done. You know, so what you're going to see unfolding over the next several quarters and not just, it won't stop there. While I say that the inflection point, you know, will peak in Q2, that's just based, on what's in the pipeline. What's coming on the next cycle likely will create higher and higher peaks, right? Because we're creating an entirely new foundation for the business, a stronger, bigger, better foundation for the business. Where we got arrogant about around pricing during COVID and we had all the price increases from the tariffs and then the supply chain, you know, raw materials goods going up, you know, we're just a lot stronger and we're going to play a very aggressive, you know, game because we can't. We have the scale to buy bigger than other people. We have the scale to get better pricing. We have the platform to prevent it. And so, you know, where I think we've, we lost the market share because we were, you know, slow to kind of ramped back up the product development and marketing of the business post-COVID. We rebuilt those muscles where we were arrogant from a pricing point of view. There's no arrogance anymore. There's just an incredible competitive focus to win. The market's going to do what the market does. I don't know if I was... You know, all the people that are out there that have been promoting this past year, what are they going to do? Stop promoting? Their business will go down 15 or 20 points. Yeah, you know, try not promoting the furniture business when you've been promoting. Like, it just doesn't work. You have to go through a whole year cycle like we went through when we moved to membership. You know, that's a painful thing to do. And You know, you have to be someone who owns a lot of the company like I did. Otherwise, you're going to be a CEO that's under attack by activists. You know, you go through a transition like that. So, you know, there's people that say, oh, we're going to do like an RH membership model. Good luck with that. You know, they're not easy things to do. You know, we spent three years planning that and transitioning the business and the model. But, you know, to stop promoting when you've been promoting, you know, you're back on that promotional drug.

You can't just get off it.

Your next question comes from the line of Chris Horvers of JPMorgan. Your line is open.

Thanks. Good evening. So a couple of follow-up questions on the gross margin. So once we get past holiday, do you think it'll be clean to start 24? And is it fair to say that the vast majority of the non-fixed-cost leverage in gross margin was clearance. And to your comment, Jack, is there any reason why you wouldn't get that back? Presumably with all the newness, you wouldn't expect a lot of markdowns.

Yeah, look, I think transition out. Yeah, look, starting there, we're going to be in a better position than, you know, let's say the start of the quarter. But I think we'll be going through, continuing to sell through the markdown goods, you know, by the end of the first half.

Yeah, I mean, we'll always have some level of markdowns, right? But what you want to think about, what does the overall mix look like? So the mix is going to be, you know, a heavier markdown mix, you know, in Q4, and you'll have some of that move into Q1. It'll probably lighten up, and it'll lighten up in Q2 as we sell down. And you're going to have, as the quarters go, you're going to have a higher mix of new, you know, higher margin product. But, yeah, so what I said in the letter, you know, over the short term, it's margin. The transformation we're making is margin dilutive. But long term, it's margin accretive. You know, it's mixed shifts. as the inventory rebalances.

Got it. One of the questions we also get from investors is trying to think about there's a lot going on with all the new galleries and the accelerations of the books, the source books back to what it was pre-COVID. As you think about what's implied here, the third quarter SG&A dollars, is that the right base? I guess said another way, is there any reason advertising steps up again next year? And if you think about the complexion of the openings next year with more international, are we just sort of naturally raising the expense base, given those two factors?

Yeah, I mean, when it's the appropriate time to guide, next year we'll guide next year. So we're not guiding next year right now. But, look, there's always going to be certain startup costs, right, when you're ramping up new countries and things like that, you know, and investments to get the galleries up and running, to get people trained, to get restaurants opened. to get the home delivery network set up and operating and people trained, and then you'll cycle those things, right? So, you know, are we going to have some cycles to get around as we open different countries? Yeah, sure. But once, you know, business is ramped, you know, you cycle those things. So, yeah, I don't know. we have a lot of confidence in the long-term margin, you know, of the business and the model. So, you know, I don't think there's any reason why this, you know, why this, you know, business and brand doesn't get back into the, you know, 20% range as, you know, we cycle through. I mean, you're not going to get there in one of the worst housing markets. This is, I mean, you know, we compare the exact numbers to 2008 and 2009, but this is, This is if it's not the worst, it's the second worst in my career. And I think I've been doing this as long as anybody leading a company in this industry. You know, there might be some people that have been doing along with me. I don't know too many, but I haven't seen a market like this, you know, and how to navigate through a housing market downturn like this. You know, so. You know, I I can't remember when. people were, you know, locked into low interest rates and they can't step up because, you know, different interest rates. So you got to kind of look beyond this kind of temporal time. I can't believe that we're going to be in this lockup like this forever. Like, could it go through 24? It could. So what? You know, it doesn't change the long term, you know, and we're you know, the good thing is we've now cycled around. So we didn't bite on the promotional, you know, drug like everybody else did. So we gave away some market share because we didn't do that. But at the same time, we've sharpened our value proposition at regular price, and we're going to be tough to compete with, you know, even if people go on sale. You know, people don't They just don't have the buying power, the platform to present it that we do. And so, you know, I wouldn't want to be on the other side of this big move we're making.

And, Chris, you know, you asked about Q3 being a base. You know, we don't look at a single quarter as a base.

You've heard me talk about if you're going to try to read some trends on a base, then, you know, look for a full four quarters given the cadence of advertising timing. Yeah, you can't just use a quarter.

Yeah, I mean, we used to be able to mail a book, and we advertised it over, you know, six or 12 months. Now you mail a book, and, you know, The day you drop it is the day the ad costs it. So, you know, and obviously, you know, the book's more valuable than that single period. But, you know, there's just an accounting rule change that, you know, is going to make a business like ours kind of lumpy, right? From, you know, quarter to quarter based on, you know, the ad costs hitting when the book drops. No amortization of the ad costs, which doesn't make sense.

You're not going to get all the sales that week.

Your next question comes from Michael of Bank of America. Your line is open.

Great. Thanks very much. Just kind of a quick one, more of a clarification than anything else. So just in the share letter, there was a comment about reaching kind of a peak inflection point in Second quarter of next year, is that in terms of kind of a ramp? Is that demand trends, you know, flow through revenue? If you could specify that a little bit more for me, that would be really helpful. I'd appreciate it.

Yeah, yeah, that'll be, you know, that'll be demand trends, you know, which will turn into revenue. And, you know, there's going to be just continued step-ups. You know, there's going to be step-ups as we get in stock. There's going to be step-ups as we finish the gallery transformation. You know, anytime you have big moves like this, you're going to have some things, some collections that are just wildly better than you could have thought. And you're not going to have, you know, we have a collection here that is the best collection in the history of RH by probably 40%. We're not going to catch up on the inventory until March, April, somewhere around there. You've got all these imbalances when you have this much newness. So you've got to kind of right size all that. You've got to get in stock because things like that and other collections and things are selling so well, you can't even put them in the stores. So you've got too much demand. So you've got to fill the demand. So, you know, some of the product that you're planning to transform the galleries with now is blown out. And then you've got to let, you know, the manufacturing base, you know, just get their legs underneath them with all this newness, right? And, you know, they're going to get more efficient, you know, and things are just, the flywheel is going to be running. Yeah, we will then have, you know, we're going to have the second round of the book mailings, which is going to have another Well, I mean, modern is going to be massively new. But then, you know, all the books will remail in the first half. You know, modern, because we're pushing a little later, may go, you know, in the third quarter. But all those books will have another probably an average 20% to 40% more newness based on what's in the pipeline. You know, so it's like big. We usually have 15% to 20% newness. And so, you know, basically the entire brand is going to transform, and the assortment is going to expand on top of that. And so you just got to kind of, you know, get it all dialed in, get all the inventory balanced, you know, get everything set. You know, some things you planned you're going to put in the galleries, in the retail galleries. and all of a sudden the demand doesn't look good, and you're like, let's swap that out with something else. And so, you know, you're reading and reacting to real data now. And so we like what we see in the data. You know, we like what we have in the pipeline. We like when we, you know, we dimensionalize all the trends and all the data and say, what does this all look like three months from now, six months from now, when this happens, that happens, that happens. And, yeah, that's when we think we'll – or for this big transformation, that's when we should start to reach peak inflection.

Got it. And then just a follow-up for Gary. Comments in Germany were interesting, right, a lot stronger. It sounded like something you'd expected. I don't think you put a ton of marketing behind it. So what drove it? I mean, you know, at least from seeing online, you know, the great locations, you know, beautiful – exteriors all the rest of it but uh in terms of just this response um what's resonating and you know anything you could say in terms of just i don't know i guess the potential relative to some of the i guess the average size uh in terms of revenue for us um if you could size that it must be too early yeah i think you know i think um uh just in general we're in

highly populated, you know, shopping areas, right? So, you know, in Dusseldorf, we're on the main shopping boulevard, you know, dead center across from Chanel, you know, a few doors down in Hermes, you know, just the main luxury shopping street, and we're dead center. You know, so there's a lot of people walking by and a lot of people walking in. In Munich, we're right in one of the key hearts of town where there's a lot of people. And you really can't compare those to what we did in England, right? Like I've said since the beginning, we didn't do England through a lens of commerce first. We did it through a lens of conversation first. How do we create the right conversation with the brand? How do we make the right first impression? How do we do something that's so extraordinary? You know, it gets high-end luxury consumers to look at us differently, think about us differently. You know, so England is really a, you know, it's a big brand investment, but there's not a lot of people, there's no one walking by that store. Not a single human is walking by. You got to drive there. It's an hour and... 45 minutes out of London. I mean, the business is built. We just, we just closed our today. We closed our, you know, they get sale. Yes. It's 330,000 for what? And the French house, the French house, but you know, so you know, the book of business is building the design business with our, you know, our internal interior designers is building with our trade clients is building, you know, all those pieces of business are building nicely. And what's funny, I really thought, oh shit, this time of the year, it's going to, it's going to go slow because it's, you know, the weather's not that nice out there right now. And, you know, it's not like you're walking around the grounds unless you've got some heavy coats and, you know, some rubber boots and stuff. So, but, but our, our demand and our, and our book of business and everything is building still most over a month. And, It's going to take a while for the brand to just people know we're here and know who we are and what we're doing. Remember, people only buy furniture really every five to 20 years, depending if you bought another new home or what you did. You don't generally just go out to furniture stores unless there's a need. you know, what, you know, RE Chinglin just doesn't have the traffic of, you know, the locations that we have in Germany. And so this is just our first look at the locations in Germany. And we like what we see. We like, you know, the people that are coming in, you know, they're starting to engage our designers. They're starting to learn about the brand. Some know about the brand. Some have lived in America and now live in Germany. And, you know, some have Yeah. Telling us at the opening part of Munich, you know, at a couple, how they shift their own, been shipping their own containers to Munich. And now they're so excited we're here, you know, they're, yeah. And, you know, so we had a lot of fans. I mean, what I was, I think, beyond my expectation was just the excitement for the brand and the quality of people that were at the opening events. Yeah. It was, I mean, it was as good as you could have expected. And so, you know, that, again, that's, again, like creating another conversation, those people telling their friends and others, you know, you just, you know, let that, you know, start building. And, you know, I would expect these countries are going to probably have pretty big compounding comps for the first three years. you know, much bigger, you know, like in America, when we open a new store, even if we're not in a market, we're already in that market. We're our age. Like we can open in Milwaukee, you know, next month and we don't have a gallery there, but we do millions of dollars in Milwaukee. People are shopping from us, you know, online. They know the brand. And so, you know, when we open in a place, Like that, you know, people are lined up, ready to shop. There's people that have been shopping. They're ready to place transactions and place orders. And you have immediate demand. I think in these new countries, you know, people are going to come in and get to know us. And, you know, we'll start working on, you know, they'll get to know the brand. We'll start working on design projects. And, you know, and then people will get familiar with, you know, who we are, what our prices are, you know, how we compare. and start to interact with us. But it'll happen faster in Germany than it did in England. You know, like there's just not that much traffic. I mean, we did catch, you know, the back half of the summer. And so, you know, we did have some really high quality traffic out there. You know, but I think, you know, what I'm amazed by in RH England is that the demand is building, you know, into the slow season. I'm like, huh. That's interesting. You know, so, you know, so we like that. And we've only mailed one book, you know, and not to that many people. So, you know, just learning about how you invest in marketing and advertising and building the brand, you know, it'd be a lot to, you know, a lot to learn here for us. So, but, you know, we like what we see. I mean, I'm, you know, you know, pleasantly surprised, you know, how the business is continuing to build in RH England. I'm really happy with just the initial turnouts for the events and then the amount of traffic just coming into the galleries, you know, just exploring and coming to see us. You know, so, you know, the demand, you know, if that's happening, the demand will then start building, right?

We'll see, but we're going to know a lot more every quarter, every six months, every year here.

Your next question comes from the line of Max Reklimko of TD Cowen. Your line is open.

Great. Thanks a lot. In the letter, you noted being pleased with improved trends from the launch of interiors and contemporaries. Just curious if you could frame the uplift in the context of revenues down 13 and change. And then how should we think about the magnitude of growth in the next couple quarters from those two collections? And bigger picture on contemporary.

Gary, what's your latest thinking around how large this collection can become? Yeah, you know, it's funny. You know, we...

We don't primarily look at it, you know, it's really, what we look at is kind of one giant assortment packaged in different vehicles, right, that allows it to break through and, you know, present an aesthetic and so on and so forth to the consumer. But it's not like we sit here and go, how's contemporary doing? How's interiors doing? How's this? We say... how's the furniture, you know, the upholstery business doing? And we're looking at every sofa in the entire assortment, whether it's interiors, contemporary, modern, you know, so it's not so much the books from how we manage the business. The books is how we present it to the consumer. We look at the entire RH assortment, right? And then we're looking at you know, the books they're in and, you know, how we're going to adjust and what's working and what's not working and, you know, so on and so forth. So, you know, when you think about it, maybe from the way you're thinking about it, okay, will that, you know, will that assortment, you know, when you parse it out, how big will it be? It depends on how big we make that book, how big we make that assortment, you know, how many things we put into contemporary or how many things that wind up going into interiors and how many things go into modern, you know, because you've got some things that, you know, that the lines are blurred. We could put it in almost any of the three books. You know, so I think about the way I think about this today is RH is going through a massive product transformation. It's the biggest thing they've ever done. How does the whole thing look? And as the whole assortment gets out there, interiors, contemporary, modern, outdoor, as the books get out there, as the products get into the galleries, as we get in stock, what does that total assortment look like and how is it performing? versus the old assortment.

We think it's going to be meaningfully accretive. Got it.

That's helpful. And then, no, that's great. And then, I guess, can you speak to the phasing of the new products to galleries and your confidence of completion by the end of first half of 24? And then, specifically, will all the galleries be touched? Will some get more newness than others? Or how should we just think about the totality of the in-gallery resets?

You mean the resets, of course. Oh, the floor sets. Yeah, I think, you know, they're being done in stages, you know, as we're ramping up inventory. And it depends, again, is that, you know, if you're ramping up – if all of a sudden you have – some really high performing collections, you're just not going to be able, you're going to have to fill demand and not put the goods in the galleries, right? You're gonna have to wait. And so I'd say we're going to get, I don't know, 90%. in stock in Q1 or something. As far as completion of the four sets, probably a March timeframe.

Yeah. It wouldn't be the end of the quarter, but as of where we're at today, it's probably a March. Yeah.

And some galleries will get, you know, prioritized versus others. And yeah, I think it's, you know, I think we'll be in really good shape by the end of Q1, going into Q2. And then I think, by mid to end of Q2. That's why I say that should be our kind of inflection point. I mean, based on all the numbers we're looking at today, you know, we don't have data on modern yet. We won't until we mail that, you know, so that'll have, you know, same kind of challenges, lots of new product. We're going to, with any new product, when you don't have data, you're going to be a hundred percent wrong with your inventory investment. Like I've been doing this a long time. I've never seen anybody buy a new product exactly right. So you're going to be a little overbought, underbought, a lot overbought, you know, underbought. You know, because you just don't, you know, you don't have exact signs. You don't have any trends on any of the newness. So, you know, it takes a few quarters to kind of, you know, get the trends, you know, you know, read the trends right, make the adjustments you need to, get the on orders corrected, you know, make less of this, make more of this, and, you know, let the factories get adjusted, you know, as they're ramping up on a lot of new products. So, yeah, but, you know, that'll all work itself out. Again, I just think about this as like, you know, the next couple of quarters will be meaningful. If we're sitting here you know, the end of Q2, and we didn't get the inflection point we needed, that would surprise me. You know, that we think we're going to get. It's not a little one. You know, it's going to be meaningful.

It's going to keep building. You know, as all these things happen.

In stocks, gallery sets, you know, modern, outdoor. and then a recycling and remailing of those books with more newness, right, with probably 30 to 40% more newness. And then you'll have some adjustments with that 30 to 40%, but that'll be much smaller compared to what we're doing today.

Your next question comes from the line of Stephen Forbes of Guggenheim Securities. Your line is open.

Hey, Gary, Jack. It might be a repetitive question, on the product transformation. But, you know, Gary, I was really just hoping you can, you know, if there's anything you can give us or speak to, whether it's sort of what you're seeing now or even a reference point back in history on sort of prior product transformation cycles that can help us contextualize, like, what the potential magnitude of the inflection on the horizon is. And, you know, whether we can reference sort of peak demand, you know, during COVID or, Is there anything that helps us think through, you know, really what should we be expecting behind this product transformation?

I think it's all going to depend on what, you know, what the macro is doing in the housing market. Yeah, so the housing market stays where it is. I mean, again, let us guide you next year, you know, like you'll get a better sense, you know.

You know, we'll have a little bit more data.

But, you know, I just say generally I'd be surprised if anybody's outperforming us. When we get to Q2 of next year, I'd be shocked.

Now, maybe someone will shock me. I don't think so. We will anxiously await that.

And then just a quick follow-up, the 70 new collections that were referenced sort of in past calls, where are we today with the number of collections that are out? And how many will be launched by spring next year, by fall next year? What's sort of the pipeline look like?

Yeah, there's more than 70 now. You know, so, yeah, we'll have probably – When modern, you know, with modern hitting and outdoor hitting, it will probably be somewhere between 70 and I'd say up to 90. And, you know, with more in the pipeline. And we have a whole other book we're working on, you know, that we haven't announced yet. So you'll hear about that, that we think is going to be meaningful. And it's not bespoke. It's not couture. It's something we haven't talked about. And that's going to be a whole new big thing. So, you know, so we're working on that, too. Yeah, so just a lot's coming, Steve. Buckle up.

Your next question comes from the line of Michael Lasser of UBS. Your line is open.

Good evening. Thank you so much for taking my question. Gary, why do you think you are losing market share? And if it's an issue with pricing, how much more do you think you need to lower prices in order to stabilize or gain market share?

Yeah, I don't think we're, well, I mean, did you miss the whole first part of this conference call? And I'm like, I can repeat myself. You know, one, the transformations in the early stages, the goods aren't in stock. They're not in the galleries yet. We haven't been through a full mailing cycle. And I don't believe, you know, I think we've massively closed the gap. I think we're gaining market share in a lot of people today. And, you know, there might be a few people out there, you know, that are outperforming us at a demand point of view. I mean... they may not outperform us, you know, in the next quarter or two. I'd say there's going to be an inflection very soon here, you know, and so what do we have to do with everything I just said? You know, so I don't think you want me to repeat myself, do you? Like, you know, I don't think we've got to lower our prices anymore. I don't think we've got to, you know, the goods just got to get in stock. We've got to get the galleries reset, you know, and we've got to go through, you know, the next cycle and, you know,

you know, we'll be off to the races.

My follow-up question is on the degree to which your P&L this quarter benefited from lower freight and transportation costs. Was that more significant? Could you, A, quantify it, and, B, was it more significant than the P&L had experienced in the second quarter? Thank you very much.

Michael, we've talked about this a few quarters now. Given our turn and the way Fernando and his team attacked ocean freight, where the bulk of the increases in costs had occurred through the pandemic, those turned over last year.

We peaked in May as far as the highest contracted rates we've ever seen. And then every month thereafter, it's been a decline. And now many markets were back to or close to 2019 levels, right, Fernando?

So, you know, as far as, you know, kind of any kind of, you know, product margin impact from freight rates, I mean, we're, for the most part, cycled through that, given our... Yeah, we're not really seeing a benefit right now.

I know other people are. I think they got stuck, you know, in longer contracts with bad freight rates than we did.

Yeah, we were just more nimble at accessing the spot market.

and taking advantage of the decline in ocean freight rates that really began last June, I think, June, July. So I wouldn't say there's any really that's quantifiable, or if it is, it's de minimis for Q3.

Your next question comes from the line of Jonathan Matuszewski of Jefferies. Your line is open.

Hey, Gary. Hey, Jack. Thanks for taking my questions.

The first one was just a follow-up on RH England. You know, great to hear the demand continues to build. A while ago, Gary, you mentioned the 50 to 250 range for first-year revenues was possible. Obviously, the backdrop has changed a lot. But, you know, what you've seen in the first six months and the sequential trends, how should we think about, you know, what you're internally expecting for an annualized first year volume? And I appreciate it's more about, you know, conversation than commerce, but just trying to think about how it's annualizing versus expectation. Thanks.

Yeah, you know, I don't know if we had any real expectations. You know, when people said, like, what could it be? Could it be, you know, I said, I don't know, it could be $50 million, it could be $250 million. And that's, you know, I think about it as, you know, we're going to keep kind of marketing the brand, right? To forget about RH, you know, that gallery. Think about that country, you know, and, you know, what will our investments in marketing do to the direct business? What will the brand recognition do? You know, how does it build? You know, when do you get to... you know, certain run rates. I just think it's super early for us to know because we didn't open a typical store, right? If we would have opened in London first, it would be massively different. You know, we opened in the countryside. We tried to do something, you know, super inspiring and something the world's never seen. And so, you know, make an investment. It's like, it's just, I wouldn't get too focused on this gallery, right? You're going to try to draw a conclusion of this one. It's not going to tell us, you're not going to get the right answer from this one, right? This is really a brand investment and to create the right first impression and the right conversation. London is going to be coming around the corner. We're looking at other locations in other parts of England. And we're going to be investing in marketing, right? And not just books, but other types of marketing to drive the online business. But we're just in the early stages of all that. You know, just like I'm telling you, don't get too obsessed with RH England. From that telling us what the market's going to be for us, I'm not too obsessed about that because it'd be the wrong place to... draw conclusions from? Has anybody opened a store like that anywhere in the world in any category?

Somebody named something similar to that. Just think about that.

Like if you've seen it, if you've been there, anybody on the call, if you haven't, take a look at the pictures. Have you ever been to a retail store

like that? No.

So if you try to draw too many, we're not going to really do another one like that, right? You know, so don't, you know, like we've got other things like seeing how, you know, how does Germany build? That's a lot more normal. We're on streets where there's a lot of people walking by, driving by, you know, so on and so forth. It's just a different, you know, there are two different objectives and goals and visions, right? You know, and strategies for the two. They serve two different purposes. So, you know, did I think RH England, you know, like there's a number I always had, you know, and yeah, it's a modest number. And, you know, but, you know, it's like what you don't know is, okay, when you open up a brand to an entire country like England, How does that go? How does it grow?

What marketing do you have to do, you know, beyond Ari Chingley? We're still learning.

So, you know, you know, I just, we're not in a hurry to jump to any conclusions on any of this. We're really happy with the work we've done, with the team we have, you know, with the initial, you know, feedback we're getting from consumers and the kind of people that are coming and all that looks directionally right.

Over time, it'll all take care of itself.

England's its own thing. There's nothing like it in the world. That's why we did it. To get people to see something they've never seen, think about our brand in a different way, have people at the highest levels of the economic ladders who are shopping the best luxury brands in the world and stuff look at us differently, think about us differently. You know, so they're all long-term. You know, things like that are really a long-term investment. It's like a guest house. You know, we opened what we believe is the highest quality hotel experience in New York City, if not one of the best in the world. I'm not looking at that thing to really tell me am I going to roll out a lot of guest houses. No, I'm just trying to communicate differently about a brand to build something that no one's ever built before. You know, it's like somebody just wrote a report that I thought was one of the most comprehensive reports written about our company. Went all the way back to the very beginning, wrote about everything, wrote about RH Music, you know, when we had a record label and we were, you know, we did a concert at the Greek Theater and we did, you know, performances in all of our new, you know, new galleries. And we had RH Contemporary Art and we owned the Rain Room, you know, the most exhibited art exhibit in the history of the MoMA New York and the history of the LACMA New York. And, you know, I remember being at the Goldman Conference and, you know, someone asking me about RH Music and, you know, this and that. And like, you know, and I said, you know, it's just a different way of communicating. I could go run ads and, digitally or in print or do anything. And, you know, like, I don't know, how do you really measure those returns? If it was that easy, you know, if everybody had really great data on digital advertising, don't you think everybody would have a really high performing business? They don't. They don't know how much to spend. They don't know what they're getting for any of it. You know, Google and other people try to give you great things to you know, make you spend more money. Oh, look, look what you're going to find out. Like they clicked on your name. Like, you don't know if they clicked on your name because they came in your store, you know, or how they got there. You know, it's, you know, but it's just a different way of communicating to building a brand. If you're going to build something unlike anything anybody's ever done, you don't take the same path as them. But we got here and we did things like RH Music and we had, three artists for, I don't know, three years. And, you know, we produced albums and we did concerts and we did other things. And I think people thought it was really cool and it made our brand look different and had people think differently about us. Like, who are those people? You know, and we did Artists Contemporary Art and we had the Rain Room. You know, first piece of art we brought became the most attended exhibit in the history of the world. I mean, we're not always going to get it right, but I'll tell you,

Anybody who's been to RH England thinks differently about RH and thinks about, huh, you know, those are pretty interesting people.

And, you know, we're trying to build something special. It's just not a game plan anybody else is running because they're all running the same game plan for the most part. We're running a different one. So at different times, it's,

Going to be hard to look at, hard to model, hard to understand. But that's how it should be, by the way.

Great.

Thanks, Gary. And then just a quick follow-up on product. A lot of discussion about disruptive pricing ahead. And just kind of curious how you're able to achieve that while preserving margins. So, you know, any color you could give us on how the materials or the finishes or the sizing of pieces in the new collection is going to be evolving would be helpful. Thanks.

Yeah, I mean, well, it's just, it's because of our scale and buying power and confidence. And, like, if you look at, you know, you look in our source books or you look online and you look at the Jacob chair, for example. And if you go look at it everywhere else and look at the pricing and you look at our pricing and you look at our assortment and you look at our presentation, you might have an ankle biter here or there and someone just bought 20 chairs and they're not making any money and they're going to match our pricing. But there's no one that can really buy as much as we can. No one that can present it on a platform as big as ours and mail as many books as we do and get behind it. And a lot of people don't place the financial bets we do on product. We do that very well. Now we got to where we are. So if you... I mean, we've got people who are selling, you know, their version of the Jacob chairs, and they pulled it off their website because their price was so embarrassing. And they already own the inventory at a much higher price, and now they don't know what to do. So they're probably sending it to an outlet. And they know who they are. They're probably listening to this call. And, you know, if you look at anybody selling the Jacob chair, you know, whether it's the cane Jacob chair, the upholstered Jacob chair, the leather Jacob chair, the dining chairs, the lounge chairs, I wouldn't want to be competing with us in that chair. And the margins are as high as anything else that we have. So it's not necessarily a lower margin when you think of disruptive pricing.

Your next question comes from the line of Seth Bashan of Wedbush Securities. Your line is open.

Thanks, all, and good afternoon. My question is also around the product transformation. Understanding there's a ton of newness and a lot going on here, but as we think about modeling it, you mentioned that's going to be margin dilutive near term. Will that switch to accretion as the sales inflect in the second quarter, or is there a longer ramp to the margin accretion? Yeah, it should.

It should.

All right. That's reassuring. And then the second question I have is just regarding the ramp in Europe and understanding those galleries will take longer to ramp as the brand awareness is more limited than the U.S., but how should we think about the ultimate margins in ROIC of those new European galleries putting Irish England aside?

Um, yeah, you know, it's, it's not that many, you know, like we're, we're just going to, we're going to get them open. You know, we're going to learn a lot. We're going to focus on how do we build our business in these different countries and what kind of marketing investments they take and what they look like. I, you know, I, it's not, you know, it's not like you start with saying like, what's our ROAC going to be in Germany? I don't know, I've never sold anything in Germany. Like, what's it going to cost to build the brand, to have people come, you know, to build up the design book and, you know, the trade book and everything else? You know, so, again, it's a handful of galleries, right? It's 10, all together, I think we've got 10, 9 or 10? 10, yeah, because we do... Sydney and yeah, the two and Madrid and stuff, you know? So, yeah. So, you know, we're going to get them open and we're going to start learning and we're going to, you know, make all kinds of adjustments and get some things right and get some things wrong and work really hard to make it great.

But, you know, I like how we're starting. I mean, like we, we look, you know,

you go into Germany, we look really good. I mean, the galleries look great. The teams are fantastic. All right. People are coming in. So it was really encouraging being, being in Munich, uh, you know, getting a, a really good feel for it. So, um, yeah, I mean, obviously very different than England. Yeah. And, uh, you know, so, and we didn't have to spend much capital, you know, in those two galleries.

We,

Yeah, we took over, you know, a couple of the Abercrombie & Fitch flagships and refitted them. And, yeah, we didn't have to build them like some of the other ones. You know, or like even in R.H. England where, you know, we had to rebuild it. So, yeah, so they're, you know, they're all going to have different kind of ROC dynamics to them. But it's really how does it all blend out? What does it look like? year two, year three, as it ramps, once you cycle some of the initial investments to get home delivery up and going and all the investments we have to make. But the real big key, I'd say, is going to be the inflection of the U.S. business. That's the key, right?

That's the big thing to focus on. These things, they're going to kind of

take their own path and, uh, and we'll learn and we'll make adjustments. But, uh, you know, when we're getting these open, it's, I don't, I don't mean to minimize it. I mean, it's just, I think it's kind of unrealistic to have really specific goals for these, you know, we just want to be directionally right. And then we'll refine it and, and, you know, learn and continue to improvise and, uh,

you know, and improve everything. But, you know, we're, our big focus is to inflect, you know, the U.S.

business and, you know, the North American business and, you know, get back to taking market share and, you know, getting our margins back to historical levels. And we're going to, you know, for part of it to get to historical levels, you know, and, in operating margins in the, you know, 20% range, we're going to need the housing market to, you know, unfreeze here and kind of return to a somewhat normal housing market.

And that could take, you know, another 12 months. You know, I don't know.

Your next question comes from the line of Peter Benedict of Verity. Your line is open.

Oh, hey, guys. Happy holidays. Yeah, follow up on that comment there, Gary. Just so I was going to ask you about the conditions you thought were required to get you back to that 20%-ish operating margin. Clearly, you know, an unfreezing of the housing market. I was thinking more, is there a revenue level or scale in a business around $3 billion now, given, you know, the cost increases across the P&L just post-pandemic? Like, is there a revenue level that you think is required to maybe support that?

That was kind of my first question.

Yeah, we know that answer, but I don't know if we want to say that right now. I mean, you know, like I think it'll – I mean, clearly it's still not higher than today.

We've said that the margin, you know, will – both gross margin and operating margin will naturally lever as we build back the revenue.

But we're not ready to give you that number.

Okay, got it. No, fair enough. Another question was just around the membership fee. I just noticed you took that up to $200. Just curious the rationale behind that decision that I think just happened here maybe in the last month or two.

So that's my second question. Thank you. Yeah, we just had plans to, you know, bump it up a bit.

It's a natural progression of our business. You know, when we started membership at $100 and for years we didn't move it, but the AOV of the business had increased. And so when we first moved it to $150, you know, we talked about that we were kind of, you know, we might see a more regular cadence of increases. So I would just say this is just part of that and then reflects the sort of average order value of our business continuing to creep up.

And so it's membership as a percentage of that is one way we look at it.

And our last question comes from the line of Brad Thomas of KeyBank Capital Markets. Your line is open.

Hey, thanks so much. Gary, I was hoping we could talk a little bit more about the outlook for Gallery when we look at what you've done in Indianapolis and what you were working on for Miami, really pushing the boundaries here of what's going on in the U.S. I think the letter referenced 40 additional markets you're looking at. I was wondering if you could just expand a little bit more on what you think the U.S. gallery network looks like 10 years from now with this continuing evolution.

Um, but you know, something like Indianapolis is an opportunistic move, right? Uh, an incredible home and the state came on the market. We bought it for 14.5 million that we bought it for. Yeah. Yeah. It's, it's in our joint venture. Um, uh, you know, so, uh, you know, so we, we, you know, own 50% of it. Uh, and you know, it's just an opportunity to get something like that for a $14.5 million investment. And, you know, what we put into it was, you know, pretty minimal versus what our normal investment was. So we had this incredible experience for the, you know, experience for the customers, you know, at a lower investment rate than we'd make, you know, and a lower occupancy cost than we would expect to have. So, you know, that was just a that's kind of a one-off great outcome. I mean, we're always looking for things like that to come up, but I wouldn't say that's like, you're out looking, you know, you're not really looking for something like that. Like that just, they just kind of happened. So, uh, um, uh, you know, I think, um, That's just an opportunistic move. But what does it look like 10 years from now? We have 35 legacy galleries.

We'll have more and more of those converted. We'll also go back to the existing design galleries. We've talked about certain ones that are going to have the next iteration, like a Houston, for example, will have a bigger gallery. Los Angeles at some point will have a bigger one, for example.

That in North America will continue. And the 40, you know, Gary talks about the design markets of the 40 and the logic there.

So that's a whole kind of different animal, I guess, in terms of adding to the store base.

Yeah, and we may learn in some of these, you know, smaller kind of, you know, what we refer to as a design studio. It's really in Palm Desert, it's like a design office, right? It's really enabling entrepreneurs, you know, interior designers that, maybe don't want to work in a retail gallery, and, you know, where there's market opportunities to do something to improve art and have a more dominant interior design presence, we think that's really good for the RH brand. You know, so some of these will look a lot less like a small store. They'll look a lot more like an interior design office with, you know, a couple of small presentations to the product, but really a real office for an interior designer to work with clients in a highly professional way and attract entrepreneurial people that want to run their own interior design business. And we've become a platform that can support them and allow them to do what they really want to do. So we may, for example, like in the first one that we got in Palm Desert, How big is that? It's like 3,000 feet. Yeah, it's like 3,000 feet. We're also looking to probably do a 10,000 to 20,000 square foot gallery there, probably 15,000 to 25,000, call the range, in that market. And we'll have both of those locations. One's really a true interior design office. But that gallery that we'll build probably won't you know, have the same dedicated space for interior design that we might have in one of our big galleries where we have interior design embedded into the gallery. So, you know, it just gives us more flexibility, reach more markets, activate the interior design business, you know, which is a, you know, growing part of what we do. And I think we're going to learn a lot of these where there's opportunities for even, you know, bigger stores. Like if, if we're right on this transformation that we're, you know, that we're kind of, you know, that began here and we're right around about how the business is going to inflect, you know, that's just going to meaningfully take up your volumes and all these markets makes all the occupancy models look different, right? And allows you to access different things and invest in different ways.

So, you know, we're going to,

I'm sure we're going to have an even new view in the second half of next year. As our baseline performance improves, it changes your economic outlook from a real estate point of view.

That's great. Thank you, Gary.

There are no further questions at this time. I will now turn the call over to Gary Friedman, Chairman and CEO, for closing remarks.

Thank you, everyone. We appreciate your interest. We wish you all a happy holiday. I would say to Team RH, we just can't tell you how much we appreciate the energy and the commitment and passion you bring to our business and to our brand. You are the heart and soul of this company. You are the ones that interface with our consumers every day. Thank you for making us so proud. And especially the teams that just brought our international galleries to life. I mean, just incredible, you know, what we've done. We were in Germany, what, just two weeks ago or 10 days ago. And you walk in, you interface with the people, you look at the gallery, you'd think it was in North America. You know, I mean, and to be honest, you know, at the very beginning of this and to be executing at that level and to have that quality of people and, you know, that energy in the galleries was just gives me and the team here a great deal of confidence of what we can do globally with this brand. So we wish everyone a wonderful and happy holiday and, you know, wish for peace in the Middle East, and hopefully this world becomes a more peaceful place very soon. So happy holidays, everyone.

This concludes today's conference call. You may now disconnect.