RH (RH) Earnings Call Transcript & Summary

Thanks so much. Hello, everyone, and good afternoon. We appreciate your presence on this call covering our fiscal 2024 third-quarter earnings results. With me right now are Gary Friedman, who serves as Chairman and Chief Executive Officer, and Jack Preston, our Chief Financial Officer. Prior to getting underway, let me point you to our legal disclaimer: certain remarks we make today will be forward-looking as defined under federal securities laws, and that covers things like what we expect for the business and other topics addressed in the press release we put out today. A variety of risks and uncertainties attach to these forward-looking statements, and those could lead to actual outcomes differing in a material way. For a fuller account of the risk factors that might impact what we report, kindly look at our SEC filings and the press release we issued today. Note as well that such forward-looking statements represent our view solely as of the moment of this call, and we assume no duty to update them or make public any revisions stemming from fresh information or later developments. In addition, we might cover non-GAAP financial measures on this call, which take our GAAP results and adjust them to strip out the effect of particular items. Details on those non-GAAP financial measures, along with a reconciliation between the non-GAAP and GAAP measures, appear in today's press release on our financial results. You can also catch a live webcast of this call through the Investor Relations area of our site, ir.rh.com. Having said that, I'll hand things over to Gary.

Alright, thanks Allison, and hello to everyone joining us. I want to begin by referencing the shareholder letter we sent out within the past hour to our team, our partners, and our investors. Momentum in our business kept building, with demand during the third quarter climbing 13% even as we contended with the toughest housing market seen in 30 years. Our trajectory is strengthening in size and course alike — November demand rose 18% — while the largest product overhaul and platform buildout our sector has ever witnessed keeps playing out. This industry-leading expansion comes primarily from the RH brand, where November demand grew 24% following the launch of our new RH Modern Sourcebook, and it has kept speeding up into December, with month-to-date demand rising 30%, which shows how disruptive our product transformation truly is. Results for the RH brand mirror market share gains between 15 and 25 points during Q3, speeding up to between 25 and 45 points in Q4, judged by present trends plus what furniture-focused retailers anticipate; we think our collections represent a degree of design and craftsmanship unavailable in today's marketplace, along with a value proposition that shakes up numerous markets, which puts RH in position to capture substantial market share well into the future. Our Contract, Outlet, Baby & Child, and Teen segments ought to gain from the product transformation we're undertaking in 2025, since, first, the fresh assortment reaches more customers to bolster our Contract Business, second, returns involving the new product feed our Outlet Business, and third, the best-performing designs get adapted into smaller sizes for Baby, Child, and Teen; we're also happy that third quarter results matched the guidance we gave, with revenues up 8.1%, adjusted operating margin at 15% compared with 7.3% the prior year, and adjusted EBITDA margin at 20.8% against 12.4% 12 months earlier. Based on how things are trending right now, we're raising our guidance for both the fourth quarter and the full year. For Q4, we now expect total demand growth of 20% to 22%, along with revenue growth of 18% to 20%. Q4 adjusted operating margin should land between 12.2% and 13.2%, and adjusted EBITDA margin between 18% and 19%. For the fiscal year, total demand growth is projected at 9.9% to 10.4%, with revenue growth of 6.8% to 7.2%. Fiscal year adjusted operating margin is expected to be between 11.5% and 11.7%, while adjusted EBITDA margin should come in between 17.2% and 17.4%. Pablo Picasso once observed that creation always begins with destruction. We've put in the effort to dismantle the version of ourselves that came before, and at this point we're focused on setting free what we regard as a much more inspiring and disruptive RH brand — one that takes in the largest product overhaul and platform buildout our sector has ever witnessed. Our position is that the major investments being made across this depressed housing cycle are generating strategic separation within our industry on a par with the most significant brands on earth. Looking ahead at what we have planned for the rest of 2024 and part of 2025 on the product transformation front: the second mailing of the new RH Modern Sourcebook reached homes in November, featuring 54 new collections spanning furniture, upholstery, lighting, rugs, and textiles. Given the demand trends we're seeing and our confidence in this new offering, we raised advertising spend by roughly $6 million during the quarter, which allowed us to grow both page count and circulation further. The demand we've seen quarter-to-date makes us confident this spend will turn out to be a smart move throughout Q4 and into the first half of 2025. Just to remind everyone, once we'd reviewed our circulation numbers, we made the decision to merge the RH Contemporary Sourcebook collections into the RH Interiors and RH Modern Sourcebooks, which allowed us to get the best possible combination of mailing depth and efficiency. By distributing fewer books that carry more weight, our brand can stand out amid the ever-increasing noise in the consumer sector, and that aligns with our Gallery approach of offering fewer but more absorbing, brand-defining physical experiences. The new RH Interiors Sourcebook is scheduled to arrive in homes in early February, bringing 89 new collections that cover furniture, upholstery, lighting, rugs, and textiles. Between these new collections and improved in-stocks, we expect to see additional vector and market share gains during the first half of 2025. Additionally, we intend to launch our 2025 RH Outdoor Sourcebook at the start of February. It showcases the strongest collection of premium outdoor furnishings found anywhere globally. Within this updated Sourcebook, customers will find eight brand-new outdoor furniture lines, an exciting debut in outdoor textiles, and inventory levels far healthier at the season's outset than was the case twelve months prior. You know that Waterworks came into our portfolio back in 2016 — a brand many would call the most coveted name in luxury bath and kitchen. Across these past eight years, the Waterworks crew has performed exceptionally well, further enhancing the brand's prestige and developing a business model that is both highly profitable and capable of scaling. On this call, I want to talk about Waterworks. Like many luxury home brands, its revenue comes mostly from trade customers—architects, designers, developers, and builders. RH does have a sizable trade operation, yet consumers drive the bulk of our sales. We see a big chance to grow Waterworks by putting it on the RH platform and bringing it in front of far more people. That's what we've done over the years with other businesses and brands that leaned toward trade. Starting this week, we'll start rolling out Waterworks across the RH platform. The first step is a 3,000 square foot Waterworks Showroom inside our biggest new Design Gallery, which opens tomorrow in Newport Beach, California. Designers working in interiors across the globe are about to gain the ability to include Waterworks when specifying products for their projects, and within a matter of weeks shoppers will have the option to browse and buy Waterworks merchandise through RH.com. Beyond that, our plans include a trial of a Waterworks Sourcebook during the latter six months of 2025. Currently, this brand constitutes a roughly $200 million enterprise, operating with an EBITDA margin somewhere between the mid and high teens, and we believe there is potential for it to become a worldwide name generating a billion dollars in revenue inside our platform. We also have plans to launch RH Couture Upholstery by Dmitriy & Co. in the opening six months of 2025. Dmitriy & Co. came into our portfolio back in 2020. with the goal of creating the most beautifully designed and expertly made upholstered furniture anywhere, which had previously been offered only to-the-trade, and making it available to consumers through the RH platform. Although plenty of guessing has occurred about the ways we could alter Dmitriy & Co. to serve a bigger market, what we intend is the exact reverse. Our view is that by leaving everything untouched, we will transform everything. Much like Waterworks, we think moving certain of the most respected brands globally from a purely trade-based model to one blending consumer and trade can be a truly massive concept, capable of producing exponential growth for these greatly sought-after brands. Also, we plan to roll out a significant new brand extension during the fall of 2025, and we believe it will considerably expand both the market size and the share that the RH brand holds. This new brand extension will include a new Sourcebook as well as a major website presence on RH.com. We expect to display the product in our Galleries in early 2026, and we will share more details about this exciting new undertaking in the new year.

Finally, we don't anticipate any margin hit from the latest announcements about possible higher tariffs in 2025. For several years now, we've been proactively shifting our sourcing out of China, and we expect to be completely out of the country by the close of the second quarter. In addition, we're moving products that are made in Mexico, and we're confident we can relocate our sourcing successfully without any supply chain interruption. Now let me direct your focus toward how we're elevating and growing our platform. We keep launching the most inspiring and immersive physical experiences in our sector — some might argue in the entire world — environments that embody human design, an exploration of balance, symmetry, and ideal proportions; environments where the boundaries between residential and retail, indoors and outdoors, home and hospitality become blurred; environments featuring garden courtyards, rooftop restaurants, wine and barista bars; environments that engage every sense, and environments that simply cannot be duplicated online. Our strategy to take the RH brand worldwide, serve new markets on a local level, and reinvent our North American Galleries amounts to an opportunity worth multiple billions of dollars. Our platform expansion blueprint for the rest of 2024 and 2025 covers RH Newport Beach — debuting tomorrow with more than 90,000 square feet of interior and exterior space across four levels, with Pacific Ocean views, it will stand as one of our most spectacular, immersive, and brand-defining physical experiences so far, and it will take the place of three legacy Galleries in that region. RH Newport Beach, The Gallery at Fashion Island includes the RH Ocean Grill, a 270 seat Indoor-Outdoor Rooftop Restaurant offering uninterrupted vistas and dramatic sunsets along the California coastline, two Wine & Barista Bars, our inaugural Waterworks Showroom, an Interior Design Atelier, and the largest Luxury Outdoor Furniture selection in our industry. We're confident RH Newport Beach will become an inspiring destination within the Southern California market and could potentially turn into our second $100 million plus Gallery. RH Montecito, which also opens this week, reimagines the Historic Fire House in the charming enclave situated above Santa Barbara. This Gallery will include The RH Firehouse Grill, an indoor-outdoor Courtyard Restaurant complete with fireplaces and fountains, a Wine & Barista Bar, and an Interior Design Atelier. The first RH Interior Design Studio opens this week in Palm Desert, California. Our aim is to make RH the world's foremost interior design firm, since we've transitioned the brand from merely curating and selling product to conceptualizing and selling spaces. The Palm Desert site serves as a distinctive test of a consumer-facing interior design firm, rather than a Gallery. Our hypothesis is that by showcasing RH Interior Design in a singular way, as a professional interior design firm, we'll draw the highest caliber interior designers, and consequently the highest value consumers. We think this could be among the most critical strategies for elevating and distinguishing the RH brand as a global design authority at the highest end of the market. We're also working on an RH Design Ecosystem over in Palm Desert, where the plan is to bring in a 10,000-square-foot RH Design Gallery plus a standalone 5,000-square-foot RH Outdoor Furniture Gallery, both on that same street. On top of that, we're looking at a freestanding RH All Day Cafe to round out the ecosystem before long. RH Raleigh launched in November of this year, spanning 50,000 square feet of indoor and outdoor space across three levels; that Gallery features a Rooftop Restaurant, Garden Courtyards, a Wine & Barista Bar, and an Interior Design Atelier. In 2025, we intend to launch seven North American Galleries, among them Montreal, Manhasset, Detroit, Oklahoma City, Los Gatos, Palm Desert, and Aspen. We also intend to launch two International Galleries during 2025: RH Paris and RH London. We expect a turning point for our business in Europe once we start opening in those key brand-building markets — Paris and London in 2025, followed by Milan in 2026. That's when we'll achieve the scale needed to fund the advertising spend required to grow our business throughout Europe; we're happy with the second-year growth patterns at RH England, since that Gallery is up 42% from July through December, while the web business is up 111%. Based on current demand patterns, the Gallery would hit roughly $31 million in its second full year, with web demand hitting $7 million in its second full year. For proper context: if an RH Gallery in the English Countryside — with an estimated population of 100,000 within a 10-mile radius, almost two hours outside of London — can produce $38 million of demand in year two, then what could an RH Gallery in the heart of Mayfair, the most exclusive district of London, a global city of 9.7 million people, achieve in its second year? Our belief is exponentially more. We're also putting significant investment into elevating and distinguishing our online experience, with plans to upgrade our website in the fourth quarter of 2024 and across 2025. A number of the features we intend to roll out are fairly revolutionary and unlike anything else out there. We intend to file for design patents covering several user interface and presentation designs, and we'll start discussing the new website strategy in greater detail as we introduce the new functionality. Leaders must be at ease with making other people uneasy. Leadership means chasing a vision, taking people somewhere they've never gone, doing what they've never done. Humans are creatures of habit, so change makes us uncomfortable, yet for the people and partners of Team RH, a culture of invention and innovation sits at the very core of who we are, and shows up in everything we do. For more than two decades, we've grown at ease with making ourselves and others uncomfortable, and we intend to keep at it for the foreseeable future. That's what leaders do, and it's how we know we're on the right path. Whether it means putting money behind the biggest product overhaul our sector has ever seen, even as rivals pull back amid the toughest housing downturn in 30 years, or launching the largest, most immersive brick-and-mortar retail spaces anywhere on earth, while competitors cut locations, shut doors, and shift to e-commerce. Because we won't run with the crowd into that anything-but-social universe of social platforms — you'll never spot us on Instagram, nor will we hand cash to strangers, so-called influencers, so they'll claim on TikTok that they adore our label — we decided to follow Ralph Waldo Emerson's advice: take the route where none exists, and leave a trail behind. Our goal is to shape a distinctive identity of our own, rooted in innovation and invention, truth and trust, taste and style, leadership and love. More than two decades back, we launched this effort with a dream of turning an almost insolvent company — one carrying a $20 million market cap and featuring a box of Oxydol laundry detergent on its catalog cover — into the top luxury home brand worldwide.

What we've taken away, what we've come to understand, the deep nuances, the things we gave up, and the thick skin we grew from being knocked down 10 times and rising 11 are what forge the mental and moral qualities that shape character in people and create cultures inside organizations — teachings no classroom can provide, nor can running a business, teachings you only obtain by constructing one. In a world that prizes copying and punishes the naturally uneven path of innovation, particularly for publicly traded companies, all of us, the people and partners of Team RH, will keep pushing ourselves to tear down today's reality so that we can build tomorrow's future, all while staying entirely at ease with putting ourselves and others in uncomfortable positions. Never undervalue what a handful of good people can accomplish when they have no idea what's impossible — above all, these people. Onward Team RH. Carpe Diem. With that, operator, let's take questions on the call.

Morning, and good afternoon as well. I really appreciate you taking the time for my question. Clearly, your results have been far ahead of what the rest of the industry has done. So with that in mind, how do you plan to capitalize on this situation — would you, for instance, speed up even further some of the spending you have planned for 2025? And should that happen, would you accept giving up some margin, letting margin come down, even if doing so meant your sales were still growing faster? Many thanks.

Well, Michael, in my view that is a question every business leader faces — what an investment cycle looks like, what a harvesting cycle looks like, and how you weigh the long term against the short term in running a business. I'd say this is a fascinating moment for our sector. You see, like, a number of players each taking a different route. In a moment like this, some hunker down or harvest, and they cut back on spending. If you studied our track record, you'd see this has consistently been a time for investing, since when a housing downturn eventually turns, it typically creates the chance to capture meaningful market share once things recover. Yeah. So looking ahead, I'd put it this way: as of today, our view is that the bulk of the major spending is now done. Take the early investments into Europe — not that nothing more remains, but the initial outlay just to stand up a platform so a business could launch there was fairly substantial; we do still have some sizable investments tied to RH Paris, RH London, and Range Milan. Still, the majority of that cash outlay is now done, right? That holds too when we consider what we've spent to transform the product across the last 24 months, since the real work started a couple of years back; so the scaling up and the building of the capabilities required to run at the level we're running at today is essentially done. And if you think about the major new brand extension we're talking about, most of that product is already in the pipeline. Honestly, we could technically launch it right now. We're just sort of putting the finishing touches on it. So those investments are largely done; even so, our company rests on invention and innovation. It rests on putting money into the future, and it rests on, if you will, growth that never ends. So here's something that tends to befall retail brands as time passes — I like to say a retail mall is nothing but a graveyard for short-lived ideas; that's because most retailers open a new concept, they get enough rights, they expand it. They don't evolve it, they don't innovate. So what happens is people start thinking, okay, we'll launch 20 of these every year, 40 of those every year, and before you know it, seven years have passed, and suddenly someone's sitting on somewhere between 100 and 300 stores, and every one of them looks outdated and worn out, since the priority was rolling out and copying rather than inventing and innovating. That's the reason the majority of retail brands can't even survive until their lease runs out. Take a shopping center, capture what it looks like right now, then go back a decade or project ahead a decade, and roughly 65% of that center transforms within every 10 to 15 years, and typically — plenty of retailers never reach the end of their lease term. So in that respect, we're a bit unusual, correct? We've traveled this road. This marks my 24th year, and what we took on was essentially a company in bankruptcy that we basically had to pull out of its grave, correct? We began beneath the surface, so to speak, and had to claw our way upward; after that we kept constructing and following a route of ascending the luxury mountain, attempting to establish the luxury brand, and that has required, yes, substantial capital; yet at this point, if you simply drive up again and examine the platform we've assembled and consider placing the present figures into context, correct? And our operating model carries a great deal of de-leverage thanks to the major investments we've committed. Every one of the cash outlays sits behind us. Consequently, I gaze ahead and consider the cash flow across the coming couple of years, and what I see is a model of compounding cash flow rising dramatically. I don't really see major capital outlays past the sort of signature brand-building Galleries. Yet even from there, most of the cash has already left the company, in Paris and London and so forth. A portion of it means you'll face a depreciation drag moving forward, since we've poured in a great deal of investment. That's the reason we figure it's likely crucial, when you consider our model going forward, to concentrate on adjusted EBITDA margin, correct, since that will be the — adjusted EBITDA margin plus the generation of cash flow, that's the proper lens for a model such as ours. It's the same as the many years Amazon ran a depressed model, because they were deeply in investment mode, constructing a platform nobody had ever constructed before and possibly nobody ever will again. When you look at where we stand, it helps to revisit the past 10, 12, or 14 years and consider what we put into our platform. Consider how many major Galleries we operate — something no one else in this industry has, not even close. Then consider everything assembled across the past several years: the product overhaul we completed, and the spending required to get there. There's also the inventory commitment needed to front-load a business like ours, so that added inventory can trigger an inflection point. And then there's the inventory you must put in to bridge the gap between your prior position and your current one, so a ditch doesn't open up while you shift from existing products to new ones. That whole thing amounts to a heavy investment cycle, and it somewhat skews how our model looks in the near term. If you take the vector — rising considerably in both size and direction — and simply trace it across time, and you recognize that a substantial portion of that investment cycle now sits behind us, you could map out how this model may perform across the coming 2, 3, 4, or 5 years. Then, if you layer on an accelerating housing market — and it will arrive, won't it? It's the weakest housing market anyone among us has witnessed throughout our entire collective experience — you need to recognize the situation we occupy right now as you look ahead across the next 5 years.

Understood, that's really useful. And for my second question: when we think about the coming 2 years, first, is it fair to say your base case is that an improving housing market will cause the business's recent trajectory to speed up, so that's what we should assume when we begin modeling next year and afterward? Second, since RH's margins have been falling at a certain pace over the last 2 years while sales were under pressure, is that the correct way to frame how margins will bounce back — recovering as sharply as the rate at which sales grow, similar to what you've shown lately? Thanks.

Yeah, I'd say that's roughly the right direction. What I mean is, what's the housing market actually worth? When it rebounds, it isn't worth just 5%. It's probably worth 30%, correct? And that will sort of build on itself across a couple of years; maybe it begins at 10% and compounds up to 15%, and — though it could simply surge and you could witness the housing market return with, say, 30% growth. You might even see 50% growth. Consider how long and how deeply depressed things have been, consider the accumulated pent-up demand, and consider how many folks have been wanting to move for years — growing families, people relocating, becoming renters, and so forth — because of the big gap between interest rates, right, and how many people are stuck with low rates. So that — that's simply — that's going to develop, that's going to shift. Precisely when that occurs, we're somewhat indifferent about it. Honestly, sometimes I say internally, hey, I'd like the housing market to remain flat for one more year. If it does, we'll face far fewer competitors; if it does, we'll capture much more market share. So I'm not exactly eager for the housing market to recover, since a weak housing market for a brand like ours, positioned as we are, is actually somewhat beneficial when you consider what the future holds. Because many of those ankle-biters who could easily raise capital across the last 5, 10 years, and in particular, yeah, pre-COVID, 5 years before COVID and the 4 or 5 years after COVID — I mean, everything in the home business looked fantastic and raising capital was really easy, and somebody could launch an online brand, and all of that represents some degree of, right, competition. Right? There are simply more places to shop, more people marketing, more people on Instagram marketing or online marketing, and so forth. And competitors have proliferated in the housing market. You're seeing that shrink very quickly now. What I'm getting at is that we've witnessed plenty of companies go through public Chapter 11 filings—or, I'd put it, near-Chapter 11 or practically Chapter 11 and then acquired out of that process—since a handful of online aggregators exist. One of those brands that has snapped up several of them, its name escapes me. Though honestly, I likely don't have to mention it. You folks probably already recognize which companies those are. But as Gavin Grover, the lead outside counsel we work with, likes to put it: a pair of intoxicated individuals propping each other up at the bar doesn't make things any better. So when you combine several struggling brands and count on gaining leverage by rolling them into one entity, that approach typically fails. Take what just happened with Overstock.com and Bed Bath & Beyond—anyone going on about that combination, my view is that this pairing will, I believe, prove solid across the long haul. So our thinking is: absolutely, opportunities exist at numerous levels. The housing market is one; should housing remain sluggish, a greater number of people in our space—the furniture-centered home furnishings sector—will face difficulties, which means greater opportunity waiting on the flip side. Our inflection point is taking place no matter what, correct? So consider this: at what point has a brand with our size and scale, operating in a mature market, ever built a market share advantage exceeding 5 points or 10 points? A 5-point gap would be viewed as genuinely strong. A 10-point gap would be viewed as exceptional. So what would somewhere between 25 and 45 points resemble? Follow that trajectory across the coming years; it has the power to transform absolutely everything.

Thanks so much, and enjoy the holiday.

Thank you — you as well.

Thank you, and good evening, everyone. I'll split what I want to ask into two parts. First, your fourth-quarter guidance sits beneath what you're currently seeing in the quarter so far — is that simply you being careful? Might there be some seasonal pattern in the business to keep in mind as the quarter unfolds? Second, given that you've done a great deal of clearance across the last few years to bring in all this newness — 80% newness this year — do you expect that eventually you can recover that clearance margin? Thanks so much.

Good question. On the guidance front, we figure it's pretty much the correct number, though a lot depends on what happens across the rest of December and into January. Somewhere around 75% of what we do — the range runs from 73% to 76% — that, in my view, is our main RH brand when you really break it down. After that, roughly a quarter more of our activity comes from areas like Contract, Outlet, Baby & Child, Teen, Waterworks, Dmitriy, and so forth; and whenever you pull back and look at those operations, they're not picking up speed in the way the core brand is. In that letter, I basically made the point that a lot of them should be speeding up. Waterworks is not going to see any impact from the changes we're making to our products. That said, the platform gives the Waterworks brand the ability to do some things it possibly couldn't pull off previously — the same way we've grown other businesses. Now, on the markdown percentage: if you went back through the record of our company in our core business, it would show you how much we have on the market. For instance, right now, were you to take a look, 75% of our — take a look today, roughly 80% of what we do in Q3 sells at full price, while around 20% carries a markdown. It's going to move around between 20% and 22%; 78% to 22%, 80% to 20%. Across the years, say in a truly strong housing market, that figure could drop to 90%-10%, though some share of clearance is always there. I'd say that if you look at our rivals, or really the entire sector, an 80%-20% split is something they'd all be thrilled to have. That mix is what they'd dream of. Now, when housing isn't doing well, does the clearance side of things perhaps face heavier strain than it otherwise would? Absolutely. And when the housing market turns bad, will clearance account for a bigger share of the business? Naturally, it does. None of that takes any great insight to figure out, correct? Beyond all that, as my letter lays out, I get into just how much of a disruptor our brand is. Over these past 2 years, you've seen us move into what looks far more like an attacking stance. We believe we can seize more of the room's oxygen, so to speak, by competing the way we currently are. It isn't really a clearance strategy—it's about design, quality, and value. We're aiming to shake up the market through design, through quality, and through value. That's what we're up to right now. Sure, that may create some initial pressure on margin, but when you're growing the way we are, you naturally get efficiencies and scale, correct? So consider the demand patterns we see now, consider us placing orders to restock product, consider the leverage that will come to us and to our manufacturing partners, and what future orders could look like—those might carry far better margins, correct? Yet it's about capturing market share, removing that oxygen from the room, building leverage into the business model from the top line, making the investments, and then steadily widening margin via the leverage the whole platform delivers. When I mention the platform, I mean our manufacturing platform and our vendor partners too. We do own a portion of our manufacturing. There's a factory we have in North Carolina, doing upholstery, and so on, and so on. But for the most part, manufacturing isn't something we own. Still, if you're one of our partners, we speak with and work with our partners as though we're a single company. We ask where their leverage lies, where scale can produce improved margin, improved pricing, more disruptive pricing, and all the rest. My view is that right now, putting money into disruptive pricing and weakening competitors beats harvesting the business and accepting lower sales. Various players are choosing various routes. Certain ones are surrendering market share, making no effort to gain share, and they're harvesting, correct? And they're widening operating margin and margins at present. We could take that route as well; we could take that route as well. I would rather have my core RH business climbing 30% than dropping three or 5% while ceding share in this period. Running up 30 will bring plenty of leverage on the far side; plenty of leverage and a much stronger market position.

Thanks a lot. Enjoy the holidays.

Thanks.

Hello, Zach here, filling in for Simeon. We appreciate you taking our question. To build on what was said earlier regarding free cash flow, could you discuss your expectations for when RH will achieve positive free cash flow? Also, as a second question, what's your perspective on the company's funding requirements and whether it can support itself financially? Thank you.

Yes, our belief is that in the coming year, free cash flow will become positive, and the company will be capable of funding itself. I mean, a major portion of what we owe isn't something we truly view as debt, correct? Our perspective is that it's more like a swap between currencies, right? So, if you examine our debt on its own, one could say they're carrying a large amount of debt; our view is a bit different; we see it as that currency swap. First, we never spent that money; no purchases were made. No physical assets were acquired by us. Not a single building was bought using that debt. No distribution centers were constructed using that debt. What we did was trade debt in one currency for something we consider an exponentially more valuable currency—our stock—which happens to be a highly liquid currency, right? Tomorrow, we could convert our stock into cash. So, we took on debt; we traded that currency for our stock. Currently, after accounting for interest expenses on that debt, we've transformed a $2.25 billion investment into something significantly larger—we've already gained several hundred million dollars on that investment, based on where our stock closed today. I mean, if you check where our stock is trading after hours, that investment appears significantly larger, right? So, given our business trends and an anticipated return to growth in the housing market, we believe that return will grow exponentially, right? But the debt on our balance sheet isn't there because we required cash. A meaningful part of the debt on our balance sheet exists because we chose to do a currency exchange, because we wanted to buy our stock while it was undervalued. I think we purchased 7.6 million shares at an average price of $295. I don't know, what's the stock after hours right now? Is it four-something?

Yeah. It is at $450 last I saw it.

$451.

Yes. $452. So that's a pretty solid return. Yeah, so what would that return be? I mean, over that period, what's our cost of capital — a hundred and something?

$350 million.

Yeah. Roughly $350 million came back. So listen, this isn't new territory for us. We've been down this road previously. If you go back through what we've done, we've swapped debt for equity in our Company and generated meaningful shareholder value along the way. When I consider my position, I hold more shares than anyone else in the Company.

Thank you.

Alright. Good afternoon, and I appreciate you taking my question. Congrats on the momentum that keeps building. Gary, I was wondering — can you walk us through what's behind the acceleration in the business? What's genuinely different about the product now? How do you view your competitive standing? What makes you think you're beating the industry by so much? And if the industry rebounds more strongly in '25, do you believe you're positioned well enough to scale up and meet that greater demand?

Well, everything we believe is in the letter. Honestly, the letter covers most of it, along with the points I've already made about the reasons behind our strong results. The thing is, we hold quite a few edges over the competition. Our platform, in our view, outpaces every other one in this space; our product features and our sharp sense of taste are, we believe, second to none in the industry. As I've noted previously, some players have taste but lack scale, while others have scale but lack taste. We see the notion of bringing taste to scale as both significant and broad in impact — and that's precisely what we're focused on. Our sense of taste, we think, comes through in the merchandise itself, but also in the Galleries we've constructed, in the brick-and-mortar side of what we do, in our Sourcebooks, on our website, and in many other places. What we're creating, in our view, is a taste-driven platform that will prove extremely disruptive and highly profitable over time. And that sensibility, together with what we can do when it comes to scaling taste — our skill at curating product, at integrating product, and at presenting product more effectively than anybody else globally — is, I'd say, evident from how big, how broad, and how profitable our business has been up to this point. Moving forward, we're going to keep carving out that strategic edge. That's the essence of who we are, isn't it? It's our mission. It's what 24 years of effort have gone into creating. And if you haven't laid eyes on our Center of Innovation and Product Leadership — anyone listening in, I'd suggest you, yeah, make an effort to arrange a tour, since nothing else out there compares to what we've established. It's an enormous edge over the competition. The approaches we use, how we approach this business, how we approach categories with strategic intent, how we pull categories together strategically into one unified, sharp perspective that cuts through the noise in the marketplace — every one of those things explains why we're beating the market. Okay, let's revisit the strategic error I discussed — the one where I shut down our product engine during COVID since we couldn't secure inventory. Early in the pandemic, when we reduced orders, revenue dropped 40%; then it swung from a 40% decline to a 40% gain. That's an 80-point shift right as we were cutting orders. Factories were closing, and so on. On top of that, procuring goods was difficult for us. So I proposed pausing our new-product pipeline for a year. Then Omicron arrived, creating yet another COVID surge. As a result, that pipeline remained inactive for two years. When we later attempted to restart it, we'd somewhat forgotten how, and our performance during that 3rd year was weak. As a result, at present, everyone faces competition not merely from the company we used to be, but from an improved iteration we turned ourselves into — that explains it. To put it plainly, for 3 years we failed to ship our flagship titles. Thus, anyone who believed they were thriving while RH was absent isn't feeling great now. These days, well, we've resumed competing in our own arena, though in a much more refined manner. In my view, we possess greater intelligence than at any prior point; we have more motivation and resolve than ever before; we are more inventive, inquisitive, and discerning than at any earlier time. Moreover, I believe the upcoming 5 years will rank as this organization's finest 5 years ever. Also, I expect that 5 years down the road we'll surpass where we stand now. Ultimately, that's simply our fundamental nature. What defines us at our core is innovation.

Got it. My next question concerns gross margin. During your report for the prior quarter, you mentioned that August brought a positive inflection in product margin. What happened with that through the rest of the quarter? Also, how ought we to view product margin for Q4? Many thanks.

Right, at the demand level, product margin remains positive. Some adjustments did occur beneath the selling margin. Market stock was one of them. I believe our Galleries underwent transformations so significant that we ended up with larger market stock. Shipping our product outside of the box is typically not a good thing. So, when a floor set transformation happens, we take the product off the floor, and we have teams — local home delivery networks — that pick up all of that product. That product isn't new, it isn't in the box, it isn't in protected packaging. They bring it back, and then it gets fed to the outlets; and a transformation this large has never been made by us. And I think we likely had more damages and more things that got banged up moving back and forth in trucks and moving around without boxes. So some write-offs had to be taken for product we thought wasn't really sellable at the outlet level.

Plus elevated cost of moving the product and elevated inventory transfer costs.

Sure, Jack, you have the floor.

Right, so there were one-time inventory transfer costs as well, tied to relocating that product; on top of that, we simply rebalanced certain product across our DCs so it would sit in the best possible spots. So…

Right, and this also means shifting that product out of Europe, bringing it back from Europe to America. When we stocked the DC over in Europe, we didn't begin by choosing every correct item. And at this point we're seeing the patterns, and we've come to realize, oh gosh, so we've got an excess of this, an excess of that. Well, rather than discounting all of that inventory over in Europe, it makes more sense for us to simply send it back to Baltimore, to supply the core business. So that's what we're doing, and that's yet another one-time sort of charge. So — but at a broad selling level, particularly within our core business, we're pleased with the direction our margins are going. We believe there will be opportunity to the upside and margins, not pressure to the downside and margins going forward.

And Gary mentioned that when you look at it through the lens of on-demand margin, and likewise through the lens of ship margin, the selling margins on a ship basis turned positive during the quarter.

Yes.

All right, that's quite useful. Appreciate it, everyone.

Wonderful. Thanks.

Good evening, Gary, Jack. Gary, perhaps a question about real estate with two parts, since you have so many openings planned — the sheer count of them — coming in the next couple of years. First, could you discuss the payback periods and the store-level ROICs you anticipate for these classes of galleries, perhaps compared with what you've described previously? And second, how have your talks with landlords and developers changed across the last couple of years? Have cost pressures perhaps settled down, given how distinctive your model is and given the pipeline itself? How has that conversation with landlords and developers shifted?

Sure. So, yes, let's begin with payback and ROICs. In the past, we've consistently cited a payback of, I believe, 1 to 3 years. We think that remains the correct figure. The place where it wasn't the correct figure was anything constructed while COVID was happening, correct? Since projects being constructed while COVID was happening halted and restarted 3 or 4 times, and raw material costs in certain places rose 2 to 3 times or 4x; thus, anything constructed while COVID was happening cost considerably more, as much as 3 times more. Generally speaking, I'd say construction costs now, at any level, whether you're in retail or any type of business, run somewhere from 70% to 100% higher; therefore, constructing the gallery costs us more now than previously. On the bright side, there's a significant turning point in both demand and sales, and we anticipate a boost as the housing market comes back. That said, for the majority of Galleries currently in the pipeline that we're opening, I'd say the payback period will be relatively short. The genuinely iconic locations—maybe London and Paris—might take 3 or 4 years, though 2 years is also possible; RH Newport Beach is a solid illustration of that. In that case, we're working with a developer and a partner at the Irvine Company. My understanding is they removed about 8 retailers on our behalf, is that right? When you factor in what a development partner has to put on the line, they'd likely gotten about eight retailers to sign on, and they ate dead rent for several years, because our projects take two to three years to complete. Securing approvals and putting up buildings like these is a lengthy process. So they absorbed rent costs across multiple years. They demolished two or three-story structures to fully clear the site and get it ready for us to build, and they invested $25 million, right? We got TI. For that particular project, we chipped in another $50 million to $60 million, roughly speaking — we're still adding up the final figures. Getting it ready for the launch celebration was a little hectic, since these installations are large and intricate. Still, from a cash perspective, that gallery should likely cover what it cost within a year, maybe a year and a half. Then you've got others, especially in Europe, where TI is pretty constrained. Those are street locations. So the outlay ends up being a bit bigger, and we'll need to wait and see how revenues come in. Should London do as well as we anticipate, the payback could be two years, or possibly three. But when you're talking about an iconic, brand-defining spot that you'll hold onto for the next 40 years, a three-year payback is the right way to think about it, isn't it? Another point I'd make is to consider how many of these large galleries we already operate that were constructed for half of what it would cost now. Yes, I believe it will be extremely difficult for anybody to replicate our physical platform. Nearly impossible, I'd say. You would need the revenues we produce, and then you would need to be prepared to pay several times what we paid for the great majority of our platform, correct? So — but I think one of the central matters we've discussed among ourselves, and how do we establish the proper lens for investors going forward is, we do have higher depreciation, and higher depreciation is coming. Sure. If you look at our operating margin, you could say depreciation is creating some pressure there. That's true — the money's already been spent, and there's a little more coming through as Paris and London come online. But from a depreciation angle rather than a cash angle, those costs will show up more, if that tracks. So when I look at the business — and remember, I'm the biggest shareholder — what I care about is the cash we'll get back over the long run. And I wonder if operating margin is really the right way to measure that. It probably isn't. Adjusted EBITDA probably is. If we're thinking about the right way to look at this, cash flow generation across the next five years is probably the best lens. But when it comes to what we're putting out there as the headline for Gallery paybacks going forward, I'd frame it as one to three years. A lot of the locations currently in the pipeline — sure, some of those will be a year, or a year and a half. London and Paris could be three. A place like that might land at two. It really hinges on what we end up seeing. And I think the math I attempted to walk through in the letter regarding RH England is a good example, right? That location sits two hours outside of London, and within a 10-mile radius you've got 100,000 people. Not many cars actually pass by that Gallery. And that trend is continuing. We generate, in our business, something close to $38 million from Galleries. Suppose we were able to produce between $35 million and $40 million from a site situated two hours outside London, where we're located 10 miles away and about 100,000 people reside inside a 10-mile radius — then what could we achieve in Mayfair, sitting dead center in London, with 9.7 million people in the surrounding area? Some multiplier has to be applied in that case, right? Would that be three times, or maybe five times? It's definitely not merely 50% higher. So viewing those numbers that way, we hold a very bullish view on Europe and on a number of those elements. And in all likelihood — judging by what we expect to unfold, and even across Europe, we'll be a far more appealing tenant, particularly once we're not the ones purchasing a building. But consider landlord conversations, and how those have shifted across the last few years. Right, landlords are asking, hey, how are your results looking? What does your market cap come to? That sort of thing. As our results improve, as our margins improve, as our share price climbs, we turn into a more attractive prospect for landlords, since we'll likely carry a stronger credit rating, and their properties will command a reduced cap rate; that explains why we've managed to accomplish what we have throughout the last 15 years while constructing this platform. So at present, folks are genuinely eager to discuss development projects with us once more. These days, we're receiving triple the inbound interest. And my sense is that will only grow.

So, the options we'll have available should improve, but at this moment, you know, building costs remain steeper since borrowing rates are elevated, and so on and so forth. That said, the future looks like it should be strong. Plenty of flexibility lies in front of us. That said, we're not looking to flood the market, and we're not looking to generate a ton of cannibalization; in our view, having fewer sites that are more iconic beats simply blanketing the market in an unremarkable way. So we'll stay highly selective about what we pursue, though we now have a variety of vehicles. We have — we'll find out how this trial performs with the inaugural freestanding design studio, which isn't a design studio along the lines of what we've done before, since we've constructed spaces we label design studios, and those are essentially tiny shops, correct? These are genuine interior design offices, open to consumers, and nothing like them exists anywhere globally, right? People in interior design don't operate consumer-facing offices. We do. I mean, just to give a benchmark on that, I believe it's fascinating, since I suspect this will matter more than we anticipate. When a gallery opens and we review applications from interior designers, perhaps 6 to 12 interior design applications come in. For our freestanding interior design office, between 200 and 300 applications arrived; and our hypothesis was that many interior designers have no interest in working inside a retail store. And we believe we're altering that in our existing retail stores, since we're building distinct design offices that are somewhat walled off using glass and such. Yet even so, you might, depending on what unfolds and the reaction we've received, plus the reaction from folks attempting to visit, consumers attempting to visit and reach us, we'll discover far more beginning next week. But many more possibilities are coming. And beyond that, as our volumes grow, doing more volume unlocks additional possibilities across additional markets; so, if you consider five years back, we did X in a market, or we believed we'd do an X in a market, yet today we examine a market and can achieve 1.5x, suddenly the real estate transactions appear entirely different, and how many markets appear entirely different, right? And that's where things could shift. We believe we could reach 60 to 70 Galleries, larger-sized Galleries 50 or 60, whatever that range turns out to be; and suddenly you're generating 50% more volume three, four, or five years from now. Suddenly you likely gain another 30 markets available to open, since there are locations you assumed could only support $20 million, and now $30 million is possible there, and the economic model transforms. So, I'd say there's a lot of enthusiasm for RH right now. Once everyone has a chance to go through the results we posted today and consider our direction, I believe that excitement will grow even more. We've also turned into something of a go-to anchor tenant. Take what's planned for Naples, for example — we're taking over a Nordstrom's spot and creating one of the first RH compounds there. I'm not sure whether I've actually discussed the RH compound concept before. You'll be hearing more on it, and it's possible I already have, my memory isn't certain, but in any case, it represents an entirely different sort of RH shopping experience, with multiple buildings linked by courtyards and walkways; nothing like it exists anywhere, but this approach lets us take a large site, fill it in a truly thrilling manner, and likely use about a third less capital; then a second RH compound is on the way in Walnut Creek, where we're taking a Neiman Marcus location; and once the landlord community and the developer community get a look at these new compounds, I think they'll be pleased as well; so we're genuinely thrilled about the upcoming openings and the brand's physical growth, though we need to stay careful about not becoming oversaturated or causing too much cannibalization.

Thanks, Gary. I appreciate that context. I'll share it along.

Thank you, Steve.

Fantastic. Many thanks, and congratulations on everything you've accomplished. So, to start, where would you place yourselves right now in the product transformation cycle? That covers both the product itself and the Gallery < >.

Which inning. Before my most recent journey to Asia and Vietnam, I'd probably have told you the sixth, and today I'd say we could be sitting in the fourth, since those dots keep linking up, and so we'll — the pipeline holds a great deal. It simply holds a great deal. I mean, once more, should you go through the letter, plenty is taking place, plenty is on the way. That major brand extension I keep mentioning could end up being worth as much as all of what we've just completed. So, I mean, my sense is it could be enormously, enormously accretive. And so, yes, we still describe it as perhaps the fourth or fifth, fourth inning, midway. Yet once more, that shifts constantly, correct, as you develop, since you link that dot, you notice more, and so forth. I think it's similar to, like, I don't want to come off as arrogant and liken us to Apple, correct, but at some point, somebody would ask Steve Jobs when the first Apple phone came out and he'd say, this will transform everything, which inning were they in? I mean, what was their market cap back then? Following the iPhone's first year or the iPhone's second year, perhaps $500 million, roughly that, perhaps $400 billion, $300 billion. I have no idea what Apple is valued at now, $2.5 trillion.

Yeah, that's about right.

Roughly $3 trillion, if I recall; thus the greater your efforts, the greater your insights. The greater your insights, the greater your capabilities. Then you enter what I call, when speaking internally, a virtuous cycle. And I would say at present, we're inside such a virtuous cycle; our efforts are expanding, our insights are expanding, which means our efforts and insights keep growing. As you move through that loop, you can continue linking pieces and perceive additional things. That's the reason I mention rivals, anyone who is digging in or attempting to reap during a reaping phase, or they're attempting to extract every last bit they can from an operational framework, that represents an extremely short-lived situation. What we have here is a genuine virtuous cycle that will simply produce ever more. So you'll continue to ask which inning we're in, and I could forever be somewhere between the third and fifth innings.

I'll remember that. And thinking about what you've said before regarding taking profits later on from the investments you're currently making or have made in the past, how do you view the size of that and where margins could reach a couple of years from now?

It's the same way we've always looked at it. We will always be somewhere in an investment phase. That's just what happens when your brand is built on invention and innovation. That said, the period we just came through was a fairly enormous investment cycle — not only to scale up and ramp all the product we have, build the pipeline, and so forth, and build the organization for that along with the new partnerships to support it, but also the launch of Europe, right? That's a significant one-time investment you're making; so part of that is behind us, yes, some is still ahead, and some is in front of us; but once the platform in Europe is built, and once we sort of get the brand moving. Honestly, if this were our second year and we had already cycled past RH England while only bringing in roughly $8 million, that would seriously concern me. But when I step back and consider that demand is trending between $35 million and $40 million — let's call it around $38 million net — and you translate that into revenue, you land near $32 million or so, maybe $33 million, then the question becomes: what kind of lending activity can we expect with 9.7 million people situated in the center of Mayfair? If you assumed triple that figure, which in my view might actually be on the low side, you'd be looking at $100 million in revenue. When you multiply that by four or five, you're looking at somewhere between $130 million and $160 million in revenue. Keep in mind, too, that our brand isn't very well known yet. We opened in a location that was unfamiliar, and the nearest competing retailer of our type is roughly 100 miles away — I'm estimating here — so it's quite a distance to find anything comparable. Given all that, I'd say our margins are in line with what we think the model ought to deliver consistently moving forward. On top of that, we're operating during a seriously weak housing market. If someone told you home values rose 3%, that's just a dead cat bounce. Nothing's changed in housing so far, and we're not seeing any real growth in that area yet. Once that turns around, we'll come out ahead, and at that point you'll begin to get a clearer picture of what the margin model looks like. As things stand, though, any margin model you're reviewing reflects a weak housing environment combined with a heavy investment cycle. This may be the largest investment cycle out there — in fact, it's hands down the biggest one we've ever taken on. So the margins you're probably seeing in that context are pretty much the lowest we'd expect.

Wonderful. Many thanks. I'm grateful for that. And have a good time in Montecito.