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 speakers remarks, there will be a question-and-answer session. [Operator Instructions] 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 issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filing as well as our press release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinion only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. 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 Invest 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 midpoint of our guidance to the quarter, and 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 Guesthouse 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 mix shift towards clearance products, pressuring gross margins. In light of the current market, we are delaying the mailing of our RH Modern Sourcebook until the first quarter of 2024 when we believe demand conditions 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 14.0%. As mentioned, we are in contact -- contract to make an opportunistic purchase of the New York Guesthouse property for approximately $58 million, scheduled to close in the fourth quarter. The building was appraised at $85 million last September when the Federal…

Thank you. [Operator Instructions] Your first question comes from the line of Simeon Guttman 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's 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, it’s -- 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. 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 was hard to kind of see the initial reaction to it. There's collections, like any collection, there's collections that are selling really well. Some are selling good, some not so well. I feel very confident that the overall mailing of contemporaries is going to be incremental, 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. So look, we couldn't be more excited. We're sailing into the probably one of the biggest headwinds any of us have experienced in the housing market, while it's not the great recession of 2008/2009, 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. So you've got a little lift in the new home markets but that's only 10% of the market. So we've got, As I said in this latest shareholder letter, and I said last time, we should continue to see our business inflect through the rest of this quarter and into 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…

Can you -- 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 sales to deal with the clearance goods and stuff like that. And we'll be aggressive pricing those goods. So we get the inventory clean, turn inventory into cash. We don't want it sitting around on the balance sheet. So, yeah, you'll see it take the appropriate action here. And so, but nothing we wouldn't normally do. We would still want to leave with promotions or start to turn the business back in that direction. We're almost to the other side of this thing. I can't believe, maybe we've got another six to 12 months, but I think, yeah, 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 the Fed 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 based on -- 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 your ability to protect the operating margin. We're now at a level that's below 2019, 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?

Yes. I mean, we're not -- we don't have a strategy to protect the operating margin. I mean, we're -- 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 than anybody's seen.

So there’s, massive, massive inflation, since that time.

Yeah

On so many items of the P&L cost.

Yeah, yeah. So that's not where I'd be focused. Like I mean you can focus there, you'll just miss everything that's going to unfold here, 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 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, the -- just one thing to comment about -- again, you mentioned the lever, but just more of a point of a tailwind is that we have elevated markdown activity this year, that as we cycle through that next year that could on unveil itself as a tailwind next year. So we'll talk more about that in March. But 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 of 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 with the operating margin in the next quarter or two. Whether that bounces around a point or two -- it's not -- as the biggest shareholder in this company, that's not what I'm worried about.

Okay. Fair enough. A 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 '24?

You mean just the broader industry?

Yes.

Yeah. No, I think the broader industry is back to pre-COVID pricing and promotions, and it will be there forever now. Once you turn that on, you can't go back. So maybe the e-mails look different or they call them different, but you go look at the websites that -- I mean, go -- I mean, you're getting pelted with sale e-mails and have been for over a year. And that's why, as I said, that's why everybody is now cycling that. And so 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. Just would have permanently created a different model. And so 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. I just -- 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 on ad cost, maybe this or that. So -- but it's not really people that we compete with that I'm too concerned with. I'm more focused on what we are doing and what our big strategies are and how this business is going to be positioned for the next five years. And we really like what I see. I think this is the best work we've ever done. 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 will peak in Q2, that's just based on what's in the pipeline, which coming on the next cycle likely will create higher and higher peaks, right?…

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 do -- once we get past holiday, do you think you'll be clean to start '24? And is it fair to say that the vast majority of the non-fixed cost deleverage 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 cap?

Yeah. I think -- look, I think transition out. Yeah. Look, starting the year, we're going to be in a better position than let's say, the start of the quarter, but I think we'll be going through continuing to sell through the markdown goods by the end of the first half, that's probably...

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 a heavier markdown mix in Q4, and you'll have some of that move into Q1, it will quite lighten up and to 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 higher-margin products. Yeah. So what I said in the letter, over the short term, it's margin -- the transformation we're making is margin dilutive. But long term, it's margin accretive. It's mix shifts, as inventory rebalances. So...

Got it. And then 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 or the third quarter SG&A dollars is like, is that the right base? I guess said another way, does advertising -- 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 I see perfect time to guide next year, we'll guide next year. So we're not in next year right now. But look, there's always going to be certain start-up costs, right, when you're ramping up new countries and things like that, 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 are we going to have some cycles to get around as we open different countries? Yeah, sure. But once businesses ramp, you cycle those things. So, yeah, we have a lot of confidence in the long-term margin of the business and the model. So I don't think there's any reason why this -- why this business and brand doesn't get back into the 20% range, as we cycle through. I mean, you're not going to get there in one of the work housing market. This is -- I mean, we compared the exact numbers to 2008 and 2009, but 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 the company in this industry. There might be some people that have been doing longer than me. I don't not too many. But I haven't seen a market like this and how to navigate through a housing market downturn like this. So I can't remember when people were locked into low interest rates and they can't step up 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? It doesn't change the long term. And we're -- the good thing is we've now cycled around. So we didn't bite on the promotional 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, even if people go on sale. Yeah, people don't -- they just don't have the buying power of the platform to present it that we do. And so I wouldn't want to be on the other side of this big move we're making.

And Chris, you asked about Q3 being a base. 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 the base and look for a full four quarters, given the -- given the cadence of the advertising timing and the -- you can't just use the quarter.

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

Your next question comes from Curtis Nagle 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 ramp? Is that demand trends? Flow through revenue? Just if you could specify that a little bit more from that would be really helpful. I’d appreciate it.

Yeah. That will be demand trends, which will turn into revenue and there's going to be just continued step-ups. There's going to be step up since we get in stock. There's going to be step up since we finished the Gallery transformation. There's -- 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 -- 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. So there's -- and you've got all these imbalances when you have these much units. 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, right? So you've got too much demand, so you've got to fill the demand. So some of the products that you're planning to transform the Galleries with now, is blown out. And then you've got to let the manufacturing base, just get their legs underneath them with all this newness, right? And they're going to get more efficient and things are just -- the flywheel is going to be running. Yeah, we will then have -- 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 all the books will remail in the first half. We -- Modern because we're pushing a little later may go 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. So it's like we usually have 15% to 20% newness. And so it's -- basically, the entire brand is going to -- is going to transform and the assortment is going to expand on top of that. And so you just got to kind of get it all dialed in, get all the inventory balance, get everything set, 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, no, let's swap that out with something else. And so you're reading and reacting to real data now. And so we like what we see in the data. We like what we have in the pipeline. We like when 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 that's when we think we'll 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 than you had expected. I don't think you put a ton of marketing behind it. So what drove it? I mean, at least seeing online, great locations, beautiful exteriors all the rest of it. But in terms of just this response, what's resonating -- and anything you could say in terms of just, I don't know, the potential relative to some of the -- I guess the average size in terms of revenue for US, if you could size that unless it's too early.

Yeah. I think, just in general, we're in highly populated shopping areas, right? So in Dusseldorf, we're on the main stopping boulevard, dead center across from Chanel, a few doors down in Hermes, the main luxury shopping street and we're dead center. So there's a lot of people walking by and a lot of people walking in Munich, we're right in one of the key hearts to town and where there's a lot of people. And you really can't compare those to what we did in England, right? I 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? It gets high-end luxury consumers to look at us differently, think about us differently. So England is really -- it's a big brand investment. But there's not a lot of -- 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 building. We just closed our -- today, we closed our biggest sale yet at $330,000 for where Chalet were.

In the French house.

In the French house, the Chalet, the French house. But so the book of business is building, the design business with our internal interior designers is building, with our trade clients is building, all those pieces of business are building nicely and what’s funny, I really thought this time of the year, it's going to go slow because the weather is not that nice out there right now, and it's not like you're walking around the ground unless you've got some heavy coats and some rubber boots and stuff. So -- but our demand and our book of business and everything is building month over month. And so the brand, it's going to take a while for the brand to that just people know we're here and know who we are and what we're doing. And remember, people only buy furniture, at least every kind of five to 20 years, right, depending if you bought another new home or what you did. So you don't generally just go out to furniture stores, unless there's a need. So with RH England just doesn't have the traffic of 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 the people that are coming in, 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, now live in Germany and some of telling it’s just the opening part of Munich. You had a couple of how they shift their -- been shipping their own containers to Munich. And now they're so excited we're here, now there and -- so we had a lot of fans. I mean what I was -- I…

Your next question comes from the line of Max Rakhlenko of TD Cowen. 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 contemporary. So 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 of quarters from those two collections? And bigger picture on contemporary. Gary, what's your latest thinking around how large this collection can become?

Yeah, it's funny. We don't primarily look at it. 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, 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 interior doing, how's this? We say how's the furniture -- the upholstery business doing? And we're looking at every sofa in the entire assortment, whether it's interiors, contemporary, modern. 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, the books they're in and how we're going to adjust and what's working and what's not working and so on and so forth. So, when you think about it, maybe from the way you're thinking about it, will that assortment, 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, how many things we put into contemporary or how many things that wind up going into interiors and how many things go into modern, because you've got some things that, that the lines are blurred. We could put it in almost any of the three books. So I think about -- the way 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 the first half of 2024? 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? The floor sets. Yeah, I think they're being done in stages, as we're ramping up inventory. And it depends again, if that, if you're ramping up, if all of a sudden you have some really high performing collections, you're just not going to be up, you're going to have to fill demand and not put the goods in the galleries, right? You're going to 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 time frame. It wouldn't be the end of the quarter, but rather where we are today, it's probably March.

Yeah, and some galleries will get prioritized versus others. And yeah, I think it's -- 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, we don't have data on modern yet, we won't until we mail that. So that'll have 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 100% 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, underbought. So if you just don't, you don't have exact science, you don't have any trends on any of the newness. So, it takes, takes a few quarters to kind of get the trends, read the trends right, make the adjustments you need to, get the on orders corrected, make less of this, make more of this and let the factories get adjusted, as they're ramping up on a lot of new products. But that'll all work itself out. Again, I just think about this as like, the next couple of quarters will be meaningful. If we're sitting here, the end of Q2 and we didn't get the inflection point we needed, that would surprise me. That we think we're going to get, it's not a little one, it's going to be meaningful and it’s going to keep building, as all these things happen, in-stocks, gallery sets, 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 Steven Forbes of Guggenheim Securities. Your line is open.

Hey, Gary, Jack. It might be a repetitive question on the product transformation, but Gary, I was really just hoping you can, 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 what the potential magnitude of the inflection that on the horizon is and whether we can reference sort of peak demand during COVID or does anything that helps us think through really what should we be expecting behind this product transformation?

I think it's all going to depend on 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, like you'll get a better sense. So we'll have a little bit more data. But, I just say generally, I'd be surprised if anybody's outperforming us when we get to Q2 of next year, I'd quite be shocked. 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 sort of the pipeline looks like?

Yeah, there's more than 70 now. We'll have probably -- when modern -- with modern hitting and outdoor hitting, it will probably be somewhere between 70 and I'd say up to 90. And with more in the pipeline. And we have a whole other book we're working on, 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, 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? I can repeat myself. The transformations in the early stages, the goods aren't in stock, they're not in the gallery yet. We haven't been through a full mailing cycle. And I don't believe -- I think we've massively closed the gap. I think we're gaining market share in a lot of people today. And there might be a few people out there that are outperforming us at a demand point of view. I mean, they may not outperform us in the next quarter, say there's going to be an inflection very soon here. And so what do we have to do? Everything I just said. So I don't think you want me to repeat myself to you. Like, I don't think we've got to lower our prices anymore. I don't think we've got to -- the goods just got to get in stock. We got to get the galleries reset, and we got to go through the next cycle and 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. We've given our turn and you know the way you know Fernando and his team attack 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, in many markets, we're back to or close to 2019 levels, right Fernando? So, as far as, kind of [any of the] (ph) 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 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 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. Great to hear the demand continues to build. A while ago, Gary, you mentioned the $50 million to $250 million range for first-year revenues was possible. Obviously, the backdrop has changed a lot, but what you've seen in the first six months and the sequential trend, how should we think about what you're internally expecting for an annualized first year volume? And appreciate it's more about conversation than commerce, but just trying to think about how it's annualizing versus expectation, thanks.

Yeah, I don't know if we had any real expectations. People said, like, what could it be? Could it be, I said I don't know, could be $50 million, could be $250 million. And that's, I think about it as, we're going to keep kind of marketing the brand, right, to forget about RH, that gallery, think about that country, and what will our investments in marketing do to the direct business? What will the brand recognition do? How does it build? When do you get to certain run rates? I just think it's super early for us to know because we didn't open a typical store. If we would have opened in London first, it would be massively different. We opened in the countryside, we tried to do something super inspiring and something the world's never seen. And so making investment, it's like, it's just, I wouldn't get too focused on this gallery, right? This -- 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. 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. 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. It's like, has anybody opened a store like that…

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 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 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 shares 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. There's 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 -- 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. So 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 if you look at anybody selling the Jacob Chair, 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 line of Seth Basham 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, but 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, 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 US. But how should we think about the ultimate margins and ROIC of those new European galleries putting RH England aside?

Yeah, it's not that many. We're just going to -- we are going to get them open. 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. It's not like you start with saying like what's going to ROIC 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, to build up the design book and the trade book and everything else. So, again, it's a handful of galleries, right, it's 10 altogether. I think we've got 10, nine or 10. 10, yes, we do yeah, because two in Sydney and the two in Madrid and stuff. So we're going to get them open and we're going to start learning. And we're going to 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 look -- you go into Germany, we look really good. I mean the galleries look great, the teams are fantastic, the right people are coming in. So it's really encouraging being in Munich, getting a really good feel for it. So yeah, I mean obviously very different than England. And so we didn't have to spend much capital in those two galleries. We took over a couple of the Abercrombie & Fitch flagships and refitted them and we didn't have to build them like some of the other ones or like even in RH England where we had to rebuild it. So yeah, so they're all going to have…

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

Oh, hey guys, happy holidays. 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 that an unfreezing of the housing market. I was thinking more is there a revenue level or scale in business around $3 billion now given 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, like, I think it'll -- we clearly have some amount higher than today. We've said that the margin will, both gross margin and operating margin, will naturally lever as we as we as we build back the revenue here. So, but we're not ready to give you that number.

Okay got it. Fair enough. I mean other question was just around the membership fee. We just know that you took that up to $200. Just curious the rationale behind that decision that just happened here maybe in the last month or two. So that's my second question. Thank you.

Yeah, we just had plans to bump it up a bit. So it's a natural progression of our business. 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, we talked about that we were kind of -- 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.

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

Hey, thanks so much. Gary, I was hoping you 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 US. 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 US gallery network looks like 10 years from now with this continuing evolution.

Something like Indianapolis is an opportunistic move, right? An incredible home and estate came on the market. We bought it for $14.5 million. Is that what we bought it for? Yeah. It's in our joint venture. So we own 50% of it. And it's just an opportunity to get something like that for a $14.5 million investment. What we put into it was pretty minimal versus what our normal investment was. So we have this incredible experience for the customers at a lower investment rate than we'd make, and the lower occupancy costs than we would expect to have. So 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. We are not really looking for something like that. Like that just, they just kind of happened. So, I think 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 big gallery. Los Angeles at some point for example. That in North America will continue. And the 40, Gary talked about the design markets of the 40 and the logic there. So that's the whole kind of different animal, I guess, in terms of adding to the store base.

Yeah, and we may learn in some of these smaller kind of 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, interior designers that maybe don't want to work in a retail gallery and 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. 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 become a platform that can support them and allow them to do what they really want to do. Yeah, so we may for example, like in the first one that we got in Palm Desert But 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. Like, if we're right on this transformation that we're kind of, that began here and we're right around about how the business is going to inflect, 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, we're going to, I'm sure we're going to have an even new, a 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 guys.

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 what we've done. We're 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 think it was in North America. I mean -- and to be at the very beginning of this and to be executing at that level and to have that quality of people and that energy in the galleries, 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 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.