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

Thank you. Good afternoon, everyone. Thank you for joining us for our third quarter earnings conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer; and Jack Preston, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings as well as our press release issued today or a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinion only as of the date of this call. And we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. With that, I'll turn the call over to Gary.

Thank you, Allison, and thank you all for joining us today. I will begin with our prepared remarks from our shareholder letter to our employees, partners, and shareholders. We are pleased to report better-than-expected results for the third quarter with net revenues of $869 million compared to $1.006 billion a year ago and an increase of 28% from the third quarter of 2019 when net revenues were $678 million. Gross margin decreased by 50 basis points in the third quarter, mainly due to fixed occupancy deleverage, although this was partially offset by an increase in product margins as we continue to avoid promotions. Widespread discounting remains prevalent in our industry, with a noticeable influx of sale emails from many home furnishings retailers. Despite the contrasting strategy, which may pose a short-term risk of market share loss, we believe there’s a significant long-term risk of brand erosion and model destruction for those following the promotional route. Our disciplined long-term approach has allowed us to set new financial performance standards in the home furnishings sector, and our results now reflect those of luxury brands, achieving a 20.8% adjusted operating margin in the third quarter, surpassing our expectations despite the sharp decline in the housing market. Our results include investments tied to the launch of RH Contemporary, opening our first RH Guesthouse, developing RH International, and launching RH In-Your-Home, contributing to around 200 of the 640 basis points of adjusted SG&A deleverage for the quarter. We also experienced adjusted SG&A deleverage due to lower revenues compared to last year. Our business generated $102 million of adjusted free cash flow in Q3, concluding the quarter with $12.5 billion in cash on hand, total net debt of $375 million, and trailing twelve months adjusted EBITDA of $1 billion. Regarding our fiscal 2022 outlook, as mentioned in our previous shareholder letter, we anticipate that business trends will continue to decline due to increasing weakness in the housing market over the upcoming quarters, possibly extending longer due to the Federal Reserve's expected monetary policy and the adjustment of record COVID-driven sales and backlog reductions. Based on current trends, we now project fiscal 2022 revenue growth of negative 3.5% to negative 4.5%, compared to our previous outlook of negative 3.5% to negative 5.5%, and an adjusted operating margin between 21.5% to 22%, updated from our earlier projection of 21% to 21.5%. We recognize that the next few quarters may present a short-term challenge as we adjust to the remarkable growth stemming from COVID-driven spending changes while shedding less valuable market share. However, we are confident that our long-term investments will allow us to continue achieving industry-leading results. We view our business vision and ecosystem as a long-term commitment. We see a distinction between those with taste but lacking scale and those with scale but lacking taste, and the potential to bridge that gap is vast. Our aim is for RH to become the definitive authority on taste for home decor, a strategy that has proven both disruptive and profitable as we strive to build the most respected brand globally. Our brand attracts top designers, artisans, and manufacturers, enhancing the value of their work across our integrated platform, allowing us to curate the planet's most enticing luxury home product collection. We will continue to elevate and expand our offerings with new introductions such as RH Couture, RH Bespoke, RH Color, RH Antiques & Artifacts, RH Atelier, and other new collections planned for the upcoming decade. We plan to open immersive Design Galleries in every major market, aiming to generate revenues of $5 billion to $6 billion in North America and $20 billion to $25 billion worldwide. Our strategy is to evolve the brand from merely curating and selling products to conceptualizing and selling spaces, establishing an ecosystem of Products, Places, Services, and Spaces that positions the RH brand as a global leader in taste and place-making. Our products are elevated and rendered more valuable by our architecturally inspiring Galleries, which are further elevated and rendered more valuable by our interior design services and seamlessly integrated hospitality experience. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our Galleries into RH Guesthouses, where our goal is to create a new market for travelers seeking privacy and luxury in the $200 billion North American hotel industry. Additionally, we are creating bespoke experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley, RH1 and RH2, our private jets, and RH3, our luxury yacht that is available for charter in the Caribbean and Mediterranean where the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design, and landscape architecture. This leads to our long-term strategy of building the world's first consumer-facing architecture, interior design, and landscape architecture services platform inside our Galleries, elevating the RH brand and amplifying our core business by adding new revenue streams while disrupting and redefining multiple industries. Our strategy comes full circle as we begin to conceptualize and sell spaces, moving beyond the $170 billion home furnishings market into the $1.7 trillion North American housing market with the launch of RH Residences – fully furnished luxury homes, condominiums, and apartments with integrated services that deliver taste and time value to discerning, time-starved consumers. The entirety of our strategy comes to life digitally with The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Our authority as an arbiter of taste will be further amplified when we introduce RH Media, a content platform that will celebrate the most innovative and influential leaders who are shaping the world of architecture and design. Our plan to expand the RH ecosystem globally multiplies the market opportunity to $7 trillion to $10 trillion, one of the largest and most valuable addressed by any brand in the world today. A 1% share of the global market represents a $70 billion to $100 billion opportunity. Our ecosystem of Products, Places, Services, and Spaces inspires customers to dream, design, dine, travel, and live in a world thoughtfully curated by RH, creating an emotional connection unlike any other brand in the world. Taste can be elusive, and we believe no one is better positioned than RH to create an ecosystem that makes taste inclusive and, by doing so, elevating and rendering our way of life more valuable. Climbing the luxury mountain and building a brand with no peer. Every luxury brand, from Chanel to Cartier, Louis Vuitton to Loro Piana, Harry Winston to Hermès, was born at the top of the luxury mountain. Never before has a brand attempted to make the climb to the top, nor do the other brands want you to. We are not from their neighborhood, nor invited to their parties. We do have a deep understanding that our work has to be so extraordinary that it creates a forced reconsideration of who we are and what we are capable of, requiring those at the top of the mountain to tip their hats in respect. We also appreciate that this climb is not for the faint of heart, and as we continue our ascent, the air gets thin and the odds become slim. We believe the level of work we have introduced this year, inclusive of RH Contemporary, The World of RH, RH San Francisco, RH1, 2, and 3, as well as the opening of our first RH Guesthouse in New York begins to demonstrate the imagination, determination, creativity, and courage of this team, and our relentless pursuit of our dream. I mentioned at the start of this year that, in over two decades leading RH, I’ve never been more excited about our future and I’ve never been more uncertain about the present. Although my uncertainty regarding the short-term has expanded due to a complete collapse of the luxury housing market, my excitement for our long-term opportunity has grown exponentially as I believe the investments we are making to elevate and expand our product and platform will once again be transformative. As we look forward to 2023, we will introduce the largest collection of new products in our history across RH Interiors, Modern, Contemporary, Outdoor, Beach & Ski House, Baby & Child, and Teen. To amplify this historic launch, we will once again unveil a revolutionary new Gallery design, as well as redesign and remodel all of our current Galleries. We will be introducing RH to the UK and the rest of Europe this Spring/Summer in the most inspiring and unforgettable fashion with the introduction of RH England, The Gallery at the Historic Aynho Park, a 16th-century, 73-acre estate that will feature three restaurants; The Orangery, The Conservatory, and The Terrace plus The Aynho Architectural Library and The Deer Park, inclusive of the largest herd of White Deer in Europe with viewing from the Grand Lawn. We are also under construction on RH Paris, The Gallery on the Champs-Élysées, scheduled to open in 2024, and RH London, The Gallery in Mayfair scheduled to open in 2024, 2025. We have also secured locations in Milan, Madrid, Munich, Dusseldorf, and Brussels, some of which will also open in 2024 and 2025. RH also announced today the following acquisitions and hires to accelerate the brand’s transformation and climb up the luxury mountain. The acquisition of Dmitriy & Co, a To-the-Trade custom upholstery atelier, and the hiring of Dmitriy founders, Donna and David Feldman, to create RH Couture Upholstery. The acquisition of the business of Jeup, Inc., a To-the-Trade custom bespoke furniture workroom, and the hiring of Joseph Jeup to create RH Bespoke Furniture. The hiring of Margaret Russell, former Editor in Chief of Architectural Digest and Elle Decor, to create RH Media, an editorial-content platform that will celebrate the most innovative and influential people and ideas that are shaping the world of architecture and design. Today’s announcements, plus our previous acquisition of Waterworks, firmly plant four RH flags at the very top of the luxury mountain and clearly state our intention of establishing RH as an arbiter of taste and design. These brands and businesses, thoughtfully integrated and amplified on what we believe will be the world’s most innovative and dynamic global design platform, will begin to fundamentally change the landscape of the luxury home furnishings market and the To-the-Trade design industry. As we approach the holidays and New Year, I would like to express our gratitude to all of our people and partners around the world for your contributions and commitment to our cause, and for bringing our vision and values to life. It’s not easy striving to become the most inspiring brand in the world, and it’s surely not for the faint of heart. It takes courage to lead rather than follow. It takes collaboration to build a brand that can break through the clutter in this world. It takes teamwork to reach the top of a mountain no one else has attempted to climb. 20 years ago we began this journey with a vision of transforming a nearly bankrupt business with a $20 million market cap and a box of Oxydol laundry detergent on the cover of the catalog into the leading luxury home brand in the world. The lessons and learnings, the passion and persistence, the courage required, and the scar tissue developed by getting knocked down ten times and getting up eleven leads to the development of the mental and moral strength that builds character in individuals and forms cultures in organizations. Lessons that can’t be learned in a classroom, or by managing a business, lessons that must be earned by building one. Or, by reaching the top of the mountain. Happy Holidays Team RH, Carpe Diem.

Ready for questions.

The floor is now open for your questions. Our first question comes from Simeon Gutman from Morgan Stanley. Please proceed.

Good afternoon, everyone. I have a question about written orders in the third quarter. I'm not sure if you'll address this, but if you use that run rate as an indicator for the business, does it indicate a decline? Also, given that you exceeded expectations in the third quarter, does that mean a steeper decline heading into the fourth quarter? Is it due to decreased backlog or increased macro risk? What changes are we seeing from the third to the fourth quarter?

Starting with the second part, Simeon. In the Q3 performance, I would describe most of it as a shift of sales from Q4 to Q3. While some of this is due to quicker relief of backlog than anticipated, we had planned to alleviate that backlog and continue doing so throughout the year. For the year, we're still looking at $3.6 billion in sales. Our outlook hasn't substantially changed; it may be slightly steeper, but it’s not a rounding error, with all due respect. It's consistent with what we previously discussed, and Q3 simply saw some sales pulled forward from Q4 along with a bit of faster backlog relief.

Okay. As a follow-up, maybe more for Gary, I understand you will continue to invest for the future while also being responsible in the near term. My question is whether you are prioritizing things differently and if anything might be sacrificed. I would love to hear your thoughts on this, especially as the year progresses with the Fed continuing to tighten.

Yes. How do you define responsible?

Yes, I don't know if I can answer…

I'm just trying to understand the question. So I think…

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

We're not putting any longer-term investments on pause. I mean, we're playing for the long-term. So we're not doing irresponsible things that other people are doing like promoting their business and selling. Sending, I don't know, 30 emails to a customer a week with sales time. So that, I think, might be irresponsible. But I guess it depends on your strategy. If your strategy is to stand for price, then maybe that's an okay strategy. Our strategy is to stand for design and quality and innovation. So it's positioned the company around product, not price. So I think we've been really consistent with our strategy. And as you think about priorities, we reprioritize all the time here. We like to say, you've kind of got to get going, get to know are we strategically right? Are we directionally right? We believe we're strategically and directionally right. We believe as we make the right long-term investments and build this business for the long-term, we'll become one of the few brands in the world that exist over a long-term period of time. So that's unusual in our industry. Most people build a concept and then they roll out 300 or 500 stores. And at the end of 10 years, it's an old concept. So we would like not to get old, and we like to continue to reinvent the business. And whatever the cycles are, if you look at it for us, if you look back at history, since I joined in 2001, there was a recession at that time, and we elevated the product and kind of transformed the brand. We did the same thing in 2008 and 2009, the financial crisis. We went through another cycle again in 2015, 2016, 2017, when we made the move to membership and rearchitect the back end. We also introduced Modern and continue to evolve and make the brand relevant and make sure we're leading the industry. And we think the work that has begun with the introduction of RH Contemporary, which will triple in size next year from an assorted midpoint of view. And the introductions we're going to make across the entire portfolio, but the new gallery design that we're going to unveil, and we'll go through and remodel and redesign all of our current Galleries and refresh all of those, as well as the platform we're building globally for the brand is going to once again transform RH and then put us in a position where we create massive strategic separation. So we're kind of comfortable being the others and going the other way. So a lot of people are hunkering down right now and slowing down. We're kind of speeding up. We're more excited, less fearful. I think we saw this coming. This is not a game that's the first time we've seen it. It's just different. But our moves over the last 22 years have been very consistent. I think we're pretty disciplined in the things we do. They're unusual. When we were opening 50,000 to 60,000 square foot stores, the rest of the industry was closing stores and shrinking footprints and trying to move all their business online. Now everybody is opening stores. And I don't know, maybe we're just a little bit ahead of everybody else.

Okay. Thank you very much. Happy Holidays.

Thank you. Happy Holidays to you.

Our next question comes from the line of Steven Zaccone from Citi. Please proceed.

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

Yes, we just opened, and we think it's extraordinary. The feedback from our guests has been incredible. We're still in the early learning phase, and since this is the first time we've done this, we're really excited. We will soon be opening our Champagne & Caviar Bar, and we have our live-fire restaurant up and running. The guest feedback indicates that many are wondering how they will get in long-term due to the limited number of rooms. We're eager to learn from this experience, which will help us improve our advertising and other aspects. This is still in the early stages, a significant test for us, and while it may seem small within the larger organization, if it grows into something substantial, that would be great. Right now, this initiative is well-positioned to redefine our brand and change perceptions. It showcases our creativity, passion, and attention to detail in delivering something extraordinary. People from the hospitality industry, including luxury CEOs who have toured it, have remarked that they haven't seen anything like it anywhere in the world. We're letting it develop naturally.

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

When we examine the change in our total sales from Q2 to Q3, revenue decreased from $992 million to $869 million, with gross margin dropping from 52.8% to 49.7%. As Gary pointed out, much of this can be attributed to occupancy deleverage. Looking ahead to Q4, we anticipate another decline, as it tends to be a smaller quarter for us. At the midpoint of our guidance, we're estimating $789 million in revenue. While we’re not providing guidance on gross margin, if you apply similar calculations moving from Q3 to Q4 as we did from Q2 to Q3, you can expect a decline in gross margin as a result of lower absolute sales compared to Q3. It’s essentially just arithmetic. Directionally, it may be around 100 basis points, but we’re not officially guiding on gross margin; this is just a correctional estimate.

If you examine the housing industry and compare the performance of home furnishings retailers during previous housing downturns, it indicates that the situation is likely to worsen before it improves. The housing sector is experiencing a significant decline, with the National Association of Realtors reporting a 37% drop in housing demand in October. In my lifetime, I have never seen interest rates rise so rapidly, which is impacting the housing market, particularly in comparison to the inflated market driven by COVID. This will lead to volatility, especially in the luxury segment. The luxury housing market began its decline in the fourth quarter of last year, having risen sharply prior to that. It is likely to decrease at an accelerated pace as well. Some market participants will try to maintain their positions and promote their businesses, but I believe this will lead to unsustainable models. We anticipated from the start that the boost from COVID was temporary—typically, such rises are followed by declines. We remain focused on long-term goals without compromising our business model during this period. There are competitors in our industry currently reporting good sales, but their discounts of 30% to 40% indicate a struggle. If we offered such discounts, we might see a significant sales increase but at the cost of margins and increased inefficiencies. We've previously managed companies with those challenges. Someone recently questioned what would happen if our long-term outlook is incorrect and the market isn’t worth $25 billion. Even if it’s only $12.5 billion, achieving a 30% EBITDA rate is feasible, and there are examples from other brands that illustrate this potential. The key focus should be on reaching our goals and establishing ourselves as the first integrated luxury home brand. This path will differ from others, as it is unprecedented. Although the housing market is in a downward trend and may worsen before improvement, our past predictions have been more accurate than not, as we avoid operating on speculation. Our management decisions are based on facts, mathematical analysis, and observed patterns. While I may not seem optimistic in the short term, I remain very optimistic about the long term. If your interest lies in short-term stock performance, ours may not be the right choice; however, for long-term investment, we present a promising opportunity.

Duly noted. Thank you. Happy holidays.

Happy holidays.

Our next question comes from the line of Max Rakhlenko from Cowen. Please proceed.

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

It depends on our investment and timing. Our underlying core business could maintain margins at 20% if we chose to, but I’m not sure that’s a long-term focus. The market's condition is uncertain, and we don’t want to push for short-term results that may not matter two quarters from now. There are many tough decisions ahead in a challenging environment, especially for those of us in the higher-end home industry. It's important to consider the significant migration from cities to suburbs during COVID; the individuals who made that move were typically able to afford it. Luxury customers drove the housing market up, and while we benefited during that period, we also recognize that there may be a correction ahead. We utilized the profits made during COVID wisely. If we see a larger decrease, we can accept that. Comparing our operating margins before and after COVID with other home furnishings retailers shows we had the best margins going into COVID and improved even further. Our consumer base had a greater urgency during this time. While others may have seen higher top-line numbers through promotion, we chose not to heavily promote. People seem surprised by current market conditions, but we must remember that the Federal Reserve's actions created the inflation and low-interest rates that facilitated home buying. Now that we’re facing higher interest rates and inflation, this is a unique situation that most won’t recognize unless they experienced the market from 1975 to 1982. We are focused on understanding trends and planning for the next five to ten years rather than just the immediate quarters. The long-term view is what matters most. The decisions we make today will shape our future trajectory, which will lead to significant differences over time. We are not merely managing our business; we are leading it toward a brighter future. It may take longer, and it requires patience. Those who want to achieve extraordinary results must be willing to wait.

Got it. It's really helpful. And then can you just separately speak to the customer reception to Contemporary? How is that going compared to your expectations? And then just any updates on the timeline of the rollout to other galleries?

We are very pleased with the initial response. We wish we could accelerate product availability. The supply chain issues have made it difficult, but those are starting to resolve. Additionally, most of the new products are entirely new to us and have not been produced at scale previously. Historical patterns show that whenever we take significant steps forward, such as in 2008 and 2015, we typically face similar challenges. These major changes tend to occur every seven or eight years, aligning with major cycles in our business. While trends may stay relevant for 10 to 15 years, brands usually require a substantial refresh within that timeframe. Our timing often coincides with economic downturns, although the shifts in 2015 and 2016 occurred during a transition to membership rather than a downturn. Introducing products that have never been scaled before poses its own challenges. While some antique stores have individual pieces of materials like Travertine furniture or Burl wood, no one manages to provide a collection of 130 SKUs at scale. Therefore, we will continuously need to enhance our supply chain capabilities to support innovation and invention, as new ideas take longer and can be more complicated to implement. Our journey is not solely about managing a business but about leading it through invention and innovation, and that involves some uncertainty. Recently, we traveled to Italy to build relationships with quarry owners to ensure we can produce stone furniture efficiently and economically. We just had an extensive trip that involved visiting factories around the world, where we discussed scaling current projects and future innovations. So far, we have introduced a first glimpse of our Contemporary line, but what is coming next year will be remarkable and transformative. We anticipate creating a strong identity similar to what we achieved with the European Belgian style in 2008 and 2009. Just like our previous launches, which debuted with a significant catalog, we expect some turbulence in scaling this new product line too, but we're confident that Contemporary will become our most impressive achievement yet. Currently, we've only seen the beginning of what we have planned, and we have more major releases coming in 2024. By that time, we believe the full vision will come together. While we wish for more products to roll out to additional galleries right now, we are encouraged by the positive response to every dollar invested, and we look forward to expanding into more galleries.

Awesome. Thanks a lot Gary, Jack, Allison. Happy Holidays everyone. Speak soon.

Happy Holidays Max.

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

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

Yes, as you consider the high-end design and trade, the revenue potential is significant. Those at the top own the most homes, which tend to be more expensive. Typically, around 10% of the home cost is spent on furnishings, décor, and art. When these individuals purchase luxurious homes, they also select higher-quality furniture, fully furnishing their houses, and often owning multiple properties. This segment represents the most lucrative and profitable area of our business, providing the highest leverage and financial returns. We see this as a key strategic focus. We have engaged with top reputations in upholstery and furniture design who share our vision of scaling quality and design. We are excited about this venture, even though it will take time to implement and assess. We need to determine the integration process. Currently, many in the high-end trade might be surprised by our direction, as this is a significant strategic shift for us. We aim to build capabilities, possibly through acquisitions, while committing to investments that will establish a media and content platform, positioning our brand as a leading voice in architecture and design. We plan to highlight the influential figures in the industry rather than merely promoting ourselves. Our strategy involves creating a market where premium products are usually inaccessible. These high-end goods are not displayed in traditional showrooms, and potential customers often have to navigate intermediaries to find quality. Making such quality and design more accessible could unlock significant opportunities, broadening our market presence. Our goal is to extend beyond the family room and second bedroom into customers' main living spaces. We've contemplated this extensively and have invested considerable time into it. Today, we officially announce our endeavor before it becomes widely known. We are thrilled about the exceptional talent we have acquired; they are remarkable creatively and culturally. In the short time together, we've learned from one another and enhanced our collective value, facilitating an upward dynamic.

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

The underlying model can handle a 20% decrease while maintaining margins around 20%. However, this doesn't mean we plan to cut back on investments when we should be making them. Currently, I don't believe it would be strategic to aim for 20% operating margins in 2023. Most people don't focus on achieving a specific margin; instead, they strive to do inspiring work that they believe will yield great long-term benefits. If we didn't have many significant projects underway or great ideas to pursue, we might consider targeting a 20% operating margin, but we have some exciting initiatives that we're working on, more exciting than anything we've done before. Our teams are dedicated, putting in countless hours to bring these projects to fruition because they truly matter. We believe this work has the potential to significantly change our trajectory and create a substantial strategic advantage. So, I wouldn't say our primary focus for 2023 is on financial outcomes. Instead, we aim to make substantial progress by 2023 and 2024, positioning ourselves far ahead of the competition when this cycle ends. We're confident in our ability to generate significant returns, as we have built the best model in the industry. We plan to enhance that model by investing, rather than taking a step back and limiting our efforts, which would ultimately lead to decline. That's not the approach we take.

Understood. Thanks very much and happy holidays.

Our final question comes from the line of Jonathan Matuszewski from Jefferies. Please proceed.

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

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

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

Hi, Jon. We're already experiencing some of that. The ocean freight contracts reset around June 1, which is when we felt the initial impact of the significantly higher rates we’ve discussed in earlier calls. However, each month since then, we’ve secured actual rates lower than the contracted ones. Achieving that means we haven't always contracted at the lower spot rates, but we’ve been active in the spot market, where rates have been decreasing due to excess availability, particularly on certain Asia Pacific routes. Initially, we did face margin pressure from the high rates for the first four to five months. Now, we are at a point where last month, our rates were lower than the contracted rates from the previous year. Considering our turnover, which can be two to three times depending on the product category, and much of our business being special orders, there is an immediate effect. While we felt pressure initially, we are now beginning to see some tailwinds, which is reflected in our guidance. As we assess the supply chain situation, I believe there will be more opportunities ahead. These trends are starting to take shape, and we expect to see continued improvement over the next year.

That's helpful. Best of luck for the rest of the year.

Thank you.

Thank you.

Our last question comes from the line of Atul Maheshwari from UBS. Please proceed.

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

Yes. The housing market has really taken a hit, dropping significantly as interest rates have increased. To address Simeon's first question about being responsible, we don’t plan to change our situation through a buyback strategy. As we enter uncertain times, it’s important to conserve resources rather than exhaust them before we know what lies ahead. There are many examples of companies that have spent heavily on buybacks and ended up going bankrupt. Bed Bath & Beyond is a notable case in point. I’m not sure how the housing market will unfold. Typically, the housing market faces downturns, and if anyone disagrees, I’d be happy to share our numbers. The luxury housing market has been declining since last September, with various percentage drops each month. The upcoming quarter will reveal more data, but it’s possible we could see declines of 35% or 40%. During downturns like in 2008, the market reaction caught many off guard. We’re not greed-driven and won’t rely on buybacks for our goals. Instead, we’re trying to assess the current economic landscape. We’ve injected unprecedented amounts of money into the economy, and interest rates have risen rapidly. Inflation has reached highs not seen in 40 years. While Powell might appear confident, he was slow to raise interest rates, missing opportunities to address the housing bubble that formed between 2020 and 2022 with a 45% increase in prices—a situation we haven’t experienced since the 1970s. I don’t want to be burdened with debt without a clear understanding of the market. We need to wait until the situation clarifies. If that means our stock temporarily trends down, we’re not overly focused on maximizing buybacks. We believe our stock is undervalued at the moment, and while conditions may worsen before improving, we have more important matters to attend to. When we have clearer visibility of the economic landscape, we will make informed decisions.

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

It's challenging to pause construction because halting work can significantly increase gallery costs while still incurring rent and other expenses. I believe every gallery we've opened has been profitable, and I expect our new galleries will perform well. Even during a downturn, a significant portion of consumers continue to make purchases. All our galleries are currently performing strongly. Although we've been opening new locations at a slower pace, this means they will have impressive comparisons once we recover from the current situation. We don’t aim to time market fluctuations. If we were a company with lower operating margins facing a downturn, we might reconsider our strategies, but we are not experiencing cash flow issues. Thus, it makes no sense for us to halt the construction of strategic stores that we know will be profitable. Others may feel pressured to do so due to cash flow problems, but we won't let ourselves get into that position. This is also why we haven't spent $2 billion on our stock repurchase yet; we have uncertainties about economic management and potential downturns. Although this situation won't resemble a sub-prime crisis, other challenges may arise unexpectedly. There is considerable confusion in the market right now, reflected in conflicting opinions from various experts. Predictions vary widely regarding housing prices, with some expecting significant drops, while others foresee small increases. This discrepancy illustrates the lack of consensus in the industry, with many opinions influenced by individual stakes in housing transactions. Overall, there is a lot of uncertainty, but I can confidently say that the housing market is experiencing a decline reminiscent of 2008, and we should look back at the substantial drops during that period for context.

That sounds ominous. So thanks for that Gary and happy holidays.

Thank you.

Thank you.

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

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

Certainly. As Jack mentioned, freight and raw material costs are decreasing, and we're adjusting our pricing accordingly to maintain good value in the marketplace. Sales have declined more than we anticipated, and the rapid decline in the housing market and rising interest rates caught us off guard. We find ourselves with more inventory than we would prefer, and we should focus on clearing out products we don't plan to keep long-term as new ones come in. This is typical in retail; as new products arrive, old ones must be marked down to make room. If sales are down, it means we have more old inventory to clear out quickly. If raw materials and shipping costs rise, we may need to increase our prices, but consumers will understand this, just as they will understand when prices drop. Our business relies on design, quality, and value, in that order. If the design isn't appealing, customers won't purchase it. If the design is strong, they will evaluate the quality next. If they appreciate both the design and quality, they will then consider the price and decide if it represents good value. We aim to find that sweet spot, though we don't always get it right.

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

We have significantly more galleries with increased foot traffic. Our full-price website attracts the highest volume of traffic, so we prefer not to move products out of that channel immediately. We can adjust our inventory quickly, unlike the luxury apparel sector where items might be discarded. Our business is different; we cannot simply discard furniture. Our outlets serve a distinct purpose, especially when items are returned or cannot be resold due to minor defects. Once products are shipped and removed from their packaging, they need to be properly managed. When we outline our collections, we anticipate that there will be items we need to discount as demand decreases, which will inevitably affect our pricing strategy. With bulky goods like ours, it's crucial to keep inventory flowing, as any stagnation will require us to find alternative storage solutions, and those may not be ideal.

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

It really depends on where demand heads, what happens with the housing market, interest rates, and inflation in that market. We're assessing how long the downturn lasts and whether it will worsen. If the housing market declines significantly, demand will decrease. Our business is closely linked to the housing market because it revolves around events like people buying new homes, remodeling, or redecorating. The essence of our business isn't just someone looking for some new bedding; it's tied to those primary activities. If fewer homes are being sold or remodeled, it impacts us negatively. When people remodel, they're typically doing so for a home they intend to live in, which actually benefits us, but a slowdown in real estate activity still affects us. For instance, if the housing market sees a 20% decline, that means two out of ten people didn't purchase a home. At a 30% drop, it's three out of ten. We've seen mortgage applications plummet by 47% in October, which is a concerning statistic for our industry. That's the highest we’ve recorded. Looking ahead to next year, which is just about a month and a half away, a slowdown like this leads to people not buying homes and subsequently not purchasing furniture immediately afterward. This whole cycle is uncertain, and it’s hard to predict. I'm not an alarmist; I'm simply stating what the numbers show. The decline in mortgage applications doesn't bode well for our sector. Anyone who claims to know the future of the housing market, I’m skeptical of. From a housing perspective, we're well past a soft landing—this is a hard landing or even a crash landing, resembling the situation in 2008 or 2009.

Understood. Thank you for your candor, and happy holidays.

Happy holidays.

Thank you.

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

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

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

Goodbye.