Good afternoon. My name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 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. Thank you. I will now turn the conference over to Allison Malkin of ICR. You may begin your conference.

Thank you. Good afternoon, everyone. Thank you for joining us for our second 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 our 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 for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinion only as of the date of this call and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today's financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. With that, I will turn the call over to Gary.

Thank you. Let me begin with our letter to our people, partners, and shareholders. Revenues of $800 million and adjusted operating margin of 20.2% exceeded our guidance for the second quarter due to a $25 million revenue benefit from faster-than-expected deliveries and a shift of approximately $40 million of advertising costs from Q2 to Q3, reflecting the later mailing of our RH Interiors Sourcebooks. We are raising the low end of our revenue guidance for the year and now expect revenue in the range of $3.04 billion to $3.1 billion versus our prior outlook of $3 billion to $3.1 billion and are maintaining our outlook for adjusted operating margins of 14.5% to 15.5%. We continue to expect the luxury housing market and broader economy to remain challenging throughout fiscal 2023 and into next year as mortgage rates continue to trend at 20-year highs and the current outlook for rates to remain unchanged until the second quarter of 2024. The company repurchased 3.7 million shares in the second quarter at an average price of $325.65, representing approximately 17% of the total shares outstanding at the beginning of the second quarter. Product Elevation. We recently mailed our new 604-page RH Interiors Sourcebook, and while it's too early to read the response with only 40% of the mailing in-home this week, the early indications do look promising. We continue to expect our business trends to inflect in the second half of this year with the mailing of our RH Contemporary Sourcebook in late October and our RH Modern Sourcebook in early January, as well as the refresh of our Galleries over the next several quarters. We believe our inflection point will peak in the first half of 2024 as our new collections fully ramp and we begin another cycle of Sourcebook mailings, completely transforming and refreshing the assortment across the entire brand over a 12-month period. We believe the new collections reflect a level of design and quality inaccessible in our current market and a value proposition that will be disruptive across multiple markets, positioning RH to gain market share throughout fiscal 2024. While a product transformation of this magnitude will be margin dilutive in the short term as we cycle out of waning collections, we believe it will once again become margin accretive as selling rates stabilize and allow for supply chain and sourcing efficiencies. Platform Expansion. Our plan to expand the RH brand globally, address new markets locally, and transform our North American Galleries represents a multi-billion dollar opportunity. This summer, we introduced RH to the United Kingdom in a dramatic and unforgettable fashion with the opening of RH England, the Gallery at the Historic Aynho Park, a 17th-century, 73-acre estate that is a celebration of history, design, food, and wine. We had a spectacular turnout for our opening event in early June and the national and global press coverage the brand received was multiple times greater than any Gallery we've ever opened. Due to RH England's countryside location, we expect the majority of revenues to be driven by our interior design and trade businesses which are dependent on building books of business with high value repeat clients like interior design firms and hospitality projects. The quote books are building and we will soon mail our first Sourcebook in the United Kingdom. While pleased with the early response, there is still much to learn about the seasonality of the business in the English countryside, especially in the winter season. We'll know more once we start mailing Sourcebooks and experience a couple of seasons. Our global expansion also includes opening locations in Dusseldorf and Munich later this year with Paris, Brussels, and Madrid scheduled for 2024, and London, Milan, and Sydney for 2025. Regarding our North American transformation, we continue to plan the opening of RH Indianapolis and RH Cleveland in the second half of this year, while RH Palo Alto and RH Montecito will now open in early '24. Additionally, we have 12 North American galleries in the development pipeline scheduled to open over the next several years. We believe there is an opportunity to address new markets locally by opening design studios in neighborhoods, towns, and small cities where the wealthy and affluent live, visit, and vacation. We have several existing locations that have validated this strategy in East Hampton, Yountville, Los Gatos, Pasadena, and our former San Francisco Gallery in the Design District where we've generated annual revenues in the range of $5 million to $20 million in 2,000 square feet to 5,000 square feet. We have just secured our first new location for Design Studio in Palm Desert, which should open in the first half of 2024. We've identified over 40 locations that are incremental to our previous plans in North America and believe the results of these design studios will provide data that could lead to opening larger galleries in those markets. Outlook. As mentioned, we are raising the low end of our revenue guidance for the year to a range of $3.04 billion to $3.1 billion and maintaining our outlook for adjusted operating margin in the range of 14.5% to 15.5%. We estimate the 53rd week will result in revenues of approximately $60 million. For the third quarter of fiscal 2023, we're forecasting revenues of $740 million to $760 million, and adjusted operating margin in the range of 8% to 10%. We expect to have increased advertising costs of approximately $50 million versus Q2 2023, reflecting the shifting of the RH Interior Sourcebook from Q2 to Q3, the mailing of RH Contemporary Sourcebooks, and the mailing of our first Sourcebook into the United Kingdom. For the fourth quarter of fiscal 2023, we're forecasting revenues of $760 million to $800 million, and adjusted operating margin in the range of 14.4% to 16.6% with incremental advertising costs of $5 million versus the fourth quarter of last year. RH business vision and ecosystem, the long view. We believe, there are those with taste and no scale and those with scale and no taste. And the idea of scaling taste is large and far-reaching. Our goal to position RH as the arbiter of taste for the home has proven to be both disruptive and lucrative as we continue our quest to build the most admired brand in the world. Our brand attracts the leading designers, artisans, and manufacturers, scaling and rendering their work more valuable across our integrated platform, enabling RH to curate the most compelling collection of luxury home products on the planet. Our efforts to elevate and expand our collection will continue with the introductions of RH Couture, RH Bespoke, RH Color, RH Antiques & Artifacts, RH Atelier, and other new collections scheduled to launch over the next decade. Our plan to open immersive Design Galleries in every major market will unlock the value of our vast assortment, generating revenues of $5 billion to $6 billion in North America and $20 billion to $25 billion globally. Our strategy is to move the brand beyond curating and selling product to conceptualizing and selling spaces by building an ecosystem of products, places, services, and spaces that establishes the RH brand as a global thought leader, taste, and place maker. 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 luxury and privacy in the $200 billion North American hotel industry. Additionally, we are creating bespoke experiences like RH Yountville, an integration of food, wine, art, and 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 brand and amplifying our core business while adding new revenue streams and disrupting and redefining multiple industries. Our strategy comes full circle as we begin to conceptualize and sell spaces, moving beyond the $170 billion 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, thereby elevating and rendering our way of life more valuable. The end of COVID confusion, the beginning of the next evolution. We've spent far too much time over the past four years debating whether this was going to be the Decade of Home or the Death of Retail. If inflation was transitory or if fiscal tightening was mandatory? Home sales and prices shooting up like a rocket, and now falling to earth like a rock. For the first time in my career, retailers were comparing their growth rates to any one of the past four years in any given month of any given year. The fact is, we're directionally in the same spot we were four years ago, worrying about a financial recession and the polls saying we might have a Presidential regression. If there was ever a time the world needed a compass, this might be it. For the people of Team RH, our compass is our vision, values, beliefs, and culture. Those things that drive us and unite us. Those things we live for, would fight for, and die for. After several years of being apart due to COVID, we finally returned to The Palace of Fine Arts Theater in San Francisco for what used to be our annual Leadership Conference and we talked about those things. For the first time in the past four years, everything came into focus; clear replaced fear, and connections were personal and not virtual. It felt different because it was different. There is a different level of accountability when someone is standing in front of you, looking straight into your eyes and making a suggestion or a request, versus looking blankly into a screen, not knowing if those on the other end have you on mute, or just aren't very interested. It's time to break the bad habits of COVID. It's time to get off the screens, get out of our home office, and reconnect in our team office, or as we did at the Palace. It just felt different because it was different. I'm sure it's going to lead to an outcome that's different. Yet it also felt familiar, like finding our way back home. Back with our people, where none of us are smarter than all of us. Getting all the brains in the game and the egos out of the room. Listening and learning, discussing and debating, elevating and aligning. It felt like the beginning of our next evolution, and it felt like we were beginners again. Never underestimate the power of a few good people who don't know what can't be done. Especially these people, onward Team RH, Carpe Diem. At this time, we'll open the call to questions.

Your first question comes from the line of Steven Forbes from Guggenheim Securities. Please go ahead.

Good afternoon, Gary, Jack. Gary, I was hoping you could expand on what's driving your confidence in seeing an inflection in the business during the back half and what the early indications from the RH Interiors books, and I guess RH England as well? Inform me about what the potential re-acceleration in demand could look like as we think out to '24 and beyond?

Sure. There are a few factors at play. We're seeing the end phases of COVID, along with a significant increase in interest rates and a decline from the highs that the housing market experienced during the pandemic with low federal funds rates. In our view, this transition will happen by the end of this year. The key question is whether there will be a prolonged downturn in the housing market. If we examine the current issues, there's a substantial difference in interest rates. Many buyers who purchased homes in recent years have locked in rates around 2.7% to 3.4%, making up 90% of the market. Meanwhile, current 30-year mortgage rates are around 7%, which is creating a large gap. This situation is worsened by the fact that home prices have not decreased enough to balance that interest rate spread. Home prices surged by 42% in the two years following the COVID boom, which prompted record migrations from cities to suburbs and into second homes. Now, with high-interest rates and very limited inventory, people are hesitant to sell their homes since they would have to trade low rates for much higher ones. The Fed's ability to control inflation will play a crucial role in determining when home prices might drop enough for buyers to accept higher rates or when interest rates could fall to narrow the gap. There's a risk that we could remain stagnant or see further declines if broader economic issues arise, particularly concerning the commercial real estate market. We believe we are past the worst of this situation, and looking ahead, some forecasts suggest we might see interest rate cuts beginning in the second half of next year, potentially reducing rates by 100 basis points. While this may provide some relief to the housing market, significant improvements depend on closing that interest rate gap, which is unprecedented. Moreover, we are working on a major transformation and rebranding, which we have been developing for several years and will roll out gradually. The initial feedback from our product books, which are set to reach homes by the end of this week, is promising. However, we need to be cautious in how we interpret early results, as we need a full picture when all products reach the market and inventory levels normalize. As we look towards the next phases of our strategy, we plan to adopt a two-contact method for reaching our customers. The first contact, targeting late August, will introduce a substantial 604-page interior book. Following that, we'll release contemporary books in mid to late October and more products in early January. By this time next year, we expect to see a complete transition as we roll out additional new items. This current refresh is significant, representing about 80% of our product lineup, marking the most extensive product shift in my career. It's crucial to pace the delivery of new products to prevent overwhelming our customers. Our long-term strategy aims to position us well in the future. We anticipate gaining considerable market share in our sector. We also plan to adopt a more aggressive pricing strategy moving forward, as we've shifted from past arrogance to a more focused approach. We believe our upcoming product offerings will make a notable impact in the market. Regardless of the housing market's variability—whether it remains flat or sees a decline—we expect a meaningful inflection in our brand and business. This is underscored by our decision to invest capital and repurchase 3.7 million shares, which reflects our positive outlook based on early product indications and our focused strategy moving forward.

Thank you, Gary.

Your next question comes from the line of Simeon Guttman from Morgan Stanley. Please go ahead.

Hey, Gary. Hey, Jack. My question, maybe a two-part question, is you mentioned product transformation and margin dilution. Is that all contained to '23 or did some of it move into '24? And then, Gary, to your point, if this market wallows a little and we do have another downdraft, given that you have leverage or the business has leveraged now, or a little more than that it's normally used to, do you operate anything differently if the macro just takes longer to come out and maybe the curve is steeper in later years but it's flatter in the medium term?

Yeah. I think by the first half of next year, the inflection is going to be much more significant than the macro. So I don't think it changes anything for us.

On the margin dilution, Simeon, look, I think about it also just where the margin or the discounting activity and clearance of that inventory will be in Q1 of '24 versus Q1 of '23. So, yeah, there's going to be still some of that in the first part of the year.

There will be two key factors to consider. First, we will experience margin dilution due to the transition of our product assortments. However, we anticipate leverage and margin growth throughout the model based on our expectations for revenue. I genuinely believe that 2024 will be an excellent year, barring any unforeseen crises that we do not foresee. Historically, when economic conditions worsen, the Federal Reserve tends to ease monetary policy. Over the past two decades, the Fed has been consistent, and we have seen a prolonged period of low interest rates with only a few minor spikes. I believe the Fed will take action to stimulate the economy again. At some point, the housing market will pick up due to significant pent-up demand. Even though this demand exists, it requires a shift in the pricing or interest rate gap for meaningful movement. If prices decrease and the Fed loosens monetary policy, we could see a substantial rebound in housing. This is outside of our control, but we remain informed and analyze numerous data to shape our perspective. In terms of our financial position, we have invested considerable capital and maintain strong confidence in our business model. We are undergoing a major transformation, one that we've tackled before, but this is the most extensive change we've ever undertaken. Our experience in managing such transitions is unmatched in our industry. We are intensely focused on understanding our balance sheet and expected cash flow, and we have prepared for various downside scenarios. We have operated successfully in challenging environments before, and we are not concerned about our level of leverage; we have experienced higher leverage and successfully navigated past difficulties, with the exception of the severe downturn in 2008-09. We feel optimistic. The main takeaway is that it would be surprising if we do not surpass expectations in the first half of next year unless circumstances are dire enough to significantly impact the economy. I don't foresee that happening. The Fed will likely implement its usual strategies, and if we see any stabilization or an uptick in the market, it will lead to an outstanding year for us. We are better positioned than ever in our company's history, and I believe we will see our most significant turning point by the second quarter of next year. There will be earlier inflection points, but I expect the peak to align with the start of the second cycle of our plans, considering production, inventory levels, and store layouts. I anticipate we will then experience an exceptional growth period.

Your next question comes from the line of Steven Zaccone from Citi. Please go ahead.

Good afternoon. Thanks for taking my question. I wanted to shift to the RH England opening. It sounds like it's a good successful opening event, but it will take some time to maturity. Do you expect the rest of your international openings to resemble this maturity curve, or is this the longest one since it's kind of your first? And similarly, the letter confirmed nine international openings by 2025. Can you talk a bit more about the pace of annual openings for international going forward? Is three kind of the right number?

Yeah. Let's start with the first one. One, RH England is unlike anything we've ever opened, not just because of an international perspective, but really the kind of location and how we wanted to introduce the brand. We thought that was really important. And we also thought the timing; how do we introduce the brand in a very unique and unforgettable fashion? It’s just the U.S. isn't really seen from a European perspective when you think about design taste and style luxury market. That’s not the game we play really well. The only true luxury brand we've had in the United States is Tiffany, and now the French own it, right? All the luxury brands are from Europe. So how are we going to go into that world and introduce ourselves? We could have waited and opened Paris first store, we could have waited and opened London first; we would have had to wait longer. We came across this opportunity at this property, and we thought this could be something remarkable. It could be a remarkable introduction for the brand. I’ve always said that we made the decision on RH England because of its location. It’s an hour and 45 minutes outside of London in the Cotswolds, around wealthy and affluent people but not around density. It is a true destination; you kind of have to go out of your way to visit. But you're going to something spectacular that you've never seen before. The impression of it is like nothing else, and I don't want to make the wrong comparison here, but if you think about kind of things that have gone into what I call the middle of nowhere and changed everything, think about Disneyland. Disneyland opened in the middle of nowhere. When they opened, that was the middle of an orange orchard, and there was no one around. No population density. It changed everything. Similarly, if you think about Las Vegas, it didn't exist; it was created. I'm not trying to suggest that exact correlation, but we’re trying to create a brand at a level of the market that hasn’t been created before. We wanted to create the right conversations and build the right halo before we introduce it in the other places, where there would be excitement and the brand generating conversation. They’ve heard about it and seen it posted and written about. The press we’ve received has been incredible, multiple times higher than any gallery we've ever opened because it's something nobody's seen before and given the world something to talk about and we have really interesting and high-profile people being drawn to it. Some of the highest-end car brands in the world want to do car shows on our property and things like that. I think it's going to open up all kinds of new opportunities and conversations and perceptions for the RH brand. However, this is not the Gallery I would use to kind of say, oh, let me extrapolate what happens here. We don't have anything like this in America. We don't have any kind of location like this at all. So I think it's getting so much conversation because it’s extraordinary. But it's just one small piece of a much bigger composition and puzzle we're creating to build RH into a dominant luxury design brand.

Second part?

The international opening cadence. Yeah, I think this is a start from the opening cadence. I like our start; it's moderately aggressive. We're planting a lot of flags in important places with fantastic real estate and we're super excited about it. I think we're going to learn a lot in the next three years.

Your next question comes from the line of Brian Nagel from Oppenheimer. Please go ahead.

Hi, good afternoon.

Hi, Brian.

So, my question is regarding the buyback. You clearly stepped up buyback significantly here in the quarter. The question is how should we think about this? Was this more or less a kind of a one-time adjustment or should we expect the buyback to stay aggressive going into future quarters?

We communicate our intentions with every kind of buyback. We still have open to buy on the buyback; I think a few hundred million, several hundred million. I think we made a relatively aggressive move here. We bought 17% of the business at a really attractive price. Our shareholders are going to benefit from that, and if we’re right with our view of the next couple of years, it's going to look like a really great investment. How aggressive we'll be in future quarters; traditionally, we have been opportunistic. We're not like a big corporation that sets up regular buybacks every quarter. If that was smart to do, Warren Buffett would probably do it. He is a very opportunistic repurchaser. We try to be opportunistic investors in our stocks or anything we do. We believe this was a great time to deploy capital and buy back a meaningful position in our company. It will depend on what the market does, what we see and how we feel, and what we'll do in the future.

Appreciate it. Thanks, Gary.

Your next question comes from the line of Curtis Nagle from Bank of America. Please go ahead.

Hey, Gary. How are you doing? Thanks for taking the question. I just wanted to go back to the point you mentioned in the shareholder letter about some of these early signals that we're reading pretty positive from Sourcebook launch, right? You said it's still early, but could you elaborate a bit in terms of what you meant? Are we seeing more people come back into the brand? Are we seeing conversion rates go up? Larger order sizes? I'd love to hear a little bit more about some of the findings in detail, if you could?

Well, the new collections that we think are the meaningful collections are acting like they’re going to be meaningful collections, and the markets that the books are getting into look good; the responses are encouraging. However, you have to see it over a period of time in our business. Our business is driven predominantly by advances; it's driven by people buying a new home, remodeling a home, or deciding to redecorate a home. All these happen rarely, right? So it's a high transaction value kind of business. Looking at our customers over a few years, they spend roughly 80% to 85% of what they spend with us in a kind of 90-day period. Then they spend very little if you look out into the next couple of years on the end. So you've got a cope to get them when they're buying, and that's why the cyclical down-market impacts our business more than others. We know when we exited the holiday businesses and all the accessories business we aren't very dominant in, we wouldn't take as big of a hit because people are still purchasing the small things. We don't sell much in small inventories or seasonal holiday stuff, right? This means we will take bigger hits in down cycles, but we will have bigger ups in up cycles. You're not going to see people right away; the books won’t hit, and you won’t see the full potential immediately. You need to let these books get into homes and ramp over a three-month period, provided in-stocks happen properly and so on and so forth. However, we really like everything we see. The early signals look good; we want more time to transition and set a few stores with some of the new goods; we want in-stocks to build. We have a lot of new things that look like they're going to be runaways and we want to optimize our real winners. Everything looks, I’d say, really good, considering we're only at 40%.

Got it. If I may, just a follow-up? Internationally, so you've got Munich and new stores coming up, right? I think, secondarily, within the four months, just looking at the newsletter. How are you feeling about openings? Why lead with those two cities?

We are focusing on smaller locations because we don't have as much capital as others in the industry, nor do we have hospitality spaces. We identified these locations as decent opportunities to test the market without significant investment. Abercrombie has never had poor locations, and these sites will provide us with valuable brand feedback. One important aspect is how we resonate with customers and what their impressions are. While we don't view these galleries as extraordinary, they will still be visually appealing. We chose some Abercrombie locations due to their exceptional quality and expect to gain important insights. We believe these locations will help promote the brand while allowing us to learn without making large financial commitments.

Got it. Thanks. I appreciate the thoughts.

Sure.

Your next question comes from the line of Seth Basham from Wedbush Securities. Please go ahead.

Thanks a lot, and good afternoon. My question is around margins. How should we think about the product margins on the new product lines that you plan to be much sharper on pricing? So if you are thinking about consolidated gross margins in the mid-40% on a run rate basis going forward?

I think we’ll have more to say. We believe long-term margins can be at our historical highs. However, we have to win some share here, and we have to play a little offense. There are going to be a few points of investment we’re making, but we also have places where we’re playing aggressively. It all depends on what we’re targeting. Let's see how these books do when they get in, and what we're responding to. You're going to probably see places where we've taken pricing that's really sharp; there are many areas where we're going to take pricing up, right? Look, we believe we are finally at the point of everything that went up during COVID now on the backside and we can think about what we should do going forward. It's a transitionary period, and you’ll see us return to a good model if we get the inflection we believe will happen in the top line, especially where we expect it to peak; you’ll see our business model snap back.

Right. But just to be clear, Gary, so the product margins on the new product that you guys are launching over the next six to nine months will be lower by a few points than what you were earning on products during the pandemic? And the real benefit to gross margins could come from improved volumes?

That's not necessarily the case. We don't guide gross margin, as you know. We don’t disclose product margins. We're trying to tell you just a directional flavor. There’s probably going to be places where we've taken pricing that's really sharp, but there are many areas where we're going to take pricing up, right? We've already got one collection that's through the roof; it looks like our best collection ever, and we’re probably going to take prices up this week. The business we're in is day-to-day, week-to-week; you’re learning, getting data, rethinking things. Everything you buy is speculative based on past data; you never buy something thinking it will sell exactly the same. You're using real data, real information and making next best decisions. I wouldn't jump to any conclusions just because of our more short-term view in this transition. You’ll see us return to a good model; if we get the inflection we believe will happen in the top line, you should see that snap back.

Understood. Thank you, guys.

Thank you, Seth.

Your next question comes from the line of Max Rakhlenko from TD Cowen. Please go ahead.

Great. Thanks a lot. If we were to bucket your initiatives over the next 12 months into U.S. gallery openings, European openings, and then new product introductions, how would you rank-order their magnitude? How much of a refresh inside the gallery should we expect both over the next one to two quarters and then a year from now, both in terms of new products as well as the number of galleries that the new products will hit?

The product is by far the most important thing we're doing, right? The new openings and building out the platform support the product. We're doing a product transformation. We just began setting RH Marin next to our headquarters. You'll see the majority of the galleries reset by Q1 next year; we will reset all the galleries with the first phase and Phase 2. I think you'll see the majority reset by Q1 next year, but you’ll have some winners and losers in the product mix. As we mail the modern books beginning in January, you're going to find some things in modern that are probably better than some things we rolled out. So, we expect all galleries to be reset by Q2 next year, and we're going to get a lot of data, information, and make adjustments. We'll keep optimizing our product mix, because we will have gone through two cycles of drops by then.

Your next question comes from the line of Brad Thomas from KeyBanc Capital Markets. Please go ahead.

Hi, good afternoon. I was hoping to follow up on operating margins. The full year guidance implies kind of the mid-teens level for the operating margin. Can you help us think about the latest thoughts on structurally what the operating margins look like in this world where you're opening up stores internationally and this world where you have a new product coming out?

I don't think we're ready to talk about that. I think we're talking about some short-term changes, near-term impacts to the margin and especially moves related to making some investments. What the other side of that looks like? We’ll discuss that for you each year in March, but as we end Q2, we don’t have that visibility or ability to tell you what the steady state looks like other than as revenues grow and we get leverage in the business, we expect margins to increase from here.

That’s correct. We're giving you color today from a different angle than what's written in the shareholder letter. We don’t want to talk about things that we haven't released, so we’re not preparing to discuss that far out. We all know a lot more next quarter. We either will be more right or wrong; we think we're going to be more right than wrong. Everything we said we believe in has some speculation, but there's data we have based on what we're doing; it’s a transitionary period, and you’ll see us snap back. The early data looks good.

Your next question comes from the line of Jonathan Matuszewski from Jefferies. Please go ahead.

Great. Good evening, Gary, Jack, and thanks for taking my question. It's on the contemporary business. In the past, you referenced the $1 billion milestone over three years. I'm hoping to see if we could get an update on how that business is looking today as more product has been rolled out across the galleries.

Yeah. I think about the totality of what we're doing here. I wouldn't just isolate contemporary. Do we think it's going to be $1 billion? Yes, we do. However, you've got to look at it in concert with the totality of the product transformation we’re making. The biggest book is our interiors book. It will continue to be the biggest driver. However, you're going to find there are some blurred lines between categories; we think contemporary might ramp bigger than modern. I wouldn’t focus too much on that right now; the bigger idea is the totality of the product transformation. We're mailing about 1,200 to 1,300 pages of product with 70% to 80% newness. This is the biggest amount of new product entering the market at this design quality, the quality of manufacture and this value equation. This is the biggest move we've made. I believe it will reset the company for the next five years.

Your next question comes from the line of Steve McManus from BNP Paribas. Please go ahead.

Hey, afternoon. Thanks for taking the question. I had the same question about suppliers. We're seeing more and more suppliers go out of business. Just curious what you're seeing with respect to the financial health of some of your key suppliers. Any challenges that you're facing right now worth calling out?

Yeah. You’re probably referencing one of our suppliers that filed for bankruptcy, Mitchell Gold and Bob Williams. They were terrific people, so it's unfortunate; they went through some private equity hands and had wrong leadership, which led them to make poor decisions. There is probably $30 million to $40 million of demand with them that we can resource pretty easily. We don’t see major interruptions; they’re not one of our big suppliers. It shows how challenging it can be to do business right. They were a furniture manufacturer with great aesthetic, marketing, and style. They got into the retail business too, adding complications. There will be some people that may not make it through this down cycle. They could, but we don’t see fundamental risk to our business that will be meaningful, otherwise, we would have disclosed it.

Got it. Appreciate the color. Thanks, Gary. Best of luck.

Sure. Thank you.

Your next question comes from the line of Michael Lasser from UBS. Please go ahead.

Good evening. Thanks a lot for taking my question, Gary. Is it right to interpret your statement that you expect the business to inflect in the first half of next year to mean that it's going to flatten out in the first half of next year before resuming a growth trajectory in the second half of next year? Would you expect that your total investment spend independent of gross margin or SG&A is going to be greater than, equal to, or less than what you're spending this year?

We expect the business to inflect in the second half of this year, meaning we're going to see a meaningful move in trend to the upside. We'll inflect positively against all those metrics: our trend, the industry's trends, and the competitive trends. We'll reach the peak of that inflection in the first half of next year. I’d recommend thinking about an inflection happening over the rest of this year; we’ll inflect up, then see another climb in the first half of next year. That movable metric is a strong indicator that we’re going to gain market share. Regarding the other question, we haven't guided on that yet. We're not prepared to speak about that.

Yeah. Hi, good afternoon, everyone. I wanted to return to the advertising spend and the shift you're making to the twice-a-year cycle. Does this mean you will go back to 4% of sales spent on advertising? I know that last couple of years it was very low, or with the product introductions and new store openings in Europe, does it make sense for that spend to be at a higher level?

We don't know yet. We'll know a lot more when we see inflections in the business.

And we have no further questions in the queue at this time. Gary Friedman, I'll turn the call back over to you for closing remarks.

Great. Thank you, operator. Thank you, everyone, for your time and interest. Thank you to team RH for your leadership and efforts. Your hard work is going to pay off, and thank you to all our partners around the world who are part of this team. Your support and efforts mean the world to us. I can tell you, all three constituencies that are listening in on this call share the sentiment we expressed today. I don't think we've ever been more excited about the future, and I believe we will demonstrate that to our shareholders. So, thank you, everyone, for your time and attention today. We look forward to the next few quarters. Thank you.

And this concludes today's conference call. Thank you for your participation, and you may now disconnect.