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. 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, Alison. 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 for 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 we are 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, which we believe 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 we now expect adjusted operating margin to be in the range of 13.6% to 14.0%. We are in contract to make an opportunistic purchase of the New York Guesthouse property for approximately $58 million, which is scheduled to close in the fourth quarter. The building was appraised at $85 million last September when the Federal Funds rate was half the level it is today. We believe controlling the outcome of this one-of-a-kind property is in our best interest. However, we will be poised to take advantage of any opportunity to do a sale-leaseback with the appropriate investor when the commercial real estate market rebounds in the future. Regarding product elevation, we anticipate that our demand trends will accelerate through the first half of 2024 as our product transformation unfolds, in-stocks improve, we complete the reset of our Galleries, and introduce our new Modern and RH Outdoor Sourcebooks in the first quarter of next year. We expect that our inflection point will peak in the second quarter of 2024 as our new collections fully ramp and we begin another cycle of Sourcebook mailings, completely transforming and refreshing the entire brand over a 12-month period. We believe our latest collections reflect a level of design and quality that is currently inaccessible in our 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, we believe it will become margin accretive over the long term as selling rates stabilize and allow for supply chain and sourcing efficiencies. Our plan to expand the RH brand globally, address new markets locally and transform our North American Galleries represents a multi-billion dollar opportunity. As discussed last quarter, we introduced RH to the UK this past summer in a dramatic and unforgettable fashion with the opening of RH England, The Gallery at the Historic 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, and the global press coverage the brand received was multiple times greater than any Gallery we have ever opened. Due to RH England’s countryside location, we expect the majority of the revenues to be driven by our Interior Design and Trade businesses, which are dependent on building books of business with high-value repeat clients like Interior Design Firms and Hospitality projects. The quote book and demand continue to build monthly, despite the seasonal nature of the location. Our first UK Interiors Sourcebook was mailed in October, with our next contact planned to be our RH Modern and RH Outdoor Sourcebooks in the first quarter of 2024. In November, we opened two new international Galleries, RH Munich and RH Dusseldorf. The response to our opening events exceeded our expectations, with RH Munich hosting over 900 chic attendees enjoying Cipriani Bellinis and Vesper Martinis, and traffic in both Galleries has been strong since opening. Although RH England is our most unique and spectacular Gallery to date, and the only one with a hospitality component in Europe, all three are architecturally impressive, multi-level expressions of the RH brand, only to be outdone by our even more impressive teams in each location. While many retailers boast a capital-light, franchise or licensing approach to international expansion, we believe the only way to build a brand and optimize the business globally is to invest in and control the brand in the same manner we do locally. With people who live and breathe our values, because it’s their values. People who will lead our cause and build our culture, because it’s their cause, and it’s their culture. We believe when you aspire to be the very best in the world, there are no shortcuts, and greatness can never be delegated, nor licensed or franchised. Our next international openings include RH Brussels, The Gallery on the Boulevard De Waterloo, and RH Madrid, The Gallery on the Plaza Marques De Salamanca in the first half of 2024, followed by RH Paris, The Gallery on the Champs-Elysees in the fall of next year. RH Paris is located one building from the corner of the Avenue Montaigne, known as one of the most exclusive and luxurious arteries in the capital, and the chosen home of major haute-couture brands such as Chanel, Dior, Vuitton, Celine, Saint Laurent, and many others. We believe the space we have designed for this location will position RH as a placemaker in the luxury fashion capital of the world. RH Paris will be a six-floor jewel-box connected by a dramatic, ornate scissor stair and a central glass elevator that will whisk you up to the fifth floor and rooftop Champagne & Caviar Bar, where you can take in views of the Eiffel Tower while enjoying our innovative menu featuring the finest Petrossian Caviars. You can also visit the second floor and dine in our dramatic atrium restaurant, inspired by the Grand Palais. With an onyx-carved bar, floors, walls, and tables looking out into the beautifully landscaped courtyard with 30-foot ivy-covered walls, it’s like dining in a secret garden, erasing the noise and chaos of the outside world. Mark your calendars for early September, RH Paris will be an opening party you won’t want to miss. We are also under construction in London and Milan in inspiring spaces that will celebrate the heritage of the historic structures and will integrate full expressions of our hospitality experiences. Our current plans call for opening both Galleries in 2025. We anticipate gaining local approvals soon for RH Sydney, the Gallery in Double Bay, with plans to open in late 2025 or early 2026. Regarding our North American transformation, we opened RH Indianapolis, The Gallery at the DeHaan Estate, one of the most accurate Palladian-style villas ever built in the United States. The estate spans 151 acres and over 60 rooms, overlooking a 35-acre lake, and represents one of the largest, most inspiring, and immersive physical expressions of our brand to date. With construction delays pushing RH Cleveland into the first quarter of next year, our plan now includes opening five North American Design Galleries in 2024, inclusive of RH Palo Alto, RH Cleveland, and RH Raleigh in the first half of next year, and RH Montecito and RH Newport Beach in the second half. We also believe there 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 have generated annual revenues in the range of $5 million to $20 million in 2,000 to 5,000 square feet. We have secured our first new location for a Design Studio in Palm Desert, which should open in the first half of 2024. We have identified over 40 locations that are incremental to our previous plans in North America and believe the results of these Design Studios will provide data that could lead to opening larger galleries in those markets. In discussing the 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 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 upholstery, RH Bespoke furniture, 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 to $6 billion in North America, and $20 to $25 billion globally. Our strategy is to move the brand beyond curating and selling products to conceptualizing and selling spaces by building an ecosystem of products, places, services, and spaces that establishes the RH brand as a global thought leader, taste-maker 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 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 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, elevate and render our way of life more valuable. Never underestimate the power of a few good people who don’t know what can’t be done. For the past 23 years, we’ve heard others tell us what can’t be done, and for the past 23 years, we’ve failed to listen. We avoided bankruptcy while being accused of lunacy. While others have been shrinking and closing stores, we’ve been building the largest and most inspiring spaces in the world. When Wall Street didn’t think our stock was worth buying, we bought 60% of it ourselves. When everyone told us we should be working from home, we were in the Center of Innovation working on rebuilding our new home, and it’s almost ready for prime time. From the largest product transformation in our history, to the most inspiring and unusual retail experiences in the world, from couches to caviar, beds to bellinis, architecture to airplanes, homes to hotels, I should say guesthouses, from Pittsburgh to Paris, Los Angeles to London, Boston to Brussels, Miami to Munich and San Francisco to Sydney, soon the world will be within our reach. Never underestimate the power of a few good people who don’t know what can’t be done, especially these people. Onward Team RH. Carpe Diem, Gary. Operator, I'll now open the call to questions.

Thank you. Your first question comes from the line of Simeon Guttman of Morgan Stanley. Your line is open.

Hi, everyone. Good afternoon. I want to ask about contemporary. I know it's early, and some of the research indicated that it shouldn't cannibalize other aesthetics. I’m not sure how much data you have on it yet, but is that a fair assessment and how are sales progressing? Also, can you remind us that you never adjust pricing on contemporary? I know we discussed changing some pricing on certain items, but I don’t think it has ever been related to the new collection. Thanks.

Yeah, we reviewed pricing and our value equation throughout the brand. So everything was touched. If you look at the contemporary brand, the contemporary book, this remailing of the book, it’s got a very high new content. But all the products have been... I don’t think there’s anything we didn’t reprice. But look, the contemporary book got mailed 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 are collections, like any collection, there are 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 are sailing into probably one of the biggest headwinds any of us have experienced in the housing market. While it’s not the Great Recession of 2008/2009, it is, from a housing point of view, as bad as it gets. So you’re seeing really big downturns 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 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 the first half of next year and hit an inflection point, I think, kind of mid-late to second quarter, and that’ll be despite kind of the housing market unless there's another gap down, but it seems that they've got inflation somewhat under control. It seems like the Fed's becoming more confident, and if we can start to see a move in interest rates and easing in interest rates, the federal funds rates, and the mortgage rates, that'll help. While mortgage rates went down a little, you still have an affordability issue with 82% of the people with mortgages at 5% or under, and 62%, 4% are under, and 25% are under 3%. So that's the biggest issue facing the market today. And that’s why we don’t have inventory. There’s not inventory in the housing market and why prices aren’t coming down because there’s not inventory. You have some pricing coming down here or there in some markets but the good news for us is we’re just taking a long view, trying to position the brand and the business for the next big run, and I think we’re going to be meaningfully better positioned than anybody else in our sector, not by a little, but by a lot. When this happens, we’ll outperform the market and the competition, I think over the next period. We gave some market share back during the post-COVID period, we haven’t been promotional like everybody else got. Everybody got on the other side of COVID and became promotional. Even though people say they're not promotional or they're not doing site-wide promotions or whatever the language is, just on people's websites, it's a very promotional environment out there. And I think what you're seeing now is the people that became promotional are now going to have lapped their promotional stance and they will have to go up against that. So that was a lever post-COVID for people to turn on promotions and lift the business. Now everybody's cycling that, and I think you're seeing people's and businesses inflecting downwards in this environment and our business is inflecting upwards and it will continue to do so.

Can you discuss your current inventory position and the ratio of discounted or clearance items? You mentioned that shifting to this could impact margins. If you have items that need to be cleared, does it make sense to strategically remove them to make room for the new products coming in?

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 us take the appropriate action here. But nothing we wouldn’t normally do. We would still want to lead 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 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 the work we’ve done and what’s in the pipeline and the plans we have. They are 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. We don't have a strategy to protect the operating margin. Comparing it to 2019 doesn't make sense. It’s nothing like 2019. We're experiencing the worst housing downturn anyone has seen.

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

Yeah, yeah. So that's not where I'd be focused. 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, I want to highlight that you mentioned the lever, but I also want to point out that we have seen increased markdown activity this year. As we move into next year, this could give us a positive boost. We will discuss this further in March, but it's one of the favorable aspects to consider.

The operating margins and cash flow are expected to be stable. We didn't repurchase $2.2 billion of stock because we believe there's an issue with the model. We're in the midst of a significant transformation in this industry. It's important to focus on what will come after that rather than just on the operating margin for the next quarter or two. If it fluctuates by a point or two, that's not a concern for me as the biggest shareholder in this company.

Okay. Fair enough. A follow-up then on just the promotional aspect of 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 finishes by the end of '24?

You mean just the broader industry?

Yes.

I believe the broader industry has returned to pre-COVID pricing and promotions, and this trend is likely permanent. Once promotional strategies are implemented, they cannot easily be undone. While the marketing approaches may change, the reality is that consumers are inundated with sale emails, which has been consistent over the past year. As a result, companies are adjusting their strategies accordingly. We could have activated promotions in the past year following COVID and significantly boosted our business, but that would have led to a permanent shift in our model. Some businesses are promoting aggressively and reducing advertising costs in hopes of developing a fundamentally different model. There may be some companies that emerge with a slightly improved approach, perhaps due to lessons learned, including spending less on advertising. However, my main focus is on our own strategies and how we plan to position our business for the next five years. I am very optimistic about what we're achieving and believe this is our best work yet. In the upcoming quarters, you will see this progress unfold, and it will not be a short-term change. While I anticipate a significant improvement by Q2 based on our current plans, I expect that the next cycle will yield even greater results as we are building a stronger and larger foundation for the business. During COVID, we became overconfident about our pricing, especially with the price increases from tariffs and rising costs in the supply chain and raw materials. Now, we are in a much stronger position and plan to adopt a very aggressive strategy. Our scale allows us to purchase in larger quantities than our competitors and to secure better pricing. We've also established a solid platform to support this approach. While we did lose some market share initially due to being slow in ramping up product development and marketing after COVID, we have rebuilt our capabilities. We no longer have that overconfidence in pricing; instead, we have a strong competitive focus to succeed. As the market fluctuates, I wonder how those who have been marketing heavily over the past year will fare if they stop—will their business decline significantly? It's challenging to stop promotion in an industry like furniture after having relied on it, and it requires a full yearly cycle of adjustment, similar to our painful transition to a membership model. Those suggesting they can easily implement a similar model should prepare for the complexities involved. We spent three years planning and executing that transition, and it's not feasible to simply withdraw from promotion after being so committed to it.

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

Thank you, good evening. I have a couple of follow-up questions about the gross margin. After the holiday, do you believe you will be ready to start 2024? Is it accurate to say that most of the non-fixed cost decrease in gross margin was due to clearance? Regarding your comment, Jack, is there any reason you wouldn’t regain that margin, especially with all the new products where you wouldn’t expect significant markdowns?

I believe we will be in a better position at the start of the year compared to the beginning of the quarter. However, we will continue to work through selling the markdown goods by the end of the first half.

We will always have some level of markdowns, but the key thing to focus on is the overall mix. In Q4, we will see a heavier mix of markdowns, with some impact moving into Q1. However, this will lighten up in Q2 as we reduce inventory. As we progress through the quarters, we will have a higher mix of new, higher-margin products. In the short term, as I mentioned in the letter, the changes we are implementing may initially reduce margins. However, in the long term, these changes should enhance margins as the inventory balance shifts.

Understood. One of the questions we often receive from investors is regarding the various developments with the new galleries and the recovery of Sourcebooks to its pre-COVID state. Considering the implications for SG&A expenses in the third quarter, is that an appropriate baseline? In other words, will advertising see an increase next year? Additionally, as we expect more international openings next year, are we effectively raising our expense base due to these two aspects?

I believe it's too early to provide guidance for next year. However, we will have some start-up costs when entering new countries, such as getting galleries established, training staff, opening restaurants, and setting up home delivery networks. There will be cycles involved as we expand into different markets. We are confident in the long-term profitability of the business and believe that our brand can return to the 20% margin range as we progress. While this market is challenging—comparable to the worst housing conditions I've witnessed in my career—I'm optimistic that this situation will not persist indefinitely. Although the current market might extend through 2024, our long-term outlook remains unchanged. We've avoided compromising our pricing strategy by engaging in heavy promotions, which has cost us some market share. Nevertheless, we have strengthened our value proposition at regular prices and are positioned to be competitive, even against discounting efforts. Our platform provides a unique buying power that others cannot match, and I wouldn't want to be in a position against the significant changes we are implementing.

Chris, regarding your question about Q3 being a base, we don’t consider it as just one quarter. I’ve mentioned before that to analyze trends and establish a base, it’s important to look at a complete four-quarter cycle. The timing of advertising plays a significant role, so we can't rely solely on one quarter.

We used to send a book and spread the cost over six or 12 months. Now, when you email a book, the ad cost is recognized the same day it is sent out. The book is worth more than just that one time period. However, a change in accounting rules is going to create fluctuations in our business from quarter to quarter, depending on when the ad campaign coincides with the book launch. There won't be any amortization of the ad costs, which doesn't really make sense. You won't capture 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 a peak inflection point in the 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.

Demand trends will lead to revenue increases, and we expect continued improvements. There will be enhancements as we replenish stock and complete the Gallery transformation. With significant changes, certain collections are outperforming expectations, and we believe one of our collections is the best in RH's history by a significant margin. However, we won't resolve inventory issues until March or April, facing imbalances due to high demand. We need to manage inventory carefully because some products are selling so well that they can't even reach the stores. As we release planned products for the Galleries, we see unexpectedly high demand. Our manufacturing processes will become more efficient as we introduce new items, resulting in better performance over time. In the upcoming months, we will have a second round of book mailings, with a strong focus on the Modern collection, which will see substantial updates. Overall, we will see 20% to 40% more newness than usual, transforming the entire brand and expanding our offerings. We'll ensure inventory is balanced, adapting plans based on real-time data to meet demand effectively. We are optimistic about our data and pipeline, and as we analyze trends for the next three to six months, we anticipate reaching a significant inflection point during this transformation.

Got it. And then just a follow-up for Gary. The comments in Germany were interesting, a lot stronger than you had expected. I don't think you put much marketing behind it. So what drove it? At least from what I'm seeing online, there are great locations, beautiful exteriors, and all the rest of it. But in terms of the response, what's resonating? Is there anything you could share about the potential compared to the average revenue size in the US, if possible, unless it's too early?

We are located in very busy shopping areas. In Dusseldorf, our store is on the main boulevard, directly across from Chanel and close to Hermes, right in the heart of luxury shopping, which brings in a lot of foot traffic. In Munich, we are situated in a bustling part of the city, attracting many visitors. This is quite different from our experience in England, where we focused more on creating conversations around the brand rather than just commerce. We aimed to make a strong first impression and present something extraordinary that would capture the attention of high-end luxury consumers. The situation in England represents a significant brand investment, but there isn't much foot traffic near our store; it requires a drive and is about an hour and 45 minutes from London. Nevertheless, the business is growing, and we just completed our largest sale to date at $330,000 for the Chalet location.

In the French house.

In the French house, the Chalet, we are seeing growth in various segments of our business. The design work with our internal designers, along with our trade clients, is progressing well. I initially expected this time of year to be slow due to the weather, which isn't ideal for outdoor activities. However, our demand and business are increasing month over month. Building awareness of our brand will take time, as furniture purchases typically happen every five to twenty years, depending on individual circumstances. In RH England, we’re experiencing lower foot traffic compared to our locations in Germany. Our first look at the German locations is promising; we appreciate the engagement from visitors and their interest in learning about our brand. Some customers are familiar with us from America and are excited we have opened in Munich. The strong enthusiasm for the brand exceeded my expectations, as did the quality of attendees at our launch events. This excitement is generating conversations, which will help stimulate further interest. I anticipate significant growth in these countries, similar to what we’ve seen in America, where we often already have a market presence before opening new stores. For instance, we could open in Milwaukee next month, even without a gallery there, yet still see substantial online sales as customers know our brand. In these new markets, people will gradually become familiar with us and start engaging in design projects. We expect this familiarity to develop more quickly in Germany than in England, where traffic has been limited. Even with the reduced traffic, it’s encouraging to see demand building during a traditionally slower season. We've only sent out one marketing book so far to a small audience, and we're eager to learn how to invest effectively in brand building here. Overall, I'm pleasantly surprised by the continued growth in RH England and the strong turnout at our events, as well as the interest in our galleries.

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?

We primarily focus on the overall assortment presented in various ways rather than breaking it down into categories like contemporary or interior. We evaluate the performance of the furniture and upholstery sector as a whole, looking at every sofa across all styles. Our approach isn't dictated by the separate categories but by how we present the entire RH assortment to consumers, analyzing which elements are effective and which aren't. When considering the assortment's size, it depends on how extensive we decide to make it and how we categorize the products. There are overlaps that allow us to place products in various categories. Currently, RH is undergoing a significant transformation in its product offerings, which is the largest change we've implemented. We're focused on understanding how this new assortment across all categories performs compared to the previous one. We're optimistic that it will positively impact our results.

Got it. That's helpful. And then, 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 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 floor 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 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 the same kind of challenges, lots of new products. 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 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 will all depend on the macro conditions in the housing market. If the housing market remains stable, we will have a clearer picture for next year. Overall, I would be surprised if anyone is outperforming us by the second quarter of next year. I would be quite shocked, but perhaps someone will surprise me. I don't believe that's likely.

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?

Yes, there are now over 70 collections. When we factor in modern hitting and outdoor hitting, we expect the number to be between 70 and possibly up to 90, with more in development. Additionally, we are working on another project that hasn’t been revealed yet, which we believe will be significant. This will not be a customized or high-end offering, and we haven't discussed it before. It's going to be a major new initiative, and we are focused on that as well. There is a lot coming, so stay tuned.

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?

I don't think we're missing the point here. The transformations are still in early stages, and the products aren't in stock or displayed yet. We haven't completed a full mailing cycle. I believe we've significantly closed the gap and are gaining market share with a lot of customers. There may be some competitors performing better in terms of demand, but that might not last into the next quarter. An inflection point is approaching. We need to focus on what I've mentioned. I don't think it's necessary to repeat myself. I also don't believe we need to lower our prices further. The products simply need to be available, we need to refresh our galleries, and we need to move through the next cycle before we can make significant progress.

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 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 anything 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.

I’m not sure we had any specific expectations. People have asked what we might achieve, and I mentioned it could be anywhere between $50 million to $250 million. My perspective is that we need to focus on marketing the brand and consider our investments in marketing and their impact on direct business and brand recognition. It’s too early to determine the results since we haven’t opened a typical store. If we had launched in London instead, the situation would look very different. We chose to open in the countryside with a unique and inspiring concept that hasn't been seen before. Therefore, I wouldn’t dwell too much on this gallery for insights. It's not going to give us accurate answers. This is more about brand investment to create a strong first impression and generate conversation. We're also exploring other locations in England and planning to invest in various marketing strategies to drive online business. We’re still in the early phases of this. I wouldn’t fixate on RH England to evaluate the market potential for us because drawing conclusions from it could be misleading. There hasn’t been a store like this anywhere else, and if you’ve seen it or experienced it, you'd understand. So while we won’t replicate this exact model, we are focusing on more typical environments like Germany, where foot traffic is greater. The goals, visions, and strategies for RH England and other locations are distinct and aim to serve different purposes. My expectation for RH England is modest, and we’re still assessing how to expand to an entire market like England and what additional marketing efforts are needed. We're learning as we go and aren’t rushing to conclusions. We’re pleased with the progress we’ve made, the team we’ve assembled, and the positive initial feedback from consumers. England is a unique opportunity aimed at reshaping perceptions of our brand among high-end shoppers. Ultimately, these are long-term investments that will unfold over time.

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.

It’s due to our scale, buying power, and confidence. If you look at our source books or online, you'll see the Jacob Chair. When you compare our pricing, assortment, and presentation with others, there might be small competitors who try to match our prices, but no one can buy or present as much as we can. Many don’t invest financially in the products like we do, and that’s a strong point for us. Some competitors are selling their versions of the Jacob Chair, but they had to pull them from their websites because they couldn’t compete on price and are stuck with inventory they bought at a higher cost. Now, they might be looking to offload it elsewhere. I wouldn't want to compete against us on any version of the Jacob Chair, as our margins are among the highest we have. So, disruptive pricing doesn't necessarily mean lower margins.

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?

We are going to open a few galleries and learn a lot from the experience. Our focus will be on how to grow our business in different countries, the necessary marketing investments, and their implications. We aren't starting by calculating the return on invested capital in Germany since we have no prior sales experience there. We need to understand the costs involved in building the brand, attracting customers, and developing our design and trade books. Overall, we plan to open around 10 galleries, including two in Sydney and two in Madrid. We are going to open the galleries and start learning from the experience. We'll make various adjustments, some of which will succeed and some won't, but we're committed to improving. I am pleased with how we're beginning. In Germany, for instance, everything looks promising. The galleries are impressive, the teams are excellent, and the right clientele is visiting. Being in Munich has been very encouraging and provides a good insight into the situation. It’s clear that our approach differs significantly from what we experienced in England. We managed to avoid significant capital expenditures for the two galleries by taking over a couple of Abercrombie & Fitch flagships and refitting them instead of constructing new ones, as was necessary in other locations like England. Each location will have unique return dynamics, and we need to consider how they will integrate over time. The focus will be on the performance of the US business, which is crucial. While each location will follow its own path, we'll learn and adapt as we go. We're eager to get these opportunities underway.

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 the 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.

Demand trends are positive and will lead to increased revenue. We anticipate ongoing improvements as our stock levels rise and we conclude the Gallery transformation. With significant changes, certain collections are exceeding our expectations by a substantial margin. We expect to resolve inventory challenges by March or April, addressing the current imbalances. We need to ensure stock availability since the demand for our products, including those designated for Gallery upgrades, is extremely high. Our manufacturing processes will adapt and improve with this new range of products, leading to greater efficiency. We will also initiate a second round of book mailings, introducing a considerable amount of new content, particularly in the Modern collection. Although there may be a slight delay, our total product offering will significantly expand, showcasing around 20% to 40% more new items than before. The entire brand is on the verge of transformation as we enhance our assortment. Your specific goals as they relate to those new international galleries, in terms of the exact revenues and timelines, it’s going to become investment namely to each country, we need to make and we'll prove out as we learn about those markets and become successful. We aren't naive to think that the curve will simply follow up to our traditional margins here in the US. We'll learn about pricing adjustments on new galleries and with the consumer. But we look forward to updating everyone in the years to come. To that end, as we mentioned, we have quite the scope of new projects that we're tackling worldwide, with the brand growing significantly in the next years. Thank you, and with that, I will now turn the call back to the operator.

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