Rh Q2 FY2024 Earnings Call

Good day everyone and welcome to today's RH Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note, today's call will be recorded, and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Allison Malkin of ICR. Please go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter fiscal 2024 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 investor relations section of our website at ir.rh.com. With that, I'll turn the call over to Gary.

Great. Thank you, Allison. Good afternoon, everyone. Thank you for joining our call. I will start with our prepared comments in the shareholder letter and then open the call to questions. To our people, partners, and shareholders, we are pleased to report that demand was up 7% in the second quarter and has continued to inflect positive, gaining momentum each month with July finishing up 10%. Demand accelerated into the third quarter with August up 12% and product margins inflecting positive despite operating in the most challenging housing market in three decades. Our investments in the most prolific product transformation and platform expansion in our history are now resulting in RH gaining significant market share in North America while building the foundation for our long-term global expansion across Europe, Australia and the Middle East over the next decade. While our inflection developed a couple of quarters later than expected, we believe the important measure is not the timing, but rather the size of the vector we are creating in comparison to our industry. Vectors are measured in magnitude and direction, and can be effective in forecasting strategic separation and future market share gains. It is now clear that our vector is increasing by both measures as we are outperforming the industry by 15 to 25 points. We expect our performance will continue to gain momentum in the second half of 2024, fueled by our multi-year effort to elevate our product, and a multi-decade effort to elevate and expand our platform. We are also pleased that results for the second quarter reflected our guidance with revenues of $830 million, up 3.6% versus a year ago, adjusted operating margin of 11.7%, and adjusted EBITDA margin of 17.2%. While aggressively investing into a downturn has put pressure on short-term results, it has also positioned RH to capitalize on the long-term opportunities that present themselves during times of disruption and dislocation. We believe our demand performance demonstrates we are the best positioned brand in our industry to benefit from the anticipated rebound of the housing market once interest rates decline and home prices reset lower, closing the affordability gap that has suppressed the market for the past several years. Every act of creation is first an act of destruction, Pablo Picasso. We have worked hard to destroy the former version of ourselves and are in the process of unleashing what we believe is an exponentially more inspiring and disruptive RH brand, inclusive of the most prolific product transformation and platform expansion in the history of our industry. Our product transformation plan for the second half of 2024 includes the second mailing of our new RH Interiors Sourcebook, which arrived in homes mid-July through mid-August, and is fueling our industry-leading demand. With new collections and improved in-stocks, our demand should continue to build throughout the second half of 2024. Post analysis of our circulation data, we decided to consolidate our RH Contemporary Sourcebook collections into the RH Interiors and RH Modern books to optimize overall mailing depth and efficiency. Mailing fewer, more meaningful books enables our brand to break through the compounding clutter across the consumer industry, and is aligned with our Gallery strategy of fewer, more immersive and brand-defining physical experiences. The second mailing of the new RH Modern Sourcebook is scheduled for November with additional new collections and an expanded assortment, including the Contemporary book consolidation. Again, we believe our expanded assortment and improved in-stock position will provide an additional lift to our business in the fourth quarter. The third mailing of the new RH Interiors Sourcebook is planned to be in homes early January through February, capitalizing on what is traditionally one of the largest selling seasons for furniture post consumers and designers returning from holiday travel. This mailing should help generate a strong finish to 2024 and continue the momentum as we enter next year. As you know, we acquired Waterworks in 2016, arguably the most desired brand in the luxury bath and kitchen category. The Waterworks team has done an outstanding job over the past eight years further elevating the brand and building a highly profitable business model that can scale. Waterworks, like most other luxury brands in the home space, generates the vast majority of its revenues from the trade market, selling to architects, designers, developers and builders. While RH has a meaningful trade business, the vast majority of our revenue is generated by consumers. We believe there is a significant opportunity to amplify the Waterworks business on the RH platform by exposing the brand to a much larger audience, similar to how we have expanded other trade-focused businesses and brands over the years. Our plan is to launch with a 3,000 square foot Waterworks Showroom in our largest new Design Gallery in Newport Beach, California, opening in the fourth quarter of 2024. We will also be developing a Waterworks Sourcebook with plans for a test mailing in 2025. Waterworks today is just shy of a $200 million business with mid-to-high teens EBITDA margin that we believe has the potential to become a billion-dollar global brand on our platform. Let me shift your attention to the elevation and expansion of our platform. We continue to open the most inspiring and immersive physical experiences in our industry and some would say the world. Spaces that are a reflection of human design, a study of balance, symmetry and perfect proportions. Spaces that blur the lines between residential and retail, indoors and outdoors, home and hospitality. Spaces with garden courtyards, rooftop restaurants, wine and barista bars. Spaces that activate all of the senses, and spaces that cannot be replicated online. Our plan to expand the RH brand globally, address new markets locally, and transform our North American Galleries represents a multi-billion-dollar opportunity. Our platform expansion plan for the second half of 2024 includes RH Newport Beach, opening in November with over 90,000 square feet of indoor and outdoor space spread over four floors with views of the Pacific Ocean, will be one of our most dramatic, immersive and brand-defining physical locations to date, and will replace three legacy galleries in the region. With a 260-seat Indoor-Outdoor Rooftop Restaurant with uninterrupted views of the California coastline, two Wine & Barista Bars, an Interior Design Atelier, our first Waterworks Showroom, and the most expansive Luxury Outdoor Furniture assortment in our industry, RH Newport Beach will be an inspiring destination in the Southern California market and has the potential to become our second $100 million plus Gallery. RH Raleigh, also opening in November, features 50,000 square feet of indoor and outdoor space over three levels, with a Rooftop Restaurant, Garden Courtyards, a Wine & Barista Bar, and an Interior Design Atelier. RH Montecito, opening in early December, is a reimagination of the Historic Fire House in the charming enclave perched above Santa Barbara, California, featuring an indoor-outdoor Courtyard Restaurant with fireplaces and fountains, a Wine & Barista Bar and an Interior Design Atelier. The opening of our first RH Interior Design Office in Palm Desert, California this November. We believe there is an opportunity to address new markets locally by opening Design Offices in neighborhoods, towns and small cities where the wealthy and affluent live, visit and vacation. The Palm Desert location is a unique test of a consumer-facing professional interior design office, separate from a Gallery. Our goal is to establish the RH brand as the leader in the world of professional interior design, and enable us to attract the highest caliber of interior designers in the industry. As we look forward, we anticipate an inflection of our business in Europe as we begin to open in the important brand building markets of Paris and London in 2025, and Milan in 2026. It is then we will begin to have the scale to support the advertising investments necessary to build our business across Europe. We are looking forward to discussing our global expansion in further detail once we open those important markets. We are also making meaningful investments to elevate and differentiate our online experience and will be making meaningful upgrades to our website throughout the second half of 2024. Some of the functionality we plan to introduce is quite revolutionary and unlike anything in the market. We plan to file for design patents on several of the user interface and presentation designs and will begin to discuss the new website strategy in more detail as we roll out the new functionality. Now, let me turn your attention to our outlook. Despite expectations for industry conditions to remain challenging until interest rates ease and the housing market begins to rebound, we expect our demand trends to accelerate throughout fiscal 2024 and into 2025. Due to the extensive transformation of our assortment, we expect revenue to lag demand during the year by approximately 4 to 8 points until we read and react to the new collections, reduce backorders and shorten special order lead times. Therefore, we will be guiding and reporting both demand and revenue growth each quarter during fiscal 2024 so shareholders and investors can accurately analyze the business. We believe it is also important to note that we are now forecasting to end the year with an increased backlog of approximately $80 million to $100 million due to revenue lagging demand throughout 2024, which will negatively impact adjusted operating and EBITDA margins by approximately 100 basis points for the year. Additionally, investments and startup costs to support our international expansion are now estimated to be approximately 230 basis point drag for 2024. Due to our inflection ramping later than expected, we are adjusting our full year forecast for fiscal 2024 as follows on a 52 versus 52-week basis. Demand in the range of 8% to 10%. Revenue growth in the range of 5% to 7%. Adjusted operating margin in the range of 11% to 12% and adjusted EBITDA margin in the range of 17% to 18%. For the third quarter of fiscal 2024, we are forecasting demand growth in the range of 12% to 14%, revenue growth in the range of 7% to 9%, adjusted operating margin in the range of 15% to 16% and adjusted EBITDA margin in the range of 21% to 22%. Leaders have to be comfortable making others uncomfortable. Leadership is about pursuing a vision, something you’ve never seen, that’s somewhere you’ve never been. As creatures of habit, change is uncomfortable for humans, but for the people and partners of Team RH, a culture of leadership and innovation is at the core of who we are, and reflected in everything we do. We’ve grown comfortable making ourselves and others uncomfortable for over two decades, and plan to continue doing so for the foreseeable future. It’s what leaders do, and how we know we’re on the right path. Whether it’s launching the most prolific product transformation in the history of our industry while others are hunkering down during the worst housing market in three decades, or opening the largest and most immersive physical retail experiences around the world while others are shrinking or closing their stores and moving online. By refusing to follow the herd into the anything-but-social world of social media, you won’t find us on Instagram, or by paying a bunch of strangers, called influencers by some, to say they love your brand on TikTok, one thing you can be sure of is that the place you will likely find us, is on the road less traveled, one guided by our vision and values that will continue to ignite our spirit and inspire our customers. Over 20 years ago, we began this journey with a vision of transforming a nearly bankrupt business that had a $20 million market cap and a box of Oxydol laundry detergent on the cover of its catalog into the leading luxury home brand in the world. The lessons and learnings, insights and intricacies, the sacrifices made and scar tissue developed by getting knocked down 10 times and getting up 11 leads to the development of the mental and moral qualities that build character in individuals and form cultures in organizations. Lessons that can’t be learned in a classroom, or by managing a business, lessons that must be earned by building one. In a world that rewards duplication and penalizes the inherent bumpy road of innovation, especially for companies in the public domain, we the people and partners of Team RH will continue to drive ourselves to destroy today’s reality so we can create tomorrow’s future, while remaining completely comfortable making ourselves and others uncomfortable. 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. Operator, we will now open the call to questions.

We'll pick our first question from Curt Nagle with Bank of America. Your line is open.

Great. Thanks so much for taking the question. Yeah, so I just know with the inflection demand trends driven by all these new product launches coming through, I'm feeling pretty good about the product margins. I think you called that out in the press release, stable, hopefully up for the rest of the year, putting you, I guess, above the price or market that feels a little more promotional. What are your thoughts on that?

I'm sorry. You were kind of — we couldn't quite hear you. Well, I think as I mentioned in the third quarter, they've inflected positive. And we feel very good about the business right now. The inflection happened a couple quarters later. When you're making big moves and big innovations like this, as I said, it's not as much about the timing as it is the vector and the increasing magnitude and direction of that vector and what that helps you kind of see down the road and we've now got enough data through the product introductions we've made over the last several seasons and now it's about refining and polishing and continuing to kind of learn and improvise and adapt. And we've got a lot more in the pipeline. So I sit here and I think about, look, the mix will begin to shift today, but, we like where we are. We like the demand vector that's unveiling itself. We like that margins have inflected positive. We like that we've got multiple galleries, new galleries opening in front of us. One of them, I mean, could be, one of them is worth like three or four galleries in and of itself. When you think about the kind of value RH Newport Beach is going to be, I think it's going to be a dominant and disruptive force throughout Southern California. And we're really excited about what's ahead of us. So, yeah, we're going to continue to do what we're doing. We're going to continue to learn, grow, improvise, adapt, and refine and elevate, continue to elevate our strategy. So I can’t be more happy about where we are. Would have liked it to happen a couple of quarters earlier, but that's not really the point, right? I said to somebody, when you're making big moves, it's really hard to be on time. If you're really innovating, it's really hard to be on time. If you're just iterating, it's easy to do that and be on time. It's just that the size of the outcome is never that meaningful in a long-term strategic perspective. So, if you think about where we started, the $20 million market cap brand that was on the edge of bankruptcy with a box of Oxydol laundry detergent and selling nostalgic discovery knickknacks with 52% of our business. And to think that we made it out of that and built the brand that we built today. I bring that up from time to time to help people think about if we could come from there and get to where we are today, what's the potential of where we can go next? And so, we couldn't be more excited, but we also couldn't be more focused. We're very focused right now. And we're going to get more focused and we're going to continue to edit and get more clear and allocate our time better, allocate our capital better. So in many ways, yes, we're just kind of warming up with this thing, since the beginning of the inflection. So, couldn't be happier.

And then just a quick follow-up. So, you noted that consolidation of the contemporary catalog, totally understand the efficiencies. Do you think that maybe points to maybe the scope of the question being a little bit smaller than anticipated or is it maybe just more of a timing thing or it's selling a very high priced set of products and market is still pretty choppy?

No. The point about, I pointed it last year, and I talked about contemporary at some point and said that we — we're kind of arrogant in pricing on the product that was, that's just a partial issue. It's more about as trends develop and evolve in any industry, right? There's an opportunity to kind of segment and focus on different looks, aesthetics, perspectives. And we have been successful to this point at thinking about kind of taking assortments, focusing them and getting them to break through the clutter, yet all kind of still integrated as one brand with a singular point of view, but delivered to the consumer with more clarity than shopping some online sites where you just have to look at a lot of stuff and you can't really find things. So the ability to just focus our business and deliver the business in a really clear and compelling way is what will continue to do. Just in this case, there is a big trend movement and no different than the big movement that was made that led us to isolate versus integrate RH Modern. That was a big discussion here years back. As we developed that assortment, do we integrate it into our RH materials book and evolve that book or do we isolate it and create a more focused message to the consumer? And so you've got to think about what are the size of the trends, how do the trends develop, how long the trends are, and you're constantly thinking about how to present in a clear and compelling way that’s going to break through. So, we've done a lot of things, a lot of different books, RH Beach House, Ski House, things like that, which you'll see come back, and continue to communicate the breadth and depth of the RH brand. And we've done big things and small things. And you don't have to keep doing them with regularity. You've got to keep painting a picture and breaking through and having people see you. We're in a world — we have six senses. And out of our six senses, our dominant sense is sight and our sight drives 80% of our behavior. And so if you can't break through visually, the odds are you're just not going to be seen and if you're not going to be seen, how can you inspire anybody? How can you create any kind of a destination or reaction? So we're always doing that. You'll always see us continue to think about how to be seen, how to break through, how to communicate visually in this world. If people don't see what you're selling, nobody cares. If they don't care about the quality, if they don't like the design or the overall presentation doesn't break through the market and they just don't see you. So, our business is all about design, quality and value in that order. Everything has to be in the right hierarchy and you've got to break through. So contemporary, it's kind of like Modern. If you went back in history, people ask me all the time, where do the trends come from? And I always tell them the debt. And it sounds — catches people off guard. What do you mean? I said, well, look, generations pass away. Their belongings go into the estate sales. These estate sales feed the high-end antique markets. The high-end antique markets feed the high-end interior design market and the high-end reproduction market, and then it trickles down from there. And it trickles through always in a unique and of the moment way, but whether it's mid-century modern or that came through, or that little trend, or the contemporary trend that followed that, the next trend that is kind of going to start building. If you just lump them on a website, which nobody can see, by the way, it's an invisible store. It's a great platform if your position is kind of priced and things like that. But if you're leading an aesthetic business, if design is really critical to kind of your positioning, launching online is very limited. Nobody walks by you, nobody sees you. You have to spend a whole bunch of money buying words and names and you're buying other brands' names. Like what a weird thing that is, like let me buy their brand name so I hope that somebody stumbles into my brand and maybe they'll see me. Or let me buy a bunch of words. There’s so many weird ways that people are trying to break through. We just go at it differently and uniquely, and we're very good at that. But we're not perfect at it. So contemporary, we never thought it was going to be a big trend, but what it did is it became bigger than we thought and it kind of blurred lines. And so the lines between the interior book, the modern book, and the contemporary book were becoming too blurred. There wasn't the need to have all three. It would be better to consolidate, make the other two more dominant, mail a more dominant book into the marketplace at greater depth and get a better financial result. That's the key here. It's not like contemporary didn’t work. The goods are out there. We have some stuff that was too expensive and when we first did Italian upholstery and things like that, and we put $70 a yard, $80 a yard fabric on it, not a $20 a yard fabric on it, and all of a sudden we had price points that were too high. Yeah, but that's okay. Mistakes are part of innovation. People who are afraid of mistakes never innovate, never take the risk. Mistakes for us are just another lesson, another learning. It's just kind of what we do. So I don't think contemporary is a mistake. I think we priced some of that book incorrectly. That was a mistake. But we learned a lot. And our view based on the data and the numbers is consolidated. And it's just going to break through, the lines would be blurred. Well, you'll see us come out with other things in the future that may or may not continue to kind of, the goods may blend in another way, but you've got to continually break through. Not doing the same thing over and over again and expecting different results doesn't work. Not in a world that's constantly evolving. But being consistent and having consistent values and beliefs and a consistent approach and point of view is really important. Everything we do goes through our filters and whether it's modern, it's an RH point of view on modern, whether it's interiors, whether it's classic, traditional, big style small spaces, beach house, ski house, all the things we do, I think are recognized out there and people go, that's RH. I mean, some people still call us Restoration Hardware. So I just try not to do that. Because we're trying to hone the brand, make it simpler, give it a breakthrough.

Really appreciate that. Understood. Thanks, Gary.

Thank you, Curtis.

We'll move next to Steven Zaccone with Citi. Your line is open.

Great. Good afternoon. Thanks for taking my questions. I wanted to talk about the product assortment, because there's been a lot of newness. I think last year you gave this point that 80% to 85% of the assortment would be new. So I'm curious, are we at that point now or do you need more newness in the second half of the year? And just with more product newness coming into the business, do you feel like you're at the right cadence now? Or as we get into 2025, you'll have incremental newness to present to the consumer? Thank you.

Sure. Thanks, Steven. Good question. So we have a lot of newness coming in the second half and a lot of newness coming throughout next year. I'd say, mid to late next year, we will start to be on a more predictable cadence. So we will hit the 85% in the first half of next year. There's a lot coming in the second half and there's a lot coming in the first half of next year. By the second half of next year, we'll be on a new regular cadence, the business will be very different. But there'll also be other things like other categories we might address, like Waterworks. We've got a really small bath business today. We're taking the best bath brand in the market and scaling it to a much larger consumer audience. What we've learned over our journey here is we took trade brands and businesses years ago, examples like Perennials, and evolved them into larger businesses by introducing them to a broader consumer market. It takes time to refine, polish, integrate, and present in the right way. For example, if anybody on this call comes to the opening of Newport Beach, you'll see how we can really disrupt the market. We're launching our first integrated Waterworks showroom there and the brand will be seen by many more people. There are currently only a small number of Waterworks showrooms, and they are mostly trade-focused. When you put the best brand in the world in front of many more people who have the financial ability to buy the best product, the opportunity scales. We built supply and manufacturing capabilities over many years to allow furniture of this quality to be sold at scale. Many of the companies we worked with when we started were small, and they are now hundreds of millions in revenue because the availability of higher quality product at scale didn't exist before. As you grow and build the brand and platform, you attract better partners and build a bigger business. We will continue to innovate and evolve. We will make mistakes along the way. We've made mistakes, we learned, and we've become better. Ultimately, I'm most excited about the people here who have gone through this journey with us and are now capable of taking RH to an entirely new level because of everything we learned together.

We'll move next to Steven Forbes with Guggenheim Securities. Your line is open.

Good afternoon, Gary, Jack, Allison. Gary, last call we briefly discussed the idea of top, middle, bottom tiers of the assortment, the new collections. So, would love to hear you sort of talk through how you think the collections are mixing into those tiers today as we all try to sit here and conceptualize what the potential aggregate demand lift could be from the actions thus far into 2025 and beyond?

Yeah, well, it's how many of the new collections made it in the top third; those will really move the business. If they made it into the top middle third, they'll move the business up. If they made it into the middle, they're not going to make that big of a difference, except when you get enough in the top third, it pulls the whole thing up and the middle tightens. When you redefine the top third, it's forever redefined, and the middle and bottom change as well. The real key today is getting things into the top third because the top third pulls everything up. It's like great people, great leaders; they pull everybody up. So the important thing is studying the data, understanding where the top third is, and learning from the introductions that are delivering the biggest results. When someone raises the bar in the market, everyone else moves faster. Competition makes you better. If you want to be the market leader, you have to conceive a vision that can leapfrog the current leader, which is much harder. You have to place big bets and take risks. It's not that contemporary didn't work — it was part of the evolution. We will continue to edit and focus, and say no to many things so we can execute exceptionally on the priorities that matter. Steve Jobs said you have to say no to a thousand things. We will keep refining and focusing to get to the next level.

We'll move next to Simeon Gutman with Morgan Stanley. Your line is open.

Hey, everyone. It's Simeon. Hi, Gary, Jack, and Allison. I wanted to ask a twist on maybe what Steve was just asking, the confidence that this initial demand that you have here has durability. And I know, Gary, you mentioned the vectors and the market share spread. And I think you have a lot of newness. You have catalogs or source books. So you have reason to be stronger than them at this point. And you had this coming. So how do you look out several quarters? And then related to Steve's question when you talked about the different tiers or tranches, do you have enough product out to see how some of the initial product is trending? How many of those top third categories might you already be sitting on? Thank you.

Yeah, we've learned a ton. We have a lot of data and are very confident in our outlook and what's ahead of us, despite interest rate uncertainty or the timing of rate cuts. We came into this year with different market expectations and the timing of macro moves is hard to predict. The key is whether you're more right than wrong, whether you're gathering data, sharpening your strategy, and seeing around the next corner. We have a lot of reasons to be stronger than the competition for a long time right now, and a lot of reasons we'll take share. It wasn't an accident; we've been working toward this for a long time. The question was when it would happen. We had an inflection later than expected, but it's clear now and accelerating. Some commentators who were critical months ago will have to re-evaluate. We also sometimes open locations earlier than ideal to secure important real estate; you have to take opportunities when they arise. Europe will be a different play once we open Paris, London, and Milan in the right order and scale. Those market-opening galleries will justify brand-building advertising investment. We're building something memorable and permanent, not a formulaic mall store. When those big international galleries open, the awareness and impact will be significant. We have a lot of edge, focus, and energy. We're excited, but we know we must stay disciplined and focused on priorities. We have a lot of ideas, but the challenge is to say no to many of them so the highest priorities receive the capital and attention they need.

We'll move next to Max Rakhlenko with TD Cowen. Your line is open.

Great, thanks a lot. Gary, so you earlier walked through the importance of galleries. Can you provide an update on where you stand in resetting the in-store assortment? I think on the last call you discussed being around 50%. So just curious, where's that now? And when do you think it'll get closer to or fully reset, just given the potential lift that it could have to the business?

Yeah, we're at the very early stages of that. You reset with early data, then get better data, then you bring in new newness and refine. Right now we're excited about certain pieces that are performing very well and we're asking how to get them into the galleries quickly. Getting the right goods on the floor in the right places will massively lift results. We are running with a higher level of inventory intentionally during this transition to avoid stockouts while learning and optimizing. These transitions are tricky; you have to invest in downside protection for a while and then edit and refine. Replenishment and production ramp are operational priorities. We are making big moves in inventory and assortment to bridge to the next stage. We are focused on getting the right items on the floor now.

We have work to do.

Yes, we have some big turns ahead to get the right assortments in the galleries and to maximize their effect. We're moving quickly.

Got it. That's helpful. And then maybe we can keep this one. You said it might be rudimentary, but where do you stand now in the promotion, in your promotions and sort of winding down the old discontinued product demands picking up? So, should we think that you're probably in the latter innings or how should we think about it? And then just the key drivers of the product margin inflecting here more recently.

I'd say we're in the middle of these big moves in and out. We're learning, transitioning, and building the bridge to the next place. I'm more focused on whether demand is growing and whether margin is inflecting positive — that's the relevant signal. We are in a period where we're reorganizing and rethinking many things and it's a bit inefficient right now because we were intensely focused on product transformation and platform investment. That generates short-term inefficiencies but long-term benefits. We're running at higher inventory partly for insurance and to ensure we don't run out of the right goods during the transition. We have major investments coming in Europe and other markets that affect timing and cost. The pacing and optimization of promotions and clearance is part of building the bridge to a much larger, more efficient platform, and we are prioritizing focus and clarity. Timing will normalize as we complete these transitions.

We'll move next to Andrew Carter with Stifel. Your line is open.

Hey, thanks. Good evening. I wanted to ask a little bit about the — I think you're going to hit with your guidance here, seven design galleries this year plus the design studio. Are you in a position to hit that cadence every year? I know two international you've reiterated today. And I know you're talking a little more about prioritization. Where do the white space markets kind of fit in within that and are the white space markets still in scope for all design gallery types? Thanks.

I'm just processing the multiple questions right now. The first is about how many we're opening this year. Jack?

Seven galleries, one design studio.

Okay, eight total. I think there will be years we'll hit that cadence and do more and there'll be years we do less because real estate opportunities and timing vary. If you try to force openings you can make expensive mistakes. Over the next four or five years the pipeline is really big and you'll see more galleries than in the last five years. The projects are large and complex, and sometimes we must make opportunistic decisions. For example, some sites we took earlier were not in the exact order we'd have preferred but they provided access to important real estate. The format of what we build can vary — we can do large galleries, mid-size galleries, and unique site-specific compounds. For instance, our upcoming Naples project will be a multi-building integrated experience with gardens and courtyards, and it's an evolution in how we think about different site types. As the brand grows and does more dollars per location, more markets look attractive that previously didn't. Market leaders create markets. In North America the ultimate opportunity could be many more galleries as awareness and revenue per location increase. We'll be thoughtful about the cadence and prioritize the highest return opportunities.

Great. Looking forward to Newport Beach. I'll pass it on.

We'll move next to Jonathan Matuszewski with Jefferies. Your line is open.

Great. Good evening. Thanks for taking my questions. Gary, first one is just on housing. I think investors are trying to understand how the eventual recovery in housing will impact furniture category spend, maybe across different income cohorts. So just wanted your perspective, how you see luxury housing reacting to the Fed rate cuts maybe relative to, you know, homes at non-luxury price points. Do you see luxury housing reacting more quickly? And if so, why?

I think a lot of it is about the affordability gap and whether interest rate cuts close that gap enough to encourage people to move. The average U.S. home price is materially higher than pre-COVID and mortgage costs are higher, and many homeowners are locked into very low rates. There's a lot of pent-up demand from families needing more space or wanting to move. How quickly that demand converts depends on the Fed's actions, mortgage rates, and how willing sellers are to adjust pricing. There are people testing the market and sometimes homes are put on and then pulled off the market — pricing and timing matter. My view is that I'd rather the Fed be absolutely certain inflation is under control before cutting rates, even if that slows the near-term recovery. If inflation bounces around because of premature cuts, it could lead to more volatile conditions like we've seen historically. For RH, we will be ready for the housing recovery and are well positioned to benefit. When housing rebounds materially, our categories — furniture, lighting, rugs, outdoor — will benefit significantly relative to businesses that are more holiday, tabletop, or accessory-led. Those businesses have less cyclicality tied to housing. We are focused on the categories that will benefit most when the housing market inflects.

That makes a lot of sense. And just a quick follow-up, Jack. Just on the international investment this year, it looks like the headwind ticked up a little bit. Just if you could contextualize for that, is there kind of any incremental investments that are being made in international versus what was previously planned?

Yeah, good question, Jonathan. Part of it was just refining the number as the year plays out. Sales came down a little lower than our earlier assumption. We originally had a certain estimate for sales contribution and we're just refining the number given current visibility. The international investments remain focused on building those brand-defining galleries and the adjustments reflect updated sales and timing assumptions.

Understood. Best of luck.

We'll move next to Brad Thomas with KeyBanc Capital Markets. Your line is open.

Great, thanks. Gary, you've touched on international a bit and some other comments that you've made and answers, but I was wondering if you could just give us an update on how you're feeling about the trajectory of that business and how some of the data points are coming in as you lap the one year anniversary of some of these locations?

I mean, look, they're all going to get better. The real conversation happens when we open Paris next spring and London late next year. We're stringing together multiple buildings in London and when you see that gallery, the consumer response will change materially. We tried to do something unforgettable in the UK; it was an unusual order but it creates conversation and brand awareness more than immediate commerce. Our current openings were not always in the ideal sequence, but they provided us entry and learning. Once we open in London, Paris, and Milan in those brand-building sites, awareness and demand will grow faster. Milan, for example, is the center of the world for design with Salone and a huge international audience; there is nothing in Milan like what we will build. Paris and London similarly provide tremendous global visibility. The restaurants and interior experiences we design will be memorable and will draw both local and international affluent customers. The trajectory for international is positive and will accelerate as we open the high-visibility, brand-defining locations. It takes time to build, but once the foundation is set, the momentum can be dramatic.

I appreciate it. Thanks, Gary.

We'll move next to Michael Lasser with UBS. Your line is open.

Good evening. Thank you so much for taking my question. Gary, if you look at the updated guidance, how much of the reduction was due to the market just not being as strong as you expected, a slower ramp in demand in response to some of the introductions and changes that were introduced, or just everything executing a little slower than what was previously anticipated. And then as part of that, if demand is shaping up to be a little lower than you had expected, shouldn't there be a benefit to the spread between demand and sales?

Michael, all good questions. I think it's a little bit of all of it. The market strength relative to our expectations was not the primary issue; it's more about the time it takes for the assortment to marinate with the consumer and for sourcebooks to reach homes and be acted upon. That timing is variable. There's also the time required to reduce backorders, shorten special order lead times, and for our partners to ramp production to the new assortments. We are learning from the data — that's why we've begun reporting both demand and revenue, and why I provided month-by-month color on recent trends so you and other investors can better analyze the business. What is indisputable is the vector: demand and margins have inflected positively and we are gaining market share in a way that is measurable. You have to be careful what you're comparing against — some companies have broader home-furnishing mixes that include a lot of holiday and tabletop merchandise that behaves differently than furniture and big-ticket items. Our categories are more cyclical with housing and will benefit more when the housing market rebounds. Regarding the spread between demand and sales: we expect revenue to lag demand through 2024 in part due to backlogs and lead times, which is why we forecast a backlog increase of approximately $80 million to $100 million for the year. The gap could narrow depending on how demand and production timing evolve, and as we normalize special-order lead times, reduce backorders and improve in-stock positions, demand and revenue growth rates will converge — probably into next year as cadence and inventory balance stabilize. We're strategically right and directionally right; the timing and cadence are what we're refining.

Maybe I could reframe the second part of the question: when do you expect demand and revenue growth rates to converge?

I don't know the exact quarter, but as we get into next year and establish a more regular cadence for newness, reduce backorders, shorten lead times, and optimize inventory, those gaps will narrow. Our guidance assumed a revenue lag relative to demand during 2024. Over time, as production scales and our new assortments are fully in stock and normalized in our galleries and online, demand and revenue will align more closely. End of next year is a reasonable frame for when we'll be much more normalized, but it depends on execution and supply timing.

Thank you very much. Much appreciated and good luck.

We'll move next to Seth Basham with Wedbush Securities. Your line is open.

Thanks a lot and good afternoon. I have one question, one follow-up. First, you mentioned in your 10-Q that your contract business is growing. I was hoping to provide a little bit more color on the size of that and the momentum there and whether that's going to become more meaningful to the overall company at any point in the near future?

Everything begins and ends with the core RH brand. If the core business gets stronger and more powerful, then the contract business, hospitality business, outlet business, and other adjacent businesses will also benefit. The core brand leads and the other businesses follow as downstream opportunities. For example, as demand and sales grow, returns and outlet opportunities can expand. Restaurants and hospitality collaborations are enabled by the gallery platform. But the core brand remains the primary driver. As the core grows and becomes more dominant, the contract and other businesses will scale along with it. We don't provide a separate large breakout for contract today, but directionally you can expect those businesses to grow as the core brand expands.

Got you. And then my second question is on inventory, which increased more than 20 percentage points faster than sales this quarter. You talked about some of the reasons why, but can you provide any more color as to how much of this is for gallery floor models and other things that would be helpful? And related to logistics, do you expect this outside inventory growth versus sales growth to persist for at least the next few quarters?

A lot of the inventory increase is an insurance policy as we transition assortments and ramp production. In a big transformation you have to ensure you don't run out of the right goods on the floor, so we carry a higher level of inventory temporarily as we learn and optimize. That includes inventory for galleries, floor models, and to ensure in-stock positions while our supply partners ramp. We're learning as we go and tuning the balance. The higher inventory supports the transition and mitigates the risk of stockouts. Over time, as production stabilizes and we refine replenishment and demand forecasting, inventory growth should moderate and align more closely with sales growth. Right now it's intentionally heavier as protection during the transition.

And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn it back to Chairman and CEO, Gary Friedman for any closing remarks.

Great. Thank you everyone. Thanks for your time and your interest and hopefully you've learned just like we've learned. I want to thank our people and partners around the world. It's a great time to be on Team RH at all levels. We're all learning a lot and getting stronger every day. Our culture here is to get all the brains in the game and the egos out of the room. None of us are smarter than all of us and we're learning together and we're growing together and we're going to build something incredible together. It takes a lot of energy, a lot of effort, a lot of courage and a lot of commitment. So thank you everyone on the team internally and externally. You've brought this to life and it's going to be a fun ride from here. It's going to be a really fun ride. So, look forward to speaking with everybody soon and carpe diem.

This does conclude today's program. Thank you for your participation. You may disconnect at any time and have a wonderful evening.