RH (NYSE: NYSE:RH), the home furnishings company formerly known as Restoration Hardware, detailed its financial performance and strategic vision during its Q3 2023 earnings call. Despite facing increased expenses and market headwinds, the company reported net revenues of $751 million and an adjusted operating margin of 7.3%. The current economic climate prompted RH to adjust its revenue guidance and delay the launch of its RH Modern Sourcebook. CEO Gary Friedman emphasized the company's focus on long-term investments, including global expansion and product transformations, aimed at establishing RH as a global thought leader in the luxury lifestyle space.
Key Takeaways
- RH reported Q3 net revenues of $751 million with an adjusted operating margin of 7.3%.
- The company faced increased expenses due to international openings and an acquisition.
- High mortgage rates and geopolitical events have led to a delay in the RH Modern Sourcebook mailing and narrowed revenue guidance.
- RH plans to elevate products and expand platforms, expecting demand trends to improve with new collections and gallery resets in the first half of 2024.
- Global expansion includes new galleries in Brussels, Madrid, and Paris, and five new design galleries in North America in 2024.
- The company aims to become a thought leader in the luxury lifestyle space, with expansions into hospitality and fully furnished luxury residences.
Company Outlook
RH's vision for the future is expansive and multifaceted. The company plans to launch new collections such as RH Bespoke furniture, RH Color, and RH Atelier, targeting revenues of $5 to $6 billion in North America and $20 to $25 billion globally. With a strategy to conceptualize and sell spaces rather than just products, RH is set to enter the hospitality industry with offerings like guesthouses, private jets, and a luxury yacht. The company is also looking to make its mark in the North American housing market with RH Residences and aims to foster an emotional connection with customers through The World of RH online portal and RH Media.
Bearish Highlights
RH experienced several challenges in Q3, with increased expenses from international openings and an unsuccessful property acquisition. The company also faced market headwinds due to high mortgage rates and geopolitical events, leading to a delay in marketing efforts and a more cautious revenue outlook for the remainder of the year.
Bullish Highlights
Despite the challenges, RH remains optimistic about its product transformation and global expansion plans. The company has opened new galleries internationally and is focusing on elevating the RH brand, expecting these initiatives to contribute to improved demand trends in the coming year. CEO Friedman expressed confidence in gaining market share and outperforming competitors by the end of Q2 next year.
Misses
The company acknowledged that elevated markdown activity was higher this year, which could potentially become a tailwind in the following year. There were also mentions of challenges in navigating the current housing market downturn and managing inventory with the introduction of new products.
QA Highlights
CEO Friedman addressed concerns about protecting the operating margin, stating that the company prioritizes long-term growth over short-term fluctuations. He also noted the impact of accounting rule changes on financials and discussed the unique challenges and opportunities presented by the performance of RH galleries in Germany and England.
Future Plans and Expansion
RH's plans for European expansion do not have set goals for ROIC or costs but focus on learning and building the business in different countries. With 10 galleries already in Europe and new openings planned, RH is optimistic about its growth potential. The company also raised its membership fee, reflecting the increased average order value, and aims to support interior designers with larger design offices that double as galleries.
The company's CEO concluded the earnings call with an expression of gratitude to the RH team and confidence in the brand's global potential, looking forward to the holiday season and peace in global regions of conflict.
Full transcript - RH (RH) Q3 2023:
Operator: Hello and welcome to the Q3 2023 RH Q&A Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions] I'll now turn the conference over to Alison Malkin. Please go ahead.
Allison Malkin: 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.
Gary Friedman: Great. Thank you, Allison. Good afternoon, everyone. As we usually do, we'll start with our shareholder letter and open the call to questions. To our people, partners, and shareholders, net revenues of $751 million were at the midpoint of our guidance to the quarter, and adjusted operating margin of 7.3% was slightly below expectations due to higher than anticipated expenses, including international openings, as well as costs related to our pending acquisition of the New York Guesthouse property and unsuccessful efforts to secure the iconic One Ocean Drive Miami Beach location. While pleased with improved demand trends generated from the launch of our new RH Interiors and RH Contemporary collections, we experienced increased headwinds in early October when mortgage rates peaked above 8%, and the Hamas invasion of Israel triggered the war in the Middle East. With 82% of homeowners having mortgages below 5%, and 62% below 4%, we continue to expect the existing housing market to remain frozen until interest rates and/or home prices fall meaningfully. Additionally, the home furnishings market has become increasingly promotional, and we believe that it will create a mix shift towards clearance products, pressuring gross margins. In light of the current market, we are delaying the mailing of our RH Modern Sourcebook until the first quarter of 2024 when we believe demand conditions will likely be more favorable. As a result, we are narrowing our revenue guidance range for the year to $3.06 billion to $3.08 billion, and now expect adjusted operating margin to be in the range of 13.6% to 14.0%. As mentioned, we are in contact -- contract to make an opportunistic purchase of the New York Guesthouse property for approximately $58 million, scheduled to close in the fourth quarter. The building was appraised at $85 million last September when the Federal 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. Product elevation. We expect our demand trends to accelerate though 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 anticipate 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 inaccessible in our current market and a value proposition that will be disruptive across multiple markets, positioning RH to gain market share throughout fiscal 2024. While a product transformation of this magnitude will be margin dilutive in the short term, we believe it will become margin accretive over the long term as selling rates stabilize and allow for supply chain and sourcing efficiencies. Platform expansion. Our plan to expand the RH brand globally, address new markets locally and transform our North American Galleries represents a multi-billion dollar opportunity. 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 in home 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 was beyond our expectations, with RH Munich hosting over 900 chic attendees roaming the three floors with 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 of 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 into, 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 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 the 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 place- maker 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 are also anticipating 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 over 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. 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 the leading designers, artisans and manufacturers, scaling and rendering their work more valuable across our integrated platform, enabling RH to curate the most compelling collection of luxury home products on the planet. Our efforts to elevate and expand our collection will continue with the introductions of RH Couture 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 product to conceptualizing and selling spaces, by building an ecosystem of products, places, services and spaces that establishes the RH brand as a global thought leader, taste and place maker. Our products are elevated and rendered more valuable by our architecturally inspiring galleries, which are further elevated and rendered more valuable by our interior design services and seamlessly integrated hospitality experience. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our galleries into RH guesthouses, where our goal is to create a new market for travelers seeking 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, elevating and rendering 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 primetime. 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.
Operator: Thank you. [Operator Instructions] Your first question comes from the line of Simeon Guttman of Morgan Stanley. Your line is open.
Simeon Guttman: Hi, everyone. Hi, Gary, Jack. Good afternoon. I want to ask about contemporary. I know it's early. I think some of the research was that it shouldn't cannibalize other aesthetics. I don't know how much data you have on it yet, but is that fair and how sales are progressing? And then I don't think -- can you just remind us, you never touch pricing on contemporary? I know we talked about changing some pricing on some items, but I don't think it's ever related to the new collection. Thanks.
Gary Friedman: Yeah, we reviewed kind of pricing and our value equation throughout the brand. So everything was touched. I mean, it’s -- if you look at the contemporary brand, the contemporary book, this remailing of the book, it's got a very high new content. So, but all the products kind of been, I don't think there's anything we didn't reprice. So, yeah. But look, the contemporary book got in mid-October, early to mid-October, it kind of hit right as the war was breaking out and interest rates peaked. So it was hard to kind of see the initial reaction to it. There's collections, like any collection, there's collections that are selling really well. Some are selling good, some not so well. I feel very confident that the overall mailing of contemporaries is going to be incremental, as we believe interiors has been and as we believe modern will be and as we believe couture upholstery will be and bespoke furniture will be and everything we do. So look, we couldn't be more excited. We're sailing into the probably one of the biggest headwinds any of us have experienced in the housing market, while it's not the great recession of 2008/2009, it is from a housing point of view. It's that bad. So, you're laughing really big down numbers in the housing market and they're still down. So you've got a little lift in the new home markets but that's only 10% of the market. So we've got, As I said in this latest shareholder letter, and I said last time, we should continue to see our business inflect through the rest of this quarter and into through the first half of next year and hit an inflection point I think kind of mid-late to second quarter and that'll be despite kind of the housing market unless there's something where 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% are 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, we're 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, by a lot. Like, when this [has] (ph) we'll outperform you know the market and the competition, I think, over the, 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 everybody got 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 has been. And I think what you're seeing now is the people that got promotional are now going to have lapped their promotional stance and they have to go up against that. So that was a lever post-COVID for people to, yeah, turn on the promotions, lift the business. Now everybody's cycling that and, I think you're going to see people's, as you're seeing it, people's and businesses inflecting downwards in this environment and our businesses inflecting upwards and it will continue to do so.
Simeon Guttman: Can you -- as a follow-up, can you talk about your own inventory position, the ratio of discounted or clearance items? Because you mentioned the shifting to that could weigh on margin. And if you have stuff that needs to be cleared or contemplated to be cleared, does it make sense to tactically move it out of the way to make way for all the new product that's coming?
Gary Friedman: We are. We just don't want to lead with clearance and lead with pricing. I mean, we'll have a few emails that go out there that talk about end of year sales to deal with the clearance goods and stuff like that. And we'll be aggressive pricing those goods. So we get the inventory clean, turn inventory into cash. We don't want it sitting around on the balance sheet. So, yeah, you'll see it take the appropriate action here. And so, but nothing we wouldn't normally do. We would still want to leave with promotions or start to turn the business back in that direction. We're almost to the other side of this thing. I can't believe, maybe we've got another six to 12 months, but I think, yeah, you get to the second half of ‘24, unless again, unless they haven't got inflation under control, I think we're going to see the Fed take an easing approach. I would be surprised if they left interest rates at these levels the entire year next year. But nonetheless, even if they do, you're going to see us perform pretty well in any environment based on -- just based on the work we've done and what's in the pipeline and the plans we have. I mean, they're all very big moves. This is by far the biggest product transformation in the history of our industry. It's multiple times bigger than anything we've ever done.
Operator: Your next question comes from the line of Steven Zaccone of Citi. Your line is open.
Steven Zaccone: 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?
Gary Friedman: Yes. I mean, we're not -- we don't have a strategy to protect the operating margin. I mean, we're -- you're comparing it to 2019, are you kidding me? Like why would you do that? It's nothing like 2019. We're in the biggest housing downfall than anybody's seen.
Jack Preston: So there’s, massive, massive inflation, since that time.
Gary Friedman: Yeah
Jack Preston: On so many items of the P&L cost.
Gary Friedman: Yeah, yeah. So that's not where I'd be focused. Like I mean you can focus there, you'll just miss everything that's going to unfold here, if you want to focus on that. I mean we're investing for the next cycle. We're investing for the long term. We're not trying to protect the operating margin a point or two. I mean, if that's going to get people really fired up about the long-term strategy of this company, it's probably the wrong shareholders.
Jack Preston: And Steve, the -- just one thing to comment about -- again, you mentioned the lever, but just more of a point of a tailwind is that we have elevated markdown activity this year, that as we cycle through that next year that could on unveil itself as a tailwind next year. So we'll talk more about that in March. But that's one aspect that's positive.
Gary Friedman: Yeah. I mean the operating margins are going to be fine. So the cash flow is going to be fine. We didn't buy back $2.2 billion of stock because we think the model has a problem. We're going through the biggest transformation in this entire industry. And so you want to think about what's going to be on the other side of that, not with the operating margin in the next quarter or two. Whether that bounces around a point or two -- it's not -- as the biggest shareholder in this company, that's not what I'm worried about.
Steven Zaccone: Okay. Fair enough. A follow-up then on just the promotional aspect to the furnishings industry. How long do you think that lasts? Is that something that continues for the next couple of years? Or is it something that probably is finished by the end of '24?
Gary Friedman: You mean just the broader industry?
Steven Zaccone: Yes.
Gary Friedman: Yeah. No, I think the broader industry is back to pre-COVID pricing and promotions, and it will be there forever now. Once you turn that on, you can't go back. So maybe the e-mails look different or they call them different, but you go look at the websites that -- I mean, go -- I mean, you're getting pelted with sale e-mails and have been for over a year. And that's why, as I said, that's why everybody is now cycling that. And so there's easy business. We could have turned on promotions, over the last year on the other side of COVID and moved our business 15 to 20 points. Just would have permanently created a different model. And so look, some people are promoting and cutting ad costs. Some people are doing a lot of different things and hoping they have a massively different model. I just -- there might be people that come out of this thing with a slightly better model. Maybe there's some things they learned, maybe they don't have to spend as much on ad cost, maybe this or that. So -- but it's not really people that we compete with that I'm too concerned with. I'm more focused on what we are doing and what our big strategies are and how this business is going to be positioned for the next five years. And we really like what I see. I think this is the best work we've ever done. So what you're going to see unfolding over the next several quarters and not just -- it won't stop there. While I say that the inflection point will peak in Q2, that's just based on what's in the pipeline, which coming on the next cycle likely will create higher and higher peaks, right? Because we just -- we're creating an entirely new foundation for the business, a stronger, bigger, better foundation to the business. Where we got arrogant around pricing during COVID and we had all the price increases from the tariffs and then the supply chain and raw material goods going up, we're just a lot stronger, and we're going to play a very aggressive game because we can. We have the scale to buy bigger than other people. We have the scale to get better pricing. We have the platform to present it. And so where I think we've -- we lost some market share because we were slow to kind of ramp back up the product development and marketing of the business post-COVID, we rebuilt those muscles, where we were arrogant from a pricing point of view, there's no arrogance anymore. There's incredible competitive focus to win. And so as the market is going to do what the market does. I don't know if I was -- all the people that are out there that have been promoting this past year, what are they going to do stop promoting their business will go down 15 or 20 points. Yeah, I have -- try not promoting to the furniture business when you've been promoting, like it just doesn't work. You have to go through a whole year cycle like we went through when we moved to membership. That's a painful thing to do. And you have to be someone who owns a lot of the company like I did. Otherwise, you're going to be a CEO that's under attack by activists. If you go through a transition like that. So there’s people that say, we're going to do like an RH membership model. Good luck with that. It's -- they're not easy things to do. We spent three years planning that and transitioning the business and the model, but to stop promoting when you've been promoting, you're back on that promotional drug. It's -- you can't just get off it.
Operator: Your next question comes from the line of Chris Horvers of JPMorgan. Your line is open.
Chris Horvers: Thanks, good evening. So a couple of follow-up questions on the gross margin. So do -- once we get past holiday, do you think you'll be clean to start '24? And is it fair to say that the vast majority of the non-fixed cost deleverage in gross margin was clearance? And to your comment, Jack, is there any reason why you wouldn't get that back, presumably with all the newness you wouldn't expect a lot of markdowns cap?
Jack Preston: Yeah. I think -- look, I think transition out. Yeah. Look, starting the year, we're going to be in a better position than let's say, the start of the quarter, but I think we'll be going through continuing to sell through the markdown goods by the end of the first half, that's probably...
Gary Friedman: Yeah. I mean we'll always have some level of markdowns, right? But what you want to think about what does the overall mix look like? So the mix is going to be a heavier markdown mix in Q4, and you'll have some of that move into Q1, it will quite lighten up and to lighten up in Q2, as we sell down. And you're going to have -- as the quarters go, you're going to have a higher mix of new higher-margin products. Yeah. So what I said in the letter, over the short term, it's margin -- the transformation we're making is margin dilutive. But long term, it's margin accretive. It's mix shifts, as inventory rebalances. So...
Chris Horvers: Got it. And then one of the questions we also get from investors is trying to think about, there's a lot going on with all the new galleries and the accelerations of the books, the Source Books back to what it was, pre-COVID. As you think about what's implied here or the third quarter SG&A dollars is like, is that the right base? I guess said another way, does advertising -- is there any reason advertising steps up again next year? And if you think about the complexion of the openings next year with more International, are we just sort of naturally raising the expense base given those two factors?
Gary Friedman: Yeah. I mean when I see perfect time to guide next year, we'll guide next year. So we're not in next year right now. But look, there's always going to be certain start-up costs, right, when you're ramping up new countries and things like that, and investments to get the galleries up and running to get people trained, to get restaurants opened to get the home delivery network set up and operating and people trained and then you'll cycle those things, right? So are we going to have some cycles to get around as we open different countries? Yeah, sure. But once businesses ramp, you cycle those things. So, yeah, we have a lot of confidence in the long-term margin of the business and the model. So I don't think there's any reason why this -- why this business and brand doesn't get back into the 20% range, as we cycle through. I mean, you're not going to get there in one of the work housing market. This is -- I mean, we compared the exact numbers to 2008 and 2009, but this is -- if it's not the worst, it's the second worst in my career. And I think I've been doing this as long as anybody leading the company in this industry. There might be some people that have been doing longer than me. I don't not too many. But I haven't seen a market like this and how to navigate through a housing market downturn like this. So I can't remember when people were locked into low interest rates and they can't step up different interest rates. So you got to kind of look beyond this kind of temporal time. I can't believe that we're going to be in this lockup like this forever. Like, could it go through '24? It could. So what? It doesn't change the long term. And we're -- the good thing is we've now cycled around. So we didn't bite on the promotional drug like everybody else did. So we gave away some market share because we didn't do that. But at the same time, we've sharpened our value proposition at regular price, and we're going to be tough to compete with, even if people go on sale. Yeah, people don't -- they just don't have the buying power of the platform to present it that we do. And so I wouldn't want to be on the other side of this big move we're making.
Jack Preston: And Chris, you asked about Q3 being a base. We don't look at it as a single quarter as a base. You've heard me talk about, if you're going to try to read some trends on the base and look for a full four quarters, given the -- given the cadence of the advertising timing and the -- you can't just use the quarter.
Gary Friedman: Yeah. I mean we used to be able to mail a book and we amortized it over six or 12 months. Now you e-mail a book and the day you drop it is the day the ad cost is. So -- and obviously, the book is more valuable than that single period. But there's just an accounting rule change that is going to make a business like ours kind of lumpy, right, from quarter-to-quarter, based on the ad bus hitting when the book drops. No amortization of the ad cost which doesn't make sense. You're not going to get all the sales that we...
Operator: Your next question comes from Curtis Nagle of Bank of America. Your line is open.
Curtis Nagle: Great. Thanks very much. Just kind of a quick one more of a clarification than anything else. So just in the share letter, there was a comment about reaching kind of a peak inflection point in second quarter of next year. Is that in terms of kind of ramp? Is that demand trends? Flow through revenue? Just if you could specify that a little bit more from that would be really helpful. I’d appreciate it.
Gary Friedman: Yeah. That will be demand trends, which will turn into revenue and there's going to be just continued step-ups. There's going to be step up since we get in stock. There's going to be step up since we finished the Gallery transformation. There's -- anytime you have big moves like this, you're going to have some things, some collections, that are just wildly better than you could have thought, and you're not going to have -- we have a collection here that is the best collection in the history of RH by probably 40%. We're not going to catch up on the inventory until March, April, somewhere around there. So there's -- and you've got all these imbalances when you have these much units. So you've got to kind of right-size all that. You've got to get in stock, because things like that and other collections and things are selling so well, you can't even put them in the stores, right? So you've got too much demand, so you've got to fill the demand. So some of the products that you're planning to transform the Galleries with now, is blown out. And then you've got to let the manufacturing base, just get their legs underneath them with all this newness, right? And they're going to get more efficient and things are just -- the flywheel is going to be running. Yeah, we will then have -- we're going to have the second round of the book mailings, which is going to have another, well, I mean, Modern is going to be massively new, but then all the books will remail in the first half. We -- Modern because we're pushing a little later may go in the third quarter. But all those books will have another -- probably an average 20% to 40% more newness, based on what's in the pipeline. So it's like we usually have 15% to 20% newness. And so it's -- basically, the entire brand is going to -- is going to transform and the assortment is going to expand on top of that. And so you just got to kind of get it all dialed in, get all the inventory balance, get everything set, some things you planned, you're going to put in the galleries in the retail galleries. And all of a sudden, the demand doesn't look good and you're like, no, let's swap that out with something else. And so you're reading and reacting to real data now. And so we like what we see in the data. We like what we have in the pipeline. We like when we dimensionalize all the trends and all the data and say, what does this all look like three months from now, six months from now, when this happens, that happens, that happens. And that's when we think we'll for this big transformation, that's when we should start to reach peak inflection.
Curtis Nagle: Got it. And then just a follow-up for Gary. Comments in Germany were interesting, right, a lot stronger, it sounded like than you had expected. I don't think you put a ton of marketing behind it. So what drove it? I mean, at least seeing online, great locations, beautiful exteriors all the rest of it. But in terms of just this response, what's resonating -- and anything you could say in terms of just, I don't know, the potential relative to some of the -- I guess the average size in terms of revenue for US, if you could size that unless it's too early.
Gary Friedman: Yeah. I think, just in general, we're in highly populated shopping areas, right? So in Dusseldorf, we're on the main stopping boulevard, dead center across from Chanel, a few doors down in Hermes, the main luxury shopping street and we're dead center. So there's a lot of people walking by and a lot of people walking in Munich, we're right in one of the key hearts to town and where there's a lot of people. And you really can't compare those to what we did in England, right? I said since the beginning, England, we didn't do England through a lens of commerce first. We did it through a lens of conversation first. How do we create the right conversation with the brand? How do we make the right first impression? How do we do something that's so extraordinary? It gets high-end luxury consumers to look at us differently, think about us differently. So England is really -- it's a big brand investment. But there's not a lot of -- there's no one walking by that store. Not a single human is walking by. You got to drive there. It's an hour and 45 minutes out of London. I mean the business is building. We just closed our -- today, we closed our biggest sale yet at $330,000 for where Chalet were.
Jack Preston: In the French house.
Gary Friedman: In the French house, the Chalet, the French house. But so the book of business is building, the design business with our internal interior designers is building, with our trade clients is building, all those pieces of business are building nicely and what’s funny, I really thought this time of the year, it's going to go slow because the weather is not that nice out there right now, and it's not like you're walking around the ground unless you've got some heavy coats and some rubber boots and stuff. So -- but our demand and our book of business and everything is building month over month. And so the brand, it's going to take a while for the brand to that just people know we're here and know who we are and what we're doing. And remember, people only buy furniture, at least every kind of five to 20 years, right, depending if you bought another new home or what you did. So you don't generally just go out to furniture stores, unless there's a need. So with RH England just doesn't have the traffic of the locations that we have in Germany. And so this is just our first look at the locations in Germany, and we like what we see. We like the people that are coming in, they're starting to engage our designers, they're starting to learn about the brand, some know about the brand. Some have lived in America, now live in Germany and some of telling it’s just the opening part of Munich. You had a couple of how they shift their -- been shipping their own containers to Munich. And now they're so excited we're here, now there and -- so we had a lot of fans. I mean what I was -- I think, beyond my expectation was just the excitement for the brand and the quality of people that were at the opening events. It was -- I mean, it was as good as you could have expected. And so that -- again, that's again creating another conversation. Those people telling their friends and others, you just let that start building. And I would expect these countries are going to probably have pretty big compounding comps for the first years. Much bigger, like in America, when we open a new store, even if we're not in the market, we're already in that market. We're RH. Like we can open in Milwaukee next month, and we don't have a gallery there, but we do millions of dollars in Milwaukee. People are shopping from us online. They know the brand. And so when we open in a place like that, people are lined up, ready to shop. There's people that have been shopping, they're ready to place transactions and place orders, and you have immediate demand. I think in these new countries, people are going to come in and get to know us and we'll start working on -- they'll get to know the brand, we'll start working on design projects and then people will get familiar with who we are, what our prices are, how we compare and start to interact with us. But it'll happen faster in Germany than it did in England. Like, there's just not that much traffic. I mean, we did catch the back half of the summer. And so we did have some really high quality traffic out there. But I think, what I'm amazed by in RH England is that the demand is building into a slow season. I'm like, that's interesting. So we like that. And we've only mailed one book, and not to that many people. So just learning about how you invest in marketing and advertising and building the brand, it would be a lot to learn here for us. So, but we like what we see. I mean, I'm pleasantly surprised how the business is continuing to build in RH England. I'm really happy with just the initial turnouts for the events and then the amount of traffic just coming into the galleries, just exploring and coming to see us. So the demand, if that's happening, the demand will then start building. So we'll see, but we're going to know a lot more every quarter, every six months, every year here.
Operator: Your next question comes from the line of Max Rakhlenko of TD Cowen. Your line is open.
Max Rakhlenko: 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?
Gary Friedman: Yeah, it's funny. We don't primarily look at it. It's really, what we look at is kind of one giant assortment packaged in different vehicles, right, that allows it to break through and, present an aesthetic and so on and so forth to the consumer. But it's not like we sit here and go how's contemporary doing, how's interior doing, how's this? We say how's the furniture -- the upholstery business doing? And we're looking at every sofa in the entire assortment, whether it's interiors, contemporary, modern. So it's not so much the books from how we manage the business. The books is how we present it to the consumer. We look at the entire RH assortment, right, and then we're looking at, the books they're in and how we're going to adjust and what's working and what's not working and so on and so forth. So, when you think about it, maybe from the way you're thinking about it, will that assortment, when you parse it out, how big will it be? It depends on how big we make that book, how big we make that assortment, how many things we put into contemporary or how many things that wind up going into interiors and how many things go into modern, because you've got some things that, that the lines are blurred. We could put it in almost any of the three books. So I think about -- the way the way I think about this today is RH is going through a massive product transformation. It's the biggest thing they've ever done. How does the whole thing look? And as the whole assortment gets out there, interiors, contemporary, modern, outdoor, as the books get out there as the products get into the galleries, as we get in stock, what does that total assortment look like and how is it performing versus the old assortment? We think it's going to be meaningfully accretive.
Max Rakhlenko: Got it. That's helpful. And then, no that's great. And then I guess, can you speak to the phasing of the new products to galleries and your confidence of completion by the end of the first half of 2024? And then specifically, will all the galleries be touched? Will some get more newness than others? Or how should we just think about the totality of the in-gallery resets?
Gary Friedman: You mean the resets, of course? The floor sets. Yeah, I think they're being done in stages, as we're ramping up inventory. And it depends again, if that, if you're ramping up, if all of a sudden you have some really high performing collections, you're just not going to be up, you're going to have to fill demand and not put the goods in the galleries, right? You're going to have to wait. And so I'd say we're going to get, I don't know, 90% in stock in Q1 or something.
Jack Preston: As far as completion of the four sets, probably a March time frame. It wouldn't be the end of the quarter, but rather where we are today, it's probably March.
Gary Friedman: Yeah, and some galleries will get prioritized versus others. And yeah, I think it's -- I think we'll be in really good shape by the end of Q1 going into Q2. And then I think by mid to end of Q2, that's why I say that should be our kind of inflection point. I mean, based on all the numbers we're looking at today, we don't have data on modern yet, we won't until we mail that. So that'll have same kind of challenges, lots of new product. We're going to, with any new product, when you don't have data, you're going to be 100% wrong with your inventory investment. Like I've been doing this a long time. I've never seen anybody buy a new product exactly right. So you're going to be a little overbought, underbought, a lot overbought, underbought. So if you just don't, you don't have exact science, you don't have any trends on any of the newness. So, it takes, takes a few quarters to kind of get the trends, read the trends right, make the adjustments you need to, get the on orders corrected, make less of this, make more of this and let the factories get adjusted, as they're ramping up on a lot of new products. But that'll all work itself out. Again, I just think about this as like, the next couple of quarters will be meaningful. If we're sitting here, the end of Q2 and we didn't get the inflection point we needed, that would surprise me. That we think we're going to get, it's not a little one, it's going to be meaningful and it’s going to keep building, as all these things happen, in-stocks, gallery sets, modern, outdoor, and then a recycling and remailing of those books with more newness, right, with probably 30% to 40% more newness. And then you'll have some adjustments with that 30% to 40%, but that'll be much smaller compared to what we're doing today.
Operator: Your Next question comes from the line of Steven Forbes of Guggenheim Securities. Your line is open.
Steven Forbes: 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?
Gary Friedman: I think it's all going to depend on what the macro is doing in the housing market. Yeah so the housing market stays where it is. I mean -- again, let us guide you next year, like you'll get a better sense. So we'll have a little bit more data. But, I just say generally, I'd be surprised if anybody's outperforming us when we get to Q2 of next year, I'd quite be shocked. Maybe someone will shock me. I don't think so.
Steven Forbes: 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?
Gary Friedman: Yeah, there's more than 70 now. We'll have probably -- when modern -- with modern hitting and outdoor hitting, it will probably be somewhere between 70 and I'd say up to 90. And with more in the pipeline. And we have a whole other book we're working on, that we haven't announced yet. So you'll hear about that, that we think is going to be meaningful. And it's not bespoke, it's not couture, it's something we haven't talked about. And that's going to be a whole new big thing. So, we're working on that too. Yeah, so just a lot's coming, Steve. Buckle (NYSE:BKE) up.
Operator: Your next question comes from the line of Michael Lasser of UBS. Your line is open.
Michael Lasser: 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?
Gary Friedman: Yeah I don't think we're -- well I mean did you miss the whole first part of this conference call? I can repeat myself. The transformations in the early stages, the goods aren't in stock, they're not in the gallery yet. We haven't been through a full mailing cycle. And I don't believe -- I think we've massively closed the gap. I think we're gaining market share in a lot of people today. And there might be a few people out there that are outperforming us at a demand point of view. I mean, they may not outperform us in the next quarter, say there's going to be an inflection very soon here. And so what do we have to do? Everything I just said. So I don't think you want me to repeat myself to you. Like, I don't think we've got to lower our prices anymore. I don't think we've got to -- the goods just got to get in stock. We got to get the galleries reset, and we got to go through the next cycle and we'll be off to the races.
Michael Lasser: 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.
Jack Preston: Michael, we've talked about this a few quarters now. We've given our turn and you know the way you know Fernando and his team attack ocean freight where the bulk of the increases in costs had occurred through the pandemic. Those turned over last year. We peaked in May as far as the highest contracted rates we've ever seen. And then every month thereafter, it's been a decline. And now, in many markets, we're back to or close to 2019 levels, right Fernando? So, as far as, kind of [any of the] (ph) product margin impact from freight rates, I mean, we're for the most part cycled through that given our...
Gary Friedman: 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.
Jack Preston: Yeah, we were just more nimble at accessing the spot market and taking advantage of the decline in ocean freight rates that really began last June, I think, June, July. So I wouldn't say there's any really that's quantifiable or if it is, it's de minimis for Q3.
Operator: Your next question comes from line of Jonathan Matuszewski of Jefferies. Your line is open.
Jonathan Matuszewski: 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.
Gary Friedman: Yeah, I don't know if we had any real expectations. People said, like, what could it be? Could it be, I said I don't know, could be $50 million, could be $250 million. And that's, I think about it as, we're going to keep kind of marketing the brand, right, to forget about RH, that gallery, think about that country, and what will our investments in marketing do to the direct business? What will the brand recognition do? How does it build? When do you get to certain run rates? I just think it's super early for us to know because we didn't open a typical store. If we would have opened in London first, it would be massively different. We opened in the countryside, we tried to do something super inspiring and something the world's never seen. And so making investment, it's like, it's just, I wouldn't get too focused on this gallery, right? This -- try to draw a conclusion of this one, it's not going to tell us, you're not going to get the right answer from this one. This is really a brand investment and to create the right first impression and the right conversation. London is going to be coming around the corner. We're looking at other locations in other parts of England, and we're going to be investing in marketing, right, and not just books but other types of marketing to drive the online business, But we're just in the early stages of all that. Just like I'm telling you, don't get too obsessed with RH England. From that telling us what the market's going to be for us, I'm not too obsessed about that because it'd be the wrong place to draw conclusions from. It's like, has anybody opened a store like that anywhere in the world in any category? Somebody name something similar to that. Just think about that. Like if you've seen it, if you've been there, you know, anybody on the call, if you haven't, take a look at the pictures. Have you ever been to a retail store like that? No. So if you try to draw too many -- we're not going to really do another one like that, right? So don't -- we've got other things like seeing how -- how does Germany build? That's a lot more normal. We're on streets where there's a lot of people walking by, driving by, so on and so forth. It's a different -- there are two different objectives and goals and visions, right, and strategies for the two. They serve two different purposes. So, did I think, RH England, like, there's a number I always had, and it's a modest number. And -- like what you don't know is, okay, when you open up a brand to an entire country like England, how does that go? How does it grow? What marketing do you have to do beyond RH England? We're still learning. So, we're not in a hurry to jump to any conclusions on any of this. We're really happy with the work we've done, with the team we have, with the initial, you know, feedback we're getting from consumers and the kind of people that are coming and all that looks directionally right. So, over time, we'll all take care of ourselves. England's its own thing. There's nothing like it in the world. That's why we did it. To get people to see something they've never seen, think about our brand in a different way, have people at the highest levels of the economic ladders, like, who are shopping the best luxury brands in the world and stuff. Look at us differently. Think about us differently. So they're all, they're all long term, things like that are really a long term investment. It's like a guest house. Yeah, we opened what we believe is the highest quality hotel experience in New York City. It's not one of the best in the world. I'm not looking at that thing to really tell me am I going to roll out a lot of guest houses. No. I'm just trying to communicate differently about a brand to build something that no one's ever built before. It's like somebody just wrote a report that I thought was one of the most comprehensive reports written about our company. Went all the way back to the very beginning, wrote about everything, wrote about RH music, when we had a record label and we were -- we did a concert at the Greek theater and we did performances in all of our new galleries and we had RH contemporary art and we owned the rain room, the most exhibited art exhibit in the history of the [indiscernible] New York and the history of the [Lackland] (ph) New York. And I remember being at the Goldman conference and someone asking me about RH music and yeah, this is not and like, and I said, it's just a different way of communicating. I could go run ads digitally or in print or do anything. Like, I don't know, how do you really measure those returns? If it was that easy, if everybody had really great data on digital advertising, don't you think everybody would have a really high performing business? They don't. They don't know how much to spend, they don't know what they're getting for any of it. Google (NASDAQ:GOOGL) and other people try to give you great things that make you spend more money. Look what you're going to find out. They clicked on your name. You don't know if they clicked on your name because they came in your store, or how they got there. It’s -- but it's just a different way of communicating and building a brand. If you're going to build something unlike anything anybody's ever done, you don't take the same path as them. But we got here and we did things like RH music and we had three artists for, I don't know, three years and we produced albums, and we did concerts, and we did other things. And I think people thought it was really cool, and it made our brand look different, and had people think differently about us, like who are those people, and we did RH Contemporary Art and we had the Rain Room, first piece of art we brought, but became the most attended exhibit in the history of the world. I mean we're not always going to get it right, but I'll tell you anybody who's been to RH England thinks differently about RH and thinks about, those are pretty interesting people. And we're trying to build something special. It's just not a game plan anybody else is running, because they're all running the same game plan, for the most part. We're running a different one. So at different times, it's going to be hard to look at, hard to model, hard to understand. But that's how it should be, by the way.
Jonathan Matuszewski: 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.
Gary Friedman: Yeah, I mean, well, it's just, it's because of our scale and buying power and confidence and like if you look at, you look in our source books or you look online and you look at the Jacob Chair, for example, and if you go look at it everywhere else and look at the pricing and you look at our pricing and you look at our assortment and you look at our presentation, you might have an ankle biter here or there and someone just bought 20 shares and they're not making any money and they're going to match our pricing. But there's no one that can really buy as much as we can. There's no one that can present it on a platform as big as ours and mail as many books as we do and get behind it. And a lot of people don't place the financial bets we do on product. We do that very well. That we got to where we are. So if you -- we've got people who are selling their version of the Jacob Chairs and they pulled it off their website because their price was so embarrassing and they already own the inventory at a much higher price. So now they don't know what to do. So they're probably sending it to an outlet and they know who they are. They're probably listening to this call and if you look at anybody selling the Jacob Chair, whether it's the cane Jacob chair, the upholstered Jacob chair, the leather Jacob chair, the dining chairs, the lounge chairs, I wouldn't want to be competing with us in that chair. And the margins are as high as anything else that we have. So it's not necessarily a lower margin when you think of disruptive pricing.
Operator: Your next question comes from line of Seth Basham of Wedbush Securities. Your line is open.
Seth Basham: 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?
Gary Friedman: Yeah, should.
Jack Preston: It should.
Seth Basham: 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?
Gary Friedman: Yeah, it's not that many. We're just going to -- we are going to get them open. We're going to learn a lot. We're going to focus on how do we build our business in these different countries and what kind of marketing investments they take and what they look like. It's not like you start with saying like what's going to ROIC going to be in Germany? I don't know, I've never sold anything in Germany. Like what's it going to cost to build the brand, to have people come, to build up the design book and the trade book and everything else. So, again, it's a handful of galleries, right, it's 10 altogether. I think we've got 10, nine or 10. 10, yes, we do yeah, because two in Sydney and the two in Madrid and stuff. So we're going to get them open and we're going to start learning. And we're going to make all kinds of adjustments and get some things right and get some things wrong and work really hard to make it great. But you know I like how we're starting. I mean like we look -- you go into Germany, we look really good. I mean the galleries look great, the teams are fantastic, the right people are coming in. So it's really encouraging being in Munich, getting a really good feel for it. So yeah, I mean obviously very different than England. And so we didn't have to spend much capital in those two galleries. We took over a couple of the Abercrombie & Fitch flagships and refitted them and we didn't have to build them like some of the other ones or like even in RH England where we had to rebuild it. So yeah, so they're all going to have different kind of ROIC dynamics to them. But it's really, how does it all blend out? What does it look like, year two, year three, as it ramps once you cycle some of the initial investments to get home delivery up and going and all the investments we have to make. But the real big key, I’d say it's like -- it's going to be the inflection of the US business. That's the key, right? That's the big thing to focus on. These things, they're going to kind of take their own path and we'll learn and we'll make adjustments but we're getting these openness. I don't mean to minimize it. I mean it's just -- I think it's kind of unrealistic to have really specific goals for these. We just want to be directionally right and then we'll refine it and learn and continue to improvise and improve everything. But our big focus is to inflect the US business and the North American business and get back to taking market share and getting our margins back to historical levels and we're going to, for part of it to get to historical levels, and operating margins in the 20% range, we're going to need the housing market to unfreeze here and kind of return to a somewhat normal housing market. And that could take another 12 months. I don't know.
Operator: Your next question comes from the line of Peter Benedict of Baird. Your line is open.
Peter Benedict: Oh, hey guys, happy holidays. Follow up on that comment there, Gary, just so I was going to ask you about the conditions you thought were required to get you back to that 20%-ish operating margin, clearly that an unfreezing of the housing market. I was thinking more is there a revenue level or scale in business around $3 billion now given the cost increases across the P&L just post-pandemic, like, is there a revenue level that you think is required to maybe support that? That was kind of my first question.
Gary Friedman: Yeah, we know that answer, but I don't know if we want to say that right now. I mean, like, I think it'll -- we clearly have some amount higher than today. We've said that the margin will, both gross margin and operating margin, will naturally lever as we as we as we build back the revenue here. So, but we're not ready to give you that number.
Peter Benedict: Okay got it. Fair enough. I mean other question was just around the membership fee. We just know that you took that up to $200. Just curious the rationale behind that decision that just happened here maybe in the last month or two. So that's my second question. Thank you.
Jack Preston: Yeah, we just had plans to bump it up a bit. So it's a natural progression of our business. When we started membership at $100, and for years we didn't move it but the AOV of the business had increased and so when we first moved it to $150, we talked about that we were kind of -- we might see a more regular cadence of increases. So I would just say this is just part of that and then reflects the sort of average order value of our business continuing to creep up. And so it's membership as a percentage of that is one way we look at.
Operator: And our last question comes from the line of Brad Thomas of KeyBanc Capital Markets. Your line is open.
Brad Thomas: Hey, thanks so much. Gary, I was hoping you could talk a little bit more about the outlook for gallery. When we look at what you've done in Indianapolis and what you were working on for Miami, really pushing the boundaries here of what's going on in the US. I think the letter referenced 40 additional markets you're looking at. I was wondering if you could just expand a little bit more on what you think the US gallery network looks like 10 years from now with this continuing evolution.
Gary Friedman: Something like Indianapolis is an opportunistic move, right? An incredible home and estate came on the market. We bought it for $14.5 million. Is that what we bought it for? Yeah. It's in our joint venture. So we own 50% of it. And it's just an opportunity to get something like that for a $14.5 million investment. What we put into it was pretty minimal versus what our normal investment was. So we have this incredible experience for the customers at a lower investment rate than we'd make, and the lower occupancy costs than we would expect to have. So that was just a -- that's kind of a one-off great outcome. I mean, we're always looking for things like that to come up, but I wouldn't say that's like you're out looking. We are not really looking for something like that. Like that just, they just kind of happened. So, I think that's just an opportunistic move. But, what does it look like 10 years from now?
Jack Preston: We have 35 legacy galleries. We'll have more and more of those converted. We'll also go back to the existing design galleries. We've talked about certain ones that are going to have the next iteration, like a Houston for example will have a big gallery. Los Angeles at some point for example. That in North America will continue. And the 40, Gary talked about the design markets of the 40 and the logic there. So that's the whole kind of different animal, I guess, in terms of adding to the store base.
Gary Friedman: Yeah, and we may learn in some of these smaller kind of what we refer to as a design studio, it's really in Palm Desert, it's like a design office, right? It's really enabling entrepreneurs, interior designers that maybe don't want to work in a retail gallery and where there's market opportunities to do something to improve art and have a more dominant interior design presence, we think that's really good for the RH brand. So some of these will look a lot less like a small store. They'll look a lot more like an interior design office with, you know, a couple of small presentations to the product, but really a real office for an interior designer to work with clients in a highly professional way and attract entrepreneurial people that want to run their own interior design business. And we become a platform that can support them and allow them to do what they really want to do. Yeah, so we may for example, like in the first one that we got in Palm Desert But how big is that? It's like 3,000 feet. Yeah, it's like 3,000 feet. We're also looking to probably do a 10,000 to 20,000 square foot gallery there, probably 15,000 to 25,000, call the range, in that market. And we'll have both of those locations. One's really a true interior design office, but that gallery that we'll build, probably won't have the same dedicated space for interior design that we might have in one of our big galleries where we have interior design embedded into the gallery. So, this gives us more flexibility, reach more markets, activate the interior design business, which is a growing part of what we do. And I think we're going to learn a lot of these, where there's opportunities for even bigger stores. Like, if we're right on this transformation that we're kind of, that began here and we're right around about how the business is going to inflect, that's just going to meaningfully take up your volumes and all these markets, makes all the occupancy models look different, right? And allows you to access different things and invest in different ways. So, we're going to, I'm sure we're going to have an even new, a new view in the second half of next year. As our baseline performance improves, it changes your economic outlook from a real estate point of view.
Brad Thomas: That's great. Thank you guys.
Operator: There are no further questions at this time. I will now turn the call over to Gary Friedman, Chairman and CEO, for closing remarks.
Gary Friedman: Great. Well, thank you, everyone. We appreciate your interest. We wish you all a happy holiday and I would say to team RH, we just can't tell you how much we appreciate the energy and the commitment and passion you bring to our business and to our brand. You are the heart and soul of this company. You are the ones that interface with our consumers every day. Thank you for making us so proud and especially the teams that just brought our international galleries to life. I mean just incredible what we've done. We're in Germany what just two weeks ago or 10 days ago and you walk in, you interface with the people, you look at the gallery, you think it was in North America. I mean -- and to be at the very beginning of this and to be executing at that level and to have that quality of people and that energy in the galleries, just gives me and the team here a great deal of confidence of what we can do globally with this brand. So we wish everyone a wonderful and happy holiday and wish for peace in the Middle East and hopefully this world becomes a more peaceful place very soon. So happy holidays, everyone.
Operator: This concludes today's conference call. You may now disconnect.
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