Rh (RH) Q3 2024 Earnings Report, Transcript and Summary

Hello, and welcome to the RH Third Quarter Fiscal 2024 Earnings 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 would now like to turn the call over to Allison Malkin of ICR. You may begin.

Thank you. Good afternoon, everyone. Thank you for joining us for our third 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 our actual results to differ materially. Please refer to our SEC filings as well as our press release issued today for a more detailed description of the risk factors that may affect our results. Please also note that these forward-looking statements reflect our opinion only as of 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, and welcome, everyone. I will start with our shareholder letter that was released in the last hour to our people, partners, and shareholders. The positive inflection of our business continued to gain momentum with third quarter demand increasing 13% despite operating in the worst housing market in 30 years. Our vector is increasing in both magnitude and direction, with November demand up 18% as the most prolific product transformation and platform expansion in the history of our industry continues to unfold. Our industry-leading growth is being driven by the RH brand, where November demand increased 24% with the introduction of our new RH Modern Sourcebook and has continued to accelerate into December with month-to-date demand up 30%, demonstrating the disruptive nature of our product transformation. The performance of the RH brand reflects market share gains of 15 to 25 points in Q3, accelerating to 25 to 45 points in Q4 based on our current trends and the expectations of furniture-based retailers. We believe our collections reflect a level of design and quality inaccessible in our current market and a value proposition that is disruptive across multiple markets, positioning RH to gain significant market share for the foreseeable future. Our Contract, Outlet, Baby & Child, and Teen businesses should benefit from our product transformation in 2025 as, one, the new assortment becomes more widely available to support our Contract Business, two, returns of the new product drive our Outlet Business, and three, the most successful designs are translated into smaller sizes for Baby, Child, and Teen. We are also pleased that our results for the third quarter reflected our guidance with revenues increasing 8.1%, adjusted operating margin of 15% versus 7.3% last year, and adjusted EBITDA margin of 20.8% versus 12.4% a year ago. Based on current trends, we are raising our fourth quarter and full year guidance to, Q4 total demand growth of 20% to 22%, and revenue growth of 18% to 20%; Q4 adjusted operating margin of 12.2% to 13.2%, and adjusted EBITDA margin of 18% to 19%; fiscal year total demand growth of 9.9% to 10.4%, and revenue growth of 6.8% to 7.2%; fiscal year adjusted operating margin of 11.5% to 11.7%, and adjusted EBITDA margin of 17.2% to 17.4%. 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. We believe the important investments we are making during this depressed housing cycle are creating a level of strategic separation in our industry that rivals the most important brands in the world. Our product transformation plan for the remainder of 2024 and select 2025 highlights include, the second mailing of our new RH Modern Sourcebook arrived in homes in November with 54 new collections across furniture, upholstery, lighting, rugs, and textiles. Based on our demand trends and confidence in the new offering, we increased our advertising investment by approximately $6 million in the quarter to further expand both page count and circulation. The quarter-to-date demand leads us to believe that this investment will prove to be a wise decision over the course of the fourth quarter and into the first half of 2025. As a reminder, post analysis of our circulation data, we decided to consolidate our RH Contemporary Sourcebook collections into the RH Interiors and RH Modern Sourcebooks 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 introduction of our new RH Interiors Sourcebook is now planned to be in homes early February with 89 new collections across furniture, upholstery, lighting, rugs, and textiles. The new collections and improved in-stocks, should further increase our vector and market share gains in the first half of 2025. The introduction of our 2025 RH Outdoor Sourcebook, featuring the most dominant assortment of high-quality outdoor furniture in the world is also planned for early February. The new Sourcebook will include eight new outdoor furniture collections, an exciting new outdoor textiles offering, plus a significantly improved in-stock position to start the season versus a year ago. 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 to further elevate the brand and build 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. This week, we will begin to introduce the Waterworks brand across the RH platform beginning with a 3,000 square foot Waterworks Showroom in our largest new Design Gallery opening tomorrow in Newport Beach, California. Our interior designers around the world will now be able to specify Waterworks in their design projects and customers will be able to view and purchase Waterworks on RH.com in the next few weeks. We also plan to test a Waterworks Sourcebook in the second half of 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. We also have plans to unveil RH Couture Upholstery by Dmitriy & Co. in the first half of 2025. We purchased Dmitriy & Co. in 2020 with a vision of making the most exquisitely designed and crafted upholstered furniture in the world, previously only available to-the-trade, accessible to consumers on the RH platform. While there has been much speculation regarding how we might change Dmitriy & Co. to address a larger market, our plan is just the opposite. We believe, by not changing anything, we will change everything. Like Waterworks, we believe transitioning some of the most admired brands in the world from a solely trade-based to a blended consumer and trade-based business model is a very big idea, and one that can result in exponential growth for these highly desired brands. Additionally, we plan to introduce a significant new brand extension in the Fall of 2025 that we believe will meaningfully expand the market size and share of the RH brand. This new brand extension will include a new Sourcebook and have a significant website presence on RH.com. We expect to present the product in our Galleries in early 2026 and will share more details of this exciting new venture in the new year. Lastly, we do not expect a negative impact to margins as a result of the most recent communications regarding the potential for increased tariffs in 2025. We have been proactively moving sourcing away from China over the past several years with the expectation of fully exiting the country by the end of the second quarter. We are also transitioning products manufactured in Mexico and believe we can successfully reposition our sourcing with no disruption to the supply chain. 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 remainder of 2024 and 2025 includes, RH Newport Beach, opening tomorrow 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 experiences to date, and will replace three legacy Galleries in the region. RH Newport Beach, The Gallery at Fashion Island features the RH Ocean Grill, a 270 seat Indoor-Outdoor Rooftop Restaurant with uninterrupted views and dramatic sunsets over the California coastline, two Wine & Barista Bars, our first Waterworks Showroom, an Interior Design Atelier, and the most expansive Luxury Outdoor Furniture assortment in our industry. We believe 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 Montecito, also opening this week, is a reimagination of the Historic Fire House in the charming enclave perched above Santa Barbara. The Gallery will feature The RH Firehouse Grill, an indoor-outdoor Courtyard Restaurant with fireplaces and fountains, a Wine & Barista Bar, plus an Interior Design Atelier. The first RH Interior Design Studio is opening this week in Palm Desert, California. Our goal is to establish RH as the leading interior design firm in the world, as we've moved the brand from simply curating and selling product to conceptualizing and selling spaces. The Palm Desert location is a unique test of a consumer-facing interior design firm, not a Gallery. Our theory is, by presenting RH Interior Design in a singular fashion, as a professional interior design firm, we will attract the highest caliber interior designers, and therefore the highest value consumers. We believe this might be one of the most important strategies to elevate and distinguish the RH brand as a global design authority at the highest end of the market. We are also developing an RH Design Ecosystem in Palm Desert with plans to add a 10,000-square-foot RH Design Gallery and a freestanding 5,000-square-foot RH Outdoor Furniture Gallery on the same street. Additionally, we are considering a freestanding RH All Day Cafe to complete the ecosystem in the near future. RH Raleigh opened in November of this year with 50,000 square feet of indoor and outdoor space over three levels, The Gallery includes a Rooftop Restaurant, Garden Courtyards, a Wine & Barista Bar, and an Interior Design Atelier. We plan to open seven North American Galleries in 2025 including Montreal, Manhasset, Detroit, Oklahoma City, Los Gatos, Palm Desert, and Aspen. Additionally, we plan to open two International Galleries in 2025, RH Paris and RH London. 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 gain scale to support the advertising investments necessary to build our business across Europe. We are pleased with the second-year growth trends at RH England as the Gallery is up 42% July through December, while the web business is up 111%. Current demand trends would indicate the Gallery would reach approximately $31 million in its second full year, with the web demand reaching $7 million in its second full year. To put these results in the proper perspective, if an RH Gallery in the English Countryside, with an estimated population of 100,000 in a 10-mile radius, almost two hours outside of London, can generate $38 million of demand in its second year, what can an RH Gallery in the center of Mayfair, the most exclusive district of London, a global city with a population of 9.7 million, do in its second year? We believe exponentially more. We are also making meaningful investments to elevate and differentiate our online experience with plans to upgrade our website in the fourth quarter of 2024 and throughout 2025. 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. Leaders have to be comfortable making others uncomfortable. Leadership is about pursuing a vision, leading people somewhere they've never been, doing things they've never done. As creatures of habit, changes are uncomfortable for humans, but for the people and partners of Team RH, a culture of invention 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 investing in 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 in 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 paying strangers, influencers, to say they love our brand on TikTok, we chose to, in the words of Ralph Waldo Emerson, go instead where there is no path, and leave a trail. We aim to craft our own unique identity, one built on a foundation of innovation and invention, truth and trust, taste and style, leadership and love. 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, the insights and intricacies, the sacrifices made, and the 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. At this point, operator, we'll open the call to questions.

[Operator Instructions] Your first question comes from the line of Michael Lasser with UBS. Your line is open.

Good morning. Good afternoon. Thank you so much for taking my question. Your outperformance relative to the industry has obviously been very wide. So, how are you thinking about taking advantage of this, such that, would you further accelerate some of the investments that you're making in 2025? And if that were the case, would you be willing to trade some margins, so suppress margins, even if it meant that you were still accelerating your sales? Thank you so much.

So, Michael, I think that's always a question for business leaders, and what does an investment cycle look like? What does the harvesting cycle look like? And how are you thinking about the business long-term versus short-term? And I think it's an interesting time in our industry. There's, like, multiple people pursuing different paths generally. A time like this is a hunkering down or harvesting time, people pull back investments. If you looked at our history, this has always been an investment period, because the other side of a downturn in a housing market usually leads to the potential to gain significant market share on the other side. Yeah. So, as we look forward, I would say, today, the view would be, most of the significant investments are behind us. The early investments into Europe, not that we don't have more, but the initial investments into Europe to just put in a platform to be able to launch a business there is pretty significant. We do have some significant investments with RH Paris and RH London and Range Milan. But most of that cash spend is behind us, right? Even as we think of the investments we've made to transform the product over the last 24 months, because the real effort began a couple of years ago. So, the ramping up and building the muscles that you need to operate at a level that we are operating are at today is really behind us. If you think about the new significant brand extension we're discussing, most of that product is in the pipeline. I mean, we could technically launch it today. We're just kind of polishing it up. So, those investments are mostly behind us. But our company is based on invention and innovation. It's based on investing into the future and it's based on kind of endless growth, if you will. So, one of the things that generally happens to retail brands over time, I'd like to say that a retail mall is nothing but a graveyard for short-lived ideas. That's because most retailers open a new concept, they get enough rights, they expand it. They don't evolve it, they don't innovate. They kind of get a model of we're going to open 20 of these a year, 40 of these a year and pretty soon you blink and seven years goes by and somebody has like a range of 100 to 300 stores and they're all kind of dated and they're all tired because there hasn't been a focus of invention and innovation, there's been a focus of rollout and duplication. And that's why most retail brands don't even last the full term of their lease. And if you look at a retail mall and take a snapshot of it today and look back 10 years or look forward 10 years, about 65% of the retail mall evolves every 10 to 15 years where generally -- and a lot of retailers don't make it to the term of the lease. So, we're somewhat different in that nature, right? We've been on this journey. Now this is my 24th year and we took a business that was basically a bankrupt business and we had to kind of dig it out of the grave, right? So, we started underground, if you will, had to kind of dig our way out. And then we've been building and we've been kind of pursuing a path of a climb up the luxury mountain and try to build the luxury brand and that's taken, yeah, considerable investment. But today, if you just again motor up and look at the platform we've built and think about put the current numbers into context, right? And we have a lot of de-leverage to our operating model because of significant investments we've made. All of the cash investments are behind us. And so, I look forward and I think about the cash flow over the next couple of years and I see significantly increasing compounding cash flow model. I don't see really significant capital investments beyond the kind of iconic brand-building Galleries. But even from that point of view, the cash is mostly out the door in the company, in Paris and London and so on and so forth. Some of it, you're going to have a drag on depreciation going forward because we've made a lot of investments. And that's why we think it's probably important as you think about our model looking forward to focus on adjusted EBITDA margin, right, because that's going to be the -- adjusted EBITDA margin and kind of cash flow generation, that's going to be the right way to look at a model like ours. It's no different than for how many years Amazon had a depressed model because they were in a serious investment mode to build a platform nobody else has ever built and you might never again. I believe that's relative to our story, if you just go back over the last 10 or 12, 14 years and think about the investments we've made in our platform, think about the number of significant Galleries we have that are unlike anything in our industry, nobody close. And think about what we've built over the last several years, think about the product transformation we went through and the investments that takes to build that. The inventory investments it takes to front-load a business like ours with inventory, so you can add the inventory to create an inflection, right? And then think about the inventory that you have to kind of invest into to kind of bridge from where you were to where you are so you don't create a ditch as you transition from current product to new products. All of that is a serious investment cycle and somewhat distorts the short-term view of our model. I think if you take the vector, which is significantly increasing, right, in magnitude and direction, and you just kind of chart out that vector over time and you think about a significant amount of the investment cycle kind of being behind us, you could plot out what this model might look like over the next two, three, four, five years. And then if you compound out with a -- an accelerating housing market, which, it will come right? I mean, it's the most depressed housing market any of us have seen in the history of -- in our history of our experience and you have to kind of appreciate the position we're in today as you look out over the next five years.

Got you. Very helpful. And my follow-up question is, as we look out over the next couple of years, A, should we think -- is your baseline assumption that as the housing market does improve, it will lead to an acceleration in the recent trajectory of the business that you've seen, so we should think about that as we start to model next year and beyond. And B, given the pacing of margin decline that RH has experienced over the last couple of years that sales have been under pressure, is that the right frame of reference to think about how margins will recover at the same degree of sharpness as the pace of sales growth maintains, like, you've seen it recently? Thank you.

Yeah, I think that's directionally marked right. I mean the question is, what is the housing market worth? It's not only worth 5% when it comes back. It's likely worth 30%, right? And that will kind of compound over a couple of years. It might start out and it's worth 10% and it compounds to 15%, and -- but it might just spike and you might see the housing market come back like, you might see 30% growth. You could see 50% growth. If you think about how depressed it's been for how long, you think about that, the built-up potential demand, and how many people have wanted to move for several years, expanding families, people relocating, turning into renters and so on and so forth because of the significant gap in between interest rates, right, and how many people are locked into low interest rates. So, that -- that's just -- that's going to evolve, that's going to change. Exactly when it happens, we're kind of ambivalent about that. Quite frankly, sometimes I talk internally about, hey, I hope the housing market stays flat for another year. We'll have a lot less competitors if it does. We'll gain a lot more market share if it does. So I'm not necessarily enthusiastic about when the housing market comes back, because a bad housing market for a brand like ours positioned the way it is, is actually kind of a good thing if you think about what the future will look like. Because a lot of the ankle-biters that were able to raise capital easily over the last five, 10 years, and especially, yeah, pre-COVID, five years before COVID and the four or five years after COVID, I mean everything in the home business was looking great and you could raise capital really easy and someone could start an online brand and all that is some level of, right, competition. Right? There's just more places to shop, there's more people marketing, there's more people on Instagram marketing or online marketing and so on and so forth. And there's been a proliferation of competitors in the housing market. You see that now shrinking very quickly. I mean, there's been a lot of public bankruptcies or I'd say almost bankrupt or kind of bankrupt and bought-out of bankruptcy because there's a couple of online aggregators. I can't remember the name of one of the brands that's bought a bunch of them. I probably don't need to say it anyway. You guys probably know who they are. But kind of Gavin Grover, our lead outside counsel always says two drunk people leaning against the bar doesn't create a better situation. So, you take kind of multiple bad brands and put them together and you hope for leverage through that aggregation, it usually doesn't work. I mean, look at the recent situation with the Overstock.com and Bed Bath & Beyond, I mean anybody babbling on that, that marriage I think is -- I think it's going to look good over the long-term. So, we would think that, yes, there's so many levels of opportunities. There's the housing market, there's if the housing market stays down, there's going to be more people struggling in our market in the furniture-based home furnishings market and there's going to be more opportunity on the other side. I mean, our inflection is happening regardless, right? So, ask yourself, when was the last time a brand of our size and scale in a mature market has created a market share lead of more than 5 points or 10 points? 5 points would be considered really good. 10 points would be considered outstanding. What does 25 to 45 points look like? Track that out over the next few years. That can completely change everything.

Thank you very much, and have a good holiday.

Thank you. You too.

The next question comes from Christopher Horvers with JPMorgan. Your line is open.

Thanks. Good evening, everybody. So, I'll keep my question to a two-parter. The first question is, is you're guiding the fourth quarter below what you're seeing quarter-to-date, is that just caution on your behalf? Is there some sort of seasonality of the business to think about proceeding through the quarter? And then the second part is, you've put a lot of clearance in the past few years to introduce all of this newness, 80% newness this year, is it your expectation that over time that you can get that clearance margin back? Thanks very much.

Good question. The guide is, we think is kind of a correct guide, like, depends on what -- how the rest of December and January plays out. So, 75% roughly of our business, it bounces between 73% and 76%, I think, is our kind of core RH brand, if you think about it. And then we have another quarter of our business that are other things like Contract, Outlet, Baby & Child, Teen, Waterworks, Dmitriy, et cetera, et cetera. And if you just kind of pull back and think about the -- those businesses are not accelerating like the core brand. I kind of outlined in the letter that those should accelerate, many of them. Obviously, Waterworks won't be impacted by our product transformation, but our platform will enable the Waterworks brand to do some things that they might not have been able to do in the past no different than other -- how we scaled other businesses. But the markdown percentage, if you looked at the history of our business in our core business, would say the amount we have on market, like today, if you looked at it, 75% of our -- today, if you look at it, about 80% of our business in the third quarter is at full price with a full price and about 20% has been a markdown. It will fluctuate 20%-22%; 78%-22%, 80%-20%, it -- over the years, like in a really up housing market, that could be as low as 90%-10%, but there's always a percentage of clearance. I would say our competitive set or that just the general industry as a whole would love to have an 80%-20% mix. They love to have an 80%-20% mix. Is the clearance part of the business may be more under pressure than it would be in a good housing market? Sure. Is the clearance part of the business going to be bigger during a bad housing market? Of course, it is. Those are all firm grasps to the obvious, right? But the other thing we're doing is, if you read my letter, you hear me talk about the disruptive nature of our brand. And you've seen us kind of move in the past couple of years into much more of an attack mode. And we think that there is an ability to take more oxygen out of the room, if you will, by playing the game that we're playing right now. And that's not necessarily it's a clearance game, but it's a design, quality, value game. It's looking at disrupting the market from a design point of view, a quality point of view, and a value point of view. And I think that's what we're doing today. So, maybe that's putting a little bit of pressure on margin initially, but as you grow like we are, there's inherent efficiencies and scale, right? So, if you think about the demand trends we have today, if you think about us ordering back into product, if you think about the leverage that we're going to get and our partners -- manufacturing partners are going to get, and what the future orders might look like, those could be at much higher margins, right? But taking the market share, taking the oxygen out of the room, creating leverage on the business model from a top-line point of view, putting the investments in place, and then continuing to expand margin through the leverage you get throughout the platform. And when I say the platform, I also am talking about our manufacturing platform, our vendor partners. We do own some of our own manufacturing. We have a factory in North Carolina, with upholstery, et cetera, et cetera. But mostly, we don't own the manufacturing platform. But if you're a partner of ours, we talk about and we interface with our partners like we're one company. And we talk about where is their leverage, where scale can create better margin, better pricing, more disruptive pricing, and so on and so forth. I think right now is that it is a better time to invest in disruptive pricing and disable competitors than it is to harvest the business and take lower sales. Different people are taking different paths. Some people are taking -- giving up market share, not trying to take market share, and they're harvesting, right? And expanding operating margin and margins right now. We could do that too. We could do that too. I'd rather be trending up 30% in my core RH business than down three or 5% giving up share during this time. There will be lots of leverage on the other side of running up 30. It will -- lots of leverage and a significantly stronger market position.

Thank you so much. Have a great holiday.

Thank you.

The next question comes from the line of Simeon Guttman with Morgan Stanley. Your line is open.

Hi, this is Zach on for Simeon. Thanks for taking our question. Following up on some of the free cash flow commentary earlier, can you speak to when you expect RH to turn free cash flow positive? And as a follow-up, how do you think about the funding needs of the business and whether it can be self-funded? Thank you.

Yeah, we believe next year we'll turn free cash flow positive and we'll be able to self-fund the business. I mean, the significant part of our debt is we don't really think about it as debt, right? We think about it more as a currency swap, right? So, if you look at our debt independently, you can say, they have a lot of debt. We look at it somewhat differently. We think of it as the currency swap. One, we didn't spend the money. We didn't buy anything. We didn't buy any physical assets. We didn't buy any buildings with our debt. We didn't build any distribution centers with our debt. We exchanged one currency debt for what we believe is an exponentially more valuable currency, our stock, which is a highly liquid currency, right? We can turn our stock into cash tomorrow. So, we took on debt. We exchanged that currency for our stock. Today, post the interest costs on the debt, we've turned a $2.25 billion investment into significantly, we've made several hundred million dollars on that investment already based on the closing price of our stock today. I mean, if you look at where our stock's trading after hours, that investment looks significantly bigger, right? So, based on our business trends and an expected return to growth in the housing market, that return we believe will grow exponentially, right? But we don't have debt on our balance sheet because we needed cash. We have meaningful part of debt on our balance sheet because we wanted to do a currency exchange, we wanted to purchase our stock when it was undervalued. I think we bought 7.6 million shares at an average price of $295. I don't know, where's the stock after hours right now? Is it four-something?

Yeah. It is at $450 last I saw it.

$451.

Yeah. $452. So, that's a pretty good return. Yeah, what would that return be? I mean, what's our cost of capital over that period of -- a hundred and something?

$350 million.

Yeah. Just about $350 million return. So, look, we've done this before. This is not the first time we've done this. If you look at our history, we have taken debt, exchanged it for our stock, and created significant value for shareholders. I'm the largest single shareholder in the Company. That's the way I think about it.

Thank you.

The next question comes from Steven Zaccone with Citi. Your line is open.

All right. Good afternoon. Thanks for taking my question. Congrats on the accelerating momentum. I was curious, Gary, if you could just help us understand the drivers of really the acceleration in the business. What's really changed with the product? How do you feel about your competitive positioning? Why do you think you're outperforming the industry by such a wide margin? And then if the industry comes back stronger in '25, do you think you're well positioned to scale and fulfill that higher demand?

Well, I think everything that we believe is in the letter. I don't know if there's a lot more to say than what's in the letter, what I might've commented on thus far, why we think we're outperforming. I mean, it's -- we have a lot of competitive advantages. We have a platform that's significantly, we believe, better than anybody else in the industry. We have product capabilities, savvy taste that's we believe better than anybody in the industry. Yes. I've said before, there are those with taste and no scale and those with scale and no taste. And we believe the idea of scaling taste is large and far-reaching. So, that's what we're doing. We believe our taste level demonstrated not only through the product, but demonstrated through the Galleries we built, the physical aspect of our business, our Sourcebooks, our website, and so on and so forth. We believe we're building a platform for taste that's going to be highly disruptive and lucrative over the long run. And that taste level and the capabilities we have at scaling taste, our ability to curate product, our ability to integrate product, and our ability to present product better than anyone in the world, I think, is demonstrated based on the size and scale and profitability of our business thus far. And we'll continue to create strategic separation as we go forward. So, that's who we are at our core, right? That's what we do. That's what we've spent 24 years building. And you haven't seen our Center of Innovation and Product Leadership. You have anybody on the call, I recommend, yeah, try to schedule a visit because nobody has anything like it. That has been built. It's a huge competitive advantage. Our methodologies, the way we think about the business, the way we strategically think about categories, the way we strategically integrate categories into a singular and focused point of view that breaks through the clutter in the market, all of those are reasons why we're outperforming. So, look, we talked about the strategic mistake I made when I turned off the product engine during COVID because we couldn't get the goods. When we cut orders in the beginning of COVID, the business went down 40%. Then the business went from down 40% to up 40%. Moved 80 points just as we cut orders. Factories were shutting down and so on and so forth. And we had a hard time getting products. So, I said, let's shut off the product engine for a year. Then Omicron hit and you had another cycle of COVID. And so the product engine was off for two years. And then we tried to turn the product engine back on. We had kind of lost our muscle memory and we executed poorly in that third year. So, now everybody's competing against not only kind of who we were, but we built ourselves into a better version of ourselves. And so, that's why. I mean, we didn't mail our core books for three years. So, everybody who thought they were doing so well with RH on the sidelines don't feel so good today. And now, well, we're back to playing our games, but in a very evolved way. I think we're smarter than we've ever been. We're more driven and determined than we've ever been. We're more creative, curious, and critical than we've ever been. And I think the next five years for this company is going to be the best five years in the history of this company. And I think five years from now we'll be better than we are today. So, it's just who we are at our core. Innovation is at the core of what we do.

Understood. The follow-up I had is just on gross margin. When you reported the last quarter, you talked about August seeing a positive inflection in product margin. How did that play out over the balance of the quarter? And maybe how should we think about product margin in the fourth quarter? Thanks very much.

Yeah, product margin at the demand level is still positive. We did have some adjustments below the selling margin. One of them was in market stock. I think we did such big transformations of our Galleries that we had some bigger market stock. When you ship our product outside of the box, it's not generally a good thing. And so, we took a -- when we do a floor set transformation, we take the product off the floor, we have teams that are local home delivery networks that pick up all that product. The product's not new, it's not in the box, not in the protected packaging. They take it back and then it gets fed to the outlets. And we've never made a transformation this large. And I think we probably had more damages and more things that got banged up moving back and forth in trucks and moving around without boxes. And so we had to take some write-offs for product that we thought wasn't really sellable at the outlet level.

Plus elevated cost of moving the product and elevated inventory transfer costs.

Yeah, go ahead, Jack.

Yeah, one-time inventory transfer costs too related to moving that product. We also just rebalanced some product in our DCs just to get it optimally positioned. So…

Yeah, this will also move the product from Europe, from Europe back to America. We didn't start off with picking all the right products when we filled the DC in Europe. And now we see the trends and we realized, oh gosh, so we got too much of this, too much of that. Well, instead of marking down all that product in Europe, it's better for us to just ship it back to Baltimore, feed the core business. So we do that, that's another one-time kind of charge. So -- but at a general selling level, especially in our core business, we liked how our margins are trending. We think there's going to be upward opportunity and margins, not downward pressure and margins looking forward.

And Gary said on demand margin basis, it's also on a ship margin basis, the selling margins on the ship basis in the quarter were inflected positive.

Yeah.

Okay, very helpful. Thanks, guys.

Great. Thank you.

The next question is from Steven Forbes with Guggenheim. Your line is open.

Good evening, Gary, Jack. Gary, maybe just a two-part question on real estate, given sort of the planned -- the sheer number of openings, right, planned over the next couple of years here. So, to start, can you speak to maybe the performance payback periods and store-level ROICs that you're sort of expecting in these classes of galleries, maybe relative to what you've spoken to in the past? And then how have the discussions with landlords and developers evolved over the past couple of years? Maybe have you seen cost pressures normalize in the uniqueness of your model and just the pipeline itself? How has the conversation with landlords and developers evolved?

Sure. So, yeah, let's start with the payback and ROICs. Historically, we've always said payback of, I think, one to three years. We believe that's still the right number. Where it wasn't the right number was anything built during COVID, right? Because things that's being built during COVID, stopped and started three or four times, and you had raw material costs in some places go up two to three times or 4x. So, anything built during COVID was significantly more expensive, up to three times more. I'd say in a general sense, building costs today to build at any level, no matter if you're in retail or any kind of business, are somewhere between 70% and 100% higher. So, it costs us more to build the gallery today than it did. The good news is we have a significant inflection in our demand and our sales, and we have an expectation for returning housing market lift. But in most of the Galleries, I'd say, in the pipeline today that we're opening will be relatively quick paybacks. Maybe the really iconic ones, like London and Paris, might take three or four years, but they might take two years. For example, RH Newport Beach is a good example. We have a developer and a partner there in the Irvine company. I think they cleared about eight retailers for us, right? So, if you think about the investment that a developer partner would make here, they cleared probably eight retailers, took dead rent for several years, because our projects take anywhere from two to three years. It takes a long time to get approvals and build these kind of buildings. So, they cleared rent for several years. They completely cleared the site, ripped down two or three-story buildings to clear the site and make it construction-ready for us, and they invested $25 million, right? We got in TI. We probably invested in that one an additional $50 million to $60 million. Directionally, we're still adding it all up. We had a bit of a chaos just trying to get it open for the opening party, because these things are big and complex. But that gallery will likely pay back in -- from our cash point of view, in one year, maybe 1.5 years. And so, but you have other ones that, the ones in Europe there's not a lot of TI. They're street locations. So, there's a somewhat bigger investment, and we'll see how the revenues are. London does what we think it's going to be. Maybe it's a two-year payback. It could be a three-year payback. But three-year paybacks on iconic brand-defining locations that you're going to control for the next 40 years is the right thing to do, right? And the other thing I'd say is, think about how many of these big galleries we already have out there that we now built for half of the price of what it costs today. Yeah, I think it's going to be really hard for anyone to try to duplicate our physical platform. Almost impossible, I would say. You'd have to have the revenues that we generate, and then you'd have to be willing to pay multiple times what we pay for the vast majority of our platform, right? So -- but I think one of the key issue that we've talked about internally, and how do we create the right lens for investors looking forward is, we do have increased depreciation, and we will have increased depreciation. Yeah, so if you look at us at an operating margin point of view, you could say, there's pressure on operating margin because of more depreciation. Well, that's true, we've spent that money, and we have a little bit more that's kind of coming through with Paris and London, and as we -- as they come on. But they -- they're going to come on more from a depreciation point of view, not from a cash point of view, if that makes sense. So, when I look at the business, again, as the company's largest shareholder, I'm thinking about what are the long-term cash returns look like. And I say to myself is operating margin the right lens? Probably not, adjusted EBITDA is probably the right lens. Cash flow generation over the next five years is probably the right lens. But the headline on Gallery paybacks going forward, I'd say one to three years. A lot of the ones that are in the pipeline today, yes, some will be one year, one and a half years. London and Paris might be three. Something like that might be two. All depends what we come out. I think that the math I tried to lay out in the letter about RH England, right? It's two hours outside of London, got a population in a 10-mile radius of 100,000 people. There's not a lot of cars that drive by that Gallery. And it's still trending, we take Galleries in our business to do somewhat like $38 million. If we can generate $35 million to $40 million, two hours outside of London, we're 10 miles, in a 10-mile radius, there's like 100,000 people, what can we generate in Mayfair in the absolute bullseye of London where there's 9.7 million people? Like you got to take some multiple, right? Is it a 3, is it a 5x? Is it -- it's not 50% more. So, in looking at the numbers that way, we're highly optimistic about Europe and some of those things. And we're probably -- based on what we think will happen, and even in Europe, we'll be a much more desirable tenant especially when we're not buying a building. But landlord discussions, how they've evolved over the past few years. Yeah, landlords are doing, hey, how are you performing? What's your market cap look like? All those kinds of things. As our performance is better, as our margins are better, as our stock price is higher, we become more attractive to landlords because we'll probably have a better credit rating, their properties are going to get a lower cap rate. And that's why we've been able to do what we've been able to do over the past 15 years in building this platform. So, right now, people are really excited to talk about developing with us again. Today, we're getting three times the inbound. And I think that that's only going to increase. So, our optionality is going to be better, but you still do right now, right, there's a bigger cost for buildings because debt is higher, et cetera, et cetera. So -- but the outlook should be great. There'll be a lot of optionality ahead of us. At the same time, we don't want to get oversaturated, and we don't want to create a whole bunch of cannibalization. We think it's better to have fewer, more iconic locations, than to just kind of cover the market in an ordinary way. So, we'll continue to be very selective in what we're doing, but we do have different vehicles now. We have -- we'll see how this test goes with the first freestanding design studio, which is not a design studio like we built in the past, because we've built things that we call design studios, they're really small stores, right? These are actual interior design offices, consumer-facing, which there are none in the world, right? Interior designers don't have consumer-facing offices. We do. I mean, just as a point of reference on that point, I think, which is interesting, because I think this is going to be more important than we think. When we open a gallery, and we look at applications for interior designers, we might get six to 12 interior design applications. For our freestanding interior design office, we got 200 to 300 applications. And our theory was, a lot of interior designers don't want to work in a retail store. And we're thinking we're changing that in our current retail stores, because we're creating separate design offices that are kind of walled off with glasses and so on and so forth. But still, so you may depending on how that happens the response we've had, and then just the response we've had from people trying to come in, consumers trying to come in and access us, we'll learn a lot more starting next week. But there's going to be lots more opportunities. And then also as our volumes build, the more we do in volume opens up more opportunities in more markets. So, if you thought about five years ago, we did X in a market, or we thought we were going to do an X in a market, but now we look at a market and we can do 1.5x, all of a sudden the real estate deals look completely different, and the number of markets look completely different, right? And so that's where that could change. We think we could have 60 to 70 Galleries, bigger size Galleries 50 or 60, whatever the range is. And all of a sudden you're doing 50% more volume in a three, four, or five years from now. All of a sudden you probably have an additional 30 markets you can open, because there's places you thought you could only do $20 million in, and now you can do $30 million in, and it changes the economic model. So, I think people are pretty excited about RH today. I think they'll be even more excited after they digest our numbers from today and think about where we're going. And we've become like a preferred anchor. Like if you look at what we're going to do in Naples, we're taking a Nordstrom's location and we're building one of our first RH compounds. I don't know if I've even talked about an RH compound yet now. You'll hear more about it, and maybe I have, I can't remember, but anyway, it's a whole new kind of RH shopping experience, multi-building connected with courtyards and walkways. And it's like nothing else anybody's ever seen, but it's a way to take a big site, cover the site in a really exciting way, and probably spend a third less capital. And then there's another RH compound coming in Walnut Creek where we're taking a Neiman Marcus location. And I think when the landlord community sees, the developer community sees the new compounds, I think people are going to like that too. So, we're really excited about looking out at openings and the physical expansion of the brand, but we want to be cautious not to get oversaturated, not to create too much cannibalization.

Thank you, Gary. I appreciate the color. I'll pass it on.

Thanks, Steve.

The next question comes from Max Rakhlenko with TD Cowen. Your line is open.

Great. Thanks a lot, and congrats on all the progress. So, first, just what inning of the product transformation cycle would you say you're in now? And that's both the product itself as well as the Gallery [indiscernible].

What inning. I would have said maybe the sixth inning before my latest trip to Asia and Vietnam and now I'd say we might be in the fourth inning because the dots have continued to connect and so we'll -- there's a lot in the pipeline. There's just a lot in the pipeline. I mean, again, if you read the letter, there's a lot happening, a lot coming. The significant brand extension I'm talking about might be worth as much as everything that we just did. So, I mean, I think it could be massively, massively accretive. And so, yeah, we still call it maybe the fourth or fifth, fourth inning halfway. But again, that always changes, right, as you evolve, because you connect that dot, you see more, so on and so forth. I think it's like, like, I don't mean to sound arrogant and compare ourselves to Apple, right, but at what point, someone would ask Steve Jobs when they introduced the first Apple phone and he said, this is going to change everything, what inning were they in? I mean, what was their market cap then? After the first year of the iPhone or second year of the iPhone, maybe $500 million, something like that, maybe $400 billion, $300 billion. I don't know what Apple's worth today, $2.5 trillion.

Yeah, around that.

$3 trillion, something like that. So the more you do, the more you see. The more you see, the more you can do. And you go into what I refer to internally as an upward spiral. And I'd say today, we are in an upward spiral. We're doing more, we're seeing more, therefore we're doing more and seeing more. And you go through that cycle, you can keep connecting dots and see more. So that's why I say competitors, anybody who's hunkering down or trying to harvest in the harvest mode or they're trying to squeak out every tap point they can out of an operating model, that's the very temporal condition. We're in a real upward spiral here that it just going to lead to more and more. So you'll keep asking me what inning you're in and I might be perpetually in the third to fifth innings.

I'll keep that in mind. And then just thinking about some of your comments previously about harvesting profits down the road on the investments that you're making or you've made in the past, how are you just thinking about the magnitude and where margins can go a couple of years from now?

No different than when we've always thought about it. And we're always going to be at some level of an investment stage. That's what you do if you're a brand that's based in invention and innovation. So -- but I'd say the phase we just went in was a pretty massive investment cycle, not just to scale up and ramp all the product that we have and build the pipeline and so on and so forth and build the organization to do that and the new partnerships to do that, but also launching Europe, right? I mean, that's a big kind of one-time investment you're making. And so some of that is behind us, yes, still up here, some of it's in front of us. But, once we build the platform in Europe, and once we kind of get the brand going. Look, if we were in year two, and, yeah, we were cycling RH England, and we were doing like $8 million, like, I'd be really worried. But when I sit there and I go like, okay, we're -- demand tracking it, $35 million to $40 million, somewhere around, you think net $38 million, something like that, and turn that into revenue, you’re $32 million, something like that, $33 million, and then you say, I don't know, what's lending going to be with 9.7 million people in the heart of Mayfair. If you said it three times that, which I think could be conservative, that's $100 million in revenue. It's four times that or five times that that's $130 million to $160 million in revenue. And that's by the way, this is with the brand relatively unknown. And we went into an unknown place where the only retailer of our kind, for like, I don't know, 100 miles, I guess I'd go like, it's a long way to anything like that. So it's, -- I think margins are where we think the margin model ought to be on a regular basis going forward. I mean, we're also in the depths of a bad housing market. If somebody said, well, homes increased 3%, that's a dead cap bounce. The housing market has not shifted yet, it's not meaningfully growing yet, and when it does, we'll benefit from it and you'll start to also see where the margin model will be. But right now, if you're looking at a margin model, you're looking at a margin model based on a bad housing market and a significant investment cycle. Maybe the biggest investment cycle, it's actually absolutely the biggest investment cycle we've ever been in. So you're probably looking at kind of bottom margins for us.

Great. Thanks a lot. I appreciate it. And enjoy Montecito.

Okay. Sorry you'll miss your first opening, Max.

The next question comes from Curt Nagle with Bank of America. Your line is open.

Great. Thanks very much for taking it. Just a couple of ones. One, in terms of just thinking about demand and the revenue trends, when should these equalize? When should the gap narrow? And maybe more specifically, looking at the first half of '25, should we hold it something similar to what we're seeing in 4Q? Is that roughly the right math? And I'll follow up after that.

That's a good question. I think it's going to, yeah, it's going to start to narrow. Our stocks are getting better. Yeah, we invested in more inventory to kind of close that gap. And so I think it'll be a little bumpy for a while until -- again, until the inflection of new product slows down a little bit. But we'll have a stronger point of view in the next quarter or two. But clearly, we see the gap shrinking. The end stocks are going up. But there's a whole new cycle of newness coming that could -- you could have some real runaways that create really high back stocks and longer lead times and so on and so forth. So, but the initial gap is closing, could be a -- could get a little wider and bounce around a bit. But I mean, directionally, I don't see it going back to as big as it was in the beginning of the transition.

Got it. That would be, I guess, a high-class problem that does happen. The second one, I guess, Gary, for you, just trying to think through very early stages here, but potential demand synergies for the core product in the trade business with this acceleration and expansion of the Waterworks business, which I think, as you said, is -- has a strong core B2B customer base.

Sure. Yeah. I think, well, one, the contract side of our business start there almost can't benefit from the new product yet because we're still getting in stock in the best product. And we still are building inventory to get into, to transform the Galleries. I mean, some of the newest product is coming out and outperforming the Phase 1 products, right? So, we're going to have to transition Galleries again to get the best product, which is, again, part of an upward spiral. So, I'd say the Galleries today are a third right. So, I think there's two more transitions in the Gallery to kind of optimize that, which that means it's going to take a while for the best product to be available to the contract business. I think that's what you mean by the trade business, but maybe I've got it wrong. And then Waterworks just having a just higher exposure and our interior designers being able to spec it across their projects and our customers being able to see it on our website, see it in a Sourcebook, just the brand recognition and awareness of Waterworks is going to grow. And the accessibility is going to grow. So, we think that's going to be a big idea. How big could it be? We think it looks like a billion-dollar idea to us when we kind of track it out. So, the synergies and then just taking the best designs and translating those into smaller sizes for Baby & Child, and Teen is going to be a real synergy. And as much as retailers don't like returns, returns are what drive the outlet business. The outlet business is dragged behind the core business significantly, right? Because there's not enough returns of the new product yet, which will drive that. So, again, it's all part of an upward spiral, right? And one begets the other. And all of the learnings right now, all of the things we're seeing all of the dots we can now connect because there's a whole new set of data that we haven't had. And so the data becomes richer, you become smarter, you start investing wiser. Your next ideas are likely better than your last ideas because you're more informed. You have more knowledge. You're making better decisions, assessing things more correctly. So, I don't know if that answers your question or not.

No, that's very clear. And I appreciate it, Gary. Happy holidays.

Great. Thank you. Thank you, Curtis.

The next question comes from Seth Basham with Wedbush Securities. Your line is open.

Thanks a lot and good afternoon. My question is just regarding the product transformation and what you characterize it for as inflection. You previously talked to a peak inflection point sometime in early 2025. So, this upward spiral that you're seeing right now, would you think that peak inflection is extended outwards?

Massively outwards. Yeah, because when I talk about the peak inflection, like think about what I knew. Almost nothing. Right? We had new products hitting. We saw trends on any product. We're tracking it out. What does it look like? But we didn't have enough data and information to really know any more than we knew. So, it got worse. Peak inflection now based on what we know, I think it's several years out.

And previously you talked about peak inflection being sort of the strongest year-over-year growth. I assume you're not thinking that strongest year-over-year growth is going to be a few years out. But you think that you'll see strong growth for the next few years, in other words.

I think the strongest growth might be a year or two out. Because the significant brand extension I talked about is significant. It's not small. It's meaningful. And the amount of new product that's coming. For example, a year ago, probably a year into this transformation, I kind of reframed everything for our internal team and our external partners. I said, look, we are still in the early stages of what I called a product development super cycle. Something we've never done. Because we haven't enough data to say, like, this can be much bigger. We think about the market completely differently. We think about the size of the market, the consumer. We see more consumers. We see more homes. We see more rooms. We see more aesthetics. We see a significantly bigger opportunity for RH. In some ways, I'd say the classical way to think about us is kind of as a specialty brand, right, with a certain point of view. And that's how I'd probably say I looked at us over the last 20 years. How do we build this specialty brand with a certain aesthetic point of view and grow this brand? I think about us differently today. And I think about us a lot differently just in the last 45 days. I just haven't articulated it completely and clearly based on what we've learned. And it is directionally what we've framed over the last five years, right, with our long-term business vision and ecosystem. We've said 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. So, and then we've articulated, right, what I call the one-pager, kind of a bigger view of how that can play. I think what the nuance is, is now I'm beginning to see us and the team beginning to see us as maybe a platform for taste. Not just a brand. So, you think about, I don't know, think about platforms or marketplaces. I mean, Wayfair is a marketplace. Somewhat is it a brand? Of course, it's recognized for certain things and so on and so forth. But they don't really -- it's not their product. It's available everywhere else. There's nothing unique about the product in Wayfair. But it is a platform and marketplace that's driving $12 billion of revenue, some number like that, right? And not all furniture. They sell lots of things. But if you start to say, can you transition the thinking about RH from just a classic way to think about a specialty brand and think about RH as a platform for taste and think about how you could dimensionalize taste across multiple aesthetics, across different life stages, across different kinds of homes and so on and so forth. That to us, that looks multiple times bigger, potentially than I thought we could be. And we're still kind of shaping that thinking. But some of it we can see relatively clearly today. And that's why I think the growth trajectory or the vector may continue longer than we think. And we may think, you're running the core businesses trending at $25 million to $30 million up, right? Well, you're going to come up to $25 million to $30 million. Are you going to grow $8 million or $10 million on top of that? I don't know. Can we grow $30 million or $40 million on top of that? It's not impossible, based on what we see today. I don't want to -- I'm not promising anything. I'm not trying to give any kind of guidance. I'm just trying to kind of share with you directly how we're thinking and what we see. Again, the more we do, the more we see. The more we see, the more we can do. And we see a lot more than we've ever seen right now because of the product transformation and the product development super cycle. And the things we're doing and the dots we're connecting. And so, I think this upward spiral that we're in can be exponentially bigger and last significantly longer than if you would have asked me a couple of months ago.

Wonderful. And just last follow-up. So, I know you'll provide more information next year, but this significant brand extension that you think could be worth over a billion dollars, is it within furniture, or is it more adjacent beyond furniture?

No, it's just kind of within the same thing we're doing. It's just unique, different, aesthetically different, and probably addresses the biggest part of the market. So -- and we think it's going to be amplified by what we think is a trend that is coming.

Wonderful. Can't wait. Thanks a lot, Gary.

Okay. Thank you, Seth.

The next question comes from Andrew Carter with Stifel. Your line is open.

Hey, thank you. Good evening. I just wanted to ask about the inventory, kind of going up again and again this quarter, the purchase is up 30%. Could you talk through kind of what kind of inefficiencies are in there? Is there some planning around there? I know that you're exiting China. Is there any safety stock in there for that, already contemplating that and you're exiting Mexico. And on those two points, correct me if I'm wrong, China was 22% of your purchase dollars last year. I don't know if you ever disclosed Mexico. Where is that going, in terms of -- thanks.

So, the first part of everything you said, I'd say correct. That would be my answer. The last part, where's that going? I think we've said where we're going in China. It all depends what's happening in Mexico. Look, Donald Trump wrote The Art of the Deal, right? And if you've ever read The Art of the Deal, you -- if you do, you will see the negotiating starting to play out. There -- it is a global negotiation happening right now. Where will Mexico -- what will happen with Mexican tariffs? How -- what moves should we make proactively. We're making some moves proactively, but I think Mexico is making moves. You're already hearing from inside sources that they're moving troops to the border. They're going to try to take more responsibility for immigration. And if I was the President of Mexico, I sure would because I wouldn't want the biggest economy of the world to cut me off from trade. So, Mexico, I think, is a little different than China, right? Mexico is not going to become the next global superpower that has a military that can threaten the United States. China can, right? So, if you think about why our country has never been attacked besides 9/11, which is basically some terrorists boarding our own planes and flying them into our buildings, that's a very unique attack. There hasn't been a military that has attacked the United States internationally on our home ground. Since when?

1812? Yeah.

Yeah, yeah. Exactly. Why? Because we have the strongest military and nuclear arsenal in the world. So, I mean, look, Donald Trump is a great negotiator. I think he's looking at the world's playing field and saying, how do you use leverage? Negotiation without leverage is impersonation. And you better hope that they don't find out you're not who you are. So, he's really good at using leverage. He's done it before. We're seeing him do it now. He hasn't even taken office and the art of the deal is in full play right now. It's actually quite impressive, I would say. And so how is Mexico going to play out? I don't think -- if you're Mexico, you do not want that faucet turned off. You don't want 25% tariffs. I'm not saying it's not going to happen. It may happen, it may happen for a while. I think we have too much leverage there. China is a whole different story. It's a whole different game. But if you even think about what happened to North Korea in Trump's first term, I mean, the guy in North Korea was sending missiles over Japan, what, every week saying he could hit California. Trump met with him once and he never sent another missile. Why? Because he likes Trump? No. For another reason. So, we're going to see a lot of negotiations played out here. I don't think there'll be a lot of decisions that becomes a big negative for us or for the US economy. I think the United States of America has a lot of leverage right now, and I think we have a leader that knows how to use leverage.

Fair enough. And then kind of switching gears a little bit, you talked about going into kind of a massive kind of cash flow mode. How are you thinking about that in terms of kind of the external investments you funded? I know you talked a little bit about prioritization last call. I don't know if those are being deemphasized, those are off the table, but in terms of the guest house, the real estate JV, do you go lean into those more heavily or is it just a straight -- more of a prioritization on the core business?

Well, I think there's -- look, there's always a prioritization in the core business. There are certain opportunities that will unveil themselves at certain times, and like an Aspen joint-venture and the develop -- the opportunity to develop an ecosystem in Aspen, which we think is a one-of-a-kind opportunity and we think there'll be a -- we think a very good, if not outstanding return on that investment as it unfolds. Unfortunately, we hit a housing market downdraft and high interest rates and that's not necessarily good for an investment cycle in real estate. So, those things get deprioritized. But we do have a Gallery opening there. We have a guest house that's coming. We finally got the city to approve our facade and we'll probably do a few residences and other things that we've talked about. Yeah. So, that will happen. And I think it will start to become more of a harvesting cycle from an investment cycle in the Aspen JV. We'll turn real estate assets into cash. We have -- we'll have a Gallery, we'll have a guest house and so on and so forth. And the prioritization, I think, will always be on the core business. Everything we do, whether it is an Aspen JV or any other investments we make are all to amplify and render the core business more valuable, to amplify the core business, amplify the brand, how people think about the brand, how people see about the brand -- see the brand and perceive the brand. And I think we're doing a very good job in building a globally iconic brand. I don't think we're there yet, but we are there, looking through a lot of people's eyes. I mean, this brand, I think, is seen very differently than any other brand in our category. I don't think anybody is close from a brand perception point of view. And that's taken years of investment, years of work to craft. Are we where we think we want to be? No, this brand will continue to evolve. But as I said earlier, we are in a significant investment mode, the biggest we've ever had. We're cycling some of that. We will keep investing. I don't think it will be today as -- what the opportunities we see, I don't think it will be at the same pace. A lot of the investments we've made, whether it's building this new brand extension and other things, there's typical investments, hey, is there an advertising investment to mail a book? Of course, there is. Do we have to build new stores for that new investment? No. Do we -- does it leverage our current platform? Yes. Is it merchandised by the same people? Yes. Is it the same product development team? Yes. Is it -- so there's massive leverage in a lot of things we're doing. But setting up Europe is an expensive piece, and so that deleverage 230 basis points or so. If you just pack that 230 basis points on this business, the model looks a lot better. If you took some of the other investments out that we've made in the real estate platform and other things that are creating more depreciation, the model looks pretty good in a very down housing market. Now, recast that model with the inflection in vector that is being built and an investment cycle that's going down, right, is how I stay it. So, you get a completely different outcome from a free cash flow point of view.

Thanks. I'll pass it on. Happy holidays.

Happy holidays. Thank you.

The next question is from Brian Nagel with Oppenheimer. Your line is open.

Hi, good afternoon. Congrats on the improving momentum within the business. So, my question and it's probably going to be a bit of a follow-up here. But just looking at the business, and Gary, you talk a lot about -- we have talked a lot about -- the last several quarters about the macro environment, we discussed it here on the call tonight, but you're looking at the business and the improving demand trajectory you're seeing. Are you -- do you think -- clearly the new product is helping -- or driving this, but do you think you're also starting to see maybe the early signs of some, so to say, let up in the US housing market?

I don't see our competitors having -- getting that. So, I -- are we the only ones getting it? I don't know. I mean -- do I think there's a pent-up demand and there are few people having to buy homes? Yes, but the numbers wouldn't say it's a -- the macro is the issue. Otherwise, you'd see a more broad pickup. So, I think people are more optimistic. I think there might be a few more people stepping into the housing market, but that's -- I mean, for the most part, our industry is down 7% or 8%. I mean, there's not too many people that have positive growth right now. And even if you looked at our growth from a comparable basis, there's only a two-point difference between total demand and comparable demand. So, could we be getting a point or two from the macro is a little better? Maybe, but I don't think that's meaningful. I think what's really meaningful is the result of a very targeted and well executed product transformation of a size and kind that the world has never seen.

No, that's helpful. And then just on that, my follow-up question. So, with regard to the product transformation and this, like you just said, very significant product transformation, so going forward, I think someone asked the question before, I think kind of what any we're in, I think someone said six or something, but I guess the question I'm asking is, is this -- was this -- should we -- as we think about RH over the next few years, I mean, is this going to be -- is it going to be a more aggressive -- more consistent product introductions than we had over the last couple of years or was this really one big one step-up?

I think it -- as I tried to articulate earlier, we see a full -- a much bigger market opportunity, and I think you're going to see a much more aggressive approach to expanding the product -- particularly the product offering. And really that's how we got here, right? I mean, in the early days, I think I used to talk about -- I think I talked about it publicly. I came up with a -- we came up with a term here called direct-centric growth. And we said, look, we are going to not -- in the early days, I think we're not going to limit our assortment to the size of the stores. We're going to size our assortment to the potential of the market. So, we're going to merchandise beyond the four walls of the stores and we're going to use our sourcebooks and our website to present that assortment. And that strategy is how we went from $300 million to where we are today. I'd say in the last 10 years post the introduction of Modern that -- we call it nine years, we kind of slowed down through that process. I think we perceived ourselves as more mature, slowed down newness, slowed down expansion of the product, and that's what I tried to articulate earlier is, I think we see the brand differently. I think we see the brand bigger. I think by kind of slowing down our product transformation or our product expansion and brand expansion, I think we allow competitors to enter the market that would not have been able to be successful had we kept doing what we were doing. And I think it's shaped by the fact or decision with an outcome of seeing the world more traditionally, seeing RH as a specialty brand, not a platform for taste. So, this idea of seeing RH not as a specialty brand, but a taste platform helps us see a much bigger market and allows us to see a much more disruptive RH brand that can take share from more people based on our taste, our style and the power of our platform.

Appreciate it. Thank you.

Thank you.

The next question comes from Jonathan Matuszewski with Jefferies. Your line is open.

Great. Good evening and thanks for taking my questions. The first one's on pricing. Gary, you shared some helpful color related to clearance activity for discontinued product. I was hoping you could just comment on the pricing strategy for some of the new collections that have been recently launched. So, when you talk about maybe peak year-over-year sales growth one to two years out, is that going to be driven by higher prices from the new collections or greater unit velocity? Thanks.

I don't exactly know. Probably both. But again, we're going to keep learning. I think a lot of it is we just see a much bigger market. We have more leverage, we can use that leverage to have more disruptive value. I think people today -- if you could buy a dining chair at RH versus somewhere else, I think the consumer would feel better about buying from RH because of the positioning and the perception of our brand versus online off a -- some other platform versus Wayfair versus other competitors we might have. I think you'd rather walk into one of our Galleries and you would perceive that the taste and style is validated by us, that the brand halo and value you get when you built brand like us, it makes things more valuable. It renders the product more valuable. And I think that all of us tend to buy things based on our trust in that brand, based on what that brand stands for, based on what their values are, and it's kind of why we buy, why we -- why do we trust certain brands versus other brands and why do we trust them more. I think we -- as consumers, we value tremendous physical experiences. We value incredible design and article presentation of product in a physical nature or a digital nature, whether it's source books or online. We value the quality perception and the design authority of brands. And I think we've built a brand that stands alone in our category today. Do we have competitors? Of course, we do, or is there people going to try to emulate what we do? Yes, they are. But I wouldn't want to be competing with us on that. So, it just allows the brand to have a bigger market because someone would -- I think someone would rather buy that chair from us than someone else, if it's similar. I think they will value it more. It's no different than cars. Why people pick a BMW or a Mercedes versus a Chevrolet or a Tesla versus a whatever, somebody else's electric car, because of the value they placed on that brand, the trust they have in that brand and they -- what they believe that they're getting a better level of design and quality and it renders the consumer more valuable. That's part of the equation people don't understand, saying like, hey, I got everything in my house from Wayfair, doesn't really render you more valuable if you're trying to position yourself higher in the economic societal perception of the world, saying you build your house -- yeah, saying you buy your house from RH, I think, renders you more valuable customers versus other people.

That's really helpful. Thank you. And then just a quick follow-up on product. Can you give us any color in terms of maybe some of the lines that have been outperforming? Not sure if there's any commonalities in terms of maybe aesthetic or price points or any other common denominators, not sure if you're leaning into particular trends relative to other peers. Any more flavor there would be helpful. Thank you.

Why would I tell you that? Think about for a minute, like why would I tell anybody that publicly?

Completely respect that. Just trying to get more color.

Yeah. All of our competitors are on this call. Yeah. Like why would I tell anybody that?

Thanks, Gary.

Okay. Thank you, Jonathan.

Your final question comes from Zach Fadem with Wells Fargo. Your line is open.

Hey, good afternoon and thanks for fitting me in. Gary, following up on the balance sheet, appreciate your currency swap comments, but since earnings are constrained by about $9 in interest expense, any thoughts on the appetite for knocking out some of the debt and interest expense and the priority versus investment or buybacks or something else?

I mean, we think we're making the right investments to create the most significant shareholder returns. So, yeah, is the debt at $9 a share compression right now? Yes, but there's 7.6 million less shares. I don't know. So, you have to do the math on the other side, and you have to think about that 7.6 million less shares two years from now, three years from now, four years, five years from now and think about where the trajectory of the business is and would you have rather taken 7.6 million shares out of the market and have that cash or would you rather have that -- what do you think is going to be more valuable? And our math would tell us what we're doing is going to be exponentially more valuable that buying our stock at $295 when we think it's going to be worth $1,200 to $2,000 down the road is going to prove to be the right move and it's no different than when we bought 60% of the stock back in 2017, and what the price we bought that stock at and where the stock is today. So, listen, I know there's not other CEOs maybe talking about currency swaps, but I am benefited from the fact that I was owned by private equity for several years and I worked for some very smart people, and I learned a lot. And I think about the business differently from an investment point of view maybe than others do, so we -- but again, I'd look at our history. You could have asked the same question in 2016, '17. I mean, we've done kind of two, three major buybacks here, and -- but you don't see us doing like regular automatic buybacks. I think that's not a very smart thing to do. It's not looking at it like an investor, yeah, we're buying back our stock at all-time highs. We're opportunistic thinkers and investors, and so we believe this will prove to be a very wise decision.

Appreciate the thoughts. And then lastly, on the decision not to renew the leases in Germany, any color there on sales or margin impact on those Galleries? And is the intention to close those right away or wait until 2027? And any thoughts on just the margin constraint right now? I think you said 230 bps this year from Europe. How much of that is Germany? Thanks.

Yeah. No, well, look, we don't give this level of detail, but the -- to get the Paris and London locations, we had to take those locations also. And we weren't maybe necessarily ready to go into Germany at that point, but the Paris and London locations we thought were so extraordinary, it could have taken us 10 or 20 years to find locations like that, 10 or 20 years. So, we decided to take those locations. In some cases, we weren't even going to open them when we did, but we were faced with a lawsuit, potential lawsuit from a landlord. We thought we were rendering this property less valuable. So, we said, okay, let's open, let's not spend too much capital, and -- but in both those cases, the landlords wanted us to renew the leases and extend the leases to 10 to 15 years. We didn't know if those were necessarily the right locations. We didn't know if it was the right timing for the market and so on and so forth. And we said, how do we secure this London location and this Paris location? What are we willing to invest to get those two locations? Not that we don't like Germany, but we wouldn't have launched in Germany. That's not how you would have rolled out the brand. But doing this deal enabled us to probably move 10 years faster than we would have moved had we not. And so is there an incremental $20 million investment in that? That's the way I'd look at it? Sure. Do we know if we want to extend those leases and stay where we are? Do we -- or -- maybe there's better locations in Germany with better rent, but that's how we think about it. No different than that. Again, it's -- every investment decision, you have to look at all the aspects of it and you have to kind of say, is it more important to do this now and invest now and maybe it's going to cost something upfront like the hit we're taking on Germany? Yeah. But I'd argue when we look at it 10 years later, we may not have a London Gallery, a Paris Gallery like the ones we have today. We might not have even pulled the trigger. So, generally, those people that move faster and do more wind up with better outcomes, right, because you're going to learn along the way. So, nothing more than that. The non-cash charge, we're still open. If you want to look at our business at an EBIT level and operating margin level next year, it's going to be accretive to operating margin and EBIT next year, neutral on a cash point of view.

Makes sense. Thanks for the time. Happy holidays.

Okay. Thanks, Zach. Happy holidays.

That is all the time we have for questions. I'll turn the call to Gary Friedman for closing remarks.

Great. Thank you, everyone, for your time and followship of RH. We appreciate it. And I want to say to our teams that have worked so hard over the past two years bringing this product transformation to life that we couldn't be more proud of the effort, the drive and the determination it takes to do this level of work and to bring a transformation like this to life. We value you at the most important level in this company. The shareholder letters are addressed to our people, our partners, and our shareholders in that order because that's how we place the value. So, thank you all of you for your efforts. Thank you for bringing this next chapter of our story to life. And we wish you a very happy holiday and we will talk to everyone more in the new year. So, thank you.

This concludes today's conference call. Thank you for joining. You may now disconnect.