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RH Set to Expand Brand Presence with New Collections and Premier Showrooms

RH, a leader in luxury home furnishings, is ready to introduce new and innovative products in homes starting early February. This includes the RH Interiors Sourcebook featuring 89 new collections that cover furniture, upholstery, lighting, rugs, and textiles.

New Outdoor Offerings and Strategic Brand Expansion

The introduction of the 2025 RH Outdoor Sourcebook is also on the horizon. It will showcase an extensive selection of premium outdoor furniture, enhancing stock availability compared to last year. RH continues to strengthen its brand portfolio since acquiring Waterworks in 2016, a notable name in the luxury bath and kitchen sector.

Over the past eight years, the Waterworks team has successfully elevated the brand and established a profitable business model. Their primary revenue comes from the trade market, including architects, designers, and builders. In contrast, RH derives most of its revenue from consumers. There’s an excellent opportunity to amplify Waterworks’ presence on the RH platform by reaching a broader audience, similar to past strategies used with other brands.

Showroom Launch and Future Plans for Waterworks

This week marks the introduction of the Waterworks brand at RH, starting with a new 3,000 square-foot showroom in Newport Beach, California. Interior designers will now specify Waterworks in projects while customers can view and purchase Waterworks products on rh.com shortly. Plans are underway to test a Waterworks sourcebook in the latter half of 2025. Currently, Waterworks is nearing a $200 million business with mid to high teens EBITDA margins, showing potential for growth into a billion-dollar global brand on the RH platform.

Additionally, RH plans to reveal RH Couture Upholstery by Dmitriy & Co in the first half of 2025. Acquired in 2020, Dmitriy & Co specializes in beautifully designed upholstered furniture, historically available only to trade professionals. Contrary to speculation, the strategy will focus on maintaining its original style to attract a larger market.

Expanding the RH Brand Model

As with Waterworks, transitioning high-end brands from a solely trade-focused model to a blended consumer and trade strategy presents significant growth potential for RH. Moreover, a new brand extension is expected in the fall of 2025, promising to broaden the market size and visibility of RH. More details about this initiative will be shared in the upcoming year.

Despite current discussions about potential increased tariffs in 2025, RH anticipates no adverse effects on margins. The company has been moving its sourcing away from China, aiming for a complete exit by the end of Q2, and transitioning its manufacturing to other regions, ensuring a smooth supply chain.

Creating Immersive Experiences with New Showroom Openings

RH continues to redefine the home furnishing landscape with inspiring and immersive physical experiences. Their brand expansion strategy for 2024 and 2025 includes the Newport Beach gallery, opening tomorrow. Spanning over 90,000 square feet across four floors with ocean views, it replaces three older galleries in the area.

RH Newport Beach will feature several amenities, including the RH Ocean Grill, a 270-seat rooftop restaurant, wine and barista bars, and the first Waterworks showroom. This gallery aims to be a notable destination in Southern California, potentially achieving over $100 million in revenue.

Similarly, RH Montecito will open as a reimagined historic fire house, offering its own unique dining and design spaces. In Palm Desert, RH is launching its inaugural Interior Design studio, focused on presenting itself as a leading interior design firm. This location serves as a test case for attracting top-tier interior designers.

With ongoing developments, RH is also planning to establish a design ecosystem in Palm Desert, including a new design gallery and outdoor furniture gallery. RH Raleigh, which opened last November, features an extensive layout and luxurious amenities. There’s a commitment to open seven North American galleries in 2025, alongside two international galleries in Paris and London, setting the stage for significant growth in Europe.

The growth trend at RH England is impressive, with a reported 42% increase in gallery sales and a 111% rise in online demand from July to December. We expect the gallery could approach around $31 million in its second full year, reflecting strong demand overall.

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RH Reports Strong Demand and Plans for Revolutionary Online Experience

In its second year, a new RH Gallery in the English countryside has achieved $7 million in demand. To understand the potential for similar galleries, consider an RH Gallery in the picturesque region with a population of 100,000 within a 10-mile radius, located nearly two hours outside London, which has generated $38 million in its second year. Imagine the possibilities for an RH Gallery situated in the affluent Mayfair district of London—a vibrant city home to 9.7 million residents. The expected performance could be astonishing.

Investments Ahead: Enhancing the Digital Experience

Investing in our online presence is a top priority. We plan to revamp our website starting in the fourth quarter of 2024 and continuing through 2025. The updates are set to introduce innovative features that are currently unmatched in the market. Along with the enhancements, we will file for design patents on several new user interface and presentation designs. In the coming months, we’ll share more details about our website strategy as the new features roll out. As leaders, we recognize that growth often requires challenging the status quo.

A Culture of Innovation

Leadership involves guiding teams toward uncharted territories and implementing unfamiliar strategies. Change can be unsettling, but at Team RH, we embrace creativity and innovation as fundamental aspects of our culture. For over 20 years, we have persevered through challenges and have grown accustomed to stepping outside our comfort zones. Whether it’s through transformative product development or the establishment of immersive retail experiences, we remain committed to innovation even in a challenging housing market.

Crafting a Unique Brand Identity

Unlike many competitors, we choose not to follow conventional trends, like relying on social media influencers to promote our brand. Instead, we aim to leave our own unique mark, built on values such as invention, trust, and leadership. Over two decades ago, we aimed to revitalize a nearly bankrupt business—with a mere $20 million market cap—into the world’s leading luxury home brand. This journey required resilience and an understanding that significant lessons are learned through firsthand experience, not in a classroom.

Investment Strategy: Looking Forward

We recognize the importance of investment cycles in business. Currently, while many in the industry may scale back during economic downturns, we view these moments as opportunities for growth. Historically, downturns have allowed us to gain market share. Our significant investments in markets like Europe, specifically RH Paris, RH London, and RH Milan, are almost complete, positioning us favorably for the future.

Despite having achieved considerable foundational work, our commitment to innovation remains unwavering. Many retail brands slide into decline due to a lack of evolution and failure to innovate, often becoming stagnant. At RH, our journey has been about overcoming challenges and building a sustainable luxury brand from the ground up. Even as we look forward to new product launches, we remain vigilant in maintaining our focus on creativity and continual improvement.

Amid changing dynamics, we aim to redefine possibilities in the retail landscape. With dedication and a willingness to embrace discomfort as a catalyst for growth, we are well-equipped to navigate the future together. Onward, Team RH.

Carpe diem. At this point, operator, we’ll open the call to questions.

Questions & Answers:

Operator

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

Michael Lasser — Analyst

Good morning. Thank you for taking my question. Your performance compared to the industry has been significantly strong.

How are you planning to take advantage of this momentum? Will you increase investments in 2025, even if it means accepting narrower margins in exchange for accelerated sales? Thank you.

Gary G. Friedman — Chairman and Chief Executive Officer

Thank you, Michael. This situation often presents a tough challenge for business leaders. The balance between investment cycles and harvesting cycles is crucial, especially during different phases of the industry. Traditionally, downturns prompt many businesses to hold back, yet our history tells a different story. We’ve consistently invested during difficult periods because we recognize that emerging from such downturns often creates valuable opportunities for gaining market share.

As we look ahead, the peak of our investments is mostly behind us, particularly regarding our initial entry into Europe. While we still possess further investments to make, we have largely established a solid foundation, especially with the groundwork completed in RH Paris, RH London, and RH Milan.

Moreover, we are already deep into developing significant new product offerings, and many elements are set to launch soon, allowing us to polish these innovations further.

Our company’s ethos revolves around continued invention and forward-thinking investments. In retail, a failure to innovate often leads to stagnation and obsolescence, while we strive to foster a culture rooted in creativity and evolution. History demonstrates that countless brands that depend on duplication rarely survive in the long run. We have effectively revitalized a business that once faced bankruptcy, continuously pushing toward becoming a renowned luxury brand.

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RH’s CEO Discusses Future Growth Amid Housing Market Dynamics

Exploring the Cash Flow Potential and Market Trends

All cash investments are now behind RH, and CEO Gary G. Friedman anticipates significant growth in cash flow in the coming years. He emphasized that major capital investments have primarily been made for brand-building projects in cities like Paris and London. Although depreciation may pose a temporary drag due to past investments, focusing on the adjusted EBITDA margin may provide a clearer view of RH’s financial outlook. Friedman compared RH’s investment phase to Amazon’s, noting that both companies faced a depressed model during major investment periods, laying the groundwork for future success.

The Path of Investment and its Impacts

Looking back over the past decade, Friedman reflected on the substantial investments RH made to cultivate a unique collection of galleries, unmatched in the industry. He detailed the ongoing transformation of their product line, necessitating significant inventory investments to transition effectively from old to new offerings. Understanding this investment cycle is crucial to accurately interpreting the company’s current financial performance.

Optimism for the Housing Market’s Recovery

Friedman believes that the housing market’s eventual recovery could be robust. He stated that it may not merely bounce back by 5%, but could even surge by 30% or more. The potential growth arises from a highly depressed market, leading to a significant demand build-up as families expand or relocate. He emphasized the contrasting pressures of interest rates, suggesting that many individuals are currently locked into lower rates and waiting to buy.

Market Dynamics and Competition

Friedman indicated that a stagnant housing market could provide strategic advantages for RH, allowing the company to capture market share from weaker competitors. Recent financial struggles and public bankruptcies among rivals have thinned the competitive landscape, presenting opportunities for RH to consolidate its position. He highlighted the challenges that newer brands face in a crowded market dominated by online marketing, noting that consumer shopping experiences will shift significantly as weaker players exit the market.

Future Market Share Perspectives

He posited that RH’s market share could dramatically shift, projecting that a growth of 25 to 45 points is possible in the future. This shift could revolutionize the company’s standing in the market, as increasing market share beyond the typical gains of five to ten points would represent a substantial achievement. The evolving housing market, along with RH’s own developments, suggests a promising outlook for the brand.

Michael Lasser — Analyst

Thank you for your insights. As we look at the trajectory of the business, do you believe that improvements in the housing market will speed up growth rates? Additionally, considering the recent decline in RH’s margins, will their recovery correlate closely with sales growth patterns?

Gary G. Friedman — Chairman and Chief Executive Officer

Yes, the expectation is that as the housing market improves, RH’s business trajectory will align positively. However, we must consider the true potential of the housing market, which could recover by as much as 30%. Such an improvement would compound over a few years, possibly starting smaller and then accelerating rapidly. This is particularly relevant considering the inherent demand built up during the prolonged downturn.

Interestingly, I sometimes wish for the market to remain flat a bit longer. This scenario would minimize competition and allow us to increase our market share significantly. While there’s desire for a recovery, a slower rebound might work in our favor, as many small competitors struggle under existing pressures, reducing overall competition.

Change is on the horizon for our sector. With the decline of many competitors, there’s a unique opportunity for RH, especially as the market shifts toward better structural stability. A brand of our size successfully gaining significant market share is a rare occurrence in a mature market; thus, tracking our progress in the coming years will be essential.

Michael Lasser — Analyst

Thanks again. Have a pleasant holiday season.

Gary G. Friedman — Chairman and Chief Executive Officer

Thank you, you too. Now, let’s turn to Christopher Horvers from JPMorgan. Your question, please.

Christopher Horvers — Analyst

Thanks, good evening. My question is in two parts. As you guide the fourth quarter lower than the current performance, is this a cautious approach or is there seasonal impact that we should consider moving forward?

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RH’s Path to Profitability: Insights on Clearance Strategy and Future Growth

Understanding the Current Business Strategy

Gary G. Friedman — Chairman and Chief Executive Officer

That’s an excellent question. Our guidance is fairly accurate, but it will depend on how December and January perform. Approximately 75 percent of our business aligns with the core RH brand, while the remaining portion spans various segments such as contract options, outlets, as well as products for babies and children, and Waterworks, among others. These segments aren’t growing as quickly as the core brand.

Our strategy is focused on pulling back to assess the overall performance. While the core brand is seeing acceleration, some of our other areas may not experience the same growth. For instance, although Waterworks isn’t directly affected by our product transformations, our platform will still enhance its capabilities, similar to how we’ve successfully scaled other divisions.

Markdowns and Market Trends

The historical markdown percentages in our primary business point towards a healthier trend now, with 80% holding steady at full price during the third quarter, whereas around 20% sees markdowns. In strong housing markets, the balance could shift to as much as 90 percent full price. Competitors in the industry might hope for an 80-20 split, yet external conditions can shift these percentages. Typically, stronger housing markets minimize markdowns, while weaker markets tend to increase them.

Currently, the market’s conditions are challenging, yet we find ourselves in a growth mode as we pivot towards disruption in design, quality, and value. This strategy, though it may exert initial pressure on margins, is aimed at long-term sustainability. Our recent performance shows that despite markdown pressures, we are investing strategically for future gains.

Investing in Market Disruption

Different companies are approaching these market dynamics from various angles. Some opt to maintain market share while increasing operating margins, but our company is focused on seizing the moment to grow our core RH business rather than risking declines.

We believe that the benefits of striving for a 30% growth in our core RH business will bring us leverage and a stronger market position moving ahead.

Balancing Cash Flow and Debt

Christopher Horvers — Analyst

Thank you very much. Wishing you a happy holiday season.

Gary G. Friedman — Chairman and Chief Executive Officer

Thank you.

Operator

The next question comes from Simeon Gutman with Morgan Stanley. Your line is open.

Zach Abraham — Analyst

Hi, this is Zach, filling in for Simeon. Can you detail when you anticipate RH becoming free cash flow positive, and how self-funding plays into this model moving forward?

Gary G. Friedman — Chairman and Chief Executive Officer

We expect to turn free cash flow positive next year and believe we can self-fund our operations. While our debt levels may raise eyebrows, we view them more as a tactical move rather than a burden. Essentially, we see our debt as a currency swap rather than a traditional liability.

Our debt stemmed not from necessity but from an opportunity to leverage our position. We converted our debt into equity, primarily stock, which we can liquidate when needed. This strategic exchange has already delivered more than $300 million in returns based on today’s stock prices. We initially invested in our stock when it was undervalued, acquiring 7.6 million shares at an average price of $295.

Jack Preston — Chief Financial Officer

It’s currently trading around $450.

Allison Malkin — Investor Relations

It’s at $451.

Gary G. Friedman — Chairman and Chief Executive Officer

Indeed, at $452, this represents a valuable return on our strategic initiatives.

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Understanding RH’s Strategic Growth and Financial Performance

Jack Preston — Chief Financial Officer

Today, our return stands at approximately $350 million.

Gary G. Friedman — Chairman and Chief Executive Officer

Indeed, that figures out to about $350 million in returns. This is not our first experience with this type of financial adjustment. Historically, we’ve replaced debt with stock to generate significant value for our shareholders. As the largest shareholder myself, this approach resonates with my perspective.

Zach Abraham — Analyst

Thank you.

Operator

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

Steve Zaccone — Analyst

Good afternoon, and thank you for the opportunity. Congratulations on your accelerated growth.

Could you elaborate, Gary, on what has driven this acceleration? What factors have contributed to the improvements in your product? Additionally, how do you view your competitive position in the market? If the industry strengthens in 2025, do you feel prepared to meet that demand?

Gary G. Friedman — Chairman and Chief Executive Officer

Most of our insights are outlined in our letter, but I’ll summarize. We believe we possess numerous competitive advantages. For starters, our platform is better than our competitors’. Our product capabilities, taste, and overall execution are unparalleled in the industry. I’ve said before that some companies have either taste or scale, while we combine both. Our approach to scaling taste influences our extensive reach, which we are actively pursuing.

Our distinct taste is reflected not only in our products but also through our crafted galleries and comprehensive online presence. This strategy is designed to establish a highly disruptive and profitable platform in the long run.

We continue to excel in curating and integrating products, ensuring we present them better than anyone else in the market, as evidenced by our current business scale and profitability. Our longstanding commitment to innovation defines who we are. After 24 years, we are still focused on these core principles.

It’s worth noting a strategic misstep I made during COVID-19 when I paused product orders. Initially, this led to a 40% decline in business, only to rebound rapidly as demand surged. Unfortunately, after two years, when we attempted to reignite our product engine, we struggled with execution due to lost momentum.

Now, we’re back, not just competing but returning as a more refined version of ourselves. While others thrived during our absence, RH has evolved significantly. I believe the next five years could be the most prosperous period in our history. Our commitment to innovation and creativity has never been stronger.

Steve Zaccone — Analyst

Got it. I’d like to follow up regarding your gross margin. In the last quarter, you mentioned a positive change in product margins in August.

Gary G. Friedman — Chairman and Chief Executive Officer

That’s correct.

Steve Zaccone — Analyst

How did this trend continue throughout the rest of the quarter? What should we anticipate for product margins in the fourth quarter?

Gary G. Friedman — Chairman and Chief Executive Officer

Currently, we’re experiencing positive demand for our product margins. However, we did face some adjustments with selling margins due to increased market stock. Our recent gallery transformations led to a higher volume of stock handled, which isn’t typically favorable.

When we transform our gallery layouts, products are removed and often returned without protective packaging, leading to potential damages. We faced additional write-offs for items we deemed unsellable at our outlets due to these circumstances.

Jack Preston — Chief Financial Officer

Moreover, we faced elevated costs related to the product’s transportation and inventory transfers.

Gary G. Friedman — Chairman and Chief Executive Officer

Absolutely, Jack. Additionally, we optimized our distribution center (DC) inventory placement and managed product movement from Europe back to America, as our initial selections weren’t ideal.

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Management Discusses Growth Strategies and Real Estate Investments

Key Business Trends and Shipping Decisions

In light of current market trends, management acknowledged that they have excess inventory. Instead of marking down products in Europe, the strategy is to ship them back to the core business in Baltimore. This approach supports their foundational operations. According to Jack Preston, Chief Financial Officer, despite these adjustments, the company’s selling margins are showing positive trends.

Real Estate Expansion Plans

Analyst Steven Forbes posed a two-part question regarding the company’s extensive real estate plans. He inquired about payback periods and the expected return on invested capital (ROIC) for their new gallery stores. Gary G. Friedman, Chairman and Chief Executive Officer, stated that historically, they expect a payback period of one to three years, though COVID impacts have resulted in longer timelines for construction initiated during that period.

Friedman noted that construction costs have skyrocketed, being 70% to 100% higher than pre-pandemic rates. However, he emphasized the growing demand and sales expectations, suggesting quicker payback for current projects. Some of their more iconic locations, such as those in London and Paris, may offer extended payback periods of up to four years, but overall, the outlook remains positive.

High-Stakes Investments and Long-Term Benefits

The company has been strategic in terms of site development. For instance, their project in Newport Beach involved significant preliminary work from their partners, who invested $25 million in site preparation alone. The anticipated payback for this project is around 1.5 years.

Friedman explained that while some European locations might demand larger investments, the potential revenues make them a wise decision. He reflected on their existing galleries built at lower costs compared to current expenditure, making competition challenging for others in the market.

Focus on Cash Flow and Long-Term Growth

As the primary shareholder, Friedman highlighted the importance of viewing the business through cash flow generation rather than merely operating margins. He pointed to upcoming racial depreciation increases as an essential factor in assessing long-term financial health, thus framing cash flow and adjusted EBITDA as critical metrics.

The Future of Landlord Relations

Conversations with landlords have shifted positively, as the company’s performance and margins have improved, enhancing their attractiveness as tenants. This change in dynamics could lead to favorable agreements in future negotiations.

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RH CEO Discusses Future Growth and Unique Business Strategies

In a recent update, Gary G. Friedman, Chairman and CEO of RH (Restoration Hardware), shared insights on the company’s achievements and future direction. He emphasized the enthusiasm for developing new opportunities while remaining cautious about market saturation.

Record Inbound Interest and the Cost of Expansion

The company is currently experiencing a threefold increase in inbound interest from potential partners and consumers, indicating strong market demand. However, higher debt costs present challenges for expansion projects.

Selective Growth Strategy and Innovative Concepts

Friedman stressed the importance of selective expansion, preferring fewer but more iconic locations instead of saturating the market. He highlighted the introduction of a new freestanding interior design studio, a unique concept as it will serve as a consumer-facing office, a rarity in the industry.

Impressive Designer Applications Signal Opportunity

In contrast to their gallery application efforts, which receive 6 to 12 applications from interior designers, the new design studio received between 200 to 300 applications. Friedman believes that many interior designers prefer this new approach over traditional retail settings.

Future Growth and Market Potential

The company aims to capitalize on its increasing volume of business, which can create opportunities in more markets. Friedman noted that past market projections have evolved, with current estimates suggesting potential revenues could increase significantly in coming years.

For instance, they now believe they can achieve revenues of $30 million in previously constrained markets, shifting the economic model positively. As a result, RH anticipates opening up to 60-70 new galleries in the near future.

Innovative Shopping Experience with RH Compounds

Friedman introduced the concept of RH compounds, showcasing a new shopping experience that involves multiple connected buildings. This innovative idea aims to reduce capital spending by approximately a third while creating a visually appealing environment for shoppers.

Upcoming sites include a compound in Naples, Florida, and another in Walnut Creek, California, both repurposing former major retail locations for RH’s new experiential model. Friedman expressed optimism that these projects will resonate with developers and enhance brand visibility.

Product Transformation Cycle: A Continuous Evolution

When asked about the current stage of the company’s product transformation cycle, Friedman identified it as potentially the fourth inning, following recent developments in Asia. He acknowledged that as RH evolves, so does its potential for future growth, akin to the early days of major tech companies like Apple.

Long-Term Profitability and Margin Expectations

As for margins and profitability from their investments, Friedman reassured analysts that the company remains focused on long-term growth, indicating that they expect these investments to pay off as RH continues its upward trajectory.

Friedman concluded by encouraging analysts to remain attentive to RH’s evolving strategies, emphasizing that their adaptive approach ensures a promising outlook for the future.

Steven Forbes — Analyst

Thank you, Gary. I appreciate the insights.

Gary G. Friedman — Chairman and Chief Executive Officer

Thanks, Steve.

Operator

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

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Chairman Gary G. Friedman Discusses Growth Strategies and Market Challenges

Investing in Innovation and Expansion

Gary G. Friedman, Chairman and CEO, shared insights about the company’s ongoing investment strategies focused on scaling product offerings and establishing new partnerships, particularly in Europe. He emphasized that launching operations in this new market requires substantial upfront investment, but the potential for significant returns is promising.

According to Friedman, the transition into Europe is a crucial step. While initial expenses are high, the demand projections suggest the possibility of generating between $100 million and $160 million in revenue, especially considering the relatively unknown nature of the brand in this region. “If we were in year two and only seeing $8 million in revenue, I would be concerned. But now, with projected demand tracking at about $38 million, we are on a stronger path,” he noted.

Current Market Conditions

Despite anticipating growth, Friedman acknowledged the current challenges posed by a sluggish housing market. He characterized the market as experiencing a “dead cat bounce,” with no meaningful shifts to indicate substantial growth yet. “When the housing market rebounds, we expect to see improvements in our margin model,” he added. He stated that this period represents the company’s largest investment cycle to date, suggesting that they are currently operating with bottom margins.

Looking Ahead

As for future trends, Friedman indicated a narrowing gap between demand and revenue. “Stock levels are improving as we’ve invested in more inventory,” he explained. He expects fluctuations in performance until new product lines stabilize but is optimistic about closing the gap. He stated, “We envision that the initial gap is closing and that we won’t return to the larger discrepancies seen previously.”

Expanding Opportunities in the Trade Sector

Friedman discussed potential synergies with the newly acquired Waterworks business, particularly in the B2B sector. He believes that by utilizing the best product designs and expanding the reach to various customer segments—including children and teens—the business could yield significant earnings potential. He estimated this could evolve into “a billion-dollar opportunity.”

The conversation also touched on challenges associated with returns, which play a vital role in driving sales in the outlet segment. As the core business grows, returns from new products are expected to boost the outlet side significantly.

On the topic of data-driven insights, Friedman conveyed that the company has gained valuable knowledge through recent experiences, allowing for smarter investments and decision-making moving forward. “Better data leads to better decisions and ideas,” he concluded.

Max Rakhlenko – Analyst

Thank you, Gary. Enjoy your time in Montecito.

Gary G. Friedman – Chairman and Chief Executive Officer

Thanks, Max. Sorry we’ll miss your opening!

Operator

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

Curt Nagle – Analyst

Thank you, Gary. I’d like to understand when the demand and revenue trends will align, particularly looking at the first half of 2025. Should we expect performance similar to what we are seeing in the fourth quarter?

Gary G. Friedman – Chairman and Chief Executive Officer

That’s a great question, Curt. Yes, we anticipate the gap to begin shrinking, but it may take time. We’ve made significant inventory investments to help address this. As new products enter the market, there will be some initial bumps, but our confidence in closing the gap remains high.

Curt Nagle – Analyst

Understood. That sounds promising. Could you also elaborate on potential synergies between your core products and the expansion of the Waterworks business?

Gary G. Friedman – Chairman and Chief Executive Officer

Of course. We are currently focusing on solidifying our contract side, ensuring we have adequate inventory. While we’re still transitioning to improve our galleries, the exposure of Waterworks to our interior designers is increasing. This recognition will enhance sales opportunities significantly going forward.

Seth Basham – Analyst

Thank you, Gary. To follow up, could you clarify your views on the product transformation timeline and the expected peak inflection point? Are we looking at a shift toward early 2025 or beyond?

RH’s Strategic Expansion: A Vision for a Taste Platform

Growing Beyond Traditional Boundaries

Gary G. Friedman — Chairman and Chief Executive Officer

As I reflect on our current position, it’s clear that we’ve transitioned into a new phase of growth. Initially, we lacked sufficient data to fully understand our opportunities. Now, I believe our peak growth inflection point may be several years away, but the potential is significant.

A Shift in Perspective on Growth

Seth Basham — Analyst

You previously indicated that peak growth was imminent. Are you suggesting this peak is now further down the road, but that you still expect strong growth in the interim?

Gary G. Friedman

Yes, the strongest growth might be a year or two away. The brand extensions I’ve mentioned are substantial and not minor changes. With the new products on the horizon, we’re undergoing what I describe as a “product development super cycle.” This is unlike anything we’ve pursued previously due to our limited data.

Uncovering New Opportunities in the Market

We perceive the market and our consumers differently now. The increase in households and aesthetic preferences indicates a larger opportunity for RH than ever before. Traditionally, I viewed us as a specialty brand; however, my perspective has changed significantly in the past month. We’ve worked towards building a unique look and expanding our reputation over the last 20 years, but our vision has evolved into constructing a platform for taste.

Redefining RH: From Specialty to a Taste Platform

When considering platforms like Wayfair, which drives around $12 billion in revenue, it highlights the importance of evolving beyond a traditional brand. Transitioning RH from merely a brand to a taste platform expands our reach immensely, allowing us to explore various aesthetics and life stages across diverse homes.

Growth: A Potential to Exceed Expectations

The growth trajectory is promising. As our core business continues to trend upwards by 25% to 30%, the question remains—can we amplify that growth further? It’s possible that we could aim for 30% to 40% growth based on current observations. However, I want to clarify that I’m not making promises; I’m simply sharing our insights based on evolving circumstances.

A Heightened Awareness of Potential

Currently, we comprehend more about our market than ever, influenced by our transformative product cycle. The opportunities to connect these new elements can lead to significant and sustained growth that could even outlive previous estimations.

Looking Ahead: Navigating Inventory and Market Changes

Seth Basham — Analyst

Final question for you: regarding inventory issues, it seems to be on the rise again with a 30% increase this quarter. What inefficiencies are present? Are there plans in motion to address these while exiting China?

Gary G. Friedman

Indeed, inventory levels are accurate as you’ve outlined. As we navigate the situation with China and Mexico, we’re proactively positioning ourselves. The United States and Mexico are currently undertaking their negotiations, and understanding these dynamics will drive our future decisions.

China constituted about 22% of our purchase dollars last year. How the situation in Mexico unfolds remains to be seen. We anticipate changes due to tariffs and other factors, particularly in light of evolving responsibilities regarding immigration. Each country presents different challenges, yet the importance of maintaining trade relationships remains crucial.

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Strategic Insights from Gary G. Friedman on Business Growth and Negotiations

Andrew Carter — Analyst

Since when?

Gary G. Friedman — Chairman and Chief Executive Officer

1812? Yeah.

Indeed. The U.S. stands strong with the most robust military and nuclear capability globally. Donald Trump excels in negotiation. He views global dynamics through the lens of leverage. Negotiating without leverage is merely pretending, and it’s crucial that one maintains authenticity. Trump has successfully used leverage in the past and continues to do so.

Even before assuming office, he’s already demonstrating negotiation skills effectively. It’s impressive, to say the least. Take Mexico’s situation; they surely want to avoid a shutdown of trade.

Imposing 25% tariffs isn’t an impossibility. It might happen temporarily, as our leverage is substantial.

China presents a different challenge altogether. Reflect on Trump’s first term with North Korea—the leader there was consistently launching missiles towards Japan, claiming he could reach California. After just one meeting with Trump, that ceased.

While it’s tempting to attribute this to a personal affinity for Trump, other factors likely influenced this shift. Moving forward, we’ll witness many negotiations unfold. I anticipate limited decisions having a detrimental effect on the U.S. economy. The United States possesses considerable leverage, and we have a leader who understands how to exploit it.

Andrew Carter — Analyst

That makes sense. Shifting topics, you mentioned transitioning into a significant cash flow strategy. What’s your thought process regarding external investments you’ve initiated? You touched on prioritization in the last call. Are those projects still in play, or have they been deprioritized?

What about the guest house and the real estate joint venture? Are you looking to focus on those more, or is the emphasis strictly on the core business?

Gary G. Friedman — Chairman and Chief Executive Officer

There’s always a focus on our core business first. At different times, unique opportunities arise—like the Aspen joint venture that allows us to create a distinctive ecosystem. We expect a solid return from that investment, although we are currently facing challenges due to changes in the housing market and rising interest rates, which can hamper real estate investments.

While those projects may be less prioritized right now, we are still progressing. We’re set to launch a gallery and have a guest house approved. We plan to integrate some residential ventures as well.

In time, the Aspen joint venture will transition into a cash-generating endeavor as we sell real estate assets. We have plans to complete the gallery and the guest house while keeping a primary focus on the core business. Every initiative we take, including ventures like Aspen, aims to enhance and amplify the core brand. The perception and visibility of our brand are crucial for its growth.

The brand has taken years to cultivate and is viewed distinctly compared to competitors. Though we have not reached our ultimate vision, we are recognized positively through many customer perspectives. Our investment mode is at its highest, and we see a continuous push forward.

While investments may not occur at the same rapid pace, we’ve made substantial investments in brand extension and marketing. This includes costs like advertising for new products, which does not require extra retail space but leverages our existing platform. Key aspects are managed by the same teams, maintaining consistency. However, establishing our presence in Europe represents a significant undertaking that affects our overall strategy.

Should we not account for a 230 basis point drop due to these investments, the model would appear markedly better, even amidst a volatile housing market. When we revise our estimates considering the investments cycle downturn, our projected free cash flow outlook shifts significantly.

Andrew Carter — Analyst

Thank you. I’ll hand it over to the next person. Happy holidays.

Gary G. Friedman — Chairman and Chief Executive Officer

Happy holidays to you as well. Thank you.

Operator

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

Brian Nagel — Analyst

Hi. Good afternoon. Congratulations on the positive momentum within the company. I’d like to follow up on your comments regarding the macro environment. Given the improving demand trends you’re observing, do you believe your new products are significantly contributing to this change? Are there early signs of easing in the U.S. housing market?

Gary G. Friedman — Chairman and Chief Executive Officer

I haven’t noticed our competitors reflecting this change. Are we alone in experiencing this growth? Perhaps. I recognize there’s pent-up demand for housing. However, market indicators don’t show dramatic shifts in the macro environment. Many are predicting a broader market recovery, which hasn’t yet materialized.

Considering our industry is down about 7% to 8%, there aren’t many showing positive growth. The difference is minor if we analyze our growth trends against overall demand. Could we be benefiting slightly from an improved macro environment? Possibly, but I believe the real driving force is our focused and effective product transformation.

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RH CEO Discusses Bold Product Strategy Amid Unique Market Dynamics

Brian Nagel — Analyst

Thank you. Regarding the product transformation, could you clarify the pace of future product introductions? Will we see a more aggressive approach moving forward compared to the last couple of years?

Gary G. Friedman — Chairman and Chief Executive Officer

Absolutely. As I mentioned earlier, we recognize a significantly larger market opportunity ahead. Expect a more aggressive strategy in expanding our product offerings. Historically, our approach focused on “direct-centric growth,” meaning we would not restrict our assortment based solely on store size. Instead, we aimed to align it with market potential, utilizing our catalogs and website to showcase our products. This vision propelled our growth from $300 million to where we are now.

Over the last decade, following the launch of our Modern collection, we perceived ourselves as more established and decreased our product introductions. In doing so, we inadvertently allowed competitors to capture market share that we could have defended. We now view RH not just as a specialty brand, but as a taste platform that encompasses a broader market perspective. This evolution enables us to challenge competitors based on our unique style and brand authority.

Brian Nagel — Analyst

Thanks for clarifying.

Gary G. Friedman — Chairman and Chief Executive Officer

Thank you.

Operator

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

Jonathan Matuszewski — Analyst

Good evening. My first question is regarding pricing. Could you elaborate on the strategy behind pricing for new collections? Will sales growth in one to two years come from higher prices or increased unit sales?

Gary G. Friedman — Chairman and Chief Executive Officer

That’s not entirely clear yet, but likely it will be a combination of both factors. We see a much larger market ahead of us. This gives us leverage to provide more disruptive value. Customers today may prefer purchasing a dining chair from RH due to our strong brand reputation, rather than from competitors like Wayfair. The enduring perception of our brand enhances product value and differentiates us in the marketplace.

Similar to automotive purchases, consumers choose luxury brands like BMW or Mercedes because they trust the quality and design associated with these brands. The same applies to furniture; buying from RH is perceived as a higher value compared to options from competitors. This consumer perspective not only elevates our brand but also expands our market reach, making RH a preferred choice.

Jonathan Matuszewski — Analyst

Thank you for that insight. For a follow-up, can you provide details about which product lines are currently outperforming? Are there any trends or specific characteristics driving their success?

Gary G. Friedman — Chairman and Chief Executive Officer

Why would I disclose that information publicly? Think about it.

Jonathan Matuszewski — Analyst

I completely understand; just seeking clarity.

Gary G. Friedman — Chairman and Chief Executive Officer

Exactly; all our competitors are on this call. It’s not in my interest to share that.

Jonathan Matuszewski — Analyst

Thanks, Gary.

Gary G. Friedman — Chairman and Chief Executive Officer

Thank you, Jonathan.

Operator

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

Zachary Fadem — Analyst

Good afternoon. Thank you for including me. Gary, I wanted to follow up on your comments regarding the balance sheet and the recent currency swaps you mentioned.

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Examining RH’s Debt Strategy amid Share Buybacks and International Moves

CEO Gary Friedman Addresses Interest Expenses and Shareholder Returns

Gary G. Friedman — Chairman and Chief Executive Officer

With interest expenses reaching about $9 per share, the conversation shifts to debt management and investment priorities. Friedman asserts that the company is focused on making the right investments to drive shareholder returns. Despite the current pressure from debt, he notes there are 7.6 million fewer shares outstanding. Evaluating the impact of those buybacks in the future is crucial. The question remains: is it more valuable to remove shares from circulation or to hold onto that cash? Based on their analysis, RH believes repurchasing shares at $295—potentially rising to between $1,200 and $2,000—will prove beneficial over time. Friedman reflects on past experiences, citing successful buybacks executed in 2017 as evidence of their strategy’s effectiveness.

Having worked in private equity, he has a unique perspective on investment evaluation that differs from conventional methods. Historical context reinforces this approach, as similar strategic questions have arisen before.

Insights on Shopping in Europe and the Decision on Germany

Zachary Fadem — Analyst

Fadem inquires about the implications of not renewing leases in Germany and how that decision will affect sales and margins. He asks whether the plan is to close those locations immediately or wait until 2027, as there seems to be a current 230 basis point margin pressure from Europe.

Gary G. Friedman — Chairman and Chief Executive Officer

Friedman acknowledges his analyst’s query, noting that they do not usually provide granular details. Quick decisions enabled them to secure prime locations in Paris and London, but they weren’t necessarily ready for Germany at that time. The choice was influenced by the consideration of potential lawsuits from landlords to maintain value in their properties. Whenever they were faced with challenging decisions about lease renewals, the focus was securing strategic locations while minimizing investments. This focused approach allowed RH to enter significant markets considerably quicker than they otherwise could have.

Closing Thoughts and Future Outlook

Gary G. Friedman — Chairman and Chief Executive Officer

In his closing remarks, Friedman emphasizes gratitude for the team’s hard work in achieving product transformation. He reiterates that at RH, the priorities are placed in order of importance, first on employees, then partners, and lastly shareholders. He expresses optimism for the future while wishing all participants a happy holiday season. Communication about progress will continue into the new year, promising ongoing engagement with stakeholders.

Operator

Thank you for joining today’s conference call. This concludes the session. [Operator signoff]

Duration: 0 minutes

Conference Call Participants:

Allison Malkin — Investor Relations

Gary G. Friedman — Chairman and Chief Executive Officer

Michael Lasser — Analyst

Jack Preston — Chief Financial Officer

Other Analysts

This article is a transcript of this conference call produced for The Motley Fool. While we strive for accuracy, there may be errors. The Motley Fool encourages readers to do their own research, including reviewing company filings. Please see our Terms and Conditions for more information.

The Motley Fool recommends RH. The Motley Fool has a disclosure policy.

The views expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.