RH (NYSE:RH) Q3 2023 Earnings Call Transcript

RH (NYSE:RH) Q3 2023 Earnings Call Transcript December 7, 2023

RH misses on earnings expectations. Reported EPS is $-0.11904 EPS, expectations were $0.91.

Operator: Hello and welcome to the Q3 2023 RH Q&A Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions] I’ll now turn the conference over to Alison Malkin. Please go ahead.

Allison Malkin: Thank you. Good afternoon, everyone. Thank you for joining us for our third quarter fiscal 2023 earnings conference call. Joining me today are Gary Friedman, Chairman and Chief Executive Officer, and Jack Preston, Chief Financial Officer. Before we start, I would like to remind you of our legal disclaimer that we will make certain statements today that are forward-looking within the meaning of the federal securities laws, including statements about the outlook of our business and other matters referenced in our press release issued today. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filing as well as our press release issued today for a more detailed description of the risk factors that may affect our results.

Please also note that these forward-looking statements reflect our opinion only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today’s financial results press release. A live broadcast of this call is also available on the Invest Relations section of our website at ir.rh.com. With that, I’ll turn the call over to Gary.

Gary Friedman: Great. Thank you, Allison. Good afternoon, everyone. As we usually do, we’ll start with our shareholder letter and open the call to questions. To our people, partners, and shareholders, net revenues of $751 million were at the midpoint of our guidance to the quarter, and adjusted operating margin of 7.3% was slightly below expectations due to higher than anticipated expenses, including international openings, as well as costs related to our pending acquisition of the New York Guesthouse property and unsuccessful efforts to secure the iconic One Ocean Drive Miami Beach location. While pleased with improved demand trends generated from the launch of our new RH Interiors and RH Contemporary collections, we experienced increased headwinds in early October when mortgage rates peaked above 8%, and the Hamas invasion of Israel triggered the war in the Middle East.

With 82% of homeowners having mortgages below 5%, and 62% below 4%, we continue to expect the existing housing market to remain frozen until interest rates and/or home prices fall meaningfully. Additionally, the home furnishings market has become increasingly promotional, and we believe that it will create a mix shift towards clearance products, pressuring gross margins. In light of the current market, we are delaying the mailing of our RH Modern Sourcebook until the first quarter of 2024 when we believe demand conditions will likely be more favorable. As a result, we are narrowing our revenue guidance range for the year to $3.06 billion to $3.08 billion, and now expect adjusted operating margin to be in the range of 13.6% to 14.0%. As mentioned, we are in contact — contract to make an opportunistic purchase of the New York Guesthouse property for approximately $58 million, scheduled to close in the fourth quarter.

The building was appraised at $85 million last September when the Federal Funds rate was half the level it is today. We believe controlling the outcome of this one-of-a-kind property is in our best interest. However, we will be poised to take advantage of any opportunity to do a sale-leaseback with the appropriate investor when the commercial real estate market rebounds in the future. Product elevation. We expect our demand trends to accelerate though the first half of 2024 as our product transformation unfolds, in-stocks improve, we complete the reset of our Galleries, and introduce our new Modern and RH Outdoor Sourcebooks in the first quarter of next year. We anticipate our inflection point will peak in the second quarter of 2024 as our new collections fully ramp and we begin another cycle of Sourcebook mailings, completely transforming and refreshing the entire brand over a 12-month period.

We believe our latest collections reflect a level of design and quality inaccessible in our current market and a value proposition that will be disruptive across multiple markets, positioning RH to gain market share throughout fiscal 2024. While a product transformation of this magnitude will be margin dilutive in the short term, we believe it will become margin accretive over the long term as selling rates stabilize and allow for supply chain and sourcing efficiencies. Platform expansion. Our plan to expand the RH brand globally, address new markets locally and transform our North American Galleries represents a multi-billion dollar opportunity. As discussed last quarter, we introduced RH to the UK this past summer in a dramatic and unforgettable fashion with the opening of RH England, The Gallery at the Historic Aynho Park, a 17th-century, 73-acre estate that is a celebration of history, design, food and wine.

We had a spectacular turnout for our opening event and the global press coverage the brand received was multiple times greater than any Gallery we have ever opened. Due to RH England’s countryside location, we expect the majority of the revenues to be driven by our Interior Design and Trade businesses, which are dependent on building books of business with high-value repeat clients like Interior Design Firms and Hospitality projects. The quote book and demand continue to build monthly, despite the seasonal nature of the location. Our first UK Interiors Sourcebook was in home in October, with our next contact planned to be our RH Modern and RH Outdoor Sourcebooks in the first quarter of 2024. In November we opened two new international Galleries, RH Munich and RH Dusseldorf.

The response to our opening events was beyond our expectations, with RH Munich hosting over 900 chic attendees roaming the three floors with Cipriani Bellinis and Vesper Martinis, and traffic in both Galleries has been strong since opening. Although RH England is our most unique and spectacular Gallery to date, and the only one with a hospitality component in Europe, all three are architecturally impressive, multi-level expressions of the RH brand, only to be outdone by our even more impressive teams in each location. While many retailers boast of a capital-light, franchise or licensing approach to international expansion, we believe the only way to build a brand and optimize the business globally, is to invest into, and control the brand in the same manner we do locally.

With people who live and breathe our values, because it’s their values. People who will lead our cause and build our culture, because it’s their cause, and it’s their culture. We believe when you aspire to be the very best in the world, there are no shortcuts, and greatness can never be delegated, nor licensed or franchised. Our next international openings include RH Brussels, The Gallery on the Boulevard De Waterloo, and RH Madrid, The Gallery on the Plaza Marques De Salamanca in the first half of 2024, followed by RH Paris, The Gallery on the Champs-Elysees in the fall of next year. RH Paris is one building from the corner of the Avenue Montaigne, known as one of the most exclusive and luxurious arteries in the capital, and the chosen home of the major haute-couture brands such as Chanel, Dior, Vuitton, Celine, Saint Laurent, and many others.

We believe the space we have designed for this location will position RH as a place- maker in the luxury fashion capital of the world. RH Paris will be a six-floor jewel-box connected by a dramatic, ornate scissor stair and a central glass elevator that will whisk you up to the fifth floor and rooftop Champagne & Caviar Bar, where you can take in views of the Eiffel Tower while enjoying our innovative menu featuring the finest Petrossian Caviars. You can also visit the second floor and dine in our dramatic atrium restaurant, inspired by the Grand Palais. With an onyx-carved bar, floors, walls and tables looking out into the beautifully landscaped courtyard with 30-foot ivy-covered walls, it’s like dining in a secret garden, erasing the noise and chaos of the outside world.

Mark your calendars for early September, RH Paris will be an opening party you won’t want to miss. We are also under construction in London and Milan in inspiring spaces that will celebrate the heritage of the historic structures and will integrate full expressions of our hospitality experiences. Our current plans call for opening both Galleries in 2025. We are also anticipating gaining local approvals soon for RH Sydney, the Gallery in Double Bay, with plans to open in late 2025 or early 2026. Regarding our North American transformation, we opened RH Indianapolis, The Gallery at the DeHaan Estate, one of the most accurate Palladian-style villas ever built in the United States. The estate spans 151 acres and over 60 rooms, overlooking over a 35-acre lake, and represents one of the largest, most inspiring and immersive physical expressions of our brand to date.

With construction delays pushing RH Cleveland into the first quarter of next year, our plan now includes opening five North American Design Galleries in 2024, inclusive of RH Palo Alto, RH Cleveland and RH Raleigh in the first half of next year, and RH Montecito and RH Newport Beach in the second half. We also believe there is an opportunity to address new markets locally by opening Design Studios in neighborhoods, towns and small cities where the wealthy and affluent live, visit and vacation. We have several existing locations that have validated this strategy in East Hampton, Yountville, Los Gatos, Pasadena and our former San Francisco Gallery in the Design District, where we have generated annual revenues in the range of $5 million to $20 million in 2,000 to 5,000 square feet.

We have secured our first new location for a Design Studio in Palm Desert, which should open in the first half of 2024. We have identified over 40 locations that are incremental to our previous plans in North America and believe the results of these Design Studios will provide data that could lead to opening larger galleries in those markets. The RH business vision and ecosystem, the long view. We believe there are those with taste and no scale, and those with scale and no taste, and the idea of scaling taste is large and far reaching. Our goal to position RH as the arbiter of taste for the home has proven to be both disruptive and lucrative, as we continue our quest to build the most admired brand in the world. Our brand attracts the leading designers, artisans and manufacturers, scaling and rendering their work more valuable across our integrated platform, enabling RH to curate the most compelling collection of luxury home products on the planet.

Our efforts to elevate and expand our collection will continue with the introductions of RH Couture upholstery, RH Bespoke furniture, RH Color, RH Antiques & Artifacts, RH Atelier and other new collections scheduled to launch over the next decade. Our plan to open immersive Design Galleries in every major market will unlock the value of our vast assortment, generating revenues of $5 to $6 billion in North America, and $20 to $25 billion globally. Our strategy is to move the brand beyond curating and selling product to conceptualizing and selling spaces, by building an ecosystem of products, places, services and spaces that establishes the RH brand as a global thought leader, taste and place maker. Our products are elevated and rendered more valuable by our architecturally inspiring galleries, which are further elevated and rendered more valuable by our interior design services and seamlessly integrated hospitality experience.

Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our galleries into RH guesthouses, where our goal is to create a new market for travelers seeking privacy and luxury in the $200 billion North American hotel industry. Additionally, we are creating bespoke experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley, RH1 and RH2, our private jets, and RH3, our luxury yacht that is available for charter in the Caribbean and Mediterranean where the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design and landscape architecture. This leads to our long-term strategy of building the world’s first consumer-facing architecture, interior design and landscape architecture services platform inside our galleries, elevating the RH brand and amplifying our core business by adding new revenue streams while disrupting and redefining multiple industries.

Our strategy comes full circle as we begin to conceptualize and sell spaces, moving beyond the $170 billion home furnishings market into the $1.7 trillion North American housing market with the launch of RH Residences, fully furnished luxury homes, condominiums and apartments with integrated services that deliver taste and time value to discerning time-starved consumers. The entirety of our strategy comes to life digitally with The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Our authority as an arbiter of taste will be further amplified when we introduce RH Media, a content platform that will celebrate the most innovative and influential leaders who are shaping the world of architecture and design.

Our plan to expand the RH ecosystem globally multiplies the market opportunity to $7 trillion to $10 trillion, one of the largest and most valuable addressed by any brand in the world today. A 1% share of the global market represents a $70 to $100 billion opportunity. Our ecosystem of products, places, services and spaces inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an emotional connection unlike any other brand in the world. Taste can be elusive, and we believe no one is better positioned than RH to create an ecosystem that makes taste inclusive and, by doing so, elevating and rendering our way of life more valuable. Never underestimate the power of a few good people who don’t know what can’t be done.

For the past 23 years we’ve heard others tell us what can’t be done, and for the past 23 years we’ve failed to listen. We avoided bankruptcy while being accused of lunacy. While others have been shrinking and closing stores, we’ve been building the largest and most inspiring spaces in the world. When Wall Street didn’t think our stock was worth buying, we bought 60% of it ourselves. When everyone told us we should be working from home, we were in the Center of Innovation working on rebuilding our new home, and it’s almost ready for primetime. From the largest product transformation in our history, to the most inspiring and unusual retail experiences in the world, from couches to caviar, beds to bellinis, architecture to airplanes, homes to hotels, I should say guesthouses, from Pittsburgh to Paris, Los Angeles to London, Boston to Brussels, Miami to Munich and San Francisco to Sydney, soon the world will be within our reach.

Never underestimate the power of a few good people who don’t know what can’t be done, especially these people. Onward Team RH. Carpe Diem, Gary. Operator, I’ll now open the call to questions.

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Simeon Guttman of Morgan Stanley. Your line is open.

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Q&A Session

Simeon Guttman: Hi, everyone. Hi, Gary, Jack. Good afternoon. I want to ask about contemporary. I know it’s early. I think some of the research was that it shouldn’t cannibalize other aesthetics. I don’t know how much data you have on it yet, but is that fair and how sales are progressing? And then I don’t think — can you just remind us, you never touch pricing on contemporary? I know we talked about changing some pricing on some items, but I don’t think it’s ever related to the new collection. Thanks.

Gary Friedman: Yeah, we reviewed kind of pricing and our value equation throughout the brand. So everything was touched. I mean, it’s — if you look at the contemporary brand, the contemporary book, this remailing of the book, it’s got a very high new content. So, but all the products kind of been, I don’t think there’s anything we didn’t reprice. So, yeah. But look, the contemporary book got in mid-October, early to mid-October, it kind of hit right as the war was breaking out and interest rates peaked. So it was hard to kind of see the initial reaction to it. There’s collections, like any collection, there’s collections that are selling really well. Some are selling good, some not so well. I feel very confident that the overall mailing of contemporaries is going to be incremental, as we believe interiors has been and as we believe modern will be and as we believe couture upholstery will be and bespoke furniture will be and everything we do.

So look, we couldn’t be more excited. We’re sailing into the probably one of the biggest headwinds any of us have experienced in the housing market, while it’s not the great recession of 2008/2009, it is from a housing point of view. It’s that bad. So, you’re laughing really big down numbers in the housing market and they’re still down. So you’ve got a little lift in the new home markets but that’s only 10% of the market. So we’ve got, As I said in this latest shareholder letter, and I said last time, we should continue to see our business inflect through the rest of this quarter and into through the first half of next year and hit an inflection point I think kind of mid-late to second quarter and that’ll be despite kind of the housing market unless there’s something where there’s another gap down but it seems that they’ve got inflation somewhat under control.

It seems like the Fed’s becoming more confident. And if we can start to see a move in interest rates and easing in interest rates, the federal funds rates and the mortgage rates that’ll help. While mortgage rates went down a little, you still have an affordability issue with 82% of the people with mortgages at 5% are under, and 62%, 4% are under, and 25% are under 3%. So that’s the biggest issue facing the market today. And that’s why we don’t have inventory. There’s not inventory in the housing market and why prices aren’t coming down because there’s not inventory. You have some pricing coming down here or there in some markets but the good news for us is we’re just taking a long view, we’re trying to position the brand and the business for the next big run and I think we’re going to be meaningfully better positioned than anybody else in our sector, not by a little, by a lot.

Like, when this [has] (ph) we’ll outperform you know the market and the competition, I think, over the, the next period. We gave some market share back during the post-COVID period, we haven’t been promotional like everybody else got. Everybody got on the other side of COVID and everybody got promotional. Even though people say they’re not promotional or they’re not doing site-wide promotions or whatever the language is, just on people’s websites, it’s a very promotional environment out there and has been. And I think what you’re seeing now is the people that got promotional are now going to have lapped their promotional stance and they have to go up against that. So that was a lever post-COVID for people to, yeah, turn on the promotions, lift the business.

Now everybody’s cycling that and, I think you’re going to see people’s, as you’re seeing it, people’s and businesses inflecting downwards in this environment and our businesses inflecting upwards and it will continue to do so.

Simeon Guttman: Can you — as a follow-up, can you talk about your own inventory position, the ratio of discounted or clearance items? Because you mentioned the shifting to that could weigh on margin. And if you have stuff that needs to be cleared or contemplated to be cleared, does it make sense to tactically move it out of the way to make way for all the new product that’s coming?

Gary Friedman: We are. We just don’t want to lead with clearance and lead with pricing. I mean, we’ll have a few emails that go out there that talk about end of year sales to deal with the clearance goods and stuff like that. And we’ll be aggressive pricing those goods. So we get the inventory clean, turn inventory into cash. We don’t want it sitting around on the balance sheet. So, yeah, you’ll see it take the appropriate action here. And so, but nothing we wouldn’t normally do. We would still want to leave with promotions or start to turn the business back in that direction. We’re almost to the other side of this thing. I can’t believe, maybe we’ve got another six to 12 months, but I think, yeah, you get to the second half of ‘24, unless again, unless they haven’t got inflation under control, I think we’re going to see the Fed take an easing approach.

I would be surprised if they left interest rates at these levels the entire year next year. But nonetheless, even if they do, you’re going to see us perform pretty well in any environment based on — just based on the work we’ve done and what’s in the pipeline and the plans we have. I mean, they’re all very big moves. This is by far the biggest product transformation in the history of our industry. It’s multiple times bigger than anything we’ve ever done.

Operator: Your next question comes from the line of Steven Zaccone of Citi. Your line is open.

Steven Zaccone: Great. Good afternoon. Thanks for taking my question. I wanted to ask on operating margin and I wanted to talk about, ask in particular about your ability to protect the operating margin. We’re now at a level that’s below 2019, granted the macro is challenging. But can you just talk through your comfort with protecting operating margin? What are some levers that you can pull if the macro deteriorates further into next year?

Gary Friedman: Yes. I mean, we’re not — we don’t have a strategy to protect the operating margin. I mean, we’re — you’re comparing it to 2019, are you kidding me? Like why would you do that? It’s nothing like 2019. We’re in the biggest housing downfall than anybody’s seen.

Jack Preston: So there’s, massive, massive inflation, since that time.

Gary Friedman: Yeah

Jack Preston: On so many items of the P&L cost.