RH (NYSE:RH) Q2 2023 Earnings Call Transcript

RH (NYSE:RH) Q2 2023 Earnings Call Transcript September 7, 2023

RH beats earnings expectations. Reported EPS is $3.39, expectations were $2.63.

Operator: Good afternoon. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 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] Thank you. I will now turn the conference over to Allison Malkin of ICR. You may begin your conference.

Allison Malkin: Thank you. Good afternoon, everyone. Thank you for joining us for our second 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 our 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 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 the date of this call and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Also, during this call, we may discuss non-GAAP financial measures, which adjust our GAAP results to eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and a reconciliation of these non-GAAP to GAAP measures in today’s financial results press release. A live broadcast of this call is also available on the Investor Relations section of our website at ir.rh.com. With that, I will turn the call over to Gary.

Gary Friedman: Thank you. Let me begin with our letter to our people, partners, and shareholders. Revenues of $800 million and adjusted operating margin of 20.2% exceeded our guidance for the second quarter due to a $25 million revenue benefit from faster-than-expected deliveries and a shift of approximately $40 million of advertising costs from Q2 to Q3, reflecting the later mailing of our RH Interiors Sourcebooks. We are raising the low end of our revenue guidance for the year and now expect revenue in the range of $3.04 billion to $3.1 billion versus our prior outlook of $3 billion to $3.1 billion and are maintaining our outlook for adjusted operating margins of 14.5% to 15.5%. We continue to expect the luxury housing market and broader economy to remain challenging throughout fiscal 2023 and into next year as mortgage rates continue to trend at 20-year highs and the current outlook for rates to remain unchanged until the second quarter of 2024.

The company repurchased 3.7 million shares in the second quarter at an average price of $325.65, representing approximately 17% of the total shares outstanding at the beginning of the second quarter. Product Elevation. We recently mailed our new 604-page RH Interiors Sourcebook, and while it’s too early to read the response with only 40% of the mailing in-home this week, the early indications do look promising. We continue to expect our business trends to inflect in the second half of this year with the mailing of our RH Contemporary Sourcebook in late October and our RH Modern Sourcebook in early January, as well as the refresh of our Galleries over the next several quarters. We believe our inflection point will peak in the first half of 2024 as our new collections fully ramp and we begin another cycle of Sourcebook mailings, completely transforming and refreshing the assortment across the entire brand over a 12-month period.

We believe the new 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 as we cycle out of waning collections, we believe it will once again become margin accretive 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. This summer, we introduced RH to the United Kingdom 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 in early June and the national and global press coverage the brand received was multiple times greater than any Gallery we’ve ever opened. Due to RH England’s countryside location, we expect the majority of 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 books are building and we will soon mail our first Sourcebook in the United Kingdom. While pleased with the early response, there is still much to learn about the seasonality of the business in the English countryside, especially in the winter season. We’ll know more once we start mailing Sourcebooks and experience a couple of seasons.

Our global expansion also includes opening the openings in Dusseldorf and Munich later this year with Paris, Brussels, and Madrid scheduled for 2024, and London, Milan, and Sydney for 2025. Regarding our North American transformation, we continue to plan opening RH Indianapolis and RH Cleveland in the second half of this year, while RH Palo Alto and RH Montecito will now open in early ’24. Additionally, we have 12 North American galleries in the development pipeline scheduled to open over the next several years. 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’ve generated annual revenues in the range of $5 million to $20 million in 2,000 square feet to 5,000 square feet.

We have just secured our first new location for Design Studio in Palm Desert, which should open in the first half of 2024. We’ve 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. Outlook. As mentioned, we are raising the low end of our revenue guidance for the year to a range of $3.04 billion to $3.1 billion and maintaining our outlook for adjusted operating margin in the range of 14.5% to 15.5%. We estimate the 53rd week will result in revenues of approximately $60 million. For the third quarter of fiscal 2023, we’re forecasting revenues of $740 million to $760 million, and adjusted operating margin in the range of 8% to 10%.

We expect to have increased advertising costs of approximately $50 million versus Q2 2023, reflecting the shifting of the RH Interior Sourcebook from Q2 to Q3, the mailing of RH Contemporary Sourcebooks, and the mailing of our first Sourcebook into the United Kingdom. For the fourth quarter of fiscal 2023, we’re forecasting revenues of $760 million to $800 million, and adjusted operating margin in the range of 14.4% to 16.6% with incremental advertising costs of $5 million versus the fourth quarter of last year. 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, RH Bespoke, 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 billion to $6 billion in North America and $20 billion 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 luxury and privacy In the $200 billion in North American hotel industry. Additionally, we are creating bespoke experiences like RH Yountville, an integration of food, wine, art, and 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 brand and amplifying our core business while 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 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. 1% share of the global market represents a $70 billion 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. The end of COVID confusion, the beginning of the next evolution. We’ve spent far too much time over the past four years debating if this was going to be the Decade of Home or the Death of Retail. If inflation was transitory or if fiscal tightening was mandatory? Home sales and prices shooting up like a rocket, and now falling to earth like a rock. For the first time in my career retailers were comparing their growth rates to any one of the past four years in any given month of any given year. The fact is we’re directionally in the same spot we were four years ago, worrying about a financial recession and the polls saying we might have a Presidential regression.

If there was ever a time the world needed a compass, this might be it. For the people of Team RH our compass is our vision, values, beliefs, and culture. Those things that drive us and unite us. Those things we live for, would fight for, and die for. After several years of being apart due to COVID, we finally returned to The Palace of Fine Arts Theater in San Francisco for what used to be our annual Leadership Conference and we talked about those things. For the first time in the past four years everything came into focus, clear replaced fear, and connections were personal and not virtual. It felt different because it was different. There is a different level of accountability when someone is standing in front of you, looking straight into your eyes and making a suggestion or a request versus looking blankly into a screen, not knowing if those on the other end have you on mute, or just aren’t very interested.

It’s time to break the bad habits of COVID. It’s time to get off the screens, get out of our home office, and reconnect in our team office, or as we did at the Palace. It just felt different, because it was different, and I’m sure it’s going to lead to an outcome that’s different. Yet it also felt familiar, like finding our way back home. Back with our people, where none of us are smarter than all of us. Getting all the brains in the game and the egos out of the room. Listening and learning, discussing and debating, elevating and aligning. It felt like the beginning of our next evolution, and it felt like we were beginners again. 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 time, we’ll open the call to questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Steven Forbes from Guggenheim Securities. Please go ahead.

Steven Forbes: Good afternoon, Gary, Jack. Gary, I was hoping you could maybe just expand on what’s driving your confidence in seeing an inflection in the business during the back half and what the early indications from the RH Interiors books, and I guess RH England as well? Inform me about what the potential re-acceleration in demand could look like as we think out to ’24 and beyond?

Gary Friedman: Sure. I think there’s a couple of dynamics happening. I think you’ve got a kind of a cycling of the backside of COVID and you’ve got a cycling of the dramatic rise in interest rates and the fall-off of the highs of what I’d call a COVID and a zero federal funds rate driven home market. So from our view, I think that cycling happens at the end of this year. And the question is, is there a longer downdraft in the home cycle? I think that the answered questions really deal with, if you say what’s the problem with the housing market today? You’ve got this real delta in interest rates between people who bought a home over the last several years at dramatically lower interest rates that are sitting there with 2.7% call it 3.4% interest rates, 90% of the market is fixed, so you’ve got 90% of market owning homes with really low-interest rates and you’ve got a interest rate gap, like current 30-year mortgages are going for 7%, somewhere between 6.8% to 7.4%.

It’s kind of the range depending on credit. So you’ve got a huge spread there and what’s compounding that huge spread is you haven’t had home prices drop enough yet, right, to offset that margin spread. If home rates dropped — home prices went up 42% in the two years post the COVID. And during the COVID boom, once COVID hit and there was everybody who stuck at home and focused on exiting cities, yeah, the biggest migration from cities to suburbs in history and the biggest migration to second homes in history. So you’ve got a lot of people that moved at a record rate, you’ve got a lot of people locked into really low interest rates. Now you’ve got really high-interest rates and you have no inventory in the market and you have no inventory in the market, because people can’t afford to buy a new home once they sell their home because they’re going to trade at 2.7% to 3.4% interest rate for call it a 7%, 7.2% interest rate, maybe at the midpoint.

And so you’ve got a lock on that. Well, we’re going to begin to cycle this. So if there — if the Fed has CPI, if they have inflation under control and we don’t — there doesn’t have to continue to be kind of tightening. The question is when do home prices come down enough for people to step up and pay the higher rate or when do rates come down and close that gap? Either housing prices have to come down or interest rates have to come down or the gap doesn’t close, right? So you may kind of wallow at the bottom or there could be further downdraft, if there is a more broader economic issue in the economy or if anything is happening with the commercial market with offices is not a good market. And our view is not all that negative news is kind of unveiled itself.

So there’s — but we’re — from our view, we’re kind of at the end of the worst of it. It’s — is there going to be a bounce? I mean, if you look forward at the market, it is saying that we should expect interest-rate cuts starting next year in Q2, Q3, and Q4 maybe 100 basis points. Does 100 basis-points of interest-rate cuts move the housing market much and maybe moves it a little. But I think there’s going to be a bigger — you got to close this gap. It’s a gap that I’ve never seen and I think anybody in the phones ever seen. That’s created kind of a conundrum in the housing market and then you’ve got — look the news in the press, so new houses are up 20%. Well, new houses are only 10% of the market, the existing home sales is 90% of the market.

So until you get existing home sales and this market stabilized, not a downdraft, that’s going to be critical. So we expect stabilization we think next year. We don’t think there’s going to be acceleration until there’s interest-rate cuts or pricing comes down, home prices come down to kind of close that gap. So let’s put that off to the side, that’s one issue. Then you’ve got what we’re doing, which is a complete transformation, reimagination, refresh of the brand that we’ve been working on now for several years. It’s going to be unveiled here over the next several quarters. So, the early indications on the books. And again we’re hitting 40% of the books in home by the end of this week, look really good. The early, early indications. Now, you got to be careful in how you extrapolate that because you have to extrapolate it on, okay, what does this look like when all the books get in home, what does this look like when the in-stocks reach their best, their optimum levels?

What does this look like when you start refreshing the galleries and the stores with those? There’s all lift factors to all of that. So when we look at this and we extrapolate this, we think there’s going to be a real inflection point. How big is that inflection point? It’s — to us it looks like a meaningful inflection point. And then there is a part of our decision to kind of push the mailing into Q3 was to kind of take a longer-term view of what should be our contact strategy as we’ve now are going through this brand refresh and re-imagination and repositioning. And our view was we through history, we went through cycles where we contact the customer twice a year with each book and periods where — years where we contact the customer once a year, one kind of big cycle of mailings.

And our view is I think we’ve got to re-acclimate the consumer to the RH brand, to the newness, the excitement that’s in the brand and everything we’re doing. And our view is to set up a two-contact strategy. So the timing of those contracts — contacts we should what we believe should be a fall contact — and a kind of fall contact and a spring contact. It’s how I’d frame it. So fall being kind of a mid to late August contact that gets in-home by end of September. Our books — especially our interior books — our interior book at 604 books nobody does a 604 book page book than — other than us and getting that printed inbound and through the system takes longer than it will on our other two books that will be more in the 300-page range. So we’ve got this first contact that will give all-in-home kind of call it, end of September, first week of October.

And then we’re going to come out with the contemporary books kind of mid-October through late October and then will come with the January books — with the contemporary book in the October period and then the modern books in early January when people get back from holidays and so on and so forth and everything reopens again. Then we’ll cycle back around and we’ll hit everyone this next contact if you look at over 12 month period and that will be kind of a March, April, May, June contact and so the three books will hit again. We’ll have another meaningful round of newness coming. And by the end of that contact, we will be kind of fully transitioned. It doesn’t mean we won’t have new products in the next contact when you think about the next fall.

But the percentage of newness will be more in the 15% to 20% range where this is basically an 80% refresh of the brand. It’s massive. It’s the biggest product move I’ve ever made in the history of my career and I’ve made some pretty big product moves. So you’ve got to kind of think about how you’re spreading it out, how much can the consumer digest at a time. How you’re going to read it correctly and how you’re going to have the contacts not overwhelm them in the news matter — overwhelm them. So as we kind of took a bigger view at it instead of this kind of one view and looked at it more how do we think about strategically, maybe, call it over the next three years? We think this is the right contact strategy and will create — by the peak of the inflection, I think it will be really meaningful.

I think we will gain significant market share versus anybody else in our category. And I think the other thing to put into context is just how we think about disruptive pricing from a circular point of view which I think we’ve — in our efforts to elevate the brand, I think we weren’t as kind of critical-minded looking at price. I mentioned in last conference call, I thought we probably were a bit arrogant looking back and now I think we’re laser-focused and laser-sharp. So we’re going to be very aggressive. We’re going to use the size and strength of our platform and the leverage it gives us to be disruptive from a pricing point of view. And so — and I think that’s going to make a meaningful impact. I think if you look at the new books and you look at the messaging and you look at the key items and you look at the key collections and you look at the quality of the product, the design — the quality design and the quality to make the product and you look at the value that the price — value of that product, I think it’s going to disrupt a lot of people.

And so I think we’re as confident as we’ve ever been. I think that’s the timing. And then the unknown is what does the housing market do? Is it flat? Does it go down another 5% or 10% or do we get a bounce? Regardless of whatever happens to the housing market, we’re going to have a meaningful inflection point with the business and the brand. And that’s why we deployed the capital, that’s why we bought back 17% of the shares, 3.7 million shares And — so we like what we see early with the books here. We like our strategy. I think we’re laser-focused on this. And I think we’re going to come out looking really good. So that’s how we see it.

Steven Forbes: Thank you, Gary.

Operator: Your next question comes from the line of Simeon Guttman from Morgan Stanley. Please go ahead.