Rh Q1 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the RH First Quarter 2022 Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Allison Malkin. Please, go ahead.

Thank you. Good afternoon, everyone. Thank you for joining us for our first quarter 2022 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 filings, as well as our press release issued today for a more detailed description of the risk factors that may affect our results.

Great. Thank you, Allison, and good afternoon, everyone. Thank you for joining us. As we do, we'll start with the shareholder letter. To our people, partners, and shareholders, we are pleased to report another quarter of record results, as revenue increased 11% to $957 million versus $861 million a year ago and up 98% versus 2020, representing one of the highest two-year growth rates in our industry. Gross margin expanded 480 basis points in the first quarter, driven by a 390 basis points increase in product margins and our resistance to promote the business, as demand trends began to slow. While there has been a widespread return to discounting across our industry, inspired by the barrage of sale emails filling our inboxes, there may be a short-term risk of market share loss by choosing not to promote. We believe there is a certain long-term risk of brand erosion and model destruction once you begin down that path. It's that discipline and long-term thinking that has enabled us to set new standards for financial performance in the home furnishings industry, and our results now reflect those of the leading luxury brands as first quarter adjusted operating margin reached 24.7% versus 22.6% a year ago. Our results are inclusive of investments related to the opening of RH San Francisco and the RH Guesthouse, the development of RH International, and the rollout of our RH In-Your-Home, which led to approximately 200 of the 270 basis points of base SG&A deleverage in the quarter. We are now forecasting SG&A as a percentage of revenue to peak in the second and third quarters as we return to mailing Source Books after a two-year hiatus. By the fourth quarter, we expect SG&A as a percentage of revenue to be in line with last year. We generated $107 million of free cash flow in Q1, ending the quarter with net debt of $166 million, $2.24 billion of cash on our balance sheet, and trailing 12 months adjusted EBITDA of $1.13 billion. We spent $481 million in cash to repurchase $180 million of our outstanding affordable notes, terminate all of the 3.4 million outstanding warrants, and unwind the remaining bond hedges. Following these transactions, we have $101 million of convertible notes outstanding. Fiscal 2022 outlook, despite our record financial performance in the first quarter, we've experienced softening demand trends, which began at the time of the Russian invasion of Ukraine and have further slowed during market disruptions over the past several months. Based on our current trends and the uncertain macro environment, we are providing the following revised outlook for the second quarter and fiscal 2022. Second quarter net revenue in the range of minus 1 to minus 3 versus up 39% last year, with adjusted operating margin in the range of 23% to 23.5% versus 26.6% a year ago. Fiscal 2022 net revenue growth in the range of 0% to 2% versus up 32% last year, with adjusted operating margin in the range of 23% to 24% versus 25.6% a year ago. While we expect the next several quarters to pose a short-term challenge as we cycle through the extraordinary growth from the COVID-driven spending shift, we believe that our long-term investments will enable us to continue driving industry-leading performance. 2022, the year of the new. As we've mentioned, while many of our plans were delayed by the virus, we were not disrupted by it. We believe 2022 will mark the beginning of the next chapter of growth and innovation for the RH brand. This includes the May opening of RH San Francisco, the Gallery At The Historic Bethlehem Steel Building, our most extraordinary new bespoke gallery to date. The launch of RH Contemporary, the most compelling and potentially disruptive product introduction in our history, and the elevation of RH Interiors and RH Modern, inclusive of new collections and enhanced quality introducing this fall; the unveiling of our first RH Guesthouse in New York, a revolutionary new hospitality concept for travelers seeking privacy and luxury in the $200 billion North American hotel market; the introduction of an elevated new Live Fire restaurant at RH San Francisco, with plans to open in RH England; and the rollout of RH In-Your-Home, a unique experience with brand investors guiding every detail of the delivery and extending the selling experience into the home. Our goal is to position RH as the arbiter of taste for the home, which 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 leading designers, artisans, and manufacturers, enabling RH to curate the most compelling selection of luxury home products on the planet. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our galleries into RH Guesthouse, 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, and design in the Napa Valley. We are determined to build the world's first consumer-facing architecture, interior design, and landscape architecture services platform inside our galleries, which will unlock new revenue streams, while redefining multiple industries. This leads to our long-term strategy of shifting our focus as we move 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 consumers. Our entire strategy will come to life digitally as we launch the World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. The authority we possess as an arbiter of taste will be further amplified when we introduce RH Media, highlighting the innovative and influential leaders shaping architecture and design. Our plans to expand the RH ecosystem globally multiply the market opportunity to $7 trillion to $10 trillion. A 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. Let's not forget that every luxury brand was born at the top of the luxury mountain. We understand that our journey has to be extraordinary, requiring those at the top to respect our work. We appreciate that this journey is not for the faint of heart. And as we continue our ascent, we understand that the air gets thin and the odds become slim. But we're committed to making it happen. Twenty years ago, we began this journey with a vision of transforming a nearly bankrupt business into the leading luxury home brand in the world. The lessons, passion, persistence, and the courage developed through this journey have built the mental and moral strength that forms character in individuals and organizations. So, at this point, operator, we'll open the call for questions.

Thank you. Our first line of questions comes from the line of Simeon Gutman from Morgan Stanley. You may begin.

Hi everyone, it's Simeon Gutman. Gary, my first question is on the promotional environment and the discipline that you spoke to. Can you give us a sense of the tolerance you will take in terms of market share loss? Is it steadfast, or will you adapt to the market if you have to continue along a more promotional path?

I think it depends on how you define market share. I think we are really well-positioned with the best operating model in our industry, a strong balance sheet, and lots of optionality to capitalize on opportunities in any environment. The last thing you want to do when you're trying to build a brand like ours and trying to scale the luxury mountain is to remain disciplined about brand perception and desirability. You just can't fall into a discounting phase. If for some catastrophic reason, the world was ending and we needed to stay liquid, would we make decisions to move inventory and turn it into cash? Of course, we would. But our path is a long journey. It’s not a year-to-year or quarter-to-quarter journey. It is a decade-long journey to build a truly sustainable brand. Generally, 65% to 70% of a retail shopping center turns over, and there's a handful of businesses that continue on. That's what we're trying to build here. We're prepared to make the right decisions for the long run, and I believe it will serve us well in the future.

Thanks for that. And the follow-up, the buyback question, you've been pretty exact in terms of your timing in the past. Is there anything you can share on how we should think about using the cash to your advantage?

Yes. We raised capital to have optionality. There are a lot of different choices we can make during uncertain times, and there are going to be a lot of opportunities to see things in a new light, which may look much more valuable than they did in the past. Whether that means returning capital to our shareholders through share repurchases or acquiring opportunities in what I believe is going to be a difficult real estate market over the next year or two, we are prepared to make decisions that will create long-term value for our shareholders.

Thank you. And our next question comes from the line of Steven Forbes from Guggenheim. Your line is open.

Good afternoon, Gary and Jack. Hey, Gary, I was curious if you could provide some color around the assumed contributions of RH Contemporary and RH England during the remainder of the year and any updated thoughts on the potential year one sales of RH England as we approach the opening?

Sure. That's a good question. When we think about Contemporary, while it's clearly the best work we've ever done and the most dramatic evolution of our brand, the feedback from high-end interior designers has been incredibly positive. We've opened fantastic opportunities in major markets, which will maximize exposure. It's essential to communicate to our consumers that they can only truly appreciate our products when they see them at retail. We've had no newness for two years, and now we are ready to optimize our business. A lot of our customers travel regionally, so placing goods to be seen is critical. I believe Contemporary is almost like a new company within our company. It will have a bigger impact than RH Modern did. By the end of June, you will see Contemporary featured prominently in our New York gallery as well.

Thank you, Gary.

Our next question will come from the line of Steven Zaccone from Citi. Your line is open.

Great. Thanks for taking my question. I appreciate the shout out for the Italian lineage on the call. I wanted to ask about the guidance change for the year. Could you comment a bit on the softening of demand you've seen as of late? What are you really seeing in the business that prompted the second quarter revenue guidance?

Well, the demand slowed at the beginning of the war and continued to soften in the following months. We are guiding based on where we see it today. It’s truly unknown how this all unfolds. We’re facing high inflation, which hasn't occurred in 42 years. The Fed must raise interest rates, and with that typically comes a recession. Rising interest rates are not good for the housing market. Nobody really knows what's going to happen right now.

Great. Thanks for all the detail.

Thank you. Our next question will come from Chuck Grom from Gordon Haskett. Your line is open.

Hey. Thanks very much. I was hoping to just talk a little more about the Source Books and advertising in general.

Yeah, we have incredible new products coming in that I think are going to transform our market. I think we're going to be the most exciting game in town. It's a really good time to have a membership model like we have right now that allows people to get great value and a discount as members of our edge program.

We are considering all of the above in terms of the Source Books. We'll see an increase in spend as we ramp back up. We're excited to expand this as we launch RH Contemporary. While print is becoming less important over time, it remains impactful for our brand. The World of RH website will launch in mid to late July and aim to enhance customer experience massively.

Thanks a lot and good afternoon. Gary, if you're successful in climbing the luxury mountain in your business and your customer profile, will be a lot different in five years than it today.

Nothing is going to get us to reconsider where we're going. We’re smart enough to figure it out. I'm confident we will make it to the top of the mountain and create a massive value.

Good evening. Gary, how big do you think the market that you're going after is in the United States? Are you going after the top 1% or top 2%?

The spending at the high end of the market is exponential. Our goal is to reach the top of the mountain where the rewards are, and we are prepared to take short-term pain for long-term gain.

Thank you. And that concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.