RH (RH) 2002 Q4 法說會逐字稿

Good day. All sites are now on the conference line. I'll turn the call over to your host, Kevin Shahan, the Chief Financial Officer.

Thank you for listening to our earnings release conference call for the fourth quarter and year end 2002. With me today on the call is Gary Friedman, CEO, Stephen Gordon, the company's founder and chairman, Tom Bazzone, our Chief Operating Officer and Vivian McDonald, our corporate controller.

This conference call will include forward-looking statements that involve known and unknown risks. These forward-looking statements include without limitation financial guidance and statements concerning or relating to implications of the company's financial results for the fourth quarter and fiscal year ended February 1, 2003 and the periods thereafter. Statements relating to the company's repositioning of the merchandising strategy and other statements containing words such as "believe, anticipate, estimate, plans, targets, expects, may, intend" and words of similar import are management's opinion. In particular, guidance offered or commented on by the company represents a point in time estimate by the company. We caution you that such forward-looking statements are just projections and actual results may differ materially from those in the guidance or other forward-looking statements. Important factors that could cause such differences include, among others, those factors detailed in the company's filings with the Securities & Exchange Commission, including its recent filings on Forms 10-K, 10-Q and 8K, including but not limited to those described in the company's Form 10-Q for the third quarter of fiscal 2002 and management's discussion and analysis of financial conditions and results of operations.

I want to begin by reviewing fourth quarter and fiscal year 2002 performance. Then sketch out some guidance with respect to fiscal 2003. And finally turn the call over to Gary for an update on our repositions strategy.

For the fourth quarter, we reported earnings of $9.7m or $.26 per share, versus a loss of $12m or $.42 per share for the fourth quarter a year ago. An improvement of $21.7m. This was a record quarter in our history for both sales and earnings. Fourth quarter sales were up 7% to $155.1m. Comparable store sales were up 3%. The direct channel, which includes both channel log and Internet increased 26 percent from last year's levels.

For the 2002 fiscal year, sales were up 9 percent to $400.3m. Comparable store sales were up 6% and direct channel sales were up 33%. Gross profit as a percent of sales in the fourth quarter was 36.9%, compared to 20.2% in the same period of last year, or 32.3% excluding fiscal 2001 year end charges related to our merchandise repositions. The 450 basis points improvement in gross profit was due to improved merchandise margins, leveraging of fixed occupancy costs, lower freight costs and improved productivity in our distribution centers.

For the 2002 fiscal year, gross profit as a percent of sales was 29.5% compared to 19% for fiscal 2001 or 24.3% excluding the fiscal 2001 year end changes. Similarly, to the fourth quarter, the 520 basis points improvement was due to improved merchandise margins, leveraging of fixed occupancy costs, lower freight costs and improved productivity and distribution. Selling, general and administrative expenses as a percent of sales were 26.8% in the fourth quarter versus last year's 24%. The 280 basis point increase is due primarily to increased expenses from the direct to customer division related to the planned expansion of this channel and to store payroll increases.

For the 2002 fiscal year, SG&A expenses as a percent of sales were 31.6% versus 29.1% last year. The 250 basis points increase is due primarily to first half expenses associated with the re-launch of our remodeled stores and professional fees incurred in connection with the implementation of the buyers revenue recognition policies and other matters. These were both one time expenses which we will not repeat in the current year. In addition, expenses increased in the direct to customer division as planned.

Operating profits for the quarter were $15.6m versus the $5.5m operating loss a year ago. For the full year, we improved from the $35.1m operating loss in 2001 or $17.6m excluding the year end charges previously noted to an $8.4m operating loss in 2002.

Moving on to the BS, inventory ended the fourth quarter at $95m, up 51% versus inventory of $63m at the end of the fourth quarter a year ago. The size of this increase was due partly to the unusually depressed levels at the end of last year as we exited old products in preparation for the receipt of new goods for the launch of our merchandising repositions. It was also affected by the softer than expected holiday selling period. Overall, inventory was $10m higher than our target level. Excess seasonal inventory was cleared out by the end of February. The remainder of the inventory overage, in core non-seasonal categories we expect to eliminate by the end of the second quarter.

With respect to inventory productivity measures, fourth quarter inventory yield was approximately flat versus last year. Gross profit comps in the fourth quarter this year increased 38 percent versus a year ago. We ended the fourth quarter with $14m of bank debt versus $0 a year ago. Accounts payable on accrued expenses at the end of the fourth quarter were $36m versus $34m last year. The increased debt and payable levels were due to the $20m of capital expenditures expended during the fiscal year, which included $15m for remodeling all of our stores in the first half, as well as the increased inventory levels.

To put the BS changes in perspective, compared to a year end 2000 BS we lowered debt and accounts payable by approximately $31m. Increased inventory by approximately $10m, and accomplished about $20m of capital expenditures. These investments in debt reductions totaled $60m compared to the net cash raised from equity offerings over the course of 2001 of about $55m, indicating that we had preserved or slightly added to the cash raised during our turn around period.

In light of the uncertain economic and political environment, we have taken a conservative approach to planning for fiscal 2003. With respect to the following guidance, I would like to note that the possibility of war in Iraq and the continuing risk of terrorism create inherent uncertainties in the guidance we are able to provide. We haven't attempted to include in this guidance any of the potential financial effects of such effect -- such events. This said, our guidance for fiscal 2003 is as follows: comparable store sales are planned to increase in the low to mid-single digit range. We plan to open two new stores and remodel and expand a third store. We expect to close two to three underperforming stores in 2003. Direct to customer sales for 2003 are planned to increase in the mid to high teens versus last year. Operating margins for the year are targeted at 1% to 2% of sales. Capital expenditures for 2003 are budgeted at $7m to $8m compared to $20m in the year just ended.

Specifically for the first quarter of 2003, we are comfortable with a range of estimates for operating losses of $9m to $10m versus an operating loss of $16m in the first quarter of last year. This will result in a net loss of $.20 to $.22 per share on a basic share count of approximately 30m versus the $.25 loss per share last year. The last year net loss included a $4m or $.14 per share of additional income tax benefits as a consequence of economic stimulus bill which was enacted on March 9, 2002 and which won't repeat in the current year. We expect to be cash flow positive for the 2003 year and to end the fiscal year with no debt on the BS. We project there will be adequate availability on our credit line throughout the year to fund our working capital and capital expenditures. Midway through the first quarter as we are now, our business is on plan and running strong merchandise margins.

Now I'll turn the call over to Gary.

Thank you, Kevin. Good afternoon. I thought I would take a few minutes and update you on our repositions strategy. I'll review the key issues we face, what strategies we put in place, our progress against those strategies and next step, where do we go from here?

Let me start with key issues. We fundamentally have a store four wall issue, we haven't generated enough sales per store to offset the fixed expense at the store level. In fiscal 2001, our average store volume was $3.1m and we need to reach sales per store of $4m to achieve the desired operating results of the high performing specialty retailer. We identified our underlying issue as lack of designation businesses. There were not you enough clear reasons to shop Restoration Hardware. We had ten under performing stores. Another key issue we faced was low merchandise margin structure.

At the core of this issue were two problems. One, at 32% of our total sales, furniture was too high a percentage of our overall mix. Furniture, as you know, is low margin high distribution cost business. The key is to balance the furniture business with enough high margin low distribution cost categories to make the overall merchandise model work. The other issue was our margin structure was the fact that we were only importing 18% of our products directly from foreign vendors. We were purchasing from domestic importers and not achieving the proper initial mark ups.

The strategies we put in place to drive sales were as follows: one, we wanted to position Restoration Hardware as a designation store, transitioning from a store that was interesting to browse to one that was relevant to shop filled with the needs of the premium store customers. We would focus our existing core businesses, hardware, bath wear, furniture and lighting and adding new synergistic core businesses like bed and bath linens, window treatments, floor coverings and pillows and throws. By reducing our overall SKU counts from 7,500 to approximately 4,500 to 5,000, we would eliminate the over catalog of items and add clarity to the shopping experience. We have an opportunity to improve our overall sales per store as well as four wall margins by closing under performing stores. Another part of our strategy was to ship from a print to a direct advertising model and use our catalog as primary marketing vehicle, aggressively increasing circulation into store trade areas and developing a catalog only assortment to improve response rates.

In regards to merchandise margins, we said we wanted to improve the overall margin mix by reducing furniture from 32% to 25% of total sales and grow our textiles category from 4% to 20% of total revenues. We also said set a goal to increase foreign imports from 18% to 50% to 60% over the next three years.

Let me comment on our progress to date. We have increased our average store volume from $3.1m to approximately $3.4m in the first 12 months of the new strategy. We are conservatively projects $3.5m to $3.6m volume for fiscal 2003. We substantially improved merchandise margins by decreasing the furniture penetration from 32% to 25%, and increasing text textiles from 40% to 20%. We also increased the foreign purchases from 18% to 45%. We have closed three under performing stores and we have almost doubled our direct business in two years.

Next step, where do we go from here? Our top priority is to continue to refine and strengthen core businesses. We are introducing exclusive lines of bath fittings and fixtures to complement the bath hardware business. Today, we present cohesive collections of towel bars, shelves, mirrors, lighting and accessories but have not sold faucets or fittings. When most architect or interior designers spec a new house or remodel a house, they usually start with faucets and fits and then spec the matching towel bars, light fittings, et cetera. So we believe this represents a sizeable opportunity to increase sales and position ourselves as the authority in the bath category. We will be introducing an extended collections of bath furniture and accessories in the second half. We will be launching new furniture merchandising and market strategy this fall. Now that furniture is at the appropriate level of sales penetration we will grow the category in relation to other businesses. Because there may be potential competitors listening in on this call and we will not elaborate further on the details of the strategy. We believe we made the appropriate adjustments throughout the assortment to improve sales and margins now that we have history in these new categories.

As mentioned in the press release, we will be introducing a new prototype Restoration Hardware store in [Inaudible], California, Richmond, Virginia and Cleveland, Ohio. The new stores are designed to showcase our businesses with the proper space allocation and being configured in multiple size variations from 7500 square feet up to 12,000. Most of our stores today range from 10,000 to 12,000 square feet. Clearly, there are many markets that should have or could have a smaller footprint store. With a smaller format is successful, it could open up opportunity in many or markets for our concepts. We will aggressively pursue closing under performing stores. We have eight stores with kick out rights over the next two years. If we can replace that volume with five average stores, it would increase operating margin for the company by 100 basis points.

In summary, this is still very much a sales and margin game at the level. Our new and spend b expanding business businesses are performing well and gaining momentum. We have significant opportunity to increase the merchandise margins through increased direct sourcing, improved mix and supply chain enhancements. We are effectively using the catalog as brand builder and traffic driver and believe the direct channel represents $300m opportunity. Our new prototype store may create enhanced growth prospects for the company over the long run. We believe Restoration Hardware has potential to become a billion dollar brand. With that, I'll open the call to questions.

At this time if your site has a question, press the star one on your touchtone phone now, please. If you need to remove that, just press the pound key. Again if your site has a question today, press the star one on your touchtone phone.

We'll take the first question from Janet Klopinberg(ph) with JJK. Go ahead.

Hi, Gary. Hi, Kevin.

Hi, Janet.

Gary, on the inventories, I think you said that you cleared up most of the seasonal product and that by the end of the second quarter you should be in better shape. Where do you think you'll be on inventory versus last year at the end of the second quarter?

Inventory versus last year, we should be close to last year's level by the end of the second quarter?

You should be flattish?

Yes.

At that time will the core product be in the shape you want it to be?

I'm sure it will.

Most of the inventory that, extra inventory we are carrying now is in key core categories and in some categories that are kind of core key items that didn't quite get the holiday lift that we anticipated. All these businesses we were able to react to by cancel canceling forward orders or slowing down receipts. So it it's not really a lot of mark down risks. The only mark downs that you'll see in the stores of significance during this period is in the bedding category. You will see a couple of programs that we had bought as core programs last year. We got deep in that inventory. We believe it's good inventory. Even the at 50% off, we have about 40-point margins on it. We felt that pretty good about just selling it at discount. It's built into our margin structure. We thought it was the right way to go. So that's the only thing you'll see out there that maybe seems strange from a mixed point of view.

Could you elaborate on your strategies to take the stores up to an average $4m volume level? I know you'll change the mix a bit and bring in some fittings and change the furniture or increase the furniture a bit as you talked about. Maybe you can focus a little bit on the holiday season and what you will be doing there to increase productivity.

Sure. Well, I think the real underlying key is continued, you know, performance of these core businesses over time. As more and more people -- as we become known for these core businesses, there's going to be more people waking up in the morning saying, “I need window treatments, I'm going to Restoration Hardware. I need bath fittings …. I need bath hardware, I’m going to Restoration Hardware. Through the increased circulation of our catalog and the top line awareness of the brand, we are seeing those core business businesses continuing to accelerate. We believe they will continue to accelerate over time. We just began, you know, our merchandising efforts in these core businesses. We have many new programs rolling out. As I said, the bath fittings and fixtures. We have in our windows treatment category, we launched the whole business with one line of window hardware, which is a significant part of the business. We have, you know, two more collections of window hardware coming in this fall that will make us more of a designation for that business. All the way through, it's really fine-tuning the core categories, merchandising and marketing the core categories with authority.

And then at holiday, you know, we are planning holiday relatively conservatively. We think there's a lot of lessons learned this last holiday that we can correct. We think we are putting together a pretty darn good holiday assortment for next year. Hopefully the economy won't be such a head wind. But I think that the key thing is, you know, the stores do not need to be $4m -- we don't have to hit $4m to be profitable. At the levels that we are projecting at the end of this year, a company can be profitable and, you know, somewhat higher sales levels over time. We think we can get into the mid-single digit operating margin range. As we look at hitting operating margins of 7% to 10% over time, we have to get up towards that $3.8m to $4m per store range.

I appreciate, you'll grow the catalog business and open more stores all the time?

Absolutely.

A last question on store closings. I think you only said you're closing two this year; is that right?

Two to three.

Two to three.

The eight that have the kick out clauses, that's over the next two years. So maybe in the following year we see five store closings?

That's a good possibility.

Thanks very much.

Once again, if your site has a question today, press the star one on your touchtone phone.

And we will go to Mike Napolitano with JMP Securities.

Couple questions. One, maybe you can talk a little bit about the catalog initiatives you'll run this year to drive the mid to high teen revenue growth you're talking about? The second question pertains to the first quarter with respect to margin, either gross or SG&A. Looks like there there's a lot of opportunity, yet you guided down a couple more pennies. I want to see where you think gross margin and SG&A are going to kind of level out given the weak performance with the new merchandising initiatives.

Let me take the first question, Mike, in regards to the catalog initiatives. Last year, because of the launch of the new strategy, we went out very aggressively in the spring season, in April specifically, and mailed very, very heavy with the high level of prospects in the first couple months to launch of the new strategy. We also were aggressive throughout the year, throughout times of the year to increase catalog circulation and try to build our lift. Through that year we have learned a lot. And we've, you know, developed some good metrics internally as it relates to our core customers and top customers and how many dollars per customer we should be driving with those customers and how do we mail smarter, more effectively this year.

This year the strategy will be less about increased circulation and will be more about increased page count. Meaning that we will put more of a selection in front of our best customers more often. So while our overall circulation numbers will be flattish to slightly down to last year, because we won't be anniversaring the launch circulations and things like that, we will be increasing page count over last year. I think Kevin, it's 20% of overall in the books. And that's where we will really see a lot of the growth. The other thing on top of that is an increase in catalog only content. Last year we, you know, ran the business anywhere from 10% to 20% catalog only at various times. This year we will grow that 30% to 40% catalog only. That should give us the ability to improve response rates in the store areas and then continue to increase circulation in those store areas over time.

Great. With respect to the first quarter?

You know, I think, Kevin, you can -- we are taking a conservative approach to our numbers based on the uncertain economic environment. So, you know, I don't think any of us know what is going to happen over the next couple of weeks. So we are being conservative. We think long-term obviously there's a lot of up side in that quarter.

You don't think margins -- you think that gross margin will be better than it was a couple years ago ago, just given the fact that merchandise margins have improved year-over-year with the new merchandising strategy?

Yes, absolutely. Merchandise margins will be significantly improved in the first quarter versus a year ago.

Okay. On the SG&A leverage then?

Kevin, you want to ...

Depending on sales, again there are uncertain elements there, but it should be strong.

As we sit here today, as Kevin said, in midway through the quarter, merchandise margins are strong but nobody knows what is going to happen in the next few days. Considering that, you know, we're trying to be conservative as we give guidance.

Thanks.

Great, thank you.

All right. Once again if your site has a question today, press the star one on your touchtone phone phone, please. Again if you have a question, press the star one on your phone now, please.

Okay. We have a question from Robin Murchison(ph) with Hibernia. Go ahead, please.

Hi, leave it to me to ask an arcane question. What is going on with the rugs? (Laughter).

What's going on with the rugs? The rug business, as we mentioned multiple times, one of the categories that underperformed our expectations last year. We think for many reasons, you know, our whole strategy was to try to offer the customer a more premium product, you know, better design, higher quality and still at a good value. I think in the categories where we are really performing like bath hardware, with our product it's really at a quality level that is not highly available in the marketplace. When you find product that is similar quality, our prices are an excellent value. I think if you look at we’re outperforming in window treatments, the quality of our window treatments is not readily found in the marketplace. The value of those window treatments are very good. If you look at rugs, we shot ourselves in the foot on multiple levels. One, the fixtures showed up and the good goods didn't. All the goods were late. We had fixtures that had 20 -- the availability to hold 20 arms of rugs, 20 rug selections and three showed up for the first couple months. We got out of the gate terribly in that business. Then we made a lot of fundamental mistakes. We were trying to differentiate things that maybe we shouldn't have tried to differentiate. We took a Seisal(ph) rugs and put mitered-corner edgings on the binding, where most people lapped cornered edges. We thought that was an enhancement. When you look at it, the thought was, gee, interior designers tend to use miter-cornered rug. My wife is an interior designer and I asked her about it. She didn’t really know there was a difference. But it made the rug 20% more expensive. So throughout the rug business, we tried to have higher quality and differentiation. We didn't achieve that or it wasn't visible to the customer. Therefore, we just looked too expensive.

I think the other issue with that business, we didn't market it very well. Most of the businesses that are performing very well, we did a great job in giving them catalog exposure and marketing and so on and so forth. An we look back and we don't think we marketed that business very well. We have a new strategy that will evolve throughout this year. It will be kind of where we want to be more towards the second half. We think we have upside in the rug business. And still, you know, in the first several months of this year it's a lay up because the numbers were so bad last year. We have more momentum because we are more known for that business now, too.

Great. Thank you very much.

Okay.

Once again, if you have any final questions, press the star one on your phone, please. Okay. That concludes our Q & A. I'll hands it over to the host site for final comments.

Thank you for your participation today. And we look forward to talking to you in the next quarter. Thank you.

Thank you. That concludes the program. You may all disconnect at this time.