RH (RH) 2003 Q3 法說會逐字稿

Good day and welcome to Restoration Hardware's third-quarter 2003 earnings conference. I would like to turn the call over to one of your speakers today, Ms. Pat McKay. Please go ahead, ma'am.

Thank you. Good afternoon everyone, and welcome to Restoration Hardware's third-quarter 2003 earnings release conference call. My name is Pat McKay, the Company's Chief Financial Officer.

I would like to remind you that the call is being recorded and will be available for replay via Webcast on our site at www.RestorationHardware.com under the tab Company Information Investor Relations event calendar. Leading our call today is Gary Friedman, the Company's President and Chief Executive Officer. Joining Gary and me is Stephen Gordon, the Company's Founder and Chairman. At the end of our remarks, we will open the call up to questions.

Before you begin, let me read our brief statement regarding forward-looking comments. Certain statements and information on this call will constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve both known and unknown risks which may cause the actual results or performance to be materially different. These statements will include without limitation financial guidance and statements related to the implication for the Company's third-quarter 2003 results on periods thereafter. Statements regarding the Company's new strategy and other statements regarding management's opinion and expectations regarding the business. Important factors that could cause such differences are contained in the Company's filings with the Securities and Exchange Commission.

And now, let me turn the call over to Gary.

Good afternoon. I will start today's call by commenting on our results this past quarter, give you an overview of our current initiatives, and then turn the call over to Pat for a more detailed financial review and Q&A.

While comparable store sales and earnings for the quarter were lower than previously forecast, customer response to our merchandising and marketing initiatives exceeded our expectations. Response to the launch of our new special order programs (inaudible), the Company's first annual item furniture sale and the relatively late timing of our famous fall lighting sale all contributed to demand, which was originally anticipated to be realized as revenue during the third quarter. The Company now expects these orders to have a positive effect in the fourth quarter as deliveries occur.

In spite of the revenue shift, the Company was still able to post considerable store increases of 2.9 percent on top of a 14.9 percent increase last year, yielding a 2 year comparable store sales increase that is at the top of our peer group. In addition, our direct-to-customer sales grew 46 percent in the quarter on top of the 66 percent increase last year. We continue to be excited about our customers' favorable response to our new strategy.

In light of my comments, I would point out that we believe significant opportunities exist to improve and reduce costs in our supply chains and furniture logistics network. This will be a key area of focus for the Company in fiscal 2004.

As I mentioned on our last call, the central focus of our strategy remains driving comparable stores sales increases as it is essential to leverage the fixed expense space for our retail stores to return the Company to profitability and provide a platform for long-term growth. The key to this strategy is to build compelling core businesses that position Restoration Hardware as an authority and destination for the categories we compete in.

In support of that strategy, this past quarter we launched several important initiatives. In August, we launched a proprietary line of bath faucets and fittings, complementing the exclusive bath hardware and accessories collections we launched last year. The addition of this component of the business positions Restoration Hardware to complete resource in the bath category, appealing not only to our core customers, but also to architects, interior designers, and contractors, thereby expanding our market. We have also retooled our assortments in cabinet and wall hardware, ceiling and wall lighting as we strive to have distinctive and well coordinated solutions for our customers and merchandise categories that are relatively unique to Restoration Hardware in our competitive set. Our efforts to differentiate our upholstered furniture through the introduction of our special order program, entitled Our Sofa, Your Style, which allows our customers to choose from over 60 unique and coordinated fabric choices has been well-received and is driving increased special order demand.

Another important aspect of our strategy is aggressively growing our direct business and using the catalog as our primary marketing vehicle. We have successfully improved response rates in our store areas, allowing us to profitably increase circulation, driving additional traffic to our stores and Web site. We believe we can continue to grow our direct business rapidly, increasing revenues and profitability and enabling us to build top of line awareness to the Restoration brand.

As mentioned in our press release, we opened two new prototype stores in Richmond, Virginia and Cleveland, Ohio. This new store model is designed to showcase our new merchandise strategy, presenting our core businesses with much greater clarity and authority. Both stores are performing ahead of plan and are on track to finish in the top quartile as it relates to store level profitability as a percentage of sales.

We believe this new store model positions Restoration Hardware uniquely in the marketplace, projecting unparalleled dominance in our core categories of hardware, bathware, lighting, textiles and accessories. Our third new store opens tomorrow morning near our corporate headquarters at the Village Shopping Center in Puerto Madera, California. We remain optimistic regarding the holiday season as initial demand from our holiday catalogs are strong and customer response to key holiday collections and key items are performing to our plans.

Now let me turn the call over to Pat McKay, our Chief Financial Officer.

Thanks, Gary. First, I will take you through our financial performance for the third quarter, and then I will provide guidance with respect to our expectations for the fourth quarter. In the end, I will open the call up for questions.

Third-quarter net revenues were up 6 percent to $95.8 million versus 90.8 million in third quarter of last year. Comparable store sales for the quarter were up 2.9 percent on top of a 14.9 percent in the third quarter of '02. In the direct channel, which includes both catalog and Internet activity, sales were up 46 percent to $16 million on top of a 66 percent increase from last year's third quarter.

Catalog circulation for the third quarter grew 18 percent and continue to be a growth catalyst for our direct channel and also providing overall brand exposure in our retail trade area. While, as Gary mentioned, the quarter's total revenues and comp store sales were lower than anticipated, demand from orders not yet delivered increased $8.8 million in the quarter. This includes deliveries in transit, which due to our revenue recognition policy may not be reported as revenue in the quarter. It also includes customer backorders and special orders. I should also note that this amount includes orders in both the retail and direct channels. We expect these orders to have a positive impact on the fourth quarter as deliveries to our customers occur and sales are then recognized as per our accounting policy. The guidance that we will provide later in this call will include the effect in the quarter of these sales.

Gross profit grew 6.2 percent in the quarter of 2003 to $28.8 from 27.1 million in the third quarter of the prior year. As a result, our gross margins as a percent of revenue expanded 10 basis points to 30 percent as compared to last year. Selling, general and administrative expenses were $33 million in the third quarter of '03 or 34.5 percent of revenue compared to 30 million or 33.1 percent in the prior year's third quarter.

During the quarter, we incurred higher cost of advertising and to a lesser degree payroll in our stores distribution and customer call centers in support of our third-quarter sales event. As mentioned previously, some of the related sales from the customer demand created during these events will not be recognized until the fourth quarter. Interest expense net approximating $519,000 during the third quarter was lower than the $834,000 incurred in the prior year's third quarter, primarily due to lower average interest rates.

During the quarter, two new stores were opened -- one in Richmond, Virginia and the other in Cleveland, Ohio. While the stores reported brisk sales since their openings, revenue for the quarter was not significantly impacted due to the timing of their opening. One store located in West Palm Beach, Florida was also closed during the quarter. There was minimal effect on the income statement from that closure. Our net loss for the quarter was 2.9 million or 9 cents per share versus 2.4 million or 8 cents per share during the third quarter of '02, using a weighted average share count in the '03 third quarter of 30,592,000.

On a year-to-date basis, our revenues were $274 million, up 12 percent from the nine months year-to-date in '02. Comp store sales were up 8 percent on top of an 8.3 percent increase in the prior year's comparable period. The direct channel posted sales increases of 53 percent on a year-to-date basis in 2003, which grew revenue in this channel to $41.3 million on top of a 38 percent increase in the first nine months of 2002. Catalog circulation on year-to-date basis was up 7 percent.

Our net loss improved for the nine months ended November 1st, 2003 to $10.8 million or 36 cents per share that is compared to the same period last year where we reported the loss of 13.7 million or 46 cents per share. Last year's results were favorably impacted by a $4 million one-time income tax benefit rather resulting of the economic stimulus enacted in March of '02.

Let me turn now to our balance sheet. We ended the quarter with inventory of $122.1 million, down 3 percent compared to levels at the close of the third quarter of '02. Importantly, that reduction was realized during a quarter where we saw total revenue increase 6 percent. Inventories remain adequate to meet our sales plans.

Bank debt was down 3.3 percent to 45.9 million at the end of the third quarter as compared to the prior year. Capital expenditures for the quarter were $4.4 million, and for the nine months year-to-date, 6.8 million. The majority of the CapEx during the quarter and year-to-date is attributable to new store openings and the planned reopening of the Puerto Madera, California store.

I should note that the capital expenditures do not reflect the amounts received as tenant allowances, which will have the effect of reducing the overall cash requirements of the four openings and reopening by a total of approximately of $1.7 million.

Common shares outstanding grew in the quarter due to the conversion of preferred shares to common and the exercise of stock options. During the quarter, approximately 4000 preferred shares were converted, which resulted in 1.984 additional million common shares outstanding. We also saw option exercises of 137,000 during the period. We left the quarter with 32,297,000 common shares outstanding and 9500 of preferred stock which are convertible into approximately 4.8 million of common.

Turning now to guidance for the fourth quarter. We expect comp store sales for the fourth quarter to be in the range of mid-single digits. We also expect to see sales (inaudible) when the growth of our direct business and the effect of our two new store openings which occurred late in Q3 and the one store reopening which will occur tomorrow. We expect earnings per share in the fourth quarter to be in the range of 30 to 34 cents per share calculated on a fully diluted basis with average shares estimated for the quarter of 38,700,000. And please note that for the full year, the weighted average share count on a fully diluted basis is estimated to be 37,600,000.

For the fourth quarter, operating margins are expected to be in the range of 11 to 13 percent expressed as a percent of total revenues. Inventory levels are expected to be flat to slightly higher than last year-end, and we expect to end the year debt free.

At this time, I would like to open the call up to questions. Operator?

(Caller Instructions). Mike Napoletana, JMP Securities.

I am missing the (inaudible) comp and some of the sales moving into the fourth quarter. Can you talk a little bit about what your feeling on the gross margin side looking forward -- hopefully, getting some improvement there versus the last couple quarters? And what do you think the impact of SG&A with a lot of these sales moving into the fourth quarter?

Mike, when you're asking about the gross margins, you're talking about quarters beyond the fourth quarter?

I am talking about fourth quarter, I'm sorry.

You're talking about this fourth quarter impact. We expect leverage -- we expect margin expansion in the fourth quarter, and we expect SG&A leverage in the fourth quarter.

And with respect to product mix, is there any changes between the third and the fourth with respect furniture continuing to be a strong category for you guys, or is this going to be more of a gift giving type quarter?

Clearly, it is going to be -- sales will start to transfer to gift giving as our sales mix will change pretty dramatically. With the shift of furniture revenues into the fourth quarter, it will give us a higher mix of furniture than we have had historically in the fourth quarter.

And what is that impact on gross margin?

That would have a slight negative effect on merchandise margins, because the furniture margins are in a slightly lower margin category.

Thanks.

Christine Corber, WR Hambrecht.

Can you talk about traffic and ticket during the quarter? Did you see an increase in traffic, or was the comp mostly ticket-driven?

The comp was mostly ticket-driven. We did see some increases in traffic during our events in September.

Okay. And then also, can you talk about the categories sales mix -- where you stand now by various categories versus your target? Thanks.

As far as our targeted (inaudible) as far as a repositioning of the business, Christine?

Yes.

Yes. We're starting to -- the model is starting to get pretty to where we wanted. I think we communicated -- if you take a look at when we embarked on this, we launched our new strategy in the spring of '02. Prior to launching the new strategy, our furniture mix was about 32 to 35 percent of our sales. We said we wanted to bring furniture down to about 25 percent of our business, and that is tracking pretty close to that now.

We said we wanted to grow the textiles business. It was prior to the (inaudible) strategy. It was 3 to 4 percent of our business. We want it to grow to about 20 percent of our business. It is tracking at about 21 percent of our business right now. So we said we wanted to double that bath business over about an 18 to 24 month period. We have done that.

When you look at the overall mix, the overall mix is looking closer to where we want it. It should put us in a position now to grow the categories relatively evenly. There is always going to be some categories we are going to grow more aggressively. But it puts us in a better position to grow the furniture business now in line with the rest of the categories.

Okay. And then lastly, can you talk about your circulation plans for the fourth quarter?

One second. Yes. Circulation versus a year ago will be slightly higher with a page count increase within the book.

Thank you.

Rob Wilson, Tiberon (ph) Research.

Gary, can you talk more about furniture logistics? We all know Williams Sonoma makes a lot of money on their furniture logistics and how you plan to implement that program?

Well, we've got I think a lot of opportunity and a lot of work to do on our back-end network as far as furniture deliveries. Sonoma has done a good job establishing a national furniture network that they have been able to leverage over the last several years, and we are just embarking on that strategy. I would say that one of the key players that was there that rolled that out in Sonoma a few years ago is now our Vice President of Customer Operations, Hillary Carroll (ph), and she is familiar with that network and rolled out that network a few years ago. We are doing the same thing. We are continuing to consolidate the number of providers we use out there. We have got to consolidate that down to a smaller number and get greater efficiencies as we move the products through the network.

There other opportunity for us is also building the price of the delivery into the product. We started to do that in this third quarter as we have raised our furniture prices, it has started to offset the delivery, and so we would eliminate the point of conflict between our sales associates and the customers. In the past, we were trying to charge anywhere from $50 to $100 per delivery. When someone comes in and tries to buy $3000 to $4000 worth of furniture and they start to negotiate, I shouldn't have to pay delivery on top of that. You have your salespeople in positions to sometimes wave delivery.

So we're adopting a model that is similar to some of our competitors. We are digging into that price to eliminate that point of contact. We think that will help us over time, but we did not want to take our prices up significantly all in one step and risk the topline and risk the sales. So we will be nudging those prices up and build the complete price of delivery into the price of the product over time.

So there's just a lot of opportunities in that area. I think we know what to do, but it's not something that happens overnight. It's something that will happen over the next several quarters, several years as we get more and more efficient there. The other key to it is taking our delivery charges up to the appropriate levels in our catalogs and on our websites, and again that is something we will do over time that should help reflect better results in that area.

Okay. Can you speak to your catalog sizes and speak of catalog circulation that several others have asked and the page count may be?

Sure and that is really pretty key to the growth of the business. I think I articulated on the last call our strategy was to try to really put more of an offer in front of our best customers more often in some order our best customers, which is an important strategy. As you are building a catalog business, that helps to make a catalog more productive and helps fund your circulation growth. You generally view that through increased page count and, when you have a store strategy like we do, through percentage of the assortment being catalog only which will increase catalog productivity in store areas. So we plan to include the page count about 23 percent, 23 or 25 percent in the fourth quarter in the numbers of pages mailed per book. We are up in pages circulated in the fourth quarter 45 to 50 percent I believe. Excuse me, the third quarter we are up around 45 to 50 percent in pages circulated.

Have you seen a dip in catalog division profitability?

Catalog division profitability continues to go up.

Finally, last question. The 8.8 million you reference in your press release, can you give me a breakout of direct channel versus retail channel?

Probably about two-thirds of it is actually in the retail channel.

Okay. How would I best properly evaluate the comp percentage gain that you are suggesting a 4 to 5 percent comp gain for Q4. How would I relate that --?

I think what we did say is we guided in the mid-single digit range.

Right. So does that two-thirds of 8.8 million get me 4 to 5 percent comp growth?

I think you are going to have to do your math on the comp side. We have not provided the actual impact or comp impact of the revenue shift.

Fair enough. Thank you.

Sarah Alamo, Buckingham Research.

Could you update us on where we stand on the closing of the underproductive stores, also on the store economics of the new prototype stores, and how many of those you plan to open next year?

Yes. We have closed seven stores thus far and plan to close there probably about three more stores over the next 12 to 18 months. We have said all along that we thought we have closed somewhere between six and 10 stores, and we will end up somewhere around 10 stores closed over the period.

Then from that point forward, we will like most other retailers just evaluate our real estate portfolio each year, and if we have underperforming stores, we will try to exit those and replace those with more productive stores. But we will be pretty close to where we want to be by the end of next year getting into the following mix.

And then on the new store economics?

Your question on the new store economics?

Can you update us on what the economics are for the new prototype stores? What are you planning for the new prototype stores?

Sure. I think our goal here internally is to develop is to build a four wall model that throws off 18 to 22 percent somewhere averaging around 20 percent at the four wall level. That will put the company in a position to drive somewhere between 7 and 10 percent operating margins. We are a ways from that, of course. But as we look at that setting standards for our new stores, we are looking at pretty higher hurdle rates where we want to really do deals, where we can be in the 15 to 20 percent range in the first 12 to 18 months.

Some of these stores we hit both based on initial sales are projecting out to be in that top range, and we would expect the new stores that we opened going forward to perform in the top quartile. So we are being very selective about the real estate deals we do, and we want these real estate deals to give us upward leverage and not be a drag on our overall four wall contribution.

Have you talked about how many new stores you are planning for next year?

Next year we are targeting to open about three to five. We want to get through the fourth quarter of this year with the three new stores we have opened and really make sure we have a handle on how they are performing and how we have formatted them. So if there are adjustments we want to make to the store design and to the presentation of the products, the size of the store, then we've got the ability to do that.

Is there anything that you are doing in terms of marketing to really get your holiday decor items advertised?

We continue to focus on using our catalog to drive our advertising and drive the brand awareness to Restoration Hardware, as well as our e-mail campaigns through our customer lists on the Web.

You had a TV special last year. Do you plan on repeating that this year?

No, we do not.

(OPERATOR INSTRUCTIONS). Russell Hoss, Roth Capital Partners.

Can you talk a little bit about the product categories during the quarter, which ones were strong and which ones were weak?

This past third quarter?

Yes.

We continue to see strong results in our bathware category and in our textiles category. Then the furniture business clearly performed well, but not all those revenues are obviously recognized in the third quarter, and a lot will be recognized in the fourth quarter.

Okay. Are you planning any promotions during the fourth quarter?

We do have our first ever bath event that we will be advertising in January, and that is all part of our strategy to take our key core businesses and market them aggressively once a year to build topline awareness in Restoration Hardware as far as why you wake up in the morning and come RSTO. When you look at our overall marketing and event strategy, we will have a January bath event, we will have a September furniture event, and our famous fall lighting sale in October

Last question. Can you breakout the 16 million in the direct business by catalog and Internet?

At this point, we have not been disclosing that level of detail.

Michael Weissberg, ING.

In case I missed this, I apologize if I did. What are the sizes of the two new prototype stores?

One is about 8,500 square feet, and the other is about 10,500 square feet. And then the third one in Puerto Madera is about 10,000 altogether, but it has also the mezzanine for storage. From a sales point of view, the stores range from 5500 to about 7000 square feet.

How does that compare to your existing 100 store base?

It is relatively similar. The one store in Richmond, Virginia is slightly smaller and would have been planned even smaller. Our initial plans were to build that store to around 8000 feet, and then we found out the mall was doing Q (ph) sided entries and having an entry on the side of the parking lot, which forced us to take some extra square footage to have a second entry.

We believe we can build this prototype in the 8,000 square foot range where most of our stores are 10,000 to 12,000 square feet, but our plans are to hopefully size this by market. If we can make it work in roughly 8000 square feet and don't have to build 10,000 to 12,000 square feet everywhere, that might open up another 50 potential locations for us.

What is the size of the three to five opening next year?

We have not committed to those locations yet, but we will look to open a variety of sizes.

Maybe talk about what is specifically different in terms of layout, etc. that makes you think that we will accomplish the goal of improving our four wall margins?

I think when you see it, it will knock you over the head with how different it is. The real key is taking the core businesses and giving them the appropriate space and dramatic presentation that they deserve.

So if you look at our typical store that we built, we have a series of small rooms running along the side of the store, and while we refixtured those stores, we really did not invest nor could we invest enough money to move walls and reproportion spaces. In the bath hardware business, for example, where we had one of the front rooms in the stores devoted to bath hardware.

If you walked into the new store, bath hardware presentation is about double to slightly more than double the size, and it has got textiles merchandise, bathware textile merchandise in there with it, so it's much more synergistic and much more dramatically presented. It's also engineered to present all of our bath faucets and tub faucets and shower fittings and everything in cohesive ways with all the other components.

If you look at the other side of the store, it is balanced out by a hardware room that is double inside. That balances out the bath hardware room where we have been enable to expand our cabinet hardware business, our door hardware business, our wall hardware business, as well as merchandise our utility business in that room.

The other thing that is very different about those two rooms, if you look at our (inaudible) stores, we typically put furniture throughout the sale floor and its mixed furniture in the hardware room and mixed furniture in the bath hardware room. In the new stores, those two rooms are somewhat unpolluted furniture, and they are merchandised with institutional fixturing that reinforces the core businesses in the categories that we are presenting. So you see very clear and powerful hardware businesses and bath hardware businesses, and we look like by far the most dominant player in this category where the only player in this category generally is a mall-based retailer.

The other big difference is we take our lighting business, which is scattered throughout the store, and we aggregated in a lighting gallery where we merchandised our lighting category in a more clear and focused way from wall lighting to ceiling lighting to floor groupings and portable lighting. And then we have taken the textiles business, and as opposed to having these in tentative separate rooms, because that is a tentative buildout if we inherited for that, we built a textile hall where all the textiles are integrated into a large floorspace. And then we have got the furniture business aggregated in the middle of the store, crossed merchandise with our accessories categories, and then our bedroom furniture merchandised in the textiles hall where our bedding, window treatments, floor coverings and bath textiles are crossed merchandised with those categories.

So I think if you called somebody, if you had a man on the street survey that after somebody walked into one of these new stores and they walked through and walked in and out, you asked them, sir, you just walked into Restoration Hardware, what do they sell in there? I think it would be clearly the person would be able to say, they really sell a lot of hardware, and they have an unbelievable bath hardware assortment. They have beautifully displayed furniture and a great lighting gallery and a tremendous textile assortment. So it does a much better job of communicating and burning in the customer's mind what you wake up in the morning and come to Restoration Hardware for.

If you get a chance, if anybody is out West over the next couple months or so and you want to get some time and schedule a store floor with us, we would be happy to walk you through our new store in Puerto Madera here that opens tomorrow. But I think when you see it, it just hits you over the head. You really get the joke as far as where we are going and what we are doing.

One other thing, Gary, if I could. The 8.8 million in revenues that you did not book in the third that you will book in the fourth, should that number be substantially lower by the end of the year? Where would that number be by the end of the year?

That number really is what the incremental demand was I guess in the third quarter, so it is kind of the way you look at it. We expected we should have for the most part sold through, but there will be a certain amount of special orders and backorders in there that we normally have cancellations on. But we would expect that the majority of that, net of that cancellation, would end up being reflected in our revenue for Q4. It is an our guidance.

Maybe one other thing. Originally, Gary, you were thinking of closing five or six or seven stores, and you really have not done that. Are you still thinking that way? Are there possibilities of other closings next year?

We closed seven stores -- (multiple speakers). We closed three in '01. I think we're trying to close four this year. We have closed four this year, and we are targeting to close about three more over the next 12 to 18 months, and then we will be pretty much done expect for our regular portfolio review as normal.

That is all the time we have for questions. I would like to turn the call back over to our speakers.

Thank you everyone for joining us in this conference call. We look forward to reporting back to you after our fourth quarter, and everybody have a happy holiday season. Thank you.

This concludes Restoration Hardware's third- quarter 2003 earnings conference call. Thank you for your participation and have a good day.