Restoration Hardware forecasts a terrible Q4 and breaks out every excuse in the book
The home-furnishings company's earnings statement contained a letter to shareholders detailing "a fair amount of bad news" about everything that went wrong in Q4.
First, although orders were up in the quarter, its RH Modern brand experienced shipping delays as some vendors struggled.
And then there's the oil crash. Restoration Hardware says that markets in regions that have been affected by the energy sector underperformed, including Canada and Texas.
Also, the company's effort to boost sales through a marketing campaign did not work out as expected. It said that high-end consumers did not spend as much money as before, given the volatility in financial markets and "extreme conditions" last month, which is historically its best period for furniture sales.
But in the company's opinion, the news about its strategies to grow outweigh the bad news. For instance, it is planning to expand RH Modern offerings, and expects RH Teen to continue to grow.
The company had originally said that it would earn $713 million in net revenues, but announced $647.2 million. Adjusted earnings had been projected at $1.40 per share, but were announced at $0.99 - a decline from the same period a year ago.
This chart shows the stock's drop in after-hours trading:
The statement from CEO Gary Friedman contained a laundry list of everything that could go wrong for the company, with some encouragement to shareholders at the end.
Here it is in full:
RH Shareholders:
We are clearly operating in different market conditions than a year ago, and believe it requires us to adjust our strategies to optimize performance in the short term, while positioning the company for long-term value creation.
Let me address what we are seeing, and consequently, how we are thinking and operating differently.
There are three key factors that had a negative effect on our fourth quarter results, along with several positive developments that give us tremendous confidence in our long-term growth strategy.
First, our demand sales/written orders were up a strong 21% in the fourth quarter on top of up 26% last year. Our delivered revenue, however, was up only 11% in the quarter on top of up 24% last year, representing a shortfall to our plan. While the initial response to RH Modern has been outstanding, we are experiencing shipping delays as certain vendors are struggling to ramp up production of this new product line. We expect the majority of the demand/written orders to turn into revenues in the first and second quarter, and anticipate our vendors will be substantially caught up by the end of the first half. Additionally, we believe the poor in-stocks also suppressed orders, and we expect demand to build as our in-stocks improve.
Second, we continue to see underperformance in markets affected by energy, oil, or currency fluctuations. The Canada, Texas and Miami markets were a drag of 2 points to total Company revenues in the first half, then accelerated to a 4 point drag in the third quarter, and continued as a 4 point drag in the fourth quarter despite increased promotional efforts, including reduced shipping charges to incentivize our Canadian customers. These results tell us the conditions remain weak in these markets and in aggregate they are trending 20 points below the rest of the Company. Looking forward, we will begin to cycle the underperformance, and the negative drag should be mitigated.
Third, our attempt to drive incremental revenue through increased promotional activity in the fourth quarter was less successful than in prior periods, signaling a further pullback by the high-end consumer. Our sense is the increased volatility in the US stock markets, especially the extreme conditions in January, which is historically our biggest month of the quarter for furniture sales, contributed to our performance. Historically, our business has a correlation to large movements in stock prices as we believe asset valuations influence our customers' buying patterns.
While there is certainly a fair amount of bad news in the quarter, the good news from our point of view greatly outweighs the bad when you put it into the context of our long-term growth strategy.
Despite the economic headwinds, our two key growth strategies - the expansion of our product offer and the transformation of our real estate - are working exceptionally well.
The strong response to RH Modern, both in retail and direct, indicates this can quickly become a billion dollar plus brand. Our first standalone gallery in Los Angeles is on trend to achieve $25 million in first year demand, and the full floor presentations in our next generation Design Galleries are performing exceedingly well. We plan to expand the RH Modern assortment this Fall and add to our retail footprint. Additionally, RH Teen is off to a strong start, and should continue to build momentum as we expand the product offer and retail presence in the second half of 2016.
We are pleased to report that all of our new next generation Design Galleries are exceeding plan. With the one-year anniversary of Atlanta, plus the openings of Chicago, Denver, and Tampa we continue to demonstrate that our strategy to transform our 7,500 selling square feet legacy stores into 45,000 to 60,000 selling square feet next generation Design Galleries will drive meaningful growth over the next 7 to 10 years. Our ability to blur the lines between residential and retail, creating an immersive environment that is more home than store, is producing industry leading results and positioning RH as the clear leader in the luxury home furnishings market. The unprecedented success of our Gallery at the Historic Three Arts Club in Chicago takes our strategy one step further, as we blur the lines between home and hospitality, with a beautifully integrated central courtyard restaurant, wine vault, pantry and coffee bar. We believe RH Chicago represents the future of experiential retail and proves we can create a destination, making us an even more valuable tenant to developers.
In summary, despite the macro economic challenges, our two key growth strategies are performing beyond our expectations.
When we pause and think about the current market uncertainty, our bias is to de-risk our strategy in the short term, focus on sharpening execution in our core business, and continue to invest in the important long-term strategies that will continue to fuel our growth and strengthen our brand.
Our focus for 2016 will be the following:
1. Optimize Our Core Business: Our energies in the first half will be focused on ramping production and improving in-stocks for RH Modern and our core RH Interiors business. With RH Modern revenues being affected in the first half by the production issues mentioned earlier, we believe the business will continue to build throughout 2016 as our inventory position strengthens, we expand the assortment, and grow our retail footprint. The results in our New York City Gallery, where we replaced a third of our core assortment with RH Modern, generated a 25% demand lift. We believe we can increase comparable store sales by creating a positive arbitrage in many of our legacy galleries by adding RH Modern, and should be in a position to do so in the second half of 2016. Additionally, we do not plan to introduce any incremental new businesses in fiscal 2016, as we believe launching into a potential headwind creates asymmetrical risk to the downside. We will, however, mail our annual RH Source Books, along with our second mailing of RH Modern, this Fall both featuring exciting new product launches and expanded assortments. We intend to assess how the current market volatility plays out during the year so we can tailor our circulation strategy to business conditions.
2. Be Opportunistic with Real Estate: In times of market dislocation, asset values in real estate generally come down, and we plan to take advantage of this likely outcome for the long term benefit of the business. Lower real estate costs translate into higher operating margins and ROIC, and we are in a strong financial position to take advantage of anticipated opportunities.
3. Elevate the Customer Experience: We are focusing a significant amount of our energy on improving the end-to-end customer experience. As we have elevated our brand, especially at retail, other customer touch points also need to leapfrog forward to create a cohesive experience. This initiative will focus on everything from product quality to in-home delivery across all channels, and includes new people, processes and systems.
4. Change the Promotional Cadence and Elevate the RH Brand: Much of how we behave promotionally is left over from the Great Recession. The multiple sale events and email communications do not reflect the brand we are building, nor are these promotions aligned with how our customers shop with us. Additionally, these promotional activities can skew customer behavior with spikes in volume and higher cancellation rates creating inefficiencies throughout our supply chain. Accordingly, we will be launching a new membership model this Spring. For an annual fee, our customers will be able to shop for what they want, when they want, at a set discount, much like the high end interior design trade. Members will also receive free interior design services, a concierge number to manage their orders, preferred financing terms, and early access to annual clearance events. We believe the new membership program will greatly enhance the customer experience, render our brand more valuable, improve execution, and significantly reduce costs.
Since the Dow peaked, and oil began to destabilize in 2014, we have been positioning the Company to win, regardless of market conditions. That is why we completed two successful, zero interest convertible debt offerings, strengthening our balance sheet, and putting us in a position to take advantage of the opportunities that present themselves in difficult markets. We are ending FY 2015 with over $500 million of cash and investments on our balance sheet, and zero borrowings on our $600 million line of credit, and expect to be cash flow positive in fiscal 2016. It has been clear to us, watching the success of others, that those with capital in difficult markets are generally those who capitalize.
At RH, our most significant transformative moves have occurred during periods of macro uncertainty. We emerged from the 2008/2009 Great Recession a much stronger brand and business than when we entered, and expect to do the same during this cycle.
Despite the uncertainty, our underlying fundamentals are very strong. We continue to have the highest sales and earnings growth in our industry. We have expanded our operating margins to nearly 10%, among the best of our peer group. We have a dynamic multi-channel platform that gives us all the advantages of online retailing, without the limitations of single channel competitors. We are opening immersive spaces that are redefining physical retailing in the age of the Internet. We are in the very early stages of the most disruptive and transformational growth strategy in all of retail. Our next generation Design Galleries are exceeding expectations, and our product expansion plans, especially the launch of RH Modern, demonstrate our ability to open the brand to new markets.
We believe what should change in this environment, is the pace at which we deploy our investments, with a focus on optimizing returns.
Being opportunistic with real estate in response to market conditions could lead to improved deal terms, and pulling back the throttle a bit on the expansion of our product offer, could avoid the missteps of subpar returns from investing into a headwind.
History has taught us that real value is created by those who have the courage to lead rather than follow, who are willing to destroy today's reality to create tomorrow's future. At our core we are innovators. We obsessively look for opportunities to destroy the current version of ourselves to create something significantly better and more valuable. This remains true in any and all market conditions.
Our plan is to take the next few weeks to sharpen our focus for 2016, and ensure we are positioning the brand and business for long-term value creation.
We will provide more details when we speak with you during our next quarterly earnings video and conference call on March 23rd.
Carpe Diem,
Gary
Gary Friedman
Chairman and Chief Executive Officer
RH Restoration Hardware