Good afternoon, my name is Erica, and I will be your conference operator today. At this time, I would like to welcome everyone to the RH First Quarter 2019 Earnings Q&A Conference call. [Operator Instructions] Thank you. Ms. Allison Malkin, you may begin your conference.

Thank you. Good afternoon everyone. Thank you for joining us for RH's first quarter fiscal 2019 Q&A 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 for 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 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 our call today, we may discuss non-GAAP financial measures, which adjust our GAAP results eliminate the impact of certain items. You will find additional information regarding these non-GAAP financial measures and the 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'll turn the call over to the operator to begin our Q&A session.

[Operator Instructions] Our first question is from the line of Chuck Grom with Gordon Haskett.

Just a question on the revenue change in the guidance. It looks like it was about $40 million, but I think you only beat the first quarter, high-end by about $10 million. So, just wondering if you can unpack for us the change in the revenue assumption. How much is stronger, a stronger core top line assumption versus higher prices from tariffs starting to flow through and then in addition to that, just wondering if you could also speak to the cadence of sales in the quarter. It sounds like in the release that it accelerated, but I'm just curious if you could speak to that also anything quarter-to-date. Thank you.

So let me start with the revenue guidance. So it was at the midpoint, it was at $14 million beat. So at the midpoint to the year, we're taking the guidance up $43 million and so again at the high end, you mentioned $11 million the high end of the guidance is being taken up by $28 million. As it relates to your higher prices due to tariffs, our guidance fully reflects the tariffs and there is no assumption that higher prices roll through to incremental revenue. So that is a reflection of the trends we're seeing and trends that we're seeing in the business.

This is Gary. Let me echo that. We're basically, we've got a chance now to see our post. I think the market volatility and the stock market kind of stabilizing. We saw our business come back in the second half of the first quarter, and we've also got early indications on RH Beach Houses. The book starts to roll-in. We also have confidence in many of the underlying trends in the business as we look forward. So that's what gives us the confidence to look forward with the guidance that we have.

And then just my follow-up would be just any deviation in trend in some of the markets that have been impacted by the soft changes over the past say 60 days to 75 days?

It's Jack here. As we mentioned this one we're watching just because of all the noise around it, heard anecdotes but I got to tell you the data shows that there was no meaningful impact. So nothing that we saw.

Yes, nothing yet.

And our next question is from the line of Michael Lasser with UBS.

So you initially offered guidance for this year with the fourth quarter, then you took it down - sorry with third quarter, then you took it down with fourth quarter and now you're raising it with the first quarter, does this just reflect some volatility in the underlying business. Where are you getting the confidence that the volatility is going to be reduced in the back half?

I'm sorry, can you just give me that question again?

So the guidance was - initial guidance was established and it was brought down and now it's being brought up. So it would be adjustive of that there's a lot of volatility in the business. What gives you confidence that volatility is not going to persist during the second half?

Look, we can't control macro or market issues. Nobody can, whoever's running the business. So we always pray for peace and plan for war. I think it's important for us not to get distracted by the short term noise and stay focused on the long-term narrative that is created a truly unique brand with the best operating model in our industry. So we can tell you what we're seeing today and what the trends are today. If the market falls or we go into a recession or something different happens, something different happens. So I don't think it's our business, it's the only business that volatile. You know that the market is volatile. I mean we haven't to be the only business of our kind that has increasing, meaningfully increasing revenues, meaningfully increasing operating margins and profitability. So that's one thing that's been consistent, right. We haven't really lowered meaningfully any earnings. So we beat earnings every quarter and we've had some movement in our top line because of the market volatility and added in parts of our business in trying to create a better model but, I think if you look back at the last three years and just look at our numbers, I don't think you'd see volatility. I think you'd see a really consistently improving business model. I mean we have the highest operating margins in our industry today. We believe that support 400 basis points to 600 basis points more so but we can't do anything about what happens to the macro environment. So, we keep an eye on that stuff, we have plans for - if the market is expanding that the business is expanding, we'll do certain things. If the marketplace is contracting we have plans for that. So we just try to capitalize for our shareholders no matter what happens.

My follow-up question is as you look over the course of the rest of the year. It sounds like you raised your guidance for the next few quarters about $20 million to $30 million. Is that coming from the contribution from new stores, is it coming from more optimism around the launch of RH Beach House or is it coming from some of the legacy stores that have been around for more than…

Yes. You got to be careful you get lost in the details here. Our business trends reversed. The market fell 800 points in one day. The day after we gave guidance, right, in the fourth quarter. So, for a high-end customer, if the market gets rocked like that it's definitely impacts our business, we saw the trends change. We revised our guidance. Since then the markets being consistently - you know the Dow has been consistently over 25,000 right. So with the Dow stabilizing people act differently. Look, in the fourth quarter, I was going to by a piece of property and build a new house, the market got rocked and I as a customer is - database of one decided not to purchase the property and not to buy the house. Now the market stabilized, I'm looking at buying the property and building a house again. So those kind of things that are more affected it then if you try to break down - our galleries are performing well. You know our product categories are performing well. They are performing better than what we guided, but they're performing more like what we would have expected them to guide in the market previously and so we're halfway through the second quarter, right. So we have pretty good visibility on the second quarter. We've got good visibility on the second half of the first quarter, those trends are pretty clear and there is nothing surprising in the numbers. We're just happy that it looks like with the stability of the stock market that our customer is responding in a more normal fashion and that's not much more to it than that.

Our next question is from Steve Forbes with Guggenheim Securities.

I wanted to start with the home delivery experience. Gary, if you can maybe just update us on the progress of the various test and comment on some of the key learnings thus far as we work our way through the year here?

Yes. We're very happy as we've indicated in the early numbers we now see about $15 million to $20 million of annual savings that we think will roll in about one-third this year, two-thirds next year just based on our early tests and what our learnings are and we're just getting started here. We think there's going to be a lot more opportunities as it relates to reducing returns, reducing exchanges, taking more cost out of the system, we think as we improve the service level, which we're doing and there's been a big impact there that will - if you think about returning, excuse me, lowering returns and that's directly as a positive to revenue. Right. So if we can get the goods to stick, if we can have better delivery experiences we have happier customers, happier customers are going to be repeat customers and buy more and so on and so forth. It's all good things for the brand and I think it's probably for the most part in our industry, it's kind of the under-appreciated strategy because the uglier part of the business, we would like to say this business is not for the faint of heart rate, it's an ugly baby but it's ours, and back in my days in apparel, you had men's and women's tops and bottoms and accessories and it all came fold the same size. It all traveled in the same size box and nothing broken transit. Our business is exactly the opposite. Nothing comes in the same size boxes and everything can break in transit and get damaged and plus we have take into the customer's home and set it up and so on and so forth. So I think for us, we just really see based on our positioning in the market, right because of our luxury positioning it costs us more to make mistakes. I mean it's all exponential. There is exponential savings and there is exponential cost. If you're on the other side of it and the customers have higher expectations. So we're just investing more into that experience. We're leading it with much more focus and passion. Yes, we're into the details. It's not like that kind of a part of the business it's sitting outside the business. Most of it, what percent are we in-sourced now.

67% it could be 80%.

67% and we're going to 83%. We'll soon be at 83% with our own insourced hubs. We were testing and taking total control the in-home delivery process and we like what we're learning. We like what we see. We've made some significant leadership upgrades. We'll talk more about that, probably in the next quarter. So, just because there some confidential things happening there, but yes, we think it's one of the next big frontiers for a massive leapfrogging customer delight and engagement and also just operating earnings and leverage in our model. So, really excited about it.

And then as a follow up, Gary. On the hospitality front, I know we talked about this in the past, but maybe you could expand on just menu optimization. Right. You think about the success at New York and sort of thinking about the menu offering right throughout the day parts at the various other locations. If you think there is opportunity right to drive whether it's productivity or profitability at the different locations. I mean, what do you sort of thinking about as it relates to the hospitality offering broadly?

Yes, I think you want to think about hospitality, right as an amplifier for our core business. It is not our core business, right. So it really amplifies the experience with the customer and you have to really think about it right. We don't - we're not just focused on saying how do we make hospitality the most profitable. We think about it is an integrated model and how does hospitality drive - how do we optimize the total model of the business with hospitality. So, we're working on all kinds of things, right. We're still really new at this. I mean we have a real hospitality company, we've got six restaurants, a lot more on the way and Guesthouse coming in the spring next year. And so I don't want to under-sell it, because we have a real hospitality company inside of RH today, but as we think about menu optimization and other tweaks to the model. There are tweaks that we think will be helpful, that will - the key, it's got to optimize the integrated model not just optimize hospitality, can't look at these in silos, you have to look at it as an integrated business model. We're looking at things like events and other things. We've so many people, who want to use our rooftops and want to use New York for their wedding and their permits where their investment bank wants to take over for the event or and it would be easy to kind of say, oh my god, we can get $150,000 a day versus maybe that $30,000 or $40,000 we're doing at the restaurant, right. If we do some events, but are those events really accretive to the business, do they create the right customer experience that we're trying to curate and…

Our next question is from Tami Zakaria with JPMorgan Chase.

Congrats on a solid quarter and thanks for taking my question. So when you spoke last time, obviously, you sounded cautiously and you attributed sales weakness in the stock market and high-end housing. Since then, the high-end housing market hasn't really improved all that much, but your performance is definitely been better than expected. So do you feel like you've sort of decoupled yourself or reduced dependence on some of these macro factors driven by the strength of your improved real estate and operating model?

Yes, we think - look we think we've got a leapfrog model and we think we've created in many cases a brand with no peer and an operating model that's significantly advantaged versus the rest of the marketplace, and is massively disruptive at the high end of the marketplace. So you really got to look at our brand in our business model in the correct context, right. A lot of people I think compare us to more of a people who are really targeting different customers. The biggest disruption we're creating is at the very high end of the market and we continue to elevate the brand. Right. Not just expand the brand, but really elevate the brand where we think the biggest share of market is where we're most disruptive. So I tell people, if you just add a point of reference in Marin County where we sit today, we have a shopping center that's three blocks from us that we have a legacy Gallery in and in that legacy gallery we do close to $18 million, somewhere around $18 million without BabyandChild, with BabyandChild we do $20 million in a small store in that center little over $20 million. If you think about that from Sausalito to Santa Rosa which is you know Sausalito is the first city kind of get to across the Golden Gate Bridge and Santa Rosa is kind of call it the wine country up near Sonoma and Napa, there is really about 32 high end home boutique stores in that part of the market, and their average size is about 3,000 square feet to 15,000 square feet. Today, we have a 7,000 square foot gallery that that fits kind of in the - almost in the middle of that marketplace and today, we…

Gary, that's really helpful as always and so my follow-up question is about tariff. What's the risk if the transport tariff that is being contemplated goes through. Does your guidance embed that as well and can you remind us about your current exposure to China in terms of percentage of products sold?

Tami, it's Jack. So most of the round three - our product resourced from China is mostly in round three. So a modest amount would be included in round four, and we would react in the same way we have done with around three tariffs and address it as we've talked about and then, so the guidance, there is - it's not specifically assume that that's going to be included, but I'm not sure it would materially change, just given the small amount that's left. And was there a second question, I missed?

Yes. Could you remind us about your current exposure to China in terms of products sold?

Right. It's about 40%. That's in terms of receipts for that the purchases of our goods, last year was about 40% from China.

Our next question is from Mike Baker with Deutsche Bank.

So a couple of follow-ups and then hopefully, these aren't little rock questions, but on the tariff I think you had said that you're planning on prices going up but no impact to revenues, which correct me if I'm wrong, but I guess I would assume that you're thinking units will come down and then also what are you thinking about the margin implications sort of passing through to keep the profit dollars flat or you try - are you, are you aiming at the margins in other words passing through the cost increase plus a little bit?

Yes, I mean, we wish we knew exactly how it would play out right, but I'll give you our logic. Our logic is to try to stabilize to kind of keep margins intact on a gross margin level with the product. So if you think about that - we renegotiated the price and get a lower price, right, but not the entire tariff. I don't know of anybody who's getting the 25% discount, but let's just take - you take a piece of tariff take half or you get two-thirds and then you balance that with the price increase of 3% to 5% and that balances your merchandise margin on the product and then at that level we're not changing sales. So that would imply that we are going to sell less units right and so we don't think that there won't be any market impact. There's a bit of a model impact, but it's not bad, to have the same dollars and slightly less unit sales because you take a ton of cost out of the business, right. We don't have to buy that unit, we don't have to shift that unit, we don't have to receive that unit, we don't have to deliver that unit. We don't have to have returns on that unit and so on and so forth. So yes, of course, that would be one way the model could play out or the model could play out that the units stay flat and revenues go up, but it's no different whether it's a tariff or just the normal price increase in anybody's business. Starbucks goes through the same math right, they raise a cup of coffee or macchiato by $0.25 and they go through the same math.

If I could follow-up one more. I think we appreciate how your business can be impacted by short-term movements in the market, but it sounds like your business stayed pretty strong in May, which probably wasn't a great month for the stock market, probably because of some of the trade issues, but didn't seem to impact you as much as it did at the end of October. Is it just a function of magnitude and the stock market was not great in May, but it wasn't certainly down 800 points in one day. So I suppose there is some level of stability before you start to see weakness in your sales trends. Is that a fair way to look at it?

Correct, Mike. I think that's the right way to look at it. I think the Dow was down with 18% in December. Right. It was the worst December, I think worst December in history. You know it's - and so you think about that everybody is home for the holidays, with their families on vacation and the market is down 18% in December. That's a big deal. I don't want to - small volatility of the market moving from 26,000 in the Dow to 25,000 or bouncing between 24,000 and 26,000. That's probably not going to have a huge impact. It might have little impact here or there Mike. You might get a little spooked but depending on how severe the moves are but, if based on our history, you really have to have kind of a meaningful move and when a market drops, 10% to 20%, 10% is that meaningful move. 20% - almost 20% that's a big move right and so - most people have most of their high net worth people with most of the net worth is tied up in the markets. And so whether it's the financial markets or the real estate market and so whether you're investing in REIT or not, that might be a public entity. So if you get the public markets moving 18% down, I mean I would expect our business to get impacted because that's no surprise to me. The fact that we just guided at the day before the 800 point drop bad timing got that like wish I was carnapped and I could hold the letter up to my head and knew what was going to happen in the next day, but we don't, so it's inconvenient, we react to it. We adjust our numbers, stock is volatile,…

Our next question is from Elizabeth Suzuki with Bank of America.

Can you just talk about what went into the capital allocation decisions this quarter specifically taking out some debt and utilizing liquidity from the revolver to buy back shares?

We didn't use the revolver really to buy back shares. We took out some incremental debt to buy back shares through the stock, the stock was undervalued. So no different than we have over the last three years. So we try to capitalize on market volatility or in the market, we believe the market undervalue our shares and again, it's just math. If you do the math on what we're borrowing the money for and how long we think we'll hold the debt and what the cost of the debt will be and what the price of the stock is and how much we're buying stock back for and what we think the stocks going be worth in three years and five years. It's just math of just investing. So that's just capital allocation.

And just one other quick one, which is how much of the RHB top line is all new product as we kind of look through catalog. It looks, some of that is, if not always product from the core line is that the case and is this more of a marketing tool then a platform to launch all new product or is there a significant portion of...

70% new products. I think 70% new products.

Our next question is from Cristina Fernandez with Telsey Advisory Group.

I wanted to ask on the gross margin guidance for the second quarter. It looks like it's down a bit year-over-year, even with some of the adjustment for the lease accounting. Is there anything that we should know about the second quarter and the puts and takes as it looks like you're expecting gross margins to recover for amount in the back half?

So there is two dynamics that are occurring in the second quarter. You may recall we talked about the drags to our business. In the second quarter one of those is the transition in our rug business model. So we were going from a single vendor to a direct source model. As all that it up. So as we sell down through the inventory and that inventory sold down at through at a lower margin, you're going to see pressure on the margin there and some of that's reflected in there and then you may recall, at the end of Q3 last year, we exited a DC facility in the East Coast. That facility had basically become - had reverse logistics sort of outlet inventory that was stored there and we've - there is just some that we've accelerated the sell-through of and that has the biggest impact. That's what you see an acceleration of the sales in Q1, Q2 with the biggest impact in Q2 is what's expected. So those two dynamics are what's weighing on not seeing a gross margin bump in Q2.

And as a follow-up, you're seeing two stores delayed a bit to next year, but still think you can open five to seven stores in 2020 and seven in 2021. Given the complexity of your stores, I guess what gives you confidence that you can achieve that higher level of store openings?

We are moving in many markets to our new prototype and our new prototype now is engineered much more simple. We've now have how many under construction, Dave, the prototype. We've four under construction today. We know what the timing looks like on those prototypes. We've learned from and we have a lot of confidence in schedule, but that's just one aspect of it. The other aspect of it is just the pipeline, because if you think about our real estate model and kind of where we are. We are much more desirable today because we have a proven model from a kind of a home and interior design point of view and so, we now have shown to the development community, we're consistent performer. We can do the kind of volumes out of these bigger stores that we're building out of the galleries and that is creating much more certainty for that right, deal certainty for them and it's much more attractive, we look like a modern day anchor tenant. And then secondarily, we now have a proven hospitality strategy and we are very accretive to a developer because, developer - all developers no matter if you're doing a street or you're doing a lifestyle center or even at the traditional shopping center, everybody needs hospitality for traffic. Right and so what developers normally have to do is have to put up big - tenant allowance money, and give relatively prime real estate to hospitality concepts. They are generally ground floor concepts and now we have - we give them all or that shopping center, the Street a hospitality concept that's on a roof and they don't have to give away the real estate. There is no incremental real estate on our side. We're getting better, better deals and…

Our next question is from Brad Thomas with KeyBanc Capital Markets.

Gary, I was hoping you give us an update on some of your research about international markets and latest thoughts on when you might have your first gallery opening overseas?

Timing is really good. We're super excited. We are leaving right after the Warriors win Game 6 at Oracle, and we have how many of us, 10 of us are on the plane. Yeah. 10 of us on a trip to 10 cities in Europe to finalize real estate deals for global expansion and we've got lots of tentative locations, I'd say two in Europe look like they're almost done in two great cities. Don't say I'm kidding, don't say anything, I'm sorry. Yes, okay. I'm getting waived off, so, it's like they know I can get excited and become an over-share but let's just say we're saying - we're seeing 10 locations, in Europe, a couple, we feel very strong about and we've been working on for quite a long time. We're looking at locations in South America, locations in Australia. We're very active with people that want to partner with us in China and the Middle East. We're just trying to go through to how much control do we want to have versus how much speed and other people's capital do we want to use. So more to come, but we're anticipating it's going to be a very productive trip for us.

And Gary, you've talked about the opportunity being very big. How should we think about the potential returns and cost to open a store overseas?

Yes. Good questions. Based on the work we are doing now, we don't see it as materially different than our current model. Except for I don't think it's going to be as prototype as rich, there'll probably be more historic buildings, so probably be more kind of unique development, just because we probably won't be as Americas much more shopping center base more traditional. So, but as we think about it from a capital point of view, we think it's going to be relatively neutral. We think we're going to be able to do development deals in some of the cases, but when you think about the size of the opportunity, I mean we say in there, we think with global could be a $7 billion to $10 billion brand, right. So I mean that's super conservative. If you really step back and you look at sometimes I call us the dumb Americans right because we grew up here. We think America's the whole world and we cannot really see the world very clearly if we are kind of an American-based company. We tend to see famous Anaïs Nin quote. We don't see things as they are. We see things as we are. We see things through our own head and our own perspective and, but if you stand back and you really think globally and you just say what is the landscape of global businesses look like in the high-end luxury market for people that don't have a U.S. centric view that really have a global view. When you look at companies like LVMH or Carrying or Janelle or Hermes or like real global brands, only 25% of their business is in the U.S., 75% of their business is outside the U.S. We're building today. We believe will become…

And our next question is from Seth Basham with Wedbush Securities.

My questions around interior design, you mentioned investments and interior design in your letter, I was hoping you could provide an update on what changes you've made here recently and if you think you still might charge these services one day?

Yes, that's a really good question. We're really focused on it and we think there is some leapfrog moves here and probably in the not-too-near future, we'll have something really meaningful to announce, but we're continued to make investments, not only in our galleries where the new galleries will have, if you've seen RH New York, you can see it's the first time we embedded kind of - it's like embedding a design from inside a retail gallery where we actually built out offices. The consumer can look and see the offices, see the interior designers in there. We have presentation rooms in the building design where we can have private meetings and presentations and you will see that in all of our new galleries. You will see embedded interior design firms, and offices. So that's a big investment for us and we think we can even make it a bigger presence now that we see what's happening in New York with you'll see it becoming an even bigger presence. We think interior design and the expansion of interior design and really taking most of the service businesses like interior design, architecture, landscape architecture. They're not consumer-facing businesses right they're like these businesses that you can't see, you have to have somebody who is your interior designer, he has to go online and kind of research and walk by interior design offices, by Barclay architecture offices, landscape architecture, things like that. So we think long-term this - we're starting with Interior Design. I mean we could become a whole services platform, because none of these businesses are consumer facing. They're all actually relatively good margin business if you can get any kind of scale as we've done more and more research, but there is hardly any scale. I mean, what…

And just as a follow-up, what percentage of your sales right now are supported by designer. I think you've given out that's done in the past. I was just wondering what the update...

Yes, I don't know if we have, I don't want to give it anymore. Like if we don't print it I know give any more. I don't want anybody to know what we're doing here. I mean I've already given - I've already gone too excited and gave you too much right there. Right and the only reason I just told you what we can do right there is I don't think anybody else has chance of actually trying to pull off what we're going to pull off, but I don't want to start giving the metrics, because it will just be too important to other competitors.

Our last question is from Chuck Grom with Gordon Haskett.

Thanks for letting me hop back on. Jack just wondering if you guys wanted to comment on the re-fi for the convert that's coming due I think in a couple of days and then just as a follow-up to that inventory levels were under excellent control again. Just how should we think about inventory levels, as you guys progress throughout the year.

Sure. So on the re-fi as we've said we are going to repay it from cash on hand and through a borrowings on the revolver and so - it's due the Saturday, which obviously business first business day falls on Monday. So we are, you'll see on the 10-Q when it's filed tomorrow. There's excess cash on the books and that will go down to just the bare minimum level we need for operating purposes and then will draw the rest. So that's just the simple plan and then beyond that, we don't give specific inventory guidance, but you've seen as I've mentioned on last call, you've seen continued improvement in our inventory turns based on the moves - all the moves we've made, and the enhancement to our operating platform. So we saw slight enhanced - just to be if you calculate inventory in terms of the face of the financials, slight - very slight improvement in Q1 versus Q4, that's - and I would just expect that sort of to continue. So certainly some inventory improvement assumed in our free cash flow in our guidance but we're not giving specific direction beyond that.

Our last question is from Mike Baker with Deutsche Bank.

Just as Chuck is going to come on for one more I may as well as also just to be a quick one. The free cash flow guidance didn't change even though your sales and operating profit guidance range, I presume that's just because of the increased interest expense. Is that the right way to think about it. Is there something else that we'd been missing in there?

No, I think that's correct. If you were just as you see, our operating income guidance went up by 20, I just under 20 and our interest expense as we noted was about 20 incremental. So it was a wash from that perspective and free cash flow guidance remains the same.

Great. Well thank you everyone for your interest in our brand and business and we look forward to talking to you next quarter. Thank you.

Thank you. This does conclude today's conference call. You may now disconnect.