RH Form 10-Q Summary
Reporting period: Three months ended May 2, 2020, compared with May 4, 2019. The request metadata identifies “2019 Q1,” but the filing is for RH’s first quarter of fiscal 2020.
Business context
RH is a luxury home furnishings retailer offering furniture, lighting, textiles, bathware, décor, outdoor and garden products, and child and teen furnishings through Galleries, outlets, showrooms, catalogs and websites. As of May 2, 2020, RH operated 69 Galleries, 38 outlets and 15 Waterworks showrooms.
All retail locations were temporarily closed on March 17, 2020 in response to COVID-19. Locations remained substantially closed at quarter-end, although RH continued serving customers through digital channels, Gallery representatives and designers. By June 3, 2020, RH had reopened 74% of Galleries, 68% of outlets and 50% of restaurants.
Financial performance
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net revenues | $482.9 million | $598.4 million | Down 19.3% |
| Gross profit | $199.7 million | $232.8 million | Down 14.2% |
| Gross margin | 41.3% | 38.9% | Up 240 basis points |
| Income from operations | $35.5 million | $68.6 million | Down 48.3% |
| Operating margin | 7.3% | 11.5% | Down 420 basis points |
| Net income (loss) | $(3.2) million | $35.7 million | Turned to loss |
| Diluted EPS | $(0.17) | $1.43 | Declined |
| Adjusted EBITDA | $77.4 million | $100.4 million | Down 22.9% |
| Adjusted net income | $29.9 million | $48.2 million | Down 37.9% |
RH Segment revenue declined 19.3% to $455.0 million, while Waterworks revenue declined 19.5% to $27.9 million. Furniture revenue decreased to $316.8 million from $396.7 million; non-furniture revenue decreased to $166.1 million from $201.7 million.
Gross margin benefited from lower outlet promotional activity, product margin improvements and price increases. Reported gross profit included a $2.4 million reserve for outlet inventory. Selling, general and administrative expense was essentially flat at $164.2 million, causing significant expense deleverage against lower revenue.
Cash flow, liquidity and debt
- Operating cash flow was negative $16.9 million, compared with positive $38.8 million in the prior-year quarter.
- Investing cash flow was negative $16.6 million, primarily for capital expenditures, compared with negative $7.9 million.
- Financing cash flow was positive $3.2 million, compared with positive $65.8 million.
- Cash and cash equivalents declined to $17.2 million at May 2, 2020 from $47.7 million at February 1, 2020. Prior-year quarter-end cash, cash equivalents and restricted cash totaled $102.6 million.
- Inventory increased to $494.3 million from $438.7 million at February 1, 2020, while accounts payable and accrued expenses declined to $285.0 million from $330.3 million.
- Aggregate principal amount of convertible notes was $985 million: $300 million due July 2020, $335 million due June 2023 and $350 million due September 2024. RH expected to repay the $300 million 2020 Notes in cash.
- RH had $10.0 million outstanding under its asset-based credit facility at May 2, 2020. Borrowing-base availability was $356.5 million, net of $13.2 million of letters of credit. As of May 29, 2020, RH reported no outstanding borrowings and $170.4 million of availability net of reserves for repayment of the 2020 Notes and letters of credit.
- Adjusted net capital expenditures were $24.2 million in the quarter. Management expected fiscal 2020 adjusted net capital expenditures of $125 million to $150 million, net of asset sales, subject to changes in business conditions.
Material changes and unusual items
- COVID-19-related closures caused a substantial revenue decline and disrupted supply-chain fulfillment. RH stated that reduced inventory receipts and supply-chain dislocations delayed conversion of demand into shipped sales.
- RH recognized a $20.5 million non-cash impairment of the Waterworks tradename because COVID-19-related showroom closures and construction slowdowns reduced projected revenue and profitability.
- RH recognized $8.5 million of asset impairments and useful-life changes, including $4.8 million of asset impairments and $2.4 million of outlet inventory reserves.
- RH incurred $4.1 million of severance and related reorganization costs after furloughing approximately 2,300 employees and terminating approximately 440 additional positions. Management salaries were also reduced across the company.
- Approximately 4,000 shares were withheld during the quarter for employee equity-plan obligations; no repurchases occurred under the public share-repurchase program. The program had $450 million remaining authorization at May 2, 2020.
- On May 2020, RH paid $9.2 million to settle $9.4 million of 2020 Notes converted by holders and issued approximately 15,000 shares, offset by the related convertible bond hedge.
Outlook, risks and contingencies
Management expected operating cash flows and available financing to be sufficient for more than the next 12 months, including debt repayments and working-capital needs. However, RH cautioned that additional COVID-19 waves, renewed closures, consumer behavior changes, economic weakness, supply-chain disruption, construction delays and reduced liquidity could materially affect future results.
RH continued to pursue Gallery expansion, international expansion, hospitality, design services and operating-margin improvement, but stated that COVID-19 could delay construction, reduce capital investment and require postponement of strategic initiatives. Approximately 70% of fiscal 2019 product purchases were sourced from Asia, including a substantial portion from China.
RH reported no material off-balance-sheet commitments. A shareholder derivative lawsuit had reached an agreement in principle involving non-monetary terms and expected insurance-funded attorneys’ fees, subject to final documentation and court approval. The previously disclosed $50 million securities class-action settlement was funded entirely by insurance and was finalized in 2019.
Most important facts to verify
- Whether RH generated sufficient cash and financing capacity to repay the $300 million 2020 Notes at or around the July 15, 2020 maturity.
- Subsequent cash flow, inventory levels, working-capital requirements and borrowing-base availability as stores reopened.
- The pace and sustainability of Gallery, outlet and restaurant reopening, including any renewed COVID-19 closures.
- Whether supply-chain delays, inventory reserves and fulfillment constraints affected second-quarter sales and margins.
- The carrying value and future impairment risk of Waterworks assets and other long-lived assets.
- Actual fiscal 2020 capital expenditures relative to the $125 million to $150 million expectation.
- Potential dilution or cash requirements from the 2023 and 2024 convertible notes and related warrants.