RH Form 10-Q Summary
Business context and reporting period
RH is a luxury home furnishings retailer selling furniture, lighting, textiles, bathware, décor, outdoor and garden products, and child and teen furnishings through Galleries, outlets, catalogs, websites, commercial channels, and Waterworks showrooms. As of November 2, 2019, RH operated 70 Galleries, 39 outlet stores, and 15 Waterworks showrooms in the United States, Canada, and the United Kingdom.
The filing covers the three and nine months ended November 2, 2019, compared with the periods ended November 3, 2018. Although the request metadata references “2018 Q3,” the supplied filing is the fiscal 2019 third-quarter Form 10-Q, filed December 5, 2019. Fiscal 2019 ends February 1, 2020.
Key financial metrics
| Metric | Three months ended Nov. 2, 2019 | Three months ended Nov. 3, 2018 | Nine months ended Nov. 2, 2019 | Nine months ended Nov. 3, 2018 |
|---|---|---|---|---|
| Net revenues | $677.5 million | $636.6 million | $1,982.5 million | $1,834.8 million |
| Gross profit | $284.2 million | $250.0 million | $811.9 million | $727.7 million |
| Gross margin | 41.9% | 39.3% | 41.0% | 39.7% |
| Income from operations | $89.2 million | $42.2 million | $261.9 million | $172.2 million |
| Operating margin | 13.2% | 6.6% | 13.2% | 9.4% |
| Net income | $52.5 million | $20.1 million | $151.9 million | $108.5 million |
| Diluted EPS | $2.17 | $0.73 | $6.38 | $4.05 |
| Adjusted EBITDA | $116.3 million | $87.8 million | $350.4 million | $268.5 million |
Net cash provided by operating activities was $211.0 million for the first nine months of fiscal 2019, compared with $96.7 million in the prior-year period. Investing cash flow was a use of $70.5 million, including $64.6 million of capital expenditures and a $30.0 million deposit on an asset under construction, partially offset by $24.1 million of asset-sale proceeds. Financing cash flow was a use of $108.0 million, including $250.0 million of share repurchases and debt repayments.
Cash and cash equivalents were $38.3 million at November 2, 2019, compared with $5.8 million at February 2, 2019. Merchandise inventories declined to $429.2 million from $531.9 million. Total assets were $2.36 billion and total liabilities were $2.43 billion, resulting in stockholders’ deficit of $63.2 million.
At November 2, 2019, RH had $985 million of convertible notes outstanding at principal value: $300 million due in 2020, $335 million due in 2023, and $350 million due in 2024. The company also had $90.0 million outstanding under its FILO term loan and $58.7 million under equipment security notes. No borrowings were outstanding under the revolving credit facility; borrowing-base availability was $345.5 million, net of $13.2 million of letters of credit. RH was in compliance with applicable credit agreement covenants.
Material changes versus the prior comparable period
- Third-quarter revenue increased 6.4%; nine-month revenue increased 8.1%. RH Segment revenue increased 6.8% in the quarter and 8.3% year to date. Waterworks revenue was flat in the quarter and increased 4.4% year to date.
- Furniture revenue increased 11.6% in the quarter and 12.3% year to date, while non-furniture revenue declined 3.5% in the quarter and was essentially flat year to date.
- Gross margin expanded 260 basis points in the quarter and 130 basis points year to date, primarily from distribution-network efficiencies, lower delivery costs, occupancy leverage, and improved core merchandise margins. Higher outlet promotions and discounts partially offset the gains.
- SG&A declined 6.2% in the quarter and 1.0% year to date, reflecting lower reorganization and preopening costs and operating leverage.
- Interest expense increased to $21.6 million in the quarter and $67.2 million year to date, from $17.7 million and $48.3 million, respectively, largely due to higher finance-lease interest, term-loan interest, and convertible-debt discount amortization.
- RH issued $350 million of 0.00% convertible notes due 2024 in September 2019. Net cash proceeds after discounts, offering costs, convertible note hedges, and warrants were approximately $304.1 million.
- The $200 million second-lien term loan was repaid in September 2019, producing a $6.7 million loss on extinguishment of debt. RH also repaid $30 million of the FILO term loan in October.
- The $350 million convertible notes due 2019 matured in June 2019 and were settled for $349.0 million in cash and 42 shares of common stock.
- RH repurchased approximately 2.2 million shares for $250.0 million in the first quarter of fiscal 2019. No program repurchases occurred in the third quarter; $450.0 million remained available under the repurchase authorization at quarter end.
- The company adopted the new lease standard using a modified retrospective approach, recognizing substantial operating and finance lease assets and liabilities. Total lease liabilities were $908.1 million at November 2, 2019.
Guidance, outlook, commentary, risks, and unusual items
- Management expects fiscal 2019 adjusted net capital expenditures of approximately $150 million to $160 million; $114.0 million had been incurred through the first nine months.
- RH expects to increase new Gallery openings from approximately three to five annually to five to seven annually beginning in fiscal 2020, supported by smaller prototype Galleries, Bespoke Galleries, secondary-market formats, and capital-light or development-oriented real-estate structures.
- Management expects to repay the $985 million of convertible-note principal at maturity in cash to minimize dilution, using operating cash flow, free cash flow, revolver borrowings, and potentially additional financing. The filing states that additional liquidity may be required and is not assured on favorable terms.
- Key strategic initiatives include expanding RH Interior Design, Hospitality, product categories, international operations, distribution efficiency, inventory turns, and the in-home delivery experience.
- Unusual items included debt-extinguishment losses, asset impairments and accelerated depreciation, reorganization costs, product-recall adjustments, a $1.5 million gain on the Yountville sale-leaseback, and prior-period legal-settlement adjustments. The $50 million securities-class-action settlement was funded by insurance and finally approved in October 2019.
- Important risks include substantial lease and debt obligations, refinancing and cash-repayment requirements, variable-rate exposure and LIBOR transition, dependence on foreign sourcing, tariffs on Chinese imports, supply-chain disruption, product recalls, execution risk in Gallery expansion, real-estate delays or cost overruns, macroeconomic weakness affecting affluent consumers, litigation, cybersecurity, and natural disasters.
- Management stated that cash from operations, convertible-note proceeds, revolver availability, and other financing arrangements should be sufficient for working capital, planned capital expenditures, and other needs for the next 12 months. This is subject to the risks and contingencies described in the filing.
Most important facts for investors to verify
- Whether operating cash flow and free cash flow can fund the $300 million 2020 convertible-note maturity and later maturities without unfavorable refinancing or dilution.
- The sustainability of gross-margin expansion after excluding recall benefits, sale-leaseback gains, accelerated depreciation, and other unusual items.
- Actual borrowing-base availability and compliance with fixed-charge coverage and other credit-facility requirements.
- The effect of tariffs, sourcing changes, freight costs, and vendor capacity on merchandise margins and inventory availability.
- Whether the planned five-to-seven annual Gallery openings achieve targeted sales productivity, payback periods, and returns on invested capital.
- The potential dilution from convertible notes and warrants, particularly the 2020, 2023, and 2024 instruments and their respective conversion or warrant strike prices.
- The accuracy and comparability of adjusted EBITDA, adjusted net income, and adjusted net capital expenditures, which are non-GAAP measures.
- The impact of the lease-accounting adoption, long-term lease commitments, and $406.9 million of legally binding lease payments for leases not yet commenced.
- Whether remaining litigation, product-recall exposure, tax contingencies, or other claims could exceed recorded reserves.