RH Form 10-Q Summary
Business context and reporting period
RH is a luxury home furnishings retailer offering furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings through Galleries, outlets, catalogs, websites and commercial channels. As of May 4, 2019, RH operated 70 Galleries, 40 outlets and 15 Waterworks showrooms in the United States, Canada and the U.K.
The filing covers the three months ended May 4, 2019, compared with May 5, 2018. The request metadata identifies “2018 Q1,” but the filing is RH’s first quarter of fiscal 2019. Fiscal 2019 ends February 1, 2020.
Financial performance and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net revenues | $598.4 million | $557.4 million | +7.4% |
| Gross profit | $232.8 million | $209.3 million | +11.2% |
| Gross margin | 38.9% | 37.6% | +1.3 percentage points |
| Income from operations | $68.6 million | $48.1 million | +42.6% |
| Operating margin | 11.5% | 8.6% | +2.9 percentage points |
| Net income | $35.7 million | $25.5 million | +40.3% |
| Diluted EPS | $1.43 | $1.01 | +41.6% |
| Adjusted EBITDA | $100.4 million | $79.9 million | +25.6% |
Revenue growth reflected new Galleries, increased RH Hospitality and Contract revenue, and higher outlet sales. RH Segment revenue rose 7.2% to $563.7 million, while Waterworks revenue rose 10.6% to $34.7 million. Furniture revenue increased to $396.7 million from $352.6 million; non-furniture revenue declined to $201.7 million from $204.8 million.
Gross-margin expansion reflected improved core merchandise margins, distribution-center efficiencies and delivery-cost leverage, partly offset by lower outlet product margins and recall-related items. SG&A increased 1.9% to $164.2 million, but declined to 27.4% of revenue from 29.0%, reflecting operating leverage despite higher Source Book marketing costs.
Net interest expense increased to $21.1 million from $15.1 million, primarily because of higher convertible-debt discount amortization, finance-lease interest and term-loan interest. The effective tax rate increased to 24.8% from 23.0%.
- Operating cash flow was $38.8 million, compared with cash used of $3.2 million in the prior-year quarter.
- Capital expenditures were $7.9 million, compared with $17.7 million; adjusted net capital expenditures were $12.5 million, compared with $36.3 million.
- Financing cash flow was $65.8 million, including $320 million of term-loan borrowings and $60 million of equipment-note borrowings, partially offset by $250.0 million of share repurchases.
- Cash and cash equivalents were $37.6 million, with restricted cash of $65.0 million, for total cash and restricted cash of $102.6 million at May 4, 2019.
- Merchandise inventories were $530.2 million, and total assets were $2.55 billion.
Debt, leases and liquidity
At May 4, 2019, RH had $350 million principal amount of 0.00% convertible notes due June 15, 2019, $300 million due July 15, 2020, and $335 million due June 15, 2023. Management intended to settle the 2019 notes with cash, restricted cash and borrowings under the asset-based credit facility. Management also expected to repay the 2020 and 2023 notes in cash to minimize dilution, while acknowledging that additional liquidity or refinancing might be required.
- No borrowings were outstanding under the revolving asset-based credit facility; borrowing-base availability was $139.4 million after reserves for the 2019 notes and outstanding letters of credit.
- A $120.0 million FILO term loan was fully borrowed in April 2019.
- A $200.0 million second-lien term loan was outstanding, bearing interest generally at LIBOR plus 6.50% and maturing in April 2024.
- Equipment security notes totaled $59.0 million.
- Total lease liabilities were $928.5 million, including $484.6 million of operating-lease liabilities and $443.9 million of finance-lease liabilities.
- Stockholders’ deficit was $247.4 million, compared with a deficit of $38.7 million at February 2, 2019, primarily after $250.0 million of share repurchases.
Management stated that operating cash flow, borrowing availability and other financing arrangements were expected to cover working capital, planned capital expenditures and other needs for the next 12 months, but noted uncertainty regarding future capital-market access, refinancing and repayment of convertible notes.
Material changes versus the prior comparable period
- Revenue, gross profit, operating income and net income increased materially, while gross, operating and net margins improved.
- Operating cash flow improved by $42.1 million year over year, while capital expenditures declined by $9.8 million.
- RH added significant debt financing during the quarter through the FILO loan, second-lien term loan and equipment notes.
- RH repurchased approximately 2.2 million shares for $250.0 million at an average price of $115.36. The repurchase authorization had $450.0 million remaining.
- RH adopted the new lease accounting standard, recognizing substantial operating and finance lease assets and liabilities on the balance sheet.
- The company corrected previously disclosed immaterial errors involving lease accounting, a lease impairment, stockholders’ equity classifications and prior cash-flow presentation.
Guidance, outlook, risks and unusual items
Management expected fiscal 2019 adjusted net capital expenditures of $165 million to $185 million, primarily for new Design Galleries and infrastructure, partially offset by anticipated asset-sale proceeds of $50 million to $60 million. Management expected the pace of new Galleries to increase from three to five annually to five to seven annually beginning in fiscal 2020.
Management’s strategy emphasizes transforming the real-estate platform, expanding product and design services, growing RH Hospitality, improving distribution and delivery operations, increasing market share and pursuing international expansion. Management expects these initiatives to support cost savings, margin improvement and higher returns on invested capital, but cautioned that timing, construction delays, cost overruns and execution risks could cause increased volatility.
- A $50 million securities class-action settlement was agreed in principle and was subject to court approval. RH recorded $60.1 million of legal-settlement and related legal-fee liabilities and a corresponding $60.1 million insurance-recovery receivable.
- Product recall adjustments reduced first-quarter pretax income by $1.6 million and created potential for future fluctuations.
- RH recorded $3.5 million of asset-impairment and useful-life-related charges, including $3.0 million of accelerated depreciation.
- New tariffs increased risks to product costs and margins. Approximately 39% of fiscal 2018 merchandise was sourced from China, and certain furniture and lighting products became subject to a 25% tariff for goods shipped on or after May 10, 2019.
- Key risks include dependence on foreign sourcing, tariffs and supply-chain disruption, high lease obligations, substantial debt maturities, variable-rate debt, luxury-consumer demand, housing-market conditions, litigation, product recalls and execution of the Gallery expansion strategy.
- Subsequent to quarter-end, RH obtained amendments and waivers related to financial-reporting requirements under both its first-lien and second-lien credit agreements; the company was deemed compliant as of May 4, 2019.
Most important facts to verify
- Actual repayment or refinancing of the $350 million convertible notes due June 15, 2019 and the resulting effect on liquidity.
- Whether the insurance proceeds fully cover the recorded $60.1 million legal-settlement receivable and the final court disposition of the securities litigation.
- The effect of the 25% China tariff and any additional trade restrictions on gross margin, pricing and merchandise availability.
- Compliance with the second-lien net senior secured leverage covenant, which was capped at 3.50 to 1.00, and other credit-facility requirements.
- Progress toward the $165 million to $185 million fiscal 2019 adjusted capital-expenditure plan and the anticipated $50 million to $60 million of asset-sale proceeds.
- Whether operating cash flow remains sufficient to fund Gallery expansion, lease obligations, share repurchases and the 2020 and 2023 convertible-note maturities without dilutive equity financing.