RH Form 10-Q Summary
Reporting period: Three and nine months ended October 29, 2016, compared with October 31, 2015. The request metadata identifies “2015 Q3,” but the filing itself is for fiscal 2016 third quarter and was filed December 8, 2016.
Business context
Restoration Hardware Holdings, Inc. was a luxury home furnishings retailer selling through stores, catalogs, websites and commercial channels. As of October 29, 2016, it operated 85 retail stores, 28 outlet stores and 15 Waterworks showrooms across the United States, Canada and the U.K. The company acquired more than 90% of Waterworks on May 27, 2016, for approximately $119.9 million.
Financial performance
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net revenues | $549.3 million | $532.4 million | $1,548.2 million | $1,461.8 million |
| Revenue growth | 3.2% | — | 5.9% | — |
| Gross profit | $175.8 million | $190.8 million | $483.1 million | $528.4 million |
| Gross margin | 32.0% | 35.8% | 31.2% | 36.1% |
| Income from operations | $15.4 million | $44.9 million | $25.9 million | $118.3 million |
| Operating margin | 2.8% | 8.4% | 1.7% | 8.1% |
| Net income (loss) | $2.5 million | $20.7 million | $(4.0) million | $57.8 million |
| Diluted EPS | $0.06 | $0.49 | $(0.10) | $1.37 |
Stores revenue increased 9.0% in the quarter and 14.1% for the nine-month period, while direct revenue declined 3.3% and 3.1%, respectively. Comparable brand revenue declined 6% in the quarter and 2% for the nine-month period. Waterworks contributed $28.3 million of third-quarter revenue and $49.1 million for the nine-month period.
Adjusted net income, a non-GAAP measure, was $8.0 million in Q3 2016 versus $27.7 million in Q3 2015, and $23.9 million for the first nine months versus $73.6 million in the prior-year period.
Cash flow, liquidity and capital structure
- Net cash used in operating activities was $29.1 million for the first nine months of 2016, compared with $17.6 million used in the prior-year period.
- Net cash used in investing activities was $263.4 million, including $116.1 million for the Waterworks acquisition, $104.2 million of capital expenditures and net investment purchases.
- Cash and cash equivalents declined to $55.4 million from $349.9 million at January 30, 2016. The company also held $191.2 million of short- and long-term investments.
- Capital expenditures were $104.2 million through October 29, 2016. Management expected fiscal 2016 gross capital expenditures of approximately $180 million to $190 million.
- The company had $586.3 million of undrawn revolving credit availability, no revolver borrowings and $13.7 million of outstanding letters of credit. It was in compliance with applicable covenants.
- Convertible senior notes had principal amounts of $350 million due 2019 and $300 million due 2020. Both instruments carry a 0.00% stated interest rate; the carrying values were $308.6 million and $231.9 million, respectively.
Material changes and unusual items
- Gross margin declined primarily because of the RH Members Program’s higher customer discount, inventory markdowns, higher shipping costs and occupancy deleverage.
- Results included $5.2 million of non-cash inventory step-up amortization related to Waterworks for the nine-month period, including $1.8 million in the quarter.
- Waterworks acquisition-related costs were $2.8 million for the nine-month period, and one-time non-cash compensation related to Waterworks options was $3.7 million.
- Reorganization costs were $5.7 million for the nine-month period, including $1.0 million in the quarter.
- Management estimated that customer accommodations related to RH Modern production delays reduced nine-month revenue by approximately $16 million.
- Prior-year results included charges related to a California ZIP-code class action and associated customer coupons; the coupons expired in March 2016.
- The company changed the annual Source Book mailing from spring to fall, delaying related revenue and advertising activity in the 2016 periods.
- The company adopted several accounting standards in fiscal 2016 without material impact. It was evaluating the future effects of revenue recognition, lease, financial instrument, breakage, stock compensation and cash-flow standards.
Outlook, management commentary and risks
Management stated that cash expected from operations, available investments, revolving credit availability and other financing sources should be sufficient for working capital and anticipated capital expenditures over the next 12 to 24 months. However, management highlighted unusually high near-term uncertainty and expected continued variability while implementing store, assortment, supply-chain, customer-experience and membership-program initiatives.
- Key strategic priorities included expanding next-generation Design Galleries, increasing product and service offerings, improving the customer experience, increasing operating margins and pursuing international expansion.
- Management cited weakness in luxury consumer spending, underperformance in energy- and oil-related markets and currency fluctuations as continuing macroeconomic risks.
- The RH Members Program may lengthen the selling cycle and depress short-term margins because membership fees are recognized over the membership period.
- Waterworks integration may involve unanticipated costs, delays and management-resource demands, and expected acquisition benefits may not materialize promptly.
- Legal proceedings are inherent in the company’s expanding operations. Management believes current matters will not materially adversely affect the financial statements, but additional losses could exceed accrued amounts.
- The company reported no material off-balance-sheet arrangements and no material changes to the risk factors disclosed in its 2015 Form 10-K.
Investor verification points
- Verify whether revenue growth and margin recovery are being driven by organic comparable sales rather than store expansion and Waterworks consolidation.
- Assess the sustainability and customer economics of the RH Members Program, including its effect on discounts, selling cycles and deferred revenue.
- Monitor operating cash flow, inventory levels, capital expenditures and the decline in cash balances relative to available revolver capacity.
- Evaluate Waterworks integration progress, acquisition-related costs and the contribution of the acquired business to consolidated profitability.
- Review the maturity, potential cash settlement and dilution implications of the 2019 and 2020 convertible notes, including associated warrants.
- Track exposure to customer-accommodation costs, production delays, litigation contingencies and macroeconomic weakness in luxury retail.