RH Form 10-Q Summary
Reporting period: The provided filing is RH’s quarterly report for the three and nine months ended October 31, 2020, compared with November 2, 2019. The request metadata identifies “2019 Q3,” but the filing itself is for fiscal 2020 third quarter. RH operates luxury home-furnishings, Waterworks, hospitality and related businesses through Galleries, outlets, showrooms, catalogs and websites.
Business Context and Operating Footprint
- At October 31, 2020, RH operated 68 Galleries, 38 outlets and 14 Waterworks showrooms across the United States, Canada and the United Kingdom.
- All Galleries and outlets had reopened by quarter-end, along with 8 of 10 restaurants, after COVID-19 closures earlier in the year.
- Management reported strong consumer demand but continuing supply-chain and inventory-receipt delays, which constrained the conversion of customer orders into reported revenue.
Financial Performance
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net revenues | $844.0 million | $677.5 million | $2.036 billion | $1.982 billion |
| Gross profit | $408.3 million | $284.2 million | $940.4 million | $811.9 million |
| Gross margin | 48.4% | 41.9% | 46.2% | 41.0% |
| Income from operations | $111.2 million | $89.2 million | $283.2 million | $261.9 million |
| Operating margin | 13.2% | 13.2% | 13.9% | 13.2% |
| Net income | $46.4 million | $52.5 million | $141.6 million | $151.9 million |
| Diluted EPS | $1.64 | $2.17 | $5.37 | $6.38 |
| Adjusted EBITDA | $258.0 million | $116.3 million | $521.2 million | $350.4 million |
Q3 revenue increased 24.6%, gross profit increased 43.7%, and operating income increased 24.6%. Net income declined 11.5% because of a substantially higher effective tax rate and significant non-cash stock compensation. The nine-month revenue increase was 2.7%, reflecting COVID-19 disruption earlier in the fiscal year.
Cash Flow, Liquidity and Capital Structure
- Cash flow from operations was $347.3 million for the first nine months of 2020, up from $211.0 million in the prior-year period.
- Investing cash outflow was $67.3 million, including $71.8 million of capital expenditures, $13.1 million for an acquisition and $7.5 million for joint ventures, partially offset by $25.0 million of asset-sale proceeds.
- Financing cash outflow was $230.8 million, primarily reflecting cash settlement of the $300 million convertible notes due 2020 and other debt repayments.
- Cash and cash equivalents were $89.9 million at October 31, 2020; including restricted cash, total cash was $96.8 million, compared with $38.3 million at November 2, 2019.
- RH had $685 million of convertible senior notes outstanding: $335 million due 2023 and $350 million due 2024. Both instruments carry a 0.00% coupon and are expected by management to be repaid in cash at maturity to minimize dilution.
- No borrowings were outstanding under the asset-based revolving facility. Availability under the borrowing base was $316.4 million, net of $14.6 million in letters of credit.
- Total lease liabilities were $973.3 million, including $503.0 million of finance lease liabilities and $470.3 million of operating lease liabilities.
- Management stated that operating cash flow and available financing are expected to fund working capital, capital needs and debt obligations for more than the next 12 months.
Material Changes Versus the Prior Comparable Period
- Q3 RH Segment revenue increased 25.9% to $812.8 million, while Waterworks revenue declined 2.9% to $31.2 million. Waterworks’ nine-month revenue declined 13.8% to $87.1 million.
- Gross margin expanded by 650 basis points in Q3 and 520 basis points for the nine months, driven primarily by pricing, product mix, higher product margins, lower outlet promotional activity and occupancy leverage.
- SG&A increased 52.4% in Q3, principally because of a $111.2 million non-cash compensation charge related to a new CEO option grant. Excluding specified unusual items, management reported lower SG&A as a percentage of revenue.
- The effective tax rate increased to 51.4% in Q3 from 13.7%, and to 32.0% for the nine months from 19.5%, primarily due to non-deductible stock compensation and changes in discrete tax benefits.
- The $300 million 2020 convertible notes matured in July 2020 and were settled with $290.6 million of cash and 1.1 million shares, offset by the related bond hedge. The notes were no longer outstanding at quarter-end.
- RH acquired a North American furniture business on August 28, 2020 for approximately $15.0 million, recognizing $10.9 million of goodwill and $4.8 million of tradename value.
- RH recognized a $20.5 million Waterworks tradename impairment in the first quarter and a $9.4 million loss on the Minneapolis Design Gallery sale-leaseback during the second quarter.
- Management granted the CEO an option for 700,000 shares at an exercise price of $385.30 per share. The grant has estimated aggregate non-cash compensation of $173.6 million, with $111.2 million recognized in Q3.
Guidance, Outlook, Risks and Unusual Items
- Management expects supply-chain constraints and manufacturing delays to persist, potentially until the second half of 2021. Customer-order demand is expected to convert into revenue over the following several quarters as inventory receipts improve.
- COVID-19 restrictions, including occupancy limits and renewed closures, were expected to negatively affect demand and hospitality operations in affected markets.
- Fiscal 2020 adjusted capital expenditures, net of asset sales, were expected to be approximately $140 million to $160 million; $116.7 million had been incurred during the first nine months.
- International expansion plans were delayed, with additional international locations now targeted to begin in 2022 rather than 2021.
- Key risks include discretionary consumer spending, luxury housing and stock-market conditions, global sourcing concentration, transportation and manufacturing disruptions, tariffs, real-estate development delays, liquidity needed to repay convertible notes, potential dilution from convertible notes and warrants, lease obligations, litigation and product recalls.
- The filing reports a $50 million securities class-action settlement funded entirely by insurance carriers and a separate shareholder derivative settlement involving non-monetary terms and expected insurance-funded legal fees.
- RH reported no material off-balance-sheet arrangements and stated that it was in compliance with applicable credit-facility financial covenants at October 31, 2020.
Important Facts for Investors to Verify
- Whether supply-chain normalization occurs as projected and allows backlog demand to translate into revenue.
- The sustainability of the expanded gross margin after COVID-19 effects and unusual items are excluded.
- The cash funding plan for the $335 million 2023 notes and $350 million 2024 notes, including potential conversion-related dilution.
- The final number of shares issued to settle the 2020 warrants, which were expected to settle through December 2020 and the first week of January 2021.
- The effect of the CEO option grant and other equity awards on future reported earnings, diluted share count and stock-based compensation.
- Whether renewed COVID-19 restrictions, hospitality limitations, luxury housing weakness or reduced discretionary spending affect demand and liquidity.
- Waterworks’ recovery prospects following revenue declines, construction delays and the $20.5 million tradename impairment.