RH Form 10-K Summary
Period covered: Fiscal year ended February 2, 2019, consisting of 52 weeks. The request metadata references “2017 Q4,” but the supplied filing is RH’s fiscal 2018 Form 10-K, filed March 29, 2019; fiscal 2017 ended February 3, 2018 and consisted of 53 weeks.
Business Context
RH is a luxury home furnishings retailer operating through Galleries, outlet stores, Source Books, websites, Trade and Contract channels, and integrated hospitality offerings. As of February 2, 2019, RH operated 86 retail Galleries and Waterworks showrooms, 39 outlet stores, and approximately 5,200 employees. The company reported two operating segments: RH Segment and Waterworks.
- Stores represented 56% of fiscal 2018 net revenue; direct channels represented 44%.
- RH opened four Design Galleries, one RH Modern Gallery, two RH Baby & Child Galleries and one Waterworks showroom, while closing or consolidating several legacy locations.
- Management is transforming the real estate platform toward larger Design Galleries, capital-light leases, development and joint-venture structures, with a targeted future opening cadence of five to seven Galleries annually.
Financial Performance
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net revenue | $2,505.7 million | $2,440.2 million | +2.7% |
| Gross profit | $1,000.8 million | $849.1 million | +17.9% |
| Gross margin | 39.9% | 34.8% | +510 bps |
| Income from operations | $289.2 million | $131.3 million | +120.2% |
| Operating margin | 11.5% | 5.4% | +610 bps |
| Net income | $150.6 million | $2.2 million | Material increase |
| Net margin | 6.0% | 0.1% | +590 bps |
| Adjusted net income | $223.7 million | $89.2 million | +150.8% |
| Adjusted EBITDA | $400.8 million | $268.3 million | +49.4% |
Stores revenue increased 3.0% to $1,412.1 million, while direct revenue increased 2.3% to $1,093.5 million. Comparable brand revenue growth was 4%. Furniture revenue increased to $1,625.6 million from $1,543.4 million, while non-furniture revenue declined to $880.1 million from $896.8 million.
Cash Flow, Liquidity and Debt
- Operating cash flow was $300.6 million, down from $556.8 million, primarily because fiscal 2017 benefited from a $220.8 million inventory reduction and favorable working-capital movements.
- Capital expenditures were $136.7 million, producing reported free cash flow of $162.7 million versus $415.1 million in fiscal 2017.
- Cash and cash equivalents were $5.8 million at year-end; working capital was $110.3 million.
- Total debt, excluding build-to-suit financing obligations, was $956.7 million. Principal convertible notes totaled $985 million: $350 million due June 2019, $300 million due July 2020 and $335 million due June 2023.
- The asset-based credit facility had $57.5 million outstanding and $378.9 million of stated availability, net of letters of credit. After the fixed-charge coverage restriction, management estimated approximately $333.9 million of incremental borrowing availability.
- Management expected to repay the convertible notes in cash at maturity to minimize dilution, using free cash flow and revolver borrowings, while acknowledging that additional liquidity or refinancing might be required.
Material Changes Versus the Prior Comparable Period
- Revenue growth slowed to 2.7% from 14.3% in fiscal 2017, partly because fiscal 2017 included an extra week and unusually high outlet and warehouse sales from inventory optimization.
- Gross margin expanded substantially due to improved core merchandise margins, lower impact from SKU rationalization, better outlet margins and distribution-center occupancy leverage. Higher delivery costs and ramping hospitality locations partially offset the improvement.
- SG&A declined 0.9% despite new Gallery openings and higher incentive compensation. Advertising expense declined partly because Topic 606 changed Source Book expense timing.
- Outlet revenue declined $26.7 million to $179.0 million as fiscal 2017 had heavier promotional activity and discounts.
- RH consolidated distribution operations from four primary furniture facilities to two, eliminating approximately 2.3 million square feet and producing expected annual savings exceeding $25 million.
- RH adopted Topic 606 using the modified retrospective method, reducing opening retained earnings by $21.0 million. Fiscal 2018 reported revenue and net income were affected by the new timing and classification rules.
- Total shares outstanding fell materially following approximately $250 million of fiscal 2018 repurchases and retirement of repurchased shares. The company had $450 million remaining under the repurchase authorization at year-end, later replenished to $700 million in March 2019.
Guidance, Outlook, Risks and Unusual Items
Management Outlook
- Fiscal 2019 gross capital expenditures were expected to be $165 million to $185 million, partially offset by anticipated asset-sale proceeds of $50 million to $60 million.
- Management expected continued operating-margin improvement from occupancy leverage, higher full-price selling, operating-platform efficiencies and organizational savings.
- Management planned to resume broader product and business expansion in fiscal 2019 and increase investment in RH Interior Design.
- Management cited stock-market volatility, weakness in luxury consumer spending and negative high-end housing trends as headwinds, particularly affecting fourth-quarter demand.
Unusual and Non-Recurring Items
- Waterworks goodwill and tradename impairment totaled $32.1 million in fiscal 2018, including $17.4 million of goodwill impairment and $14.6 million of tradename impairment. Waterworks goodwill was fully impaired at year-end.
- Fiscal 2018 included $10.0 million of reorganization costs, $7.2 million of asset impairment and lease losses, $1.8 million of distribution-center closure costs and $1.6 million of product-recall costs.
- RH recorded a $50.0 million provision for a securities class-action settlement memorandum of understanding, offset by a $50.0 million insurance recovery receivable. Final court approval remained required.
- Product recalls reduced fiscal 2018 income before tax by $1.6 million; the product-recall reserve was $7.8 million at year-end.
- The company’s effective tax rate was 16.8%, affected by the Tax Cuts and Jobs Act, stock-compensation tax benefits and impairment-related tax effects.
- Ryno Blignaut was stepping down as President, Chief Financial and Administrative Officer due to health considerations. Jack Preston was appointed Chief Financial Officer and Glenda Citragno Chief Accounting Officer effective after filing.
Principal Risks
- Repayment or refinancing risk associated with the $350 million convertible notes due June 2019 and the broader $985 million convertible-note obligation.
- Exposure to luxury consumer spending, high-end housing, stock-market volatility, interest rates and macroeconomic conditions.
- Import, tariff and supply-chain risk; approximately 73% of fiscal 2018 purchase dollar volume was sourced from Asia and approximately 41% from China.
- Execution risk from simultaneous real estate, hospitality, international expansion, product-category, supply-chain and technology initiatives.
- Waterworks underperformance and potential for additional impairment charges.
- Product recalls, quality failures, litigation, cybersecurity incidents and data-privacy liability.
- Long-term lease commitments, construction delays, cost overruns and risks from development, joint-venture and capital-light real estate structures.
Most Important Facts for Investors to Verify
- Whether RH ultimately repaid or refinanced the $350 million 2019 Notes and how the repayment affected liquidity and leverage.
- Actual fiscal 2019 revenue, comparable brand growth, gross margin and free cash flow relative to management’s stated outlook.
- Whether the $50.0 million securities litigation settlement received final court approval and whether insurance proceeds fully offset the recorded provision.
- Progress, capital requirements and returns from new Design Galleries, hospitality locations, real estate development and joint-venture projects.
- Waterworks revenue, operating profitability and any additional goodwill or tradename impairment.
- The effects of tariffs, sourcing changes and vendor concentration on product costs, pricing and gross margin.
- The impact of Topic 842 lease adoption on reported assets, liabilities, operating income, interest expense and cash-flow classification.
- The sustainability of reported adjusted EBITDA and free cash flow after excluding impairment, recall, restructuring, legal and other unusual items.