RH Form 10-K Summary
Reporting-period note: The supplied filing is RH’s Form 10-K for the fiscal year ended January 30, 2021, not 2019 Q4. Fiscal 2020 and fiscal 2019 each contained 52 weeks. The filing was signed March 30, 2021.
Business Context
RH is a luxury home-furnishings retailer operating Galleries, websites, Source Books, outlets, Trade and Contract channels, Waterworks showrooms, and hospitality concepts. As of January 30, 2021, RH operated 68 Galleries, 38 outlets, 14 Waterworks showrooms, and hospitality experiences in 10 Design Galleries.
Fiscal 2020 was materially affected by COVID-19. RH temporarily closed all retail locations and Restaurants during the first quarter, then experienced strong demand after reopening. As of March 24, 2021, all Galleries and Outlets and nine of ten Restaurants had reopened, although many Restaurants remained subject to capacity and other restrictions.
Financial Performance and Liquidity
| Metric | Fiscal 2020 | Fiscal 2019 | Change |
|---|---|---|---|
| Net revenues | $2.849 billion | $2.647 billion | Up 7.6% |
| Gross profit | $1.326 billion | $1.095 billion | Up 21.1% |
| Gross margin | 46.5% | 41.4% | Up 510 basis points |
| Income from operations | $466.9 million | $362.8 million | Up 28.6% |
| Net income | $271.8 million | $220.4 million | Up 23.4% |
| Diluted earnings per share | $9.96 | $9.07 | Up 9.8% |
| Adjusted EBITDA | $745.6 million | $495.4 million | Up 50.5% |
| Adjusted net income | $462.9 million | $276.3 million | Up 67.5% |
| Cash flow from operations | $500.8 million | $339.2 million | Up 47.6% |
| Free cash flow | $405.4 million | $330.4 million | Up 22.7% |
| Adjusted capital expenditures | $180.6 million | $157.9 million | Up 14.4% |
RH Segment revenue increased 8.6% to $2.729 billion, while Waterworks revenue declined 10.5% to $119.2 million because of showroom closures and construction delays. Furniture revenue increased 10.1% to $1.941 billion; non-furniture revenue increased 2.5% to $908.0 million.
Operating margin increased to 16.4% from 13.7%. Net income margin increased to 9.5% from 8.3%. The filing attributes gross-margin improvement primarily to product mix, price increases, improved product margins, lower outlet promotional activity, and occupancy-cost leverage.
Cash and cash equivalents were $100.4 million at year-end, compared with $47.7 million in the prior year. Working capital was negative $97.2 million, compared with negative $20.4 million. Merchandise inventories increased to $544.2 million from $438.7 million, reflecting strong demand and supply-chain delays.
Total debt, including current maturities and net of discounts, was $610.4 million, compared with $954.9 million. RH had no outstanding borrowings under its revolving credit facility and reported $271.9 million of availability, net of $15.4 million in letters of credit. Net debt to trailing-twelve-month adjusted EBITDA was 0.7x at year-end, compared with more than 5.0x in fiscal 2017.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated despite first-quarter store closures, with strong demand in the second half of fiscal 2020.
- Gross margin expanded substantially to 46.5%, supported by pricing, mix, merchandise margins, lower outlet discounting, and fixed-cost leverage.
- Operating cash flow increased by $161.6 million, helped by higher net income, increased deferred revenue and customer deposits, and higher accounts payable and accrued expenses.
- Inventory increased by $105.5 million, while the company reported backorders and delays in converting demand into recognized revenue.
- Interest expense declined by $17.9 million following debt repayments and the maturity of the 2020 convertible notes.
- RH recorded a $20.5 million non-cash Waterworks tradename impairment, a $9.4 million loss on the Minneapolis sale-leaseback, $7.4 million of recall-related charges, and $7.0 million of reorganization costs.
- Stock-based compensation increased sharply to $145.7 million, including $117.1 million related to a 700,000-share option grant to CEO Gary Friedman.
- RH invested $99.2 million in three Aspen, Colorado equity-method real estate investments and recorded a $0.9 million share of related losses.
- RH completed two acquisitions for total consideration of approximately $19.7 million, before deferred and contingent payments.
- No share repurchases were made under the authorized program during fiscal 2020; $450 million remained available at year-end.
Guidance, Outlook, Commentary, and Risks
- Management expected the supply chain to catch up with demand in the second half of fiscal 2021, but emphasized that the timing remained uncertain.
- Fiscal 2021 adjusted capital expenditures were projected at $250 million to $300 million, primarily for new Design Galleries and infrastructure.
- Management expects to repay the $335 million of 2023 convertible notes and $350 million of 2024 convertible notes in cash at maturity to minimize dilution, subject to available liquidity and financing conditions.
- RH plans to launch RH Contemporary in 2021 and pursue international Gallery openings in Europe beginning in 2022. It also targets five to seven new Galleries per year over time, although COVID-19 slowed the development cadence.
- Long-term internal opportunity estimates include $5 billion to $6 billion of North American revenue potential from Gallery transformation and a potential $20 billion to $25 billion global brand opportunity. These are management objectives, not guarantees.
- Primary risks include renewed COVID-19 restrictions, changes in consumer spending after reopening, exposure to luxury housing and stock-market conditions, supply-chain disruptions, vendor concentration, foreign sourcing and tariffs, rising freight and raw-material costs, execution risk from numerous simultaneous initiatives, real-estate development risk, competition, cybersecurity, product recalls, litigation, impairment charges, and the need to fund substantial lease, capital, and convertible-debt obligations.
- Approximately 72% of fiscal 2020 purchase dollar volume was sourced from Asia, including approximately 35% from China. One vendor represented approximately 11% of purchase dollar volume.
- Contractual obligations totaled approximately $2.155 billion, including $685 million of convertible-note principal, $1.416 billion of lease payments, and $677.4 million of merchandise purchase commitments.
Most Important Facts for Investors to Verify
- Confirm that the intended filing period is fiscal 2020 ended January 30, 2021, rather than 2019 Q4.
- Assess whether revenue growth and elevated gross margins are sustainable after COVID-19-related stay-at-home demand, pricing actions, and unusually strong second-half demand normalize.
- Monitor inventory, backorders, cancellation rates, vendor capacity, freight costs, and whether supply-chain constraints improve as management expects.
- Evaluate the quality of reported earnings, particularly the effect of the $117.1 million CEO option expense, Waterworks impairment, recall charges, reorganization costs, and other non-GAAP adjustments.
- Verify liquidity available to fund $250 million to $300 million of planned fiscal 2021 capital expenditures and the $685 million of convertible-note maturities due in 2023 and 2024.
- Review dilution exposure from the 2023 and 2024 convertible notes and warrants, including warrant strike prices of approximately $309.84 and $338.24 per share.
- Review the assumptions and funding obligations underlying the $100.6 million Aspen equity-method investments, including the additional $5.8 million of disclosed future funding requirements.
- Evaluate Waterworks’ declining revenue, remaining $17.0 million tradename carrying value, and risk of further impairment.
- Review the company’s extensive lease commitments, including $793.5 million of legally binding payments for leases signed but not yet commenced.
- Confirm that PwC and management concluded that the financial statements and internal control over financial reporting were effective as of January 30, 2021.