RH Form 10-Q Summary
Reporting period: The supplied filing is RH’s quarterly report for the three and six months ended August 3, 2019, compared with August 4, 2018. The request metadata identifies “2018 Q2,” but the filing itself represents fiscal 2019 second quarter. RH is a luxury home furnishings retailer operating RH Galleries, outlets, catalogs, websites and Waterworks showrooms. As of August 3, 2019, it operated 70 RH Galleries, 40 outlets and 15 Waterworks showrooms.
Financial Performance and Position
| Metric | Three months ended August 3, 2019 | Three months ended August 4, 2018 | Six months ended August 3, 2019 | Six months ended August 4, 2018 |
|---|---|---|---|---|
| Net revenues | $706.5 million | $640.8 million | $1,304.9 million | $1,198.2 million |
| Gross profit | $295.0 million | $268.3 million | $527.8 million | $477.7 million |
| Gross margin | 41.7% | 41.9% | 40.4% | 39.9% |
| Income from operations | $104.0 million | $81.8 million | $172.6 million | $130.0 million |
| Operating margin | 14.7% | 12.8% | 13.2% | 10.8% |
| Net income | $63.8 million | $62.9 million | $99.5 million | $88.4 million |
| Diluted EPS | $2.86 | $2.29 | $4.21 | $3.35 |
| Adjusted EBITDA | $133.7 million | $103.1 million | $234.1 million | $180.8 million |
- Second-quarter revenue increased 10.3%; six-month revenue increased 8.9%.
- Second-quarter gross profit increased 9.9%, while gross margin declined 20 basis points. Six-month gross margin improved 50 basis points.
- Interest expense increased to $24.5 million in the quarter and $45.6 million year to date, versus $15.5 million and $30.6 million, respectively, primarily due to term-loan borrowings, finance-lease interest and convertible debt discount amortization.
- The effective tax rate increased to 20.7% in the quarter and 22.2% year to date, compared with 3.9% and 10.3%, respectively, largely because of lower discrete tax benefits from stock-based compensation.
- Cash provided by operating activities was $97.1 million for the six months, compared with $49.0 million in the prior-year period. Capital expenditures were $25.3 million, and net cash used in financing activities was $66.0 million.
- Cash and cash equivalents were $11.6 million at August 3, 2019, compared with $5.8 million at February 2, 2019.
- Total assets were $2.39 billion and total liabilities were $2.57 billion, resulting in stockholders’ deficit of $177.9 million.
Material Changes Versus the Prior Comparable Period
- RH Segment revenue increased 10.7% in the quarter and 9.0% year to date. Waterworks revenue increased 3.0% and 6.7%, respectively.
- Outlet revenue increased by $16.0 million in the quarter and $28.4 million year to date, primarily because of increased promotional activity to reduce inventory and four additional outlet locations.
- Management attributed margin improvement primarily to distribution-center redesign benefits, lower delivery expense, occupancy leverage and improved core merchandise margins. Outlet promotions and discounts partially offset these gains.
- SG&A increased only 2.4% in the quarter and 2.1% year to date, causing SG&A leverage as a percentage of revenue. Management cited employment, corporate and marketing leverage, although Source Book circulation and pages increased advertising costs year to date.
- RH adopted the new lease accounting standard using a modified retrospective approach. At August 3, 2019, lease right-of-use assets totaled $1.07 billion and lease liabilities totaled $914.7 million.
- The $350.0 million 0.00% convertible notes due 2019 matured in June 2019 and were settled for $349.0 million in cash and 42 shares, producing a $1.0 million gain on extinguishment. Remaining convertible notes had $300.0 million principal due in 2020 and $335.0 million due in 2023.
- RH repurchased approximately 2.2 million shares for $250.0 million during the first quarter of fiscal 2019. No program repurchases occurred during the reported quarter; $450.0 million remained available under the repurchase authorization at August 3, 2019.
Outlook, Commentary, Risks and Unusual Items
- Management expected fiscal 2019 adjusted net capital expenditures of $160 million to $170 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 Gallery openings to increase from three to five annually to five to seven annually beginning in fiscal 2020, subject to site availability, permitting, construction and economic terms.
- RH stated that it expected to repay the $635 million of remaining convertible-note principal in cash at maturity to minimize dilution, using operating cash flow, excess cash and revolver borrowings. Management also acknowledged that additional liquidity or refinancing may be required.
- At August 3, 2019, the asset-based revolver had $145.0 million outstanding and borrowing-base availability of $254.6 million, net of $12.8 million of letters of credit. The $200.0 million second-lien term loan had no availability. RH reported compliance with applicable debt covenants.
- Material unusual items included asset impairments and accelerated depreciation, product-recall adjustments, legal-settlement items, debt extinguishment gains and prior-year reorganization costs. Adjusted EBITDA and adjusted net income are non-GAAP measures and should be reconciled to GAAP results.
- RH recorded a $50.2 million provision for a securities class-action settlement and a corresponding $50.2 million insurance recovery receivable. The settlement remained subject to final court approval, with a hearing scheduled for October 22, 2019.
- Key risks include tariffs and sourcing concentration, particularly exposure to China and other foreign manufacturing markets; potential margin pressure from tariff mitigation or price increases; high lease and debt obligations; variable-rate borrowings; execution of Gallery, hospitality, international and product-category initiatives; luxury housing and consumer-demand sensitivity; litigation; and supply-chain or product-quality disruptions.
- The company identified and revised certain immaterial prior-period errors involving stock retirement accounting, lease accounting and cash-flow classification. Management concluded that disclosure controls and procedures were effective and reported no material change in internal control over financial reporting.
Investor Verification Points
- Confirm that reported growth and margin expansion are sustainable after excluding outlet promotions, recall adjustments, legal settlements, asset charges and other unusual items.
- Assess liquidity available for the $300 million 2020 convertible-note maturity, planned capital expenditures and lease obligations, given only $11.6 million of cash at period-end.
- Review borrowing-base availability, fixed-charge and leverage covenants, floating-rate exposure and the terms of the second-lien and FILO facilities.
- Evaluate whether the planned $160 million to $170 million of adjusted capital expenditures and Gallery expansion can generate the expected returns and asset-sale proceeds.
- Monitor the $50.2 million securities settlement, insurance recovery and final court approval.
- Assess the financial effects of China tariffs, sourcing changes, potential price increases and any resulting demand or gross-margin impact.
- Review the effect of lease capitalization, significant long-term lease commitments and the company’s stockholders’ deficit on leverage and valuation.