RH Form 10-Q Summary
Reporting period: Quarter and nine months ended October 28, 2017, compared with October 29, 2016. The provided request metadata labels the period “2016 Q3,” but the filing is for fiscal 2017 third quarter. RH is a luxury home furnishings retailer operating through Galleries, outlet stores, catalogs, websites and Waterworks showrooms. At period-end, RH operated 84 retail Galleries, 31 outlet stores and 15 Waterworks showrooms.
Financial performance and liquidity
| Metric | Three months ended Oct. 28, 2017 | Three months ended Oct. 29, 2016 | Nine months ended Oct. 28, 2017 | Nine months ended Oct. 29, 2016 |
|---|---|---|---|---|
| Net revenues | $592.5 million | $549.3 million | $1,769.9 million | $1,548.2 million |
| Gross profit | $214.3 million | $175.8 million | $590.4 million | $483.1 million |
| Gross margin | 36.2% | 32.0% | 33.4% | 31.2% |
| Income from operations | $43.2 million | $15.4 million | $62.2 million | $25.9 million |
| Operating margin | 7.3% | 2.8% | 3.5% | 1.7% |
| Net income (loss) | $13.2 million | $2.5 million | $1.9 million | $(4.0) million |
| Diluted earnings (loss) per share | $0.56 | $0.06 | $0.06 | $(0.10) |
- Third-quarter revenue increased 7.9%; nine-month revenue increased 14.3%. Comparable brand revenue growth was 6% for the quarter and 7% year to date.
- Stores revenue rose 11.9% in the quarter and 15.8% year to date; direct revenue rose 2.8% and 12.5%, respectively.
- Adjusted net income, a non-GAAP measure, was $24.4 million for the quarter and $45.9 million year to date, versus $8.0 million and $23.9 million in the comparable periods.
- Net cash provided by operating activities was $386.8 million year to date, compared with $19.0 million of cash used in the prior-year period. The improvement was primarily driven by a $190.6 million inventory reduction and other working-capital changes.
- Capital expenditures were $76.8 million year to date, with construction-related deposits of $12.8 million. Management expected fiscal 2017 gross capital expenditures of approximately $120 million to $130 million.
- Cash and cash equivalents were $22.2 million at October 28, 2017, down from $87.0 million at January 28, 2017. RH held no short- or long-term investments at period-end.
- Debt included $341.0 million outstanding under the asset-based revolving facility, an $80.0 million LILO term loan, $323.8 million carrying value of 2019 convertible notes, and $248.6 million carrying value of 2020 convertible notes. Total principal amount of convertible notes was $650 million.
- The revolving facility had stated availability of $189.0 million net of letters of credit, but the fixed-charge coverage restriction reduced actual incremental borrowing availability to approximately $125.2 million. RH was in compliance with applicable covenants.
Material changes versus the prior comparable period
- Gross margin expanded 420 basis points in the quarter and 220 basis points year to date, reflecting improved merchandise margins, lower shipping costs and occupancy leverage. Higher outlet and warehouse sales and promotional activity partially offset the improvement.
- Operating margin improved substantially despite higher interest expense. Interest expense increased to $18.9 million in the quarter and $45.5 million year to date, from $11.1 million and $32.5 million, respectively.
- RH repurchased approximately $1.0 billion of common stock during the first nine months: approximately 7.8 million shares for $300 million and 12.4 million shares for $700 million. These programs were completed, and stockholders’ equity was $(25.3) million at period-end versus $919.9 million at fiscal year-end.
- Weighted-average basic shares declined to 21.2 million in the quarter and 29.1 million year to date, compared with 40.7 million and 40.7 million, respectively, primarily because of the repurchases.
- Waterworks revenue increased to $29.3 million in the quarter and $89.4 million year to date. Year-to-date comparability is affected because the prior-year period included only 22 weeks of Waterworks results versus 39 weeks in 2017.
- Management’s membership model had approximately 380,000 members, who generated approximately 95% of core RH sales in the quarter.
Outlook, unusual items and risks
- Management planned to consolidate furniture distribution centers from four locations to two by the end of fiscal 2017 and expected related near-term closure costs. Third-quarter closure costs were $1.9 million; an additional $0.5 million to $1.0 million was estimated for the Mira Loma closure, while the Dallas closure charge was not yet estimable.
- RH expects to reduce its new Gallery opening cadence to three to five locations annually and expected to open at least three Design Galleries in fiscal 2018. Management emphasized real-estate transformation, merchandise expansion, customer experience, margin improvement and capital discipline.
- Third-quarter results included a $3.6 million product-recall charge, $1.9 million of distribution-center closure costs, a $4.9 million loss on extinguishment of debt, and a $0.8 million gain on the sale of building and land. Year-to-date results also included a $23.9 million non-cash executive stock-compensation charge.
- The $100 million second-lien term loan was repaid on October 10, 2017, generating the $4.9 million debt-extinguishment loss.
- RH stated that operating cash flow, borrowing availability and other financing sources were expected to meet needs for the next 12 months. However, management noted that additional liquidity may be required to repay or refinance the $350 million 2019 notes and $300 million 2020 notes at maturity.
- Key risks include substantial leverage and variable-rate debt, refinancing and liquidity requirements, distribution-center closures, execution of the Gallery and supply-chain strategies, product recalls, litigation, consumer demand, inventory markdowns and the ability to sustain improved margins.
- A consolidated securities class action concerning alleged misstatements about the RH Modern rollout remained at an early stage. The filing states that potential losses could not be estimated, although management believed the claims lacked merit.
- RH adopted new stock-based compensation guidance in fiscal 2017 and planned to adopt the new revenue recognition standard in the first quarter of fiscal 2018 using a modified retrospective approach. The filing states that gift-card breakage presentation will change, but the full impact was not yet determined.
Important facts for investors to verify
- Confirm that revenue growth and margin expansion persist after adjusting for outlet and warehouse inventory-clearing activity, product recalls, source-book timing and other unusual items.
- Assess liquidity relative to $650 million of convertible-note principal due in 2019 and 2020, including refinancing or cash-repayment capacity.
- Review borrowing-base availability, fixed-charge coverage restrictions, covenant compliance and exposure to variable interest rates.
- Evaluate the sustainability of operating cash flow, particularly the extent to which the $386.8 million year-to-date inflow resulted from one-time inventory reductions and working-capital releases.
- Monitor distribution-center closure costs, lease-loss exposure and the operational effects of reducing the network from four locations to two.
- Separate GAAP earnings from management’s adjusted net income, including the effects of debt-discount amortization, stock compensation, recalls, debt extinguishment and other excluded items.
- Review the status and potential financial impact of the RH Modern securities litigation, product recalls and other ordinary-course claims.