RH Form 10-Q Summary
Reporting period: The filing covers the quarter and six months ended August 2, 2014, with comparisons to August 3, 2013. Although the request metadata identifies “2013 Q2,” the filing itself is for fiscal 2014 second quarter. RH is a luxury home furnishings retailer operating through stores, catalogs, and websites. As of August 2, 2014, it operated 68 retail stores and 17 outlet stores.
Financial Performance and Position
| Metric | Three months ended Aug. 2, 2014 | Three months ended Aug. 3, 2013 | Six months ended Aug. 2, 2014 | Six months ended Aug. 3, 2013 |
|---|---|---|---|---|
| Net revenues | $433.8 million | $382.1 million | $800.0 million | $683.4 million |
| Gross profit | $167.9 million | $139.2 million | $292.3 million | $241.1 million |
| Gross margin | 38.7% | 36.4% | 36.5% | 35.3% |
| Operating income (loss) | $48.9 million | $(27.8) million | $53.7 million | $(27.3) million |
| Net income (loss) | $27.3 million | $(17.8) million | $29.0 million | $(18.0) million |
| Diluted EPS | $0.66 | $(0.46) | $0.71 | $(0.47) |
- Second-quarter revenue increased 13.5%; six-month revenue increased 17.1%.
- Direct revenue increased 19.1% in the quarter and 21.4% year to date, representing 49% of total revenue in both periods.
- Comparable brand revenue growth was 13% for the quarter and 15% year to date, versus 30% and 34%, respectively, in the prior-year periods.
- Second-quarter operating margin was 11.3%; six-month operating margin was 6.7%.
- Adjusted net income, a non-GAAP measure, was $27.7 million for the quarter and $34.9 million year to date, compared with $19.8 million and $22.1 million, respectively, in the prior-year periods.
Liquidity, Cash Flow, and Capital Investment
- Cash and cash equivalents were $181.5 million at August 2, 2014, compared with $13.4 million at February 1, 2014.
- Six-month operating cash flow was negative $29.7 million, compared with positive $31.4 million in the prior-year period. The decline primarily reflected a $93.2 million inventory increase, largely in preparation for the fall collection and outdoor selling season, and a $22.4 million increase in prepaid expenses and other assets.
- Investing cash outflow was $39.1 million, including $38.8 million of capital expenditures.
- Fiscal 2014 capital expenditures were planned at approximately $115 million to $125 million; $38.8 million had been spent through August 2, 2014.
- Financing activities provided $236.9 million, primarily from the convertible notes financing.
Debt and Liquidity
- In June 2014, RH issued $350.0 million of 0.00% convertible senior notes due June 15, 2019. Net proceeds after note hedges, warrant proceeds, discounts, commissions, and offering costs were $311.7 million.
- The notes had a net carrying amount of $277.7 million on the balance sheet, while the principal amount was $350.0 million. The filing records non-cash interest expense from debt-discount amortization at an effective rate of 4.51%.
- RH used $154.8 million to repay the revolving line of credit. No revolver borrowings were outstanding at August 2, 2014, and undrawn availability was $380.9 million, subject to borrowing-base limitations. Outstanding letters of credit totaled $19.1 million.
- Total liabilities were $752.5 million and stockholders’ equity was $614.3 million at August 2, 2014.
- Contractual obligations totaled $1.481 billion, including $350.0 million of convertible notes, $596.3 million of operating leases, and $495.1 million of other long-term obligations.
Material Changes Versus the Prior Comparable Period
- Revenue growth moderated from the prior year, but RH moved from operating and net losses to profitability.
- Gross margin expanded by 230 basis points in the quarter and 120 basis points year to date, driven primarily by improved merchandise margins, shipping-cost improvements, and retail occupancy leverage.
- SG&A fell 28.8% in the quarter and 11.1% year to date. The prior-year periods included substantial non-cash executive compensation and follow-on offering costs; therefore, reported SG&A comparisons are not fully representative of recurring trends.
- The company recorded a $9.2 million legal charge during the six months ended August 2, 2014, related to a California class action concerning collection of customer ZIP codes in credit-card transactions.
- Inventory increased to $547.1 million from $453.8 million at fiscal year-end, contributing to negative operating cash flow.
- RH completed a $350.0 million convertible debt financing, repaid its revolver, and added approximately 3.0 million-share convertible note hedges and warrants with a $171.98 warrant strike price.
- Retail store count declined to 68 from 70 at the prior-year comparable period end, while total leased selling square footage increased to 564,000 square feet from 521,000 square feet.
Outlook, Risks, and Unusual Items
- Management stated that expected operating cash flow, convertible-note proceeds, and revolver availability should be sufficient for working-capital needs and planned capital expenditures for at least the next 12 to 24 months.
- Management identified planned fiscal 2014 capital expenditures of approximately $115 million to $125 million, focused on Full Line Design Galleries, stores, infrastructure, information technology, and supply-chain investments.
- Key operating risks include reliance on foreign vendors, limited or sole-source artisan and specialty suppliers, import and freight costs, inventory availability, seasonal working-capital requirements, and execution of the store-expansion strategy.
- The convertible notes introduce potential cash-settlement requirements, dilution from conversion or warrants, refinancing and liquidity risk, and exposure to stock-price volatility and hedge-counterparty credit risk.
- The notes are obligations of RH Holdings and are structurally subordinated to creditors of its operating subsidiaries. Transfers from subsidiaries to service the notes may be restricted by the operating subsidiary’s credit agreement.
- The company reported litigation reserves for current matters but stated that additional losses could exceed accrued amounts. The court awarded $9.2 million of attorney fees and costs on September 5, 2014, after the reporting date.
- There were no material off-balance-sheet arrangements, and management concluded that disclosure controls were effective as of August 2, 2014.
Investor Verification Points
- Verify the filing period: the source is for the quarter ended August 2, 2014, not 2013 Q2.
- Assess whether revenue growth and comparable brand growth can be sustained as the store base changes and growth rates moderate.
- Monitor inventory levels, inventory-related charges, working-capital conversion, and the return to positive operating cash flow.
- Reconcile reported earnings with adjusted net income, particularly the $9.2 million legal charge and the non-cash convertible-note discount amortization.
- Review the $350.0 million convertible notes, cash-settlement provisions, conversion price, warrant dilution threshold, and subsidiary-transfer restrictions.
- Track the California ZIP-code litigation and any additional costs beyond the amounts accrued.
- Evaluate execution and funding of the $115 million to $125 million fiscal 2014 capital-expenditure plan and the company’s long-term lease obligations.