RH Form 10-Q Summary
Reporting period: The filing covers the three and nine months ended October 31, 2015, with comparison periods ended November 1, 2014. The request metadata identifies “2014 Q3,” but the filing is clearly for fiscal 2015 third quarter. RH is a luxury home furnishings retailer selling through 68 retail stores, 17 outlet stores, catalogs and websites across the United States and Canada.
Financial Performance and Position
| Metric | Three months ended Oct. 31, 2015 | Year-over-year change | Nine months ended Oct. 31, 2015 | Year-over-year change |
|---|---|---|---|---|
| Net revenues | $532.4 million | +9.8% | $1.462 billion | +13.8% |
| Gross profit | $190.8 million | +5.8% | $528.4 million | +11.8% |
| Gross margin | 35.8% | Down from 37.2% | 36.1% | Down from 36.8% |
| Income from operations | $44.9 million | +22.3% | $118.3 million | +30.9% |
| Operating margin | 8.4% | Up from 7.6% | 8.1% | Up from 7.0% |
| Net income | $20.7 million | +6.6% | $57.8 million | +19.2% |
| Diluted EPS | $0.49 | Up from $0.47 | $1.37 | Up from $1.18 |
Stores revenue increased 15.7% in the quarter and 16.7% for the nine-month period; direct revenue increased 4.0% and 10.7%, respectively. Comparable brand revenue growth was 7% for the quarter and 12% year to date. Furniture represented $332.1 million of quarterly revenue and $924.7 million year to date.
Cash and cash equivalents were $227.0 million at October 31, 2015, compared with $148.9 million at January 31, 2015. Short-term and long-term investments totaled $162.7 million, bringing cash and investments to approximately $389.7 million. Merchandise inventory increased to $760.9 million from $559.3 million, reflecting new collections and distribution-center requirements.
Net cash used in operating activities was $17.6 million for the first nine months, compared with $22.8 million used in the prior-year period. Inventory consumed $201.7 million of cash. Investing cash outflow was $182.8 million, including $90.8 million of capital expenditures, $8.9 million of construction deposits and $156.1 million of investment purchases, partly offset by $73.1 million of investment maturities. Financing activities provided $278.5 million.
Debt, Liquidity and Capital Structure
- RH issued $300 million of 0.00% convertible senior notes due 2020, generating net proceeds of approximately $256.0 million after note hedges, warrant proceeds, discounts and offering costs.
- Carrying value of the 2019 convertible notes was $297.3 million and carrying value of the 2020 notes was $221.3 million at October 31, 2015. Principal amounts were $350 million and $300 million, respectively.
- The company had no borrowings outstanding under its revolving credit facility and reported $586.6 million of undrawn availability, subject to borrowing-base limitations. Outstanding letters of credit totaled $13.4 million.
- Total liabilities were $1.220 billion and stockholders’ equity was $839.3 million at October 31, 2015. Financing obligations under build-to-suit leases were $206.2 million.
Material Changes and Unusual Items
- Gross margin declined because of approximately $4.8 million of quarterly and $11.0 million of year-to-date impact from coupons associated with the California ZIP-code class action. RH expects coupon redemptions to affect gross margins through expiration in March 2016 and until related merchandise is delivered.
- Excluding the legal-claim coupon impact, quarterly gross margin still declined approximately 0.5 percentage points, primarily because of non-comparable warehouse sales, higher shipping and transportation costs, and occupancy deleverage from a new distribution center.
- Interest expense increased to $11.0 million in the quarter and $24.1 million year to date, primarily because of non-cash amortization of convertible-note discounts and higher build-to-suit lease-related costs.
- Adjusted net income, a non-GAAP measure, was $27.7 million for the quarter and $73.6 million year to date, compared with $20.3 million and $55.1 million, respectively. Adjustments included legal-claim costs and convertible-debt discount amortization.
- RH purchased an aircraft for $9.5 million in February 2015 and entered into a time-sharing arrangement governing the CEO’s personal use.
Outlook, Commentary and Risks
Management is pursuing larger-format next-generation Design Galleries, broader merchandise categories, expanded service offerings, international expansion, and margin improvement through occupancy leverage, advertising leverage, product-margin improvements and shipping efficiencies. RH stated that more than half of its 2015 product introductions occurred in the second half of the year, primarily through RH Modern and RH Teen, creating potential period-to-period variability.
Management expected fiscal 2015 gross capital expenditures of approximately $140 million to $160 million, partly offset by approximately $10 million of landlord contributions and other capital inflows. Management believed available cash, operating cash flow, convertible-note proceeds and revolving-credit availability would meet working-capital and capital-expenditure needs for at least the next 12 to 24 months.
Key risks include inventory and working-capital requirements, execution of the real-estate transformation, product-launch timing, margin pressure from shipping and occupancy costs, possible dilution from convertible notes and warrants, litigation and coupon redemptions, lease and build-to-suit obligations, and the variability of revenue growth. The company reported no material off-balance-sheet arrangements and no material changes to previously disclosed risk factors.
Investor Verification Checklist
- Verify the request-period mismatch: the filing is for the quarter ended October 31, 2015, not 2014.
- Reconcile reported GAAP earnings with adjusted net income and assess the recurring versus non-recurring nature of legal-claim and debt-discount adjustments.
- Monitor inventory growth, operating cash usage and the effect of RH Modern and RH Teen product introductions on future sales and working capital.
- Review the $700 million principal amount of convertible notes, conversion thresholds, warrant strike prices and potential future dilution or cash settlement requirements.
- Assess execution and funding requirements for planned capital expenditures, new galleries, distribution infrastructure and build-to-suit lease commitments.
- Track the remaining exposure from the California class action, including coupon redemption through March 2016 and any potential losses beyond recorded reserves.