RH Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended August 1, 2015, compared with August 2, 2014. The request metadata identifies “2014 Q2,” but the filing is for fiscal 2015 second quarter. Restoration Hardware Holdings, Inc. operated 67 retail stores and 15 outlet stores across the United States and Canada, selling luxury home furnishings through stores, catalogs, and websites.
Key Financial Metrics
| Metric | Q2 FY2015 | Q2 FY2014 | Six Months FY2015 | Six Months FY2014 |
|---|---|---|---|---|
| Net revenues | $506.9 million | $433.8 million | $929.4 million | $800.0 million |
| Gross profit | $194.3 million | $167.9 million | $337.7 million | $292.3 million |
| Gross margin | 38.3% | 38.7% | 36.3% | 36.5% |
| Income from operations | $56.4 million | $48.9 million | $73.5 million | $53.7 million |
| Operating margin | 11.1% | 11.3% | 7.9% | 6.7% |
| Net income | $29.9 million | $27.3 million | $37.1 million | $29.0 million |
| Diluted EPS | $0.71 | $0.66 | $0.88 | $0.71 |
| Net cash from operating activities | — | — | $13.6 million | $(29.7) million |
Q2 revenue increased 16.9% year over year, while six-month revenue increased 16.2%. Comparable brand revenue growth was 16% in the quarter and 15% year to date. Store revenue grew 20.9% in Q2 and 17.3% year to date; direct revenue grew 12.6% and 14.9%, respectively.
Reported Q2 net margin was approximately 5.9%, compared with 6.3% in the prior-year quarter. Year-to-date net margin improved to approximately 4.0% from 3.6%. The effective tax rate was 38.93% for Q2 and 38.59% year to date.
Cash Flow, Liquidity, and Capital Structure
- Cash and cash equivalents were $304.9 million at August 1, 2015, compared with $148.9 million at January 31, 2015. Short-term investments were $149.7 million, bringing cash and short-term investments to approximately $454.6 million.
- Operating cash flow was $13.6 million year to date, despite a $148.3 million increase in merchandise inventories.
- Investing cash outflow was $125.9 million, including $56.1 million of capital expenditures, $9.9 million for building and land, and $104.6 million of investment purchases, partly offset by $35.0 million of investment maturities.
- Financing cash inflow was $268.3 million, primarily reflecting the 2020 convertible notes offering.
- Gross capital expenditures were $56.1 million year to date. 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.
- The company had no borrowings under its revolving credit facility, $516.9 million of undrawn availability, and $13.2 million of outstanding letters of credit at August 1, 2015. It was in compliance with applicable covenants.
- Debt included $350 million principal amount of 0.00% convertible notes due 2019 and $300 million principal amount of 0.00% convertible notes due 2020. Net carrying values were $294.0 million and $217.7 million, respectively, after debt discounts.
Material Changes Versus the Prior Comparable Period
- The company issued $300 million of 0.00% convertible senior notes due 2020 in June and July 2015. Net proceeds after bond hedges, warrant proceeds, discounts, and offering costs were approximately $256.0 million.
- Interest expense increased to $7.4 million in Q2 from $4.3 million and to $13.1 million year to date from $6.4 million, primarily because of non-cash amortization of convertible debt discounts and additional financing-related obligations.
- Gross margin declined 40 basis points in Q2 and 20 basis points year to date. Excluding the effect of legal-claim coupons, management stated that gross margin would have improved by approximately 60 basis points in Q2 and 50 basis points year to date.
- Operating margin improved year to date because SG&A declined as a percentage of revenue, although Q2 operating margin decreased modestly.
- Inventory increased substantially in preparation for the 2015 Outdoor and Spring collections and the planned second-half product launches.
- Adjusted net income was $36.0 million in Q2 and $45.9 million year to date, compared with $27.7 million and $34.9 million, respectively, in the prior comparable periods. Adjusted results exclude legal-claim effects, convertible debt discount amortization, and related tax impacts.
Outlook, Commentary, Risks, and Unusual Items
Management continued to emphasize transforming the real estate platform toward larger-format, next-generation galleries; expanding merchandise, services, and market share; improving operating margins through occupancy, advertising, product-margin, shipping, and SG&A leverage; and pursuing selective international expansion. More than half of planned 2015 new product introductions were expected in the second half of the year, primarily through RH Modern and RH Teen.
Management stated that revenue growth and other performance metrics would remain variable because of numerous concurrent business initiatives and the timing of product introductions. It expected cash from operations, note proceeds, and revolving-credit availability to fund working capital and anticipated capital expenditures for at least the next 12 to 24 months.
- A California class-action matter relating to collection of customer ZIP codes resulted in approximately $8 million of accrued charges after adjustments. Q2 gross profit and SG&A included approximately $4.8 million and $0.6 million, respectively, related to coupon redemptions. The company expected margin effects to continue until coupon expiration in March 2016.
- Convertible notes, bond hedges, and warrants may create future cash obligations, dilution, or warrant-related dilution if the stock price exceeds the applicable warrant strike prices. The 2019 and 2020 warrant strike prices were approximately $171.98 and $189.00 per share.
- The notes may require cash settlement upon conversion or a fundamental change, potentially reducing liquidity. The notes are also structurally subordinated to obligations of subsidiaries, and the 2020 notes’ guarantee is subordinated to the operating subsidiary’s credit facility.
- Key operating risks include inventory and working-capital volatility, execution of the real estate transformation, product-launch timing, shipping costs, litigation, employment and consumer claims, product liability, international expansion, and potential volatility from convertible-note hedging and arbitrage activity.
- The company reported no material off-balance-sheet arrangements and no impairment charges during the periods presented. Disclosure controls were deemed effective; new accounting systems were implemented during the first six months of fiscal 2015.
Important Facts for Investors to Verify
- Confirm the applicable period: the filing covers Q2 fiscal 2015, not Q2 fiscal 2014.
- Assess whether inventory growth and planned second-half product launches translate into sales without increased markdowns or margin pressure.
- Track the continuing impact and ultimate resolution of the ZIP-code class-action coupons through March 2016.
- Evaluate liquidity against $350 million of 2019 notes, $300 million of 2020 notes, substantial lease obligations, and planned capital expenditures.
- Review the potential dilution and cash-settlement exposure from the convertible notes and related warrants.
- Compare reported GAAP results with management’s adjusted net income and understand the recurring versus non-recurring nature of each adjustment.