RH Form 10-Q Summary
Reporting period: The supplied filing is for the quarter ended August 1, 2020, RH’s fiscal second quarter of fiscal 2020, with comparisons to August 3, 2019. This differs from the request metadata identifying “2019 Q2.” The filing is unaudited and was filed September 10, 2020.
Business context
RH is a luxury home furnishings retailer offering furniture, lighting, textiles, bathware, decor, outdoor and garden products, and child and teen furnishings through Galleries, outlets, catalogs, websites and commercial channels. As of August 1, 2020, RH operated 68 Galleries, 38 outlets and 15 Waterworks showrooms.
COVID-19 temporarily closed all retail locations beginning March 17, 2020. By August 1, 2020, 66 of 68 Galleries, all outlets and 8 of 10 restaurants had reopened. Management reported strong customer demand but continued supply-chain disruption and delays converting orders into shipped revenue.
Financial performance
| Metric | Three months ended August 1, 2020 | Three months ended August 3, 2019 | Six months ended August 1, 2020 | Six months ended August 3, 2019 |
|---|---|---|---|---|
| Net revenues | $709.3 million | $706.5 million | $1,192.2 million | $1,304.9 million |
| Gross profit | $332.4 million | $295.0 million | $532.1 million | $527.8 million |
| Gross margin | 46.9% | 41.7% | 44.6% | 40.4% |
| Income from operations | $136.6 million | $104.0 million | $172.0 million | $172.6 million |
| Operating margin | 19.3% | 14.7% | 14.4% | 13.2% |
| Net income | $98.4 million | $63.8 million | $95.2 million | $99.5 million |
| Diluted EPS | $3.71 | $2.86 | $3.75 | $4.21 |
| Adjusted EBITDA | $185.8 million | $133.7 million | $263.2 million | $234.1 million |
- Second-quarter revenue increased 0.4%, while six-month revenue declined 8.6%, primarily because first-quarter store and outlet closures affected the year-to-date comparison.
- Second-quarter gross profit increased 12.7%, and gross margin expanded 520 basis points. Management attributed the improvement to higher product margins, price increases, lower outlet promotional activity and occupancy and shipping leverage.
- Six-month gross profit increased 0.8% despite lower revenue, reflecting a 420-basis-point gross-margin expansion.
- Second-quarter net income increased 54.4%; six-month net income declined 4.3%.
- Waterworks revenue declined 18.4% in the quarter and 19.0% year to date, primarily from construction delays and COVID-19-related showroom closures.
- Furniture revenue was $488.3 million in the quarter, essentially flat year over year, while non-furniture revenue was $221.0 million, also essentially flat.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $128.3 million, compared with $97.1 million in the prior-year period.
- Investing cash flow was an outflow of $25.6 million, including $47.5 million of capital expenditures and $25.0 million of proceeds from asset sales.
- Financing cash flow was an outflow of $133.0 million, including cash payments related to the maturity and settlement of the 2020 convertible notes, partially offset by $91.6 million of net borrowings under the asset-based credit facility.
- Cash and cash equivalents declined to $17.4 million at August 1, 2020, from $47.7 million at February 1, 2020.
- Merchandise inventories increased to $487.6 million from $438.7 million, reflecting supply-chain timing and inventory buildup.
- Total liabilities were $2.378 billion and stockholders’ equity was $128.5 million at August 1, 2020, compared with $2.427 billion and $18.7 million, respectively, at February 1, 2020.
- Outstanding debt included $335.0 million principal amount of 0.00% convertible notes due 2023, $350.0 million principal amount of 0.00% convertible notes due 2024, $91.6 million under the asset-based credit facility and $48.5 million of equipment notes.
- The $300.0 million 0.00% convertible notes due 2020 matured in July 2020. RH paid $290.6 million in cash for the remaining notes and delivered 1.1 million shares, offset by shares received under its bond hedge; the company received a net 17 shares into treasury stock.
- The asset-based credit facility had $259.2 million of borrowing-base availability, net of $14.5 million of letters of credit, at August 1, 2020. RH was in compliance with applicable financial covenants.
- Management stated that operating cash flow and available financing are expected to be sufficient for more than the next 12 months, while acknowledging that future cash needs could require additional financing.
Material changes versus the prior comparable period
- COVID-19 caused a significant first-half revenue decline, but second-quarter demand recovered as stores reopened. Revenue continued to lag customer-order growth because of manufacturing, inventory and transportation constraints.
- RH’s gross and operating margins improved materially despite pandemic-related disruptions.
- Interest expense declined by $5.1 million in the quarter and $6.6 million year to date, primarily because prior-year term-loan interest was no longer incurred and asset-based facility interest was lower.
- RH recorded a $20.5 million non-cash Waterworks tradename impairment in the first quarter of fiscal 2020.
- Other unusual items included a $9.4 million loss on the Minneapolis Gallery sale-leaseback, $7.0 million of year-to-date reorganization costs, $4.8 million of product-recall accruals and $4.8 million of asset impairments and related items.
- RH completed a $25.5 million sale-leaseback of the Minneapolis Design Gallery in July 2020 and recognized a $9.4 million loss.
- No share repurchases were made under the public repurchase program during the six months ended August 1, 2020; $450 million remained authorized. Employee-related share withholding repurchases totaled 26,802 shares during the quarter.
Guidance, outlook, risks and contingencies
- Management expects customer demand delayed by supply-chain constraints to convert into revenue over the next several quarters as manufacturing and inventory receipts normalize.
- Management projected fiscal 2020 adjusted capital expenditures, net of asset sales, of $125 million to $150 million; adjusted capital expenditures were $70.5 million in the first six months.
- RH expects to repay the $685 million principal amount of its 2023 and 2024 convertible notes in cash at maturity to minimize dilution, but may require excess cash flow, credit-facility borrowings or additional financing.
- Key risks include additional COVID-19 outbreaks, renewed store or restaurant restrictions, supply-chain disruption, changes in consumer behavior, economic and housing-market weakness, liquidity and refinancing risk, construction delays, international expansion risk, tariffs, interest-rate exposure and potential LIBOR replacement effects.
- Lease liabilities totaled $976.1 million, including $506.3 million of finance-lease liabilities and $469.9 million of operating-lease liabilities. The filing also disclosed $660.4 million of legally binding payments for signed but not yet commenced leases, subject in part to government approvals.
- The securities class-action settlement was funded entirely by insurance and was finally approved in October 2019. A shareholder derivative settlement received preliminary court approval in August 2020; the final hearing was scheduled for October 6, 2020, with expected attorney-fee funding by insurance carriers.
- On August 28, 2020, RH completed the acquisition of a home furnishings brand for a preliminary purchase price of $20 million. The initial purchase accounting was incomplete as of the filing date.
- Management concluded that disclosure controls and procedures were effective as of August 1, 2020, with no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether supply-chain constraints and order backlogs convert into revenue without materially increasing cancellations, delivery costs or inventory reserves.
- The sustainability of the second-quarter gross-margin expansion after product recalls, lower promotions and temporary COVID-19 cost effects normalize.
- Cash generation, borrowing-base availability and covenant compliance as RH funds capital expenditures and prepares for the 2023 and 2024 convertible-note maturities.
- The pace and returns of new Galleries, hospitality projects, international expansion and real-estate joint ventures.
- The financial impact of the Waterworks impairment, ongoing product-recall obligations, sale-leaseback arrangements and the subsequent acquisition.
- Potential dilution from the 2023 and 2024 convertible notes and related warrants, particularly above conversion and warrant strike prices.