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RH Reports Record Second Quarter Fiscal 2019 Results

CORTE MADERA, Calif.--(BUSINESS WIRE)--

Company Raises Fiscal 2019 Guidance for the Third Time this Year

RH (RH) today announced second quarter fiscal 2019 results. Chairman & Chief Executive Officer Gary Friedman provided an update on the Company’s continued evolution and outlook. RH Leadership will host a Q&A conference call at 2:00 p.m. PT (5:00 p.m. ET) today.

SECOND QUARTER 2019 HIGHLIGHTS

Q2 GAAP NET REVENUES INCREASED +10.3% TO $706.5M
Q2 ADJUSTED NET REVENUES INCREASED +9.9% TO $706.5M

Q2 GAAP OPERATING INCOME INCREASED +27% TO $104.0M VS. $81.8M LY
Q2 ADJUSTED OPERATING INCOME INCREASED +39% TO $105.0M VS. $75.5M LY

Q2 GAAP OPERATING MARGIN INCREASED 190 BASIS POINTS TO 14.7% VS. 12.8% LY
Q2 ADJUSTED OPERATING MARGIN INCREASED 320 BASIS POINTS TO 14.9% VS. 11.7% LY

Q2 GAAP NET INCOME INCREASED +1% TO $63.8M VS. $62.9M LY
Q2 ADJUSTED NET INCOME INCREASED +31% TO $71.4M* VS. $54.5M* LY

Q2 GAAP EPS INCREASED +25% TO $2.86 VS. $2.29 LY
Q2 ADJUSTED DILUTED EPS INCREASED +59% TO $3.20* VS. $2.01* LY

Q2 FREE CASH FLOW INCREASED TO $109.2M VS. $25.2M LY
YTD Q2 FREE CASH FLOW INCREASED TO $137.9M VS. $2.5M LY

*The Company’s adjusted net income and adjusted diluted EPS benefited by $4.5M and $0.20, respectively, in the second quarter due to a change of the normalized tax rate to 21% versus the previous estimate of 26%, and the Company now expects the effective tax rate for fiscal 2019 to be 21%. The Company has normalized all periods presented using a tax rate of 21% to support comparability of growth for purposes of presenting non-GAAP adjusted earnings in order to facilitate year over year comparison of operating results on a comparable basis with historical results at a consistent tax rate across time periods. The Company has also provided reconciliation tables that update historical results to reflect these changes.

As of February 3, 2019, the Company adopted Accounting Standards Update 2016-02, Accounting Standards Update 2018-10 and Accounting Standards Update 2018-11 (together, “ASC 842”), which pertain to accounting for leases. The Company’s previous and current guidance conforms to the new policy. Under the Company’s adoption method, the Company’s financial results for prior comparative periods are presented with adjustments to reflect the impact of ASC 842. The Company has provided reconciliation tables that update historical results to reflect these changes in lease accounting standards.

Please see the tables below for reconciliations of all GAAP to non-GAAP measures referenced in this press release.

To Our People, Partners, and Shareholders,

We are pleased to report another quarter of record results, and are raising our fiscal 2019 guidance for the third time this year. We generated record GAAP revenues of $706.5 million, an increase of 10.3%, record GAAP operating margin of 14.7%, record adjusted operating margin of 14.9%, record GAAP earnings per share of $2.86, and record adjusted diluted earnings per share of $3.20, a 59% increase versus $2.01 a year ago applying a 21% normalized tax rate in both years.

We are raising our fiscal 2019 guidance for the year as follows:

Prior Guidance

Updated Guidance

Adjusted net revenues

$2,658.0 - $2,674.0

$2,680.3 - $2,694.3
Adjusted operating income*

$342.0 - $358.0

$365.5 - $372.3
Adjusted operating margin*

12.9% - 13.4%

13.6% - 13.8%
Adjusted net income*

$213.3 - $223.8

$246.9 - $252.3
Adjusted diluted EPS

$9.08 - $9.52

$10.53 - $10.76

* The prior guidance for this financial measure is implied by the Company’s July 29, 2019 upward revision to adjusted earnings guidance. The last actual guidance issued for this financial measure was on June 12, 2019 in connection with the Company’s first quarter earnings release, when the Company provided fiscal 2019 adjusted operating income guidance of $332.5 million to $350.5 million, adjusted operating margin guidance of 12.6% to 13.2%, and adjusted net income guidance of $206.2 million to $218.2 million.

Our focus on elevating the brand, architecting an integrated operating platform, and pivoting the Company back to growth has resulted in RH standing out as one of the few brands that is growing revenues, expanding operating margins, and driving significantly higher returns on invested capital and free cash flow. Despite achieving industry leading operating margins, we continue to demonstrate our ability to grow earnings significantly faster than revenues, illustrating the desirability of our differentiated product offering, and the emergence of RH as a luxury brand generating luxury margins.

Second quarter adjusted net revenues increased 9.9% over last year reflecting the strength of our core RH business, the performance of our new galleries, particularly RH New York, the continued expansion of RH Hospitality and planned accelerated outlet sales due to the previously mentioned closure of a 500,000 square foot distribution facility in the fourth quarter of fiscal 2018. Additionally, we experienced better than expected delivered sales in the last few weeks of the quarter as a result of shipping efficiencies and lower returns due to the recent redesign of our home delivery network.

As a reminder, embedded in our 2019 guidance there is an approximate 3 point revenue reduction as a result of editing unprofitable and non-strategic businesses, namely the elimination of the remaining holiday business (1 point), the elimination of fringe promotions (1 point), and the transition of our rug business from a single source importer to a direct sourcing model (1 point). As planned, the drag was approximately 2 points in the first quarter, 4 points in the second quarter and we expect approximately 2 points in the third quarter and 4 points in the fourth quarter. Taking into account the approximate 4 point negative drag, adjusted net revenues would have increased 13.9% in the second quarter. We expect our new rug collection to contribute to both revenue and earnings growth in fiscal 2020.

Despite the increase in tariffs and some negative macro trends, we remain optimistic that our business momentum will continue, supported by a number of positive factors including by the recent mailing of the Fall Interiors and soon to be in-home Modern Source Books, the increasing contribution from RH Beach House, the launch of RH Ski House and new Galleries opening this fall.

Our largest and most important new Gallery, RH New York, continues to trend comfortably in excess of $100 million in annualized revenue for fiscal 2019 and will generate more than $30 million of cash contribution in its first full fiscal year. We are on track to open RH Minneapolis, the Gallery in Edina, RH Columbus, the Gallery at Easton Town Center, and RH Marin, the Gallery at the Village of Corte Madera, in the second half. These new prototype Galleries average 45,000 square feet of indoor and outdoor selling space spanning three levels with rooftop parks, restaurants, barista bars and consumer facing RH Interior Design offices, and will enable us to place our disruptive product assortment and immersive retail experience into the market at a fraction of our former investment. Looking forward, we expect to accelerate our real estate transformation to a rate of 5 to 7 new Galleries in Fiscal 2020 and 7 or more new Galleries in Fiscal 2021.

Regarding trade with China, we do not expect the current tariffs to impair our ability to achieve stated financial goals and the impact from the increased tariffs is embedded in our guidance for the year. We continue to receive pricing accommodations from vendors and have implemented price increases where necessary with little to no impact to our business.

As it relates to our balance sheet, we ended the second quarter with inventory of $481 million versus $551 million last year, down $70 million, or 13% versus a 10% revenue increase. Due to the efficiency of our supply chain network redesign and the simplification of our reverse logistics and outlet model we expect to end the year with inventories down $80 to $90 million versus 2018. We are now projecting to generate free cash flow in the range of $325 to $350 million and expect total net debt to trailing twelve month adjusted EBITDA of approximately 1.8x to 1.9x at year end.

While we remain comfortable with our balance sheet, the current market conditions for convertible debt are attractive. As previously communicated, we will continue to be opportunistic as it relates to the capital markets. If there is an opportunity to issue convertible debt at acceptable terms, it could enable us to lower interest expense and increase adjusted diluted EPS by as much as $0.20 to $0.25 this year, and $0.65 to $0.70 next year, creating shareholder value and providing increased optionality for RH.

We believe our Company remains undervalued and will continue to evaluate share repurchases. Thus far in 2019, we have acquired 2.2 million shares at an average price of $115.36. Inclusive of our share repurchases in 2017 and 2018, we have repurchased 24.4 million shares at an average price of $61.40 per share, or approximately 60% of the total shares previously outstanding. We believe the repurchase of our shares will prove to be an outstanding allocation of capital for the benefit of our long term shareholders.

Looking forward, we continue to see a clear path to $4 to $5 billion in North America revenues, with mid-to-high teens operating margins and ROIC in excess of 50%. Additionally, we now believe there is an opportunity to more than double those revenues as we begin to expand globally, and move the brand beyond creating and selling products to conceptualizing and selling spaces.

Our long term targets remain:

Net revenue growth of 8% to 12%
Adjusted operating margins in the mid to high teens
Adjusted net income growth of 15% to 20% annually
Return on invested capital (ROIC) in excess of 50%

We do understand the strategies we are pursuing – opening the largest specialty retail experiences in our industry while most are shrinking the size of their retail footprint or closing stores; moving from a promotional to a membership model, while others are increasing promotions, positioning their brands around price versus product; continuing to mail inspiring Source Books, while many are eliminating catalogs; and refusing to follow the herd in self-promotion on social media, instead allowing our brand to be defined by the taste, design, and quality of the products and experiences we are creating – are all in direct conflict with conventional wisdom and the plans being pursued by many in our industry.

Ironically, I was reading an article in Forbes this morning with the headline “RH, (A.K.A. Restoration Hardware) Fails When It Comes To Digital.” The writer, Pamela Danziger, points to the Digital IQ Index published by Gartner L2, a consulting group who ranks the digital IQ of 103 specialty retailers with only Charlotte Russe keeping RH off the bottom of the ranking. She pointed out that Gartner L2’s principal specialty retail research analyst Supriya Jain mentioned, “For at least the last three years, RH has ranked in our (feeble) class in specialty retail”, and goes on to point out that every other directly competitive brand ranks higher, with Pier 1 ranking in the highest (gifted) class. I like to advise our team that it is dangerous to run your business or live your life based on other people’s thinking, especially ones who tend to be sideline critics and have no experience building a business like ours. I’m sure if Pamela, Supriya, and Gartner L2 did a Retail IQ Index that looked at earnings growth and shareholder value creation over the past three years across all channels, they would find RH’s placement in the hierarchy quite different. Or better yet, since 85% of retail sales are still done in stores, maybe a Retail Store IQ Index, ranking retailers on store performance or the metrics important to customers would be interesting, and most likely find us somewhere near the very top. Nonetheless, somehow “feebly” we generate over a billion dollars in our digital channel, which also ranks above all the competitive brands mentioned in the article. We like to say on Team RH that “Leaders have to be comfortable making others uncomfortable.” It’s what leaders do, and when you know you’re on the right path, even when it makes others uncomfortable, or when they call you feeble.

We believe when you step back and consider: one, we are building a brand with no peer; two, we are creating a customer experience that cannot be replicated online; and three, we have total control of our brand from concept to customer, you realize what we are building is extremely rare in today’s retail landscape and, we would argue, will also prove to be equally valuable.

We would like to thank all of our people and partners whose passion and persistence bring our vision and values to life each and every day, as we pursue our quest to become one of the most admired brands in the world.

Carpe Diem,

Gary

Note: We define return on invested capital (ROIC) as adjusted operating income after-tax for the most recent twelve-month period, divided by the average of beginning and ending debt and equity less cash and equivalents as well as short and long-term investments for the most recent twelve- month period. ROIC is not a measure of financial performance under GAAP, and should be considered in addition to, and not as a substitute for other financial measures prepared in accordance with GAAP. Our method of determining ROIC may differ from other companies’ methods and therefore may not be comparable.

Q&A CONFERENCE CALL INFORMATION

Accompanying this release, RH leadership will host a live question and answer conference call at 2:00 p.m. PT (5:00 p.m. ET). Interested parties may access the call by dialing (866) 394-6658 (United States/ Canada) or (706) 679-9188 (International). A live broadcast of the question and answer session conference call will also be available online at the Company’s investor relations website, ir.rh.com. A replay of the question and answer session conference call will be available through September 24, 2019 by dialing (855) 859-2056 or (404) 537-3406 and entering passcode 6784388, as well as on the Company’s investor relations website.

ABOUT RH

RH (RH) is a curator of design, taste and style in the luxury lifestyle market. The Company offers its collections through its retail galleries across North America, the Company’s multiple Source Books, and online at RH.com, RHModern.com, RHBabyandChild.com, RHTeen.com and Waterworks.com.

NON-GAAP FINANCIAL MEASURES

To supplement its condensed consolidated financial statements, which are prepared and presented in accordance with Generally Accepted Accounting Principles (“GAAP”), the Company uses the following non-GAAP financial measures: adjusted net revenue, adjusted operating income, adjusted net income or adjusted net earnings, adjusted net income margin, adjusted diluted earnings per share, normalized adjusted net income, normalized adjusted diluted net income per share, ROIC or return on invested capital, free cash flow, adjusted operating margin, adjusted gross margin, adjusted SG&A, EBITDA and Adjusted EBITDA (collectively, “non-GAAP financial measures”). We compute these measures by adjusting the applicable GAAP measures to remove the impact of certain recurring and non-recurring charges and gains and the tax effect of these adjustments. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. The Company uses these non-GAAP financial measures for financial and operational decision making and as a means to evaluate period-to-period comparisons. The Company believes that they provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to key metrics used by management in its financial and operational decision making. The non-GAAP financial measures used by the Company in this press release may be different from the non-GAAP financial measures, including similarly titled measures, used by other companies.

For more information on the non-GAAP financial measures, please see the Reconciliation of GAAP to non-GAAP Financial Measures tables in this press release. These accompanying tables include details on the GAAP financial measures that are most directly comparable to non-GAAP financial measures and the related reconciliations between these financial measures.

FORWARD-LOOKING STATEMENTS

This release contains forward-looking statements within the meaning of the federal securities laws, including without limitation, statements regarding: Our fiscal 2019 guidance including our expectations for adjusted net revenue, adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted EPS, the impact from the increased tariffs, the impact of revenue reduction as a result of editing unprofitable and non-strategic businesses; our future opportunity, growth plans and strategies, including our focus on elevating the brand and architecting an integrated operating platform, and RH becoming one of the few retailers that is growing revenues, expanding margins, and driving significantly higher returns on invested capital; our optimism that our business momentum will continue despite negative macro trends and increased tariffs; our expectations regarding our tax rate for fiscal 2019 including assumptions regarding our applicable tax rate and factors that would affect our tax rate; our expectation that our RH New York gallery will continue to trend comfortably in excess of $100 million in annualized revenue for fiscal 2019 and will generate more than $30 million of cash contribution in its first full fiscal year; our plan to open new stores in the remainder of 2019; our belief that the current tariffs will not impair our ability to achieve our stated financial goals and that our response to tariffs will not have an adverse impact on our business; the impact on our business trends from macro factors; the expected acceleration of our real estate transformation including the opening of 5 to 7 new Galleries in fiscal 2020 and a minimum of 7 new Galleries in fiscal 2021; our belief that our Company remains undervalued and that the repurchase of our shares will prove to be an outstanding allocation of capital for the benefit of our long term shareholders; our expectations regarding the convertible notes market and our ability to complete a convertible notes financing on favorable terms; our expectations regarding sources and uses of capital; our expectations with respect to year-end inventory levels; planned accelerated outlet sales; our projections regarding free cash flow and net debt to trailing twelve month adjusted EBITDA at year end; our path to $4 to $5 billion in North America revenues, with mid-to-high teens operating margins and ROIC in excess of 50%; our belief that there is an opportunity to more than double revenues as we begin to expand globally; our long term targets, including net revenue growth of 8% to 12%, adjusted operating margins in the mid to high teens, adjusted net income growth of 15% to 20% annually and ROIC in excess of 50%; our intention to be opportunistic as it relates to the capital markets and the potential benefits to our Company of completing a notes offering on acceptable terms; our positioning on store performance and metrics important to customers relative to other retailers; and any statements or assumptions underlying any of the foregoing. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future events. We cannot assure you that future developments affecting us will be those that we have anticipated. Important risks and uncertainties that could cause actual results to differ materially from our expectations include, among others, risks related to our dependence on key personnel and any changes in our ability to retain key personnel; successful implementation of our growth strategy; risks related to the number of new business initiatives we are undertaking; successful implementation of our growth strategy including our real estate transformation and the number of new gallery locations that we seek to open and the timing of openings; uncertainties in the current performance of our business including a range of risks related to our operations as well as external economic factors; general economic conditions and the housing market as well as the impact of economic conditions on consumer confidence and spending; changes in customer demand for our products; our ability to anticipate consumer preferences and buying trends, and maintaining our brand promise to customers; decisions concerning the allocation of capital; factors affecting our outstanding convertible senior notes or other forms of our indebtedness; our ability to anticipate consumer preferences and buying trends, and maintain our brand promise to customers; changes in consumer spending based on weather and other conditions beyond our control; risks related to the number of new business initiatives we are undertaking; strikes and work stoppages affecting port workers and other industries involved in the transportation of our products; our ability to obtain our products in a timely fashion or in the quantities required; our ability to employ reasonable and appropriate security measures to protect personal information that we collect; our ability to support our growth with appropriate information technology systems; risks related to our sourcing and supply chain including our dependence on imported products produced by foreign manufacturers and risks related to importation of such products including risks related to tariffs, the countermeasures and mitigation steps that we adopt in response to tariffs and other similar issues, as well as those risks and uncertainties disclosed under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in RH’s most recent Form 10-K and Form 10-Q filed with the Securities and Exchange Commission, and similar disclosures in subsequent reports filed with the SEC, which are available on our investor relations website at ir.rh.com and on the SEC website at www.sec.gov. Any forward-looking statement made by us in this press release speaks only as of the date on which we make it. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable securities laws.

RETAIL GALLERY METRICS

(Unaudited)

 

We operated the following number of retail Galleries, outlets and showrooms:

 

August 3,

 

August 4,

2019

 

2018

RH
Design Galleries [a]

20

18

Legacy Galleries

43

44

Modern Galleries

2

2

Baby & Child Galleries

5

6

Total RH Galleries

70

70

Outlets [b]

40

36

 
Waterworks Showrooms

15

15

[a]

As of August 3, 2019 and August 4, 2018, six and four of our RH Design Galleries include an integrated RH Hospitality experience, respectively.

[b]

Net revenues for outlet stores, which include warehouse sales, were $53.9 million and $37.9 million for the three months ended August 3, 2019 and August 4, 2018, respectively. Net revenues for outlet stores, which include warehouse sales, were $109.5 million and $81.1 million for the six months ended August 3, 2019 and August 4, 2018, respectively.

The following table presents RH Gallery and Waterworks showroom metrics and excludes outlets:

Three Months Ended

August 3,

 

August 4,

2019

 

2018

 

 

Total Leased Selling

 

 

 

Total Leased Selling

Store Count

 

Square Footage

 

Store Count

 

Square Footage

(in thousands) (in thousands)
Beginning of period

85

1,078

84

1,012

Design Galleries:
Nashville Design Gallery

1

45.6

Baby & Child Galleries:
Portland RH Baby & Child Gallery

1

4.7

Dallas RH Baby & Child Gallery

1

3.7

Legacy Galleries:
San Antonio legacy Gallery (relocation)

(3.8)

Nashville legacy Gallery

(1)

(7.1)

Washington DC legacy Gallery

(1)

(5.6)

End of period

85

1,074

85

1,053

 
Weighted-average leased selling square footage

1,075

1,035

% Growth year over year

4

%

13

%

See the Company’s most recent Form 10‑K and Form 10‑Q filings for square footage definitions.

Total leased square footage as of August 3, 2019 and August 4, 2018 was 1,451,000 and 1,414,000, respectively.

Weighted-average leased square footage for the three months ended August 3, 2019 and August 4, 2018 was 1,451,000 and 1,392,000, respectively.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except share and per share amounts)

(Unaudited)
Three Months Ended Six Months Ended

August 3,

 

% of Net

 

August 4,

 

% of Net

 

August 3,

 

% of Net

 

August 4,

 

% of Net

2019

 

Revenues

 

2018

 

Revenues

 

2019

 

Revenues

 

2018

 

Revenues

Net revenues

$

 

 

706,514

 

100.0

 

%

$

 

 

640,798

100.0

%

$

 

 

1,304,935

 

100.0

%

$

 

 

1,198,204

100.0

%

Cost of goods sold

411,556

 

58.3

 

%

372,454

58.1

%

777,163

 

59.6

 

%

720,527

60.1

%

Gross profit

294,958

 

41.7

 

%

268,344

41.9

%

527,772

 

40.4

 

%

477,677

39.9

%

Selling, general and administrative expenses

190,977

 

27.0

 

%

186,521

29.1

%

355,158

 

27.2

 

%

347,707

29.1

%

Income from operations

103,981

 

14.7

 

%

81,823

12.8

%

172,614

 

13.2

 

%

129,970

10.8

%

Other expenses

 

 

 

 

Interest expense—net

24,513

 

3.4

 

%

15,467

2.5

%

45,631

 

3.5

 

%

30,565

2.5

%

(Gain) loss on extinguishment of debt

(954

)

(0.1

)

%

917

0.1

%

(954

)

(0.1

)

%

917

0.1

%

Total other expenses

23,559

 

3.3

 

%

16,384

2.6

%

44,677

 

3.4

 

%

31,482

2.6

%

Income before income taxes

80,422

 

11.4

 

%

65,439

10.2

%

127,937

 

9.8

 

%

98,488

8.2

%

Income tax expense

16,665

 

2.4

 

%

2,533

0.4

%

28,458

 

2.2

 

%

10,121

0.8

%

Net income

$

 

 

63,757

 

9.0

 

%

$

 

 

62,906

9.8

%

$

 

 

99,479

 

7.6

 

%

$

 

 

88,367

7.4

%

 
Weighted-average shares used in computing basic net income per share

18,465,876

 

21,925,702

19,221,367

 

21,735,364

Basic net income per share

$

 

 

3.45

 

$

 

 

2.87

$

 

 

5.18

 

$

 

 

4.07

 
Weighted-average shares used in computing diluted net income per share

22,324,112

 

27,496,561

23,629,050

 

26,363,395

Diluted net income per share

$

 

 

2.86

 

$

 

 

2.29

$

 

 

4.21

 

$

 

 

3.35

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)
 

August 3,

 

February 2,

 

August 4,

2019

 

2019

 

2018

ASSETS
Cash and cash equivalents

$

 

11,555

 

$

 

5,803

 

$

 

22,199

Merchandise inventories

480,688

 

531,947

 

551,343

Other current assets

165,379

 

166,217

 

110,380

Total current assets

657,622

 

703,967

 

683,922

Property and equipment—net

950,594

 

952,957

 

798,212

Operating lease right-of-use assets

421,001

 

440,504

 

463,063

Goodwill and intangible assets

210,392

 

210,401

 

242,498

Other non-current assets

148,199

 

115,189

 

126,661

Total assets

$

 

2,387,808

 

$

 

2,423,018

 

$

 

2,314,356

 
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Liabilities
Accounts payable and accrued expenses

$

 

289,713

 

$

 

320,497

 

$

 

284,942

Convertible senior notes due 2019—net

343,789

 

335,670

Convertible senior notes due 2020—net

280,688

 

Operating lease liabilities

57,162

 

66,249

 

59,664

Deferred revenue, customer deposits and other current liabilities

297,394

 

262,051

 

224,066

Total current liabilities

924,957

 

992,586

 

904,342

Asset based credit facility

145,000

 

57,500

 

Term loans—net

316,348

 

Equipment promissory notes—net

42,113

 

Convertible senior notes due 2020—net

271,157

 

261,929

Convertible senior notes due 2023—net

257,766

 

249,151

 

240,804

Non-current operating lease liabilities

415,803

 

437,557

 

454,812

Non-current finance lease liabilities

433,591

 

421,245

 

278,550

Other non-current obligations

30,148

 

32,512

 

32,410

Total liabilities

2,565,726

 

2,461,708

 

2,172,847

 
Stockholders’ equity (deficit)

(177,918

)

(38,690

)

141,509

Total liabilities and stockholders’ equity (deficit)

$

 

2,387,808

 

$

 

2,423,018

 

$

 

2,314,356

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)
 
Six Months Ended

August 3,

 

August 4,

2019

 

2018

CASH FLOWS FROM OPERATING ACTIVITIES
Net income

$

 

99,479

 

$

 

88,367

 

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization

52,510

 

41,939

 

Accretion of debt discount upon settlement of debt

(70,482

)

Other non-cash items

77,559

 

74,839

 

Change in assets and liabilities:
Prepaid expense and other assets

(2,882

)

(40,646

)

Accounts payable and accrued expenses

(40,073

)

(31,707

)

Current and non-current operating lease liability

(44,513

)

(43,025

)

Other changes in assets and liabilities

25,535

 

(40,747

)

Net cash provided by operating activities

97,133

 

49,020

 

 
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures

(25,283

)

(42,916

)

Net cash used in investing activities

(25,283

)

(42,916

)

 
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings (repayments) under asset based credit facility

87,500

 

(199,970

)

Net borrowings (repayments) under term loans

320,000

 

(80,000

)

Net borrowings (repayments) under promissory and equipment security notes

64,007

 

(31,974

)

Debt issuance costs

(4,636

)

Repayments of convertible senior notes

(278,560

)

Repurchases of common stock—including commissions

(250,032

)

Proceeds from issuance of convertible senior notes

335,000

 

Proceeds from issuance of warrants

51,021

 

Purchase of convertible notes hedges

(91,857

)

Debt issuance costs related to convertible senior notes

(6,349

)

Other financing activities

(4,302

)

17,779

 

Net cash used in financing activities

(66,023

)

(6,350

)

Effects of foreign currency exchange rate translation

(75

)

(124

)

Net increase (decrease) in cash and cash equivalents and restricted cash equivalents

5,752

 

(370

)

Cash and cash equivalents and restricted cash equivalents
Beginning of period—cash and cash equivalents

5,803

 

17,907

 

Beginning of period—restricted cash equivalents (construction related deposits)

7,407

 

Beginning of period—cash and cash equivalents and restricted cash equivalents

$

 

5,803

 

$

 

25,314

 

 
End of period—cash and cash equivalents

11,555

 

22,199

 

End of period—restricted cash equivalents (construction related deposits)

2,745

 

End of period—cash and cash equivalents and restricted cash equivalents

$

 

11,555

 

$

 

24,944

 

 

CALCULATION OF FREE CASH FLOW

(In thousands)

(Unaudited)

 

Three Months Ended

 

Six Months Ended

August 3,

 

August 4,

 

August 3,

 

August 4,

2019

 

2018

 

2019

 

2018

Net cash provided by operating activities

$

 

58,309

 

$

 

52,249

 

$

 

97,133

 

$

 

49,020

 

Accretion of debt discount upon settlement of debt

70,482

 

70,482

 

Capital expenditures

(17,367

)

(25,237

)

(25,283

)

(42,916

)

Principal payments under finance leases

(2,270

)

(1,791

)

(4,399

)

(3,567

)

Free cash flow [a]

$

 

109,154

 

$

 

25,221

 

$

 

137,933

 

$

 

2,537

 

[a]

Free cash flow is calculated as net cash provided by operating activities and the non-cash accretion of debt discount upon settlement of debt, less capital expenditures and principal payments under finance leases. Free cash flow excludes all non-cash items. Free cash flow is included in this press release because management believes that free cash flow provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

RECONCILIATION OF GAAP NET INCOME TO ADJUSTED NET INCOME

(In thousands)

(Unaudited)

Three Months Ended

 

Six Months Ended

August 3,

 

August 4,

 

August 3,

 

August 4,

2019

 

2018

 

2019

 

2018

GAAP net income

$

63,757

 

$

62,906

 

$

99,479

 

$

88,367

 

Adjustments (pre-tax):
Net revenues:
Recall accrual [a]

1,853

 

413

 

1,853

 

Cost of goods sold:
Asset impairments and change in useful lives [b]

1,916

 

4,909

 

Recall accrual [a]

(320

)

(3,262

)

(2,381)

 

(3,516

)

Impact of inventory step-up [c]

190

 

380

 

Selling, general and administrative expenses:
Legal settlements [d]

(1,193

)

(7,204

)

(1,193

)

(5,289)

 

Asset impairments and change in useful lives [b]

629

 

1,112

 

Recall accrual [a]

345

 

33

 

345

 

Reorganization related costs [e]

1,721

 

1,721

 

Reversal of loss on asset disposal [f]

(840

)

Interest expense—net:
Amortization of debt discount [g]

9,918

 

9,000

 

21,607

 

16,272

 

(Gain) loss on extinguishment of debt [h]

(954

)

917

 

(954

)

917

 

Subtotal adjusted items

9,996

 

3,560

 

23,546

 

11,843

 

Impact of income tax items [i]

(2,323

)

(11,957

)

(3,354

)

(13,049

)

Adjusted net income [j]

$

71,430

 

$

54,509

 

$

119,671

 

$

87,161

 

[a]

Represents an adjustment to net revenues, increase in cost of goods sold and inventory charges associated with product recalls, as well as accrual adjustments and vendor claims.

[b]

The adjustment to cost of goods sold represents the acceleration of depreciation expense due to a change in the estimated useful lives of certain assets. The adjustment to selling, general and administrative expenses for the six months ended August 3, 2019 includes a $0.5 million charge related to the termination of a service agreement associated with such assets. The adjustment to selling, general and administrative expenses for the three and six months ended August 3, 2019 also includes asset impairment of $0.6 million.

[c]

Represents the non-cash amortization of the inventory fair value adjustment recorded in connection with our acquisition of Waterworks.

[d]

Represents legal settlements, net of related legal expenses.

[e]

Represents costs associated with a supply chain reorganization, including the closure of the Dallas customer call center, which include severance costs and related taxes, partially offset by a reversal of stock-based compensation expense related to unvested equity awards.

[f]

Represents the reversal of an estimated loss on disposal of asset due to negotiations of the sales price being finalized.

[g]

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were issued in June 2014 (the “2019 Notes”), for the $300 million aggregate principal amount of convertible senior notes that were issued in June and July 2015 (the “2020 Notes”) and for the $335 million aggregate principal amount of convertible senior notes that were issued in June 2018 (the “2023 Notes”), we separated the 2019 Notes, 2020 Notes and 2023 Notes into liability (debt) and equity (conversion option) components and we are amortizing as debt discount an amount equal to the fair value of the equity components as interest expense on the 2019 Notes, 2020 Notes and 2023 Notes over their expected lives. The equity components represent the difference between the proceeds from the issuance of the 2019 Notes, 2020 Notes and 2023 Notes and the fair value of the liability components of the 2019 Notes, 2020 Notes and 2023 Notes, respectively. Amounts are presented net of interest capitalized for capital projects of $0.7 million and $0.8 million during the three months ended August 3, 2019 and August 4, 2018, respectively. Amounts are presented net of interest capitalized for capital projects of $1.4 million during both the six months ended August 3, 2019 and August 4, 2018. The 2019 Notes matured on June 15, 2019 and did not impact amortization of debt discount post-maturity.

[h]

The three and six months ended August 3, 2019 includes a gain on extinguishment of debt upon the maturity and settlement of the 2019 Notes in June 2019. The three and six months ended August 4, 2018 includes a loss on extinguishment of debt related to the LILO term loan, the promissory note secured by our aircraft and the equipment security notes, all of which were repaid in June 2018.

[i]

Assumes a normalized tax rate of 21% for the three and six months ended August 3, 2019 and August 4, 2018 in order to facilitate year over year comparison of operating results on a comparable basis with historical results at a consistent tax rate across time periods.

[j]

Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted net income as net income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance. Adjusted net income is included in this press release because management believes that adjusted net income provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

RECONCILIATION OF DILUTED NET INCOME PER SHARE TO

ADJUSTED DILUTED NET INCOME PER SHARE

(Unaudited)
 

Three Months Ended

 

Six Months Ended

August 3,

 

August 4,

 

August 3,

 

August 4,

2019

 

2018

 

2019

 

2018

Diluted net income per share

$

2.86

 

$

2.29

 

$

4.21

 

$

3.35

 

 
Pro forma diluted net income per share [a]

$

2.86

 

$

2.32

 

$

4.25

 

$

3.38

 

Per share impact of adjustments (pre-tax) [b]:
Amortization of debt discount

0.44

 

0.34

 

0.92

 

0.62

 

Asset impairments and change in useful lives

0.11

 

0.26

 

Recall accrual

(0.01

)

(0.04

)

(0.08

)

(0.05

)

Legal settlements

(0.05

)

(0.27

)

(0.05

)

(0.20

)

(Gain) loss on extinguishment of debt

(0.04

)

0.03

 

(0.04

)

0.04

 

Reorganization related costs

0.06

 

0.06

 

Impact of inventory step-up

0.01

 

0.01

 

Reversal of loss on asset disposal

(0.03

)

Subtotal adjusted items

0.45

 

0.13

 

1.01

 

0.45

 

Impact of income tax items [b]

(0.11

)

(0.44

)

(0.14

)

(0.50

)

Adjusted diluted net income per share [c]

$

3.20

 

$

2.01

 

$

5.12

 

$

3.33

 

[a]

For GAAP purposes, we incur dilution above the lower strike prices of our 2019 Notes, 2020 Notes and 2023 Notes of $116.09, $118.13 and $193.65, respectively. However, we exclude from our adjusted diluted shares outstanding calculation the dilutive impact of the convertible notes between $116.09 and $171.98 for our 2019 Notes, between $118.13 and $189.00 for our 2020 Notes, and between $193.65 and $309.84 for our 2023 Notes, based on the bond hedge contracts in place that will deliver shares to offset dilution in these ranges. At stock prices in excess of $171.98, $189.00 and $309.84, we will incur dilution related to the 2019 Notes, 2020 Notes and 2023 Notes, respectively, and our obligation to deliver additional shares in excess of the dilution protection provided by the bond hedges. The 2019 Notes, 2020 Notes and 2023 Notes did not have an impact on dilution during the three months ended August 3, 2019. Pro forma diluted net income per share for the three months ended August 4, 2018 is calculated based on GAAP net income and pro forma diluted weighted-average shares of 27,084,293, which excludes dilution related to the 2019 Notes and 2020 Notes of 412,268 shares. Pro forma diluted net income per share for the six months ended August 3, 2019 is calculated based on GAAP net income and pro forma diluted weighted-average shares of 23,386,758, which excludes dilution related to the 2019 Notes and 2020 Notes of 242,292 shares. Pro forma diluted net income per share for the six months ended August 4, 2018 is calculated based on GAAP net income and pro forma diluted weighted-average shares of 26,157,261, which excludes dilution related to the 2019 Notes and 2020 Notes of 206,134 shares. The 2019 Notes matured on June 15, 2019 and did not have an impact of the Company’s dilutive share count post-maturity.

[b]

Refer to table titled “Reconciliation of GAAP Net Income to Adjusted Net Income” and the related footnotes for additional information.

[c]

Adjusted diluted net income per share is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted diluted net income per share as net income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance divided by the Company’s share count. Adjusted diluted net income per share is included in this press release because management believes that adjusted diluted net income per share provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

RECONCILIATION OF NET REVENUES TO ADJUSTED NET REVENUES

AND GROSS PROFIT TO ADJUSTED GROSS PROFIT

(In thousands)

(Unaudited)
 

Three Months Ended

 

Six Months Ended

August 3,

 

August 4,

 

August 3,

 

August 4,

2019

 

2018

 

2019

 

2018

Net revenues

$

706,514

 

$

640,798

 

$

1,304,935

 

$

1,198,204

 

Recall accrual [a]

1,853

 

413

 

1,853

 

Adjusted net revenues [b]

$

706,514

 

$

642,651

 

$

1,305,348

 

$

1,200,057

 

 
Gross profit

$

294,958

 

$

268,344

 

$

527,772

 

$

477,677

 

Asset impairments and change in useful lives [a]

1,916

 

4,909

 

Recall accrual [a]

(320

)

(1,409

)

(1,968

)

(1,663

)

Impact of inventory step-up [a]

190

 

380

 

Adjusted gross profit [b]

$

296,554

 

$

267,125

 

$

530,713

 

$

476,394

 

 
Gross margin [c]

41.7

 

%

41.9

 

%

40.4

 

%

39.9

 

%

Adjusted gross margin [c]

42.0

 

%

41.6

 

%

40.7

 

%

39.7

 

%

 

[a]

Refer to table titled “Reconciliation of GAAP Net Income to Adjusted Net Income” and the related footnotes for additional information.

[b]

Adjusted net revenues and adjusted gross profit are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We define adjusted net revenues as net revenues, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance. We define adjusted gross profit as gross profit, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance. Adjusted net revenues and adjusted gross profit are included in this press release because management believes that adjusted net revenues and adjusted gross profit provide meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses these non-GAAP financial measures in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

[c]

Gross margin is defined as gross profit divided by net revenues. Adjusted gross margin is defined as adjusted gross profit divided by adjusted net revenues.

RECONCILIATION OF NET INCOME TO OPERATING INCOME

AND ADJUSTED OPERATING INCOME

(In thousands)

(Unaudited)
 

Three Months Ended

 

Six Months Ended

August 3,

 

August 4,

 

August 3,

 

August 4,

2019

 

2018

 

2019

 

2018

Net income

$

63,757

 

$

62,906

 

$

99,479

 

$

88,367

 

Interest expense—net

24,513

 

15,467

 

45,631

 

30,565

 

(Gain) loss on extinguishment of debt

(954

)

917

 

(954

)

917

 

Income tax expense

16,665

 

2,533

 

28,458

 

10,121

 

Operating income

103,981

 

81,823

 

172,614

 

129,970

 

Asset impairments and change in useful lives [a]

2,545

 

6,021

 

Recall accrual [a]

(320

)

(1,064

)

(1,935

)

(1,318

)

Legal settlements [a]

(1,193

)

(7,204

)

(1,193

)

(5,289

)

Reorganization related costs [a]

1,721

 

1,721

 

Impact of inventory step-up [a]

190

 

380

 

Reversal of loss on asset disposal [a]

(840

)

Adjusted operating income [b]

$

105,013

 

$

75,466

 

$

175,507

 

$

124,624

 

 
Net revenues

$

706,514

 

$

640,798

 

$

1,304,935

 

$

1,198,204

 

Adjusted net revenues [c]

$

706,514

 

$

642,651

 

$

1,305,348

 

$

1,200,057

 

 
Operating margin [c]

14.7

 

%

12.8

 

%

13.2

 

%

10.8

 

%

Adjusted operating margin [c]

14.9

 

%

11.7

 

%

13.4

 

%

10.4

 

%

[a]

Refer to table titled “Reconciliation of GAAP Net Income to Adjusted Net Income” and the related footnotes for additional information.

[b]

Adjusted operating income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted operating income as operating income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance. Adjusted operating income is included in this press release because management believes that adjusted operating income provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

[c]

Operating margin is defined as operating income divided by net revenues. Adjusted operating margin is defined as adjusted operating income divided by adjusted net revenues. Refer to table titled “Reconciliation of Net Revenues to Adjusted Net Revenues and Gross Profit to Adjusted Gross Profit” and the related footnotes for a definition and reconciliation of adjusted net revenues.

RECONCILIATION OF NET INCOME TO EBITDA AND ADJUSTED EBITDA

(In thousands)

(Unaudited)

 

Three Months Ended

 

Six Months Ended

August 3,

 

August 4,

 

August 3,

 

August 4,

2019

 

2018

 

2019

 

2018

Net income

$

63,757

 

$

62,906

 

$

99,479

 

$

88,367

 

Depreciation and amortization

25,321

 

21,354

 

52,510

 

41,939

 

Interest expense—net

24,513

 

15,467

 

45,631

 

30,565

 

Income tax expense

16,665

 

2,533

 

28,458

 

10,121

 

EBITDA [a]

130,256

 

102,260

 

226,078

 

170,992

 

Stock-based compensation [b]

5,298

 

6,234

 

10,993

 

14,231

 

Asset impairments and change in useful lives [c]

629

 

1,112

 

Recall accrual [c]

(320

)

(1,064

)

(1,935

)

(1,318

)

Legal settlements [c]

(1,193

)

(7,204

)

(1,193

)

(5,289

)

(Gain) loss on extinguishment of debt [c]

(954

)

917

 

(954

)

917

 

Reorganization related costs [c]

1,721

 

1,721

 

Impact of inventory step-up [c]

190

 

380

 

Reversal of loss on asset disposal [c]

(840

)

Adjusted EBITDA [a]

$

133,716

 

$

103,054

 

$

234,101

 

$

180,794

 

[a]

EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income before depreciation and amortization, interest expense and income tax expense. Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the impact of stock-based compensation, as well as certain non-recurring and other items that we do not consider representative of our underlying operating performance. EBITDA and Adjusted EBITDA are included in this press release because management believes that these metrics provide meaningful supplemental information for investors regarding the performance of our business and facilitate a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses these non-GAAP financial measures in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter. Our measures of EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions for other companies due to different methods of calculation.

[b]

Represents non-cash compensation related to equity awards granted to employees.

[c]

Refer to table titled “Reconciliation of GAAP Net Income to Adjusted Net Income” and the related footnotes for additional information.

RECONCILIATION OF NET INCOME TO TRAILING TWELVE MONTHS EBITDA

AND TRAILING TWELVE MONTHS ADJUSTED EBITDA

(In thousands)

(Unaudited)

 

Trailing Twelve Months

August 3,

2019

Net income

$

 

146,843

 

Depreciation and amortization

102,358

 

Interest expense—net

82,835

 

Income tax expense

43,570

 

EBITDA [a]

375,606

 

Goodwill and tradename impairment [b]

32,086

 

Stock-based compensation [c]

20,884

 

Asset held for sale impairment [d]

8,497

 

Reorganization related costs [e]

8,256

 

Distribution center closures [f]

3,886

 

Lease losses [g]

3,411

 

Asset impairments and change in useful lives [h]

2,308

 

Recall accrual [i]

1,002

 

Legal settlement [j]

(1,193

)

Gain on extinguishment of debt [k]

(954

)

Adjusted EBITDA [a]

$

 

453,789

 

[a]

Refer to footnote [a] within table titled “Reconciliation of Net Income to EBITDA and Adjusted EBITDA.”

[b]

Represents goodwill and tradename impairment related to the Waterworks reporting unit.

[c]

Represents non-cash compensation related to equity awards granted to employees.

[d]

Represents the impairment recorded upon reclassification of an owned Design Gallery as held for sale.

[e]

Represents severance costs and related taxes associated with reorganizations.

[f]

Represents disposals of inventory and property and equipment, lease related charges, inventory transfer costs and other costs associated with distribution center closures.

[g]

The adjustment represents additional lease related charges due to the remeasurement of the lease loss liability for RH Contemporary Art resulting from an update to both the timing and the amount of future estimated lease related cash inflows.

[h]

Represents a $1.2 million inventory impairment charge related to holiday merchandise, an asset impairment of $0.6 million and a $0.5 million charge related to the termination of a service agreement.

[i]

Represents adjustments to net revenues and cost of goods sold, inventory charges associated with product recalls, as well as accrual adjustments and vendor claims.

[j]

Represents a legal settlement.

[k]

Represents a gain on extinguishment of debt upon the maturity and settlement of the 2019 Notes in June 2019.

CALCULATION OF TOTAL DEBT, TOTAL NET DEBT AND

RATIO OF TOTAL NET DEBT TO TRAILING TWELVE MONTHS ADJUSTED EBITDA

(In thousands)

(Unaudited)

 

August 3,

 

Interest

2019

 

Rate [a]

Asset based credit facility

$

145,000

 

3.75

%

FILO term loan

120,000

 

5.13

%

Second lien term loan

200,000

 

8.94

%

Equipment promissory notes

64,007

 

4.56

%

Convertible senior notes due 2020 [b]

281,868

 

0.00

%

Convertible senior notes due 2023 [b]

261,848

 

0.00

%

Notes payable for share repurchases

18,741

 

4.97

%

Total debt

$

1,091,464

 

Cash and cash equivalents

(11,555

)

Total net debt

$

1,079,909

 

 
Trailing twelve months Adjusted EBITDA [c]

$

453,789

 

 
Ratio of total net debt to trailing twelve months Adjusted EBITDA [c]

2.4

 

[a]

The interest rates for the equipment promissory notes and notes payable for share repurchases ...