RH Reports Record First Quarter Fiscal 2019 Results

GAAP EPS of $1.43, Adjusted Diluted EPS of $1.85 Increased 53% Versus $1.21 Last Year

Company Raises Fiscal 2019 Guidance

CORTE MADERA, Calif.--(BUSINESS WIRE)-- RH (NYSE: RH) today announced first 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.

FIRST QUARTER 2019 HIGHLIGHTS

Q1 GAAP NET REVENUES INCREASED +7.4% TO $598M
Q1 ADJUSTED NET REVENUES INCREASED +7.4% TO $599M

Q1 GAAP OPERATING INCOME INCREASED +43% TO $68.6M VS. $48.1M LY
Q1 ADJUSTED OPERATING INCOME INCREASED +43% TO $70.5M VS. $49.2M LY

Q1 GAAP OPERATING MARGIN INCREASED 290 BASIS POINTS TO 11.5% VS. 8.6% LY
Q1 ADJUSTED OPERATING MARGIN INCREASED 300 BASIS POINTS TO 11.8% VS. 8.8% LY

Q1 GAAP NET INCOME INCREASED +40% TO $35.7M VS. $25.5M LY
Q1 ADJUSTED NET INCOME INCREASED +48% TO $45.2M VS. $30.6M LY

Q1 GAAP EPS INCREASED +42% TO $1.43 VS. $1.01 LY
Q1 ADJUSTED DILUTED EPS INCREASED +53% TO $1.85 VS. $1.21 LY

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. We have provided reconciliation tables that update historical results to reflect these changes in lease accounting standards.

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

To Our People, Partners, and Shareholders,

First quarter fiscal 2019 was an exceptional start to the year for Team RH. We generated record GAAP revenues of $598 million, an increase of 7.4%, record GAAP operating margin of 11.5%, record adjusted operating margin of 11.8%, record GAAP earnings per share of $1.43, and record adjusted diluted earnings per share of $1.85, a 53% increase versus $1.21 a year ago.

As a result of our strong first quarter results, we are raising our fiscal 2019 adjusted net revenue, adjusted operating income, adjusted operating margin and adjusted earnings guidance for the year as follows:

The above guidance reflects approximately $20 million of incremental interest expense due to the Company’s first quarter debt financings representing a $0.58 reduction to our fiscal 2019 adjusted diluted EPS guidance. This is offset by our repurchase of 2.17 million shares in the first quarter, which has a weighted average reduction of 1.79 million to our full year diluted share count and a $0.59 benefit to our fiscal 2019 adjusted diluted EPS guidance. As a reminder, the guidance reflects a normalized 26.0% tax rate.

Our focus on elevating the brand and architecting an integrated operating platform continues to result in our profit model leapfrogging past the home furnishings industry and RH becoming one of the few retailers that is growing revenues, expanding margins, increasing operating earnings, and driving significantly higher returns on invested capital.

First quarter revenues accelerated in late March, increasing 7.4% for the quarter compared to the prior year quarter. Net of the approximately 2 point negative drag from eliminating fringe promotions, adjusted net revenues increased 9.4% in the first quarter fiscal 2019. We remain cautiously optimistic that business momentum will continue despite negative macro trends and increased tariffs, supported by the recent introduction of RH Beach House, the continued elevation and expansion of our product offering, investments in RH Interior Design, plus the launch of RH Ski House and new galleries opening this fall.

Our largest and most important new Gallery, RH New York, continues to build momentum and is trending comfortably in excess of $100 million in annualized revenue. Two of our projects scheduled to open late in the fourth quarter, RH San Francisco, The Gallery at The Historic Bethlehem Steel Building, and RH Charlotte, The Gallery at Phillips Place, are experiencing slight delays and will now open in the first quarter of fiscal 2020. We have productive legacy galleries in each of those markets, and due to the late planned openings, we don’t anticipate a material impact to this year’s revenues. We continue to be on track to achieve planned asset sales of $50 - $60 million in Fiscal 2019. We are negotiating a letter of intent for the sale of RH Yountville and expect to begin receiving offers for RH Edina in the fall when the Gallery opens.

Looking forward, we expect to accelerate our real estate transformation to a rate of 5 to 7 new galleries in Fiscal 2020 and a minimum of 7 new galleries in Fiscal 2021.

As a reminder, embedded in our 2019 guidance is approximately 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 and we expect the negative impact to be about 4 points in the second quarter, 2 points in the third quarter and 4 points in the fourth quarter.

Regarding China tariffs, we have renegotiated product costs and selectively raised prices to mitigate the impact of the increase from 10 to 25 percent. We are also moving certain production and new product development out of China, plus exploring new partnerships and expanding our own manufacturing facilities in the United States. Long term, we do not believe the current trade climate will impair our ability to achieve our stated financial goals and the expected impact from the increased tariffs is embedded in our guidance for the year.

We believe our Company remains undervalued, and we continued to execute our share repurchase program in the first quarter, acquiring 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, or approximately 60% of the total shares outstanding at an average price of $61.40. We believe the repurchase of our shares will prove to be an outstanding allocation of capital for the benefit of our long term shareholders.

In the first quarter we completed multiple debt financings totaling $380 million and amended our credit facility, which in aggregate added $420 million of new liquidity, supporting both further purchases under our share repurchase and the planned repayment of $350 million of convertible notes due June 15, 2019 and $300 million of convertible notes due July 15, 2020. We will continue to be opportunistic as it relates to the capital markets and the repurchase of our shares. Our net debt is currently 2.8x TTM Adjusted EBITDA and we project that we will end the year with net debt to TTM Adjusted EBITDA of approximately 2.0x.

Looking forward, we continue to see a clear path to $4 to $5 billion in North America revenues, and an international opportunity that could lead to RH becoming a $7 to $10 billion dollar global brand.

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 believe the following initiatives will lead to another step change in our financial performance and return on invested capital over the next several years.

1. Revenue growth driven by our real estate transformation, the elevation and expansion of our product offering, and investments in RH Interior Design will continue to leverage SG&A and Occupancy costs;
2. The cycling of several capital intensive real estate projects and the shift to predominantly capital light projects, will decrease occupancy costs and increase operating earnings and ROIC;
3. Increased inventory turns and decreased working capital requirements as a result of our new supply chain strategy will continue to drive lower costs and higher returns on invested capital. To put this point into perspective, if our inventory had grown at the same rate of revenues since Q1 2016, we would have approximately $470 million of additional inventory than we do today and significantly higher operating costs; and
4. Higher revenues, lower returns and reduced operating costs as a result of our new Home Delivery strategy. We have already identified cost savings of $15 to $20 million that will be captured over fiscal 2019 and 2020.

In total, the above initiatives should translate into an additional 400 to 600 basis points of operating margin and ROIC in excess of 50%.

We do understand that the strategies we are pursuing – opening the largest specialty retail experiences in our industry while most are shrinking the size of the 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.

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 June 26, 2019 by dialing (855) 859-2056 or (404) 537-3406 and entering passcode 6032768, as well as on the Company’s investor relations website.

ABOUT RH

RH (NYSE: 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 income, adjusted net income, adjusted diluted EPS, the impact from the increased tariffs, and a 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); our future opportunity, growth plans and strategies, including our focus on elevating the brand and architecting an integrated operating platform, our profit model leapfrogging past the home furnishings industry, and RH becoming one of the few retailers that is growing revenues, expanding margins, increasing operating earnings, and driving significantly higher returns on invested capital; our expectation that our business momentum will continue despite negative macro trends and increased tariffs, supported by the recent introduction of RH Beach House, the continued elevation and expansion of our product offering, investments in RH Interior Design, plus the launch of RH Ski House and new galleries opening this fall; our expectation that our RH New York gallery will continue to build momentum and trend comfortably in excess of $100 million in revenue annually; our plan to open RH San Francisco, The Gallery at The Historic Bethlehem Steel Building, and RH Charlotte, The Gallery at Phillips Place, in the first quarter of fiscal 2020, and our expectation that the slight delays in opening such galleries will not have a material impact on this year’s revenues; our expectation of receiving offers for RH Edina in the fall when the Gallery opens; our plans to move certain production and new product development out of China plus explore new partnerships and expand our own manufacturing facilities in the United States; our belief that in the long term the current trade climate will not impair our ability to achieve our stated financial goals; 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 expectation that we will end the year with net debt to TTM Adjusted EBITDA of approximately 2.0x; our path to $4 to $5 billion in North America revenues; our expectations regarding an International opportunity that could lead to RH becoming a $7 to $10 billion dollar global brand; 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 belief that our initiatives, including (1) revenue growth driven by our real estate transformation, the elevation and expansion of our product offering, and investments in RH Interior Design that will continue to leverage SG&A and Occupancy costs, (2) the cycling of several capital intensive real estate projects and the shift to predominantly capital light projects that will decrease occupancy costs and increase operating earnings and ROIC, (3) increased inventory turns and decreased working capital requirements as a result of our new supply chain strategy that will continue to drive lower costs and higher returns on invested capital, and (4) higher revenues, lower returns and reduced operating costs as a result of our new Home Delivery strategy, including cost savings of $15 to $20 million that will be captured over fiscal 2019 and 2020, will lead to another step change in our financial performance and return on invested capital over the next several years and should translate into an additional 400 to 600 basis points of operating margin and return on invested capital in excess of 50%; 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:

As of May 4, 2019, six of our RH Design Galleries include an integrated RH Hospitality experience.

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

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

Total leased square footage as of May 4, 2019 and May 5, 2018 was 1,454,000 and 1,358,000, respectively.

Weighted-average leased square footage for the three months ended May 4, 2019 and May 5, 2018 was 1,461,000 and 1,323,000, respectively.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

CALCULATION OF FREE CASH FLOW
(In thousands)
(Unaudited)

RECONCILIATION OF GAAP NET INCOME TO ADJUSTED NET INCOME
(In thousands)
(Unaudited)

RECONCILIATION OF DILUTED NET INCOME PER SHARE TO
ADJUSTED DILUTED NET INCOME PER SHARE
(Unaudited)

RECONCILIATION OF NET REVENUES TO ADJUSTED NET REVENUES
AND GROSS PROFIT TO ADJUSTED GROSS PROFIT
(In thousands)
(Unaudited)

RECONCILIATION OF NET INCOME TO OPERATING INCOME
AND ADJUSTED OPERATING INCOME
(In thousands)
(Unaudited)

RECONCILIATION OF NET INCOME TO EBITDA AND ADJUSTED EBITDA
(In thousands)
(Unaudited)

RECONCILIATION OF NET INCOME TO EBITDA
AND ADJUSTED EBITDA TRAILING TWELVE MONTHS
(In thousands)
(Unaudited)

ASC 842 IMPACT OF ADOPTION
(In thousands)
(Unaudited)

We adopted Accounting Standards Update (“ASU”) 2016-02, ASU 2018-10 and ASU 2018-11 (together, “ASC 842”), which pertain to accounting for leases, on February 3, 2019, the first day of our first fiscal quarter of 2019, using a modified retrospective approach. Under this adoption method, the results of prior comparative periods are revised with an adjustment to opening retained earnings of fiscal 2017.

Condensed Consolidated Statements of Income

The following tables summarize the impact of adopting ASC 842 on our fiscal 2018 annual and quarterly condensed consolidated statements of income:

Condensed Consolidated Balance Sheet

The following table summarizes the impact of adopting ASC 842 on certain line items of our fiscal 2018 condensed consolidated balance sheet:

ASC 842: Reconciliation of Net Income to Adjusted Net Income

The following table presents our adjusted reconciliation of net income to adjusted net income for the quarterly and annual fiscal 2018 periods:

ASC 842: Reconciliation of Diluted Net Income Per Share to Adjusted Diluted Net Income Per Share

The following table presents our adjusted reconciliation of net income to adjusted net income for the quarterly and annual fiscal 2018 periods:

ASC 842: Reconciliation of Net Revenues to Adjusted Net Revenues and Gross Profit to Adjusted Gross Profit

The following table presents our adjusted reconciliation of net revenues to adjusted net revenues and gross profit to adjusted gross profit for the quarterly and annual fiscal 2018 periods:

ASC 842: Reconciliation of Net Income to Operating Income and Adjusted Operating Income

The following table presents our adjusted reconciliation of net income to operating income and adjusted operating income for the quarterly and annual fiscal 2018 periods: