The latest Restoration Hardware 10-Q discloses 2 unusual loans. The first loan is a $14M promissory note “secured by the Company’s aircraft”.
- The collateralization of the loan is unusual. I could not find FAA registration records that would suggest that there are any airplanes currently backing this loan.
- Secondly, it’s unclear if the interest rate is attractive for the lender. The statement of cash flows and contractual obligations in the Q2 2017 10-Q imply that the lender will receive $14.0M back ($0.117M plus $13.883M) by 2022 or later. On the face of it, it seems that this loan has a term of over 4 years and a cash interest rate of 0% (!!). Now perhaps I am wrong about the terms of this loan as the 10-Q does not disclose many details on the note (e.g. effective interest rate, non-cash components, etc.).
- Similarly, there is a $20M “equipment security” note that also seems to have a cash interest rate of 0%.
It is a little weird that RH was able to find a party willing to lend money in such an unusual manner.
Unfortunately, I actually don’t know what’s going on… perhaps my readers can figure this one out.
Here’s a list of ideas I’ve talked about on this blog that could be relevant today.
Google Trends may be an interesting tool for investors.
- It allows investors to gather data on a company that’s fresher than the last quarter’s earnings release. This can be helpful in turnaround situations such as Aeropostale (ARO) and Cafepress (PRSS).
- Having leading earnings indicators can be helpful for manufacturing companies (e.g. RGR, SWHC) where there is not much data on consumer demand due to fluctuating inventory at the retail and distributor level.
- In rare cases where fraud is suspected, Google Trends may provide some indications about actual revenues.
Here is an example of Google Trends in action:
My theory is that RH’s capex guidance telegraphs what future earnings will be. The latest guidance is for 27-45% higher capex than last fiscal year ($140-160M versus $110M).
- If RH is the real deal, then the growth investments should generate high returns on invested capital. If so, RH should rapidly grow earnings. (Of course, anything can happen and RH may see poor or negative returns on its new investments.)
- Suppose you believe that RH has been aggressively capitalizing costs that should more appropriately be expensed. Such accounting practices would inflate earnings. The high capex guidance may telegraph high reported earnings.
In either scenario, earnings will increase in the short term. My theory (and it’s just a theory) is that short sellers may wish to wait until the company guides capex lower.
*Disclosure: Short RH via common shares and put options.
I did a quick look at a few other retailers that post their actual sales returns in their SEC filings (WSM, AEO, and NILE). The pattern among those three is that sales returns as a percentage of revenue fluctuates very little. The rapidly-growing online retailer NILE shows the most variation of the three, ranging from 9.11% to 10.60%. RH’s range is from 4.43% to 7.47%. Without the error disclosed in RH’s latest 10-K, the range is from 10.22% to 11.14%.
On LinkedIn, a Restoration Hardware employee states that their department (ocean freight operations) has a consistent annual growth of 12%. This is much lower than the company’s reported
revenue COGS growth (20%+). I would note that RH has been increasingly sourcing more and more of its product from overseas:
- (EDIT: 4/2/2015) The 2011 S-1 states: Based on total dollar volume of purchases for fiscal 2010, approximately 73% of our products were sourced in Asia, the majority of which originated from China, 16% from the United States, 8% from Europe and the remainder from other regions.
- The FY2013 10-K states: Based on total dollar volume of purchases for fiscal 2013, approximately 69% of our products were sourced in Asia, the majority of which originated from China, 26% from the United States and the remainder from other regions.
- The FY2014 10-K states: Based on total dollar volume of purchases for fiscal 2014, approximately 84% of our products were sourced in Asia, the majority of which originated from China, 10% from the United States and the remainder from other regions.
Adjusting for the lower domestic sourcing would suggest that RH’s total overall buying may have grown at less than 12% annualized.
Restoration Hardware’s financial statements paint a picture of very high growth. In the past, the financials were more or less internally consistent. Numbers with a relationship to revenues (taxes paid, contingent rent, actual sales returns, employee count) largely tracked the growth in revenue growth. What’s curious in the latest 10-K is that actual sales returns no longer track reported revenues due to an error identified for FY2013 and FY2012.