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What you didn’t hear on the RH earnings call
Apr 4, 2018
Dennis Scully

Analysts and traders who follow RH, the company formerly known as Restoration Hardware, were given insights into the company’s performance in the fourth quarter on an earnings call last week. But while the call focused primarily on RH’s successes breaking into the hospitality business through its growing in-store restaurant spaces, several rather significant developments for the company didn’t get much—if any—airtime.

It was the first public statement from the company since the start of 2018, and the recent 25 percent decline in the company’s shares suggested that many on Wall Street were feeling apprehensive about RH’s financial state. (Just last year the company embarked on a rather unconventional strategy to bolster its stock price, borrowing $1 billion to repurchase more than 20 million of its own shares on the open market—an all-out assault on short sellers who had helped drive down the stock price by nearly 80 percent.)

Stock traders who profit from the fall in value of RH’s shares aren’t the only demon that CEO Gary Friedman has been battling. He may have been hoping that 2017 would be the year that would erase the memory of the disastrous introduction of RH Modern, which wiped away $3 billion of the company’s market capitalization and led investors to file a class action complaint against the company. Their case alleges that Friedman and his team breached their fiduciary responsibility to shareholders by not properly informing them of all of the issues the company was facing with the RH Modern launch. Although lawyers on behalf of RH had filed a motion to dismiss the case, the Honorable Yvonne Gonzalez Rogers of the U.S. District Court for the Northern District of California denied RH’s motion to dismiss just last month, paving the way for litigation to proceed.

Another line item in the earnings release that got little attention was the $33.7 million charge the company was taking against its earnings for the quarter related to its acquisition of Waterworks. In 2016, RH acquired a controlling interest in the company for approximately $117 million; now, they have recognized what is known in accounting terms as a goodwill impairment—essentially an acknowledgement that an asset being carried on the company’s balance sheet no longer aligns with what the company paid for it.

Goodwill is an intangible asset that is created any time an acquiring company ends up paying more than the book value of a company. It is the portion of the acquisition cost that takes into account things like a company’s reputation or a special patent or exclusive product. Goodwill sits on the acquiring company’s balance sheet as an asset; a goodwill impairment, then, occurs when there is a meaningful reduction in the value of the acquired business. In this case, according to the annual report RH filed with the Securities and Exchange Commission, an updated long-range financial plan in the fourth quarter of last year indicated a reduction of revenues and earnings compared to prior long-range financial plans.

In the press materials that accompanied the earnings release, the numbers were largely as expected: RH reported that its adjusted revenue for the quarter came in at $670 million, and though the number was just shy of Wall Street estimates, it was nearly 14 percent higher than year-ago levels. The company also reported that its adjusted earnings per share came in at $1.69, well ahead of the $1.56 consensus estimate and more than double last year’s fourth quarter.

Traders were relieved by the information presented, and RH’s shares rebounded from some of their recent losses in after-hours trading. Friedman stressed on the call that the company would not be launching any new initiatives in 2018, nor would he be pursuing any new acquisitions in the foreseeable future. Clearly, he has more than enough to contend with already.

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