UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended August 1, 2020July 31, 2021
or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-35720
(Exact name of registrant as specified in its charter)
Delaware |
| 45-3052669 |
(State or other jurisdiction of |
| (I.R.S. Employer |
15 Koch Road |
| 94925 |
(Address of principal executive offices) |
| (Zip Code) |
Registrant’s telephone number, including area code: (415) 924-1005
Securities registered pursuant to Section 12(b) of the Act:
| | ||
---|---|---|---|
Common Stock, $0.0001 par value | | RH | New York Stock Exchange, Inc. |
(Title of each class) | | (Trading symbol) | (Name of each exchange on which registered) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer |
| ☒ |
| Accelerated filer |
| ☐ |
Non-accelerated filer |
| ☐ |
| Smaller reporting company |
| ☐ |
| | | | Emerging growth company | | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of September 4, 2020, 19,514,2063, 2021, 21,413,557 shares of the registrant’s common stock were outstanding.
RH
INDEX TO FORM 10-Q
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6 | ||||
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Notes to Condensed Consolidated Financial Statements (Unaudited) |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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PART I
ItemITEM 1. Financial StatementsFINANCIAL STATEMENTS
RH
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
ASSETS |
| |
|
| |
|
| |
|
| |
|
Current assets: |
| |
|
| |
|
| |
|
| |
|
Cash and cash equivalents | | $ | 17,387 | | $ | 47,658 | | $ | 291,461 | | $ | 100,446 |
Accounts receivable—net | |
| 55,916 | |
| 48,979 | |
| 59,798 | |
| 59,474 |
Merchandise inventories | |
| 487,639 | |
| 438,696 | |
| 645,987 | |
| 544,227 |
Prepaid expense and other current assets | |
| 60,497 | |
| 61,619 | |
| 140,570 | |
| 97,337 |
Total current assets | |
| 621,439 | |
| 596,952 | |
| 1,137,816 | |
| 801,484 |
Property and equipment—net | |
| 1,053,435 | |
| 967,599 | |
| 1,131,501 | |
| 1,077,198 |
Operating lease right-of-use assets | | | 404,508 | | | 410,904 | | | 553,834 | | | 456,164 |
Goodwill | |
| 124,350 | |
| 124,367 | |
| 141,132 | |
| 141,100 |
Tradenames, trademarks and domain names | |
| 66,863 | |
| 86,022 | ||||||
Tradenames, trademarks and other intangible assets | |
| 72,584 | |
| 71,663 | ||||||
Deferred tax assets | |
| 39,013 | |
| 45,005 | |
| 50,047 | |
| 49,924 |
Equity method investments | | | 97,412 | | | 100,603 | ||||||
Other non-current assets | |
| 196,801 | |
| 214,845 | |
| 282,826 | |
| 200,177 |
Total assets | | $ | 2,506,409 | | $ | 2,445,694 | | $ | 3,467,152 | | $ | 2,898,313 |
LIABILITIES AND STOCKHOLDERS’ EQUITY | |
|
| |
|
| |
|
| |
|
|
Current liabilities: | |
|
| |
|
| |
|
| |
|
|
Accounts payable and accrued expenses | | $ | 340,266 | | $ | 330,309 | | $ | 426,785 | | $ | 424,422 |
Deferred revenue and customer deposits | | | 230,089 | |
| 162,433 | | | 397,161 | |
| 280,641 |
Convertible senior notes due 2020—net | | | — | | | 290,532 | ||||||
Convertible senior notes due 2023—net | | | 172,141 | | | 2,354 | ||||||
Convertible senior notes due 2024—net | | | 66,503 | | | — | ||||||
Operating lease liabilities | | | 63,866 | | | 58,924 | | | 74,074 | | | 71,524 |
Other current liabilities | |
| 150,759 | |
| 140,714 | |
| 92,336 | |
| 142,691 |
Total current liabilities | |
| 784,980 | |
| 982,912 | |
| 1,229,000 | |
| 921,632 |
Asset based credit facility | |
| 91,600 | |
| — | |
| — | |
| — |
Equipment promissory notes—net | |
| 26,047 | |
| 31,053 | |
| 2,115 | |
| 14,614 |
Convertible senior notes due 2023—net | |
| 275,837 | |
| 266,658 | |
| 93,867 | |
| 282,956 |
Convertible senior notes due 2024—net | | | 273,100 | | | 264,982 | | | 223,547 | | | 281,454 |
Non-current operating lease liabilities | |
| 406,012 | |
| 409,930 | |
| 542,510 | |
| 448,169 |
Non-current finance lease liabilities | | | 492,136 | | | 442,988 | | | 523,797 | | | 485,481 |
Other non-current obligations | |
| 28,206 | |
| 28,520 | |
| 15,458 | |
| 16,981 |
Total liabilities | |
| 2,377,918 | |
| 2,427,043 | |
| 2,630,294 | |
| 2,451,287 |
Commitments and contingencies (Note 16) | |
| | |
| | |
| | |
| |
Mezzanine equity—convertible senior notes (Note 9) | |
| 30,515 | |
| — | ||||||
Stockholders’ equity: | |
|
| |
|
| |
|
| |
|
|
Preferred stock—$0.0001 par value per share, 10,000,000 shares authorized, no shares issued or outstanding as of August 1, 2020 and February 1, 2020 | |
| — | |
| — | ||||||
Common stock—$0.0001 par value per share, 180,000,000 shares authorized, 19,485,843 shares issued and 19,485,826 shares outstanding as of August 1, 2020; 19,236,681 shares issued and outstanding as of February 1, 2020 | |
| 2 | |
| 2 | ||||||
Preferred stock—$0.0001 par value per share, 10,000,000 shares authorized, 0 shares issued or outstanding as of July 31, 2021 and January 30, 2021 | |
| — | |
| — | ||||||
Common stock—$0.0001 par value per share, 180,000,000 shares authorized, 21,407,717 shares issued and outstanding as of July 31, 2021; 20,995,387 shares issued and outstanding as of January 30, 2021 | |
| 2 | |
| 2 | ||||||
Additional paid-in capital | |
| 444,378 | |
| 430,662 | |
| 583,112 | |
| 581,897 |
Accumulated other comprehensive loss | |
| (1,842) | |
| (2,760) | ||||||
Accumulated deficit | |
| (314,042) | |
| (409,253) | ||||||
Treasury stock—at cost, 17 shares as of August 1, 2020 and 0 shares as of February 1, 2020 | | | (5) | | | — | ||||||
Accumulated other comprehensive income | |
| 3,265 | |
| 2,565 | ||||||
Retained earnings (accumulated deficit) | |
| 219,964 | |
| (137,438) | ||||||
Total stockholders’ equity | |
| 128,491 | |
| 18,651 | |
| 806,343 | |
| 447,026 |
Total liabilities and stockholders’ equity | | $ | 2,506,409 | | $ | 2,445,694 | ||||||
Total liabilities, mezzanine equity and stockholders’ equity | | $ | 3,467,152 | | $ | 2,898,313 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
RH
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 1, | | August 3, | | August 1, | | August 3, | ||||
|
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Net revenues | | $ | 709,282 | | $ | 706,514 | | $ | 1,192,177 | | $ | 1,304,935 |
Cost of goods sold | |
| 376,863 | |
| 411,556 | |
| 660,104 | |
| 777,163 |
Gross profit | |
| 332,419 | |
| 294,958 | |
| 532,073 | |
| 527,772 |
Selling, general and administrative expenses | |
| 195,851 | |
| 190,977 | | | 360,052 | |
| 355,158 |
Income from operations | |
| 136,568 | |
| 103,981 | |
| 172,021 | |
| 172,614 |
Other expenses | | | | | | | |
| | | | |
Interest expense—net | | | 19,418 | | | 24,513 | | | 39,047 | |
| 45,631 |
Tradename impairment | | | — | | | — | | | 20,459 | | | — |
Gain on extinguishment of debt | |
| (152) | |
| (954) | |
| (152) | |
| (954) |
Total other expenses | |
| 19,266 | |
| 23,559 | |
| 59,354 | |
| 44,677 |
Income before income taxes | |
| 117,302 | |
| 80,422 | |
| 112,667 | |
| 127,937 |
Income tax expense | |
| 18,879 | |
| 16,665 | |
| 17,456 | |
| 28,458 |
Net income | | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Weighted-average shares used in computing | |
| 19,386,115 | |
| 18,465,876 | |
| 19,314,479 | |
| 19,221,367 |
Basic net income per share | | $ | 5.08 | | $ | 3.45 | | $ | 4.93 | | $ | 5.18 |
Weighted-average shares used in computing | |
| 26,564,705 | |
| 22,324,112 | |
| 25,383,730 | |
| 23,629,050 |
Diluted net income per share | | $ | 3.71 | | $ | 2.86 | | $ | 3.75 | | $ | 4.21 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
4
RH
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
| | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | ||||||||
| August 1, | | August 3, | | August 1, | | August 3, | ||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Net income | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Net gains (losses) from foreign currency translation |
| 3,290 | | | 490 | |
| 918 | |
| (447) |
Total comprehensive income | $ | 101,713 | | $ | 64,247 | | $ | 96,129 | | $ | 99,032 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
5
RH
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(In thousands, except share amounts)
(Unaudited)
| | | | | | | | | | | | |
| | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||
| | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||
|
| 2021 |
| 2020 |
| 2021 |
| 2020 | ||||
Net revenues | | $ | 988,859 | | $ | 709,282 | | $ | 1,849,651 | | $ | 1,192,177 |
Cost of goods sold | |
| 501,183 | |
| 376,863 | |
| 954,998 | |
| 660,104 |
Gross profit | |
| 487,676 | |
| 332,419 | |
| 894,653 | |
| 532,073 |
Selling, general and administrative expenses | |
| 238,688 | |
| 195,851 | | | 457,777 | |
| 360,052 |
Income from operations | |
| 248,988 | |
| 136,568 | |
| 436,876 | |
| 172,021 |
Other expenses | | | | | | | |
| | | | |
Interest expense—net | | | 13,581 | | | 19,418 | | | 26,889 | |
| 39,047 |
Tradename impairment | | | — | | | — | | | — | | | 20,459 |
(Gain) loss on extinguishment of debt | |
| 3,166 | |
| (152) | |
| 3,271 | |
| (152) |
Total other expenses | |
| 16,747 | |
| 19,266 | |
| 30,160 | |
| 59,354 |
Income before income taxes | |
| 232,241 | |
| 117,302 | |
| 406,716 | |
| 112,667 |
Income tax expense | |
| 3,009 | |
| 18,879 | |
| 44,733 | |
| 17,456 |
Income before equity method investments | | | 229,232 | | | 98,423 | | | 361,983 | | | 95,211 |
Share of equity method investments losses | | | (2,486) | | | — | | | (4,581) | | | — |
Net income | | $ | 226,746 | | $ | 98,423 | | $ | 357,402 | | $ | 95,211 |
Weighted-average shares used in computing basic net income per share | |
| 21,166,638 | |
| 19,386,115 | |
| 21,084,941 | |
| 19,314,479 |
Basic net income per share | | $ | 10.71 | | $ | 5.08 | | $ | 16.95 | | $ | 4.93 |
Weighted-average shares used in computing diluted net income per share | |
| 31,979,098 | |
| 26,564,705 | |
| 31,594,555 | |
| 25,383,730 |
Diluted net income per share | | $ | 7.09 | | $ | 3.71 | | $ | 11.31 | | $ | 3.75 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
4 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
RH
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands) (Unaudited)
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||||||
| | | | | | | | |
| Accumulated |
| Retained | | | | | |
| Total | |||
| | | | | |
| Additional |
| Other |
| Earnings | | | | | |
| Stockholders’ | ||||
|
| Common Stock |
| Paid-In |
| Comprehensive |
| (Accumulated |
| Treasury Stock |
| Equity | ||||||||||
|
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit) |
| Shares |
| Amount |
| (Deficit) | ||||||
Balances—May 2, 2020 |
| 19,264,127 |
| $ | 2 |
| $ | 436,799 |
| $ | (5,132) |
| $ | (412,465) |
| 600 |
| $ | (72) |
| $ | 19,132 |
Stock-based compensation |
| — | | | — | | | 6,755 | | | — | | | — | | — | | | — |
| | 6,755 |
Issuance of restricted stock |
| 3,192 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units |
| 60,006 | | | — | | | (6,437) | | | — | | | — | | — | | | — |
| | (6,437) |
Exercise of stock options |
| 158,518 | | | — | | | 7,328 | | | — | | | — | | — | | | — |
| | 7,328 |
Retirement of treasury stock |
| — | | | — | | | (72) | | | — | | | — | | (600) | | | 72 |
| | — |
Settlement of convertible senior notes | | 1,131,645 | | | — | | | (315,708) | | | — | | | — | | (1,131,645) | | | 315,708 | | | — |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | (1,131,662) | | | — | | | 315,713 | | | — | | | — | | 1,131,662 | | | (315,713) | | | — |
Net income |
| — | | | — | | | — | | | — | | | 98,423 | | — | | | — |
| | 98,423 |
Net gains from foreign currency translation |
| — | | | — | | | — | | | 3,290 | | | — | | — | | | — |
| | 3,290 |
Balances—August 1, 2020 |
| 19,485,826 |
| $ | 2 |
| $ | 444,378 |
| $ | (1,842) |
| $ | (314,042) |
| 17 |
| $ | (5) |
| $ | 128,491 |
| | | | | | | | | | | | | | | | | | | | | | |
Balances—May 4, 2019 |
| 18,357,816 |
| $ | 2 |
| $ | 362,986 |
| $ | (3,270) |
| $ | (356,816) |
| 2,170,196 |
| $ | (250,275) |
| $ | (247,373) |
Stock-based compensation |
| — | | | — | | | 5,191 | | | — | | | — | | — | | | — |
| | 5,191 |
Issuance of restricted stock |
| 7,014 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock |
| 80,400 | | | — | | | (5,984) | | | — | | | — | | — | | | — |
| | (5,984) |
Exercise of stock options |
| 146,491 | | | — | | | 5,997 | | | — | | | — | | — | | | — |
| | 5,997 |
Retirement of treasury stock |
| — | | | — | | | (13,180) | | | — | | | (237,091) | | (2,170,154) | | | 250,271 |
| | — |
Conversion of convertible senior notes |
| 42 | | | — | | | — | | | — | | | — | | (42) | | | 4 |
| | 4 |
Net income |
| — | | | — | | | — | | | — | | | 63,757 | | — | | | — |
| | 63,757 |
Net gains from foreign currency translation |
| — | | | — | | | — | | | 490 | | | — | | — | | | — |
| | 490 |
Balances—August 3, 2019 |
| 18,591,763 |
| $ | 2 |
| $ | 355,010 |
| $ | (2,780) |
| $ | (530,150) |
| — |
| $ | — |
| $ | (177,918) |
| | | | | | | | | | | | |
| | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||
| | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||
| | 2021 |
| 2020 |
| 2021 |
| 2020 | ||||
Net income | | $ | 226,746 | | $ | 98,423 | | $ | 357,402 | | $ | 95,211 |
Net gains (losses) from foreign currency translation | |
| (648) | | | 3,290 | |
| 700 | |
| 918 |
Total comprehensive income | | $ | 226,098 | | $ | 101,713 | | $ | 358,102 | | $ | 96,129 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 5 |
RH
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share amounts) (Unaudited)
| | | | | | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||||||
| | | | | | | | |
| Accumulated |
| Retained | | | | | |
| Total | |||
| | | | | |
| Additional |
| Other |
| Earnings | | | | | |
| Stockholders’ | ||||
|
| Common Stock |
| Paid-In |
| Comprehensive |
| (Accumulated |
| Treasury Stock |
| Equity | ||||||||||
|
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit) |
| Shares |
| Amount |
| (Deficit) | ||||||
Balances—February 1, 2020 |
| 19,236,681 |
| $ | 2 |
| $ | 430,662 |
| $ | (2,760) |
| $ | (409,253) |
| — |
| $ | — |
| $ | 18,651 |
Stock-based compensation |
| — | | | — | | | 12,476 | | | — | | | — | | — | | | — |
| | 12,476 |
Issuance of restricted stock |
| 3,192 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units |
| 70,292 | | | — | | | (6,818) | | | — | | | — | | — | | | — |
| | (6,818) |
Exercise of stock options |
| 176,278 | | | — | | | 8,125 | | | — | | | — | | — | | | — |
| | 8,125 |
Repurchases of common stock |
| (600) | | | — | | | — | | | — | | | — | | 600 | | | (72) |
| | (72) |
Retirement of treasury stock |
| — | | | — | | | (72) | | | — | | | — | | (600) | | | 72 |
| | — |
Settlement of convertible senior notes | | 1,131,645 | | | — | | | (315,708) | | | — | | | — | | (1,131,645) | | | 315,708 | | | — |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | (1,131,662) | | | — | | | 315,713 | | | — | | | — | | 1,131,662 | | | (315,713) | | | — |
Net income |
| — | | | — | | | — | | | — | | | 95,211 | | — | | | — |
| | 95,211 |
Net gains from foreign currency translation |
| — | | | — | | | — | | | 918 | | | — | | — | | | — |
| | 918 |
Balances—August 1, 2020 |
| 19,485,826 |
| $ | 2 |
| $ | 444,378 |
| $ | (1,842) |
| $ | (314,042) |
| 17 |
| $ | (5) |
| $ | 128,491 |
| | | | | | | | | | | | | | | | | | | | | | |
Balances—February 2, 2019 |
| 20,477,813 |
| $ | 2 |
| $ | 356,422 |
| $ | (2,333) |
| $ | (392,538) |
| 2,800 |
| $ | (243) |
| $ | (38,690) |
Stock-based compensation |
| — | | | — | | | 10,779 | | | — | | | — | | — | | | — |
| | 10,779 |
Issuance of restricted stock |
| 7,014 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units |
| 101,641 | | | — | | | (6,234) | | | — | | | — | | — | | | — |
| | (6,234) |
Exercise of stock options |
| 172,649 | | | — | | | 7,223 | | | — | | | — | | — | | | — |
| | 7,223 |
Repurchases of common stock |
| (2,167,396) | | | — | | | — | | | — | | | — | | 2,167,396 | | | (250,032) |
| | (250,032) |
Retirement of treasury stock |
| — | | | — | | | (13,180) | | | — | | | (237,091) | | (2,170,154) | | | 250,271 |
| | — |
Conversion of convertible senior notes |
| 42 | | | — | | | — | | | — | | | — | | (42) | | | 4 |
| | 4 |
Net income |
| — | | | — | | | — | | | — | | | 99,479 | | — | | | — |
| | 99,479 |
Net losses from foreign currency translation |
| — | | | — | | | — | | | (447) | | | — | | — | | | — |
| | (447) |
Balances—August 3, 2019 |
| 18,591,763 |
| $ | 2 |
| $ | 355,010 |
| $ | (2,780) |
| $ | (530,150) |
| — |
| $ | — |
| $ | (177,918) |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | THREE MONTHS ENDED | ||||||||||||||||||||||||
| | | | | | COMMON STOCK | | | | | | | | | | | TREASURY STOCK | | | | ||||||
| | | | | | | | | | | | |
| ACCUMULATED |
| RETAINED | | | | | |
| | |||
| | | | | | | | | |
| ADDITIONAL |
| OTHER |
| EARNINGS | | | | | |
| TOTAL | ||||
| | MEZZANINE | | | |
| PAID-IN |
| COMPREHENSIVE |
| (ACCUMULATED |
| |
| STOCKHOLDERS' | |||||||||||
| | EQUITY | | | SHARES |
| AMOUNT |
| CAPITAL |
| INCOME (LOSS) |
| DEFICIT) |
| SHARES |
| AMOUNT |
| EQUITY | |||||||
Balances—May 1, 2021 | | $ | — | |
| 21,020,538 |
| $ | 2 |
| $ | 597,329 |
| $ | 3,913 |
| $ | (6,782) |
| — |
| $ | — |
| $ | 594,462 |
Stock-based compensation | | | — | |
| — | | | — | | | 10,089 | | | — | | | — | | — | | | — |
| | 10,089 |
Issuance of restricted stock | | | — | |
| 1,260 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units | | | — | |
| 34,891 | | | — | | | (17,721) | | | — | | | — | | — | | | — |
| | (17,721) |
Exercise of stock options | | | — | |
| 351,027 | | | — | | | 24,586 | | | — | | | — | | — | | | — |
| | 24,586 |
Settlement of convertible senior notes | | | — | | | 112,297 | | | — | | | (78,621) | | | — | | | — | | (112,296) | | | 77,965 | | | (656) |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | | — | | | (112,296) | | | — | | | 77,965 | | | — | | | — | | 112,296 | | | (77,965) | | | — |
Reclassification of equity component related to early converted senior notes outstanding | | | 30,515 | |
| — | | | — | | | (30,515) | | | — | | | — | | — | | | — |
| | (30,515) |
Net income | | | — | |
| — | | | — | | | — | | | — | | | 226,746 | | — | | | — |
| | 226,746 |
Net losses from foreign currency translation | | | — | |
| — | | | — | | | — | | | (648) | | | — | | — | | | — |
| | (648) |
Balances—July 31, 2021 | | $ | 30,515 | |
| 21,407,717 |
| $ | 2 |
| $ | 583,112 |
| $ | 3,265 |
| $ | 219,964 |
| — |
| $ | — |
| $ | 806,343 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Balances—May 2, 2020 | | $ | — | |
| 19,264,127 |
| $ | 2 |
| $ | 436,799 |
| $ | (5,132) |
| $ | (412,465) |
| 600 |
| $ | (72) |
| $ | 19,132 |
Stock-based compensation | | | — | |
| — | | | — | | | 6,755 | | | — | | | — | | — | | | — |
| | 6,755 |
Issuance of restricted stock | | | — | |
| 3,192 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units | | | — | |
| 60,006 | | | — | | | (6,437) | | | — | | | — | | — | | | — |
| | (6,437) |
Exercise of stock options | | | — | |
| 158,518 | | | — | | | 7,328 | | | — | | | — | | — | | | — |
| | 7,328 |
Retirement of treasury stock | | | — | |
| — | | | — | | | (72) | | | — | | | — | | (600) | | | 72 |
| | — |
Settlement of convertible senior notes | | | — | | | 1,131,645 | | | — | | | (315,708) | | | — | | | — | | (1,131,645) | | | 315,708 | | | — |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | | — | | | (1,131,662) | | | — | | | 315,713 | | | — | | | — | | 1,131,662 | | | (315,713) | | | — |
Net income | | | — | |
| — | | | — | | | — | | | — | | | 98,423 | | — | | | — |
| | 98,423 |
Net gains from foreign currency translation | | | — | |
| — | | | — | | | — | | | 3,290 | | | — | | — | | | — |
| | 3,290 |
Balances—August 1, 2020 | | $ | — | |
| 19,485,826 |
| $ | 2 |
| $ | 444,378 |
| $ | (1,842) |
| $ | (314,042) |
| 17 |
| $ | (5) |
| $ | 128,491 |
6 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSSTOCKHOLDERS’ EQUITY (continued)
(In thousands) (Unaudited)
(Unaudited)
| | | | | | |
| | Six Months Ended | ||||
| | August 1, | | August 3, | ||
|
| 2020 |
| 2019 | ||
CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | |
Net income | | $ | 95,211 | | $ | 99,479 |
Adjustments to reconcile net income to net cash provided by operating activities: | |
| | |
| |
Depreciation and amortization | |
| 50,212 | |
| 52,510 |
Non-cash operating lease cost | | | 31,355 | | | 33,227 |
Tradename impairment | | | 20,459 | | | — |
Asset impairments | | | 4,783 | | | — |
Loss on sale leaseback transaction | | | 9,352 | | | — |
Amortization of debt discount | |
| 25,378 | |
| 22,962 |
Accretion of debt discount upon settlement of debt | | | (84,003) | | | (70,482) |
Stock-based compensation expense | |
| 12,689 | |
| 10,993 |
Non-cash finance lease interest expense | | | 11,729 | | | 11,186 |
Product recalls | | | 4,780 | | | (2,106) |
Other non-cash items | |
| 2,404 | |
| 1,297 |
Change in assets and liabilities: | |
| | |
| |
Accounts receivable | |
| (6,431) | |
| (504) |
Merchandise inventories | |
| (48,984) | |
| 51,189 |
Prepaid expense and other assets | |
| (10,307) | |
| (2,882) |
Landlord assets under construction—net of tenant allowances | |
| (22,934) | |
| (27,555) |
Accounts payable and accrued expenses | |
| (13,127) | |
| (40,073) |
Deferred revenue and customer deposits | |
| 67,647 | |
| 12,987 |
Other current liabilities | |
| 8,777 | |
| 3,179 |
Current and non-current operating lease liabilities | |
| (18,388) | |
| (44,513) |
Other non-current obligations | |
| (12,327) | |
| (13,761) |
Net cash provided by operating activities | |
| 128,275 | |
| 97,133 |
CASH FLOWS FROM INVESTING ACTIVITIES | |
|
| |
| |
Capital expenditures | |
| (47,531) | |
| (25,283) |
Investments in joint ventures | |
| (3,050) | |
| — |
Proceeds from sale of assets | |
| 25,006 | |
| — |
Net cash used in investing activities | |
| (25,575) | |
| (25,283) |
CASH FLOWS FROM FINANCING ACTIVITIES | |
|
| |
|
|
Borrowings under asset based credit facility | |
| 283,200 | |
| 302,000 |
Repayments under asset based credit facility | |
| (191,600) | |
| (214,500) |
Borrowings under term loans | |
| — | |
| 320,000 |
Borrowings under promissory and equipment security notes | |
| — | |
| 69,000 |
Repayments under promissory and equipment security notes | |
| (5,408) | |
| (4,993) |
Debt issuance costs | |
| — | |
| (4,636) |
Repayments of convertible senior notes | | | (215,846) | | | (278,560) |
Principal payments under finance leases | | | (4,641) | | | (4,399) |
Repurchases of common stock—including commissions | |
| — | |
| (250,032) |
Proceeds from exercise of stock options | |
| 8,125 | |
| 7,223 |
Tax withholdings related to issuance of stock-based awards | | | (6,818) | |
| (6,234) |
Payments under promissory notes related to share repurchases | | | — | |
| (892) |
Net cash used in financing activities | |
| (132,988) | |
| (66,023) |
Effects of foreign currency exchange rate translation | |
| 17 | |
| (75) |
Net increase (decrease) in cash and cash equivalents | |
| (30,271) | |
| 5,752 |
Cash and cash equivalents | |
|
| |
|
|
Beginning of period—cash and cash equivalents | | $ | 47,658 | | $ | 5,803 |
End of period—cash and cash equivalents | | $ | 17,387 | | $ | 11,555 |
Non-cash transactions: | |
| | |
| |
Property and equipment additions in accounts payable and accrued expenses at period-end | | $ | 19,978 | | $ | 10,875 |
Landlord asset additions in accounts payable and accrued expenses at period-end | | | 17,515 | | | 21,055 |
Reclassification of assets from landlord assets under construction to finance lease right-of-use assets | | | 68,441 | | | — |
Shares issued on settlement of convertible senior notes | | | (315,708) | | | — |
Shares received on exercise of call option under bond hedge upon settlement of convertible senior notes | | | 315,713 | | | — |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | SIX MONTHS ENDED | ||||||||||||||||||||||||
| | | | | | COMMON STOCK | | | | | | | | | | | TREASURY STOCK | | | | ||||||
| | | | | | | | | | | | |
| ACCUMULATED |
| RETAINED | | | | | |
| | |||
| | | | | | | | | |
| ADDITIONAL |
| OTHER |
| EARNINGS | | | | | |
| TOTAL | ||||
| | MEZZANINE | | | |
| PAID-IN |
| COMPREHENSIVE |
| (ACCUMULATED |
| |
| STOCKHOLDERS' | |||||||||||
| | EQUITY | | | SHARES |
| AMOUNT |
| CAPITAL |
| INCOME (LOSS) |
| DEFICIT) |
| SHARES |
| AMOUNT |
| EQUITY | |||||||
Balances—January 30, 2021 | | $ | — | | | 20,995,387 | | $ | 2 | | | 581,897 | | $ | 2,565 | | $ | (137,438) | | — | | $ | — | | $ | 447,026 |
Stock-based compensation | | | — | |
| — | | | — | | | 25,289 | | | — | | | — | | — | | | — |
| | 25,289 |
Issuance of restricted stock | | | — | |
| 1,260 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units | | | — | |
| 37,698 | | | — | | | (18,648) | | | — | | | — | | — | | | — |
| | (18,648) |
Exercise of stock options | | | — | |
| 373,369 | | | — | | | 25,979 | | | — | | | — | | — | | | — |
| | 25,979 |
Settlement of convertible senior notes | | | — | | | 119,604 | | | — | | | (82,135) | | | — | | | — | | (119,601) | | | 81,245 | | | (890) |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | | — | | | (119,601) | | | — | | | 81,245 | | | — | | | — | | 119,601 | | | (81,245) | | | — |
Reclassification of equity component related to early converted senior notes outstanding | | | 30,515 | |
| — | | | — | | | (30,515) | | | — | | | — | | — | | | — |
| | (30,515) |
Net income | | | — | |
| — | | | — | | | — | | | — | | | 357,402 | | — | | | — |
| | 357,402 |
Net gains from foreign currency translation | | | — | |
| — | | | — | | | — | | | 700 | | | — | | — | | | — |
| | 700 |
Balances—July 31, 2021 | | $ | 30,515 | |
| 21,407,717 |
| $ | 2 |
| $ | 583,112 |
| $ | 3,265 |
| $ | 219,964 |
| — |
| $ | — |
| $ | 806,343 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Balances—February 1, 2020 | | $ | — | |
| 19,236,681 |
| $ | 2 |
| $ | 430,662 |
| $ | (2,760) |
| $ | (409,253) |
| — |
| $ | — | | | 18,651 |
Stock-based compensation | | | — | |
| — | | | — | | | 12,476 | | | — | | | — | | — | | | — |
| | 12,476 |
Issuance of restricted stock | | | — | |
| 3,192 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units | | | — | |
| 70,292 | | | — | | | (6,818) | | | — | | | — | | — | | | — |
| | (6,818) |
Exercise of stock options | | | — | |
| 176,278 | | | — | | | 8,125 | | | — | | | — | | — | | | — |
| | 8,125 |
Repurchases of common stock | | | — | |
| (600) | | | — | | | — | | | — | | | — | | 600 | | | (72) |
| | (72) |
Retirement of treasury stock | | | — | |
| — | | | — | | | (72) | | | — | | | — | | (600) | | | 72 |
| | — |
Settlement of convertible senior notes | | | — | | | 1,131,645 | | | — | | | (315,708) | | | — | | | — | | (1,131,645) | | | 315,708 |
| | — |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | | — | | | (1,131,662) | | | — | | | 315,713 | | | — | | | — | | 1,131,662 | | | (315,713) |
| | — |
Net income | | | — | |
| — | | | — | | | — | | | — | | | 95,211 | | — | | | — |
| | 95,211 |
Net gains from foreign currency translation | | | — | |
| — | | | — | | | — | | | 918 | | | — | | — | | | — |
| | 918 |
Balances—August 1, 2020 | | $ | — | |
| 19,485,826 |
| $ | 2 |
| $ | 444,378 |
| $ | (1,842) |
| $ | (314,042) |
| 17 |
| $ | (5) |
| $ | 128,491 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 7 |
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
| | | | | | |
---|---|---|---|---|---|---|
| | SIX MONTHS ENDED | ||||
| | JULY 31, | | AUGUST 1, | ||
| | 2021 |
| 2020 | ||
CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | |
Net income | | $ | 357,402 | | $ | 95,211 |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |
| | |
| |
Depreciation and amortization | |
| 46,556 | |
| 50,212 |
Non-cash operating lease cost | | | 35,541 | | | 31,355 |
Tradename impairment | | | — | | | 20,459 |
Asset impairments | | | 7,354 | | | 4,783 |
Loss on sale leaseback transaction | | | — | | | 9,352 |
Amortization of debt discount | |
| 17,461 | |
| 25,378 |
Accretion of debt discount upon settlement of debt | | | (5,070) | | | (84,003) |
Stock-based compensation expense | |
| 25,431 | |
| 12,689 |
Non-cash finance lease interest expense | | | 12,757 | | | 11,729 |
Product recalls | | | 500 | | | 4,780 |
Deferred income taxes | |
| (239) | |
| — |
Loss on extinguishment of debt | | | 3,271 | | | — |
Share of equity method investments losses | | | 4,581 | | | — |
Other non-cash items | |
| (4,069) | |
| 2,404 |
Change in assets and liabilities: | |
| | |
| |
Accounts receivable | |
| (306) | |
| (6,431) |
Merchandise inventories | |
| (101,641) | |
| (48,984) |
Prepaid expense and other assets | |
| (57,919) | |
| (10,307) |
Landlord assets under construction—net of tenant allowances | |
| (43,352) | |
| (22,934) |
Accounts payable and accrued expenses | |
| 6,930 | |
| (13,127) |
Deferred revenue and customer deposits | |
| 116,492 | |
| 67,647 |
Other current liabilities | |
| (51,661) | |
| 8,777 |
Current and non-current operating lease liabilities | |
| (38,933) | |
| (18,388) |
Other non-current obligations | |
| (14,368) | |
| (12,327) |
Net cash provided by operating activities | |
| 316,718 | |
| 128,275 |
8 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(In thousands) (Unaudited)
| | | | | | |
---|---|---|---|---|---|---|
| | SIX MONTHS ENDED | ||||
| | JULY 31, | | AUGUST 1, | ||
| | 2021 |
| 2020 | ||
CASH FLOWS FROM INVESTING ACTIVITIES | |
|
| |
| |
Capital expenditures | |
| (82,138) | |
| (47,531) |
Equity method investments | |
| (1,939) | |
| (3,050) |
Proceeds from sale of assets | |
| — | |
| 25,006 |
Net cash used in investing activities | |
| (84,077) | |
| (25,575) |
CASH FLOWS FROM FINANCING ACTIVITIES | |
|
| |
|
|
Borrowings under asset based credit facility | |
| — | |
| 283,200 |
Repayments under asset based credit facility | |
| — | |
| (191,600) |
Repayments under promissory and equipment security notes | |
| (11,446) | |
| (5,408) |
Debt issuance costs | |
| (3,634) | |
| — |
Repayments of convertible senior notes | | | (28,111) | | | (215,846) |
Principal payments under finance leases | | | (7,108) | | | (4,641) |
Proceeds from exercise of stock options | |
| 25,979 | |
| 8,125 |
Tax withholdings related to issuance of stock-based awards | | | (18,648) | |
| (6,818) |
Net cash used in financing activities | |
| (42,968) | |
| (132,988) |
Effects of foreign currency exchange rate translation | |
| 92 | |
| 17 |
Net increase (decrease) in cash and cash equivalents and restricted cash equivalents | |
| 189,765 | |
| (30,271) |
Cash and cash equivalents and restricted cash equivalents | |
| | |
|
|
Beginning of period—cash and cash equivalents | |
| 100,446 | |
| 47,658 |
Beginning of period—restricted cash equivalents (acquisition related escrow deposits) | |
| 6,625 | |
| — |
Beginning of period—cash and cash equivalents | | $ | 107,071 | | $ | 47,658 |
End of period—cash and cash equivalents | |
| 291,461 | |
| 17,387 |
End of period—restricted cash equivalents (acquisition related escrow deposits) | |
| 5,375 | |
| — |
End of period—cash and cash equivalents and restricted cash equivalents | | $ | 296,836 | | $ | 17,387 |
Non-cash transactions: | |
| | |
| |
Property and equipment additions in accounts payable and accrued expenses at period-end | | $ | 14,696 | | $ | 19,978 |
Landlord asset additions in accounts payable and accrued expenses at period-end | | | 32,290 | | | 17,515 |
Reclassification of assets from landlord assets under construction to finance lease right-of-use assets | | | — | | | 68,441 |
Shares issued on settlement of convertible senior notes | | | (82,135) | | | (315,708) |
Shares received on exercise of call option under bond hedge upon settlement of convertible senior notes | | | 81,245 | | | 315,713 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 9 |
7
RH
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—THE COMPANY
Nature of Business
RH, a Delaware corporation, together with its subsidiaries (collectively, “we,” “us,” or the “Company”), is a leading luxury retailer in the home furnishings retailermarket that offers merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings. These products are sold through our stores, catalogsretail locations, websites and websites.Source Books.
As of August 1, 2020,July 31, 2021, we operated a total of 6866 RH Galleries and 38 RH outlet stores in 3130 states, the District of Columbia and Canada, as well as 1514 Waterworks showroomsShowrooms throughout the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared from our records and, in our senior leadership team’s opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state our financial position as of August 1, 2020,July 31, 2021, and the results of operations for the three and six months ended July 31, 2021 and August 1, 2020 and August 3, 2019.2020. Our current fiscal year, which consists of 52 weeks, ends on January 30, 202129, 2022 (“fiscal 2020”2021”).
Certain information and disclosures normally included in the notes to annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted for purposes of these interim condensed consolidated financial statements.
The preparation of our condensed consolidated financial statements in conformity with GAAP requires managementour senior leadership team to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and such differences could be material to the condensed consolidated financial statements.
We have assessed various accounting estimates and other matters, including those that require consideration of forecasted financial information, in context of the unknown future impacts of the novel coronavirus disease (“COVID-19” or “the pandemic”) using information that is reasonably available to us at this time. The accounting estimates and other matters we have assessed include, but were not limited to, sales return reserve, inventory reserve, allowance for doubtful accounts, goodwill, intangible and other long-lived assets. Our current assessment of these estimates areis included in our condensed consolidated financial statements as of and for the three and six months ended August 1, 2020 and August 3, 2019.July 31, 2021. As additional information becomes available to us, our future assessment of these estimates, including our expectations at the time regarding the duration, scope and severity of the pandemic, as well as other factors, could materially and adversely impact our condensed consolidated financial statements in future reporting periods.
These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020January 30, 2021 (the “2019“2020 Form 10-K”).
The results of operations for the three and six months ended August 1, 2020 and August 3, 2019July 31, 2021 presented herein are not necessarily indicative of the results to be expected for the full fiscal year. Our business, like the businesses of retailers generally, is subject to uncertainty surrounding the financial impact of the novel coronavirus diseasepandemic as discussed in Recent Developments—COVID-19 below.
10 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
8
Recent Developments—COVID-19
The initial wave of the COVID-19 outbreak starting in Marchthe first quarter of fiscal 2020 caused disruption to our business operations as we temporarily closed all of our retail locations on March 17, 2020. While our retail locations were substantially closed at the end ofbeginning in the first quarter of fiscal quarter on May 2, 2020, during2020. The pandemic has continued since the second fiscal quarter we have reopened substantially all of our retail locations. As ofinitial outbreak and has included spikes and outbreaks in various locations around the end of the second fiscal quarter on August 1, 2020 we had reopened 66 out of 68 of our Galleries, all of our Outlets, and 8 out of 10 of our restaurants. In addition, our business has substantially recovered during the second fiscal quarterworld including as a result of both the reopening of most of our retail locations and also due to strong consumer demand for our products.
Our global supply chain has not fully recovered from the impactnew strains of the COVID-19 dislocation. DespiteCOVID virus such as the strong growth in consumer demand in our business during the second fiscal quarter, revenue growth has lagged the increase in customer orders. As manufacturing and inventory receipts catch up with this backlog, we expect this demand will convert into revenue in the next several quarters as our supply chain recalibrates to the new level of our business.
While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
“Delta” variant. In our initial response to the COVID-19 health crisis, we undertook immediate adjustments to our business operations including temporarily closing all of our retail locations and Restaurants, curtailing expenses, and delaying investments.investments including scaling back some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second through fourth fiscal quarter.quarters of fiscal 2020 as a result of both the reopening of most of our retail locations and also strong consumer demand for our products. Operational restrictions related to the pandemic affecting our Galleries and hospitality locations continued to fluctuate through the second quarter of 2021 based upon changes in local conditions and regulations. As of September 3, 2021, all of our Galleries, Outlets and Restaurants were open.
Our overall customer demand in specific markets has generally correlated favorably with our customers’ ability to experience our Galleries and Outlets. Although our business has strengthened during the period from the second quarter of fiscal 2020 and continuing into fiscal 2021, consumer spending patterns may shift away from spending on the home and home-related categories, such as home furnishings, as pandemic restrictions are lifted and consumers return to pre-COVID consumption trends, such as spending on travel and leisure and other activities. In addition, various constraints in our merchandise supply chain have resulted in some delays in our ability to convert business demand into revenues at normal historical rates. We anticipate that the backlog of orders for merchandise from our vendors, coupled with business conditions related to the pandemic, will continue to makeadversely affect the capacity of our vendors and supply chain to meet our merchandise demand levels during fiscal 2021. It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand and as a result the exact timing cannot be accurately predicted due to ongoing uncertainty of the continuing impact of the pandemic on our global supply chain. In particular, business circumstances and operational conditions in numerous international locations where our vendors operate are subject to ongoing risks, and regions in which our vendors have production facilities, most notably Vietnam, have experienced various surges in outbreaks and, in some cases, facility closures related to the pandemic. As a result, the ongoing nature of the pandemic may continue to adversely affect our business operations in various jurisdictions, which could, in turn, have a negative impact on our vendors and supply chain, and therefore, our business.
Our decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business including any lasting effects of COVID-19. While we deferred some capital expenditures and other expenses in responsefurther developments with respect to the initial circumstances ofpandemic. For more information, refer to the COVID-19 health crisis, we are continuing both long term investments and shorter term initiatives necessary to supportsection entitled Risk Factors in our business and the recent increase in consumer demand.
2020 Form 10-K.
NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS
Cloud ComputingNew Accounting Standards or Updates Adopted
Income Taxes
In August 2018,December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-15—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which amends Accounting Standards Update 2015-05—Customers Accounting for Fees in a Cloud Computing Agreement. The amendments in this ASU more closely align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license).
We adopted the ASU as of February 2, 2020 using a prospective method. We capitalize implementation costs related to hosted arrangements, which typically include three-year service terms with additional renewal periods generally ranging from one to three years. The related assets are recorded within other non-current assets on our condensed consolidated balance sheets, net of accumulated amortization for assets placed in service. The amortization of assets placed in service is recorded in either cost of goods sold or selling, general and administrative expenses, consistent with the costs of the hosting arrangement, on the condensed consolidated statements of income on a straight-line basis over the term of the hosting arrangement, which includes reasonably certain renewal periods. The adoption of the ASU did not have a material effect on our condensed consolidated financial statements. Refer to Note 3—Prepaid Expense and Other Assets.
9
Current Expected Credit Losses
In June 2016, the FASB issued Accounting Standards Update 2016-13—Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments and also issued subsequent amendments to the initial guidance through ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, ASU 2020-02 and ASU 2020-03 (collectively, the “ASUs”). The ASUs amend the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology to result in more timely recognition of losses. The guidance in the ASUs applies to financial assets measured at amortized cost basis, such as receivables that result from revenue transactions.
Accounts receivable consist primarily of receivables from our credit card processors for sales transactions, receivables related to our contract business and other miscellaneous receivables. Accounts receivable is presented net of allowance for doubtful accounts as a result of the assessment of the collectability of customer accounts, which is recorded by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts was $3.0 million and $2.2 million as of August 1, 2020 and February 1, 2020, respectively.
We adopted the ASUs as of February 2, 2020 using a modified retrospective transition method, which requires a cumulative-effect adjustment, if any, to the opening balance of retained earnings. We did not recognize a cumulative-effect adjustment upon adoption as the adoption of the ASUs did not have a material effect on our condensed consolidated financial statements.
Income Taxes
In December 2019, the FASB issued Accounting Standards Update 2019-12—Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.Taxes. The ASU impacts various topic areas within ASC 740, including accounting for taxes under hybrid tax regimes, accounting for increases in goodwill, allocation of tax amounts to separate company financial statements within a group that files a consolidated tax return, intra period tax allocation, interim period accounting, and accounting for ownership changes in investments, among other minor codification improvements. The guidance in this ASU becomesbecame effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We will adoptadopted this standard in the first quarter of fiscal 2021 and are currently evaluating the effects that the adoption of this ASU willdid not have an impact on our condensed consolidated financial statements.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 11 |
New Accounting Standards or Updates Not Yet Adopted
Convertible Instruments and Contracts in an Entity’s Own Equity
In August 2020, the FASB issued Accounting Standards UpdateASU 2020-06—Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The ASU simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. Specifically, the ASU removes the separation models for convertible debt with a cash conversion feature or convertible instruments with a beneficial conversion feature. As a result, after adopting the ASU’s guidance, we will not separately present in equity an embedded conversion feature of such debt. Instead, we will account for a convertible debt instrument wholly as debt unless (i) a convertible instrument contains features that require bifurcation as a derivative or (ii) a convertible debt instrument was issued at a substantial premium. Additionally, the ASU removes certain conditions for equity classification related to contracts in an entity’s own equity (e.g., warrants) and amends certain guidance related to the computation of earnings per share for convertible instruments and contracts on an entity’s own equity. The guidance in this ASU can be adopted using either a full or modified retrospective approach and becomes effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021. We will adopt the ASU in the first quarter of fiscal 2022, and we are currently evaluating the effects that the adoption of this ASU will have on our condensed consolidated financial statements, including the timing and adoption approach.
10
NOTE 3—PREPAID EXPENSE AND OTHER ASSETS
Prepaid expense and other current assets consist of the following (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Prepaid expense and other current assets | | $ | 29,625 | | $ | 30,875 | | $ | 53,970 | | $ | 42,079 |
Vendor deposits | | | 27,796 | | | 12,519 | ||||||
Capitalized catalog costs | |
| 13,128 | |
| 13,740 | |
| 17,606 | |
| 19,067 |
Vendor deposits | | | 12,518 | | | 11,258 | ||||||
Federal and state tax receivable | | | 15,863 | | | — | ||||||
Promissory notes receivable, including interest (1) | |
| 14,083 | |
| 13,569 | ||||||
Right of return asset for merchandise | |
| 5,226 | |
| 5,746 | |
| 6,502 | |
| 7,453 |
Acquisition related escrow deposits | | | 4,750 | | | 2,650 | ||||||
Total prepaid expense and other current assets | | $ | 60,497 | | $ | 61,619 | | $ | 140,570 | | $ | 97,337 |
(1) | Represents promissory notes, including principal and accrued interest, due from a related party. Refer to Note 5—Equity Method Investments. |
12 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Other non-current assets consist of the following (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Landlord assets under construction | | $ | 109,549 | | $ | 138,315 | ||||||
Deposits on asset under construction | |
| 60,000 | |
| 60,000 | ||||||
Promissory note receivable, including interest | |
| 5,479 | |
| 5,354 | ||||||
Landlord assets under construction—net of tenant allowances | | $ | 201,375 | | $ | 135,531 | ||||||
Initial direct costs prior to lease commencement | | | 46,531 | |
| 36,770 | ||||||
Capitalized cloud computing costs—net (1) | | | 10,300 | | | 7,254 | ||||||
Other deposits | |
| 5,289 | |
| 5,157 | |
| 7,534 | |
| 5,287 |
Investments in joint ventures (Note 5) | | | 3,050 | | | — | ||||||
Deferred financing fees | |
| 2,063 | |
| 2,602 | |
| 4,235 | |
| 1,525 |
Acquisition related escrow deposits | | | 1,030 | | | 3,975 | ||||||
Other non-current assets | |
| 11,371 | |
| 3,417 | |
| 11,821 | |
| 9,835 |
Total other non-current assets | | $ | 196,801 | | $ | 214,845 | | $ | 282,826 | | $ | 200,177 |
(1) | Presented net of accumulated amortization of $1.9 million and $0.5 million as of July 31, 2021 and January 30, 2021, respectively. |
NOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND DOMAIN NAMESOTHER INTANGIBLE ASSETS
The following sets forth the goodwill, tradenames, trademarks and domain namesother intangible assets activity for the RH Segment and Waterworks (See Note 17—Segment Reporting), for the six months ended August 1, 2020July 31, 2021 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
| | |
| |
| |
| Foreign |
| | |
| | |
| |
| FOREIGN |
| | | |||||
| | February 1, | | | | | | Currency | | August 1, | | JANUARY 30, | | | | CURRENCY | | JULY 31, | |||||||||
| | 2020 | | Acquisition | | Impairment (1) | | Translation | | 2020 | | 2021 | | ADDITIONS | | TRANSLATION | | 2021 | |||||||||
RH Segment |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Goodwill | | $ | 124,367 | | $ | — | | $ | — | | $ | (17) | | $ | 124,350 | | $ | 141,100 | | $ | — | | $ | 32 | | $ | 141,132 |
Tradenames, trademarks and domain names | |
| 48,563 | |
| 1,300 | |
| — | |
| — | |
| 49,863 | ||||||||||||
| |
|
| |
|
| |
|
| |
|
| |
| | ||||||||||||
Tradenames, trademarks and other intangible assets | |
| 54,663 | |
| 921 | |
| — | |
| 55,584 | |||||||||||||||
Waterworks (1) | |
|
| |
|
| |
|
| |
|
| |
| | |
| | |
|
| |
|
| |
| |
Tradename (2) | |
| 37,459 | |
| — | |
| (20,459) | |
| — | |
| 17,000 | |
| 17,000 | |
| — | |
| — | |
| 17,000 |
(1) | Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $17.4 million and $33.7 million of impairment recorded in fiscal 2018 and fiscal 2017, respectively. |
(2) | Presented net of an impairment charge of $35.1 million, with $20.5 million |
11
Waterworks Tradename Impairment
During the first quarter of fiscal 2020, as a result of the COVID-19 health crisis and related Showroom closures and slowdown in construction activity, management updated the long-term financial projections for the Waterworks reporting unit which resulted in a significant decrease in forecasted revenues and profitability. We performed an interim impairment test on the Waterworks tradename and the estimated future cash flows of the Waterworks reporting unit indicated the fair value of the tradename asset was below its carrying amount. We determined fair value utilizing a discounted cash flow methodology under the relief-from-royalty method. Significant assumptions under this method include forecasted net revenues and the estimated royalty rate, expressed as a percentage of revenues, in addition to the discount rate based on the weighted-average cost of capital. Based on the impairment test performed, we concluded that the Waterworks reporting unit tradename was impaired as of the first quarter of fiscalMay 2, 2020.
As a result, we recognized a $20.5 million non-cash impairment charge for the Waterworks reporting unit tradename during the first quarterthree months ended May 2, 2020.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 13 |
NOTE 5—EQUITY METHOD INVESTMENTS
Equity method investments represent our 50 percent membership interests in 3 privately-held limited liability companies in Aspen, Colorado (each, an “Aspen LLC” and collectively, the “Aspen LLCs” or the “equity method investments”) which were formed during fiscal 2020, and the carrying value of the Waterworks indefinite-lived tradename asset after the impairment charge was $17.0 million.
NOTE 5—INVESTMENTS IN JOINT VENTURES
During the second quarter of fiscal 2020, we entered into transactions whereby we became a 50 percent member of 2 privately held limited liability companies (the “JVs”) that each have the purpose of acquiring, constructing, developing, operating and ultimately selling certain specified real estate projects. The JVs are financed by capital contributions from the members on an as-needed basis, as well as via third-party debt secured by the underlying real estate projects and guaranteed by a member other than us. The JVs are considered variable interest entities because the equity investment at risk is not sufficient to permit the JV’s to finance their activities without additional financial support. A variable interest entity is consolidated by its primary beneficiary, which is defined as the party who has a controlling financial interest in the variable interest entity.Aspen, Colorado. As we do not have a controlling financial interest in the JVsAspen LLCs but have the ability to exercise significant influence over the operating and financial policies of the JVs,Aspen LLCs, we recognizedaccount for these investments using the equity method.method of accounting.
AsDuring the three and six months ended July 31, 2021, we recorded our proportionate share of August 1, 2020, we had $3.1equity method investments losses of $2.5 million of investments in the JVs,and $4.6 million, respectively, which is included in other non-current assetsthe condensed consolidated statements of income and a corresponding decrease to the carrying value of equity method investments on the condensed consolidated balance sheets.sheets as of July 31, 2021.
As of July 31, 2021, $14.1 million of promissory notes receivable, inclusive of accrued interest, are outstanding with the managing member, which are included in prepaid expense and other current assets on the condensed consolidated balance sheets. These promissory notes are expected to be settled in cash and not converted into additional equity investment in the Aspen LLCs.
An affiliate of the managing member of the Aspen LLCs became the landlord of an additional RH Design Gallery in the first quarter of fiscal 2021.
NOTE 6—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accounts payable and accrued expenses consist of the following (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Accounts payable | | $ | 182,944 | | $ | 180,714 | | $ | 238,607 | | $ | 224,906 |
Accrued compensation | |
| 59,218 | |
| 64,659 | |
| 71,748 | |
| 84,860 |
Accrued freight and duty | |
| 21,620 | |
| 25,170 | |
| 30,685 | |
| 29,754 |
Accrued sales taxes | |
| 21,327 | |
| 19,618 | |
| 27,158 | |
| 23,706 |
Accrued occupancy | |
| 14,086 | |
| 12,067 | |
| 26,680 | |
| 17,671 |
Accrued professional fees | |
| 9,135 | |
| 5,383 | ||||||
Accrued catalog costs | |
| 3,979 | |
| 4,354 | ||||||
Deferred consideration for asset purchase | | | 13,739 | | | — | | | — | | | 14,387 |
Accrued catalog costs | |
| 6,346 | |
| 8,267 | ||||||
Accrued professional fees | |
| 4,810 | |
| 4,381 | ||||||
Other accrued expenses | |
| 16,176 | |
| 15,433 | |
| 18,793 | |
| 19,401 |
Total accounts payable and accrued expenses | | $ | 340,266 | | $ | 330,309 | | $ | 426,785 | | $ | 424,422 |
14 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
12
Other current liabilities consist of the following (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Promissory notes on asset under construction | | $ | 53,000 | | $ | 53,000 | ||||||
Current portion of equipment promissory notes | | | 22,235 | |
| 22,009 | | $ | 24,072 | | $ | 22,747 |
Allowance for sales returns | | | 18,795 | | | 19,206 | | | 23,574 | | | 25,559 |
Unredeemed gift card and merchandise credit liability | |
| 17,597 | |
| 16,625 | |
| 20,322 | |
| 19,173 |
Federal and state taxes payable | |
| 15,198 | |
| 13,591 | ||||||
Finance lease liabilities | | | 14,117 | | | 9,188 | | | 14,231 | | | 14,671 |
Product recall reserve | |
| 6,429 | |
| 2,055 | |
| 5,780 | |
| 8,181 |
Federal and state tax payable | | | — | | | 49,539 | ||||||
Other current liabilities | |
| 3,388 | |
| 5,040 | |
| 4,357 | |
| 2,821 |
Total other current liabilities | | $ | 150,759 | | $ | 140,714 | | $ | 92,336 | | $ | 142,691 |
Contract Liabilities
We defer revenue associated with merchandise delivered via the home-delivery channel. We expect that substantially all of the deferred revenue and customer deposits and deferred membership fees as of August 1, 2020July 31, 2021 will be recognized within the next six months (with the exception of cancelled orders) as the performance obligations are satisfied. New membership fees are recorded as deferred revenue when collected from customers and recognized as revenue based on expected product revenues over the annual membership period, based on historical trends of sales to members. Membership renewal fees are recorded as deferred revenue when collected from customers and are recognized as revenue on a straight-line basis over the membership period, or one year.
In addition, we defer revenue when cash payments are received in advance of performance for unsatisfied obligations related to our gift cards and merchandise credits.cards. During the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recognized $6.5$4.9 million and $4.6$6.5 million, respectively, of revenue related to previous deferrals related to our gift cards and merchandise credits.cards. During the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recognized $10.6$9.8 million and $9.3$10.6 million, respectively, of revenue related to previous deferrals related to our gift cards and merchandise credits.cards. During the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recorded gift card breakage of $0.2$0.5 million and $0.4$0.2 million, respectively. During both the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recorded gift card breakage of $0.9 million and $0.8 million.million, respectively. We expect that approximately 70%75% of the remaining gift card and merchandise credit liabilities as of August 1, 2020July 31, 2021 will be recognized within the next twelve months aswhen the gift cards are redeemed by customers.
NOTE 7—OTHER NON-CURRENT OBLIGATIONS
Other non-current obligations consist of the following (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Notes payable for share repurchases | | $ | 18,813 | | $ | 18,741 | ||||||
Deferred payroll taxes | | $ | 4,461 | | $ | 4,461 | ||||||
Rollover units and profit interests (1) | |
| 3,277 | |
| 3,064 | |
| 3,632 | |
| 3,490 |
Unrecognized tax benefits | |
| 3,098 | |
| 3,020 | |
| 3,346 | |
| 3,114 |
Other non-current obligations | |
| 3,018 | |
| 3,695 | |
| 4,019 | |
| 5,916 |
Total other non-current obligations | | $ | 28,206 | | $ | 28,520 | | $ | 15,458 | | $ | 16,981 |
(1) | Represents rollover units and profit interests associated with the acquisition of Waterworks. Refer to Note 15—Stock-Based Compensation. |
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 15 |
NOTE 8—LEASES
Lease costs—net consist of the following (in thousands):
| | | | | | | | | | | |
| THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||
| JULY 31, |
| AUGUST 1, | | JULY 31, |
| AUGUST 1, | ||||
| 2021 |
| 2020 | | 2021 |
| 2020 | ||||
Operating lease cost (1) | $ | 25,590 | | $ | 20,181 |
| $ | 49,157 | | $ | 40,907 |
Finance lease costs | | | | | | | | | | | |
Amortization of leased assets (1) | | 10,796 | | | 10,125 | | | 21,714 | | | 19,713 |
Interest on lease liabilities (2) | | 6,607 | | | 5,948 | | | 12,757 | | | 11,729 |
Variable lease costs (3) | | 7,913 | | | 3,920 | | | 16,340 | | | 7,480 |
Sublease income (4) | | (1,136) | | | (2,119) | | | (2,318) | | | (4,694) |
Total lease costs—net | $ | 49,770 | | $ | 38,055 | | $ | 97,650 | | $ | 75,135 |
(1) | Operating lease costs and amortization of finance lease right-of-use assets are included in cost of goods sold or selling, general and administrative expenses on the condensed consolidated statements of income based on our accounting policy. Refer to Note 3—Significant Accounting Policies in the 2020 Form 10-K. |
(2) | Included in interest expense—net on the condensed consolidated statements of income. |
(3) | Represents variable lease payments under operating and finance lease agreements. The amounts primarily represent contingent rent based on a percentage of retail sales over contractual levels of $5.6 million and $2.2 for the three months ended July 31, 2021 and August 1, 2020, respectively, and $11.9 million and $4.2 million for the six months ended July 31, 2021 and August 1, 2020, respectively. Other variable costs, which include single lease cost related to variable lease payments based on an index or rate that were not included in the measurement of the initial lease liability and right-of-use asset, were not material in any period. |
(4) | Included in selling, general and administrative expenses on the condensed consolidated statements of income. |
16 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
13
NOTE 8—LEASES
Lease costs—net consist of the following (in thousands):
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 1, |
| August 3, | | August 1, |
| August 3, | ||||
|
| 2020 |
| 2019 | | 2020 |
| 2019 | ||||
Operating lease cost (1) | | $ | 20,181 | | $ | 23,259 |
| $ | 40,907 | | $ | 42,376 |
| | | | | | | | | | | | |
Finance lease costs | | | | | | | | | | | | |
Amortization of leased assets (1) | | | 10,125 | | | 9,235 | | | 19,713 | | | 18,087 |
Interest on lease liabilities (2) | | | 5,948 | | | 5,672 | | | 11,729 | | | 11,186 |
| | | | | | | | | | | | |
Variable lease costs (3) | | | 3,920 | | | 5,791 | | | 7,480 | | | 11,398 |
Sublease income (4) | | | (2,119) | | | (1,507) | | | (4,694) | | | (4,789) |
Total lease costs—net | | $ | 38,055 | | $ | 42,450 | | $ | 75,135 | | $ | 78,258 |
Lease right-of-use assets and lease liabilities consist of the following (in thousands):
| | | | | | | | | | | | | | | | |
| | | | August 1, | | February 1, | | | | JULY 31, | | JANUARY 30, | ||||
| | | | 2020 | | 2020 | | |
| 2021 |
| 2021 | ||||
| | Balance Sheet Classification | | | | | | | | Balance Sheet Classification | | | | | | |
Assets | | | | | | | | | | | | | | | | |
Operating leases | | Operating lease right-of-use assets | | $ | 404,508 | | $ | 410,904 | | Operating lease right-of-use assets | | $ | 553,834 | | $ | 456,164 |
Finance leases (1)(2) | | Property and equipment—net | | | 732,047 | | | 642,117 | | Property and equipment—net | | | 731,620 | | | 711,804 |
Total lease right-of-use assets | | | | $ | 1,136,555 | | $ | 1,053,021 | | | | $ | 1,285,454 | | $ | 1,167,968 |
| | | | | | | | | ||||||||
Liabilities | | | | | | | | | | | | | | | | |
Current (3) | | | | | | | | | | | | | | | | |
Operating leases | | Operating lease liabilities | | $ | 63,866 | | $ | 58,924 | | Operating lease liabilities | | $ | 74,074 | | $ | 71,524 |
Finance leases | | Other current liabilities | | | 14,117 | | | 9,188 | | Other current liabilities | | | 14,231 | | | 14,671 |
Total lease liabilities—current | | | | | 77,983 | | | 68,112 | | | | | 88,305 | | | 86,195 |
| | | | | | | | | ||||||||
Non-current | | | | | | | | | | | | | | | | |
Operating leases | | Non-current operating lease liabilities | | | 406,012 | | | 409,930 | | Non-current operating lease liabilities | | | 542,510 | | | 448,169 |
Finance leases | | Non-current finance lease liabilities | | | 492,136 | | | 442,988 | | Non-current finance lease liabilities | | | 523,797 | | | 485,481 |
Total lease liabilities—non-current | | | | | 898,148 | | | 852,918 | | | | | 1,066,307 | | | 933,650 |
Total lease liabilities | | | | $ | 976,131 | | $ | 921,030 | | | | $ | 1,154,612 | | $ | 1,019,845 |
(1) | Finance lease right-of-use assets include capitalized amounts related to our completed construction activities to design and build leased assets, which are reclassified from other non-current assets upon lease commencement. |
(2) | Finance lease right-of-use assets are recorded net of accumulated amortization of |
(3) | Current portion of lease liabilities represents the reduction of the related lease liability over the next 12 months. |
The maturities of lease liabilities are as follows as of July 31, 2021 (in thousands):
| | | | | | | | | | | |
| | | | OPERATING | | FINANCE | | | |||
FISCAL YEAR | | |
| LEASES |
| LEASES |
| TOTAL | |||
Remainder of fiscal 2021 | | | | $ | 48,990 | | $ | 19,982 | | $ | 68,972 |
2022 | | | | | 93,163 | | | 40,356 | | | 133,519 |
2023 | | | | | 84,601 | | | 40,770 | | | 125,371 |
2024 | | | | | 78,145 | | | 41,162 | | | 119,307 |
2025 | | | | | 77,631 | | | 42,377 | | | 120,008 |
2026 | | | | | 74,864 | | | 43,156 | | | 118,020 |
Thereafter | | | | | 292,992 | | | 673,365 | | | 966,357 |
Total lease payments (1)(2) | | | | | 750,386 | | | 901,168 | | | 1,651,554 |
Less—imputed interest (3) | | | | | (133,802) | | | (363,140) | | | (496,942) |
Present value of lease liabilities | | | | $ | 616,584 | | $ | 538,028 | | $ | 1,154,612 |
(1) | Total lease payments include future obligations for renewal options that are reasonably certain to be exercised and are included in the measurement of the lease liability. Total lease payments exclude $656.8 million of legally binding payments under the non-cancellable term for leases signed but not yet commenced under our accounting policy as of July 31, 2021, of which $12.3 million, $32.6 million, $37.8 million, $39.3 million, $40.2 million and $38.9 million will be paid in fiscal 2021, fiscal 2022, fiscal 2023, fiscal 2024, fiscal 2025 and fiscal 2026, respectively, and $455.7 million will be paid subsequent to fiscal 2026. |
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 17 |
14
The maturities of lease liabilities are as follows as of August 1, 2020 (in thousands):
| | | | | | | | | |
Fiscal year | | Operating | | Finance | | Total | |||
Remainder of fiscal 2020 | | $ | 41,441 | | $ | 19,253 | | $ | 60,694 |
2021 | | | 75,412 | | | 38,591 | | | 114,003 |
2022 | | | 64,215 | | | 39,009 | | | 103,224 |
2023 | | | 58,766 | | | 39,423 | | | 98,189 |
2024 | | | 54,712 | | | 39,910 | | | 94,622 |
2025 | | | 54,447 | | | 41,135 | | | 95,582 |
Thereafter | | | 218,467 | | | 594,040 | | | 812,507 |
Total lease payments (1)(2) | | | 567,460 | | | 811,361 | | | 1,378,821 |
Less—imputed interest (3) | | | (97,582) | | | (305,108) | | | (402,690) |
Present value of lease liabilities | | $ | 469,878 | | $ | 506,253 | | $ | 976,131 |
(2) | Excludes future commitments under short-term lease agreements of |
(3) | Calculated using the |
Supplemental information related to leases consists of the following:
| | | | | | | | | | | | | | | | | |
| | | | Six Months Ended | SIX MONTHS ENDED | ||||||||||||
| | | | August 1, | | August 3, | JULY 31, | | AUGUST 1, | ||||||||
| | | | 2020 |
| 2019 | 2021 | | 2020 | ||||||||
Weighted-average remaining lease term (years) | | | | | | | | | | | | | | | | | |
Operating leases | | | | | | | | | 9.0 | | | 8.9 | | 9.4 | | | 9.0 |
Finance leases | | | | | | | | | 18.8 | | | 18.9 | | 20.0 | | | 18.8 |
| | | | | | | | | | | | | |||||
Weighted-average discount rate | | | | | | | | | | | | | | | | | |
Operating leases | | | | | | | | | 3.91% | | | 3.81% | | 3.98% | | | 3.91% |
Finance leases | | | | | | | | | 5.04% | | | 5.26% | | 5.04% | | | 5.04% |
Other information related to leases consists of the following (in thousands):
| | | | | | |
| | Six Months Ended | ||||
| | August 1, |
| August 3, | ||
| | 2020 |
| 2019 | ||
Cash paid for amounts included in the measurement of lease liabilities | | | | | | |
Operating cash flows from operating leases | | $ | (26,413) | | $ | (53,670) |
Operating cash flows from finance leases | | | (6,767) | | | (11,186) |
Financing cash flows from finance leases | | | (4,641) | | | (4,399) |
Total cash outflows from leases | | $ | (37,821) | | $ | (69,255) |
| | | | | | |
Lease right-of-use assets obtained in exchange for lease obligations—net of lease terminations (non-cash) | | | | | | |
Operating leases | | $ | 27,880 | | $ | 17,997 |
Finance leases | | | 57,286 | | | 13,839 |
15
| | | | | |
| SIX MONTHS ENDED | ||||
| JULY 31, | | AUGUST 1, | ||
| 2021 | | 2020 | ||
Cash paid for amounts included in the measurement of lease liabilities | | | | | |
Operating cash flows from operating leases | $ | (50,914) | | $ | (26,413) |
Operating cash flows from finance leases | | (12,943) | | | (6,767) |
Financing cash flows from finance leases | | (7,108) | | | (4,641) |
Total cash outflows from leases | $ | (70,965) | | $ | (37,821) |
Lease right-of-use assets obtained in exchange for lease obligations—net of lease terminations (non-cash) | | | | | |
Operating leases | $ | 134,763 | | $ | 27,880 |
Finance leases | | 44,432 | | | 57,286 |
Build-to-Suit Asset
During the second quarter of fiscal 2021, we opened the Dallas Design Gallery. During the construction period of this Design Gallery, we were the “deemed owner” for accounting purposes and classified the construction costs as build-to-suit asset within property & equipment—net on our condensed consolidated balance sheets. Upon construction completion and lease commencement, we performed a sale-leaseback analysis and determined that we cannot derecognize the build-to-suit asset. Therefore, the asset will remain classified as a build-to-suit asset within property and equipment—net and will depreciate over the term of the useful life of the asset.
Sale-Leaseback Transaction
In JulyDuring the second quarter of fiscal 2020, we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $25.5 million, which qualified for sale-leaseback accounting in accordance with ASC 842. Concurrently with the sale, we entered into an operating leaseback arrangement with an initial lease term of 20 years and a renewal option for an additional 10 years. We recognized a loss related to the execution of the sale transaction of $9.4 million in the three months ended August 1,second quarter of fiscal 2020, which was recorded in selling, general and administrative expenses on the condensed consolidated statements of income.
Long-lived Asset Impairment
During the first quarter of fiscal 2020, we recognized long-lived asset impairment charges of $3.5 million related to one1 RH Baby & Child and TEEN Gallery and one1 Waterworks showroom, comprised of lease right-of-use asset impairment of $2.0 million and property and equipment impairment of $1.5 million.
18 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
NOTE 9—CONVERTIBLE SENIOR NOTES
$350 million 0.00% Convertible Senior Notes due 2024
In September 2019, we issued in a private offering $350 million principal amount of 0.00% convertible senior notes due 2024 (the “2024 Notes”). The 2024 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2024 Notes will mature on September 15, 2024, unless earlier purchased by us or converted. The 2024 Notes will not bear interest, except that the 2024 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2024 Notes. The 2024 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events are also considered “events of default” under the 2024 Notes, which may result in the acceleration of the maturity of the 2024 Notes, as described in the indenture governing the 2024 Notes. Events of default under the indenture for the 2024 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2024 Notes then outstanding.
The initial conversion rate applicable to the 2024 Notes is 4.7304 shares of common stock per $1,000 principal amount of 2024 Notes, or a total of approximately 1.656 million shares for the total $350 million principal amount. This initial conversion rate is equivalent to an initial conversion price of approximately $211.40 per share, which represents a 25% premium to the $169.12 closing share price on the day the 2024 Notes were priced. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the 2024 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2024 Notes in connection with such make-whole fundamental change.
Prior to June 15, 2024, the 2024 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after December 31, 2019, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the 5 consecutive business day period after any 10 consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2024 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As
16
of August 1,The first condition was satisfied from the calendar quarter ended September 30, 2020 none of these conditions have occurredthrough the calendar quarter ended June 30, 2021 and, as a result, theaccordingly, holders were eligible to convert their 2024 Notes were not convertible as of August 1, 2020.beginning in the calendar quarter ended December 31, 2020 and are currently eligible to convert their 2024 Notes during the calendar quarter ending September 30, 2021. On and after June 15, 2024, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2024 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2024 Notes will be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. If the Company has not delivered a notice of its election of settlement method prior to the final conversion period it will be deemed to have elected combination settlement with a dollar amount per note to be received upon conversion of $1,000.
We may not redeem the 2024 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require us to purchase all or a portion of their 2024 Notes for cash at a price equal to 100% of the principal amount of the 2024 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 19 |
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 the issuance of the 2024 Notes, we separated the 2024 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2024 Notes and the fair value of the liability component of the 2024 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 5.74% over the expected life of the 2024 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
Debt issuance costs related to the 2024 Notes were comprised of discounts upon original issuance of $3.5 million and third party offering costs of $1.3 million. In accounting for the debt issuance costs related to the issuance of the 2024 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2024 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.
Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2024 balance on the condensed consolidated balance sheets. During both the three months ended July 31, 2021 and August 1, 2020, we recorded $0.1 million related to the amortization of debt issuance costs related to the 2024 Notes. During both the six months ended July 31, 2021 and August 1, 2020, we recorded $0.3 million related to the amortization of debt issuance costs related to the 2024 Notes.
During the second quarter of fiscal 2021, holders of $67.0 million in aggregate principal amount of the 2024 Notes elected to exercise the early conversion option and we elected to settle such conversions using combination settlement comprised of cash equal to the principal amount of the 2024 Notes converted and shares of our common stock for the remaining conversion value. In accordance with the provisions for such combination settlements, the conversion value is to be determined based on the average conversion value over a 45 trading day observation period. As of July 31, 2021, the observation periods of these converted 2024 Notes had not been completed and, as a result, these converted 2024 Notes remain outstanding as of July 31, 2021. During the third quarter of fiscal 2021, we expect to pay $67.0 million in cash and to deliver shares of common stock to settle the early conversion of these 2024 Notes, net of the shares of common stock we expect to receive from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2024 Notes as described below. Accordingly, as of July 31, 2021, we reclassified $67.0 million of the outstanding principal balance to current liabilities, as well as reclassified $11.0 million of the equity component of the 2024 Notes to mezzanine equity from permanent equity on our condensed consolidated balance sheets and statements of stockholders’ equity, representing the difference between the current portion of aggregate principal of our converted 2024 Notes required to be settled in cash based on our irrevocable elections and the current portion of the carrying value of the converted 2024 Notes outstanding as of July 31, 2021. As the settlement of conversion of the remainder of the 2024 Notes will be made, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock, the remaining liability for the 2024 Notes is classified as a non-current obligation on our condensed consolidated balance sheets.
20 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
The carrying value of the 2024 Notes, excluding the discounts upon original issuance and third party offering costs, is as follows (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Liability component |
| |
|
| |
|
| |
|
| |
|
Principal | | $ | 350,000 | | $ | 350,000 | | $ | 350,000 | | $ | 350,000 |
Less: Debt discount | |
| (73,839) | |
| (81,634) | |
| (57,563) | |
| (65,818) |
Net carrying amount | | $ | 276,161 | | $ | 268,366 | | $ | 292,437 | | $ | 284,182 |
Equity component | | $ | 87,252 | | $ | 87,252 | | $ | 87,252 | | $ | 87,252 |
(1) |
(2) | Includes $11.0 million in mezzanine equity and the remaining amount in additional paid-in capital on the condensed consolidated balance sheets as of July 31, 2021. As of January 30, 2021, the full amount is included in additional paid-in capital on the condensed consolidated balance sheets. |
We recorded interest expense of $4.2 million and $3.9 million for the amortization of the debt discount related to the 2024 Notes during the three months ended July 31, 2021 and August 1, 2020, respectively. We recorded interest expense of $8.3 million and $7.8 million for the amortization of the debt discount related to the 2024 Notes during the three and six months ended July 31, 2021 and August 1, 2020, respectively.
17
2024 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2024 Notes and exercise of the overallotment option in September 2019, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 1.656 million shares of our common stock at a price of approximately $211.40 per share. The total cost of the convertible note hedge transactions was approximately $91.4 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.656 million shares of our common stock at a price of $338.24 per share, which represents a 100% premium to the $169.12 closing share price on the day the 2024 Notes were priced. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 3.3 million shares of common stock (which cap may also be subject to adjustment). We received approximately $50.2 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately $338.24 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.
We recorded a deferred tax liability of $21.7 million in connection with the debt discount associated with the 2024 Notes and recorded a deferred tax asset of $22.7 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 21 |
$335 million 0.00% Convertible Senior Notes due 2023
In June 2018, we issued in a private offering $300 million principal amount of 0.00% convertible senior notes due 2023 and issued an additional $35 million principal amount in connection with the overallotment option granted to the initial purchasers as part of the offering (collectively, the “2023 Notes”). The 2023 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2023 Notes will mature on June 15, 2023, unless earlier purchased by us or converted. The 2023 Notes will not bear interest, except that the 2023 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2023 Notes. The 2023 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events are also considered “events of default” under the 2023 Notes, which may result in the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes. Events of default under the indenture for the 2023 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2023 Notes then outstanding.
The initial conversion rate applicable to the 2023 Notes is 5.1640 shares of common stock per $1,000 principal amount of 2023 Notes, which is equivalent to an initial conversion price of approximately $193.65 per share. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the 2023 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2023 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2023, the 2023 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2018, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the 5 consecutive business day period after any 10
18
consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2023 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of August 1,The first condition was satisfied from the calendar quarter ended September 30, 2020 none of these conditions have occurredthrough the calendar quarter ended June 30, 2021 and, as a result, theaccordingly, holders were eligible to convert their 2023 Notes were not convertible as of August 1, 2020.beginning in the calendar quarter ended December 31, 2020 and are currently eligible to convert their 2023 Notes during the calendar quarter ending September 30, 2021. On and after March 15, 2023, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2023 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2023 Notes will be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. If the Company has not delivered a notice of its election of settlement method prior to the final conversion period it will be deemed to have elected combination settlement with a dollar amount per note to be received upon conversion of $1,000.
We may not redeem the 2023 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require us to purchase all or a portion of their 2023 Notes for cash at a price equal to 100% of the principal amount of the 2023 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.
22 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
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 the issuance of the 2023 Notes, we separated the 2023 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2023 Notes and the fair value of the liability component of the 2023 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 6.35% over the expected life of the 2023 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
Debt issuance costs related to the 2023 Notes were comprised of discounts upon original issuance of $1.7 million and third party offering costs of $4.6 million. In accounting for the debt issuance costs related to the issuance of the 2023 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2023 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.
Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2023 balance on the condensed consolidated balance sheets. During both the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recorded $0.3 million related to the amortization of debt issuance costs. During both the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recorded $0.5 million related to the amortization of debt issuance costs.
In December 2020, holders of $2.4 million in aggregate principal amount of the 2023 Notes elected early conversion at the option of the noteholders. During the three months ended May 1, 2021, we paid $2.4 million in cash and delivered 7,307 shares of common stock to settle the early conversion of these 2023 Notes. As a result, we recognized a loss on extinguishment of the liability component of $0.1 million in the three months ended May 1, 2021. We also received 7,305 shares of common stock from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2023 Notes as described below, and therefore, on a net basis issued 2 shares of our common stock in respect to such settlement of the converted 2023 Notes.
During the second quarter of fiscal 2021, holders of $30.8 million in aggregate principal amount of the 2023 Notes elected to exercise the early conversion option and we elected to settle such conversions using combination settlement comprised of cash equal to the principal amount of the 2023 Notes converted and shares of our common stock for the remaining conversion value. During the three months ended July 31, 2021, we paid $30.8 million in cash and delivered 112,297 shares of common stock to settle the early conversion of these 2023 Notes. As a result, we recognized a loss on extinguishment of $3.2 million in the three months ended July 31, 2021. We also received 112,296 shares of common stock from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2023 Notes as described below, and therefore, on a net basis issued 1 share of our common stock in respect to such settlement of the converted 2023 Notes.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 23 |
During the second quarter of fiscal 2021, holders of $173.5 million in aggregate principal amount of the 2023 Notes elected to exercise the conversion option and we elected to settle such conversions using combination settlement comprised of cash equal to the principal amount of the 2023 Notes converted and shares of our common stock for the remaining conversion value. In accordance with the provisions for such combination settlements, the conversion value is to be determined based on the average conversion value over a 45 trading day observation period. As of July 31, 2021, the observation periods of these converted 2023 Notes had not been completed and, as a result, these converted 2023 Notes remain outstanding as of July 31, 2021. During the third quarter of fiscal 2021, we expect to pay $173.5 million in cash and to deliver shares of common stock to settle the early conversion of these 2023 Notes, net of the shares of common stock we expect to receive from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2023 Notes as described below. Accordingly, as of July 31, 2021, we reclassified $173.5 million of the outstanding principal balance to current liabilities, as well as reclassified $19.5 million of the equity component of the 2023 Notes to mezzanine equity from permanent equity on our condensed consolidated balance sheets as of July 31, 2021, representing the difference between the current portion of aggregate principal of our converted 2023 Notes required to be settled in cash based on our irrevocable elections and the current portion of the carrying value of the converted 2023 Notes outstanding as of July 31, 2021. As the settlement of conversion of the remainder of the 2023 Notes will be made, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock, the remaining liability for the 2023 Notes is classified as a non-current obligation on our condensed consolidated balance sheets.
The carrying values of the 2023 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows (in thousands):
| | | | | | | | | | | | |
|
| August 1, |
| February 1, |
| JULY 31, |
| JANUARY 30, | ||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||
Liability component |
| |
|
| |
|
| |
|
| |
|
Principal | | $ | 335,000 | | $ | 335,000 | | $ | 301,819 | | $ | 335,000 |
Less: Debt discount | |
| (56,036) | |
| (64,729) | |
| (33,914) | |
| (47,064) |
Net carrying amount | | $ | 278,964 | | $ | 270,271 | | $ | 267,905 | | $ | 287,936 |
Equity component | | $ | 90,990 | | $ | 90,990 | | $ | 90,099 | | $ | 90,990 |
(1) |
(2) | Includes $19.5 million in mezzanine equity and the remaining amount in additional paid-in capital on the condensed consolidated balance sheets as of July 31, 2021. As of January 30, 2021, the full amount is included in additional paid-in capital on the condensed consolidated balance sheets. |
19
We recorded interest expense of $4.4$4.6 million and $4.1$4.4 million for the amortization of the debt discount related to the 2023 Notes during the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. We recorded interest expense of $8.7$9.2 million and $8.2$8.7 million for the amortization of the debt discount related to the 2023 Notes during the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively.
24 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
2023 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2023 Notes and exercise of the overallotment option in June 2018, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 1.730 million shares of our common stock at a price of approximately $193.65 per share. The total cost of the convertible note hedge transactions was approximately $91.9 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.730 million shares of our common stock at a price of $309.84 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 3.5 million shares of common stock (which cap may also be subject to adjustment). We received approximately $51.0 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2023 Notes until our common stock is above approximately $309.84 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.
We recorded a deferred tax liability of $22.3 million in connection with the debt discount associated with the 2023 Notes and recorded a deferred tax asset of $22.5 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.
$300 million 0.00% Convertible Senior Notes due 2020
In June 2015, we issued in a private offering $250 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, we issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of our June 2015 offering (collectively, the “2020 Notes”). The 2020 Notes were governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2020 Notes did not bear interest, except that the 2020 Notes were subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2020 Notes. The 2020 Notes were unsecured obligations and did not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events were also considered “events of default” under the 2020 Notes, which could have resulted in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes. The 2020 Notes were guaranteed by our primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The 2020 Notes matured on July 15, 2020.
The initial conversion rate applicable to the 2020 Notes was 8.4656 shares of common stock per $1,000 principal amount of 2020 Notes, which was equivalent to an initial conversion price of approximately $118.13 per share. The conversion rate was subject to adjustment upon the occurrence of certain specified events, but was not adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the 2020 Notes, we would, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elected to convert its 2020 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2020, the 2020 Notes were convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2015, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the 5 consecutive business day period after any 10 consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of
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2020 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. The first condition was satisfied during the calendar quarter ended December 31, 2019 and, accordingly, holders were eligible to convert their 2020 Notes during the calendar quarter ending March 31, 2020. In addition, on and after March 15, 2020, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders could convert all or a portion of their 2020 Notes at any time.
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 the issuance of the 2020 Notes, we separated the 2020 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the liability component of the 2020 Notes. The debt discount was amortized to interest expense using an effective interest rate of 6.47% over the expected life of the 2020 Notes. The equity component was not remeasured as it continued to meet the conditions for equity classification.
Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $3.8 million and third party offering costs of $2.3 million. In accounting for the debt issuance costs related to the issuance of the 2020 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component were amortized to interest expense using the effective interest method over the expected life of the 2020 Notes, and debt issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.
Discounts and third party offering costs attributable to the liability component were recorded as a contra-liability and were presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets. During both the three months ended August 1, 2020 and August 3, 2019, we recorded $0.3 million related to the amortization of debt issuance costs. During both the six months ended August 1, 2020 and August 3, 2019, we recorded $0.6 million related to the amortization of debt issuance costs.
In May 2020, $9.4 million in aggregate principal amount of 2020 Notes were converted at the option of the noteholders. We paid $9.2 million in cash and delivered 14,927 shares of common stock to settle the converted 2020 Notes. As a result, we recognized a gain on extinguishment of the liability component of $0.2 million in the three months ended August 1, 2020. We also received 14,927 shares of common stock from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes as described below, and therefore, on a net basis did not issue any shares of our common stock in respect to such settlement of the 2020 Notes.
In July 2020, upon the maturity of the 2020 Notes, the remaining $290.6 million in aggregate principal amount of the 2020 Notes were converted at the option of the noteholders. We paid $290.6 million in cash and delivered 1,116,718 shares of common stock to settle the converted 2020 Notes. NaN gain or loss arose on extinguishment of the liability component. We also received 1,116,735 shares of common stock from the exercise of the remainder of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes as described below, and therefore, on a net basis received 17 shares of our common stock (which were recorded as treasury stock within the condensed consolidated statements of stockholders’ equity) in respect to such settlement of the 2020 Notes.
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As of August 1, 2020, the 2020 Notes are 0 longer outstanding. As of February 1, 2020, the carrying values of the 2020 Notes, excluding the discounts upon original issuance and third party offering costs, was as follows (in thousands):
| | | |
|
| February 1, | |
| | 2020 | |
Liability component |
| |
|
Principal | | $ | 300,000 |
Less: Debt discount | |
| (8,890) |
Net carrying amount | | $ | 291,110 |
Equity component (1) | | $ | 84,003 |
We recorded interest expense of $4.2 million and $4.5 million for the amortization of the debt discount related to the 2020 Notes during the three months ended August 1, 2020 and August 3, 2019, respectively. We recorded interest expense of $8.9 million for the amortization of the debt discount related to the 2020 Notes during both the six months ended August 1, 2020 and August 3, 2019.
2020 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment option in July 2015, we entered into convertible note hedge transactions whereby we had the option to purchase a total of approximately 2.540 million shares of our common stock at a price of approximately $118.13 per share. The total cost of the convertible note hedge transactions was approximately $68.3 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.540 million shares of our common stock at a strike price of $189.00 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 5.1 million shares of common stock (which cap may also be subject to adjustment). We received approximately $30.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants were intended to offset any actual earnings dilution from the conversion of the 2020 Notes until our common stock is above approximately $189.00 per share. As these transactions met certain accounting criteria, the convertible note hedges and warrants were recorded in stockholders’ equity, not accounted for as derivatives and not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.
As a result of the operation of the bond hedge in connection with the maturity of the 2020 Notes, we were not required to issue any new shares to settle the notes as these shares were delivered to us under the terms of the bond hedge. The bond hedge was exercised in connection with the maturity date of the 2020 Notes. The warrants will expire through January 2021. To the extent they are exercised prior to expiration, the warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants.
We recorded a deferred tax liability of $32.8 million in connection with the debt discount associated with the 2020 Notes and recorded a deferred tax asset of $26.6 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in non-current deferred tax assets on the condensed consolidated balance sheets. There is no deferred tax asset or liability remaining as of August 1, 2020 due to the maturity of the 2020 Notes.
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NOTE 10—CREDIT FACILITIES
The outstanding balances under our credit facilities were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | ||||||||||||||||||
| | JULY 31, | | JANUARY 30, | ||||||||||||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | 2021 | | 2021 | ||||||||||||||
| | August 1, | | February 1, | | | | UNAMORTIZED | | | | | | UNAMORTIZED | | | ||||||||||||||||||||
| | 2020 | | 2020 | | | | | DEBT | | NET | | | | | DEBT | | NET | ||||||||||||||||||
| | Outstanding | | Unamortized Debt | | Net Carrying | | Outstanding | | Unamortized Debt | | Net Carrying | | OUTSTANDING | | ISSUANCE | | CARRYING | | OUTSTANDING | | ISSUANCE | | CARRYING | ||||||||||||
|
| Amount |
| Issuance Costs |
| Amount |
| Amount |
| Issuance Costs |
| Amount | | AMOUNT |
| COSTS |
| AMOUNT |
| AMOUNT |
| COSTS |
| AMOUNT | ||||||||||||
Asset based credit facility (1) | | $ | 91,600 | | $ | — | | $ | 91,600 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — |
Equipment promissory notes (2) |
| | 48,523 |
| | (240) |
| | 48,283 |
| | 53,372 |
| | (310) |
| | 53,062 |
| | 26,288 | | | (101) | | | 26,187 |
| | 37,532 |
| | (171) |
| | 37,361 |
Total credit facilities | | $ | 140,123 | | $ | (240) | | $ | 139,883 | | $ | 53,372 | | $ | (310) | | $ | 53,062 | | $ | 26,288 | | $ | (101) | | $ | 26,187 | | $ | 37,532 | | $ | (171) | | $ | 37,361 |
(1) | Deferred financing fees associated with the asset based credit facility as of |
(2) | Represents total equipment security notes secured by certain of our property and equipment, of which |
Asset Based Credit Facility
In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into athe ninth amended and restated credit agreement with Bank of America, N.A., as administrative agent and collateral agent (“First Lien Administrative Agent”), and certain other lenders (the(as amended prior to June 28, 2017, the “Original Credit Agreement”).
On June 28, 2017, Restoration Hardware, Inc. entered into anthe eleventh amended and restated credit agreement (as amended prior to July 29, 2021, the “Credit Agreement”) among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., variouscertain subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and Bank of America, N.A. as administrative agent and collateral agent (“First Lien Administrative Agent”),Agent, which amended and restated the Original Credit Agreement.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 25 |
On July 29, 2021, Restoration Hardware, Inc. entered into the twelfth amended and restated credit agreement (as amended, the “Amended Credit Agreement”) among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., certain subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and First Lien Administrative Agent, which amended and restated the Credit Agreement. The Amended Credit Agreement has a revolving line of credit with initial availability of up to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0$300.0 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600.0 million to up to $800.0$900.0 million if and to the extent the lenders whether existing lenders or new lenders, agree to increaserevise their credit commitments. In addition, thecommitments to encompass a larger facility. The Amended Credit Agreement established an $80.0provides that the $300.0 million last in, last out (“LILO”)accordion, or a portion thereof, may be added as a first-in, last-out term loan facility if and to the extent the lenders revise their credit commitments for such facility. The Amended Credit Agreement further provides the borrowers may request a European sub-credit facility under the revolving line of credit or under the accordion feature for borrowing by certain European subsidiaries of RH if certain conditions set out in the Amended Credit Agreement are met. The maturity date of the Amended Credit Agreement is June 28, 2022.
On April 4, 2019, Restoration Hardware, Inc., entered into a third amendment to the Credit Agreement (the “Third Amendment”). The Third Amendment, among other things, (a) established a $120.0 million first in, last out (“FILO”) term loan facility, which amount was fully borrowed as of April 4, 2019 and which incurs interest at a rate that is 1.25% greater than the interest rate applicable to the revolving loans provided for under the Credit Agreement at any time, (b) provided for additional permitted indebtedness, as defined in the Credit Agreement, that the loan parties can incur, and (c) modified the borrowing availability under the Credit Agreement in certain circumstances.
We repaid the full amount of the FILO term loan as of February 1, 2020. As a result of the repayment, we incurred a $0.8 million loss on extinguishment of debt in fiscal 2019, which represents the acceleration of amortization of debt issuance costs. We did not incur any prepayment penalties upon the early extinguishment of the FILO term loan.
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On May 31, 2019, Restoration Hardware, Inc. entered into a fourth amendment to the Credit Agreement (the “Fourth Amendment”). The Fourth Amendment, among other things, amends the Credit Agreement to (a) extend the time to deliver monthly financial statements to the lenders for the fiscal months ending February 2019 and March 2019 until June 19, 2019, (b) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter, and (c) waive any default or event of default under the Credit Agreement relating to the delivery of monthly financial statements or other information to lenders for the fiscal months ending February 2019 and March 2019.July 29, 2026.
The availability of credit at any given time under the Amended Credit Agreement is limitedwill be constrained by reference tothe terms and conditions of the Amended Credit Agreement, including the amount of collateral available, a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable. As a result ofreceivable, and other restrictions contained in the borrowing base formula, actual borrowing availability under the revolving line of credit could be less than the stated amount of the revolving line of credit (as reduced by the actual borrowings and outstanding letters of credit under the revolving line of credit).Amended Credit Agreement. All obligations under the Amended Credit Agreement are secured by substantially allsubstantial assets of the assets,loan parties, including accounts receivable, inventory, intangible assets, property, equipment, goodsreceivables and fixturescertain types of Restoration Hardware, Inc., Restoration Hardware Canada, Inc., RH US, LLC, Waterworks Operating Co., LLC and Waterworks IP Co., LLC.intellectual property.
Borrowings under the revolving line of credit (other than swing line loans, which are subject to interest at the borrowers’base rate) are subject to interest, at the borrower’s option, at either the bank’s referencebase rate or London Inter-bank Offered Rate (“LIBOR”) (or, in the case of the revolving line of credit,Canadian borrowings, the Bank of America “BA” Rate“BA Rate” or the Canadian“Canadian Prime Rate,Rate”, as such terms are defined in the Amended Credit Agreement, for the Canadian borrowings denominated in Canadian dollars, or the United States“U.S. Index RateRate”, as such term is defined in the Amended Credit Agreement, or LIBOR for Canadian borrowings denominated in United States dollars) plus an applicable margin rate, in each case.
The Amended Credit Agreement contains various restrictive and affirmative covenants, including among others,required financial reporting, limitations on the ability to incurgrant liens, make loans or other investments, incur additional debt, issue additional equity, merge or consolidate with or into another person, sell assets, pay dividends or make other distributions or enter into transactions with affiliates, along with other restrictions and limitations typicalsimilar to those frequently found in credit agreements of this type and size.
The Amended Credit Agreement also contains various affirmativedoes not contain any significant financial ratio covenants includingor coverage ratio covenants other than a consolidated fixed charge coverage ratio (“FCCR”) covenant based on the obligation to deliver noticeratio of (i) consolidated EBITDA to the First Lien Administrative Agent following the Company’s obtaining knowledgeamount of any matter that has resulted or could reasonably be expected to result in a “Material Adverse Effect” (as(ii) debt service costs plus certain other amounts, including dividends and distributions and prepayments of debt as defined in the Credit Agreement).
In addition, under theAmended Credit Agreement we are required to meet specified financial ratios(the “FCCR Covenant”). The FCCR Covenant only applies in order to undertake certain actions, and we may be required to maintain certain levels of excess availability or meet a specified consolidated fixed-charge coverage ratio (“FCCR”). Subject to certain exceptions,limited circumstances, including when the trigger for the FCCR occurs if the domesticunused availability under the revolving line of credit is less thanAmended Credit Agreement drops below the greater of (i)(A) $40.0 million and (ii)(B) an amount based on 10% of the lesser of (x)total borrowing availability at the domestic revolving commitments under the Credit Agreementtime. The FCCR Covenant ratio is set at 1.0 and (y) the domestic revolving borrowing base. If the availability under the Credit Agreement is less than the foregoing amount, then Restoration Hardware, Inc. is required subject to certain exceptions to maintain an FCCR of at least one to one.measured on a trailing twelve-month basis. As of August 1, 2020,July 31, 2021, Restoration Hardware, Inc. was in compliance with all applicable financial covenants of the Credit Agreement.FCCR Covenant.
The Amended Credit Agreement requires a daily sweep of all cash receipts and collections to prepay the loans under the agreement while (i) an event of default exists or (ii) when the unused availability under the revolving line of credit for extensions of credit is less thanAmended Credit Agreement drops below the greater of (A) $40.0 million and (B) an amount based on 10% of the sum of (a)total borrowing availability at the lesser of (x) the aggregate revolving commitments under the Credit Agreement and (y) the aggregate revolving borrowing base, plus (b) the lesser of (x) the then outstanding amount of the LILO term loan or (y) the LILO term loan borrowing base.time.
The Amended Credit Agreement includes customary events of default, in certain cases subject to customary periods to cure. The occurrence of an event of default, following the applicable cure period, would permit the lenders to, among other things, terminate any existing commitments under the Amended Credit Agreement and declare the unpaid principal, accrued and unpaid interest and all other amounts payable under the Amended Credit Agreement to be immediately due and payable.
26 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
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As of August 1, 2020,July 31, 2021, we had $91.6 million0 outstanding borrowings under the revolving credit facility portion of the Amended Credit Agreement. The availability of the revolving line of credit at any given time under the Amended Credit Agreement is limited by reference tothe terms and conditions of the Amended Credit Agreement, including the amount of collateral available, a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable.receivable, and other restrictions contained in the Amended Credit Agreement. As a result, of the borrowing base formula, actual borrowing availability under the revolving line of credit could be less than the stated amount of the revolving line of credit (as reduced by the actual borrowings and outstanding letters of credit under the revolving line of credit). UnderAs of July 31, 2021, the terms of such provisions, the amount available for borrowing under the revolving line of credit borrowing base that could be available pursuant tounder the Amended Credit Agreement as of August 1, 2020 was $259.2$389.1 million, net of $14.5$20.1 million in outstanding letters of credit.
Second Lien Credit Agreement
On April 10, 2019, Restoration Hardware, Inc., entered into a credit agreement, dated as of April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom were managed or advised by either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and its affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to a second lien term loan in an aggregate principal amount equal to $200.0 million with a maturity date of April 9, 2024 (the “Second Lien Term Loan”). The Second Lien Term Loan of $200.0 million in principal was repaid in full on September 20, 2019.
The Second Lien Term Loan bore interest at an annual rate generally based on the LIBOR plus 6.50%. This rate was a floating rate that reset periodically based upon changes in LIBOR rates during the life of the Second Lien Term Loan. At the date of the initial borrowing, the rate was set at one-month LIBOR plus 6.50%.
Intercreditor Agreement
On April 10, 2019, in connection with the Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an Intercreditor Agreement (the “Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the First Lien Administrative Agent and the Second Lien Administrative Agent. The Intercreditor Agreement established various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the Credit Agreement and the Second Lien Credit Agreement without the consent of the other party. The Intercreditor Agreement was terminated upon repayment of the Second Lien Term Loan on September 20, 2019.
Equipment Loan Facility
On September 5, 2017, Restoration Hardware, Inc. entered into a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC (“BAL”) pursuant to which BAL and we agreed that BAL would finance certain equipment of ours from time to time, with each such equipment financing to be evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each equipment loan is secured by a purchase money security interest in the financed equipment. The maturity dates of the equipment security notes vary, but generally have a maturity of three or four years. We are required to make monthly installment payments under the equipment security notes.
NOTE 11—FAIR VALUE MEASUREMENTS
Certain financial assets and liabilities are required to be carried at fair value. Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. In determining the fair value, we utilize market data or assumptions that we believe market participants would use in pricing the asset or liability, which would maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, including assumptions about risk and the risks inherent in the inputs of the valuation technique.
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The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Financial instruments with readily available active quoted prices for which fair value can be measured generally will have a higher degree of pricing observability and a lesser degree of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.
Our financial assets and liabilities measured and reported at fair value are classified and disclosed in one of the following categories:
Level 1—Quoted prices are available in active markets for identical investments as of the reporting date.
Level 2—Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies.
Level 3—Pricing inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment. The inputs used in the determination of fair value require significant management judgment or estimation.
A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 27 |
Fair Value Measurements—Measurements—Recurring
Amounts reported as cash and equivalents receivables,, accounts receivables—net, and accounts payable and accrued expenses approximate fair value due to the short-term nature of activity within these accounts. The estimated fair value of the asset based credit facility approximates cost as the interest rate associated with the facility is variable and resets frequently. The estimated fair value and carrying value of the 2020 Notes, 2023 Notes and 2024 Notes were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | August 1, | | February 1, | | JULY 31, | | JANUARY 30, | ||||||||||||||||
| | 2020 | | 2020 | | 2021 | | 2021 | ||||||||||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying |
| FAIR |
| CARRYING |
| FAIR |
| CARRYING | ||||||||
| | Value | | Value (1) | | Value | | Value (1) | | VALUE | | VALUE (1) | | VALUE | | VALUE (1) | ||||||||
Convertible senior notes due 2020 (2) | | $ | — | | $ | — | | $ | 295,573 | | $ | 291,110 | ||||||||||||
Convertible senior notes due 2023 | | | 276,106 | | | 278,964 | | | 272,623 | | | 270,271 | | $ | 287,314 | | $ | 267,905 | | $ | 301,794 | | $ | 287,936 |
Convertible senior notes due 2024 | |
| 251,670 | |
| 276,161 | |
| 255,849 | |
| 268,366 | |
| 314,630 | | | 292,437 | |
| 286,161 | |
| 284,182 |
(1) | Carrying value represents the principal amount less the equity component of the |
The fair value of each of the 2020 Notes, 2023 Notes and 2024 Notes was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the trading price of our convertible notes, when available, our common stock price and interest rates based on similar debt issued by parties with credit ratings similar to ours (Level 2).
Fair Value Measurements—Measurements—Non-Recurring
The fair value of the Waterworks reporting unit tradename was determined based on unobservable (Level 3) inputs and valuation techniques, as discussed in Note 4—4—Goodwill, Trademarks, Tradenames,Trademarks and Domain NamesOther Intangible Assets and in “Impairment” within Note 3—Significant Accounting Policies in the 2019 Form 10-K..
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TableThe fair value of Contentsthe acquired goodwill and tradename associated with acquisitions by the RH Segment in fiscal 2020 were determined based on unobservable (Level 3) inputs and valuation techniques.
The fair value of the real estate assets associated with our investment in the Aspen LLCs in fiscal 2020, as discussed in Note 5—Equity MethodInvestments, were determined based on unobservable (Level 3) inputs and valuation techniques.
NOTE 12—INCOME TAXES
We recorded income tax expense of $18.9$3.0 million and $16.7$18.9 million in the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. We recorded income tax expense of $17.5$44.7 million and $28.5$17.5 million in the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The effective tax rate was 16.1%1.3% and 20.7%16.1% for the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The effective tax rate was 15.5%11.1% and 22.2%15.5% for the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The decrease in theour effective tax rate for both the three and six months ended August 1, 2020July 31, 2021 as compared to the three months August 3, 2019 and the six months ended August 1, 2020 as compared to the six months ended August 3, 2019 is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in 20202021 as compared to 2019.2020.
As of August 1, 2020,July 31, 2021, we had $8.7$8.9 million of unrecognized tax benefits, of which $7.9$8.1 million would reduce income tax expense and the effective tax rate, if recognized. The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized. As of August 1, 2020,July 31, 2021, we had $6.3$6.2 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.
28 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
NOTE 13—NET INCOME PER SHARE
The weighted-average shares used for net income per share are as follows:
| | | | | | | | | | | | | | | | |
|
| Three Months Ended | | Six Months Ended | | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||
|
| August 1, | | August 3, | | August 1, | | August 3, | | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, |
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
| 2021 |
| 2020 |
| 2021 |
| 2020 |
Weighted-average shares—basic | | 19,386,115 | | 18,465,876 | | 19,314,479 | | 19,221,367 | | 21,166,638 | | 19,386,115 | | 21,084,941 | | 19,314,479 |
Effect of dilutive stock-based awards | | 5,205,159 |
| 3,858,236 |
| 4,787,988 |
| 4,165,391 |
| 6,757,728 |
| 5,205,159 |
| 6,737,107 |
| 4,787,988 |
Effect of dilutive convertible senior notes (1) | | 1,973,431 |
| — |
| 1,281,263 |
| 242,292 |
| 4,054,732 |
| 1,973,431 |
| 3,772,507 |
| 1,281,263 |
Weighted-average shares—diluted | | 26,564,705 |
| 22,324,112 |
| 25,383,730 |
| 23,629,050 |
| 31,979,098 |
| 26,564,705 |
| 31,594,555 |
| 25,383,730 |
(1) | The |
While the share price for our common stock trades above the applicable conversion price of each series of notes or the applicable exercise price of each series of warrants for the notes, these instruments will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock continues to exceed the applicable conversion or exercise price of the notes and warrants. Refer to Note 9—Convertible Senior Notes.
Dilutive options of 800,85482,562 and 717,627800,854 were excluded from the calculation of diluted net income per share for the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively, because their inclusion would have been anti-dilutive. Dilutive options of 521,71768,918 and 590,567521,717 were excluded from the calculation of diluted net income per share for the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively, because their inclusion would have been anti-dilutive.
NOTE 14—SHARE REPURCHASES AND SHARE RETIREMENTSREPURCHASE PROGRAM
Share Repurchase Program
On October 10,In 2018, our Board of Directors authorized a share repurchase programprogram. In fiscal 2018, we repurchased approximately 2.0 million shares of up to $700.0 million, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700.0 million authorization amount was replenished by the Board of Directors on March 25, 2019 (as replenished, the “$950 Million Repurchase Program”). We did not make any repurchasesour common stock under this share repurchase program during the six months ended August 1, 2020. During the first halfat an average price of $122.10 per share, for an aggregate repurchase amount of approximately $250.0 million. In fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under this program at an average price of $115.36 per share, for an aggregate repurchase amount of approximately $250.0 million under this share repurchase program. As of August 1, 2020, there was $450.0 million remaining for future sharemillion. We did not make any repurchases under this program.
27
Share Repurchases Under Equity Plans
As of August 1, 2020 and February 1, 2020, the aggregate unpaid principal amount of the notes payable for share repurchases was $18.8 million and $18.7 million, respectively, which were included in other non-current obligations on the condensed consolidated balance sheets. During both the three months ended August 1, 2020 and August 3, 2019, we recorded interest expense on the outstanding notes of $0.3 million. During bothprogram during either the six months ended August 1, 2020 and August 3, 2019, we recorded interest expense on the outstanding notes of $0.5 million.
Of the $18.8 million and $18.7 million notes payable for share repurchases outstanding as of August 1, 2020 and February 1, 2020, $15.5 million is related to a promissory note due to a current board member.
Share Retirements
In the first half of fiscal 2020, we retired 600 shares of our common stock related to shares we had repurchased under equity plans. As a result of this retirement, we reclassified a total of $0.1 million from treasury stock to additional paid-in capital on the condensed consolidated balance sheets and on the condensed consolidated statements of stockholders’ equity (deficit) as ofJuly 31, 2021 or August 1, 2020.
In The total current authorized size of the first half of fiscal 2019, we retired 2,170,154 shares of our common stock relatedshare repurchase program is up to shares we had repurchased under the $950 million (the “950 Million Repurchase Program. As a result of this retirement, we reclassified a total of $250.3 million from treasury stock,Program”), of which $13.2$450.0 million was allocated to additional paid-in capital and $237.1 million was allocated to retained earnings (accumulated deficit) on the condensed consolidated balance sheetsremained available as of February 1, 2020 and on the condensed consolidated statements of stockholders’ equity (deficit) as of August 3, 2019.
July 31, 2021 for future share investments.
NOTE 15—STOCK-BASED COMPENSATION
We recorded stock-based compensation expense of $6.9$10.1 million and $5.3$6.9 million during the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively, which is included in selling, general and administrative expenses on the condensed consolidated statements of income. We recorded stock-based compensation expense of $12.7$25.4 million and $11.0$12.7 million during the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. NaN stock-based compensation cost has been capitalized in the accompanying condensed consolidated financial statements.
Chairman and Chief Executive Officer Option Grant
On October 18, 2020, our Board of Directors granted Mr. Friedman an option to purchase 700,000 shares of our common stock with an exercise price equal to $385.30 per share under the 2012 Stock Incentive Plan. See Note 18—Stock-Based Compensation in the 2020 Form 10-K.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 29 |
The option contains selling restrictions on the underlying shares that lapse upon the achievement of both time-based service requirements and stock price performance-based metrics as described further below. The option is fully vested on the date of grant but the shares underlying the option remain subject to transfer restrictions to the extent the performance-based and time-based requirements have not been met. The option will result in aggregate non-cash stock compensation expense of $173.6 million, of which $5.8 million and $11.7 million was recognized during the three and six months ended July 31, 2021, respectively (which is included in the stock-based compensation expense recorded during the three and six months ended July 31, 2021 noted above). As of July 31, 2021, the total unrecognized compensation expense was $44.8 million, which will be recognized on an accelerated basis through May 2025.
2012 Stock Incentive Plan and 2012 Stock Option Plan
As of August 1, 2020, 7,697,037July 31, 2021, 7,895,050 options were outstanding with a weighted-average exercise price of $69.34$107.35 per share and 5,954,4677,555,774 options were vested with a weighted-average exercise price of $53.83$102.88 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of August 1, 2020July 31, 2021 was $1,678.6$4,395.8 million, $1,596.4$4,240.6 million, and $1,391.0$3,794.8 million, respectively. Stock options exercisable as of August 1, 2020July 31, 2021 had a weighted-average remaining contractual life of 3.93.38 years. As of August 1, 2020,July 31, 2021, the total unrecognized compensation expense related to unvested options was $75.9$97.7 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 4.795.04 years. In addition, as of July 31, 2021, the total unrecognized compensation expense related to the fully vested option grant made to Mr. Friedman in October 2020 was $44.8 million, which will be recognized on an accelerated basis through May 2025 (refer to Chairman and Chief Executive Officer Option Grant above).
As of August 1, 2020,July 31, 2021, we had 100,01023,690 restricted stock units outstanding with a weighted-average grant date fair value of $46.63$157.52 per share. During the three months ended August 1, 2020, 86,650July 31, 2021, 61,340 restricted stock units vested with a weighted-average grant date and vest date fair value of $49.67$42.47 per share. During the six months ended August 1, 2020, 100,575July 31, 2021, 65,760 restricted stock units vested with a weighted-average grant date and vest date fair value of $52.29$43.06 per share. As of August 1, 2020,July 31, 2021, there was $3.6$2.9 million of total unrecognized compensation expense related to unvested restricted stock and restricted stock units, which is expected to be recognized over a weighted-average period of 1.191.76 years.
28
Rollover Units
In connection with the acquisition of Waterworks in May 2016, $1.5 million rollover units in the Waterworks subsidiary (the “Rollover Units”) were recorded as part of the transaction. The Rollover Units are subject to the terms of the Waterworks LLC agreement, including redemption rights at an amount equal to the greater of (i) the $1.5 million remitted as consideration in the business combination or (ii) an amount based on the percentage interest represented in the overall valuation of the Waterworks subsidiary (the “Appreciation Rights”). The Appreciation Rights are measured at fair value and are subject to fair value measurements during the expected life of the Rollover Units, with changes to fair value recorded in the condensed consolidated statements of income. The fair value of the Appreciation Rights is determined based on an option-pricing model (“OPM”). We did not record any expense related to the Appreciation Rights during both the three and six months ended July 31, 2021 and August 1, 2020 and August 3, 2019.2020. As of both August 1, 2020July 31, 2021 and February 1, 2020,January 30, 2021, the liability associated with the Rollover Units and related Appreciation Rights was $1.5 million, which is included in other non-current obligations on the condensed consolidated balance sheets.
Profit Interests
In connection with the acquisition of Waterworks in May 2016, profit interests units in the Waterworks subsidiary (the “Profit Interests”) were issued to certain Waterworks associates. The Profit Interests are measured at their grant date fair value and expensed on a straight-line basis over their expected life, or five years. The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of income. The fair value of the Profit Interests is determined based on an OPM. For bothDuring the threesix months ended July 31, 2021 and August 1, 2020, and August 3, 2019, we recorded $0.1 million and $0.2 million related to the Profit Interests, respectively, which is included in selling, general and administrative expenses on the condensed consolidated statements of income. For both the six months ended August 1, 2020 and August 3, 2019, we recorded $0.2 million related to the Profit Interests. As of August 1, 2020July 31, 2021 and February 1, 2020,January 30, 2021, the liability associated with the Profit Interests was $1.8$2.1 million and $1.6$2.0 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.
NOTE 16—COMMITMENTS AND CONTINGENCIES
Commitments
We had 0 material off balance sheet commitments as of August 1, 2020.July 31, 2021.
30 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Contingencies
We are involved in lawsuits, claims, investigations and other legal proceedings incident to the ordinary course of our business. These disputes are increasing in number as the business expands and we grow larger. Litigation is inherently unpredictable. As a result, the outcome of matters in which we are involved could result in unexpected expenses and liability that could adversely affect our operations. In addition, any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of managementour senior leadership team’s time and result in the diversion of significant operational resources.
We review the need for any loss contingency reserves and establishesestablish reserves when, in the opinion of management,our senior leadership team, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. Generally, in view of the inherent difficulty of predicting the outcome of those matters, particularly in cases in which claimants seek substantial or indeterminate damages, it is not possible to determine whether a liability has been incurred or to reasonably estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no reserve is established until that time. When and to the extent that we do establish a reserve, there can be no assurance that any such recorded liability for estimated losses will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time. WeAlthough we believe that the ultimate resolution of our current matterslegal proceedings will not have a material adverse effect on our condensed consolidated financial statements.
29
Securities Class Action
On February 2, 2017, City of Miami General Employees’ & Sanitation Employees’ Retirement Trust filed a class action complaint in the United States District Court, Northern District of California, against the Company, Gary Friedman, and Karen Boone. On March 16, 2017, Peter J. Errichiello, Jr. filed a similar class action complaint in the same forum and against the same parties. On April 26, 2017, the court consolidated the two actions. The consolidated actionlegal matters is captioned In re RH, Inc. Securities Litigation. An amended consolidated complaint was filed in June 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The complaint asserts claims purportedly on behalf of a class of purchasers of our common stock from March 26, 2015 to June 8, 2016. The alleged misstatements relate to statements regarding the roll out of the RH Modern product line and our inventory levels. The complaint seeks class certification, monetary damages, and other appropriate relief, including an award of costs and attorneys’ fees. On March 21, 2019, we and the individual defendants in the case entered into a binding memorandum of understanding to settle the case. The settlement amount is $50 million, which was funded entirely by our insurance carriers. On May 6, 2019, the plaintiffs filed a motion for preliminary approval of the proposed settlement together with a settlement agreement executed by both parties. The settlement agreement was subject to customary conditions including court approval following notice to our shareholders, and a hearing at which time the court will consider the fairness, reasonableness and adequacy of the settlement. On June 21, 2019, the court issued an order preliminarily approving the settlement. The court granted final approval of the settlement on October 25, 2019.inherent uncertainty.
As a result of the court approval and adjudication of the claims in 2019, as well as our insurance carriers funding the settlement amount, we have derecognized the provision for legal settlement and unpaid legal fees within other current liabilities and the associated litigation insurance recovery receivable on the condensed consolidated balance sheets as of August 1, 2020, which settlement resolved all of the claims that were or could have been brought in the action.
Shareholder Derivative Lawsuit
On April 24, 2018, purported Company shareholder David Magnani filed a purported shareholder derivative suit in the United States District Court, Northern District of California, captioned Magnani v. Friedman et al. (No. 18-cv-02452). On June 29, 2018, Hosrof Izmirliyan filed a similar purported shareholder derivative complaint in the same forum, captioned Izmirliyan v. Friedman et al. (No. 18-cv-03930). On July 29, 2018, the court consolidated both derivative actions, and the consolidated action is captioned In re RH Shareholder Derivative Litigation. On August 24, 2018, plaintiffs filed an amended complaint that names the Company as a nominal defendant and Gary Friedman, Karen Boone, Carlos Alberini, Keith Belling, Eri Chaya, Mark Demilio, Katie Mitic, Ali Rowghani and Leonard Schlesinger as defendants. The allegations substantially track those in the securities class action described above. Plaintiffs bring claims against all individual defendants under Section 14(a) of the Exchange Act, as well as claims for breach of fiduciary duty, unjust enrichment, and waste of corporate assets. The plaintiffs also allege insider trading and misappropriation of information claims against two of the individual defendants. The amended complaint seeks monetary damages, corporate governance changes, restitution, and an award of costs and attorneys’ fees. We believe that plaintiffs lack standing to bring this derivative action. On September 28, 2018, we filed a motion to stay proceedings and a motion to dismiss the consolidated complaint. On January 23, 2019, the court granted the motion to stay the case pending resolution of the securities class action discussed above. On March 19, 2020, the parties reached an agreement in principle to settle the litigation and subsequently entered into a stipulation of settlement that was preliminarily approved by the Court on August 3, 2020. The settlement involves certain non-monetary terms as well as payment of the plaintiffs’ attorneys’ legal fees, which payment is expected to be funded by our insurance carriers. The Court will hold a final settlement hearing on October 6, 2020.
NOTE 17—SEGMENT REPORTING
We define reportable and operating segments on the same basis that we use to evaluate our performance internally by the Chief Operating Decision Maker (the “CODM”), which we have determined is our Chief Executive Officer. We have 23 operating segments: RH Segment, Waterworks and Waterworks.Real Estate Development. The 2RH Segment and Waterworks operating segments (the “retail operating segments”) include all sales channels accessed by our customers, including sales through catalogs,retail locations and outlets, websites, stores,Source Books, and the commercial channel. The Real Estate Development segment represents operations associated with our equity method investments entered into in fiscal 2020, as described in Note 5—Equity Method Investments.
The retail operating segments are strategic business units that offer products for the home furnishings customer. While RH Segment and Waterworks have a shared senior leadership team and customer base, we have determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.
We use operating income to evaluate segment profitability for the retail operating segments. Operating income is defined as net income before interest expense—net, tradename impairment, (gain) loss on extinguishment of debt, income tax expense and our share of equity method investments losses.
Segment Information
The following table presents the statements of income metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280—Segment Reporting (in thousands):
| | | | | | | | | | | | | | | | | | |
| | THREE MONTHS ENDED | ||||||||||||||||
| | JULY 31, | | AUGUST 1, | ||||||||||||||
| | 2021 | | 2020 | ||||||||||||||
|
| RH SEGMENT |
| WATERWORKS |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| TOTAL | ||||||
Net revenues | | $ | 947,618 | | $ | 41,241 | | $ | 988,859 | | $ | 681,387 | | $ | 27,895 | | $ | 709,282 |
Gross profit | |
| 467,067 | |
| 20,609 | |
| 487,676 | |
| 320,481 | |
| 11,938 | |
| 332,419 |
Depreciation and amortization | |
| 21,484 | | | 1,186 | |
| 22,670 | |
| 24,234 | |
| 1,108 | |
| 25,342 |
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 31 |
30
Our 2 operating segments are strategic business units that offer products for the home furnishings customer. While RH Segment and Waterworks have a shared management team and customer base, we have determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.
We use operating income to evaluate segment profitability. Operating income is defined as net income before interest expense—net, tradename impairment and income tax expense.
Segment Information
The following table presents the statements of income metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280—Segment Reporting (in thousands):
| | | | | | | | | | | | | | | | | | |
| | SIX MONTHS ENDED | ||||||||||||||||
| | JULY 31, | | AUGUST 1, | ||||||||||||||
| | 2021 | | 2020 | ||||||||||||||
|
| RH SEGMENT |
| WATERWORKS |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| TOTAL | ||||||
Net revenues | | $ | 1,767,441 | | $ | 82,210 | | $ | 1,849,651 | | $ | 1,136,344 | | $ | 55,833 | | $ | 1,192,177 |
Gross profit | |
| 853,620 | |
| 41,033 | |
| 894,653 | |
| 508,243 | |
| 23,830 | |
| 532,073 |
Depreciation and amortization | |
| 44,164 | | | 2,392 | |
| 46,556 | |
| 47,951 | | | 2,261 | |
| 50,212 |
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 681,387 | | $ | 27,895 | | $ | 709,282 | | $ | 672,328 | | $ | 34,186 | | $ | 706,514 |
Gross profit | |
| 320,481 | |
| 11,938 | |
| 332,419 | |
| 280,469 | |
| 14,489 | |
| 294,958 |
Depreciation and amortization | |
| 24,234 | | | 1,108 | |
| 25,342 | |
| 24,170 | | | 1,151 | |
| 25,321 |
| | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 1,136,344 | | $ | 55,833 | | $ | 1,192,177 | | $ | 1,236,034 | | $ | 68,901 | | $ | 1,304,935 |
Gross profit | |
| 508,243 | |
| 23,830 | |
| 532,073 | |
| 498,412 | |
| 29,360 | |
| 527,772 |
Depreciation and amortization | |
| 47,951 | | | 2,261 | |
| 50,212 | |
| 50,174 | | | 2,336 | |
| 52,510 |
The Real Estate Development segment share of equity method investments losses were $2.5 million and $4.6 million during the three and six months ended July 31, 2021, respectively.
The following table presents the balance sheet metrics as required under ASC 280—Segment Reporting (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | ||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | JULY 31, | | JANUARY 30, | ||||||||||||||||||||
| | August 1, | | February 1, | | 2021 | | 2021 | ||||||||||||||||||||||||||||||||||
| | 2020 | | 2020 | | | | | | | | REAL ESTATE | | | | | | | | | | | REAL ESTATE | | | | ||||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total |
| RH SEGMENT |
| WATERWORKS |
| DEVELOPMENT |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| DEVELOPMENT |
| TOTAL | ||||||||||||||
Goodwill (1) | | $ | 124,350 | | $ | — | | $ | 124,350 | | $ | 124,367 | | $ | — | | $ | 124,367 | | $ | 141,132 | | $ | — | | $ | — | | $ | 141,132 | | $ | 141,100 | | $ | — | | $ | — | | $ | 141,100 |
Tradenames, trademarks and domain names (2) | |
| 49,863 | |
| 17,000 | |
| 66,863 | |
| 48,563 | |
| 37,459 | |
| 86,022 | ||||||||||||||||||||||||
Tradenames, trademarks and other intangible assets (2) | |
| 55,584 | |
| 17,000 | |
| — | |
| 72,584 | |
| 54,663 | |
| 17,000 | |
| — | |
| 71,663 | ||||||||||||||||||
Equity method investments | | | — | | | — | | | 97,412 | | | 97,412 | | | — | | | — | | | 100,603 | | | 100,603 | ||||||||||||||||||
Total assets | |
| 2,382,857 | |
| 123,552 | |
| 2,506,409 | |
| 2,301,823 | |
| 143,871 | |
| 2,445,694 | |
| 3,215,534 | |
| 154,206 | |
| 97,412 | |
| 3,467,152 | |
| 2,659,944 | |
| 137,766 | |
| 100,603 | |
| 2,898,313 |
(1) | The Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $17.4 million and $33.7 million impairment recorded in fiscal 2018 and fiscal 2017, respectively. |
(2) | The Waterworks reporting unit tradename is presented net of an impairment charge of $35.1 million, |
We use segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes (i) a non-cash compensation charge related to a fully vested option grant made to Mr. Friedman in October 2020, (ii) asset impairments and change in useful lives, (ii) loss on sale leaseback transaction,lease losses, (iii) product recall accruals, (iv) severance costs associated with reorganizations (iv) product recall accruals and adjustments—net and (v) favorable legal settlements, net of legal expenses.loss on sale leaseback transaction. These items are excluded from segment operating income in order to provide better transparency of segment operating results. Accordingly, these items are not presented by segment because they are excluded from the segment profitability measure that the CODM and managementour senior leadership team review.
32 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
31
The following table presents segment operating income and income before income taxes (in thousands):
| | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||||||||||
| August 1, | | August 3, | | August 1, | | August 3, | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | 2021 |
| 2020 |
| 2021 |
| 2020 | ||||||||
Operating income: | | | | | | | | | | | | | | | | | | | | | | |
RH Segment | $ | 153,350 | | $ | 104,093 | | $ | 202,867 | | $ | 173,493 | $ | 257,242 | | $ | 153,350 | | $ | 445,252 | | $ | 202,867 |
Waterworks |
| 1,573 | |
| 920 | |
| 123 | |
| 2,014 |
| 5,413 | |
| 1,573 | |
| 11,655 | |
| 123 |
Asset impairments and change in useful lives |
| (1,339) | |
| (2,545) | |
| (9,810) | |
| (6,021) | |||||||||||
Non-cash compensation | | (5,864) | | | — | | | (11,728) | | | — | |||||||||||
Asset impairments and lease losses |
| (7,354) | |
| (1,339) | |
| (7,354) | |
| (9,810) | |||||||||||
Recall accrual |
| — | |
| (4,780) | |
| (500) | |
| (4,780) | |||||||||||
Reorganization related costs |
| (449) | |
| (2,884) | |
| (449) | |
| (7,027) | |||||||||||
Loss on sale leaseback transaction | | (9,352) | | | — | | | (9,352) | | | — | | — | | | (9,352) | | | — | | | (9,352) |
Reorganization related costs |
| (2,884) | |
| — | |
| (7,027) | |
| — | |||||||||||
Recall accrual |
| (4,780) | |
| 320 | |
| (4,780) | |
| 1,935 | |||||||||||
Legal settlements |
| — | |
| 1,193 | |
| — | |
| 1,193 | |||||||||||
Income from operations |
| 136,568 | |
| 103,981 | |
| 172,021 | |
| 172,614 |
| 248,988 | |
| 136,568 | |
| 436,876 | |
| 172,021 |
Interest expense—net |
| 19,418 | |
| 24,513 | |
| 39,047 | |
| 45,631 |
| 13,581 | |
| 19,418 | |
| 26,889 | |
| 39,047 |
(Gain) loss on extinguishment of debt |
| 3,166 | |
| (152) | |
| 3,271 | |
| (152) | |||||||||||
Tradename impairment | | — | | | — | | | 20,459 | | | — | | — | | | — | | | — | | | 20,459 |
Gain on extinguishment of debt |
| (152) | |
| (954) | |
| (152) | |
| (954) | |||||||||||
Income before income taxes | $ | 117,302 | | $ | 80,422 | | $ | 112,667 | | $ | 127,937 | $ | 232,241 | | $ | 117,302 | | $ | 406,716 | | $ | 112,667 |
We classify our sales into furniture and non-furniture product lines. Furniture includes both indoor and outdoor furniture. Non-furniture includes lighting, textiles, fittings, fixtures, surfaces, accessories and home décor, as well as hospitality.cor. Net revenues in each category were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||||||||||
| August 1, | | August 3, | | August 1, | | August 3, | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | 2021 |
| 2020 |
| 2021 |
| 2020 | ||||||||
Furniture | $ | 488,303 | | $ | 485,639 | | $ | 805,082 | | $ | 882,337 | $ | 699,729 | | $ | 483,205 | | $ | 1,279,740 | | $ | 795,728 |
Non-furniture |
| 220,979 | |
| 220,875 | |
| 387,095 | |
| 422,598 |
| 289,130 | |
| 226,077 | |
| 569,911 | |
| 396,449 |
Total net revenues | $ | 709,282 | | $ | 706,514 | | $ | 1,192,177 | | $ | 1,304,935 | $ | 988,859 | | $ | 709,282 | | $ | 1,849,651 | | $ | 1,192,177 |
During the third fiscal quarter of 2020, we reviewed our segments and product lines and updated certain products and categories in our reporting of furniture and non-furniture product lines. While this reporting change did not impact our consolidated results, prior period segment data has been recast for consistency in reporting.
We are domiciled in the United States and primarily operate our retail and outlet storeslocations in the United States. As of August 1, 2020,July 31, 2021, we operated 4 retail and 2 outlet stores in Canada and 1 retail store in the U.K. Revenues from Canadian and U.K. operations, and the long-lived assetsGeographical revenues in Canada and the U.K., are not material. Canada and U.K. geographic revenues are based upon revenues recognized at the retail store locations in the respective country.country and were not material in any fiscal period presented. Long-lived assets held internationally were not material in any fiscal period presented.
NaN single customer accounted for more than 10% of our revenues in the three or six months ended July 31, 2021 and August 1, 2020 or August 3, 2019.
NOTE 18—SUBSEQUENT EVENT
On August 28, 2020, we completed the acquisition of a home furnishings brand for a preliminary purchase price of $20 million. Due to the close proximity of the acquisition date to the filing date of our Quarterly Report on Form 10-Q for the quarterly period ended August 1, 2020, the initial accounting for this business combination is incomplete, and therefore we are unable to disclose certain information in accordance with ASC 805—Business Combinations. Such information will be included in our Quarterly Report on Form 10-Q for the quarterly period ending October 31, 2020.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 33 |
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ItemITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of OperationsMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and the results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our 20192020 Form 10-K.
FORWARD-LOOKING STATEMENTS AND MARKET DATA
This quarterly report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. 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,” “short-term,” “non-recurring,” “one-time,” “unusual,” “should,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.
Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those that we expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results, and matters that we identify as “short term,” “non-recurring,” “unusual,” “one-time,” or other words and terms of similar meaning may, in fact, recur in one or more future financial reporting periods. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the sectionssection entitled Risk Factors in Part II of this quarterly report, our Quarterly Report on Form 10-Q for the quarterly period ended May 2, 2020 (“First Quarter Form 10-Q”) and in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020 (“2019January 30, 2021 (the “2020 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report, in our FirstQuarterly Report on Form 10-Q for the quarterly period ended May 1, 2021 (the “First Quarter Form 10-Q10-Q”) and in our 20192020 Form 10-K. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this quarterly report in the context of these risks and uncertainties.
We cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this quarterly report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.
Overview
We are a leading luxury retailer in the home furnishings marketplace.market. Our curated and fully-integratedfully integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers.settings. We offer dominant merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings. We position our Galleries as showrooms for our brand, while our websites and Source Books and websites act as virtual extensions of our stores.physical spaces. Our retail business is fully integrated across our multiple channels of distribution, consisting of our stores,retail locations, websites and Source Books, and websites.Books. We have an integrated RH Hospitality experience in ten11 of our new Design Gallery locations, which include restaurantsRestaurants and wine vaults.Wine Bars.
34 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
33
As of August 1, 2020,July 31, 2021, we operated the following number of retail Galleries, outletsOutlets and showrooms:Showrooms:
| | |
| |
|
RH | | |
Design Galleries | |
|
Legacy Galleries | |
|
Modern Galleries | |
|
Baby & Child and | |
|
Total Galleries | |
|
Outlets | | 38 |
|
|
|
Waterworks Showrooms | |
|
The initial waveCOVID-19 outbreak in the first quarter of the novel coronavirus disease (“COVID-19”) outbreak starting in Marchfiscal 2020 caused disruption to our business operations as we temporarily closed all of our retail locations on March 17, 2020. While our retail locations were substantially closed at the end ofbeginning in the first quarter of fiscal quarter on May 2, 2020, during2020. The pandemic has continued since the second fiscal quarter we have reopened substantially all of our retail locations. As ofinitial outbreak and has included spikes and outbreaks in various locations around the end of the second fiscal quarter on August 1, 2020 we had reopened 66 out of 68 of our Galleries, all of our Outlets, and 8 out of 10 of our restaurants. In addition, our business has substantially recovered during the second fiscal quarterworld including as a result of both the reopening of most of our retail locations and also due to strong consumer demand for our products.
As our business has strengthened during the second fiscal quarter, the reduction in inventory receipts together with dislocations in our supply chain has resulted in some delays in our ability to convert business demand into shipped sales. Our global supply chain has not fully recovered from the impactnew strains of the COVID-19 dislocation. DespiteCOVID virus such as the strong growth in consumer demand in our business during the second fiscal quarter, revenue growth has lagged the increase in customer orders. As manufacturing and inventory receipts catch up with this backlog, we expect this demand will convert into revenue in the next several quarters as our supply chain recalibrates to the new level of our business.
While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
The COVID-19 pandemic may continue to have an adverse impact on elements of our supply chain including the manufacture, supply, distribution, transportation and delivery of our products and our inventory levels. The presence of the virus and the response to the health crisis in various countries can affect the speed at which the factories that manufacture our products are able to resume normal operations and production levels, and the extent to which business conditions are able to return to normal in areas that affect our supply chain including factories and transportation. Furthermore, our hospitality business may not recover as quickly as other parts of our business, as in most of our retail locations that have reopened, substantial operational restrictions related to COVID-19 health and safety considerations, for example limits to seating capacity, have been imposed on such business by various governmental authorities. Such operational restrictions may cause our hospitality offerings to be less attractive to customers or may lower its margins and profitability.
“Delta” variant. In our initial response to the COVID-19 health crisis we undertook immediate adjustments to our business operations including temporarily closing all of our retail locations and Restaurants, curtailing expenses, and delaying investments including scaling back some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second through fourth fiscal quarter.
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While we are pursuingfiscal 2020 as a large numberresult of new business initiatives,both the COVID-19 health crisis has had a short-term impact on somereopening of those efforts and initiatives such as the timingmost of some construction efforts with respect to opening new Galleryour retail locations and optimizingalso strong consumer demand for our inventoryproducts. Operational restrictions related to the pandemic affecting our Galleries and hospitality locations continued to fluctuate through the second quarter of 2021 based upon changes in lightlocal conditions and regulations. As of Outlet inventory buildup resultingSeptember 3, 2021, all of our Galleries, Outlets and Restaurants were open.
Our overall customer demand in specific markets has generally correlated favorably with our customers’ ability to experience our Galleries and Outlets. Although our business has strengthened during the period from our temporary retail closures. For example, while we have generally experienced positive and improving business trends during the second quarter of fiscal 2020 counterpartiesand continuing into fiscal 2021, consumer spending patterns may shift away from spending on the home and home-related categories, such as home furnishings, as pandemic restrictions are lifted and consumers return to pre-COVID consumption trends, such as spending on travel and leisure and other activities. In addition, various constraints in our merchandise supply chain have resulted in some delays in our ability to convert business demand into revenues at normal historical rates. We anticipate that the backlog of orders for merchandise from our vendors, coupled with respect to some of our Gallery development projects may experience capital or liquidity constraints due to COVID-19 related difficulties, which may impact the timing or scope of some of our development projects. The impact of COVID-19 abroad, including travel restrictions imposed by various countries, may affect certain aspects of our planned international expansion. Given the pace at which business conditions are evolving in responserelated to the COVID-19 health crisis, we may adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020.
Wepandemic, will continue to closely manage our expenses and investments while considering bothadversely affect the overall economic environment as well as the needscapacity of our vendors and supply chain to meet our merchandise demand levels during fiscal 2021. It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand and as a result the exact timing cannot be accurately predicted due to ongoing uncertainty of the continuing impact of the pandemic on our global supply chain. In particular, business operations. In addition,circumstances and operational conditions in numerous international locations where our near termvendors operate are subject to ongoing risks, and regions in which our vendors have production facilities, most notably Vietnam, have experienced various surges in outbreaks and, in some cases, facility closures related to the pandemic. As a result, the ongoing nature of the pandemic may continue to adversely affect our business operations in various jurisdictions, which could, in turn, have a negative impact on our vendors and supply chain, and therefore, our business.
Our decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business relatedincluding further developments with respect to the impact of COVID-19. While we have taken measures to defer some capital expenditures and other expenses in response to the COVID-19 health crisis, we expect to resume those investments as and to the extent that conditions for our business continue to improve during the COVID-19 crisis.pandemic. For more information, refer to the section entitled Item 1A—Risk Factors—The COVID-19 pandemic poses significant and widespread risks toFactors in our business as well as to the business environment and the markets in which we operate in Part II of this quarterly report2020 Form 10-K.
Key Value Driving Strategies
In order to drive growth across our business, we are focused on a numberthe following long-term key strategies and business initiatives:
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 35 |
Table of key long-term strategies, including:Contents
As part of these efforts, we continue to attract and collaborate withProduct Elevation. We have built the best designers, artisans,most comprehensive and manufacturers in our industry, scaling their work across our integrated platform and thereby rendering it more valuable, enabling us to curate a compelling collection of luxury home furnishings under one brand in the world. Our products are presented across multiple collections, categories and channels that we control, and their desirability and exclusivity has enabled us to our customers.achieve industry leading revenues and margins. Our vision is not onlycustomers know them as RH Interiors, RH Modern, RH Beach House, RH Ski House, RH Outdoor, RH Rugs, RH Lighting, RH Linens, RH Baby & Child, RH Teen and Waterworks. Our strategy to elevate the design and quality of our merchandise offering, but also to offer a broader ecosystem of products and experiencesproduct will continue as we moveintroduce RH Contemporary in 2022. We also have plans to introduce RH Couture Upholstery, RH Bespoke Furniture and RH Color over the brand beyond curating and selling product to conceptualizing and selling spaces by building an integrated platform of products, places, services and spaces that elevate and establish the RH brand as a global thought leader, taste and placemaker.next several years.
As an example, our
Gallery Transformation. Our product is elevated and rendered more valuable by our architecturally inspiring Galleries. We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of $5 to $6 billion in North America. We believe we can significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that is sized to the potential of each market and the size of our assortment. In addition, we plan to incorporate Hospitality into most of the new Design Galleries that we open in the future, which further elevates and renders our product and brand more valuable. We believe Hospitality has created a unique new retail experience that cannot be replicated online, and that the addition of Hospitality will help drive incremental sales of home furnishings in these Galleries.
Brand Elevation. We are further elevatedbeginning to evolve the brand beyond curating and renderedselling product, towards conceptualizing and selling spaces, by building an ecosystem of products, services, places and spaces designed to elevate and render our product more valuable by our seamlessly integrated hospitality experience. Our Hospitality efforts will continue to elevatewhile establishing the RH brand as a thought leader, taste and place maker. We believe our seamlessly integrated ecosystem of immersive experiences inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an impression and connection unlike any other brand in the world.
Digital Reimagination. Our strategy is to digitally reimagine the RH brand and business model both internally and externally. Internally regarding how we move beyondinnovate, curate, and integrate all the four wallsdynamic aspects of our Galleries intobrand, and externally as we introduce our customers to The World of RH, Guesthouses wherea new digital portal presenting our goal isProducts, Services, Places and Spaces. This multi-year effort began internally last year with the reimagination of our Center of Innovation & Product Leadership, which will incorporate digitally integrated visuals and decision data designed to amplify the creative process from product ideation to product presentation.
Our external efforts will begin with the launch of phase one of our new digital portal, The World of RH, which will include rich, immersive content with simplified navigation and search functionality, all designed to enhance the shopping experience and render our product and brand more valuable. We believe an opportunity exists to create similar strategic separation online as we have with our Galleries offline, reconceptualizing what a newwebsite can and should be.
Global Expansion. We believe that our luxury brand positioning and unique aesthetic have strong international appeal, and that pursuit of global expansion will provide RH a substantial long-term market opportunity to build a $20 to $25 billion global brand over time. Our view is the competitive environment globally is more fragmented and primed for travelers seeking privacydisruption than the North American market, and luxurythere is no direct competitor of scale that possesses the product, operational platform, and brand of RH. As such, we are actively pursuing the expansion of the RH brand globally with the objective of launching international locations in Europe beginning in 2022. We have secured a number of locations in various markets in the hotel industry. Additionally,United Kingdom and continental Europe in which we are creating bespoke hospitality experiences like RH Yountville, an integrationexpect to introduce our first Galleries outside of Food, Wine, Art & Design in the Napa Valley. These immersive experiences expose existingU.S. and new customers to our evolvoing authority in interior design, architecture, landscape architecture and hospitality.Canada.
36 | 2021 SECOND QUARTER FORM 10-Q |
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New sites are identified based on a variety of factors, such as (i) the availability of suitable new site locations based on several store specific factors including geographic location, demographics, and proximity to affluent consumers, (ii) the ability to negotiate favorable economic terms, as well as (iii) the satisfactory and timely completion of real estate development including procurement of permits and completion of construction. The number of Design Galleries we open in any fiscal year is highly dependent upon these variables and individual new Design Galleries may be subject to delay or postponement depending on the circumstances of specific projects, which we have experienced with some of our new Gallery openings from time to time including in connection with the COVID-19 crisis.
Today we operate 24 Design Galleries, and based on our analysis, we believe we have the opportunity to operate Design Galleries in 60 to 70 locations in the United States and Canada. We opened our Minneapolis Design Gallery in September 2019, our Columbus Design Gallery in December 2019, our Charlotte Design Gallery in June 2020 and our Marin Design Gallery in July 2020. Nearly all of our new Design Galleries include integrated restaurants and wine vaults.
We have identified key learnings from our real estate transformation that have supported the development of a multi-tier market approach that we believe will optimize both market share and return on invested capital. Our Gallery designs include (i) prototype Design Galleries that are suited to many North American markets, similar to those we opened most recently in Charlotte and Marin, (ii) larger Bespoke Design Galleries in the top metropolitan markets, similar to those we opened in New York and Chicago, and (iii) indigenous Bespoke Galleries in the best second home markets where the wealthy and affluent visit and vacation including our location in Yountville, California as well as our Gallery under development in Aspen, Colorado.
Like our evolving multi-tier market approach, we have developed a multi-tier real estate strategy that is designed to significantly increase our unit level profitability and return on invested capital. Several of our primary deal constructs are outlined below:
We anticipate that all of the above deal structures should lead to lower capital requirements, higher unit profitability, and significantly higher return on invested capital versus our prior Gallery development strategies.
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During fiscal 2017, we repurchased approximately 20.2 million shares of our common stock under two separate repurchase programs for an aggregate repurchase amount of approximately $1 billion. During fiscal 2018, we repurchased approximately 2.0 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately $250 million. During fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately $250 million. Our focus on cash also resulted in our generating substantial free cash flow in fiscal 2017 through 2019 and we expect this objective to continue to be a priority in fiscal 2020 and 2021 .
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Business Initiatives
We are undertaking a large number of new business initiatives in support of our key value driving strategies. In particular, beginning in fiscal 2016 and continuing through fiscal 2020, we have pursued a range of strategic efforts to improve our business and operations including the following:
We believe that the shift to a membership model has positively affected the financial results of our business. Specifically, we believe some of the benefits include:
Improved customer experience. Our interior design professionals can now work with customers based on their timeline and project deadlines, as opposed to our prior promotional calendar. We believe this will lead to larger overall sales transactions for individual customer design projects.
Lower cancellations and returns. As a result of the elimination of time-limited promotional events and the associated pressure of placing an order before a promotion expires, we believe the shift to a membership model has also resulted in lower rates of cancelled orders and returns.
Improved operational costs. The volume of sales, orders and shipments in our business under the prior promotional model was characterized by large spikes in customer orders based upon promotional events followed by lower orders and sales after the end of an event. This buying pattern also affected numerous other aspects of our business, including staffing and costs as we required elevated staffing levels to service the increased number of customers during peak sales events. Likewise, significant fluctuations in sales had downstream implications for our supply chain related to merchandise orders, manufacturing and production, shipment to our distribution centers and final delivery to our customers. All of these aspects of our operations are experiencing improved efficiencies as a result of the membership model whereby sales are more evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales under the prior model.
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We continue to pursue and test numerous initiatives to improve many aspects of our business including through efforts to optimize inventory, elevate the home delivery experience, simplify our distribution network and improve our organizational design including by streamlining and realigning our home office operations, as well as to elevate our product offering, transform our real estate using a range of different models for specific real estate development projects and expand our brand internationally. Many of these initiatives and other initiatives such as our transition to a direct sourcing model for our rug business have improved our operating margins, but other initiatives such as RH Hospitality, Waterworks and investments to develop our international expansion strategy are expected to offset some planned margin improvement in fiscal 2020 due to our investments in these platforms. There can be no assurance as to the timing and extent of the operational benefits and financial contributions of these strategic efforts. In addition, our pursuit of multiple initiatives with respect to our business in any given period may result in period-to-period changes in, and increased fluctuation in, our results of operations. We have also experienced delays in development timelines for some of our recent projects, and delays in completion of our real estate development projects or costs overruns could negatively affect our results of operations and revenues. Further, macroeconomic or political events outside of our control could impact our ability to pursue our initiatives or the success of such initiatives. While we believe that the tariffs imposed to date on most of our goods sourced from China have not had an adverse effect on our results of operations, including our revenues, margins and earnings, there can be no assurance that the existing tariffs and the additional tariffs that will become effective, as well as other future tariffs that may be imposed, will not adversely affect our results of operation in future time periods.
The stock market has experienced significant increases in volatility during fiscal 2020. In general we have experienced some correlation between stock market performance and consumer spending patterns in our business. Accordingly, we may encounter shifts in consumer spending in future time periods as a result of stock market declines including in the event that heightened market volatility related to the COVID-19 health crisis or other factors including deterioration in market conditions leads to stock price declines. Our business is also correlated to the housing market. The housing market is affected by a range of factors including home prices and interest rates and slowdowns in the housing market can have a negative impact on demand for our products. Factors that affect the higher end housing market in particular may have an outsized influence on our levels of consumer demand since our business is geared toward the higher end of the home furnishings market. The above factors and other current and future operational initiatives may create additional uncertainty with respect to our consolidated net revenues and profit in the near term.
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Basis of Presentation and Results of Operations
Matters Affecting Comparability
The disruption to our business operations from the initial wave of the COVID-19 outbreakpandemic has had a significant impact on the comparability of certain ratiosyear-over-year and year-over-yearsequential trends for our operating results for the three and six months ended August 1, 2020July 31, 2021, as compared to the three and six months ended August 3, 2019.1, 2020. The primaryongoing pandemic has resulted in escalating disruption in our supply chain, which continues to negatively impact our revenues and costs. The initial negative impact to our revenues from store closures occurred during the first quarterhalf of fiscal 2020, but despite2020. Despite the reopening of most of our Galleries during the second and third quarters of fiscal quarter2020 and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances in the first half of fiscal 2021 related to COVID-19 includingthe pandemic. These circumstances include delays in manufacturing and inventory receipts and manufacturing as our supply chain recovers from the impact of the global health crisis.crisis and responds to virus outbreaks and surges, including new strains such as the “Delta” variant, which has had a severe impact in certain jurisdictions, most notably Vietnam. We have also changeddelayed the cadenceopening of our expenses and investments as wecertain new Gallery locations due to issues related to the pandemic, including the extensive travel restrictions that have soughtbeen in place with respect to addresstravel to various locations in Europe. Beginning in the impact of COVID-19 on the business. During the firstsecond quarter of fiscal 2020, we implemented a number of short-term and long-term initiatives in response to COVID-19 including the implementation of a business reorganization and the deferral of certain investments. During the second fiscal quarter of 2020 we have resumed many investments and previously deferred expenditures, but we anticipate thatand our decisions regarding these matters will continue to evolve in response to changing business circumstances, including further developments with respect to COVID-19.the pandemic. Although we have experienced strong demand for our products since the second half of fiscal 2020, for example, some of the demand may have been driven by consumers electing to spend more money on home-related purchases due to stay-at-home restrictions that were in place throughout many parts of the United States and Canada. The relaxation of COVID-19-related restrictions may trigger a shift in consumer spending patterns toward other categories, such as travel and leisure activities, and away from the purchase of merchandise related to the home, including home furnishings, of which could affect our results of operation in fiscal 2021. Additionally, recent COVID-19 resurgences in various jurisdictions are expected to have direct and indirect effects on our business and operations that will continue to affect the comparability of our results during fiscal 2021.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 37 |
Results of Operations
The following table sets forth our condensed consolidated statements of income and other financial and operating data.data:
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | Six Months Ended | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||||||||||
| August 1, | | August 3, | | August 1, | | August 3, | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | 2021 |
| 2020 |
| 2021 |
| 2020 | ||||||||
| (in thousands) | (in thousands) | | (in thousands) | ||||||||||||||||||
Condensed Consolidated Statements of Income: | | | | | | | | | | | | | | | | | | | | | | |
Net revenues | $ | 709,282 | | $ | 706,514 | | $ | 1,192,177 | | $ | 1,304,935 | $ | 988,859 | | $ | 709,282 | | $ | 1,849,651 | | $ | 1,192,177 |
Cost of goods sold |
| 376,863 | |
| 411,556 | |
| 660,104 | |
| 777,163 |
| 501,183 | |
| 376,863 | |
| 954,998 | |
| 660,104 |
Gross profit |
| 332,419 | |
| 294,958 | |
| 532,073 | |
| 527,772 |
| 487,676 | |
| 332,419 | |
| 894,653 | |
| 532,073 |
Selling, general and administrative expenses |
| 195,851 | |
| 190,977 | |
| 360,052 | |
| 355,158 |
| 238,688 | |
| 195,851 | |
| 457,777 | |
| 360,052 |
Income from operations |
| 136,568 | |
| 103,981 | |
| 172,021 | |
| 172,614 |
| 248,988 | |
| 136,568 | |
| 436,876 | |
| 172,021 |
Other expenses |
| | | | | | | | | | |
| | | | | | | | | | |
Interest expense—net |
| 19,418 | |
| 24,513 | |
| 39,047 | |
| 45,631 |
| 13,581 | |
| 19,418 | |
| 26,889 | |
| 39,047 |
Tradename impairment | | — | | | — | | | 20,459 | | | — | | — | | | — | | | — | | | 20,459 |
Gain on extinguishment of debt |
| (152) | |
| (954) | |
| (152) | |
| (954) | |||||||||||
(Gain) loss on extinguishment of debt |
| 3,166 | |
| (152) | |
| 3,271 | |
| (152) | |||||||||||
Total other expenses |
| 19,266 | |
| 23,559 | |
| 59,354 | |
| 44,677 |
| 16,747 | |
| 19,266 | |
| 30,160 | |
| 59,354 |
Income before income taxes |
| 117,302 | |
| 80,422 | |
| 112,667 | |
| 127,937 |
| 232,241 | |
| 117,302 | |
| 406,716 | |
| 112,667 |
Income tax expense |
| 18,879 | |
| 16,665 | |
| 17,456 | |
| 28,458 |
| 3,009 | |
| 18,879 | |
| 44,733 | |
| 17,456 |
Income before equity method investments | | 229,232 | | | 98,423 | | | 361,983 | | | 95,211 | |||||||||||
Share of equity method investments losses | | (2,486) | | | — | | | (4,581) | | | — | |||||||||||
Net income | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 | $ | 226,746 | | $ | 98,423 | | $ | 357,402 | | $ | 95,211 |
Other Financial and Operating Data: |
|
| |
|
| |
|
| |
|
|
|
| |
|
| |
|
| |
|
|
Adjusted net income (1) | $ | 123,013 | | $ | 71,430 | | $ | 152,962 | | $ | 119,671 | $ | 251,625 | | $ | 123,013 | | $ | 393,875 | | $ | 152,962 |
Adjusted EBITDA (2) | $ | 185,787 | | $ | 133,716 | | $ | 263,214 | | $ | 234,101 | $ | 290,370 | | $ | 185,787 | | $ | 518,628 | | $ | 263,214 |
| | | | | | | | | | | | |||||||||||
Capital expenditures | $ | 30,899 | | $ | 17,367 | | $ | 47,531 | | $ | 25,283 | $ | 31,887 | | $ | 30,899 | | $ | 82,138 | | $ | 47,531 |
Landlord assets under construction—net of tenant allowances | | 15,334 | | | 23,013 | | | 22,934 | | | 27,555 | | 29,774 | | | 15,334 | | | 43,352 | | | 22,934 |
Adjusted capital expenditures (3) | $ | 46,233 | | $ | 40,380 | | $ | 70,465 | | $ | 52,838 | $ | 61,661 | | $ | 46,233 | | $ | 125,490 | | $ | 70,465 |
(1) | Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, generally accepted accounting principles (“GAAP”). We define adjusted net income as consolidated 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 filing because |
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comparable basis with historical results. Our |
| | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | ||||||||
| August 1, | | August 3, | | August 1, | | August 3, | ||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
| (in thousands) | ||||||||||
Net income | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Adjustments pre-tax: |
|
| |
|
| |
|
| |
|
|
Amortization of debt discount (a) |
| 11,113 | |
| 9,918 | |
| 22,238 | |
| 21,607 |
Tradename impairment (b) | | — | | | — | | | 20,459 | | | — |
Asset impairments and lease losses (c) | | 1,339 | | | 2,545 | | | 9,810 | | | 6,021 |
Loss on sale leaseback transaction (d) |
| 9,352 | |
| — | | | 9,352 | | | — |
Reorganization related costs (e) |
| 2,884 | |
| — | |
| 7,027 | |
| — |
Recall accrual (f) |
| 4,780 | |
| (320) | |
| 4,780 | |
| (1,935) |
Gain on extinguishment of debt (g) |
| (152) | |
| (954) | |
| (152) | |
| (954) |
Legal settlements (h) | | — | | | (1,193) | | | — | | | (1,193) |
Subtotal adjusted items |
| 29,316 | |
| 9,996 | |
| 73,514 | |
| 23,546 |
Impact of income tax items (i) |
| (4,726) | |
| (2,323) | |
| (15,763) | |
| (3,354) |
Adjusted net income | $ | 123,013 | | $ | 71,430 | | $ | 152,962 | | $ | 119,671 |
38 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
| | | | | | | | | | | |
| THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||
| JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||
| 2021 |
| 2020 |
| 2021 |
| 2020 | ||||
| (in thousands) | | (in thousands) | ||||||||
Net income | $ | 226,746 | | $ | 98,423 | | $ | 357,402 | | $ | 95,211 |
Adjustments pre-tax: |
|
| |
|
| |
|
| |
|
|
Amortization of debt discount (a) |
| 5,865 | |
| 11,113 | |
| 11,846 | |
| 22,238 |
Non-cash compensation (b) |
| 5,864 | |
| — | |
| 11,728 | |
| — |
Asset impairments and change in useful lives (c) | | 7,354 | | | 1,339 | | | 7,354 | | | 9,810 |
(Gain) loss on extinguishment of debt (d) |
| 3,166 | |
| (152) | |
| 3,271 | |
| (152) |
Recall accrual (e) |
| — | |
| 4,780 | |
| 500 | |
| 4,780 |
Reorganization related costs (f) |
| 449 | |
| 2,884 | |
| 449 | |
| 7,027 |
Tradename impairment (g) | | — | | | — | | | — | | | 20,459 |
Loss on sale leaseback transaction (h) |
| — | |
| 9,352 | | | — | | | 9,352 |
Subtotal adjusted items |
| 22,698 | |
| 29,316 | |
| 35,148 | |
| 73,514 |
Impact of income tax items (i) | | (305) | | | (4,726) | |
| (3,256) | |
| (15,763) |
Share of equity method investments losses (j) |
| 2,486 | |
| — | |
| 4,581 | |
| — |
Adjusted net income | $ | 251,625 | | $ | 123,013 | | $ | 393,875 | | $ | 152,962 |
(a) | 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 |
(b) | Represents |
41
(c) | The adjustment |
(d) | The adjustment in each of the three and six months ended |
| | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | ||||||||
| August 1, | | August 3, | | August 1, | | August 3, | ||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
| (in thousands) | ||||||||||
Decrease to net revenues | $ | 406 | | $ | — | | $ | 406 | | $ | 413 |
Increase (decrease) to cost of goods sold |
| 4,374 | |
| (320) | |
| 4,374 | |
| (2,381) |
(Increase) decrease to gross profit |
| 4,780 | |
| (320) | |
| 4,780 | |
| (1,968) |
Increase (decrease) to selling, general and administrative expenses |
| — | |
| — | |
| — | |
| 33 |
(Increase) decrease to income before income taxes | $ | 4,780 | | $ | (320) | | $ | 4,780 | | $ | (1,935) |
2023 Notes that were early converted at the option of the noteholders. The adjustment in each of the three and six months ended August 1, 2020 represents a gain on extinguishment of debt of upon the maturity and settlement of the 2020 Notes in July 2020. |
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 39 |
(e) | Represents adjustments to net revenues, cost of goods sold and inventory charges associated with product recalls, as well as accrual adjustments. The |
| | | | | | | | | | | | |
| | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||
| | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||
|
| 2021 |
| 2020 |
| 2021 |
| 2020 | ||||
| | (in thousands) | ||||||||||
Decrease to net revenues | | $ | — | | $ | 406 | | $ | — | | $ | 406 |
Increase to cost of goods sold | |
| — | |
| 4,374 | |
| — | |
| 4,374 |
Decrease to gross profit | |
| — | |
| 4,780 | |
| — | |
| 4,780 |
Increase to selling, general and administrative expenses | |
| — | |
| — | |
| 500 | |
| — |
Decrease to income before income taxes | | $ | — | | $ | 4,780 | | $ | 500 | | $ | 4,780 |
(f) | Represents severance costs and related payroll taxes associated with reorganizations. |
(g) | Represents tradename impairment related to the Waterworks reporting unit. Refer to “Waterworks Tradename Impairment” within Note 4—Goodwill, Tradenames, Trademarks and Other Intangible Assets in |
(h) | Represents |
(i) | The adjustment for the three and six months ended July 31, 2021 is based on an adjusted tax rate of 1.3% and 9.3%, respectively, which excludes the tax impact associated with our share of equity method investments losses. The adjustment for the three months ended August 1, 2020 is based on our effective tax rate of 16.1%.The adjustment for the six months ended August 1, 2020 is based on an adjusted tax rate of 17.8%, which excludes the tax impact associated with the Waterworks reporting unit tradename impairment recorded in the first quarter of fiscal 2020. |
(j) | Represents our proportionate share of the |
40 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
(2) | 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—net and income tax |
42
reconciliation of net income, the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below. |
| | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | THREE MONTHS ENDED | | SIX MONTHS ENDED | ||||||||||||||||
| August 1, | | August 3, | | August 1, | | August 3, | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, | ||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | |||||||||||||||
| (in thousands) | 2021 |
| 2020 |
| 2021 |
| 2020 | ||||||||||||||
Net income | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 | $ | 226,746 | | $ | 98,423 | | $ | 357,402 | | $ | 95,211 |
Depreciation and amortization |
| 25,342 | |
| 25,321 | |
| 50,212 | |
| 52,510 |
| 22,670 | |
| 25,342 | |
| 46,556 | |
| 50,212 |
Interest expense—net |
| 19,418 | |
| 24,513 | |
| 39,047 | |
| 45,631 |
| 13,581 | |
| 19,418 | |
| 26,889 | |
| 39,047 |
Income tax expense |
| 18,879 | |
| 16,665 | |
| 17,456 | |
| 28,458 |
| 3,009 | |
| 18,879 | |
| 44,733 | |
| 17,456 |
EBITDA |
| 162,062 | |
| 130,256 | |
| 201,926 | |
| 226,078 |
| 266,006 | |
| 162,062 | |
| 475,580 | |
| 201,926 |
Tradename impairment (a) | | — | | | — | | | 20,459 | | | — | |||||||||||
Non-cash compensation (b) |
| 6,861 | |
| 5,298 | |
| 12,689 | |
| 10,993 | |||||||||||
Loss on sale leaseback transaction (a) | | 9,352 | | | — | | | 9,352 | | | — | |||||||||||
Asset impairment and lease losses (a) |
| — | |
| 629 | |
| 7,133 | |
| 1,112 | |||||||||||
Non-cash compensation (a) |
| 10,124 | |
| 6,861 | |
| 25,431 | |
| 12,689 | |||||||||||
Asset impairments (b) |
| 7,354 | |
| — | |
| 7,354 | |
| 7,133 | |||||||||||
Share of equity method investments losses (b) |
| 2,486 | |
| — | |
| 4,581 | |
| — | |||||||||||
(Gain) loss on extinguishment of debt (b) | | 3,166 | | | (152) | | | 3,271 | | | (152) | |||||||||||
Capitalized cloud computing amortization (c) | | 785 | | | — | | | 1,462 | | | — | |||||||||||
Recall accrual (b) |
| — | |
| 4,780 | |
| 500 | |
| 4,780 | |||||||||||
Reorganization related costs | | 2,884 | | | — | | | 7,027 | | | — | | 449 | | | 2,884 | | | 449 | | | 7,027 |
Recall accrual (a) |
| 4,780 | |
| (320) | |
| 4,780 | |
| (1,935) | |||||||||||
Gain on extinguishment of debt (a) | | (152) | | | (954) | | | (152) | | | (954) | |||||||||||
Legal settlements (a) | | — | | | (1,193) | | | — | | | (1,193) | |||||||||||
Loss on sale leaseback transaction (b) | | — | | | 9,352 | | | — | | | 9,352 | |||||||||||
Tradename impairment (b) | | — | | | — | | | — | | | 20,459 | |||||||||||
Adjusted EBITDA | $ | 185,787 | | $ | 133,716 | | $ | 263,214 | | $ | 234,101 | $ | 290,370 | | $ | 185,787 | | $ | 518,628 | | $ | 263,214 |
(a) | Represents non-cash compensation related to equity awards granted to employees. |
(b) | Refer to the reconciliation of net income to adjusted net income table above and the related footnotes for additional information. |
Represents |
(3) | We define adjusted capital expenditures as |
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 41 |
43
The following tables presenttable presents RH Gallery and Waterworks showroomShowroom metrics, and exclude outlets:excludes Outlets:
| | | | | | | | | | | | | | | | | | | | |
| | Six Months Ended | | SIX MONTHS ENDED | ||||||||||||||||
| | August 1, | | August 3, | | JULY 31, | | AUGUST 1, | ||||||||||||
| | 2020 | | 2019 | | 2021 | | 2020 | ||||||||||||
|
| |
| Total Leased |
| |
| Total Leased |
| |
| TOTAL LEASED |
| |
| TOTAL LEASED | ||||
| | | | Selling Square | | | | Selling Square | | | | SELLING SQUARE | | | | SELLING SQUARE | ||||
| | Count | | Footage (1) | | Count | | Footage (1) | | COUNT | | FOOTAGE (1) | | COUNT | | FOOTAGE (1) | ||||
| | | | | (in thousands) | | | | | (in thousands) | | | | (in thousands) | | | | (in thousands) | ||
Beginning of period |
| 83 |
| | 1,111 |
| 86 |
| | 1,089 |
| 82 |
| | 1,162 |
| 83 |
| | 1,111 |
Design Galleries: |
|
|
| |
|
|
|
| |
| ||||||||||
RH Design Galleries: |
|
|
| |
|
|
|
| |
| ||||||||||
Dallas Design Gallery | | 1 | | | 38.0 | | — | | | — | ||||||||||
Marin Design Gallery |
| 1 |
| | 32.9 |
| — |
| | — |
| — | | | — | | 1 | | | 32.9 |
Charlotte Design Gallery |
| 1 |
| | 32.4 |
| — |
| | — |
| — | | | — | | 1 | | | 32.4 |
Modern Galleries: | | | | | | | | | | | ||||||||||
Dallas RH Modern Gallery (relocation) | | — | | | — | | — | | | (4.5) | ||||||||||
Baby & Child Galleries: | | | | | | | | | | | ||||||||||
Dallas RH Baby & Child Gallery | | — | | | — | | (1) | | | (3.7) | ||||||||||
Legacy Galleries: | | | | | | | | | | | ||||||||||
RH Modern Galleries: | | | | | | | | | | | ||||||||||
Dallas RH Modern Gallery | | (1) | | | (3.9) | | — | | | — | ||||||||||
RH Baby & Child and TEEN Galleries: | | | | | | | | | | | ||||||||||
Santa Monica Baby & Child and TEEN Gallery | | (1) | | | (7.3) | | — | | | — | ||||||||||
RH Legacy Galleries: | | | | | | | | | | | ||||||||||
Dallas legacy Gallery | | (1) | | | (8.4) | | — | | | — | ||||||||||
Raleigh legacy Gallery | | 1 | | | 4.4 | | — | | | — | | — | | | — | | 1 | | | 4.4 |
Charlotte legacy Gallery | | (1) | | | (7.0) | | — | | | — | | — | | | — | | (1) | | | (7.0) |
Corte Madera legacy Gallery | | (1) | | | (7.0) | | — | | | — | | — | | | — | | (1) | | | (7.0) |
Westport legacy Gallery | | (1) | | | (6.5) | | | | | | | — | | | — | | (1) | | | (6.5) |
Dallas legacy Gallery (relocation) | | — | | | — | | — | | | (2.6) | ||||||||||
San Antonio legacy Gallery (relocation) | | — | | | — | | — | | | (3.7) | ||||||||||
End of period |
| 83 |
| | 1,160 |
| 85 |
| | 1,075 |
| 80 |
| | 1,180 |
| 83 |
| | 1,160 |
| | | | | | | | | | | ||||||||||
Total leased square footage at end of period (2) | | | | | 1,560 | | | | | 1,451 | | | | | 1,580 | | | | | 1,560 |
Weighted-average leased square footage (3) |
| | |
| 1,513 | |
| |
| 1,456 |
| | |
| 1,573 | |
| |
| 1,513 |
Weighted-average leased selling square footage (3) | | | | | 1,123 | | | | | 1,079 | | | | | 1,172 | | | | | 1,123 |
(1) | Leased selling square footage is retail space at our retail locations used to sell our |
(2) | Total leased square footage includes approximately 5,400 square feet as of both July 31, 2021 and August 1, 2020 related to |
(3) | Weighted-average leased square footage and leased selling square footage are calculated based on the number of days a |
42 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
44
The following table sets forth our condensed consolidated statements of income as a percentage of total net revenues.
| | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| ||||
| | August 1, | | August 3, | | August 1, | | August 3, |
|
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
|
Condensed Consolidated Statements of Income: | | | | | | | | | |
Net revenues | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of goods sold | | 53.1 |
| 58.3 |
| 55.4 |
| 59.6 | |
Gross profit | | 46.9 |
| 41.7 |
| 44.6 |
| 40.4 | |
Selling, general and administrative expenses | | 27.6 |
| 27.0 |
| 30.2 |
| 27.2 | |
Income from operations | | 19.3 |
| 14.7 |
| 14.4 |
| 13.2 | |
Other expenses | |
|
|
|
| | | | |
Interest expense—net | | 2.8 |
| 3.4 |
| 3.2 |
| 3.5 | |
Tradename impairment | | — | | — | | 1.7 |
| — | |
Gain on extinguishment of debt | | — |
| (0.1) |
| — |
| (0.1) | |
Total other expenses | | 2.8 |
| 3.3 |
| 4.9 |
| 3.4 | |
Income before income taxes | | 16.5 |
| 11.4 |
| 9.5 |
| 9.8 | |
Income tax expense | | 2.6 |
| 2.4 |
| 1.5 |
| 2.2 | |
Net income | | 13.9 | % | 9.0 | % | 8.0 | % | 7.6 | % |
| | | | | | | | | |
| | THREE MONTHS ENDED | | SIX MONTHS ENDED |
| ||||
| | JULY 31, | | AUGUST 1, | | JULY 31, | | AUGUST 1, |
|
|
| 2021 |
| 2020 |
| 2021 |
| 2020 |
|
Condensed Consolidated Statements of Income: | | | | | | | | | |
Net revenues |
| 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of goods sold |
| 50.7 |
| 53.1 |
| 51.6 |
| 55.4 | |
Gross profit |
| 49.3 |
| 46.9 |
| 48.4 |
| 44.6 | |
Selling, general and administrative expenses |
| 24.1 |
| 27.6 |
| 24.8 |
| 30.2 | |
Income from operations |
| 25.2 |
| 19.3 |
| 23.6 |
| 14.4 | |
Other expenses |
|
|
|
|
| | | | |
Interest expense—net |
| 1.4 |
| 2.8 |
| 1.4 |
| 3.2 | |
Tradename impairment | | — | | — | | — |
| 1.7 | |
(Gain) loss on extinguishment of debt |
| 0.3 |
| — |
| 0.2 |
| — | |
Total other expenses |
| 1.7 |
| 2.8 |
| 1.6 |
| 4.9 | |
Income before income taxes |
| 23.5 |
| 16.5 |
| 22.0 |
| 9.5 | |
Income tax expense |
| 0.3 |
| 2.6 |
| 2.4 |
| 1.5 | |
Income before equity method investments | | 23.2 | | 13.9 | | 19.6 | | 8.0 | |
Share of equity method investments losses | | (0.3) | | — | | (0.3) | | — | |
Net income |
| 22.9 | % | 13.9 | % | 19.3 | % | 8.0 | % |
Three Months Ended August 1, 2020July 31, 2021 Compared to Three Months Ended August 3, 20191, 2020
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 681,387 | | $ | 27,895 | | $ | 709,282 | | $ | 672,328 | | $ | 34,186 | | $ | 706,514 |
Cost of goods sold | |
| 360,906 | |
| 15,957 | |
| 376,863 | |
| 391,859 | |
| 19,697 | |
| 411,556 |
Gross profit | |
| 320,481 | |
| 11,938 | |
| 332,419 | |
| 280,469 | |
| 14,489 | |
| 294,958 |
Selling, general and administrative expenses | |
| 185,486 | |
| 10,365 | |
| 195,851 | |
| 177,408 | |
| 13,569 | |
| 190,977 |
Income from operations | | $ | 134,995 | | $ | 1,573 | | $ | 136,568 | | $ | 103,061 | | $ | 920 | | $ | 103,981 |
| | | | | | | | | | | | | | | | | | |
| | THREE MONTHS ENDED | ||||||||||||||||
| | JULY 31, | | AUGUST 1, | ||||||||||||||
| | 2021 | | 2020 | ||||||||||||||
|
| RH SEGMENT |
| WATERWORKS |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| TOTAL | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 947,618 | | $ | 41,241 | | $ | 988,859 | | $ | 681,387 | | $ | 27,895 | | $ | 709,282 |
Cost of goods sold | |
| 480,551 | |
| 20,632 | |
| 501,183 | |
| 360,906 | |
| 15,957 | |
| 376,863 |
Gross profit | |
| 467,067 | |
| 20,609 | |
| 487,676 | |
| 320,481 | |
| 11,938 | |
| 332,419 |
Selling, general and administrative expenses | |
| 223,492 | |
| 15,196 | |
| 238,688 | |
| 185,486 | |
| 10,365 | |
| 195,851 |
Income from operations | | $ | 243,575 | | $ | 5,413 | | $ | 248,988 | | $ | 134,995 | | $ | 1,573 | | $ | 136,568 |
Net revenues
Consolidated net revenues increased $2.8$279.6 million, or 0.4%39.4%, to $988.9 million in the three months ended July 31, 2021 compared to $709.3 million in the three months ended August 1, 2020 compared to $706.5 million in the three months ended August 3, 2019.
Consolidated net revenues for the three months ended August 1, 2020 were negatively impacted by $0.4 million related to the reduction of revenue associated with product recalls. Excluding the product recall adjustments, consolidated net revenues increased $3.2 million, or 0.4%, to $709.7 million in the three months ended August 1, 2020 compared to $706.5 million in the three months ended August 3, 2019. Product recalls and the establishment or adjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of our results. No assurance can be provided that any accruals will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time, which could further affect results.2020.
RH Segment net revenues
RH Segment net revenues increased $9.1$266.2 million, or 1.3%39.1%, to $947.6 million in the three months ended July 31, 2021 compared to $681.4 million in the three months ended August 1, 2020 compared to $672.3 million in the three months ended August 3, 2019.2020. The below discussion highlights several significant factors that resulted in increasedan increase in RH Segment net revenues, which are listed in order of magnitude.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 43 |
45
RH Segment net revenues increasedfor the three months ended July 31, 2021 was driven primarily due toby a strong increase in customer demand for our products, duringaided by elements of our supply chain beginning to catch up with customer demand.
Outlet sales increased $16.7 million to $68.3 million in the three months ended July 31, 2021 compared to $51.6 million in the three months ended August 1, 2020. The growth in revenue was much lower than the growth in customer demand for our products during the three month period primarily2020 due to pandemic related retail closures in the effectssecond quarter of COVID-19 on our supply chain. It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand. In addition,fiscal 2020. Additionally, RH Segment net revenues were impacted by a 23% reduction in open store days for Galleries due to the pandemic, a decrease in revenues from our Contract business, as well as decreasesincreased in our RH Hospitality operations and Outlet business dueas COVID-19 operating restrictions continued to COVID-19 related closuresease during the quarter compared to the three months ended August 1, 2020.
Waterworks net revenues
Waterworks net revenues decreased $6.3increased $13.3 million, or 18.4%47.8%, to $41.2 million in the three months ended July 31, 2021 compared to $27.9 million in the three months ended August 1, 2020 compareddue to $34.2 millionan increase in demand related to resumed construction activity and significant residential investments by high-end homeowners. Waterworks net revenues for the three months ended August 3, 2019 primarily due to1, 2020 was negatively impacted by construction delays, which negatively impacted demand, as well as temporary showroom COVID-19 related closures.closures, in response to the pandemic.
Gross profit
Consolidated gross profit increased $37.5$155.3 million, or 12.7%46.7%, to $487.7 million in the three months ended July 31, 2021 compared to $332.4 million in the three months ended August 1, 2020 compared to $295.0 million in the three months ended August 3, 2019.2020. As a percentage of net revenues, consolidated gross margin increased 5.2%240 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 46.9% of net revenues in the three months ended August 1, 2020 from 41.7% of net revenues in the three months ended August 3, 2019.2020.
RH Segment gross profit for the three months ended August 1, 2020 was negatively impacted by $4.8 million related to product recalls.
RH Segment gross profit for the three months ended August 3, 2019 was negatively impacted by $1.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the three months ended August 3, 2019 was positively impacted by $0.3 million related to reserve adjustments associated with product recalls initiated in prior years.
Excluding the product recall adjustments and accelerated asset depreciationadjustment mentioned above, consolidated gross margin would have increased 5.5%180 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 47.5% of net revenues in the three months ended August 1, 2020 from 42.0% of net revenues in the three months ended August 3, 2019.2020.
RH Segment gross profit
RH Segment gross profit increased $40.0$146.6 million, or 14.3%45.7%, to $467.1 million in the three months ended July 31, 2021 from $320.5 million in the three months ended August 1, 2020 from $280.5 million in the three months ended August 3, 2019.2020. As a percentage of net revenues, RH Segment gross margin increased 5.3%230 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 47.0% of net revenues in the three months ended August 1, 2020 from 41.7% of net revenues in the three months ended August 3, 2019.2020.
Excluding the product recall and accelerated asset depreciation adjustmentsadjustment mentioned above, RH Segment gross margin would have increased 5.7%160 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 47.7% of net revenues in the three months ended August 1, 2020 from 42.0% of net revenues2020. The increase in the three months ended August 3, 2019. The increasegross margin was primarily driven by higher product margins in select product categories, as well as price increasesthe Outlet and Core business. Additionally, we drove higher margins through leveraging our RH Segment occupancy costs in our Core business and lower Outlet promotional activity during the period of operations. In addition, we experienced leverage in occupancy and shipping costs.three months ended July 31, 2021.
46
Waterworks gross profit
Waterworks gross profit decreased $2.6increased $8.7 million, or 17.6%72.6%, to $20.6 million in the three months ended July 31, 2021 from $11.9 million in the three months ended August 1, 2020 from $14.5 million in the three months ended August 3, 2019.2020. As a percentage of net revenues, Waterworks gross margin increased 0.4%720 basis points to 50.0% of net revenues in the three months ended July 31, 2021 from 42.8% of net revenues in the three months ended August 1, 2020 from 42.4% of netprimarily driven by higher revenues, favorable changes in the three months ended August 3, 2019.product mix, and leverage in Waterworks occupancy costs, offset by an increase in shipping costs related to customer deliveries.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $4.9$42.8 million, or 2.6%21.9%, to $238.7 million in the three months ended July 31, 2021 compared to $195.9 million in the three months ended August 1, 2020 compared to $191.0 million in the three months ended August 3, 2019.2020.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $8.1$38.0 million, or 4.6%20.5%, to $223.5 million in the three months ended July 31, 2021 compared $185.5 million in the three months ended August 1, 2020 compared $177.4 million in2020.
44 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
RH Segment selling, general and administrative expenses for the three months ended August 3, 2019.
July 31, 2021 include $7.4 million of asset impairments, amortization of the non-cash compensation of $5.8 million related to the option grant made to Mr. Friedman in October 2020 and $0.4 million related to severance costs and related payroll taxes associated with reorganizations. RH Segment selling, general and administrative expenses for the three months ended August 1, 2020 includes a loss of $9.4 million related to a sale leaseback transaction, $2.9 million related to severance costs and related payroll taxes associated with reorganizations and $1.3 million due to accelerated asset depreciation. RH Segment selling, general and administrative expenses for the three months ended August 3, 2019 include a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a $0.6 million asset impairment.
Excluding the loss on the sale leaseback transaction, asset impairments, reorganization costs, accelerated asset depreciation and legal settlementadjustments mentioned above, RH Segment selling, general and administrative expenses were 25.2%22.1% and 26.5%25.2% of net revenues for the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by a reduction in advertising costs and leverage in employment and employment relatedadvertising, as well as leverage in our corporate occupancy costs, and travel related expenses, partially offset by increased professional fees, incremental COVID-19 related expenses, preopening costs anddeleverage in other corporate expenses.costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased $3.2increased $4.8 million, or 23.6%46.6%, to $15.2 million in the three months ended July 31, 2021 compared to $10.4 million in the three months ended August 1, 2020 compared to $13.6 million in the three months ended August 3, 2019.2020. Waterworks selling, general and administrative expenses were 37.2%36.8% and 39.7%37.2% of net revenues for the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively.
47
Interest expense—net
Interest expense—net decreased $5.1$5.8 million to $13.6 million for the three months ended July 31, 2021 compared to $19.4 million for the three months ended August 1, 2020 compared to $24.5 million for the three months ended August 3, 2019.2020. Interest expense—net consisted of the following:
| | | | | | | | | | | | |
| | Three Months Ended | | THREE MONTHS ENDED | ||||||||
| | August 1, | | August 3, | | JULY 31, | | AUGUST 1, | ||||
|
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||
| | (in thousands) | | (in thousands) | ||||||||
Amortization of convertible senior notes debt discount | | $ | 12,462 | | $ | 10,585 | | $ | 8,791 | | $ | 12,462 |
Finance lease interest expense | |
| 5,948 | |
| 5,672 | |
| 6,607 | |
| 5,948 |
Promissory notes | | | 1,072 | | | 988 | ||||||
Amortization of debt issuance costs and deferred financing fees | |
| 982 | |
| 1,171 | |
| 797 | |
| 982 |
Other interest expense | |
| 436 | |
| 388 | |
| 473 | |
| 436 |
Promissory notes | | | 352 | | | 1,072 | ||||||
Asset based credit facility | |
| 130 | |
| 1,087 | |
| — | |
| 130 |
Term loans | |
| — | |
| 6,086 | ||||||
Capitalized interest for capital projects | |
| (1,426) | |
| (1,184) | |
| (3,048) | |
| (1,426) |
Interest income | |
| (186) | |
| (280) | |
| (391) | |
| (186) |
Total interest expense—net | | $ | 19,418 | | $ | 24,513 | | $ | 13,581 | | $ | 19,418 |
Gain(Gain) loss on extinguishment of debt
WeDuring the three months ended July 31, 2021 we recognized a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders of $3.2 million. During the three months ended August 1, 2020, we recognized a $0.2 million gain on extinguishment of debt in the three months ended August 1, 2020 related to the maturity and settlement of the 2020 Notes in July 2020. We recognized a $1.0 million gain on extinguishment of debt in the three months ended August 3, 2019 related to the maturity and settlement of the 2019 Notes in June 2019.
Income tax expense
Income tax expense was $18.9$3.0 million and $16.7$18.9 million in the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. Our effective tax rate was 16.1%1.3% and 20.7%16.1% for the three months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the three months ended August 1, 2020July 31, 2021 as compared to the three months ended August 3, 2019.1, 2020.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 45 |
Equity method investments losses
Equity method investments losses consists of our proportionate share of the losses of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $2.5 million loss during the three months ended July 31, 2021.
Six Months Ended August 1, 2020July 31, 2021 Compared to Six Months Ended August 3, 20191, 2020
| | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 1,136,344 | | $ | 55,833 | | $ | 1,192,177 | | $ | 1,236,034 | | $ | 68,901 | | $ | 1,304,935 |
Cost of goods sold | |
| 628,101 | |
| 32,003 | |
| 660,104 | |
| 737,622 | |
| 39,541 | |
| 777,163 |
Gross profit | | | 508,243 | | | 23,830 | | | 532,073 | | | 498,412 | | | 29,360 | | | 527,772 |
Selling, general and administrative expenses | |
| 334,762 | |
| 25,290 | |
| 360,052 | |
| 327,812 | |
| 27,346 | |
| 355,158 |
Income (loss) from operations | | $ | 173,481 | | $ | (1,460) | | $ | 172,021 | | $ | 170,600 | | $ | 2,014 | | $ | 172,614 |
| | | | | | | | | | | | | | | | | | |
| | SIX MONTHS ENDED | ||||||||||||||||
| | JULY 31, | | AUGUST 1, | ||||||||||||||
| | 2021 | | 2020 | ||||||||||||||
| | RH SEGMENT |
| WATERWORKS |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| TOTAL | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 1,767,441 | | $ | 82,210 | | $ | 1,849,651 | | $ | 1,136,344 | | $ | 55,833 | | $ | 1,192,177 |
Cost of goods sold | |
| 913,821 | |
| 41,177 | |
| 954,998 | |
| 628,101 | |
| 32,003 | |
| 660,104 |
Gross profit | | | 853,620 | | | 41,033 | | | 894,653 | | | 508,243 | | | 23,830 | | | 532,073 |
Selling, general and administrative expenses | |
| 427,899 | |
| 29,878 | |
| 457,777 | |
| 334,762 | |
| 25,290 | |
| 360,052 |
Income (loss) from operations | | $ | 425,721 | | $ | 11,155 | | $ | 436,876 | | $ | 173,481 | | $ | (1,460) | | $ | 172,021 |
Net revenues
Consolidated net revenues decreased $112.8increased $657.5 million, or 8.6%55.1%, to $1,849.7 million in the six months ended July 31, 2021 compared to $1,192.2 million in the six months ended August 1, 2020 compared to $1,304.9 million in the six months ended August 3, 2019.2020.
48
RH Segment net revenues
RH Segment net revenues decreased $99.7increased $631.1 million, or 8.1%55.5%, to $1,767.4 million in the six months ended July 31, 2021 compared to $1,136.3 million in the six months ended August 1, 2020 compared to $1,236.0 million in the six months ended August 3, 2019.2020. The below discussion highlights several significant factors that resulted in a decreasean increase in RH Segment net revenues, which are listed in order of magnitude.
RH Segment net revenues declined primarily due to the temporary closure of our Outlet and retail locations in response to COVID-19 during the first several months offor the six months ended August 1, 2020 was negatively impacted by Gallery closures and to a lesser extent, the negative impact to overall customer demand in our business due to macroeconomic conditions resulting from the COVID-19 primarily during March and April withinpandemic. RH Segment net revenues for the six months ended August 1, 2020. July 31, 2021 increased due to strong customer demand for our products, aided by elements of our supply chain beginning to catch up with customer demand.
Outlet sales decreased $45.7increased $66.8 million to $130.6 million in the six months ended July 31, 2021 compared to $63.8 million in the six months ended August 1, 2020 compareddue to $109.5 millionpandemic related retail closures in the six months ended August 3, 2019 due to COVID-19 related closures.first half of fiscal 2020. Additionally, RH Segment net revenues also decreasedincreased in our RH Hospitality business as COVID-19 operating restrictions continued to ease during the first half of fiscal 2021 and in our Contract business and RH Hospitality operations duedriven by increased commercial purchasing activities as compared to COVID-19 related factors including extended closuresthe first half of our RH Hospitality locations.fiscal 2020.
Waterworks net revenues
Waterworks net revenues decreased $13.1increased $26.4 million, or 19.0%47.2%, to $82.2 million in the six months ended July 31, 2021 compared to $55.8 million in the six months ended August 1, 2020 compareddue to $68.9 millionan increase in demand related to resumed construction activity and significant residential investments by high-end homeowners. Waterworks net revenues for the six months ended August 3, 2019.1, 2020 was negatively impacted by construction delays, as well as temporary showroom closures, in response to the pandemic.
Gross profit
Consolidated gross profit increased $4.3$362.6 million, or 0.8%68.1%, to $894.7 million in the six months ended July 31, 2021 from $532.1 million in the six months ended August 1, 2020 from $527.8 million in the six months ended August 3, 2019.2020. As a percentage of net revenues, consolidated gross margin increased 4.2%380 basis points to 48.4% of net revenues in the six months ended July 31, 2021 from 44.6% of net revenues in the six months ended August 1, 2020 from 40.4%2020.
46 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
RH Segment gross profit for the six months ended August 1, 2020 was negatively impacted by $4.8 million related to product recalls and includes inventory reserves of $2.4 million related to Outlet inventory build up resulting from retail closures in response to the COVID-19 pandemic. RH Segment gross profit for the six months ended August 3, 2019 was negatively impacted by $4.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the six months ended August 3, 2019 was positively impacted by $2.0 million related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the reduction of revenue and incremental costs associated with such product recalls.
Excluding the product recall, inventory reserves and acceleration of depreciation adjustments mentioned above, consolidated gross margin would have increased 4.5%320 basis points to 48.4% of net revenues in the six months ended July 31, 2021 from 45.2% of net revenues in the six months ended August 1, 2020 from 40.7% of net revenues in the six months ended August 3, 2019.2020.
RH Segment gross profit
RH Segment gross profit increased $9.8$345.4 million, or 2.0%68.0%, to $853.6 million in the six months ended July 31, 2021 from $508.2 million in the six months ended August 1, 2020 from $498.4 million in the six months ended August 3, 2019.2020. As a percentage of net revenues, RH Segment gross margin increased 4.4%360 basis points to 48.3% of net revenues in the six months ended July 31, 2021 from 44.7% of net revenues in the six months ended August 1, 2020 from 40.3% of net revenues in the six months ended August 3, 2019.2020.
Excluding the product recall, inventory reserves and acceleration of depreciation adjustments mentioned above, RH Segment gross margin would have increased 4.8%300 basis points to 48.3% of net revenues in the six months ended July 31, 2021 from 45.3% of net revenues in the six months ended August 1, 2020 from 40.5% of net revenues2020. The increase in gross margin was primarily driven by leverage in our RH Segment occupancy costs and higher product margins in the Core and Outlet businesses in the six months ended August 3, 2019. The increase was primarily driven by higher product margins in select product categories, as well as price increases in our Core business and lower Outlet promotional activity during the period of operations.July 31, 2021.
49
Waterworks gross profit
Waterworks gross profit decreased $5.5increased $17.2 million, or 18.8%72.2%, to $41.0 million in the six months ended July 31, 2021 from $23.8 million in the six months ended August 1, 2020 from $29.4 million in the six months ended August 3, 2019.2020. As a percentage of net revenues, Waterworks gross margin increased 0.1%720 basis points to 49.9% of net revenues in the six months ended July 31, 2021 from 42.7% of net revenues in the six months ended August 1, 2020 from 42.6% of netprimarily driven by higher revenues, favorable changes in the six months ended August 3, 2019.product mix, and leverage in Waterworks occupancy costs, offset by an increase in shipping costs related to customer deliveries.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $4.9$97.7 million, or 1.4%27.1%, to $457.8 million in the six months ended July 31, 2021 compared to $360.1 million in the six months ended August 1, 2020 compared to $355.2 million in the six months ended August 3, 2019.2020.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $7.0$93.1 million, or 2.1%27.8%, to $427.9 million in the six months ended July 31, 2021 compared to $334.8 million in the six months ended August 1, 2020 compared to $327.8 million in2020.
RH Segment selling, general and administrative expenses for the six months ended August 3, 2019.July 31, 2021 include amortization of the non-cash compensation of $11.7 million related to the option grant made to Mr. Friedman in October 2020, $7.4 million related to asset impairments and $0.4 million related to severance costs and related payroll taxes associated with reorganizations.
RH Segment selling, general and administrative expenses for the six months ended August 1, 2020 include a loss of $9.4 million related to a sale leaseback transaction, $7.0 million related to severance costs and related payroll taxes associated with the termination of associates and a reorganization undertaken in response to the impact of retail closures on our business, $3.3 million related to asset impairments and $2.6 million due to accelerated asset depreciation.
RH Segment selling, general and administrative expenses for the six months ended August 3, 2019 included a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a $0.6 million asset impairment and a $0.5 million loss on disposal of an asset.
Excluding the adjustments for the reorganizations, asset impairments, product recalls and legal settlements mentioned above, RH Segment selling, general and administrative expenses were 27.5%23.1% and 26.5%27.5% of net revenues for the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The increasedecrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by increased professional fees, incremental COVID-19 related expenses, preopeningreduction in costs and other corporate expenses, partially offset by a reductionleverage in advertising costs due to our decision to not mail the Spring 2021 Source Books, leverage in employment and travelemployment related expenses.costs, as well as leverage in our corporate occupancy costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased $2.1increased $4.6 million, or 7.5%18.1%, to $29.9 million in the six months ended July 31, 2021 compared to $25.3 million in the six months ended August 1, 2020 compared to $27.3 million in the six months ended August 3, 2019. 2020.
Waterworks selling, general and administrative expenses were 45.3%for the six months ended July 31, 2021 include $0.5 million related to product recalls and 39.7% of net revenues for the six months ended August 1, 2020 and August 3, 2019, respectively.include $1.6 million related to asset impairments.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 47 |
50
Excluding the adjustments mentioned above, Waterworks selling, general and administrative expenses were 35.7% and 42.5% of net revenues for the six months ended July 31, 2021 and August 1, 2020.
Interest expense—net
Interest expense—net decreased $6.6$12.2 million to $26.9 million for the six months ended July 31, 2021 compared to $39.0 million for the six months ended August 1, 2020 compared to $45.6 million for the six months ended August 3, 2019.2020. Interest expense—net consisted of the following:
| | | | | | | | | | | | |
| | Six Months Ended | | SIX MONTHS ENDED | ||||||||
| | August 1, | | August 3, | | JULY 31, | | AUGUST 1, | ||||
|
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||
| | (in thousands) | | (in thousands) | ||||||||
Amortization of convertible senior notes debt discount | | $ | 25,378 | | $ | 22,962 | | $ | 17,461 | | $ | 25,378 |
Finance lease interest expense | |
| 11,729 | |
| 11,186 | |
| 12,757 | |
| 11,729 |
Promissory notes | | | 2,526 | | | 1,420 | ||||||
Amortization of debt issuance costs and deferred financing fees | |
| 1,995 | |
| 2,261 | |
| 1,542 | |
| 1,995 |
Other interest expense | |
| 879 | |
| 783 | |
| 937 | |
| 879 |
Promissory notes | | | 777 | | | 2,526 | ||||||
Asset based credit facility | |
| 232 | |
| 1,774 | |
| — | |
| 232 |
Term loans | |
| — | |
| 7,810 | ||||||
Capitalized interest for capital projects | |
| (3,312) | |
| (2,003) | |
| (5,849) | |
| (3,312) |
Interest income | |
| (380) | |
| (562) | |
| (736) | |
| (380) |
Total interest expense—net | | $ | 39,047 | | $ | 45,631 | | $ | 26,889 | | $ | 39,047 |
Gain(Gain) loss on extinguishment of debt
WeDuring the six months ended July 31, 2021 we recognized a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders of $3.3 million. During the six months ended August 1, 2020, we recognized a $0.2 million gain on extinguishment of debt in the six months ended August 1, 2020 related to the maturity and settlement of the 2020 Notes in July 2020. We recognized a $1.0 million gain on extinguishment of debt in the six months ended August 3, 2019 related to the maturity and settlement of the 2019 Notes in June 2019.
Income tax expense
Income tax expense was $17.5$44.7 million and $28.5$17.5 million in the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. Our effective tax rate was 15.5%11.1% and 22.2%15.5% for the six months ended July 31, 2021 and August 1, 2020, and August 3, 2019, respectively. The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the six months ended August 1, 2020July 31, 2021 as compared to the six months ended August 3, 2019.1, 2020.
Equity method investments losses
Equity method investments losses consists of our proportionate share of the losses of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $4.6 million loss during the six months ended July 31, 2021.
48 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Liquidity and Capital Resources
General
The primary cash needs of our business have historically been for merchandise inventories, payroll, Source Books, store rent, capital expenditures associated with opening new stores and updating existing stores, as well as the development of our infrastructure and information technology. We seek out and evaluate opportunities for effectively managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. In fiscal 2017,the past we completed two share repurchase programs in an aggregate amount of $1 billion. A $300 million share repurchase was completed during the first quarter of fiscal 2017 and a $700 million share repurchase was completed during the second quarter of fiscal 2017. In October 2018, our Board of Directors approved a new $700 million share repurchase program, of which $250 million in sharehave pursued substantial repurchases were completed in fiscal 2018, and the $700 million authorization amount was replenished by the Board of Directors in March 2019. During the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock when we believed that such investments represented a good long term investment for an aggregate repurchase amountthe benefit of approximately $250 million, with $450 million still available under the $700 million repurchase program.our shareholders. Refer to “Share Repurchase Programs” below. We evaluate our capital allocation from time to time and may engage in future investments in connection with existing or new share repurchasesrepurchase programs in circumstances where buying shares of our common stock representsor related investments, which may include investments in derivatives or other equity linked instruments, represent a good value and provides a favorable return for our shareholders.
51
Table We have in the past been opportunistic in responding to favorable market conditions regarding both sources and uses of Contentscapital. Our use of convertible notes financings has enabled us to pursue various investments, such as our share repurchase programs which we consider to have been an excellent allocation of capital for the benefit of our shareholders. We regularly evaluate various debt and other financing alternatives, including convertible notes and other equity-linked instruments. Financing that we arrange through the sale of equity linked instruments such as our convertible notes financings may lead to substantial dilution to our investors if the price of our common stock exceeds the upper strike exercise price of the warrants in connection with our bond hedge transactions, which has been the case in connection with our convertible notes which matured in 2019 and 2020. At the same time, the investments we have previously made in connection with our share repurchase programs have more than offset the amount of dilution we experienced in relation to these warrants. We expect to continue to take an opportunistic approach regarding both sources and uses of capital in connection with our business.
We have $685$652 million remaining in aggregate principal amount of convertible notes outstanding as of August 1, 2020,July 31, 2021, of which $335$67 million of the 2024 Notes and $174 million of the 2023 Notes will be settled in the third quarter of fiscal 2021 due to early conversions at the option of the noteholders. As a result, $128 million of the remaining 2023 Notes will mature in June 2023 (the “2023 Notes”)(absent further early conversion elections) and $350$283 million of the remaining 2024 Notes will mature in September 2024 (the “2024 Notes”)(absent further early conversion elections). Based on the anticipated strong cash flow generationgenerated in fiscal 2020 and beyond,first half of fiscal 2021, as well as the continued strong cash flow anticipated in future years, we expect to repay the outstanding principal amount of our convertible notes at maturity in June 2023 and September 2024 in cash, in each case in order to minimize dilution. Likewise, we expect to pay the principal amount in cash with respect to any convertible notes for which the holder elects early conversion of such convertible notes in order to minimize dilution. While we purchased convertible note hedges and sold warrants with respect to each convertible note transaction, which are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately $338.24 per share and from the conversion of the 2023 Notes until our common stock is above approximately $309.84 per share, our shareholders may still experience dilution to the extent our common stock trades above such levels.levels at the time of the maturity of the warrants with respect to the bond hedge and warrant transactions. While we anticipate using excess cash, free cash flow and borrowings on our asset based credit facility to repay the convertible notes in cash in order to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates or upon early conversion, as applicable. There can be no assurance as to the availability of capital to fund such repayments, or that if capital is available through additional debt issuances or refinancing of the convertible notes, that such capital will be available on terms that are favorable to us.
Our business has historically relied on cash flows from operations, net cash proceeds from the issuance of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity. We continue to closely manage our business and our investments while considering both the overall economic environment as well as the needs of our operations. In addition, our near term decisions regarding the sources and uses of capital will continue to reflect and adapt to changes in market conditions and our business including further developments with respect to the pandemic. We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months.
While we have taken measures to defer some capital expenditures and other expenses in response to the COVID-19 health crisis, we expect to resume those investments as and to the extent that conditions for our business continue to improve during the COVID-19 crisis. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 49 |
While we have continued to serve our customers and operate our business through the initial phase of theongoing COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis,pandemic, including additional waves or resurgences of COVID-19 outbreaks in certain jurisdictions, including with regard to new strains or variants of the virus, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 health crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
In recognition of the significant threat to economic conditions2021 and the liquidity of financial markets posed by COVID-19, the Federal Reserve and Congress have taken dramatic actions to provide liquidity to businesses and the banking system in the U.S. For example, on March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), a sweeping stimulus bill intended to bolster the U.S. economy, among other things, and provide emergency assistance to qualifying businesses and individuals. There can be no assurance that these interventions by the government will be successful, and the financial markets may experience significant contractions in available liquidity. While we may receive financial, tax or other relief and other benefits under and as a result of the CARES Act, it is not possible to estimate at this time the availability, extent or impact of any future relief.beyond.
We extended and amended our asset based credit facility in June 2017,July 2021, which has a total availability of up to $600 million, of which $10 million is available to Restoration Hardware Canada, Inc., and includes a $200$300 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600 million to up to $800$900 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. The Amended Credit Agreement provides that the $300 million accordion, or a portion thereof, may be added as a first-in, last-out term loan facility if and to the extent the lenders revise their credit commitments for such facility. The Amended Credit Agreement further provides the borrowers may request a European sub-credit facility under the revolving line of credit has aor under the accordion feature for borrowing by certain European subsidiaries of RH if certain conditions set out in the Amended Credit Agreement are met. The maturity date of June 28, 2022.the Amended Credit Agreement is July 29, 2026.
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the many opportunities that we identify in connection with our business and operations. We have pursued in the past, and may pursue in the future, additional strategies to generate capital to pursue opportunities and investments, including through the strategic sale of existing assets, utilization of our credit facilities, entry into various second lien credit agreements and other new debt financing arrangements that present attractive terms. We expect to continue to use additional sources of debt financing in future periods as a source of additional capital to fund our various investments. In addition to funding the normal operations of our business, we have used our liquidity to fund significant investments and strategies such as our share repurchase programs, various acquisitions and growth initiatives, including through joint ventures and real estate investments. For example, in fiscal 2019 we executed a sale-leaseback transaction for the Yountville Design Gallery for sales proceeds of $23.5 million and in Julyfiscal 2020 we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $25.5 million, both of which qualified for sale-leaseback accounting in accordance with ASC 842. We may pursue strategies in the future, through the use of existing assets and debt facilities, or through the pursuit of new external sources of liquidity and debt financing, to fund our strategies to enhance stockholder value. There can be no assurance that additional capital, whether raised through the sale of assets, utilization of our existing debt financing sources, or pursuit of additional debt financing sources, will be available to us on a timely manner, on favorable terms or at all. To the extent we pursue additional debt as a source of liquidity, our capitalization profile may change and may include significant leverage, and as a result we may be required to use future liquidity to repay such indebtedness and may be subject to additional terms and restrictions which affect our operations and future uses of capital.
In addition, our capital needs and uses of capital may change in the future due to changes in our business or new opportunities that we choose to pursue. We have invested significant capital expenditures in remodelingdeveloping and opening new Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future periods as we open additional Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings.
Our adjusted capital expenditures include (i) capital expenditures from investing activities and (ii) cash outflows of capital related to construction activities to design and build landlordlandlord-owned leased assets, net of tenant allowances received. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may further adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020.2021 and beyond. We anticipate our adjusted capital expenditures net of asset sales, to be $125$250 million to $150$300 million in fiscal 2020,2021, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments. During the six months ended August 1, 2020,July 31, 2021, adjusted capital expenditures were $70.5$125.5 million, net of cash received related to landlord tenant allowances of $10.2$11.2 million. Our fiscal 2020 adjusted capital expenditures are partially offset by net proceeds from sales
50 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us. Other lease arrangements for our new Design Galleries require the landlord to fund a portion of the construction related costs directly to third parties, rather than through traditional construction allowances and accordingly, under these arrangements we do not expect to receive contributions directly from our landlords related to the building of our Design Galleries. As we develop new Galleries, as well as other potential strategic initiatives in the future like our integrated hospitality experience, we may explore other models for our real estate, which could include longer lease terms or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated with new sites and buildings. These approaches might require greaterdifferent levels of capital investment on our part than a traditional store lease with a landlord. We also believe there is an opportunity to transition our real estate strategy from a leasing model to a development model, where we potentially buy and develop our Design Galleries then recoup the investments through a sale-leaseback arrangement resulting in lower capital investment and lower rent. For example, we have used this strategy in fiscal 2019 through the sale-leaseback transaction for the Yountville Design Gallery and in Julyfiscal 2020 through the sale-leaseback transaction for the Minneapolis Design Gallery. In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurances that we will be successful in securing additional funding on attractive terms or at all.
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In addition, we continue to address the effects of COVID-19the pandemic on our business with respect to real estate development and the introduction of new Galleries in both the USU.S. and internationally. A range of factors involved in the development of new Gallery and RH Hospitality may continue to be affected by the COVID-19 health crisispandemic including delays in construction as well as permitting and other necessary governmental actions. In addition, the scope and cadence of investments by third parties including landlords and other real estate counterparties may be adversely affected by the health crisis. Actions taken by international as well as federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the outbreak,pandemic, may require changes to our real estate strategy and related capital expenditure and financing plans. In addition, we may continue to be required to make lease payments in whole or in part for our Galleries, restaurantsOutlets and outletsRestaurants that were temporarily closed or are required to close in the future in the event of futureresurgences in COVID-19 outbreaks or for other reasons. Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from COVID-19,the pandemic, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence.
There can be no assurance that we will have sufficient financial resources, or will be able to arrange financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental debt will be available to us in order to fund our cash payments in respect of the repayment of ourthe remaining outstanding convertible senior notes in an aggregate principal amount of $685$652 million at maturity or early conversion of such senior convertible notes. To the extent we need to secure additional sources of liquidity, we cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future financing requirements would not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock. Any adverse developments in the U.S. or global credit markets as a result of COVID-19the pandemic or any other reason could affect our ability to manage our debt obligations and our ability to access future debt. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the covenants or other requirements of existing or new debt facilities, any such event could have an impact on our other commitments and obligations including triggering cross defaults or other consequences with respect to other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur, exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 51 |
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the following table:
| | | | | | | |
| | Six Months Ended | |||||
| | August 1, | | August 3, | | ||
|
| 2020 |
| 2019 |
| ||
| | (in thousands) | |||||
Net cash provided by operating activities | | $ | 128,275 | | $ | 97,133 | |
Net cash used in investing activities | |
| (25,575) | |
| (25,283) | |
Net cash used in financing activities | |
| (132,988) | |
| (66,023) | |
Net increase (decrease) in cash and cash equivalents | |
| (30,271) | |
| 5,752 | |
Cash and cash equivalents at end of period | |
| 17,387 | |
| 11,555 | |
| | | | | | |
| | SIX MONTHS ENDED | ||||
| | JULY 31, | | AUGUST 1, | ||
|
| 2021 |
| 2020 | ||
| | (in thousands) | ||||
Net cash provided by operating activities | | $ | 316,718 | | $ | 128,275 |
Net cash used in investing activities | |
| (84,077) | |
| (25,575) |
Net cash used in financing activities | |
| (42,968) | |
| (132,988) |
Net increase (decrease) in cash and cash equivalents and restricted cash equivalents | |
| 189,765 | |
| (30,271) |
Cash and cash equivalents and restricted cash equivalents at end of period | |
| 296,836 | |
| 17,387 |
Net Cash Provided By Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items including depreciation and amortization, impairments, stock-based compensation, amortization of debt discount and the effect of changes in working capital and other activities.
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TableFor the six months ended July 31, 2021, net cash provided by operating activities was $316.7 million and consisted of Contentsnet income of $357.4 million and an increase in non-cash items of $144.1 million, partially offset by a change in working capital and other activities of $184.8 million. The source of cash from working capital was primarily driven by an increase in deferred revenue and customer deposits of $116.5 million primarily due to strong consumer demand for our products. These sources of cash from working capital were partially offset by uses of cash driven by an increase in merchandise inventory of $101.6 million, a decrease in other current liabilities of $51.7 million, an increase in landlord assets under construction of $43.4 million, an increase in prepaid expenses and other assets of $57.9 million, and a decrease in operating lease liabilities of $38.9 million primarily due to payments made under the related lease agreements.
For the six months ended August 1, 2020, net cash provided by operating activities was $128.3 million and consisted of net income of $95.2 million and non-cash items of $89.1 million, partially offset by cash used for working capital and other activities of $56.0 million. Working capital and other activities consisted primarily of an increase in merchandise inventory of $49.0 million, an increase in landlord assets under construction of $22.9 million, a decrease in operating lease liabilities of $18.4 million primarily due to payments made under the related lease agreements, a decrease in accounts payable and accrued expenses of $13.1 million due to timing of payments, and a decrease in other non-current obligations of $12.3 million. These decreases in working capital were partially offset by increases in deferred revenue and customer deposits of $67.6 million.
For the six months ended August 3, 2019, net cash provided by operating activities was $97.1 million and consisted of net income of $99.5 million and non-cash items of $59.5 million, partially offset by cash used for working capital and other activities of $61.9 million. Working capital and other activities consisted primarily of a decrease in operating lease liabilities of $44.5 million primarily due to payments made under the agreements, a decrease in accounts payable and accrued expense of $40.1 million related to timing of payments, an increase in landlord assets under construction of $27.6 million, as well as a decrease in other non-current liabilities of $13.8 million. These decreases to working capital were partially offset by a decrease in merchandise inventory of $51.2 million and increases in deferred revenue and customer deposits of $13.0 million.
Net Cash Used In Investing Activities
Investing activities consist primarily of investments in capital expenditures related to investments in retail stores, information technology and systems infrastructure, as well as supply chain investments. Investing activities also include our strategic investments.
For the six months ended July 31, 2021, net cash used in investing activities was $84.1 million and was comprised of investments in retail stores, information technology and systems infrastructure of $82.1 million and additional funding of our equity method investments of $1.9 million.
For the six months ended August 1, 2020, net cash used in investing activities was $25.6 million primarily due to investments in information technology and systems infrastructure, supply chain investments and retail stores of $32.1 million, as well as the acquisition of building and land assets of $14.2 million. Net cash used in investing activities was partially offset by net proceeds from the sale of building and land of $25.0 million. For the six months ended August 3, 2019, net cash used in investing activities was $25.3 million due to investments in information technology and systems infrastructure, supply chain investments and retail stores.
52 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Net Cash Used In Financing Activities
Financing activities consist primarily of borrowings and repayments related to convertible senior notes, credit facilities and other financing arrangements, as well asand cash used in connection with such financing activities include investments in share repurchases,repurchase programs, repayment of indebtedness including principal payments under finance lease agreements and other equity related transactions.transactions such as the convertible note bond hedge and warrant transactions in connection with our convertible notes financings.
For the six months ended July 31, 2021, net cash used in financing activities was $43.0 million, partially due to the repayment of $33.2 million of the 2023 Notes in the six months ended July 31, 2021 as a result of early conversion at the option of the noteholders, of which $28.1 million is presented as repayments of convertible senior notes within cash from financing activities and $5.1 million is reflected as non-cash accretion of debt discount upon settlement of debt within cash from operating activities. In addition, we made repayments of $11.4 million on our equipment notes, $7.1 million of principal payments under finance lease agreements and incurred $3.6 million of debt issuance costs related to the Amended Credit Agreement. Equity related transactions provided $7.3 million due to $25.9 million of proceeds from exercise of employee stock options, partially offset by $18.6 million of cash paid for employee taxes related to net settlement of equity awards.
For the six months ended August 1, 2020, net cash used in financing activities was $133.0 million. The $300 million 2020 Notes matured in July 2020, of which $215.8 million is presented within net cash used in financing activities and $84.0 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities. Net cash used in financing activities was partially offset by net borrowings of $91.6 million under the asset based credit facility.
For the six months ended August 3, 2019, net cash used in financing activities was $66.0 million. The $350.0 million 2019 Notes matured in June 2019, of which $278.6 million is presented within net cash used in financing activities and $70.5 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities. Additionally, net cash used in financing activities included the repurchase of approximately 2.2 million shares of our common stock for an aggregate repurchase amount of $250.0 million. Net cash used by financing activities was partially offset by borrowings under new debt arrangements of $389.0 million, which includes the issuance of a $200.0 million second lien term loan, a $120.0 million FILO term loan and $69.0 million of promissory notes secured by certain equipment. We incurred costs of $4.6 million related to the debt issuances. Under the asset based credit facility, we made repayments of $214.5 million in connection with the debt issuances described above pursuant to the terms of such facility, and we subsequently had borrowings of $302.0 million under such facility to partially fund the repayment of the 2019 Notes upon maturity.
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Non-Cash Transactions
Non-cash transactions primarily consist of non-cash additions of property and equipment and landlord assets and reclassificationsreclassification of assets from landlord assets fromunder construction to finance lease right-of-use assets. In addition, non-cash transactions consist of shares issued and received related to the settlement of convertible senior note transactions.
Convertible Senior Notes
Refer to Note 9—Convertible Senior Notesin our condensed consolidated financial statements for further information on our 0.00% Convertible Senior Notes due 2024 0.00% Convertible Senior Notes due 2023 and 0.00% Convertible Senior Notes due 2020. Our 0.00% Convertible Senior Notes due 2020 matured on July 15, 2020.2023.
Asset Based Credit Facility
Refer to Note 10—Credit Facilitiesin our condensed consolidated financial statements for further information on our asset based credit facility.
Equipment Loan Facility
Refer to Note 10—Credit Facilitiesin our condensed consolidated financial statements for further information on our equipment loan facility.
Share Repurchase ProgramsProgram
We regularly review share repurchase activity and consider various factors in determining whether and when to execute investments in connection with our share repurchases,repurchase programs, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock. We believe that these share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 53 |
Our free cash flow has historically supported our current and completed share repurchase programs. We generated $405 million, $330 million $163 million and $415$163 million in free cash flow in fiscal 2020, fiscal 2019 and fiscal 2018, and fiscal 2017, respectively, which supported our share repurchase programs. Free cash flow is calculated as net cash provided by operating activities, the non-cash accretion of debt discount upon settlement of debt and proceeds from sale of assets, less capital expenditures and principal payments under finance leases.respectively. Free cash flow excludes all non-cash items. Free cash flow is net cash provided by operating activities adjusted by the non-cash accretion of debt discount upon settlement of debt, proceeds from sale of asset, capital expenditures, principal payments under finance leases and equity method investments. Free cash flow is included in this filing because managementour senior leadership team 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 managementsenior leadership team uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.business. A reconciliation of our net cash provided by operating activities to free cash flow is as follows:
| | | | | | | | | |
|
| Year Ended | |||||||
| | February 2, | | February 2, | | February 3, | |||
| | 2020 | | 2019 | | 2018 | |||
| | (in thousands) | |||||||
Net cash provided by operating activities | | $ | 339,188 | | $ | 249,603 | | $ | 474,505 |
Accretion of debt discount upon settlement of debt | |
| 70,482 | |
| — | |
| — |
Proceeds from sale of assets | |
| 24,078 | |
| — | |
| 15,123 |
Capital expenditures | | | (93,623) | | | (79,992) | | | (68,393) |
Principal payments under finance leases | |
| (9,682) | |
| (6,885) | |
| (6,105) |
Free cash flow | | $ | 330,443 | | $ | 162,726 | | $ | 415,130 |
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| | | | | | | | | |
| | YEAR ENDED | |||||||
| | JANUARY 30, | | FEBRUARY 1, | | FEBRUARY 2, | |||
| | 2021 | | 2020 | | 2019 | |||
| | (in thousands) | |||||||
Net cash provided by operating activities | | $ | 500,770 | | $ | 339,188 | | $ | 249,603 |
Accretion of debt discount upon settlement of debt | |
| 84,003 | |
| 70,482 | |
| — |
Proceeds from sale of assets | |
| 25,006 | |
| 24,078 | |
| — |
Capital expenditures | | | (111,126) | | | (93,623) | | | (79,992) |
Principal payments under finance leases | |
| (12,498) | |
| (9,682) | |
| (6,885) |
Equity method investments | | | (80,723) | | | — | | | — |
Free cash flow | | $ | 405,432 | | $ | 330,443 | | $ | 162,726 |
$950 Million Share Repurchase Program
On October 10,In 2018, our Board of Directors authorized a share repurchase program of up to $700 million through open market purchases, privately negotiated transactions or other means, including through Rule 10b1810b-18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as the acquisition of other equity linked instruments, accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives, of whichderivatives. We completed $250.0 million in share repurchases were completed in fiscal 2018. The $700 million authorization amount was replenished by the Board of Directors on March 25, 2019 (as replenished, the “$950 Million Repurchase Program”).2018 under this program. In the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under the $950 Million Repurchase Program at an average price of $115.36 per share, for an aggregate repurchase amount of approximately $250.0 million. There were nomillion under this share repurchase program. We did not make any repurchases under this program during either the three or six months ended July 31, 2021 or August 1, 2020. The total current authorized size of this share repurchase program is up to $950 million (the “950 Million Repurchase Program during the first quarterProgram”), of fiscal 2020. Aswhich $450.0 million remained available as of August 1, 2020, there was $450 million remainingJuly 31, 2021 for future share repurchases under this program.investments.
Contractual Obligations
As of August 1, 2020,July 31, 2021, there were no material changes to our contractual obligations described within Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations in the 20192020 Form 10-K.10-K other than lease agreements entered into in the normal course of business (refer to Note 8—Leases).
Off Balance Sheet Arrangements
We have no material off balance sheet arrangements as of August 1, 2020.July 31, 2021.
54 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires managementsenior leadership to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our accounting policies, estimates, and judgments on an on-going basis. We base our estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions and such differences could be material to the consolidated financial statements.
We evaluate the development and selection of our critical accounting policies and estimates and believe that certain of our significant accounting policies involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results of operations and financial position, and are therefore discussed as critical:
Merchandise Inventories—Reserves
Impairment
Tradenames, Trademarks and Other Intangible Assets
Long-Lived Assets
Lease Accounting
Reasonably Certain Lease Term
Incremental Borrowing Rate
Fair Market Value
Stock-Based Compensation—Performance-Based Awards
Equity Method Investments
There have been no material changes to the other critical accounting policies and estimates listed above from the disclosures included in the 20192020 Form 10-K. For further discussion regarding these policies, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates in the 20192020 Form 10-K.
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Recent Accounting Pronouncements
Refer to Note 2—Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently proposedissued accounting standards whichthat may impact our consolidated financial statementsus in future reporting periods.
ItemITEM 3. Quantitative and Qualitative Disclosure of Market RisksQUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
Interest Rate Risk
We currently do not engage in any interest rate hedging activity and we have no intention to do so in the foreseeable future.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 55 |
We are subject to interest rate risk in connection with borrowings under our revolving line of credit under the Amended Credit Agreement whichthat bears interest at variable rates and we may incur additional indebtedness that bears interest at variable rates. As of August 1, 2020, $91.6 million wasJuly 31, 2021, we had no outstanding borrowings under the revolving line of credit. The Amended Credit Agreement provides for a borrowing amount based on the value of eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Amended Credit Agreement as of August 1, 2020July 31, 2021 was $259.2$389.1 million, net of $14.5$20.1 million in outstanding letters of credit. Based on the average interest rate on the revolving line of credit during the three months ended August 1, 2020,July 31, 2021, and to the extent that borrowings were outstanding on such line of credit, we do not believe that a 10% change in the interest rate would have a material effect on our consolidated results of operations or financial condition. To the extent that we incur additional indebtedness, we may increase our exposure to risk from interest rate fluctuations.
A number of our current debt agreements, including the Amended Credit Agreement, have an interest rate tied to LIBOR, which is expected to be discontinued after 2021. A number of alternatives to LIBOR have been proposed or are being developed, but it is not clear which, if any, will be adopted. Any of these alternative methods may result in interest payments that are higher than expected or that do not otherwise correlate over time with the payments that would have been made on such indebtedness for the interest periods if the applicable LIBOR rate was available in its current form.
As of August 1, 2020,July 31, 2021, we had $335$302 million principal amount of 0.00% convertible senior notes due 2023 outstanding (the “2023 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.
As of August 1, 2020,July 31, 2021, we had $350 million principal amount of 0.00% convertible senior notes due 2024 outstanding (the “2024 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.
Market Price Sensitive Instruments
0.00% Convertible Senior Notes due 2020
In connection with the issuance of the 2020 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The 2020 Notes matured on July 15, 2020, and the convertible note hedge terminated upon the maturity date of the 2020 Notes. We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrants will expire through January 2021. To the extent they are exercised prior to expiration, the warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants. The strike price of the warrant transactions is initially $189.00 per share. Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements.
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0.00% Convertible Senior Notes due 2023
In connection with the issuance of the 2023 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively, 1.7 million shares of our common stock, which represents the number of shares of our common stock underlying the 2023 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2023 Notes. These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to our common stock upon conversion of the 2023 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion of the 2023 Notes.
We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant transactions is initially $309.84 per share. Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements.
0.00% Convertible Senior Notes due 2024
In connection with the issuance of the 2024 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively, 1.7 million shares of our common stock, which represents the number of shares of our common stock underlying the 2024 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2024 Notes. These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to our common stock upon conversion of the 2024 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion of the 2024 Notes.
We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant transactions is initially $338.24 per share. Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements.
56 | 2021 SECOND QUARTER FORM 10-Q | PART I. FINANCIAL INFORMATION |
Impact of Inflation
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our consolidated results of operations and financial condition have been immaterial.
ItemITEM 4. Controls and ProceduresCONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management,senior leadership team, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that the information required to be disclosed by us in such reports is accumulated and communicated to our management,senior leadership team, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
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Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter ended July 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART I. FINANCIAL INFORMATION | 2021 SECOND QUARTER FORM 10-Q | 57 |
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PART II
ItemITEM 1. Legal ProceedingsLEGAL PROCEEDINGS
From time to time, we and/or our managementsenior leadership team are involved in litigation, claims and other proceedings relating to the conduct of our business, including purported class action litigation, as well as securities class action litigation. Such legal proceedings may include claims related to our employment practices, wage and hour claims, claims of intellectual property infringement, including with respect to trademarks and trade dress, claims asserting unfair competition and unfair business practices, claims with respect to our collection and sale of reproduction products, and consumer class action claims relating to our consumer practices including the collection of zip code or other information from customers. In addition, from time to time, we are subject to product liability and personal injury claims for the products that we sell and the stores we operate. Subject to certain exceptions, our purchase orders generally require the vendor to indemnify us against any product liability claims; however, if the vendor does not have insurance or becomes insolvent, we may not be indemnified. In addition, we could face a wide variety of employee claims against us, including general discrimination, privacy, labor and employment, ERISA and disability claims. Any claims could result in litigation against us and could also result in regulatory proceedings being brought against us by various federal and state agencies that regulate our business, including the U.S. Equal Employment Opportunity Commission. Often these cases raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant managementsenior leadership team’s time. Litigation and other claims and regulatory proceedings against us could result in unexpected expenses and liability and could also materially adversely affect our operations and our reputation.
For additional information regarding certain pending securities litigation, refer to Note 16—Commitments and Contingencies in our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q.
ItemITEM 1A. Risk FactorsRISK FACTORS
We operate in a rapidly changing environment that involves a number of risks that could materially and adversely affect our business, financial condition, prospects, operating results or cash flows. For a detailed discussion of certain risks that affect our business, refer to the sections entitled “Risk Factors”Risk Factors in our Annual Report on Form 10-K for the fiscal year ended February 1, January 30, 2021 (“2020 (“2019 Form 10-K”) and in our Quarterly Report on Form 10-Q for the quarterly period ended May 2, 20201, 2021 (“First Quarter Form 10-Q”). There have been no material changes to the risk factors disclosed in our 2020 Form 10-K and First Quarter Form 10-Q.
The risks described herein and those described in our 20192020 Form 10-K and in our First Quarter Form 10-Q are not the only risks we face. We describe in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report certain known trends and uncertainties that affect our business. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business, operating results and financial condition. We have identified additional material changes to our risk factors set forth below.
Risks Related to Our Business
The COVID-19 pandemic poses significant and widespread risks to our business as well as to the business environment and the markets in which we operate.
The global outbreak of the novel coronavirus disease (“COVID-19”) and resulting health crisis had an immediate and widespread impact on our customers, our business environment, the economic climate in the U.S. and globally, and financial and consumer markets. The initial wave of the COVID-19 outbreak caused disruption to our business operations, as we temporarily closed all of our retail locations on March 17, 2020 in response to the public health crisis.
While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
Volatility in consumer demand and sentiment as the COVID-19 pandemic continues to evolve can also expose us to risks in our operations. In our immediate response to COVID-19, we aggressively scaled back some inventory orders while we assessed the status of our business. As our business has strengthened during the second fiscal quarter, the reduction in inventory receipts together with dislocations in our supply chain resulted in some delays in our ability to convert business demand into shipped sales. In addition, our near term decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business related to the impact of COVID-19. The global scale and scope of COVID-19 is unknown and the duration of the business disruption is uncertain. The extent to which the COVID-19 pandemic impacts our business will depend on future developments that are highly uncertain, including developing information concerning the severity of COVID-19 and the actions taken by governments and private businesses to attempt to contain COVID-19.
We may face operational restrictions with respect to some or all of our physical locations for prolonged periods of time due to, among other factors, evolving international, federal, state and local restrictions, standards and safety regulations including recommendations related to “social distancing.” Public health officials and other governmental authorities have adopted numerous mitigation measures to address the spread of the virus, and in particular to discourage people from congregating in public, commercial or private spaces. Federal, state and local authorities in the U.S. and Canada have implemented a number of different directives that may require changes in our business practices. The scope and duration of these directives is evolving and not entirely clear. In response to future COVID-19 outbreaks or other concerns, states and municipalities in the U.S. where we operate may implement or reinstate temporary closure requirements with respect to non-essential business operations and the duration of these requirements is unknown. Governmental restrictions applicable to our restaurants have different terms and conditions than those that apply to our Galleries. For example, in most of our retail locations that have reopened, substantial operational restrictions related to COVID-19 health and safety considerations, such as limits to seating capacity, have been imposed on our hospitality business by various governmental authorities. Such operational restrictions may cause our hospitality offerings to be less attractive to customers or may lower its margins and profitability. Many of our Galleries are located in malls or otherwise located in proximity to a number of other retail stores. Mall operators and other retailers have imposed, and may continue to impose, additional health and safety practices and procedures and may in the future elect to temporarily cease operations in response to renewed or localized outbreaks.
In addition, new regulation or requirements that governmental authorities may impose with respect to the compensation of our employees or the manner or location in which our employees may work could also have an adverse effect on our business. At various times since the beginning of the pandemic, substantially all of our management personnel, including those in our corporate office in Corte Madera, CA, have been subject to state and local shelter-in-place requirements, which have varied over time and which have resulted in most of our management team being required to work remotely. These working arrangements as well as other related restrictions including severe limitations on travel may have an impact on our operations and management effectiveness. Although we have technology and other resources to support these new work requirements, there can be no assurance that we will not suffer material risks to our business, operations, productivity and results of operations as a result of these restrictions. If a significant percentage of our workforce is unable to work, including because of illness or travel or government restrictions in connection with COVID-19, our operations may be negatively impacted, potentially materially adversely affecting our business, liquidity, financial condition or results of operations.
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The COVID-19 outbreak may continue to have an adverse impact on elements of our supply chain including the manufacture, supply, distribution, transportation and delivery of our products and our inventory levels. There have been substantial disruptions that have already occurred with respect to the global supply chain as a result of the COVID-19 health crisis. Our business depends on the successful operation of a global supply chain. Based on total dollar volume of purchases for fiscal 2019, approximately 70% of our products were sourced from Asia (including a substantial portion from China), 16% from the United States and the remainder from other countries and regions. Although China was at the center of the initial outbreak of the COVID-19, the health crisis has spread to numerous other countries throughout the world. The presence of the virus and the response to the health crisis in various countries is likely to have a continuing impact on our supply chain, for example by affecting the speed at which the factories that manufacture our products are able to resume normal operations and production levels after initial or subsequent waves of closures, and the extent that the health crisis may abate in particular countries such as China is uncertain.
Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may further adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020. If we are not able to access capital at the time and on terms that our business requires, we may encounter difficulty funding our business requirements including debt repayments when due. We may not be able to access liquidity or the terms and conditions of available credit may be substantially more expensive than previously expected due to changes in financial conditions and credit markets. We may require waivers or amendments to our existing credit facilities and these requirements may trigger pricing increases from lenders for available credit. If we are not able to access credit to fund our business requirements for liquidity, or the cost of available credit increases, we may need to curtail our business operations including various business initiatives that require capital investment. We have recently commenced an effort to expand our business internationally by establishing a new retail presence in global markets including Europe and the United Kingdom. The impact of COVID-19 abroad, including travel restrictions imposed by various countries, may affect certain aspects of our planned international expansion. In addition, we are in the process of developing a number of new Gallery locations in the U.S. Counterparties with respect to some of our Gallery development projects may experience capital or liquidity constraints due to COVID-19 related difficulties, which may impact the timing or scope of some of our development projects. In addition, our RH Guesthouse initiative may be negatively impacted by the disease outbreak as international, federal, state and local governments have restricted travel, conferences, events and gatherings. Any reductions in our liquidity position and the need to use capital for other day-to-day requirements of our business could affect a number of our business initiatives and long-term investments and as a result we may be required to curtail and/or postpone business investments including those related to international expansion, the pace of opening new Galleries in the U.S. as well as other initiatives that require capital investment.
Our business also depends on a number of third parties including vendors, landlords, lenders and other suppliers. One or more of these third parties may experience financial distress, staffing shortages or liquidity challenges, file for bankruptcy protection, go out of business, or suffer disruptions in their business due to the COVID-19 outbreak. The health crisis, resulting deterioration in financial markets and overall economic conditions could have a material adverse effect on the financial condition of third parties that are essential to our business operations and we may incur losses and other negative impacts for difficulties experienced by our vendors and other third parties.
The magnitude and duration of the negative impact to general economic and market conditions from the COVID-19 pandemic cannot be predicted with certainty, and there can be no assurance that the pace of economic activity in the wake of COVID-19 outbreaks will not have a negative impact on our business. The COVID-19 pandemic and mitigation measures have had an adverse impact on global economic conditions as well as the business climate in our primary consumer markets in the U.S. and Canada. Our business also depends to some extent on conditions in financial markets. We have determined that our customer purchasing patterns are influenced by economic factors including the health and volatility of the stock market. We have seen that previous downturns in the stock market have been correlated with a reduction in consumer demands for our products. The timing, magnitude and duration of disruptions of financial markets and weakening of overall economic conditions as a result of COVID-19 is unknown, and the precise impact of such trends on our business is also unknown. Uncertainties regarding the economic impact of COVID-19 have resulted in, and are likely to continue to result in, sustained impact on the economy. Our business is particularly sensitive to reductions in discretionary consumer spending, which may be adversely impacted by a recession or fears of a recession, volatility and declines in the stock market and increasingly pessimistic consumer sentiment due to perceived or actual economic and/or health risks.
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ItemITEM 2. Unregistered Sales of Equity Securities and Use of ProceedsUNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Repurchases of Common Stock
During the three months ended August 1, 2020,July 31, 2021, we repurchased the following shares of our common stock:
| | | | | | | | | | | | | | | | | | |
|
| |
| | |
| Total Number of |
| Approximate Dollar |
| |
| | |
| APPROXIMATE DOLLAR | ||
| | | | Average | | Shares Repurchased | | Value of Shares That | | | | AVERAGE | | VALUE OF SHARES THAT | ||||
| | | | Purchase | | as Part of Publicly | | May Yet Be | | | | PURCHASE | | MAY YET BE | ||||
| | Number of | | Price Per | | Announced Plans or | | Purchased Under the | | NUMBER OF | | PRICE PER | | PURCHASED UNDER THE | ||||
| | Shares (1) | | Share | | Programs (2) | | Plans or Programs | | SHARES (1) | | SHARE | | PLANS OR PROGRAMS (2) | ||||
| | | | | | | | | (in millions) | | | | | | | (in millions) | ||
May 3, 2020 to May 30, 2020 |
| 3,839 | | $ | 150.24 |
| — | | $ | 450 | ||||||||
May 31, 2020 to July 4, 2020 |
| 22,963 | | $ | 254.80 |
| — | | $ | 450 | ||||||||
July 5, 2020 to August 1, 2020 |
| — | | $ | — |
| — | | $ | 450 | ||||||||
May 2, 2021 to May 29, 2021 |
| 9,264 | | $ | 687.20 | | $ | 450 | ||||||||||
May 30, 2021 to July 3, 2021 |
| 17,185 | | $ | 660.77 | | $ | 450 | ||||||||||
July 4, 2021 to July 31, 2021 |
| 7 | | $ | 664.35 | | $ | 450 | ||||||||||
Total |
| 26,802 | | | |
| — | |
|
|
| 26,456 | | | | |
|
|
(1) | Reflects shares withheld from delivery to satisfy exercise price and tax withholding obligations of employee recipients that occur upon the vesting of restricted stock units granted under our 2012 Stock Incentive Plan. |
(2) | Reflects the dollar value of shares that may yet be repurchased |
ItemITEM 3. Defaults Upon Senior SecuritiesDEFAULTS UPON SENIOR SECURITIES
Not applicable.
ItemITEM 4. Mine Safety DisclosuresMINE SAFETY DISCLOSURES
Not applicable.
ItemITEM 5. Other InformationOTHER INFORMATION
Not applicable.
ItemITEM 6. ExhibitsEXHIBITS