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 October 28, 2017May 2, 2020
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) (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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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. (Check one):
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 December 1, 2017, 21,309,941May 29, 2020, 19,290,966 shares of the registrant’s common stock were outstanding.
RH
INDEX TO FORM 10-Q
| | | | |
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| |
| Page |
| | | | |
3 | ||||
3 | ||||
4 | ||||
5 | ||||
6 | ||||
| ||||
Notes to Condensed Consolidated Financial Statements (Unaudited) |
| |||
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| |||
| ||||
| 50 | |||
52 | ||||
| | | | |
| ||||
| ||||
| |
| ||
| |
| ||
|
| |||
|
| |||
|
| |||
| | 56 | ||
| | 56 | ||
57 | ||||
58 |
2
PART I
RH
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
ASSETS |
| |
|
| |
|
Current assets: |
| |
|
| |
|
Cash and cash equivalents | | $ | 17,208 | | $ | 47,658 |
Accounts receivable—net | |
| 49,099 | |
| 48,979 |
Merchandise inventories | |
| 494,260 | |
| 438,696 |
Prepaid expense and other current assets | |
| 65,154 | |
| 61,619 |
Total current assets | |
| 625,721 | |
| 596,952 |
Property and equipment—net | |
| 953,738 | |
| 967,599 |
Operating lease right-of-use assets | | | 392,934 | | | 410,904 |
Goodwill | |
| 124,290 | |
| 124,367 |
Tradenames, trademarks and domain names | |
| 65,563 | |
| 86,022 |
Deferred tax assets | |
| 38,875 | |
| 45,005 |
Other non-current assets | |
| 228,772 | |
| 214,845 |
Total assets | | $ | 2,429,893 | | $ | 2,445,694 |
LIABILITIES AND STOCKHOLDERS’ EQUITY | |
|
| |
|
|
Current liabilities: | |
|
| |
|
|
Accounts payable and accrued expenses | | $ | 284,980 | | $ | 330,309 |
Deferred revenue and customer deposits | |
| 189,048 | |
| 162,433 |
Convertible senior notes due 2020—net | | | 295,574 | | | 290,532 |
Operating lease liabilities | | | 61,997 | | | 58,924 |
Other current liabilities | |
| 137,336 | |
| 140,714 |
Total current liabilities | |
| 968,935 | |
| 982,912 |
Asset based credit facility | |
| 10,000 | |
| — |
Equipment promissory notes—net | |
| 28,475 | |
| 31,053 |
Convertible senior notes due 2023—net | |
| 271,211 | |
| 266,658 |
Convertible senior notes due 2024—net | | | 269,012 | | | 264,982 |
Non-current operating lease liabilities | |
| 395,641 | |
| 409,930 |
Non-current finance lease liabilities | | | 439,470 | | | 442,988 |
Other non-current obligations | |
| 28,017 | |
| 28,520 |
Total liabilities | |
| 2,410,761 | |
| 2,427,043 |
Commitments and contingencies (Note 15) | |
| | |
| |
Stockholders’ equity: | |
|
| |
|
|
Preferred stock—$0.0001 par value per share, 10,000,000 shares authorized, 0 shares issued or outstanding as of May 2, 2020 and February 1, 2020 | |
| — | |
| — |
Common stock—$0.0001 par value per share, 180,000,000 shares authorized, 19,264,727 shares issued and 19,264,127 shares outstanding as of May 2, 2020; 19,236,681 shares issued and outstanding as of February 1, 2020 | |
| 2 | |
| 2 |
Additional paid-in capital | |
| 436,799 | |
| 430,662 |
Accumulated other comprehensive loss | |
| (5,132) | |
| (2,760) |
Accumulated deficit | |
| (412,465) | |
| (409,253) |
Treasury stock—at cost, 600 shares as of May 2, 2020 and 0 shares as of February 1, 2020 | | | (72) | | | — |
Total stockholders’ equity | |
| 19,132 | |
| 18,651 |
Total liabilities and stockholders’ equity | | $ | 2,429,893 | | $ | 2,445,694 |
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
| $ | 22,162 |
|
| $ | 87,023 |
|
Short-term investments |
|
| — |
|
|
| 142,677 |
|
Accounts receivable—net |
|
| 34,447 |
|
|
| 34,191 |
|
Merchandise inventories |
|
| 557,345 |
|
|
| 752,304 |
|
Asset held for sale |
|
| — |
|
|
| 4,900 |
|
Prepaid expense and other current assets |
|
| 75,041 |
|
|
| 117,162 |
|
Total current assets |
|
| 688,995 |
|
|
| 1,138,257 |
|
Long-term investments |
|
| — |
|
|
| 33,212 |
|
Property and equipment—net |
|
| 778,320 |
|
|
| 682,056 |
|
Goodwill |
|
| 175,553 |
|
|
| 173,603 |
|
Trademarks and other intangible assets |
|
| 100,726 |
|
|
| 100,757 |
|
Deferred tax assets |
|
| 29,214 |
|
|
| 28,466 |
|
Other non-current assets |
|
| 28,758 |
|
|
| 36,169 |
|
Total assets |
| $ | 1,801,566 |
|
| $ | 2,192,520 |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses |
| $ | 252,569 |
|
| $ | 226,980 |
|
Deferred revenue and customer deposits |
|
| 166,579 |
|
|
| 145,918 |
|
Other current liabilities |
|
| 50,609 |
|
|
| 43,271 |
|
Total current liabilities |
|
| 469,757 |
|
|
| 416,169 |
|
Asset based credit facility |
|
| 341,000 |
|
|
| — |
|
Term loan—net |
|
| 79,471 |
|
|
| — |
|
Convertible senior notes due 2019—net |
|
| 323,828 |
|
|
| 312,379 |
|
Convertible senior notes due 2020—net |
|
| 248,633 |
|
|
| 235,965 |
|
Financing obligations under build-to-suit lease transactions |
|
| 230,259 |
|
|
| 203,015 |
|
Deferred rent and lease incentives |
|
| 63,499 |
|
|
| 60,439 |
|
Other non-current obligations |
|
| 70,395 |
|
|
| 44,684 |
|
Total liabilities |
|
| 1,826,842 |
|
|
| 1,272,651 |
|
Commitments and contingencies (Note 17) |
|
| — |
|
|
| — |
|
Stockholders’ equity (deficit): |
|
|
|
|
|
|
|
|
Preferred stock, $0.0001 par value per share, 10,000,000 shares authorized, no shares issued or outstanding as of October 28, 2017 and January 28, 2017 |
|
| — |
|
|
| — |
|
Common stock, $0.0001 par value per share, 180,000,000 shares authorized, 41,525,393 shares issued and 21,305,261 shares outstanding as of October 28, 2017; 41,123,521 shares issued and 40,828,633 shares outstanding as of January 28, 2017 |
|
| 2 |
|
|
| 4 |
|
Additional paid-in capital |
|
| 843,965 |
|
|
| 790,866 |
|
Accumulated other comprehensive loss |
|
| (1,527 | ) |
|
| (1,692 | ) |
Retained earnings |
|
| 152,133 |
|
|
| 150,214 |
|
Treasury stock—at cost, 20,220,132 shares as of October 28, 2017 and 294,888 shares as of January 28, 2017 |
|
| (1,019,849 | ) |
|
| (19,523 | ) |
Total stockholders’ equity (deficit) |
|
| (25,276 | ) |
|
| 919,869 |
|
Total liabilities and stockholders’ equity (deficit) |
| $ | 1,801,566 |
|
| $ | 2,192,520 |
|
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
3
RH
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
| | | | | | |
| | Three Months Ended | ||||
| | May 2, | | May 4, | ||
|
| 2020 |
| 2019 | ||
Net revenues | | $ | 482,895 | | $ | 598,421 |
Cost of goods sold | |
| 283,241 | |
| 365,607 |
Gross profit | |
| 199,654 | |
| 232,814 |
Selling, general and administrative expenses | | | 164,201 | |
| 164,181 |
Income from operations | |
| 35,453 | |
| 68,633 |
Other expenses | |
| | | | |
Interest expense—net | | | 19,629 | |
| 21,118 |
Tradename impairment | | | 20,459 | | | — |
Total other expenses | |
| 40,088 | |
| 21,118 |
Income (loss) before income taxes | |
| (4,635) | |
| 47,515 |
Income tax expense (benefit) | |
| (1,423) | |
| 11,793 |
Net income (loss) | | $ | (3,212) | | $ | 35,722 |
Weighted-average shares used in computing | |
| 19,242,641 | |
| 19,976,858 |
Basic net income (loss) per share | | $ | (0.17) | | $ | 1.79 |
Weighted-average shares used in computing | |
| 19,242,641 | |
| 24,933,987 |
Diluted net income (loss) per share | | $ | (0.17) | | $ | 1.43 |
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
Net revenues |
| $ | 592,473 |
|
| $ | 549,328 |
|
| $ | 1,769,879 |
|
| $ | 1,548,165 |
|
Cost of goods sold |
|
| 378,148 |
|
|
| 373,509 |
|
|
| 1,179,485 |
|
|
| 1,065,032 |
|
Gross profit |
|
| 214,325 |
|
|
| 175,819 |
|
|
| 590,394 |
|
|
| 483,133 |
|
Selling, general and administrative expenses |
|
| 171,163 |
|
|
| 160,433 |
|
|
| 528,213 |
|
|
| 457,207 |
|
Income from operations |
|
| 43,162 |
|
|
| 15,386 |
|
|
| 62,181 |
|
|
| 25,926 |
|
Other expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense—net |
|
| 18,915 |
|
|
| 11,091 |
|
|
| 45,496 |
|
|
| 32,528 |
|
Loss on extinguishment of debt |
|
| 4,880 |
|
|
| — |
|
|
| 4,880 |
|
|
| — |
|
Total other expenses |
|
| 23,795 |
|
|
| 11,091 |
|
|
| 50,376 |
|
|
| 32,528 |
|
Income (loss) before income taxes |
|
| 19,367 |
|
|
| 4,295 |
|
|
| 11,805 |
|
|
| (6,602 | ) |
Income tax expense (benefit) |
|
| 6,216 |
|
|
| 1,778 |
|
|
| 9,886 |
|
|
| (2,567 | ) |
Net income (loss) |
| $ | 13,151 |
|
| $ | 2,517 |
|
| $ | 1,919 |
|
| $ | (4,035 | ) |
Weighted-average shares used in computing basic net income (loss) per share |
|
| 21,221,848 |
|
|
| 40,730,059 |
|
|
| 29,076,556 |
|
|
| 40,653,091 |
|
Basic net income (loss) per share |
| $ | 0.62 |
|
| $ | 0.06 |
|
| $ | 0.07 |
|
| $ | (0.10 | ) |
Weighted-average shares used in computing diluted net income (loss) per share |
|
| 23,535,617 |
|
|
| 40,926,450 |
|
|
| 30,593,382 |
|
|
| 40,653,091 |
|
Diluted net income (loss) per share |
| $ | 0.56 |
|
| $ | 0.06 |
|
| $ | 0.06 |
|
| $ | (0.10 | ) |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
4
RH
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
| | | | | | |
| | Three Months Ended | ||||
| | May 2, | | May 4, | ||
|
| 2020 |
| 2019 | ||
Net income (loss) | | $ | (3,212) | | $ | 35,722 |
Net losses from foreign currency translation | |
| (2,372) | |
| (937) |
Total comprehensive income (loss) | | $ | (5,584) | | $ | 34,785 |
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
Net income (loss) |
| $ | 13,151 |
|
| $ | 2,517 |
|
| $ | 1,919 |
|
| $ | (4,035 | ) |
Net gains (losses) from foreign currency translation |
|
| (723 | ) |
|
| (915 | ) |
|
| 154 |
|
|
| 485 |
|
Net unrealized holding gains (losses) on available-for-sale investments |
|
| — |
|
|
| (59 | ) |
|
| 11 |
|
|
| 84 |
|
Total comprehensive income (loss) |
| $ | 12,428 |
|
| $ | 1,543 |
|
| $ | 2,084 |
|
| $ | (3,466 | ) |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
5
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSSTOCKHOLDERS’ EQUITY (DEFICIT)
(In thousands)thousands, except share amounts)
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| 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 2, 2019 |
| 20,477,813 |
| $ | 2 |
| $ | 356,422 |
| $ | (2,333) |
| $ | (392,538) |
| 2,800 |
| $ | (243) |
| $ | (38,690) |
Stock-based compensation |
| — |
| | — |
| | 5,588 |
| | — |
| | — |
| — |
| | — |
| | 5,588 |
Vested and delivered restricted stock |
| 21,241 |
| | — |
| | (250) |
| | — |
| | — |
| — |
| | — |
| | (250) |
Exercise of stock options |
| 26,158 |
| | — |
| | 1,226 |
| | — |
| | — |
| — |
| | — |
| | 1,226 |
Repurchases of common stock |
| (2,167,396) |
| | — |
| | — |
| | — |
| | — |
| 2,167,396 |
| | (250,032) |
| | (250,032) |
Net income |
| — |
| | — |
| | — |
| | — |
| | 35,722 |
| — |
| | — |
| | 35,722 |
Net losses from foreign currency |
| — |
| | — |
| | — |
| | (937) |
| | — |
| — |
| | — |
| | (937) |
Balances—May 4, 2019 |
| 18,357,816 |
| $ | 2 |
| $ | 362,986 |
| $ | (3,270) |
| $ | (356,816) |
| 2,170,196 |
| $ | (250,275) |
| $ | (247,373) |
| | | | | | | | | | | | | | | | | | | | | | |
Balances—February 1, 2020 |
| 19,236,681 |
| $ | 2 |
| $ | 430,662 |
| $ | (2,760) |
| $ | (409,253) |
| — |
| $ | — |
| $ | 18,651 |
Stock-based compensation |
| — |
| | — |
| | 5,721 |
| | — |
| | — |
| — |
| | — |
| | 5,721 |
Vested and delivered restricted stock units |
| 10,286 |
| | — |
| | (381) |
| | — |
| | — |
| — |
| | — |
| | (381) |
Exercise of stock options |
| 17,760 |
| | — |
| | 797 |
| | — |
| | — |
| — |
| | — |
| | 797 |
Repurchases of common stock |
| (600) |
| | — |
| | — |
| | — |
| | — |
| 600 |
| | (72) |
| | (72) |
Net loss |
| — |
| | — |
| | — |
| | — |
| | (3,212) |
| — |
| | — |
| | (3,212) |
Net losses from foreign currency translation |
| — |
| | — |
| | — |
| | (2,372) |
| | — |
| — |
| | — |
| | (2,372) |
Balances—May 2, 2020 |
| 19,264,127 |
| $ | 2 |
| $ | 436,799 |
| $ | (5,132) |
| $ | (412,465) |
| 600 |
| $ | (72) |
| $ | 19,132 |
|
| Nine Months Ended |
| |||||
|
| October 28, |
|
| October 29, |
| ||
|
| 2017 |
|
| 2016 |
| ||
|
|
|
|
|
| As Revised |
| |
CASH FLOWS FROM OPERATING ACTIVITIES |
|
|
|
|
|
|
|
|
Net income (loss) |
| $ | 1,919 |
|
| $ | (4,035 | ) |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
| 51,092 |
|
|
| 41,248 |
|
Non-cash charges resulting from inventory step-up |
|
| 2,108 |
|
|
| 5,187 |
|
Amortization of debt discount |
|
| 22,685 |
|
|
| 21,467 |
|
Excess tax shortfall from exercise of stock options |
|
| — |
|
|
| 2,275 |
|
Stock-based compensation expense |
|
| 42,929 |
|
|
| 21,711 |
|
Non-cash loss on extinguishment of debt |
|
| 1,880 |
|
|
| — |
|
Other non-cash interest expense |
|
| 4,914 |
|
|
| 2,971 |
|
Change in assets and liabilities—net of acquisition: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
| (319 | ) |
|
| (1,445 | ) |
Merchandise inventories |
|
| 190,620 |
|
|
| (23,261 | ) |
Prepaid expense and other assets |
|
| 38,419 |
|
|
| (30,378 | ) |
Accounts payable and accrued expenses |
|
| 10,491 |
|
|
| (63,435 | ) |
Deferred revenue and customer deposits |
|
| 20,617 |
|
|
| 22,652 |
|
Other current liabilities |
|
| 448 |
|
|
| (25,372 | ) |
Deferred rent and lease incentives |
|
| 846 |
|
|
| 2,953 |
|
Other non-current obligations |
|
| (1,887 | ) |
|
| 8,477 |
|
Net cash provided by (used in) operating activities |
|
| 386,762 |
|
|
| (18,985 | ) |
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
|
|
|
|
Capital expenditures |
|
| (76,789 | ) |
|
| (104,152 | ) |
Construction related deposits |
|
| (12,772 | ) |
|
| (3,829 | ) |
Purchase of trademarks and domain names |
|
| (39 | ) |
|
| (164 | ) |
Proceeds from sale of assets held for sale—net |
|
| 15,123 |
|
|
| — |
|
Purchase of investments |
|
| (16,109 | ) |
|
| (186,967 | ) |
Maturities of investments |
|
| 46,890 |
|
|
| 115,938 |
|
Sales of investments |
|
| 145,020 |
|
|
| 31,896 |
|
Acquisition of business—net of cash acquired |
|
| — |
|
|
| (116,100 | ) |
Net cash provided by (used in) investing activities |
|
| 101,324 |
|
|
| (263,378 | ) |
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
|
|
|
|
Borrowing under asset based credit facility |
|
| 446,000 |
|
|
| — |
|
Repayments under asset based credit facility |
|
| (105,000 | ) |
|
| — |
|
Borrowings under term loans |
|
| 180,000 |
|
|
| — |
|
Repayments under term loans |
|
| (100,000 | ) |
|
| — |
|
Borrowing under promissory and equipment security notes |
|
| 34,000 |
|
|
| — |
|
Repayments under promissory and equipment security notes |
|
| (841 | ) |
|
| — |
|
Debt issuance costs |
|
| (8,298 | ) |
|
| — |
|
Repurchases of common stock—including commissions |
|
| (1,000,326 | ) |
|
| — |
|
Payments on build-to-suit lease transactions |
|
| (8,734 | ) |
|
| — |
|
Proceeds from exercise of stock options |
|
| 15,369 |
|
|
| 1,591 |
|
Excess tax shortfall from exercise of stock options |
|
| — |
|
|
| (2,275 | ) |
Tax withholdings related to issuance of stock-based awards |
|
| (4,881 | ) |
|
| (1,365 | ) |
Payments on capital leases |
|
| (258 | ) |
|
| (262 | ) |
Net cash used in financing activities |
|
| (552,969 | ) |
|
| (2,311 | ) |
Effects of foreign currency exchange rate translation |
|
| 22 |
|
|
| 342 |
|
Net decrease in cash and cash equivalents |
|
| (64,861 | ) |
|
| (284,332 | ) |
Cash and cash equivalents |
|
|
|
|
|
|
|
|
Beginning of period |
|
| 87,023 |
|
|
| 331,467 |
|
End of period |
| $ | 22,162 |
|
| $ | 47,135 |
|
Non-cash transactions: |
|
|
|
|
|
|
|
|
Property and equipment additions due to build-to-suit lease transactions |
| $ | 35,463 |
|
| $ | 46,193 |
|
Property and equipment additions from use of construction related deposits |
| $ | 27,077 |
|
| $ | 3,965 |
|
Property and equipment additions in accounts payable and accrued expenses at period-end |
| $ | 24,081 |
|
| $ | 23,440 |
|
Property and equipment acquired under capital lease |
| $ | 753 |
|
| $ | — |
|
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
6
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| | | | | | |
| | Three Months Ended | ||||
| | May 2, | | May 4, | ||
|
| 2020 |
| 2019 | ||
CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | |
Net income (loss) | | $ | (3,212) | | $ | 35,722 |
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |
| | |
| |
Depreciation and amortization | |
| 24,870 | |
| 27,189 |
Non-cash operating lease cost | | | 15,907 | | | 16,279 |
Tradename impairment | | | 20,459 | | | — |
Asset impairments | | | 4,783 | | | — |
Amortization of debt discount | |
| 12,916 | |
| 12,377 |
Stock-based compensation expense | |
| 5,828 | |
| 5,695 |
Non-cash finance lease interest expense | | | 5,781 | | | 5,514 |
Product recalls | | | — | | | (1,786) |
Other non-cash interest expense | |
| 1,145 | |
| 1,089 |
Change in assets and liabilities: | |
| | |
| |
Accounts receivable | |
| 1,554 | |
| (7,218) |
Merchandise inventories | |
| (55,837) | |
| 1,653 |
Prepaid expense and other assets | |
| (8,324) | |
| (17,846) |
Landlord assets under construction—net of tenant allowances | |
| (7,600) | |
| (4,542) |
Accounts payable and accrued expenses | |
| (52,989) | |
| (38,595) |
Deferred revenue and customer deposits | |
| 26,679 | |
| 21,641 |
Other current liabilities | |
| 4,696 | |
| 15,231 |
Current and non-current operating lease liabilities | |
| (7,065) | |
| (27,131) |
Other non-current obligations | |
| (6,459) | |
| (6,448) |
Net cash provided by (used in) operating activities | |
| (16,868) | |
| 38,824 |
CASH FLOWS FROM INVESTING ACTIVITIES | |
|
| |
| |
Capital expenditures | |
| (16,632) | |
| (7,916) |
Net cash used in investing activities | |
| (16,632) | |
| (7,916) |
CASH FLOWS FROM FINANCING ACTIVITIES | |
|
| |
|
|
Borrowings under asset based credit facility | |
| 71,100 | |
| 94,000 |
Repayments under asset based credit facility | |
| (61,100) | |
| (151,500) |
Borrowings under term loans | |
| — | |
| 320,000 |
Borrowings under promissory and equipment security notes | |
| — | |
| 60,000 |
Repayments under promissory and equipment security notes | |
| (5,166) | |
| (983) |
Debt issuance costs | |
| — | |
| (4,499) |
Principal payments under finance leases | | | (2,068) | | | (2,129) |
Repurchases of common stock—including commissions | |
| — | |
| (250,032) |
Proceeds from exercise of stock options | |
| 797 | |
| 1,226 |
Tax withholdings related to issuance of stock-based awards | | | (381) | |
| (250) |
Net cash provided by financing activities | |
| 3,182 | |
| 65,833 |
Effects of foreign currency exchange rate translation | |
| (132) | |
| 6 |
Net increase (decrease) in cash and cash equivalents and restricted cash | |
| (30,450) | |
| 96,747 |
Cash, cash equivalents and restricted cash | |
|
| |
|
|
Beginning of period—cash and cash equivalents | | $ | 47,658 | | $ | 5,803 |
| |
|
| |
|
|
End of period—cash and cash equivalents | |
| 17,208 | |
| 37,550 |
End of period—restricted cash | |
| — | |
| 65,000 |
End of period—cash, cash equivalents and restricted cash | | $ | 17,208 | | $ | 102,550 |
| | | | | | |
Non-cash transactions: | |
| | |
| |
Property and equipment additions in accounts payable and accrued expenses at period-end | | $ | 2,935 | | $ | 8,529 |
Landlord asset additions in accounts payable and accrued expenses at period-end | | | 23,489 | | | 19,481 |
Landlord asset additions from unpaid construction related deposits | |
| 195 | |
| 2,056 |
Issuance of non-current notes payable related to share repurchases from former employees | |
| 72 | |
| — |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
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,” “our” or the “Company”), is a luxury home furnishings retailer that offers a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, tableware, and child and teen furnishings. These products are sold through the Company’sour stores, catalogs and websites.
On May 27, 2016, the Company acquired a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name “Waterworks”. Refer to Note 3—Business Combination.
As of October 28, 2017, the CompanyMay 2, 2020, we operated a total of 84 retail69 RH Galleries and 3138 RH outlet stores in 3231 states, the District of Columbia and Canada, and includesas well as 15 Waterworks showrooms inthroughout 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 the Company’s records and, in management’s opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the Company’sour financial position as of October 28, 2017,May 2, 2020, and the results of operations for the three and nine months ended October 28, 2017May 2, 2020 and October 29, 2016. The Company’sMay 4, 2019. Our current fiscal year, which consists of 5352 weeks, ends on February 3, 2018January 30, 2021 (“fiscal 2017”2020”).
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 management 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 COVID-19 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 are included in our condensed consolidated financial statements as of and for the three months ended May 2, 2020. 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 the Company’sour Annual Report on Form 10-K for the fiscal year ended January 28, 2017February 1, 2020 (the “2016“2019 Form 10-K”). Certain prior year amounts have been reclassified for consistency with the current period presentation. Refer to “Revision” below.
The results of operations for the three and nine months ended October 28, 2017May 2, 2020 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 disease as discussed in Recent Developments—COVID-19 below.
8
Recent Developments—COVID-19
Revision
In March 2020, the World Health Organization declared the outbreak of a novel coronavirus disease (“COVID-19”) as a pandemic. 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 our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, since that date we have been able to reopen a large number of our stores based on local market circumstances including the gradual lifting of restrictions on business operations, including shelter-in-place rules. During the fourth quarter of fiscal 2016, management determinedtime that the Company had incorrectly reported negative cash balances dueour Gallery locations were closed, we continued to outstanding checksserve our customers in the accounts payablethose market areas virtually through our Gallery representatives and accrued expenses financial statement line item in its condensed consolidated balance sheets without properly applying the limited right of offset against cash and cash equivalents in accordance with ASC 210—Balance Sheet. This resulted in an overstatement of cash and cash equivalents and an overstatement of accounts payable and accrued expenses on its condensed consolidated balance sheets,designers, as well as a misstatementour online capabilities.
As of June 3, 2020, we had reopened 74% of our Gallery locations, 68% of our Outlets and 50% of our Restaurants, and are moving toward the expected complete reopening of our retail locations in the U.S. and Canada based on local conditions and requirements. While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis and retail closures in the U.S. and Canada, there can be no assurance that future events including additional waves of COVID-19 outbreaks, evolving federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, or other similar issues will not adversely affect our business, results of operations or financial condition in the future, or that the pace of economic activity in the wake of the first wave of COVID-19 outbreaks will not have a negative impact on our business, results of operations or financial condition. The extent and duration of the crisis remains uncertain, and the results of the fiscal year ending January 30, 2021 could be further impacted in future periods, through reduced revenues, increased receivable and merchandise inventory reserves, asset impairments, valuation allowances and potential declines in liquidity.
We have historically relied on cash provided by operating activitiesflows from operations, net cash proceeds from the issuance of convertible senior notes, as well as borrowings under credit facilities as primary sources of liquidity. When our retail locations were closed as a result of the COVID-19 outbreak, we took immediate action to assure that our liquidity needs would not be materially affected, including our ability to fund our business operations, as well as to make debt repayments when due, such as the $300 million convertible senior notes maturing in July 2020 (the “2020 Notes”) and payments under equipment promissory notes. In response to the initial impact of COVID-19, we implemented a number of measures to minimize cash outlays, including managing workforce costs, delaying planned capital expenditures, deferring new business introductions, adjusting the timing and circulation of Source Books and minimizing discretionary expenses. 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. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs of our business operations. 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 COVID-19.
We have utilized, and expect to continue to utilize, our asset based credit facility, and we may pursue other sources of capital that may include other forms of external financing, in order to increase our cash position and preserve financial flexibility in response to the uncertainty in the United States and global markets resulting from COVID-19. Refer to Note 8—Convertible Senior Notes and Note 9—Credit Facilities for further information on the condensed consolidated statementsterms and conditions of cash flows. Thereour outstanding debt agreements. We had 0 outstanding borrowings under our asset based credit facility as of May 29, 2020 and the amount under the revolving line of credit borrowing base that could be available pursuant to the asset based credit facility was no impact on$170.4 million, net of reserves for the condensed consolidated statementsrepayment of income or stockholders’ equity related to these misstatements.
The Company assessed the materiality2020 Notes and outstanding letters of these misstatements on prior periods’ financial statements in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 99—Materiality, codified in Accounting Standards Codification (“ASC”) 250—Presentation of Financial Statements, and concluded that these misstatements were not material to any prior annual or interim periods. Accordingly, in accordance with ASC 250 (SAB No. 108—Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements), the amounts have been revised in the condensed consolidated statements of cash flows.
7
The following are selected line items from the Company’s unaudited condensed consolidated statements ofcredit. We believe our operating cash flows, illustratingin 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 effectnext 12 months.
9
|
| Nine Months Ended |
| |||||||||
|
| October 29, |
| |||||||||
|
| 2016 |
| |||||||||
|
| As Reported |
|
| Adjustment |
|
| As Revised |
| |||
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Change in accounts payable and accrued expenses |
| $ | (73,574 | ) |
| $ | 10,139 |
|
| $ | (63,435 | ) |
Net cash used in operating activities |
| $ | (29,124 | ) |
| $ | 10,139 |
|
| $ | (18,985 | ) |
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period |
| $ | 349,897 |
|
| $ | (18,430 | ) |
| $ | 331,467 |
|
End of period |
| $ | 55,426 |
|
| $ | (8,291 | ) |
| $ | 47,135 |
|
NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS
Stock-Based CompensationCloud Computing
In March 2016,August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting StandardStandards Update No. 2016-09—Improvements(“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 Employee Share Based Payment 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 operations 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.
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 2016-09”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 new guidance simplifies several aspectsASUs amend the impairment model to utilize an expected loss methodology in place of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classificationcurrently used incurred loss methodology to result in more timely recognition of losses. The guidance in the statementASUs applies to financial assets measured at amortized cost basis, such as receivables that result from revenue transactions.
Accounts receivable consist primarily of cash flows. One provision requires that the excess income tax benefits and tax deficienciesreceivables from our credit card processors for sales transactions, receivables related to share-based payments be recognized within income tax expense in the statementour contract business and other miscellaneous receivables. Accounts receivable is presented net of operations, rather than within additional paid-in capital on the balance sheet. The new guidance was effectiveallowance for the Company beginning on January 29, 2017. Asdoubtful 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 $3.2 million and $2.2 million as of May 2, 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 this new guidance, the Company recognized an excess tax benefit of $1.9 million and $4.3 million in the provision for income taxes as a discrete item during the three and nine months ended October 28, 2017, respectively. These amounts may not necessarily be indicative of future amounts that may be recognized as any excess tax benefits recognized would be dependent on future stock price, employee exercise behavior and applicable tax rates. As permitted, the Company elected to classify excess tax benefits (shortfalls) as an operating activity in the condensed consolidated statements of cash flows instead of as a financing activity on a prospective basis andASUs did not retrospectively adjust prior periods.have a material effect on our condensed consolidated financial statements.
Income Taxes
In May 2017,December 2019, the FASB issued Accounting StandardStandards Update No. 2017-09—Compensation—Stock Compensation2019-12—Income Taxes (Topic 718)740): Scope of ModificationSimplifying the Accounting for Income Taxes. The newASU 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 clarifies when modification accounting should be appliedin this ASU becomes effective for changes to terms or conditions of a share-based payment award. The new guidance is effective forfiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted. The2020. We will adopt this standard will be applied prospectively. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.
Revenue from Contracts with Customers
In May 2014, the FASB and International Accounting Standards Board issued their converged accounting standard update on revenue recognition, Accounting Standards Update 2014-09—Revenue from Contracts with Customers (Topic 606). This guidance outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Under the new guidance, transfer of control is no longer the same as transfer of risks and rewards as indicated in the prior guidance. The FASB deferred the effective date for the new revenue reporting standard for entities reporting under GAAP for one year from the original effective date. In 2016, the FASB issued several amendments to the standard, including principal versus agent considerations when another party is involved in providing goods or services to a customer, the application of identifying performance obligations, and the recognition of expected breakage amounts.
The Company continues to assess all potential impacts of the standard. In applying the guidance under Topic 606, specifically related to the indicators of transfer of control, the Company continues to assess the guidance and has not yet concluded how such guidance will be applied to its revenue streams. The Company plans to elect to adopt the practical expedient related to shipping and handling activities. The Company has concluded that the new standard will have an impact related to the accounting for gift card breakage. Under Topic 606 the Company expects to recognize breakage, which is currently recorded as a reduction to selling, general and administrative expenses, as revenue and breakage will be recognized proportional to actual gift card redemptions.
Topic 606 is effective forfirst fiscal years beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted for annual reporting periods beginning after December 15, 2016. The Company will adopt Topic 606 in
8
the first quarter of fiscal 2018. The Company has elected to adopt using a modified retrospective approach with the cumulative effect of initially applying the new standard recognized in retained earnings at the date of adoption.
Accounting for Leases
In February 2016, the FASB issued Accounting Standards Update 2016-02—Leases, which, for operating leases, requires a lessee to recognize a right-of-use asset2021 and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company isare currently evaluating the effects that the adoption of this ASU 2016-02 will have on its consolidated financial statements and anticipates the new guidance will significantly impact its consolidated financial statements given the Company has a significant number of leases.
Financial Instruments
In January 2016, the FASB issued Accounting Standards Update 2016-01—Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends various aspects of the recognition, measurement, presentation and disclosure for financial instruments. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted only for certain provisions. The Company is evaluating the impact of adopting this new accounting standard on itsour consolidated financial statements.
Cash Flow Classification
In August 2016, the FASB issued Accounting Standard Update No. 2016-15—Statement10
Income Taxes: Intra-Entity Asset Transfers
In October 2016, the FASB issued Accounting Standard Update No. 2016-16—Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The new guidance requires the recognition of the income tax consequences of an intercompany asset transfer, other than transfers of inventory, when the transfer occurs. For intercompany transfers of inventory, the income tax effects will continue to be deferred until the inventory has been sold to a third party. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.
Goodwill and Intangibles
In January 2017, the FASB issued Accounting Standard Update No. 2017-04—Intangibles—Goodwill and Other (Topic 350). The updated guidance simplifies the measurement of goodwill impairment by removing step two of the goodwill impairment test, which requires the determination of the fair value of individual assets and liabilities of a reporting unit. The new guidance requires goodwill impairment to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments should be applied on a prospective basis. The new standard is effective for fiscal years beginning after December 15, 2019 with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.
NOTE 3—BUSINESS COMBINATION
On May 27, 2016, the Company acquired a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name “Waterworks”. The purchase price of the acquisition was approximately $119.9 million consisting of $118.4 million funded with available cash and $1.5 million representing the fair value of rollover units, which amount is subject to adjustment for changes in working capital and other items. The rollover units, which are classified as a liability, are included in non-current liabilities on the condensed consolidated balance sheets (refer to Note 15—Stock-Based Compensation). After the transaction, and giving effect to equity interests acquired by management in the business, the Company owns in excess of 90% of the total equity interest in Waterworks, and owns 100% of the voting equity interest.
9
During the nine months ended October 29, 2016, the Company incurred $2.8 million, of acquisition-related costs associated with the transaction. The Company did not incur any acquisition-related costs during the three months ended October 29, 2016. These costs and expenses include fees associated with financial, legal and accounting advisors, and employment related costs, and are included in selling, general and administrative expenses on the condensed consolidated statements of operations.
The Company recorded a purchase price allocation adjustment of $1.9 million during the first half of 2017. The adjustment primarily related to a subset of inventory acquired for which the Company completed a fair value analysis based on the facts and circumstances that existed as of the acquisition date. Subsequent to the acquisition date, only a small portion of such inventory had been sold and therefore the impact on the Company’s results of operations for historical periods since the acquisition was insignificant. The following table summarizes the purchase price allocation based on the estimated fair value of the acquired assets and assumed liabilities, prior to and after the purchase price allocation adjustments (in thousands):
|
|
|
|
|
| Purchase Price |
|
|
|
|
| |
|
| January 28, |
|
| Allocation |
|
| October 28, |
| |||
|
| 2017 |
|
| Adjustments |
|
| 2017 |
| |||
Tangible assets acquired and liabilities assumed |
| $ | 18,615 |
|
| $ | (1,916 | ) |
| $ | 16,699 |
|
Trademarks |
|
| 52,100 |
|
|
| — |
|
|
| 52,100 |
|
Goodwill |
|
| 49,229 |
|
|
| 1,916 |
|
|
| 51,145 |
|
Total |
| $ | 119,944 |
|
| $ | — |
|
| $ | 119,944 |
|
Any future changes to the purchase price will be recorded directly to the consolidated statements of operations and will not impact the goodwill recorded as a result of this acquisition.
Under purchase accounting rules, the Company valued the acquired finished goods inventory to fair value, which is defined as the estimated selling price less the sum of (a) costs of disposal and (b) a reasonable profit allowance for the Company’s selling effort. This valuation resulted in an increase in inventory carrying value of approximately $9.7 million for marketable inventory.
Trademarks have been assigned an indefinite life and therefore are not subject to amortization. The goodwill is representative of the benefits and expected synergies from the integration of Waterworks products and Waterworks’ management and employees, which do not qualify for separate recognition as an intangible asset. A portion of the trademarks and goodwill are not deductible for tax purposes.
Results of operations of Waterworks have been included in the Company’s condensed consolidated statements of operations since the May 27, 2016 acquisition date. Pro forma results of the acquired business have not been presented as the results were not considered material to the Company’s condensed consolidated financial statements for all periods presented and would not have been material had the acquisition occurred at the beginning of fiscal 2016.
NOTE 4—ASSET HELD FOR SALE
Building and Land
During the first quarter of fiscal 2017, the Company committed to a plan to sell the building and land at one of its owned retail Galleries, resulting in a reclassification of building and land of $8.2 million from property and equipment to asset held for sale on the condensed consolidated balance sheets as of April 29, 2017. In May 2017, the Company completed the sale of the building and land for approximately $10.2 million and entered into a short-term five month lease agreement to lease the property. As a result, the gain associated with the sale of this property was amortized over a five month period. During the three and nine months ended October 28, 2017, the Company recorded a gain of $0.8 million and $2.1 million, respectively, which is included as a reduction of selling, general and administrative expenses on the condensed consolidated statements of operations. No additional gain associated with this transaction will be recognized in future periods.
Aircraft
During the fourth quarter of fiscal 2016, the Company committed to a plan to sell an aircraft, which resulted in a reclassification of such aircraft from property and equipment to asset held for sale on the condensed consolidated balance sheets as of January 28, 2017. The asset held for sale had a carrying value of $4.9 million as of January 28, 2017. In April 2017, the sale of the aircraft was completed for a purchase price of $5.2 million and the Company incurred costs of $0.3 million to dispose of the asset.
10
NOTE 5—PREPAID EXPENSE AND OTHER ASSETS
Prepaid expense and other current assets consist of the following (in thousands):
|
| October 28, |
|
| January 28, |
| ||||||||
|
| 2017 |
|
| 2017 |
| ||||||||
| | | | | | | ||||||||
|
| May 2, |
| February 1, | ||||||||||
| | 2020 | | 2020 | ||||||||||
Prepaid expense and other current assets | | $ | 34,118 | | $ | 30,875 | ||||||||
Capitalized catalog costs |
| $ | 44,252 |
|
| $ | 61,258 |
| |
| 14,616 | |
| 13,740 |
Vendor deposits |
|
| 8,374 |
|
|
| 13,276 |
| | | 11,187 | | | 11,258 |
Federal and state tax receivable |
|
| 5,598 |
|
|
| 13,124 |
| ||||||
Prepaid expense and other current assets |
|
| 16,817 |
|
|
| 29,504 |
| ||||||
Right of return asset for merchandise | |
| 5,233 | |
| 5,746 | ||||||||
Total prepaid expense and other current assets |
| $ | 75,041 |
|
| $ | 117,162 |
| | $ | 65,154 | | $ | 61,619 |
Other non-current assets consist of the following (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Landlord assets under construction | | $ | 148,487 | | $ | 138,315 |
Deposits on asset under construction | |
| 60,000 | |
| 60,000 |
Promissory note receivable, including interest | |
| 5,417 | |
| 5,354 |
Other deposits | |
| 5,258 | |
| 5,157 |
Deferred financing fees | |
| 2,332 | |
| 2,602 |
Other non-current assets | |
| 7,278 | |
| 3,417 |
Total other non-current assets | | $ | 228,772 | | $ | 214,845 |
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
Construction related deposits |
| $ | 13,739 |
|
| $ | 28,044 |
|
Other deposits |
|
| 4,926 |
|
|
| 4,706 |
|
Deferred financing fees |
|
| 4,698 |
|
|
| 1,530 |
|
Other non-current assets |
|
| 5,395 |
|
|
| 1,889 |
|
Total other non-current assets |
| $ | 28,758 |
|
| $ | 36,169 |
|
NOTE 6—4—GOODWILL, TRADENAMES, TRADEMARKS AND INTANGIBLE ASSETSDOMAIN NAMES
The following sets forth the goodwill, tradenames, trademarks and intangible assets as of October 28, 2017domain names activity for the RH Segment and Waterworks (See Note 16—Segment Reporting), for the three months ended May 2, 2020 (in thousands):
| | | | | | | | | | | | |
|
| | |
| |
| Foreign |
| | | ||
| | February 1, | | | | Currency | | May 2, | ||||
| | 2020 | | Impairment (1) | | Translation | | 2020 | ||||
RH Segment |
| |
|
| |
|
| |
|
| |
|
Goodwill | | $ | 124,367 | | $ | — | | $ | (77) | | $ | 124,290 |
Tradenames, trademarks and domain names | |
| 48,563 | |
| — | |
| — | |
| 48,563 |
| |
|
| |
|
| |
|
| |
| |
Waterworks (1) | |
|
| |
|
| |
|
| |
| |
Tradename (2) | |
| 37,459 | |
| (20,459) | |
| — | |
| 17,000 |
|
| Gross Carrying Amount |
|
| Accumulated Amortization |
|
| Foreign Currency Translation |
|
| Net Book Value |
| ||||
Intangible assets subject to amortization |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of leases (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair market write-up |
| $ | 1,925 |
|
| $ | (1,862 | ) |
| $ | — |
|
| $ | 63 |
|
Fair market write-down (2) |
|
| (1,467 | ) |
|
| 1,393 |
|
|
| — |
|
|
| (74 | ) |
Total intangible assets subject to amortization |
| $ | 458 |
|
| $ | (469 | ) |
| $ | �� |
|
| $ | (11 | ) |
Intangible assets not subject to amortization |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill (3)(4) |
| $ | 175,605 |
|
| $ | — |
|
| $ | (52 | ) |
| $ | 175,553 |
|
Trademarks and domain names (4) |
| $ | 100,663 |
|
| $ | — |
|
| $ | — |
|
| $ | 100,663 |
|
(1) |
|
|
|
|
|
|
|
11
The following sets forth the goodwill and intangible assets as of January 28, 2017 (in thousands):
|
| Gross Carrying Amount |
|
| Accumulated Amortization |
|
| Foreign Currency Translation |
|
| Net Book Value |
| ||||
Intangible assets subject to amortization |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of leases (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair market write-up |
| $ | 1,925 |
|
| $ | (1,792 | ) |
| $ | — |
|
| $ | 133 |
|
Fair market write-down (2) |
|
| (1,467 | ) |
|
| 1,350 |
|
|
| — |
|
|
| (117 | ) |
Total intangible assets subject to amortization |
| $ | 458 |
|
| $ | (442 | ) |
| $ | — |
|
| $ | 16 |
|
Intangible assets not subject to amortization |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill (3)(4) |
| $ | 173,690 |
|
| $ | — |
|
| $ | (87 | ) |
| $ | 173,603 |
|
Trademarks and domain names (3)(4) |
| $ | 100,624 |
|
| $ | — |
|
| $ | — |
|
| $ | 100,624 |
|
|
|
|
|
|
|
(2) | Presented net of an impairment charge of $35.1 million, with $20.5 million recorded in the three months ended May 2, 2020 and $14.6 million recorded in fiscal 2018. Refer to |
Waterworks Tradename Impairment
During the first fiscal quarter of 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
11 |
|
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 May 2, 2020.
As a result, we recognized a $20.5 million non-cash impairment charge for the Waterworks reporting unit tradename during the three months ended May 2, 2020, and the carrying value of the Waterworks indefinite-lived tradename asset after the impairment charge was $17.0 million.
NOTE 7—5—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accounts payable and accrued expenses consist of the following (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Accounts payable | | $ | 151,890 | | $ | 180,714 |
Accrued compensation | |
| 61,950 | |
| 64,659 |
Accrued freight and duty | |
| 18,260 | |
| 25,170 |
Accrued sales taxes | |
| 16,792 | |
| 19,618 |
Accrued occupancy | |
| 9,266 | |
| 12,067 |
Accrued catalog costs | |
| 6,250 | |
| 8,267 |
Accrued professional fees | |
| 5,187 | |
| 4,381 |
Other accrued expenses | |
| 15,385 | |
| 15,433 |
Total accounts payable and accrued expenses | | $ | 284,980 | | $ | 330,309 |
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
Accounts payable |
| $ | 130,902 |
|
| $ | 134,720 |
|
Accrued compensation |
|
| 43,697 |
|
|
| 26,886 |
|
Accrued freight and duty |
|
| 21,952 |
|
|
| 27,955 |
|
Accrued sales taxes |
|
| 15,517 |
|
|
| 14,908 |
|
Accrued catalog costs |
|
| 13,296 |
|
|
| 3,874 |
|
Accrued occupancy |
|
| 11,422 |
|
|
| 8,137 |
|
Accrued professional fees |
|
| 3,801 |
|
|
| 2,082 |
|
Other accrued expenses |
|
| 11,982 |
|
|
| 8,418 |
|
Total accounts payable and accrued expenses |
| $ | 252,569 |
|
| $ | 226,980 |
|
Other current liabilities consist of the following (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Promissory notes on asset under construction | | $ | 53,000 | | $ | 53,000 |
Unredeemed gift card and merchandise credit liability | |
| 21,877 | |
| 16,625 |
Current portion of equipment promissory notes | | | 19,587 | |
| 22,009 |
Allowance for sales returns | | | 17,962 | | | 19,206 |
Finance lease liabilities | | | 11,752 | | | 9,188 |
Federal and state taxes payable | |
| 6,048 | |
| 13,591 |
Product recall reserve | |
| 1,819 | |
| 2,055 |
Other current liabilities | |
| 5,291 | |
| 5,040 |
Total other current liabilities | | $ | 137,336 | | $ | 140,714 |
Contract Liabilities
We defer revenue associated with merchandise delivered via the home-delivery channel. We expect that substantially all of the deferred revenue, customer deposits and deferred membership fees as of May 2, 2020 will be recognized within the next six months as the performance obligations are satisfied.
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. During the three months ended May 2, 2020 and May 4, 2019, we recorded $4.1 million and $4.7 million, respectively, of revenue for previous deferrals related to our gift cards and merchandise credits. During the three months ended May 2, 2020 and May 4, 2019, we recorded gift card breakage of $0.6 million and $0.4 million, respectively. We expect that approximately 70% of the remaining gift card and merchandise credit liabilities as of May 2, 2020 will be recognized within the next twelve months as the gift cards are redeemed by customers.
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
Unredeemed gift card and merchandise credit liability |
| $ | 27,448 |
|
| $ | 24,524 |
|
Allowance for sales returns |
|
| 10,999 |
|
|
| 10,077 |
|
Current portion of non-current debt |
|
| 5,986 |
|
|
| — |
|
Product recall reserves |
|
| 2,218 |
|
|
| 4,324 |
|
Other current liabilities |
|
| 3,958 |
|
|
| 4,346 |
|
Total other current liabilities |
| $ | 50,609 |
|
| $ | 43,271 |
|
12
NOTE 8—6—OTHER NON-CURRENT OBLIGATIONS
Other non-current obligations consist of the following (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Notes payable for share repurchases | | $ | 18,813 | | $ | 18,741 |
Rollover units and profit interests (1) | |
| 3,170 | |
| 3,064 |
Unrecognized tax benefits | |
| 3,063 | |
| 3,020 |
Other non-current obligations | |
| 2,971 | |
| 3,695 |
Total other non-current obligations | | $ | 28,017 | | $ | 28,520 |
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
Notes payable for share repurchases |
| $ | 19,390 |
|
| $ | 19,390 |
|
Equipment security notes (1) |
|
| 15,040 |
|
|
| — |
|
Promissory note (2) |
|
| 11,968 |
|
|
| — |
|
Capital lease obligations—non-current |
|
| 7,553 |
|
|
| 7,242 |
|
Deferred contract incentive (3) |
|
| 5,953 |
|
|
| 7,739 |
|
Unrecognized tax benefits |
|
| 2,617 |
|
|
| 2,508 |
|
Rollover units and profit interests (4) |
|
| 2,104 |
|
|
| 1,784 |
|
Other non-current obligations |
|
| 5,770 |
|
|
| 6,021 |
|
Total other non-current obligations |
| $ | 70,395 |
|
| $ | 44,684 |
|
(1) |
|
|
|
|
|
| Represents rollover units and profit interests associated with the acquisition of Waterworks. Refer to Note |
.
NOTE 7—LEASES
Lease costs—net consist of the following (in thousands):
| | | | | | | |
| | | Three Months Ended | ||||
| | | May 2, |
| May 4, | ||
|
| | 2020 |
| 2019 | ||
Operating lease cost (1) | |
| $ | 20,726 | | $ | 19,117 |
| | | | | | | |
Finance lease costs | | | | | | | |
Amortization of leased assets (1) | | | | 9,588 | | | 8,852 |
Interest on lease liabilities (2) | | | | 5,781 | | | 5,514 |
| | | | | | | |
Variable lease costs (3) | | | | 3,560 | | | 5,607 |
Sublease income (4) | | | | (2,575) | | | (3,282) |
Total lease costs—net | | | $ | 37,080 | | $ | 35,808 |
(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 operations based on our accounting policy. Refer to Note 3—Significant Accounting Policies in the 2019 Form 10-K. |
(2) | Included in interest expense—net on the condensed consolidated statements of operations. |
(3) | Represents variable lease payments under operating and finance lease agreements, primarily associated with contingent rent based on a percentage of retail sales over contractual levels of $2.0 million and $3.3 million for the three months ended May 2, 2020 and May 4, 2019, respectively. Other variable costs, such as 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 for the three months ended May 2, 2020 and May 4, 2019. |
(4) | Included in selling, general and administrative expenses on the condensed consolidated statements of operations. |
13
Lease right-of-use assets and lease liabilities consist of the following (in thousands):
| | | | | | | | |
| | | | May 2, | | February 1, | ||
| | | | 2020 | | 2020 | ||
| | Balance Sheet Classification | | | | | | |
Assets | | | | | | | | |
Operating leases | | Operating lease right-of-use assets | | $ | 392,934 | | $ | 410,904 |
Finance leases (1)(2) | | Property and equipment—net | | | 630,781 | | | 642,117 |
Total lease right-of-use assets | | | | $ | 1,023,715 | | $ | 1,053,021 |
| | | | | | | | |
Liabilities | | | | | | | | |
Current (3) | | | | | | | | |
Operating leases | | Operating lease liabilities | | $ | 61,997 | | $ | 58,924 |
Finance leases | | Other current liabilities | | | 11,752 | | | 9,188 |
Total lease liabilities—current | | | | | 73,749 | | | 68,112 |
| | | | | | | | |
Non-current | | | | | | | | |
Operating leases | | Non-current operating lease liabilities | | | 395,641 | | | 409,930 |
Finance leases | | Non-current finance lease liabilities | | | 439,470 | | | 442,988 |
Total lease liabilities—non-current | | | | | 835,111 | | | 852,918 |
Total lease liabilities | | | | $ | 908,860 | | $ | 921,030 |
(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 $101.7 million and $92.3 million as of May 2, 2020 and February 1, 2020, respectively. |
(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 May 2, 2020 (in thousands):
| | | | | | | | | |
Fiscal year | | Operating | | Finance | | Total | |||
Remainder of fiscal 2020 | | $ | 59,698 | | $ | 25,738 | | $ | 85,436 |
2021 | | | 69,968 | | | 35,311 | | | 105,279 |
2022 | | | 60,642 | | | 35,729 | | | 96,371 |
2023 | | | 56,210 | | | 36,143 | | | 92,353 |
2024 | | | 52,407 | | | 36,630 | | | 89,037 |
2025 | | | 52,396 | | | 37,791 | | | 90,187 |
Thereafter | | | 193,769 | | | 530,520 | | | 724,289 |
Total lease payments (1)(2) | | | 545,090 | | | 737,862 | | | 1,282,952 |
Less—imputed interest (3) | | | (87,452) | | | (286,640) | | | (374,092) |
Present value of lease liabilities | | $ | 457,638 | | $ | 451,222 | | $ | 908,860 |
(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 $381.9 million of legally binding payments under the noncancellable term for leases signed but not yet commenced as of May 2, 2020. |
(2) | Excludes future commitments under short-term lease agreements of $0.5 million as of May 2, 2020. |
(3) | Calculated using the incremental borrowing rate for each lease at lease commencement. |
14
Supplemental information related to leases consists of the following:
| | | | | | | |
| | | Three Months Ended | ||||
| | | May 2, | | May 4, | ||
| | | 2020 |
| 2019 | ||
Weighted-average remaining lease term (years) | | | | | | | |
Operating leases | | | | 8.7 | | | 9.1 |
Finance leases | | | | 18.4 | | | 19.1 |
| | | | | | | |
Weighted-average discount rate | | | | | | | |
Operating leases | | | | 3.82% | | | 3.80% |
Finance leases | | | | 5.25% | | | 5.26% |
Other information related to leases consists of the following (in thousands):
| | | | | | | |
| | | Three Months Ended | ||||
| | | May 2, | | May 4, | ||
| | | 2020 |
| 2019 | ||
Cash paid for amounts included in the measurement of lease liabilities | | | | | | | |
Operating cash flows from operating leases | | | $ | (10,786) | | $ | (31,780) |
Operating cash flows from finance leases | | | | (2,437) | | | (5,514) |
Financing cash flows from finance leases | | | | (2,068) | | | (2,129) |
Total cash outflows from leases | | | $ | (15,291) | | $ | (39,423) |
| | | | | | | |
Lease right-of-use assets obtained in exchange for lease obligations—net of lease terminations (non-cash) | | | | | | | |
Operating leases | | | $ | 1,198 | | $ | 8,173 |
Finance leases | | | | 58 | | | 17,984 |
Long-lived Asset Impairment
During the three months ended May 2, 2020, we recognized long-lived asset impairment charges of $3.5 million related to one RH Baby & Child Gallery and one Waterworks showroom, comprised of lease right-of-use asset impairment of $2.0 million and property and equipment impairment of $1.5 million.
NOTE 9—8—CONVERTIBLE SENIOR NOTES
$350 million 0.00% Convertible Senior Notes due 20202024
In June 2015, the CompanySeptember 2019, we issued in a private offering $250$350 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, the Company issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of its June 2015 offering (collectively, the “20202024 (the “2024 Notes”). The 20202024 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 20202024 Notes will mature on JulySeptember 15, 2020,2024, unless earlier purchased by the Companyus or converted. The 20202024 Notes will not bear interest, except that the 20202024 Notes will be subject to “special interest” in certain limited circumstances in the event of theour failure of the Company to perform certain of itsour obligations under the indenture governing the 20202024 Notes. The 20202024 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 the Companyus or any of itsour subsidiaries. Certain events are also considered “events of default” under the 20202024 Notes, which may result in the acceleration of the maturity of the 20202024 Notes, as described in the indenture governing the 20202024 Notes. The 2020Events of default under the indenture for the 2024 Notes are guaranteedinclude, 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
15
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 Company’s primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The guarantee isTrustee or to the unsecured obligationCompany and the Trustee by the holders of at least 25% of the Guarantor and is subordinated toaggregate principal amount of the Guarantor’s obligations from time to time with respect to its credit agreement and ranks equal in right of payment with respect to Guarantor’s other obligations.2024 Notes then outstanding.
The initial conversion rate applicable to the 20202024 Notes is 8.46564.7304 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 of May 2, 2020, none of these conditions have occurred and, as a result, the 2024 Notes were not convertible as of May 2, 2020. 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.
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
16
sheets. During the three months ended May 2, 2020 we recorded $0.2 million related to the amortization of debt issuance costs related to the 2024 Notes.
The carrying value of the 2024 Notes, excluding the discounts upon original issuance and third party offering costs, is as follows (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Liability component |
| |
|
| |
|
Principal | | $ | 350,000 | | $ | 350,000 |
Less: Debt discount | |
| (77,764) | |
| (81,634) |
Net carrying amount | | $ | 272,236 | | $ | 268,366 |
Equity component (1) | | $ | 87,252 | | $ | 87,252 |
(1) | Included in additional paid-in capital on the condensed consolidated balance sheets. |
We recorded interest expense of $3.9 million for the amortization of the debt discount related to the 2024 Notes during the three months ended May 2, 2020.
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.
$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
17
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 $118.13$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 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 May 2, 2020, none of these conditions have occurred and, as a result, the 2023 Notes were not convertible as of May 2, 2020. 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.
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
18
sheets. During both the three months ended May 2, 2020 and May 4, 2019, we recorded $0.2 million related to the amortization of debt issuance costs.
The carrying values of the 2023 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Liability component |
| |
|
| |
|
Principal | | $ | 335,000 | | $ | 335,000 |
Less: Debt discount | |
| (60,417) | |
| (64,729) |
Net carrying amount | | $ | 274,583 | | $ | 270,271 |
Equity component (1) | | $ | 90,990 | | $ | 90,990 |
(1) | Included in additional paid-in capital on the condensed consolidated balance sheets. |
We recorded interest expense of $4.3 million and $4.1 million for the amortization of the debt discount related to the 2023 Notes during the three months ended May 2, 2020 and May 4, 2019, respectively.
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 are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2020 Notes will mature on July 15, 2020, unless earlier purchased by us or converted. The 2020 Notes will not bear interest, except that the 2020 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 2020 Notes. The 2020 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 2020 Notes, which may result in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes. Events of default under the indenture for the 2020 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
19
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 2020 Notes then outstanding. The 2020 Notes are guaranteed by our primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The guarantee is the unsecured obligation of the Guarantor and is subordinated to the Guarantor’s obligations from time to time with respect to its Credit Agreement and ranks equal in right of payment with respect to Guarantor’s other obligations.
The initial conversion rate applicable to the 2020 Notes is 8.4656 shares of common stock per $1,000 principal amount of 2020 Notes, which is equivalent to an initial conversion price of approximately $118.13 per share. To the extent the stock price is less than $118.13 per share, we are required to settle the par value in cash, subject to the cash settlement averaging period under the indenture. To the extent the stock price is greater than $118.13 per share, we may settle the par value at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. 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 2020 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2020 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2020, the 2020 Notes will bewere 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 fiscalcalendar quarter, the last reported sale price of the Company’sour 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 five5 consecutive business day period after any ten10 consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2020 Notes for such trading day was less than 98% of the product of the last reported sale price of the Company’sour common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of October 28, 2017, none of these conditions have occurredThe first condition was satisfied during the calendar quarter ended December 31, 2019 and, as a result, theaccordingly, holders were eligible to convert their 2020 Notes are not convertible as of October 28, 2017. Onduring 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 may convert all or a portion of their 2020 Notes at any time, regardless of the foregoing circumstances.time. Upon conversion, the 2020 Notes will be settled, at the Company’sour election, in cash, shares
13
of the Company’sour common stock, or a combination of cash and shares of our common stock to the Company’s common stock.extent our stock price is greater than $118.13 per share. 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 expect to repay the $300 million outstanding principal amount of the convertible notes in cash, whether in connection with a conversion of such notes or repayment at maturity in July 2020.
The CompanyWe may not redeem the 2020 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require the Companyus to purchase all or a portion of their 2020 Notes for cash at a price equal to 100% of the principal amount of the 2020 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.
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, the Companywe 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 excess of the principal amount of the liability component over its carrying amount (“debt discount”)discount will be amortized to interest expense using an effective interest rate of 6.47% over the expected life of the 2020 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 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
20
Notes, the Companywe 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 2020 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.
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. Discounts and third party offering costs attributable to the liability component arewere recorded as a contra-liability and are presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets. During both the three months ended October 28, 2017May 2, 2020 and October 29, 2016, the CompanyMay 4, 2019, we recorded $0.3 million and $0.2 million, respectively, related to the amortization of debt issuance costs. During the nine months ended October 28, 2017 and October 29, 2016, the Company recorded $0.8 million and $0.7 million, respectively, related to the amortization of debt issuance costs.
The carrying values of the 2020 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows (in thousands):
| | | | | | |
|
| May 2, |
| February 1, | ||
| | 2020 | | 2020 | ||
Liability component | | | |
| |
|
Principal | | $ | 300,000 | | $ | 300,000 |
Less: Debt discount | |
| (4,156) | |
| (8,890) |
Net carrying amount | | $ | 295,844 | | $ | 291,110 |
Equity component (1) | | $ | 84,003 | | $ | 84,003 |
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
Liability component |
|
|
|
|
|
|
|
|
Principal |
| $ | 300,000 |
|
| $ | 300,000 |
|
Less: Debt discount |
|
| (48,229 | ) |
|
| (60,124 | ) |
Net carrying amount |
| $ | 251,771 |
|
| $ | 239,876 |
|
Equity component (1) |
| $ | 84,003 |
|
| $ | 84,003 |
|
(1) | Included in additional paid-in capital on the condensed consolidated balance sheets. |
The CompanyWe recorded interest expense of $4.0$4.7 million and $3.8$4.4 million for the amortization of the debt discount related to the 2020 Notes during the three months ended October 28, 2017May 2, 2020 and October 29, 2016,May 4, 2019, respectively. The Company recorded interest expense
In May 2020, we paid $9.2 million in cash to settle $9.4 million in aggregate principal amount of $11.9 million and $11.2 million for2020 Notes converted at the amortizationoption of the debt discount related tonoteholders. In settlement, such noteholders also received approximately 15,000 shares of common stock. We did not issue any shares of our common stock on a net basis in respect of such settlement of the 2020 Notes duringas a result of our exercise of the nine months ended October 28, 2017 and October 29, 2016, respectively.convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes, as described below.
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, the Companywe entered into convertible note hedge transactions whereby the Company haswe have the option to purchase a total of approximately 2.52.540 million shares of itsour 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, the Companywe sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.52.540 million shares of the Company’sour common stock at a 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). The CompanyWe 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
14
the warrants are intended to offset any actual earnings dilution from the conversion of the 2020 Notes until the Company’sour common stock is above approximately $189.00 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.
The CompanyWe 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.
0.00% Convertible Senior Notes due 201921
NOTE 9—CREDIT FACILITIES
The initial conversion rate applicable to the 2019 Notes is 8.6143 shares of common stock per $1,000 principal amount of 2019 Notes, which is equivalent to an initial conversion price of approximately $116.09 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,” the Company will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2019 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2019, the 2019 Notes will be convertible onlyoutstanding balances under the following circumstances: (1) during any calendar quarter commencing after September 30, 2014, 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 fiscal quarter, the last reported sale price of the Company’s 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 five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2019 Notes for such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of October 28, 2017, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of October 28, 2017. On and after March 15, 2019, 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 2019 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2019 Notes will be settled, at the Company’s election, in cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s 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 of $1,000.
The Company may not redeem the 2019 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require the Company to purchase all or a portion of their 2019 Notes for cash at a price equal to 100% of the principal amount of the 2019 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.
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 2019 Notes, the Company separated the 2019 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 2019 Notes and the fair value of the liability component of the 2019 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 4.51% over the expected life of the 2019 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
15
In accounting for the debt issuance costs related to the issuance of the 2019 Notes, the Company 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 2019 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.
Debt issuance costs related to the 2019 Notesour credit facilities were comprised of discounts and commissions payable to the initial purchasers of $4.4 million and third party offering costs of $1.0 million. Discounts, commissions payable to the initial purchasers 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 2019 balance on the condensed consolidated balance sheets. During both the three months ended October 28, 2017 and October 29, 2016, the Company recorded $0.2 million related to the amortization of debt issuance costs. During both the nine months ended October 28, 2017 and October 29, 2016, the Company recorded $0.6 million related to the amortization of debt issuance costs.
The carrying values of the 2019 Notes, excluding the discounts and commissions payable to the initial purchasers and third party offering costs, are as follows (in thousands):
| | | | | | | | | | | | | | | | | | |
| | May 2, | | February 1, | ||||||||||||||
| | 2020 | | 2020 | ||||||||||||||
| | Outstanding | | Unamortized Debt | | Net Carrying | | Outstanding | | Unamortized Debt | | Net Carrying | ||||||
|
| Amount |
| Issuance Costs |
| Amount |
| Amount |
| Issuance Costs |
| Amount | ||||||
Asset based credit facility (1) | | $ | 10,000 | | $ | — | | $ | 10,000 | | $ | — | | $ | — | | $ | — |
Equipment promissory notes (2) |
| | 48,337 |
| | (275) |
| | 48,062 |
| | 53,372 |
| | (310) |
| | 53,062 |
Total credit facilities | | $ | 58,337 | | $ | (275) | | $ | 58,062 | | $ | 53,372 | | $ | (310) | | $ | 53,062 |
|
| October 28, |
|
| January 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
Liability component |
|
|
|
|
|
|
|
|
Principal |
| $ | 350,000 |
|
| $ | 350,000 |
|
Less: Debt discount |
|
| (24,666 | ) |
|
| (35,457 | ) |
Net carrying amount |
| $ | 325,334 |
|
| $ | 314,543 |
|
Equity component (1) |
| $ | 70,482 |
|
| $ | 70,482 |
|
(1) |
|
(2) | Represents total equipment security notes secured by certain of our property and equipment, of which $19.6 million outstanding was included in other current liabilities on the condensed consolidated balance sheets. The remaining $28.7 million outstanding, included in other non-current obligations on the condensed consolidated balance sheets, has principal payments due of $16.2 million, $11.4 million and $1.1 million in fiscal 2021, fiscal 2022 and fiscal 2023, respectively. |
The Company recorded interest expense of $3.6 million and $3.5 million for the amortization of the debt discount related to the 2019 Notes during the three months ended October 28, 2017 and October 29, 2016, respectively. The Company recorded interest expense of $10.8 million and $10.3 million for the amortization of the debt discount related to the 2019 Notes during the nine months ended October 28, 2017 and October 29, 2016, respectively.
2019 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2019 Notes, the Company entered into convertible note hedge transactions whereby the Company has the option to purchase a total of approximately 3.0 million shares of its common stock at a price of approximately $116.09 per share. The total cost of the convertible note hedge transactions was $73.3 million. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 3.0 million shares of the Company’s common stock at a price of $171.98 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 6.0 million shares of common stock (which cap may also be subject to adjustment). The Company received $40.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual dilution from the conversion of the 2019 Notes and to effectively increase the overall conversion price from $116.09 per share to $171.98 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.
The Company recorded a deferred tax liability of $27.5 million in connection with the debt discount associated with the 2019 Notes and recorded a deferred tax asset of $28.6 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax assets are included in deferred tax assets on the condensed consolidated balance sheets.
NOTE 10—CREDIT FACILITIES
The following credit facilities were outstanding as of October 28, 2017 (in thousands):
|
| Outstanding |
|
| Unamortized Debt |
|
| Net Carrying |
| |||
|
| Amount |
|
| Issuance Costs |
|
| Amount |
| |||
Asset based credit facility |
| $ | 341,000 |
|
| $ | — |
|
| $ | 341,000 |
|
LILO term loan |
|
| 80,000 |
|
|
| (529 | ) |
|
| 79,471 |
|
Total credit facilities |
| $ | 421,000 |
|
| $ | (529 | ) |
| $ | 420,471 |
|
There were no amounts outstanding under any credit facilities as of January 28, 2017.
Asset Based Credit Facility & LILO Term Loan
In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into a credit agreement with Bank of America, N.A., as administrative agent, and certain other lenders.lenders (the “Original Credit Agreement”).
On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit agreement (as amended, the “Credit Agreement”) among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., various 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 (the “credit agreement”(“First Lien Administrative Agent”)., which amended and restated the Original Credit Agreement. The credit agreementCredit 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 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$800.0 million if and to the extent the lenders, revisewhether existing lenders or new lenders, agree to increase their credit commitments to encompass a larger facility.commitments. In addition, the credit agreement establishesCredit Agreement established an up to $80.0 million LILOlast in, last out (“LILO”) term loan facility. The maturity date of the 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.
22
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.
The Company incurred $3.9 millionavailability of deferred financing fees relatedcredit at any given time under the Credit Agreement is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable. As a result of the borrowing base formula, actual borrowing availability under the revolving line of credit agreement, which are included in other non-current assets oncould be less than the condensed consolidated balance sheets, and will be amortized on a straight line basis over the lifestated amount of the revolving line of credit which has a maturity date(as reduced by the actual borrowings and outstanding letters of June 28, 2022. As a result of the credit agreement, unamortized deferred financing fees of $0.1 million related to the previous facility were expensed during the nine months ended October 28, 2017 and $1.1 million related to the previous facility will be amortized over the life of the new revolving line of credit.
The Company incurred $0.6 million of debt issuance costs related to the LILO term loan facility, which are presented net against the term loans balance on the condensed consolidated balance sheets, and will be amortized over the life ofunder the revolving line of credit.credit). All obligations under the Credit Agreement are secured by substantially all of the assets, including accounts receivable, inventory, intangible assets, property, equipment, goods and fixtures of Restoration Hardware, Inc., Restoration Hardware Canada, Inc., RH US, LLC, Waterworks Operating Co., LLC and Waterworks IP Co., LLC.
Borrowings under the revolving line of credit and LILO term loan facility are subject to interest, at the borrowers’ option, at either the bank’s reference rate or LIBORLondon Inter-bank Offered Rate (“LIBOR”) (or, in the case of the revolving line of credit, the Bank of America “BA” Rate or the Canadian Prime Rate, as such terms are defined in the credit agreement,Credit Agreement, for Canadian borrowings denominated in Canadian dollars or the United States Index Rate or LIBOR for Canadian borrowings denominated in United States dollars) plus an applicable margin rate, in each case.
The credit agreementCredit Agreement contains various restrictive covenants, including, among others, limitations on the ability to incur 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 typical to credit agreements of this type and size. AsThe Credit Agreement also contains various affirmative covenants, including the obligation to deliver notice to the First Lien Administrative Agent following the Company’s obtaining knowledge of October 28, 2017, Restoration Hardware, Inc. wasany matter that has resulted or could reasonably be expected to result in compliance with all applicable covenantsa “Material Adverse Effect” (as defined in the Credit Agreement).
In addition, under the Credit Agreement, we are required to meet specified financial ratios 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, the credit agreement.
As of October 28, 2017,trigger for the Company had $341.0 million in outstanding borrowings and $189.0 million ofFCCR occurs if the domestic availability under the revolving line of credit is less than the greater of (i) $40.0 million and (ii) 10% of the lesser of (x) the domestic revolving commitments under the Credit Agreement 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. As of May 2, 2020, Restoration Hardware, Inc. was in compliance with all applicable financial covenants of the Credit Agreement.
The 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) the availability under the revolving line of credit for extensions of credit is less than the greater of (A) $40.0 million and (B) 10% of the sum of (a) 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.
The 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 Credit Agreement and declare the unpaid principal, accrued and unpaid interest and all other amounts payable under the Credit Agreement to be immediately due and payable.
As of May 2, 2020, we had $10.0 million outstanding borrowings under the revolving credit facility portion of the Credit Agreement. The availability of credit at any given time under the Credit Agreement is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable. 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
23
letters of credit under the revolving line of credit). Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of May 2, 2020 was $356.5 million, net of $27.7$13.2 million in outstanding letters of credit. As of October 28, 2017, the Company had $80.0 million outstanding borrowings under the LILO term loan facility. As a result of the consolidated fixed-charge coverage ratio (“FCCR”) restriction that limits the last 10% of borrowing availability, actual incremental borrowing available to the Company and the other affiliated parties under the revolving line of credit is approximately $125.2 million as of October 28, 2017.
Second Lien Credit Agreement
On July 7, 2017,April 10, 2019, Restoration Hardware, Inc., a wholly-owned subsidiary of RH, entered into a credit agreement, (the “second lien credit agreement”), dated as of July 7, 2017,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 are funds and accountswere managed or advised by Apollo Capital Management, L.P.,either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and Wilmington Trust, National Associationits affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to an initiala second lien term loan in an aggregate principal amount equal to $100.0$200.0 million with a maturity date of January 7, 2023April 9, 2024 (the “second lien term loan”“Second Lien Term Loan”). The second lien term loanSecond Lien Term Loan of $100.0$200.0 million in principal was repaid in full on October 10, 2017. As a result of the repayment, the Company incurred a $4.9 million loss on extinguishment of debt, which includes a prepayment penalty of $3.0 million and acceleration of amortization of debt issuance costs of $1.9 million.September 20, 2019.
The Company incurred $3.6 million of debt issuance costs related to the second lien credit agreement.
The second lien term loanSecond Lien Term Loan bore interest at an annual rate generally based on the LIBOR plus 8.25%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.Second Lien Term Loan. At the date of the initial borrowing, the rate was set at one monthone-month LIBOR plus 8.25%6.50%.
17
All obligations under the second lien term loan were secured by a second lien security interest in assets of the loan parties including inventory, receivables and certain types of intellectual property. The second lien security interest was granted with respect to substantially the same collateral that secures the credit agreement. The second lien ranked junior in priority and is subordinated to the first lien in favor of the lenders with respect to the credit agreement.
The second lien credit agreement contained various restrictive and affirmative covenants generally in line with the covenants and restrictions contained in the credit agreement including required financial reporting, limitations on the ability to incur liens, make loans or other investments, incur additional debt, make certain restricted payments, or enter into transactions with affiliates, along with other restrictions and limitations typical to credit agreements of this type and size.
The second lien credit agreement also contained a financial ratio covenant not found in the credit agreement based upon a senior secured leverage ratio of consolidated secured debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”).
The second lien credit agreement also contained a consolidated fixed charge coverage ratio generally based on the same formulation set forth in the credit agreement such that the borrower may not make certain “restricted payments” in the event that certain ratios were not met and contained certain events of default and other customary terms and conditions for a second lien credit agreement.
Intercreditor Agreement
On July 7, 2017,April 10, 2019, in connection with the second lien credit agreement,Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an intercreditor agreementIntercreditor Agreement (the “intercreditor agreement”“Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the administrative agent and collateral agent under the credit agreementFirst Lien Administrative Agent and the administrative agent and collateral agent under the second lien credit agreement.Second Lien Administrative Agent. The intercreditor agreementIntercreditor 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 agreementCredit Agreement and the second lien credit agreementSecond Lien Credit Agreement without the consent of the other party. The intercreditor agreementIntercreditor Agreement was terminated upon repayment of the second lien termSecond 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 on October 10, 2017.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—10—FAIR VALUE OF FINANCIAL INSTRUMENTS
Financial Assets and LiabilitiesMEASUREMENTS
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, the Company utilizeswe utilize market data or assumptions that itwe believes 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.
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.
24
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.
The Company’sOur 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. |
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.
18
All of the Company’s investments are classified as available-for-sale and are carried at fair value. The Company did not hold any short-term or long-term investments as of October 28, 2017. Assets measured at fair value were as follows as of January 28, 2017 (in thousands):
|
| Level 1 |
|
| Level 2 |
|
| Total |
| |||
Cash equivalents |
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds |
| $ | 2,510 |
|
| $ | — |
|
| $ | 2,510 |
|
Commercial paper |
|
| — |
|
|
| 5,493 |
|
|
| 5,493 |
|
Total cash equivalents |
|
| 2,510 |
|
|
| 5,493 |
|
|
| 8,003 |
|
Short-term investments |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper |
|
| — |
|
|
| 34,534 |
|
|
| 34,534 |
|
Government agency obligations |
|
| 2,553 |
|
|
| 105,590 |
|
|
| 108,143 |
|
Total short-term investments |
|
| 2,553 |
|
|
| 140,124 |
|
|
| 142,677 |
|
Long-term investments |
|
|
|
|
|
|
|
|
|
|
|
|
Government agency obligations |
|
| — |
|
|
| 33,212 |
|
|
| 33,212 |
|
Total long-term investments |
|
| — |
|
|
| 33,212 |
|
|
| 33,212 |
|
Total |
| $ | 5,063 |
|
| $ | 178,829 |
|
| $ | 183,892 |
|
The following table summarizes the amortized cost and estimated fair value of the available-for-sale securities within the Company’s investment portfolio as of January 28, 2017 based on stated maturities, which are recorded within cash and cash equivalents, short-term investments and long-term investments on the condensed consolidated balance sheets (in thousands):
|
| Cost |
|
| Fair Value |
| ||
Range of maturity |
|
|
|
|
|
|
|
|
Due within 1 year |
| $ | 148,155 |
|
| $ | 148,170 |
|
Due in 1 to 2 years |
| $ | 33,238 |
|
| $ | 33,212 |
|
The Company invests excess cash primarily in investment-grade interest-bearing securities such as money market funds, certificates of deposit, commercial paper, government agency obligations and guaranteed obligations of the U.S. government, all of which are subject to minimal credit and market risks. The Company estimates the fair value of its commercial paper and U.S. government agency bonds by taking into consideration valuations obtained from third party pricing services. The pricing services utilize industry standard valuation models, including both income and market based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trade dates of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities, prepayment/default projections based on historical data; and other observable inputs.
There were no purchases, sales, issuances, or settlements related to recurring level 3 measurements during the three and nine months ended October 28, 2017 or October 29, 2016. There were no transfers into or out of level 1 and level 2 during the three and nine months ended October 28, 2017 or October 29, 2016.
Fair Value of Financial Instruments—Recurring
Amounts reported as cash and equivalents, receivables, 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 20192020 Notes, 2023 Notes and 20202024 Notes (carrying value excludes the equity component of the 2019 Notes and 2020 Notes classified in stockholders’ equity) were as follows (in thousands):
| | | | | | | | | | | | |
| | May 2, | | February 1, | ||||||||
| | 2020 | | 2020 | ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying | ||||
| | Value | | Value (1) | | Value | | Value (1) | ||||
Convertible senior notes due 2020 | | $ | 287,841 | $ | | 295,844 | | $ | 295,573 | | $ | 291,110 |
Convertible senior notes due 2023 | | | 232,109 | | | 274,583 | | | 272,623 | | | 270,271 |
Convertible senior notes due 2024 | |
| 214,761 | |
| 272,236 | |
| 255,849 | |
| 268,366 |
(1) | Carrying value represents the principal amount less the equity component of the 2020 Notes, 2023 Notes and 2024 Notes classified in stockholders’ equity, and does not exclude the discounts upon original issuance, discounts and commissions payable to the initial purchasers and third party offering costs, as applicable. |
|
| October 28, |
|
| January 28, |
| ||||||||||
|
| 2017 |
|
| 2017 |
| ||||||||||
|
| Fair Value |
|
| Carrying Value |
|
| Fair Value |
|
| Carrying Value |
| ||||
Convertible senior notes due 2019 |
| $ | 312,281 |
|
| $ | 325,334 |
|
| $ | 295,381 |
|
| $ | 314,543 |
|
Convertible senior notes due 2020 |
| $ | 247,300 |
|
| $ | 251,771 |
|
| $ | 232,463 |
|
| $ | 239,876 |
|
The fair value of each of the 20192020 Notes, 2023 Notes and 20202024 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 the Company’sour convertible
19
notes, when available, the Company’sour common stock price and interest rates based on similar debt issued by parties with credit ratings similar to the Company (levelours (Level 2).
Fair Value Measurements—Non-Recurring
The estimated fair value of the asset based credit facility was $341.0 million, which approximates cost,Waterworks reporting unit tradename as of October 28, 2017. Fair value approximates costMay 2, 2020 and February 1, 2020 was determined based on unobservable (Level 3) inputs and valuation techniques, as discussed in Note 4—Goodwill, Trademarks,Trademarks and Domain Names and in “Impairment” within Note 3—Significant Accounting Policies in the interest rate associated with the facility is variable and resets frequently.2019 Form 10-K.
The estimated fair value of the LILO term loan is $80.0 million, which approximates cost, as of October 28, 2017. Fair value approximates cost as the interest rate associated with the facility is variable and resets frequently.
NOTE 12—11—INCOME TAXES
The CompanyWe recorded income tax benefit of $1.4 million and income tax expense of $6.2 million and $1.8$11.8 million in the three months ended October 28, 2017May 2, 2020 and October 29, 2016, respectively. The Company recorded income tax expense of $9.9 million and an income tax benefit of $2.6 million in the nine months ended October 28, 2017 and October 29, 2016,May 4, 2019, respectively. The effective tax rate was 32.1%30.7% and 41.4%24.8% for the three months ended October 28, 2017May 2, 2020 and October 29, 2016,May 4, 2019, respectively. The increase in the effective tax rate was 83.7% and 38.9% for the nine months ended October 28, 2017 and October 29, 2016, respectively. The effective tax rates for the three and nine months ended October 28, 2017 were impacted by
25
May 2, 2020, as compared to the three months May 4, 2019, is primarily attributable to the Company reporting a loss before income taxes, and, to a lesser extent, discrete tax benefits related to net excess tax benefits from stock-based compensation of $1.9 million and $4.3 million, respectively, resulting from the Company’s adoption of ASU 2016-09 in the first quarter of fiscal 2017. The effective tax rate for the nine months ended October 28, 2017 was also significantly impacted by non-deductible stock-based compensation.
As of October 28, 2017 and January 28, 2017, $6.8May 2, 2020, we had $8.5 million and $1.4 million, respectively, of the exposures related to unrecognized tax benefits, of which $7.8 million would affectreduce income tax expense and the effective tax rate, if realized, of which, as of both October 28, 2017 and January 28, 2017, $1.4 million is included inrecognized. The remaining unrecognized tax benefits would offset other non-current obligations on the condensed consolidated balance sheets. In October 2017, the Company filed an amended federaldeferred tax return claiming a $5.4 million refund, however, no income tax benefit was recorded during the three months ended October 28, 2017 given the technical nature and amount of the refund claim. An income tax benefit related to this refund claim could be recorded in a future period upon settlement with the respective taxing authority.assets, if recognized. As of October 28, 2017, the Company does not have anyMay 2, 2020, we had $6.3 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.
NOTE 13—12—NET INCOME (LOSS) PER SHARE
The weighted-average shares used for net income (loss) per share isare presented in the table below. As the Company was inwe reported a net loss position for the ninethree months ended October 29, 2016,May 2, 2020, the weighted-average shares outstanding for basic and diluted are the same.
| | | | |
|
| Three Months Ended | ||
|
| May 2, | | May 4, |
|
| 2020 |
| 2019 |
Weighted-average shares—basic | | 19,242,641 | | 19,976,858 |
Effect of dilutive stock-based awards | | — |
| 4,472,545 |
Effect of dilutive convertible senior notes (1) | | — |
| 484,584 |
Weighted-average shares—diluted | | 19,242,641 |
| 24,933,987 |
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
Weighted-average shares—basic |
|
| 21,221,848 |
|
|
| 40,730,059 |
|
|
| 29,076,556 |
|
|
| 40,653,091 |
|
Effect of dilutive stock-based awards |
|
| 2,313,769 |
|
|
| 196,391 |
|
|
| 1,516,826 |
|
|
| — |
|
Weighted-average shares—diluted |
|
| 23,535,617 |
|
|
| 40,926,450 |
|
|
| 30,593,382 |
|
|
| 40,653,091 |
|
(1) | The 2020 Notes, 2023 Notes and 2024 Notes have an impact on our dilutive share count beginning at stock prices of $118.13 per share, $193.65 per share and $211.40 per share, respectively. |
The following number of dilutive options, and restricted stock units and convertible senior notes were excluded from the calculation of diluted net income (loss) per share because their inclusion would have been anti-dilutive:
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||
| | | | | ||||||||||||||||
| | Three Months Ended | ||||||||||||||||||
| | May 2, | | May 4, | ||||||||||||||||
|
| 2020 |
| 2019 | ||||||||||||||||
Options |
|
| 2,222,103 |
|
|
| 7,995,703 |
|
|
| 3,701,484 |
|
|
| 8,594,487 |
| | 4,436,083 | | 463,506 |
Restricted stock units |
|
| 128,723 |
|
|
| 892,279 |
|
|
| 305,744 |
|
|
| 1,151,993 |
|
| 177,312 |
| — |
Convertible senior notes | | 589,095 | | — | ||||||||||||||||
Total anti-dilutive stock-based awards |
|
| 2,350,826 |
|
|
| 8,887,982 |
|
|
| 4,007,228 |
|
|
| 9,746,480 |
|
| 5,202,490 |
| 463,506 |
20
NOTE 14—13—SHARE REPURCHASES
$700 Million Share Repurchase Program
On May 2, 2017, the Company’sOctober 10, 2018, our Board of Directors authorized a stockshare repurchase program of up to $700$700.0 million, (the “$700 Million Repurchase Program”). Underof which $250.0 million in share repurchases were completed in fiscal 2018. The $700.0 million authorization amount was replenished by the $700 Million Repurchase Program,Board of Directors on March 25, 2019. We did not make any repurchases under this program during the Companythree months ended May 2, 2020. During the three months ended May 4, 2019, we repurchased approximately 12.42.2 million shares of itsour common stock at an average price of $56.60$115.36 per share, for an aggregate repurchase amount of approximately $700$250.0 million during the three months ended July 29, 2017. As the $700 Million Repurchase Program was completed during the three months ended July 29, 2017, no additional shares were repurchased during the three months ended October 28, 2017 and there will be no repurchases in future periods under this share repurchase authorization.
$300 Million Share Repurchase Program
On February 21, 2017, the Company’s Boardprogram. As of Directors authorized a stock repurchase program of up to $300May 2, 2020, there was $450.0 million (the “$300 Million Repurchase Program”). Under the $300 Million Repurchase Program, the Company repurchased approximately 7.8 million shares of its common stock at an average price of $38.24 perremaining for future share for an aggregate repurchase amount of approximately $300 million, during the three months ended April 29, 2017. As the $300 Million Repurchase Program was completed during the three months ended April 29, 2017, no additional shares were repurchased during the three months ended October 28, 2017 and there will be no repurchases in future periods under this repurchase authorization.program.
Share Repurchases Under Equity Plans
Certain options and awards granted under the Company’s equity plans contain a repurchase right, which may be exercised at the Company’s discretion in the event of the termination of an employee’s employment with the Company. No shares were repurchased under equity plans during either the three and nine months ended October 28, 2017 or October 29, 2016. As of both October 28, 2017May 2, 2020 and January 28, 2017,February 1, 2020, the aggregate unpaid principal amount of the notes payable for share repurchases was $19.4$18.8 million and $18.7 million, respectively, which iswere included in other non-current obligations on
26
the condensed consolidated balance sheets. During both the three months ended October 28, 2017May 2, 2020 and October 29, 2016, the CompanyMay 4, 2019, we recorded interest expense on the outstanding notes of $0.2 million. During both the nine months ended October 28, 2017 and October 29, 2016, the Company recorded interest expense on the outstanding notes of $0.7 million.
Of the $19.4$18.8 million and $18.7 million notes payable for share repurchases outstanding as of both October 28, 2017May 2, 2020 and January 28, 2017,February 1, 2020, $15.5 million was due to a current board member of the Company.
NOTE 15—14—STOCK-BASED COMPENSATION
The Company estimates the value of equity grants based upon an option-pricing model and recognizes this estimated value asWe recorded stock-based compensation expense overof $5.8 million and $5.7 million during the vesting periods. The Company recognizes expense associated with performance-based awards when it becomes probable that the performance condition will be met. Once it becomes probable that an award will vest, the Company recognizes compensation expense equal to the number of sharesthree months ended May 2, 2020 and May 4, 2019, respectively, which are probable to vest multiplied by the fair value of the related shares measured at the grant date.
Stock-based compensation expense is included in selling, general and administrative expenses on the condensed consolidated statements of operations. The Company recorded stock-based compensation expense of $6.7 million and $7.4 million during the three months ended October 28, 2017 and October 29, 2016, respectively. The Company recorded stock-based compensation expense of $42.9 million and $21.7 million during the nine months ended October 28, 2017 and October 29, 2016, respectively. NoNaN stock-based compensation cost has been capitalized in the accompanying condensed consolidated financial statements.
2012 Stock Incentive Plan and 2012 Stock Option Plan
As of October 28, 2017, 8,837,586May 2, 2020, 7,766,765 options were outstanding with a weighted-average exercise price of $50.20$66.74 per share and 6,318,9805,906,720 options were vested with a weighted-average exercise price of $51.96$53.62 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of October 28, 2017May 2, 2020 was $323.7$563.5 million, $283.8$550.3 million, and $220.6$495.2 million, respectively. Stock options exercisable as of October 28, 2017May 2, 2020 had a weighted-average remaining contractual life of 6.374.13 years. As of October 28, 2017,May 2, 2020, the total unrecognized compensation expense related to unvested options was $26.8$65.2 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.334.47 years.
As of October 28, 2017, the CompanyMay 2, 2020, we had 825,307201,920 restricted stock units outstanding with a weighted-average grant date fair value of $52.20$47.78 per share. During the three months ended October 28, 2017, 18,590May 2, 2020, 13,685 restricted stock units vested with a weighted-average grant date and vest date fair value of $73.95$68.82 per share and $73.06 per share, respectively. During the nine months ended
21
October 28, 2017, 264,843 restricted stock units vested with a weighted-average grant date and vest date fair value of $59.11 per share and $54.71 per share, respectively.share. As of October 28, 2017,May 2, 2020, there was $22.5$4.0 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 3.261.26 years.
Chairman and Chief Executive Officer Option Grant
On May 2, 2017, the Company’s Board of Directors granted Mr. Friedman an option to purchase 1,000,000 shares of the Company’s common stock with an exercise price equal to $50 per share.
The option contains dual-condition restrictions consisting of both time-based service restrictions over four years and performance-based restrictions linked to achieving the Company’s common stock price objectives of $100, $125 and $150 per share. 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 resulted in a one-time non-cash stock compensation charge of $23.9 million in the nine months ended October 28, 2017. The Company did not record any expense related to this grant in the three months ended October 28, 2017.
Time-Based Restrictions
The time-based restrictions are measured over an initial four year service period from the date of the award and these restrictions will lapse at the end of each of these first four years at a rate of 250,000 shares per year if (i) Mr. Friedman remains employed at the end of such year, and (ii) the stock price goals have been achieved in such year as described further below.
Performance-Based Restrictions
The stock price objectives are measured each year and are set at prices for the Company’s common stock of $100, $125 and $150 per share. If all three stock price objectives are met in the first performance year, restrictions will lapse as to 250,000 shares in aggregate at the end of such year, with 83,333 shares tied to a $100 price per share, 83,333 shares tied to a $125 price per share and 83,334 shares tied to a $150 price per share.
The same price performance tests are applied in the second year of performance such that restrictions will lapse for an additional 250,000 shares at the end of the second year and then again as to an additional 250,000 shares at the end of each of the third and fourth years so long as Mr. Friedman remains employed at the end of each year.
To the extent that any of the price performance objectives is not reached within one of these first four performance years, the stock price objective can be achieved in any subsequent year until the 8th anniversary of the date of grant.
2012 Stock Incentive Plan Grant to Waterworks Associates
On May 27, 2016, on the date of our acquisition of Waterworks, the Company granted stock options to certain Waterworks associates under the 2012 Stock Incentive Plan to purchase 322,784 shares of its common stock, with an exercise price of $33.54 per share, which is equal to the closing price of the Company’s common stock on the date of grant. These options are fully vested as of the date of grant but any shares issued upon exercise of such options will be subject to selling restrictions which are scheduled to lapse in five equal installments on the first, second, third, fourth and fifth anniversaries of the grant date. The fully vested options resulted in a one-time non-cash stock-based compensation charge of $3.7 million in the second quarter of fiscal 2016.
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 operations. The fair value of the Appreciation Rights is determined based on an option pricing methodoption-pricing model (“OPM”). The CompanyWe did not record any expense related to the Appreciation Rights during both the three or nine months ended October 28, 2017 or October 29, 2016.May 2, 2020 and May 4, 2019. As of both October 28, 2017May 2, 2020 and January 28, 2017,February 1, 2020, 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.
22
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 operations. The fair value of the Profit Interests is determined based on an OPM. For both the three and nine months ended October 28, 2017, the CompanyMay 2, 2020 and May 4, 2019, we recorded $0.1 million and $0.3 million, respectively, related to the Profit Interests, which is included in selling, general and administrative expenses on the condensed consolidated statements of operations. For the three and nine months ended October 29, 2016 the Company recorded $0.1 million and $0.2 million, respectively, related to the Profit Interests. As of October 28, 2017May 2, 2020 and January 28, 2017,February 1, 2020, the liability associated with the Profit Interests was $0.6$1.7 million and $0.3$1.6 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.
27
NOTE 16—RELATED PARTY TRANSACTIONS
Aircraft Time Sharing Agreement
On March 29, 2016, Restoration Hardware, Inc., a wholly-owned subsidiary of the Company entered into an Amended and Restated Aircraft Time Sharing Agreement (the “Time Sharing Agreement”) with Gary Friedman, its Chairman and Chief Executive Officer. The Time Sharing Agreement governs use of any of the Company’s aircraft (“Corporate Aircraft”) by Mr. Friedman for personal trips and provides that Mr. Friedman will lease such Corporate Aircraft and pay Restoration Hardware, Inc. an amount equal to the aggregate actual expenses of each personal use flight based on the variable costs of the flight, with the amount of such lease payments not to exceed the maximum payment level established under the Federal Aviation Administration rules. Mr. Friedman maintains a deposit with the Company, to be used towards payment of amounts due under the Time Sharing Agreement. The amount of the deposit is immaterial to the condensed consolidated financial statements.
NOTE 17—15—COMMITMENTS AND CONTINGENCIES
Commitments
The CompanyWe had no0 material off balance sheet commitments as of October 28, 2017.May 2, 2020.
Contingencies
The Company isWe are involved in lawsuits, claims and proceedings incident to the ordinary course of itsour business. These disputes are increasing in number as the business expands and the Company growswe grow larger. Litigation is inherently unpredictable. As a result, the outcome of matters in which the Company iswe are involved could result in unexpected expenses and liability that could adversely affect the Company’sour operations. In addition, any claims against the Company,us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources.
The Company reviewsWe review the need for any loss contingency reserves and establishes reserves when, in the opinion of management, 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 the Company doeswe 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 the Company accrueswe accrue from time to time. The Company believesWe believe that the ultimate resolution of itsour current matters will not have a material adverse effect on itsour condensed consolidated financial statements.
RH Modern 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 action is captioned In re RH, Inc. Securities Litigation. The complaints allege, among other things, fraudAn amended consolidated complaint was filed in connection with alleged misstatementsJune 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. Both complaints purport to makeamended (the “Exchange Act”). The complaint asserts claims purportedly on behalf of a class of purchasers of Companyour common stock from March 26, 2015 to June 8, 2016. The alleged misstatements relate to forward looking statements regarding the roll out of the RH Modern product line.line and our inventory levels. The claims are currently atcomplaint seeks class certification, monetary damages, and other appropriate relief, including an early stageaward of costs and it is not possible to estimate the amount or range of any potential loss at this time. An amended consolidated complaint was filed in June 2017attorneys’ 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.
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 May 2, 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
28
derivative actions, and its officers have moved
23
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. WhileOn January 23, 2019, the outcomecourt 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, which agreement is inherently uncertain,subject to the Companyfinalization of a stipulation of settlement, and its officers intendcertain conditions, including approval by our Board of Directors, and approval by the Court. The settlement involves certain non-monetary terms as well as payment of the plaintiffs’ attorneys’ legal fees, which payment is expected to vigorously defend the claims and believe the complaints lack merit.be funded by our insurance carriers.
NOTE 18—16—SEGMENT REPORTING
The Company definesWe define reportable and operating segments on the same basis that it useswe use to evaluate performance internally by the Chief Operating Decision Maker (the “CODM”). The Company has, which we have determined that theis our Chief Executive Officer is its CODM. As of October 28, 2017, the Company had twoOfficer. We have 2 operating segments: RH Segment and Waterworks. The two2 operating segments include all sales channels accessed by the Company’sour customers, including sales through catalogs, sales through the Company’s websites, sales through stores, and sales through the commercial channel.channel.
The Company’s twoOur 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, the Company haswe have determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.
The Company usesWe use operating income (loss) to evaluate segment profitability. Operating income (loss) is defined as net income (loss) before interest expense—net, tradename impairment and income taxes.tax expense (benefit).
Prior to the Waterworks acquisition, the Company had one reportable segment. As the Company’s acquisition of Waterworks was completed on May 27, 2016, reportable segment financial information for Waterworks below represents twenty-two weeks of results for the nine months ended October 29, 2016, whereas the RH Segment results represent thirty-nine weeks for the nine months ended October 29, 2016. The results for both the three months ended October 28, 2017 and October 29, 2016 include thirteen weeks for both the RH Segment and Waterworks.
Segment Information
The following table presents the statements of operations metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280—Segment Reporting (in thousands)thousands):
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | May 2, | | May 4, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 454,957 | | $ | 27,938 | | $ | 482,895 | | $ | 563,706 | | $ | 34,715 | | $ | 598,421 |
Gross profit | |
| 187,762 | |
| 11,892 | |
| 199,654 | |
| 217,943 | |
| 14,871 | |
| 232,814 |
Depreciation and amortization | |
| 23,717 | | | 1,153 | |
| 24,870 | |
| 26,004 | | | 1,185 | |
| 27,189 |
|
| Three Months Ended |
|
| Three Months Ended |
| ||||||||||||||||||
|
| October 28, |
|
| October 29, |
| ||||||||||||||||||
|
| 2017 |
|
| 2016 |
| ||||||||||||||||||
|
| RH Segment |
|
| Waterworks |
|
| Total |
|
| RH Segment |
|
| Waterworks |
|
| Total |
| ||||||
Net revenues |
| $ | 563,174 |
|
| $ | 29,299 |
|
| $ | 592,473 |
|
| $ | 521,027 |
|
| $ | 28,301 |
|
| $ | 549,328 |
|
Gross profit |
| $ | 203,221 |
|
| $ | 11,104 |
|
| $ | 214,325 |
|
| $ | 166,124 |
|
| $ | 9,695 |
|
| $ | 175,819 |
|
Depreciation and amortization |
| $ | 17,474 |
|
| $ | 1,072 |
|
| $ | 18,546 |
|
| $ | 13,966 |
|
| $ | 1,070 |
|
| $ | 15,036 |
|
|
| Nine Months Ended |
|
| Nine Months Ended |
| ||||||||||||||||||
|
| October 28, |
|
| October 29, |
| ||||||||||||||||||
|
| 2017 |
|
| 2016 |
| ||||||||||||||||||
|
| RH Segment |
|
| Waterworks |
|
| Total |
|
| RH Segment |
|
| Waterworks |
|
| Total |
| ||||||
Net revenues |
| $ | 1,680,495 |
|
| $ | 89,384 |
|
| $ | 1,769,879 |
|
| $ | 1,499,101 |
|
| $ | 49,064 |
|
| $ | 1,548,165 |
|
Gross profit |
| $ | 555,844 |
|
| $ | 34,550 |
|
| $ | 590,394 |
|
| $ | 467,402 |
|
| $ | 15,731 |
|
| $ | 483,133 |
|
Depreciation and amortization |
| $ | 47,761 |
|
| $ | 3,331 |
|
| $ | 51,092 |
|
| $ | 39,484 |
|
| $ | 1,764 |
|
| $ | 41,248 |
|
24
29
The following table presents the balance sheet metrics reviewed by the CODM to evaluate performance internally as required under ASC 280—Segment Reporting(in thousands)thousands):
| | | | | | | | | | | | | | | | | | |
| | May 2, | | February 1, | ||||||||||||||
| | 2020 | | 2020 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Goodwill (1) | | $ | 124,290 | | $ | — | | $ | 124,290 | | $ | 124,367 | | $ | — | | $ | 124,367 |
Tradenames, trademarks and domain names (2) | |
| 48,563 | |
| 17,000 | |
| 65,563 | |
| 48,563 | |
| 37,459 | |
| 86,022 |
Total assets | |
| 2,310,111 | |
| 119,782 | |
| 2,429,893 | |
| 2,301,823 | |
| 143,871 | |
| 2,445,694 |
|
| October 28, |
|
| January 28, |
| ||||||||||||||||||
|
| 2017 |
|
| 2017 |
| ||||||||||||||||||
|
| RH Segment |
|
| Waterworks |
|
| Total |
|
| RH Segment |
|
| Waterworks |
|
| Total |
| ||||||
Goodwill (1) |
| $ | 124,409 |
|
| $ | 51,144 |
|
| $ | 175,553 |
|
| $ | 124,374 |
|
| $ | 49,229 |
|
| $ | 173,603 |
|
Trademarks and domain names |
| $ | 48,563 |
|
| $ | 52,100 |
|
| $ | 100,663 |
|
| $ | 48,524 |
|
| $ | 52,100 |
|
| $ | 100,624 |
|
Total assets |
| $ | 1,649,057 |
|
| $ | 152,509 |
|
| $ | 1,801,566 |
|
| $ | 2,040,346 |
|
| $ | 152,174 |
|
| $ | 2,192,520 |
|
(1) | The Waterworks reporting unit goodwill |
(2) | The Waterworks reporting unit tradename is presented net of an impairment charge of $35.1 million, with $20.5 million recorded in the |
The Company usesWe use segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes (i) non-cash compensation charges related to a fully vested option grant made to Mr. Friedmanasset impairments and the fully vested option grants made change in connection with the acquisition of Waterworks,useful lives, (ii) reduction of net revenues, incremental costs and inventory charges associated with product recalls, (iii) non-cash amortization of the inventory fair value adjustment recorded in connection with the acquisition of Waterworks, (iv) severance costs associated with anticipated distribution center closures, (v) gain on sale of buildingreorganizations and land, (vi) charges incurred for the estimated cumulative impact of coupons redeemed in connection with a legal claim, (vii) costs associated with a reorganization, which include severance costs(iii) product recall accruals and related taxes, partially offset by a reversal of stock-based compensation expense related to unvested equity awards, and (viii) costs incurred in connection with the acquisition of Waterworks including professional fees.adjustments. 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 management reviews.review.
The following table showspresents segment operating income (loss) and income (loss) before taxincome taxes (in thousands):
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
Operating income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RH Segment |
| $ | 48,724 |
|
| $ | 18,660 |
|
| $ | 98,332 |
|
| $ | 51,687 |
|
Waterworks |
|
| (719 | ) |
|
| (514 | ) |
|
| (2,143 | ) |
|
| 344 |
|
Non-cash compensation |
|
| — |
|
|
| — |
|
|
| (23,872 | ) |
|
| (3,672 | ) |
Recall accrual |
|
| (3,552 | ) |
|
| — |
|
|
| (8,285 | ) |
|
| — |
|
Impact of inventory step-up |
|
| (248 | ) |
|
| (1,786 | ) |
|
| (2,108 | ) |
|
| (5,187 | ) |
Distribution center closures |
|
| (1,862 | ) |
|
| — |
|
|
| (1,862 | ) |
|
| — |
|
Gain on sale of building and land |
|
| 819 |
|
|
| — |
|
|
| 2,119 |
|
|
| — |
|
Legal claim |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (8,701 | ) |
Reorganization related costs |
|
| — |
|
|
| (974 | ) |
|
| — |
|
|
| (5,698 | ) |
Acquisition related costs |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (2,847 | ) |
Operating income |
|
| 43,162 |
|
|
| 15,386 |
|
|
| 62,181 |
|
|
| 25,926 |
|
Interest expense—net |
|
| 18,915 |
|
|
| 11,091 |
|
|
| 45,496 |
|
|
| 32,528 |
|
Loss on extinguishment of debt |
|
| 4,880 |
|
|
| — |
|
|
| 4,880 |
|
|
| — |
|
Income (loss) before tax |
| $ | 19,367 |
|
| $ | 4,295 |
|
| $ | 11,805 |
|
| $ | (6,602 | ) |
| | | | | | |
| | Three Months Ended | ||||
| | May 2, | | May 4, | ||
|
| 2020 |
| 2019 | ||
Operating income (loss): | | | | | | |
RH Segment | | $ | 49,517 | | $ | 69,400 |
Waterworks | |
| (1,450) | |
| 1,094 |
Asset impairments and change in useful lives | |
| (8,471) | |
| (3,476) |
Reorganization related costs | |
| (4,143) | |
| — |
Recall accrual | |
| — | |
| 1,615 |
Income from operations | |
| 35,453 | |
| 68,633 |
Interest expense—net | |
| 19,629 | |
| 21,118 |
Tradename impairment | ��� | | 20,459 | | | — |
Income (loss) before income taxes | | $ | (4,635) | | $ | 47,515 |
The Company classifies itsWe 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.cor, as well as hospitality. Net revenues in each category were as follows (in thousands):
|
| Three Months Ended |
|
| Nine Months Ended |
| |||||||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| |||||||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| |||||||||
| | | | | | ||||||||||||||||
| Three Months Ended | ||||||||||||||||||||
| May 2, | | May 4, | ||||||||||||||||||
| 2020 |
| 2019 | ||||||||||||||||||
Furniture |
| $ | 383,281 |
|
| $ | 343,946 |
|
| $ | 1,125,220 |
|
| $ | 985,639 |
| $ | 316,779 | | $ | 396,698 |
Non-furniture |
|
| 209,192 |
|
|
| 205,382 |
|
|
| 644,659 |
|
|
| 562,526 |
|
| 166,116 | |
| 201,723 |
Total net revenues |
| $ | 592,473 |
|
| $ | 549,328 |
|
| $ | 1,769,879 |
|
| $ | 1,548,165 |
| $ | 482,895 | | $ | 598,421 |
The Company isWe are domiciled in the United States and primarily operates itsoperate our retail and outlet stores in the United States. As of October 28, 2017, the Company operatesMay 2, 2020, we operate 4 retail and 2 outlet stores in Canada and 1 retail store in the U.K. Revenues from Canadian
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and U.K. operations, and the long-lived assets in Canada and the U.K., are not material to the Company. Geographicmaterial. Canada and U.K. geographic revenues are determined based upon where service is rendered.revenues recognized at the retail store locations in the respective country.
No
NaN single customer accounted for more than 10% of the Company’sour revenues in the three or nine months ended October 28, 2017May 2, 2020 or October 29, 2016.May 4, 2019.
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Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of OperationsThe following discussion and analysis of theour 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 20162019 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 sections entitled Risk Factors in Part II of this quarterly report and in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017February 1, 2020 (“20162019 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report and in our 20162019 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 otherwise required by law.
Overview
We are a leading luxury retailer in the home furnishings marketplace. Our curated and fully-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. We offer dominant merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, tableware, and child and teen furnishings. We position our Galleries as showrooms for our brand, while our Source Books and websites act as virtual extensions of our stores.
Our retail business is fully integrated across our multiple channels of distribution, consisting of our stores, Source Books, and websites. We have an integrated RH Hospitality experience in eight of our new Design Gallery locations, which include restaurants and wine vaults.
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As of October 28, 2017,May 2, 2020, we operated a totalthe following number of 84 retail Galleries, consistingoutlets and showrooms:
| | |
| | Count |
RH | | |
Design Galleries | 22 | |
Legacy Galleries | | 41 |
Modern Galleries | | 2 |
Baby & Child and Teen Galleries | | 4 |
Total Galleries | | 69 |
Outlets | | 38 |
| | |
Waterworks Showrooms | | 15 |
Our recent business operations have focused on responding to the closure of 48 legacy Galleries, 6 larger format Design Galleries, 9 next generation Design Galleries, 1 RH Modernour retail locations in connection with the COVID-19 health crisis and managing our business operations in the face of dramatic changes in customer traffic and consumer purchasing patterns. 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.
In response to the public health crisis posed by COVID-19, on March 17, 2020, we temporarily closed our retail locations. While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, since that date we have been able to reopen a large number of our stores based on local market circumstances including the gradual lifting of restrictions on business operations, including shelter-in-place rules. During the time that our Gallery locations were closed, we continued to serve our customers in those market areas virtually through our Gallery representatives and 5 RH Baby & Child Galleries throughoutdesigners, as well as our online capabilities. We have continued to serve our customers and operate our business through this initial phase of retail closures in the United StatesU.S. and Canada and 15 Waterworks showroomsare in the process of reopening our physical locations. While the COVID-19 health crisis is ongoing and continues to evolve, we have reopened 74% of our Gallery locations, 68% of our Outlets and 50% of our Restaurants as of June 3, 2020. There can be no assurance that future events including additional waves of COVID-19 outbreaks, evolving federal, state and local restrictions, standards and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, or other similar issues will not adversely affect our business, results of operations or financial condition in the future, or that the pace of economic activity in the wake of the first wave of COVID-19 outbreaks will not have a negative impact on our business, results of operations or financial condition. In addition, 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. 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 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. 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, and the extent to which business conditions are able to return to normal in areas that affect our supply chain including factories and transportation.
As the COVID-19 health crisis is ongoing and continues to evolve, we expect that our short-term focus in managing the business will continue to emphasize responding to some of the business effects related to the COVID-19 crisis. Despite the uncertainty of the overall economic climate and the temporary closure of our retail locations, a number of our business trends have been very strong. While the time period during which we have had to adjust our operations to respond to the COVID-19 health crisis will have some negative impact on margins, we believe that our longer term effort to increase operating margins will continue as the business continues to normalize after the effects of COVID-19 moderate. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs of our business operations. 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 COVID-19. We have taken measures to defer some capital expenditures and other expenses, but we may resume those investments as and to the extent that business conditions continue to improve during the COVID-19 crisis. For more information, refer to Item 1A—Risk Factors—The COVID-19 pandemic poses significant
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and widespread risks to our business as well as to the business environment and the markets in which we operate in Part II of this quarterly report.
Key Value Driving Strategies
In order to drive growth across our business, we are focused on a number of key long-term strategies including:
● | Transform Our Real Estate Platform. We believe we have an opportunity to significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that are sized to the potential of each market and the size of our assortment. |
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. 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. 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 recent projects.
We opened our Portland Design Gallery in March 2018, our Nashville Design Gallery in June 2018, our New York Design Gallery and our Yountville Design Gallery in September 2018, our Minneapolis Design Gallery in September 2019, and our Columbus Design Gallery in December 2019. Our Galleries in Nashville, New York, Yountville, Minneapolis and Columbus include integrated restaurants and wine vaults.
We have identified key learnings from our real estate transformation that have supported the development of a new multi-tier market approach that we believe will optimize both market share and return on invested capital.
First, we have developed a new RH prototype Design Gallery that is an innovative and flexible blueprint which we believe will enable us to more quickly place our disruptive product assortment and immersive retail experience into the market. The new model is a standard we will utilize in the U.K.future that is based on key learnings from more recent Design Gallery openings and will have approximately 38,000 leased selling square feet inclusive of our integrated hospitality experience. This prototype will present our assortments across our businesses and contain interior design offices and presentation rooms where design professionals can work with clients on their projects. This new model will be more capital efficient with less time and cost risk, but yield similar productivity. We anticipate the new prototype Design Galleries will represent the format of most of our upcoming Design Galleries in North America. Our most recently opened Design Galleries in Minneapolis, MN and Columbus, OH are prototype Design Galleries, and upcoming prototype locations include Corte Madera, CA, Charlotte, NC, Jacksonville, FL, Dallas, TX and Oakbrook, IL.
Second, we will continue to develop and open larger Bespoke Design Galleries in the top metropolitan markets, similar to those we opened in New York and Chicago. These iconic locations are highly profitable statements for our brand, and we believe they create a long-term competitive advantage that will be difficult to duplicate.
Third, we will continue to open indigenous Bespoke Galleries in the best second home markets where the wealthy and affluent visit and vacation. These Galleries are tailored to reflect the local culture and are sized to the potential of each market. Examples of current indigenous Bespoke Galleries include Yountville, CA and Aspen, CO.
Fourth, we are developing a new Gallery model tailored to secondary markets. Targeted to be 10,000 to 18,000 square feet, we believe these smaller expressions of our brand will enable us to gain share in markets currently only served by smaller competitors. Examples of target secondary markets include Oklahoma City, OK and Milwaukee, WI, among others. We expect these Galleries to require a substantially smaller net investment than our larger Design Galleries and to pay back our capital investment in most instances within
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two years or less. Our plan is to test a few of these Galleries over the next several years, and if proven successful, this format could lead to an increase in our long-term Gallery potential in the United States.
We believe our multi-tier market approach to transforming our real estate will enable us to ramp our opening cadence from 3 to 5 new Galleries per year, to a pace of 5 to 7 new Galleries per year.
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. Our three primary deal constructs are outlined below:
● | First, due to the productivity and proof of concept of our recent new Galleries, and the addition of a powerful, traffic-generating hospitality experience, we are able to negotiate “capital light” leasing deals, where as much as 65% to 100% of the capital requirement would be funded by the landlord, versus 35% to 50% previously. |
● | Second, in select projects we are migrating from a leasing to a development model. We currently have two Galleries, Yountville and Minneapolis, using this new model, and have additional projects in the pipeline. In the case of Yountville and Minneapolis, we have completed or expect to complete sale-leaseback transactions that should allow us to recoup all or a large portion of our capital. |
● | Third, we are working on joint venture projects, where we share the upside of a development with the developer/landlord. An example of this new model would be our future Gallery and Guesthouse in Aspen, where we are contributing the value of our lease to the development in exchange for a profits interest in the project. The developer will deliver to RH a substantially turnkey Gallery and Guesthouse, while we continue to retain a 20% and 25% profits interest in the properties, respectively. We would expect to monetize the profits interest at the time of sale of the properties during the first five years. The net result should be a minimal capital investment to operationalize the business, with the expectation for a net positive capital benefit at time of monetization of the profits interest. |
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.
● | Pursue International Expansion. We believe that our luxury brand positioning and unique aesthetic has strong international appeal. As such, we are actively pursuing expanding the RH brand globally with the objective of launching in several international locations in 2021 or 2022. We have secured a number of locations in various markets in the United Kingdom and continental Europe in which we expect to introduce our first Galleries outside of the U.S. and Canada. We believe that expanding our business into these and other international markets represents a substantial long-term market opportunity given the size of these markets for home furnishings and are pursuing international expansion as one of our key business priorities. |
● | Expand Our Offering and Increase Our Market Share. We believe we have a significant opportunity to increase our market share by: |
● | transforming our real estate platform; |
● | growing our merchandise assortment and introducing new products and categories; |
● | expanding our service offerings, including design services; |
● | exploring and testing new business opportunities complementary to our core business; and |
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● | increasing our brand awareness and customer loyalty through our Source Book circulation strategy, membership program, our digital marketing initiatives, advertising, and public relations activities and events. |
During fiscal 2017 and fiscal 2018 we deferred the introduction of major new product category expansions other than the ongoing development of RH Hospitality in conjunction with new Design Galleries. In fiscal 2019, we resumed introducing product expansions in our merchandise assortment including a number of new merchandise collections in both RH Interiors and RH Modern, as well as the launch of RH Beach House in the Spring and RH Ski House in the Fall.
We also plan to increase our investment in RH Interior Design with a long-term goal of building the leading interior design firm in North America and ultimately creating the world’s first consumer facing interior design, architecture and landscape architecture services platform inside our Galleries. We believe there is a significant revenue opportunity by offering world class design and installation services as we move the brand beyond creating and selling products, to conceptualizing and selling spaces.
We also intend to continue to pursue innovative business opportunities complementary to our core business, such as by testing new categories, for example by offering beautifully designed and furnished turnkey homes and condominiums through the concept of RH Residences.
● | Grow Our Integrated Hospitality Experience. In 2015 we began to introduce an integrated hospitality experience, including restaurants and wine vaults, into a number of our new Gallery locations. The success of our initial hospitality offering in Chicago led us to broaden this initiative by adding hospitality to a number of our other new Gallery locations. We believe this has created a unique new retail experience that cannot be replicated online, and that the addition of hospitality is helping to drive incremental sales of home furnishings in these Galleries. We plan to incorporate hospitality in many of the new Galleries that we open in the future. |
Our hospitality efforts will also elevate the RH brand as we move beyond the four walls of our Galleries into other opportunities such as RH Guesthouses and RH3, our luxury yacht. These immersive experiences expose existing and new customers to our evolving authority in interior design, architecture, landscape architecture and hospitality.
● | Architect New Operating Platform. We have spent the last four years architecting a new operating platform, inclusive of transitioning from a promotional to membership model, our distribution center network redesign, the redesign of our reverse logistics and outlet business, and the reconceptualization of our home delivery and customer experience, which enables us to drive lower costs and inventory levels, and higher earnings and inventory turns. Looking forward, we expect this multi-year effort to result in a dramatically improved customer experience, continued margin enhancement and significant cost savings over the next several years. |
● | Maximize Cash Flow and Optimize the Allocation of Capital in the Business. From fiscal 2017 through and including fiscal 2020, we have increasingly operated our business with a goal to maximize cash flow and the allocation of capital. We believe that our operations and current initiatives are providing a significant opportunity to optimize the allocation of capital in our business, including generating free cash flow and optimizing our balance sheet, as well as deploying capital to repay debt and repurchase shares of our common stock, which we believe creates a long term benefit to our shareholders. |
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. Total repurchases made in fiscal 2019, fiscal 2018 and fiscal 2017 represent 59.8% of the shares outstanding as of October 28,the end of fiscal 2016. Our focus on cash also resulted in our generating $330 million, $163 million and $415 million in free cash flow in fiscal 2019,
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fiscal 2018 and fiscal 2017, we operated 31 outlet stores throughout the United Statesrespectively (refer to “Share Repurchase Programs” within Liquidity and Canada.Capital Resources below for our free cash flow calculation).
● | Increase Operating Margins. Since fiscal 2016, we have substantially increased the operating margins in our business. While the time period during which we have had to adjust our operations to respond to the COVID-19 crisis will have some negative impact on margins, we believe that our longer term effort to increase operating margins will continue as the business continues to normalize after the effects of COVID-19 moderate. We anticipate continued improvements in operating margins as a result of our focus on a number of our strategic initiatives including (i) the occupancy leverage we expect to gain from our real estate transformation, (ii) product margin expansion as we continue to drive higher full price selling in our core business, and (iii) the continued cost savings of improvements to our operating platform and organizational structure. |
Business Initiatives
We are undertaking a large number of new business initiatives in support of our key value driving strategies. In fiscal 2016, we experienced a slowdown in sales and substantially lower level of profits than in prior periods. We have undertaken initiatives to specifically address the temporal factors affecting our resultsparticular, beginning in fiscal 2016 in addition to the other numerous initiativesand continuing through fiscal 2020, we are undertakinghave pursued a range of strategic efforts to improve our business and financial performance in fiscal 2017 and beyond. If these initiatives are successful, we may return to rates of growth in revenues and improvements in margins and profitability that are more in line with our historical growth patterns prior tooperations including the downturn that we experienced in fiscal 2016. However, there can be no assurance that these efforts will be successful or that we will not encounter other operational difficulties during fiscal 2017 and future time periods that may have a negative impact on growth and profitability. For further information on the temporal factors affecting our results and our initiatives, see Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Key Value Driving Strategies in this Quarterly Report on Form 10-Q and Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting our Results of Operations in our 2016 Form 10-K.following:
Over the past 18 months, we transformed our business from a promotional to a membership model that is enhancing our brand, streamlining our operations, and improving the customer
● | Introduction of Membership Model. In March 2016, we introduced the RH Members Program, an exclusive program that reimagines and simplifies the shopping experience. For an annual fee, the RH Members Program provides a set discount every day across all RH brands, excluding RH Hospitality and Waterworks, in addition to other benefits including complimentary interior design services through the RH Interior Design program and eligibility for preferred financing plans on the RH Credit Card, among other benefits. The RH Members Program allows our customers to shop for what they want, when they want, and receive the greatest value, which has resulted in orders and sales being more evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales we experienced under the prior promotional model. We believe the shift to a membership model has enhanced the customer experience, rendered our brand more valuable, improved operational execution and reduced costs. |
We believe that the transitionshift to a membership model has hadpositively 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.
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favorable impact onImproved 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 financial performance including through a reduction in our return rate, exchange rate and cancel rate resulting in higher conversionsales after the end of demand into revenues. As of October 28, 2017, we had approximately 380,000 members which drove approximately 95% of salesan event. This buying pattern also affected numerous other aspects of our core RH business, including staffing and costs as we required elevated staffing levels to service the increased number of customers during the three months ended October 28, 2017.
Simultaneously we began the redesign ofpeak sales events. Likewise, significant fluctuations in sales had downstream implications for our supply chain network, rationalizingrelated to merchandise orders, manufacturing and production, shipment to our product offerings,distribution centers and transitioning inventory into fewer facilities, creating a more capital efficient model. Asfinal delivery to our customers. All of these aspects of our operations are experiencing improved efficiencies as a result we were ableof the membership model whereby sales are more evenly distributed throughout the year as opposed to forego building a fifth furniture distribution center planned to open in 2017the peaks and we expect to consolidate our current furniture distribution center network from four to two locations byvalleys of orders and sales under the fourth quarterprior model.
● | Luxury In-Home Furniture Delivery Experience. We believe there is an opportunity to improve the customer experience by enhancing our approach to services in connection with in-home delivery. We are in the process of implementing a number of measures that are designed to increase our level of control and improve service levels throughout the delivery experience to the customer’s residence. We believe that we are well positioned to develop improved solutions for in-home delivery to the customer in the luxury market. We have already adopted a number of service improvements that are yielding improvements in the customer |
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experience and reductions in product return and exchange rates. We expect to continue to optimize our service offering to customers in connection with the in-home delivery experience and are confident that our efforts in this regard will continue to achieve substantial results. |
● | Elevate the Customer Experience. We are continuing to pursue the positioning of our business as a luxury brand. As one part of this ongoing initiative, we are focused on improving the end-to-end customer experience. As we have elevated our brand, especially at retail, we are also working to enhance the brand experience in other aspects of our business. We are making changes in many aspects of our business processes that affect our customers, including the in-home delivery experience, improvements in product quality and enhancements in sourcing, product availability, and all aspects of customer care and service. We also believe that the introduction of experiential brand-enhancing products and services, such as expanded design ateliers, the RH Interior Design program and the launch of an integrated hospitality experience in a number of our new Galleries, will further enhance our customers’ in-store experience, allowing us to further disrupt the highly fragmented home furnishings landscape and achieve market share gains. |
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, and simplify our distribution network and improve our organizational design including by streamlining and realigning our home office operations, as well as to expand our product offering, and transform our real estate.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 this year 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. For example,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 are pursuing a large number of new business initiatives, the COVID-19 health crisis has had a short-term impact on some of those efforts to optimize our distribution network could cause us to incur costs and expenses ininitiatives such as the short termtiming of some construction efforts with respect to changesopening new Gallery locations in the wayUnited States and optimizing our inventory in which we operatelight of Outlet inventory build up resulting from our temporary retail closures. We have also experienced immediate operational impacts to our business such as chargesthe temporary closure of our retail locations, our furloughing of employees and the curtailment or cessation of other activities such as construction of new Galleries. In addition, we face conditions of overall economic uncertainty in terms of the longer term impact of COVID-19 on consumer spending and related effects that could affect our business.
While we believe that the tariffs imposed to date on most of our goods sourced from China have not hadan 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 closurethe 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 distribution centers.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 of the Company may create additional uncertainty with respect to our consolidated net revenues and profit in the near term.
Acquisition of Waterworks
On May 27, 2016, we acquired a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name “Waterworks,” for consideration consisting of approximately $119.9 million, consisting of $118.4 million funded with available cash and $1.5 million representing the fair value of rollover units, which amount is subject to adjustment for changes in working capital and other items. After the transaction, and giving effect to equity interests acquired by management in the business, we own in excess of 90% of the total equity interests in Waterworks.
Waterworks has long been the definition of the well-appointed bath, and is the only complete bath and kitchen business offering fittings, fixtures, furniture, furnishings, accessories, lighting, hardware and surfaces under one brand in the market. Waterworks is composed of the Waterworks, Waterworks Kitchen and Waterworks Studio brands, all built on a foundation of impeccable style, design integrity, quality and craftsmanship. Waterworks prides itself on its deep relationships in the design community and the technical expertise and tenure of its people.
Waterworks products are sold through its 15 showrooms in the United States and in the U.K., as well as through its boutique retail partners, hospitality division and online.
Key Value Driving Strategies
In order to drive growth across our business, we are focused on the following long-term key strategies:
Transform Our Real Estate Platform. We believe we have an opportunity to significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of next generation Design Galleries that are sized to the potential of each market and the size of our assortment. New next generation Design Gallery sites are identified based on a variety of factors, including timing of legacy Gallery lease expiration, availability of suitable new site locations, the negotiation of favorable economic terms to the Company for the new location, as well as satisfactory and timely completion of real estate development including procurement of permits and completion of construction. The number of next generation 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. We opened RH Toronto in October 2017 and RH West Palm in November 2017, both with integrated food and beverage offerings, and expect to open at least three Design Galleries in fiscal 2018.
Expand Our Offering and Increase Our Market Share. We believe we have a significant opportunity to increase our market share by:37
growing our merchandise assortment;Table of Contents
introducing new products and categories, including our introduction of RH Modern, RH TEEN and the addition of the Waterworks business;
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exploring and testing new business opportunities complementary to our core business; and
increasing our brand awareness and customer loyalty through our Source Book circulation strategy, our digital marketing initiatives and our advertising and public relations activities and events.
Increase Operating Margins. We have the opportunity to continue to improve our operating margins by leveraging our fixed occupancy, advertising and corporate general and administrative costs, as well as leveraging our scalable infrastructure. Key areas in which we believe we will increase operating margins include:
Occupancy leverage;
Advertising cost leverage;
Improved product margin and shipping efficiencies; and
Other selling, general and administrative expenses.
Optimize the Allocation of Capital in the Business. We believe that our operations and current initiatives present a significant opportunity to optimize the allocation of capital in our business, including generating free cash flow and optimizing cash on our balance sheet as well as deploying capital to repurchase shares of our common stock which we believe creates a long term benefit to our shareholders. We have also incurred additional debt to fund a portion of our share repurchase programs and we believe that was a good capital allocation given favorable interest rates on debt and the ability of our business to generate cash in light of current business initiatives in order to paydown and service such debt. During fiscal 2017, one of our initiatives has been to generate additional cash flow through the optimization of inventory and other efforts to make our business more efficient in its use of capital to support operations. Our current efforts to generate more cash flow in our business include rationalizing our SKU count and reducing overall levels of inventory, which involves selling slower moving, discontinued and other inventory through markdowns and through our outlet channel. We have also undertaken initiatives to optimize our distribution network and make significant improvements in the way that we handle merchandise in the distribution and delivery part of our business. We expect that these improvements will result in operational efficiencies in the handling and transportation of merchandise and will enable us to achieve greater efficiency and lower requirements for carrying inventory to meet customer demand. We plan to lower our new Gallery opening cadence to three to five Galleries per year, which we believe will result in improved deal economics, lower build out costs and higher returns and will lower our capital requirements and execution risk over the course of our real estate transformation. We also believe the slower opening cadence will put less pressure on our infrastructure, enabling greater capital discipline throughout the organization. In addition, we have a number of assets that can be sold to third parties in order to generate cash. We expect to transition from a lease to a development model and may enter into sale leaseback transactions with respect to certain real estate that we own, for example, and may enter into capital or operating leases in lieu of purchasing or holding certain assets that are used in our business. We intend to continue to seek out and evaluate opportunities for effectively managing and deploying capital in ways that support and enhance our business initiatives and strategies.
Pursue International Expansion. We plan to strategically expand our business into select countries outside of the United States, Canada and the U.K. in the future. We believe that our luxury brand positioning and unique aesthetic will have strong international appeal.
In fiscal 2016, we made several strategic investments and changes to our business model in order to strengthen our brand and position the business for growth in the future. Our fiscal 2016 results also reflected the effect of temporal issues that we faced, including the costs related to the launch of RH Modern; the timing of recognizing Membership revenues related to the transition from
29
a promotional to a membership model; efforts to reduce inventories and rationalize our SKU count; and the decision to move our 2016 Source Book mailing from the spring to the fall.
In fiscal 2017, we have continued our efforts to optimize inventory and rationalize our SKU count. In the nine months ended October 28 2017, net revenues increased 14%, of which 3 points of growth was related to higher outlet and warehouse sales stemming from our accelerated inventory optimization efforts. While our higher outlet revenues and inventory optimization efforts had a positive impact on revenues and working capital in the first nine months of the year, they had a negative impact on margins and earnings.
Additionally, in fiscal 2017, we expect incremental revenues from the four new Design Galleries opened in 2016, our new Design Gallery in Toronto which opened in October 2017, and the Design Gallery in West Palm Beach which opened in November 2017. The majority of our new Design Galleries under development include a dedicated floor for RH Modern as well as an RH Hospitality offering including restaurants, wine vaults, and pantries, similar to our successful hospitality offering at RH Chicago, The Gallery at the Three Arts Club.
Basis of Presentation and Results of Operations
Matters Affecting Comparability
The disruption to our business operations from the initial wave of the COVID-19 outbreak has had a significant impact on the comparability of certain ratios and year-over-year trends for our operating results for the three months ended May 2, 2020 as compared to the three months ended May 4, 2019. In addition to lost revenues due to our retail locations being closed for approximately one-half of the first fiscal quarter of 2020, we continued to pay wages and provide benefits to our associates for all, or a portion of, this time period. We also incurred expenses due to additional merchandise inventory write-downs, fulfillment of certain vendor commitments and a reorganization undertaken in response to the impact of retail closures on our business.
Results of Operations
The following table sets forth our condensed consolidated statements of operations and other financial and operating data.
| | | | | |
| | | | | |
| Three Months Ended | ||||
| May 2, | | May 4, | ||
| 2020 |
| 2019 | ||
| | | | | |
Condensed Consolidated Statements of Operations: | | | | | |
Net revenues | $ | 482,895 | | $ | 598,421 |
Cost of goods sold |
| 283,241 | |
| 365,607 |
Gross profit |
| 199,654 | |
| 232,814 |
Selling, general and administrative expenses |
| 164,201 | |
| 164,181 |
Income from operations |
| 35,453 | |
| 68,633 |
Other expenses | | | | | |
Interest expense—net |
| 19,629 | |
| 21,118 |
Tradename impairment | | 20,459 | | | — |
Total other expenses |
| 40,088 | |
| 21,118 |
Income (loss) before income taxes |
| (4,635) | |
| 47,515 |
Income tax expense (benefit) |
| (1,423) | |
| 11,793 |
Net income (loss) | $ | (3,212) | | $ | 35,722 |
Other Financial and Operating Data: |
|
| |
|
|
Adjusted net income (1) | $ | 29,949 | | $ | 48,241 |
Adjusted EBITDA (2) | $ | 77,427 | | $ | 100,385 |
| | | | | |
Capital expenditures | $ | 16,632 | | $ | 7,916 |
Landlord assets under construction—net of tenant allowances | | 7,600 | | | 4,542 |
Adjusted net capital expenditures (3) | $ | 24,232 | | $ | 12,458 |
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
|
| (dollars in thousands) |
| |||||||||||||
Condensed Consolidated Statements of Operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues |
| $ | 592,473 |
|
| $ | 549,328 |
|
| $ | 1,769,879 |
|
| $ | 1,548,165 |
|
Cost of goods sold |
|
| 378,148 |
|
|
| 373,509 |
|
|
| 1,179,485 |
|
|
| 1,065,032 |
|
Gross profit |
|
| 214,325 |
|
|
| 175,819 |
|
|
| 590,394 |
|
|
| 483,133 |
|
Selling, general and administrative expenses |
|
| 171,163 |
|
|
| 160,433 |
|
|
| 528,213 |
|
|
| 457,207 |
|
Income from operations |
|
| 43,162 |
|
|
| 15,386 |
|
|
| 62,181 |
|
|
| 25,926 |
|
Other expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense—net |
|
| 18,915 |
|
|
| 11,091 |
|
|
| 45,496 |
|
|
| 32,528 |
|
Loss on extinguishment of debt |
|
| 4,880 |
|
|
| — |
|
|
| 4,880 |
|
|
| — |
|
Total other expenses |
|
| 23,795 |
|
|
| 11,091 |
|
|
| 50,376 |
|
|
| 32,528 |
|
Income (loss) before income taxes |
|
| 19,367 |
|
|
| 4,295 |
|
|
| 11,805 |
|
|
| (6,602 | ) |
Income tax expense (benefit) |
|
| 6,216 |
|
|
| 1,778 |
|
|
| 9,886 |
|
|
| (2,567 | ) |
Net income (loss) |
| $ | 13,151 |
|
| $ | 2,517 |
|
| $ | 1,919 |
|
| $ | (4,035 | ) |
Other Financial and Operating Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stores (1) |
| $ | 343,222 |
|
| $ | 306,800 |
|
| $ | 1,010,120 |
|
| $ | 872,662 |
|
Direct |
| $ | 249,251 |
|
| $ | 242,528 |
|
| $ | 759,759 |
|
| $ | 675,503 |
|
Direct as a percentage of net revenues (2) |
|
| 42 | % |
|
| 44 | % |
|
| 43 | % |
|
| 44 | % |
Growth in net revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stores (1) |
|
| 12 | % |
|
| 9 | % |
|
| 16 | % |
|
| 14 | % |
Direct |
|
| 3 | % |
|
| -3 | % |
|
| 12 | % |
|
| -3 | % |
Total |
|
| 8 | % |
|
| 3 | % |
|
| 14 | % |
|
| 6 | % |
Comparable brand revenue growth (3) |
|
| 6 | % |
|
| -6 | % |
|
| 7 | % |
|
| -2 | % |
Adjusted net income (4) |
| $ | 24,424 |
|
| $ | 8,019 |
|
| $ | 45,919 |
|
| $ | 23,861 |
|
Capital: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
| $ | 37,427 |
|
| $ | 58,876 |
|
| $ | 76,789 |
|
| $ | 104,152 |
|
Construction related deposits (5) |
|
| 7,487 |
|
|
| 168 |
|
|
| 12,772 |
|
|
| 3,829 |
|
Total capital |
| $ | 44,914 |
|
| $ | 59,044 |
|
| $ | 89,561 |
|
| $ | 107,981 |
|
(1) |
|
|
|
30
| Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, |
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
|
| (in thousands) |
| |||||||||||||
Net income (loss) |
| $ | 13,151 |
|
| $ | 2,517 |
|
| $ | 1,919 |
|
| $ | (4,035 | ) |
Adjustments pre-tax: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive non-cash compensation (a) |
|
| — |
|
|
| — |
|
|
| 23,872 |
|
|
| — |
|
Amortization of debt discount (b) |
|
| 6,879 |
|
|
| 6,629 |
|
|
| 20,384 |
|
|
| 19,550 |
|
Recall accrual (c) |
|
| 3,552 |
|
|
| — |
|
|
| 8,285 |
|
|
| — |
|
Loss on extinguishment of debt (d) |
|
| 4,880 |
|
|
| — |
|
|
| 4,880 |
|
|
| — |
|
Distribution center closure (e) |
|
| 1,862 |
|
|
| — |
|
|
| 1,862 |
|
|
| — |
|
Gain on sale of building and land (f) |
|
| (819 | ) |
|
| — |
|
|
| (2,119 | ) |
|
| — |
|
Legal claim (g) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 8,701 |
|
Reorganization related costs (h) |
|
| — |
|
|
| 974 |
|
|
| — |
|
|
| 5,698 |
|
Waterworks acquisition related: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash compensation (i) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 3,672 |
|
Impact of inventory step-up (j) |
|
| 248 |
|
|
| 1,786 |
|
|
| 2,108 |
|
|
| 5,187 |
|
Acquisition related costs (k) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 2,847 |
|
Subtotal adjusted items |
|
| 16,602 |
|
|
| 9,389 |
|
|
| 59,272 |
|
|
| 45,655 |
|
Impact of income tax items (l) |
|
| (5,329 | ) |
|
| (3,887 | ) |
|
| (15,272 | ) |
|
| (17,759 | ) |
Adjusted net income |
| $ | 24,424 |
|
| $ | 8,019 |
|
| $ | 45,919 |
|
| $ | 23,861 |
|
38
| | | | | |
| Three Months Ended | ||||
| May 2, | | May 4, | ||
| 2020 |
| 2019 | ||
| | | | | |
Net income (loss) | $ | (3,212) | | $ | 35,722 |
Adjustments pre-tax: |
|
| |
|
|
Tradename impairment (a) | | 20,459 | | | — |
Amortization of debt discount (b) |
| 11,125 | |
| 11,689 |
Asset impairments and change in useful lives (c) | | 8,471 | | | 3,476 |
Reorganization related costs (d) |
| 4,143 | |
| — |
Recall accrual (e) |
| — | |
| (1,615) |
Subtotal adjusted items |
| 44,198 | |
| 13,550 |
Impact of income tax items (f) |
| (11,037) | |
| (1,031) |
Adjusted net income | $ | 29,949 | | $ | 48,241 |
| (a) | Represents |
| (b) | Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were issued in June 2014 (the “2019 Notes”) |
(c) | The adjustment in the |
| (d) | Represents severance costs and related payroll taxes associated with a reorganization undertaken in response to the impact of retail closures on our business. |
(e) | Represents adjustments to net revenues, cost of goods sold and inventory charges associated with |
| | |
Decrease to net revenues | $ | 413 |
Decrease to cost of goods sold |
| (2,061) |
Increase to gross profit |
| (1,648) |
Increase to selling, general and administrative expenses |
| 33 |
Increase to income before income taxes | $ | (1,615) |
39
| Three Months Ended |
|
| Nine Months Ended |
| |||
|
| October 28, |
|
| October 28, |
| ||
|
| 2017 |
|
| 2017 |
| ||
|
| (in thousands) |
| |||||
Reduction of net revenues |
| $ | — |
|
| $ | 3,813 |
|
Incremental cost of goods sold and inventory charges |
|
| 3,552 |
|
|
| 4,315 |
|
Impact on gross profit |
|
| 3,552 |
|
|
| 8,128 |
|
Incremental selling, general and administrative expenses |
|
| — |
|
|
| 157 |
|
Impact on income (loss) before income taxes |
| $ | 3,552 |
|
| $ | 8,285 |
|
|
|
|
|
(f) |
|
|
|
|
|
|
|
|
|
|
|
| The adjustment for the three months ended |
(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 (loss) before depreciation and amortization, interest expense—net and income tax expense (benefit). Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the |
| | | | | |
| Three Months Ended | ||||
| May 2, | | May 4, | ||
| 2020 |
| 2019 | ||
| | | | | |
Net income (loss) | $ | (3,212) | | $ | 35,722 |
Depreciation and amortization |
| 24,870 | |
| 27,189 |
Interest expense—net |
| 19,629 | |
| 21,118 |
Income tax expense (benefit) |
| (1,423) | |
| 11,793 |
EBITDA |
| 39,864 | |
| 95,822 |
Tradename impairment (a) | | 20,459 | | | — |
Asset impairments (a) |
| 7,133 | |
| 483 |
Non-cash compensation (b) |
| 5,828 | |
| 5,695 |
Reorganization related costs (a) | | 4,143 | | | — |
Recall accrual (a) |
| — | |
| (1,615) |
Adjusted EBITDA | $ | 77,427 | | $ | 100,385 |
|
| Refer to the reconciliation of net income (loss) to adjusted net income table above and the related |
(b) | Represents non-cash compensation related to equity awards granted to employees. |
(3) | We define adjusted net capital expenditures as (i) capital expenditures from investing activities and (ii) cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received. |
3240
The following tables present retailRH Gallery metrics, which have been calculated based upon retail stores, which includes our RH Baby & Child, RH Modern Galleries and Waterworks Showrooms,showroom metrics and excludes outlet stores.exclude outlets:
| | | | | | | | | | |
| | Three Months Ended | ||||||||
| | May 2, | | May 4, | ||||||
| | 2020 | | 2019 | ||||||
|
| |
| Total Leased |
| |
| Total Leased | ||
| | | | Selling Square | | | | Selling Square | ||
| | Count | | Footage (1) | | Count | | Footage (1) | ||
| | | | | (in thousands) | | | | | (in thousands) |
Beginning of period |
| 83 |
| | 1,111 |
| 86 |
| | 1,089 |
Modern Galleries: | | | | | | | | | | |
Dallas RH Modern Gallery (relocation) | | — | | | — | | — | | | (4.5) |
Baby & Child Galleries: | | | | | | | | | | |
Dallas RH Baby & Child Gallery | | — | | | — | | (1) | | | (3.7) |
Legacy Galleries: | | | | | | | | | | |
Raleigh legacy Gallery | | 1 | | | 4.4 | | — | | | — |
Dallas legacy Gallery (relocation) | | — | | | — | | — | | | (2.6) |
End of period |
| 84 |
| | 1,115 |
| 85 |
| | 1,078 |
| | | | | | | | | | |
Total leased square footage at end of period (2) | | | | | 1,502 | | | | | 1,454 |
Weighted-average leased square footage (3) |
| | |
| 1,501 | |
| |
| 1,461 |
Weighted-average leased selling square footage (3) |
| | | | 1,114 | |
| | | 1,084 |
|
| Nine Months Ended |
| |||||||||||||
|
| October 28, |
|
| October 29, |
| ||||||||||
|
| 2017 |
|
| 2016 |
| ||||||||||
|
| Store Count |
|
| Total Leased Selling Square Footage (1) |
|
| Store Count |
|
| Total Leased Selling Square Footage (1) |
| ||||
|
|
|
|
|
| (in thousands) |
|
|
|
|
|
| (in thousands) |
| ||
Beginning of period |
|
| 85 |
|
|
| 912 |
|
|
| 69 |
|
|
| 725 |
|
Waterworks Showrooms acquired |
| — |
|
| — |
|
|
| 15 |
|
|
| 51.0 |
| ||
Retail Galleries opened: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waterworks Boston Showroom |
|
| 1 |
|
|
| 5.0 |
|
| — |
|
| — |
| ||
Yorkdale next generation Design Gallery |
|
| 1 |
|
|
| 43.3 |
|
| — |
|
| — |
| ||
Leawood next generation Design Gallery |
| — |
|
| — |
|
|
| 1 |
|
|
| 33.5 |
| ||
Waterworks San Francisco Showroom |
| — |
|
| — |
|
|
| 1 |
|
|
| 5.8 |
| ||
Austin next generation Design Gallery |
| — |
|
| — |
|
|
| 1 |
|
|
| 39.6 |
| ||
Las Vegas next generation Design Gallery |
| — |
|
| — |
|
|
| 1 |
|
|
| 47.6 |
| ||
Retail Galleries closed: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waterworks Boston Showroom |
|
| (1 | ) |
|
| (2.1 | ) |
| — |
|
| — |
| ||
Toronto (Bayview) Legacy Gallery |
|
| (1 | ) |
|
| (6.0 | ) |
| — |
|
| — |
| ||
Toronto (Yonge Street) Legacy Gallery |
|
| (1 | ) |
|
| (8.6 | ) |
| — |
|
| — |
| ||
Kansas City Legacy Gallery |
| — |
|
| — |
|
|
| (1 | ) |
|
| (9.9 | ) | ||
Waterworks - Kansas Street, SF |
| — |
|
| — |
|
|
| (1 | ) |
|
| (2.0 | ) | ||
Austin Legacy Gallery |
| — |
|
| — |
|
|
| (1 | ) |
|
| (6.2 | ) | ||
End of period |
|
| 84 |
|
|
| 944 |
|
|
| 85 |
|
|
| 884 |
|
| Leased selling square footage is retail space at our |
|
| Three Months Ended |
|
| Nine Months Ended |
| ||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| ||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
|
| (in thousands) |
| |||||||||||||
Total leased square footage at end of period (1) |
|
| 1,276 |
|
|
| 1,208 |
|
|
| 1,276 |
|
|
| 1,208 |
|
Weighted-average leased square footage (2) |
|
| 1,250 |
|
|
| 1,146 |
|
|
| 1,245 |
|
|
| 1,066 |
|
Weighted-average leased selling square footage (2) |
|
| 918 |
|
|
| 816 |
|
|
| 914 |
|
|
| 767 |
|
Retail sales per leased selling square foot (in dollars) (3) |
| $ | 329 |
|
| $ | 330 |
|
| $ | 941 |
|
| $ | 1,004 |
|
| Total leased square footage includes approximately 48,700 and 16,100 square feet as of |
| Weighted-average leased square footage and leased selling square footage |
|
|
33
The following table sets forth our condensed consolidated statements of operations as a percentage of total net revenues.
|
| Three Months Ended |
|
| Nine Months Ended |
| |||||||||||||||
|
| October 28, |
|
| October 29, |
|
| October 28, |
|
| October 29, |
| |||||||||
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| |||||||||
| | | | | | ||||||||||||||||
| | Three Months Ended |
| ||||||||||||||||||
| | May 2, | | May 4, |
| ||||||||||||||||
|
| 2020 |
| 2019 |
| ||||||||||||||||
Condensed Consolidated Statements of Operations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| | | | | |
Net revenues |
|
| 100.0 | % |
|
| 100.0 | % |
|
| 100.0 | % |
|
| 100.0 | % | | 100.0 | % | 100.0 | % |
Cost of goods sold |
|
| 63.8 |
|
|
| 68.0 |
|
|
| 66.6 |
|
|
| 68.8 |
| | 58.7 |
| 61.1 | |
Gross profit |
|
| 36.2 |
|
|
| 32.0 |
|
|
| 33.4 |
|
|
| 31.2 |
| | 41.3 |
| 38.9 | |
Selling, general and administrative expenses |
|
| 28.9 |
|
|
| 29.2 |
|
|
| 29.9 |
|
|
| 29.5 |
| | 34.0 |
| 27.4 | |
Income from operations |
|
| 7.3 |
|
|
| 2.8 |
|
|
| 3.5 |
|
|
| 1.7 |
| | 7.3 |
| 11.5 | |
Other expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| | | | | |
Interest expense—net |
|
| 3.2 |
|
|
| 2.0 |
|
|
| 2.5 |
|
|
| 2.1 |
| | 4.1 |
| 3.6 | |
Loss on extinguishment of debt |
|
| 0.8 |
|
|
| — |
|
|
| 0.3 |
|
|
| — |
| |||||
Tradename impairment | | 4.2 |
| — | | ||||||||||||||||
Total other expenses |
|
| 4.0 |
|
|
| 2.0 |
|
|
| 2.8 |
|
|
| 2.1 |
| | 8.3 |
| 3.6 | |
Income (loss) before income taxes |
|
| 3.3 |
|
|
| 0.8 |
|
|
| 0.7 |
|
|
| (0.4 | ) | | (1.0) |
| 7.9 | |
Income tax expense (benefit) |
|
| 1.1 |
|
|
| 0.3 |
|
|
| 0.6 |
|
|
| (0.1 | ) | | (0.3) |
| 1.9 | |
Net income (loss) |
|
| 2.2 | % |
|
| 0.5 | % |
|
| 0.1 | % |
|
| (0.3 | %) | | (0.7) | % | 6.0 | % |
41
Three Months Ended October 28, 2017May 2, 2020 Compared to Three Months Ended October 29, 2016May 4, 2019
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | May 2, | | May 4, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 454,957 | | $ | 27,938 | | $ | 482,895 | | $ | 563,706 | | $ | 34,715 | | $ | 598,421 |
Cost of goods sold | |
| 267,195 | |
| 16,046 | |
| 283,241 | |
| 345,763 | |
| 19,844 | |
| 365,607 |
Gross profit | |
| 187,762 | |
| 11,892 | |
| 199,654 | |
| 217,943 | |
| 14,871 | |
| 232,814 |
Selling, general and administrative expenses | |
| 149,276 | |
| 14,925 | |
| 164,201 | |
| 150,404 | |
| 13,777 | |
| 164,181 |
Income (loss) from operations | | $ | 38,486 | | $ | (3,033) | | $ | 35,453 | | $ | 67,539 | | $ | 1,094 | | $ | 68,633 |
|
| Three Months Ended |
| |||||||||||||||||||||
|
| October 28, |
|
| October 29, |
| ||||||||||||||||||
|
| 2017 |
|
| 2016 |
| ||||||||||||||||||
|
| RH Segment |
|
| Waterworks (1) |
|
| Total |
|
| RH Segment |
|
| Waterworks (1) |
|
| Total |
| ||||||
|
| (in thousands) |
| |||||||||||||||||||||
Net revenues |
| $ | 563,174 |
|
| $ | 29,299 |
|
| $ | 592,473 |
|
| $ | 521,027 |
|
| $ | 28,301 |
|
| $ | 549,328 |
|
Cost of goods sold |
|
| 359,953 |
|
|
| 18,195 |
|
|
| 378,148 |
|
|
| 354,903 |
|
|
| 18,606 |
|
|
| 373,509 |
|
Gross profit |
|
| 203,221 |
|
|
| 11,104 |
|
|
| 214,325 |
|
|
| 166,124 |
|
|
| 9,695 |
|
|
| 175,819 |
|
Selling, general and administrative expenses |
|
| 159,092 |
|
|
| 12,071 |
|
|
| 171,163 |
|
|
| 148,438 |
|
|
| 11,995 |
|
|
| 160,433 |
|
Income (loss) from operations |
| $ | 44,129 |
|
| $ | (967 | ) |
| $ | 43,162 |
|
| $ | 17,686 |
|
| $ | (2,300 | ) |
| $ | 15,386 |
|
|
|
Net revenues
Consolidated net revenues increased $43.1decreased $115.5 million, or 7.9%19.3%, to $592.5$482.9 million in the three months ended October 28, 2017May 2, 2020 compared to $549.3$598.4 million in the three months ended October 29, 2016. Stores net revenues increased $36.4 million, or 11.9%, to $343.2 million in the three months ended October 28, 2017 compared to $306.8 million in the three months ended October 29, 2016. Direct net revenues increased $6.7 million, or 2.8%, to $249.3 million in the three months ended October 28, 2017 compared to $242.5 million in the three months ended October 29, 2016. Comparable brand revenue was 6% for the three months ended October 28, 2017.May 4, 2019.
RH Segment net revenues
RH Segment net revenues increased $42.1decreased $108.7 million, or 8.1%19.3%, to $563.2$455.0 million in the three months ended October 28, 2017May 2, 2020 compared to $521.0$563.7 million in the three months ended October 29, 2016.
A number ofMay 4, 2019. The below discussion highlights several significant factors contributed to the increasethat resulted in increased RH Segment net revenues, duringwhich are listed in order of magnitude.
RH Segment net revenues declined primarily due to the temporary closure of our retail locations in response to the COVID-19 health crisis for approximately half of the three months ended October 28, 2017, including, in order of magnitude,May 2, 2020 and, to a lesser extent, the introduction of new product categoriesnegative impact to net revenues generated from our direct business due to macroeconomic conditions resulting from the COVID-19 health crisis. During such retail closure period, our Gallery representatives and designers continued to serve our customers virtually and our customers continued to be able to place orders via our online websites. In our immediate response to COVID-19, we aggressively scaled back some inventory orders while we assessed the expansion of existing product categories, the performancestatus of our new Design Galleries and an increasebusiness. As our business has strengthened during the second 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.
While our retail weighted-average leased selling square footage, as well as an increase inlocations were substantially closed at the end of the first fiscal quarter on May 2, 2020, since that date we have been able to reopen a large number of our stores based on local market circumstances including the gradual lifting of restrictions on business operations, including shelter-in-place rules.
RH Segment net revenues from our Contract business which represents sales to commercial customers.
Outlet sales, which include sales via warehouse locations, increased $5.1 million infor the three months ended October 28, 2017 comparedMay 4, 2019 were negatively impacted by $0.4 million related to product recalls. Product recalls and the three months ended October 29, 2016. We also had an increase in Membership revenue recognizedestablishment or adjustment of $4.6 million.
34
The above increases were partially offset by an approximate 1% negative impactany related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of Hurricanes Harveyour results. No assurance can be provided that any accruals will be for the appropriate amount, and Irma primarily dueactual losses could be higher or lower than what we accrue from time to store closures and lost sales.time, which could further affect results.
Waterworks net revenues
Waterworks net revenues increased $1.0decreased $6.8 million, or 3.5%19.5%, to $29.3$27.9 million in the three months ended October 28, 2017May 2, 2020 compared to $28.3$34.7 million in the three months ended October 29, 2016. Waterworks net revenues represented 4.9% and 5.2% of our net revenues forMay 4, 2019 primarily due to construction delays, as well as temporary showroom closures, in response to the three months ended October 28, 2017 and October 29, 2016, respectively.COVID-19 health crisis.
Gross profit
Consolidated gross profit increased $38.5decreased $33.2 million, or 21.9%14.2%, to $214.3$199.7 million in the three months ended October 28, 2017 from $175.8May 2, 2020 compared to $232.8 million in the three months ended October 29, 2016.May 4, 2019. As a percentage of net revenues, consolidated gross margin increased 4.2%2.4% to 36.2%41.3% of net revenues in the three months ended October 28, 2017May 2, 2020 from 32.0%38.9% of net revenues in the three months ended October 29, 2016.May 4, 2019.
42
RH Segment gross profit for the three months ended May 2, 2020 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 three months ended October 28, 2017May 4, 2019 was negatively impacted by $3.6$3.0 million related to inventory charges associated with product recalls and $0.5 million relatedthe acceleration of depreciation due to costs associated with anticipated distribution center closures. Waterworksa change in the estimated useful lives of certain assets. RH Segment gross profit for the three months ended October 28, 2017 and October 29, 2016May 4, 2019 was negativelypositively impacted by $0.2$1.6 million and $1.8 million, respectively, of amortization related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the inventory fair value adjustment recorded in connectionreduction of revenues and incremental costs associated with the acquisition.such product recalls.
Excluding the inventory reserves, accelerated asset depreciation and product recall costs, costs associated with anticipated distribution center closures and the impact of the amortization related to the inventory fair value adjustmentadjustments mentioned above, consolidated gross margin would have increased 4.6%2.7% to 36.9%41.8% of net revenues in the three months ended October 28, 2017May 2, 2020 from 32.3%39.1% of net revenues in the three months ended October 29, 2016.May 4, 2019.
RH Segment gross profit
RH Segment gross profit increased $37.1decreased $30.2 million, or 22.3%13.8%, to $203.2$187.8 million in the three months ended October 28, 2017May 2, 2020 from $166.1$217.9 million in the three months ended October 29, 2016.May 4, 2019. As a percentage of net revenues, RH Segment gross margin increased 4.2%2.6% to 36.1%41.3% of net revenues in the three months ended October 28, 2017May 2, 2020 from 31.9%38.7% of net revenues in the three months ended October 29, 2016.May 4, 2019.
Excluding the inventory reserves, accelerated asset depreciation and product recalls and costs associated with anticipated distribution center closuresrecall adjustments mentioned above, RH Segment gross margin would have increased 4.9%2.9% to 36.8%41.8% of net revenues in the three months ended October 28, 2017May 2, 2020 from 31.9%38.9% of net revenues in the three months ended October 29, 2016.May 4, 2019. The increase was primarily driven by a decrease in orderrevenues generated by our Outlet business as a result of magnitude,store closures, as well as lower Outlet promotional activity during the period of operations. In addition, the increase was due to improvements in our core merchandise margins as our SKU rationalization efforts had a reduced impact on our margins this year compared to last year, partially offsetalso driven by higher outletproduct margins in select product categories as well as price increases.
While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, since that date we have gradually reopened certain of our stores as restrictions on business operations, including shelter-in-place rules, have been revised and warehouse sales driven by increased promotions and higher discounts. Additionally, gross margin increased due to improvementeased in shipping costs asvarious locations in which we have a percentage of net revenues.physical retail presence.
Waterworks gross profit
Waterworks gross profit increased $1.4decreased $3.0 million, or 14.5%20.0%, to $11.1$11.9 million in the three months ended October 28, 2017May 2, 2020 from $9.7$14.9 million in the three months ended October 29, 2016.May 4, 2019. As a percentage of net revenues, Waterworks gross margin increased 3.6%decreased 0.2% to 37.9%42.6% of net revenues in the three months ended October 28, 2017May 2, 2020 from 34.3%42.8% of net revenues in the three months ended October 29, 2016.
Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have decreased 1.9% to 38.7% of net revenues in the three months ended October 28, 2017 from 40.6% of net revenues in the three months ended October 29, 2016. The decrease in gross margin is primarily due to changes in product mix and deleverage in occupancy costs.May 4, 2019.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $10.7remained consistent at $164.2 million or 6.7%, to $171.2 million in both the three months ended October 28, 2017 compared to $160.4 million in the three months ended October 29, 2016.
35
RH Segment selling, generalMay 2, 2020 and administrative expenses
RH Segment selling, general and administrative expenses increased $10.7 million, or 7.2%, to $159.1 million in the three months ended October 28, 2017 compared $148.4 million in the three months ended October 29, 2016.
RH Segment selling, general and administrative expenses for the three months ended October 28, 2017 included $1.4 million related to costs associated with anticipated distribution center closures and a gain of $0.8 million related to the sale of building and land. RH Segment selling, general and administrative expenses for the three months ended October 29, 2016 included $1.0 million associated with a reorganization, including severance and related taxes.
Advertising and marketing costs increased $9.8 million during the three months ended October 28, 2017 as compared to October 29, 2016, primarily due to the timing of our Source Book mailings. In the third quarter of fiscal 2017 we amortized costs related to our 2016 Interiors Source Book which was circulated in the fall of 2016. The 2016 Interiors Source Book mailing was complete in mid-December and therefore resulted in amortized costs in the third quarter of fiscal 2017, whereas the third quarter of fiscal 2016 did not incur similarly timed expenses.
RH Segment selling, general and administrative expenses were 28.2% and 28.3% of net revenues for the three months ended October 28, 2017 and October 29, 2016, respectively, excluding the costs associated with anticipated distribution center closures, the gain related to the sale of building and land and the reorganization costs mentioned above. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by leverage in employment and employment related costs and, to a lesser extent, leverage in our corporate occupancy costs, partially offset by an increase in advertising and marketing costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased $0.1 million, or 0.6%, to $12.1 million in the three months ended October 28, 2017 compared to $12.0 million in the three months ended October 29, 2016.
Interest expense—net
Interest expense increased $7.8 million to $18.9 million for the three months ended October 28, 2017 compared to $11.1 million for the three months ended October 29, 2016. Interest expense consisted of the following:
|
| Three Months Ended |
| |||||
|
| October 28, |
|
| October 29, |
| ||
|
| 2017 |
|
| 2016 |
| ||
|
| (in thousands) |
| |||||
Amortization of convertible senior notes debt discount |
| $ | 7,667 |
|
| $ | 7,254 |
|
Build-to-suit lease transactions |
|
| 4,133 |
|
|
| 3,083 |
|
Term loans |
|
| 2,721 |
|
|
| — |
|
Asset based credit facility |
|
| 2,622 |
|
|
| 584 |
|
Amortization of debt issuance costs and deferred financing fees |
|
| 1,996 |
|
|
| 634 |
|
Other interest expense |
|
| 772 |
|
|
| 833 |
|
Capitalized interest for capital projects |
|
| (966 | ) |
|
| (625 | ) |
Interest income |
|
| (30 | ) |
|
| (672 | ) |
Total interest expense—net |
| $ | 18,915 |
|
| $ | 11,091 |
|
Loss on extinguishment of debt
We incurred a $4.9 million loss on extinguishment of debt in the three months ended October 28, 2017 due to the repayment in full of the second lien term loan on October 10, 2017, which includes a prepayment penalty of $3.0 million and acceleration of amortization of debt issuance costs of $1.9 million.
Income tax expense
Income tax expense was $6.2 million and $1.8 million in the three months ended October 28, 2017 and October 29, 2016, respectively. Our effective tax rate was 32.1% and 41.4% for the three months ended October 28, 2017 and October 29, 2016, respectively. The effective tax rate in the three months ended October 28, 2017 was impacted by net excess tax benefits from stock-based compensation of $1.9 million resulting from the Company’s adoption of ASU 2016-09 in the first quarter of fiscal 2017.
36
Nine Months Ended October 28, 2017 Compared to Nine Months Ended October 29, 2016
Prior to the Waterworks acquisition on May 27, 2016, we had one reportable segment. As we acquired the Waterworks business on May 27, 2016, reportable segment information presented below for Waterworks includes results for twenty-two weeks during the nine months ended October 29, 2016 and includes results for thirty-nine weeks during the nine months ended October 28, 2017. The RH Segment includes results for thirty-nine weeks during both the nine months ended October 28, 2017 and October 29, 2016.
|
| Nine Months Ended |
| |||||||||||||||||||||
|
| October 28, |
|
| October 29, |
| ||||||||||||||||||
|
| 2017 |
|
| 2016 |
| ||||||||||||||||||
|
| RH Segment |
|
| Waterworks (1) |
|
| Total |
|
| RH Segment |
|
| Waterworks (1) |
|
| Total |
| ||||||
|
| (in thousands) |
| |||||||||||||||||||||
Net revenues |
| $ | 1,680,495 |
|
| $ | 89,384 |
|
| $ | 1,769,879 |
|
| $ | 1,499,101 |
|
| $ | 49,064 |
|
| $ | 1,548,165 |
|
Cost of goods sold |
|
| 1,124,651 |
|
|
| 54,834 |
|
|
| 1,179,485 |
|
|
| 1,031,699 |
|
|
| 33,333 |
|
|
| 1,065,032 |
|
Gross profit |
|
| 555,844 |
|
|
| 34,550 |
|
|
| 590,394 |
|
|
| 467,402 |
|
|
| 15,731 |
|
|
| 483,133 |
|
Selling, general and administrative expenses |
|
| 489,412 |
|
|
| 38,801 |
|
|
| 528,213 |
|
|
| 432,961 |
|
|
| 24,246 |
|
|
| 457,207 |
|
Income (loss) from operations |
| $ | 66,432 |
|
| $ | (4,251 | ) |
| $ | 62,181 |
|
| $ | 34,441 |
|
| $ | (8,515 | ) |
| $ | 25,926 |
|
|
|
Net revenues
Consolidated net revenues increased $221.7 million, or 14.3%, to $1,769.9 million in the nine months ended October 28, 2017 compared to $1,548.2 million in the nine months ended October 29, 2016. Stores net revenues increased $137.5 million, or 15.8%, to $1,010.1 million in the nine months ended October 28, 2017 compared to $872.7 million in the nine months ended October 29, 2016. Direct net revenues increased $84.3 million, or 12.5%, to $759.8 million in the nine months ended October 28, 2017 compared to $675.5 million in the nine months ended October 29, 2016. Comparable brand revenue was 7% for the nine months ended October 28, 2017.
RH Segment net revenues
RH Segment net revenues increased $181.4 million, or 12.1%, to $1,680.5 million in the nine months ended October 28, 2017 compared to $1,499.1 million in the nine months ended October 29, 2016.
A number of factors contributed to the increase in RH Segment net revenues during the nine months ended October 28, 2017, the most significant of which was our decision to move the mailing of our 2016 Interiors Source Book to the fall of 2016. The 2016 Interiors Source Book mailing was complete in mid-December and therefore was a contributor to net revenues in the first three quarters of fiscal 2017, whereas the first three quarters of fiscal 2016 did not benefit from a similarly timed mailing.
In addition, the following factors resulted in increased RH Segment net revenues, which are listed in order of magnitude. Outlet sales, which include sales via warehouse locations, increased $49.2 million in the nine months ended October 28, 2017 compared to the nine months ended October 29, 2016, representing 3.3% of growth in RH Segment net revenues. Increased outlet sales occurred primarily as a result of our inventory optimization efforts as we increased our outlet promotional activity, including through warehouse sales, and we increased outlet selling square footage by approximately 32% compared to the prior period. Additionally, the performance of our new Design Galleries and an increase in retail weighted-average leased selling square footage contributed to the increase in RH Segment net revenues. Net revenues also increased related to deeper markdowns on discontinued merchandise based on our continued efforts to rationalize our SKU count. We also had an increase in Membership revenue recognized of $18.2 million.
RH Segment net revenues for the nine months ended October 28, 2017 were negatively impacted by $3.8 million related to the reduction of revenue associated with product recalls. During the nine months ended October 29, 2016, RH Segment net revenues were reduced by an estimated $16 million due to customer accommodation and related expenses as a result of our initiative to elevate the customer experience, including in response to production delays related to RH Modern. We did not experience similar production delays during the nine months ended October 28, 2017.
Waterworks net revenues
On May 27, 2016, we acquired a controlling interest in Waterworks. As a result of this acquisition, we acquired 15 Waterworks showrooms and included such additional retail stores in our weighted-average leased selling square footage for both the nine months
37
ended October 28, 2017 and October 29, 2016. Waterworks net revenues increased $40.3 million, or 82.2%, to $89.4 million in the nine months ended October 28, 2017 compared to $49.1 million in the nine months ended October 29, 2016. Waterworks net revenues represented 5.1% and 3.2% of our net revenues for the nine months ended October 28, 2017 and October 29, 2016, respectively. The increase in Waterworks net revenues is primarily due to the nine months ended October 28, 2017 representing thirty-nine weeks of results, whereas the nine months ended October 29, 2016 only includes twenty-two weeks of results as Waterworks was acquired on May 27, 2016.
Gross profit
Consolidated gross profit increased $107.3 million, or 22.2%, to $590.4 million in the nine months ended October 28, 2017 from $483.1 million in the nine months ended October 29, 2016. As a percentage of net revenues, consolidated gross margin increased 2.2% to 33.4% of net revenues in the nine months ended October 28, 2017 from 31.2% of net revenues in the nine months ended October 29, 2016.
RH Segment gross profit for the nine months ended October 28, 2017 was negatively impacted by $8.2 million related to the reduction of revenue, incremental costs and inventory charges associated with product recalls and $0.5 million related to costs associated with anticipated distribution center closures. RH Segment gross profit for the nine months ended October 29, 2016 was negatively impacted by $7.7 million related to the estimated cumulative impact of coupons redeemed in connection with a legal claim alleging that the Company violated California’s Song-Beverly Credit Card Act of 1971 by requesting and recording ZIP codes from customers paying with credit cards. The coupons expired in March 2016.
Waterworks gross profit for the nine months ended October 28, 2017 and October 29, 2016 was negatively impacted by $2.1 million and $5.2 million, respectively, of amortization related to the inventory fair value adjustment recorded in connection with the acquisition.
Excluding the product recall costs, costs associated with the distribution center closure, impact of the coupons redeemed in connection with the legal claim and amortization related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased 1.9% to 33.9% of net revenues in the nine months ended October 28, 2017 from 32.0% of net revenues in the nine months ended October 29, 2016.
RH Segment gross profit
RH Segment gross profit increased $88.4 million, or 18.9%, to $555.8 million in the nine months ended October 28, 2017 from $467.4 million in the nine months ended October 29, 2016. As a percentage of net revenues, RH Segment gross margin increased 1.9% to 33.1% of net revenues in the nine months ended October 28, 2017 from 31.2% of net revenues in the nine months ended October 29, 2016. Excluding the product recall costs, costs associated with anticipated distribution center closures and impact of the coupons redeemed in connection with the legal claim mentioned above, RH Segment gross margin would have increased 1.8% to 33.5% of net revenues in the nine months ended October 28, 2017 from 31.7% of net revenues in the nine months ended October 29, 2016.
The increase in gross margin was primarily due to incremental shipping charges incurred during the nine months ended October 29, 2016 related to RH Modern production delays and our investment to elevate the customer experience. In addition, our merchandise margins were impacted by our SKU rationalization efforts that had a reduced impact on our margins this year compared to last year, partially offset by higher outlet and warehouse sales driven by increased promotions and higher discounts. During the nine months ended October 28, 2017, we experienced occupancy leverage in our fixed distribution and retail occupancy costs, partially offset by increased outlet occupancy costs.
Waterworks gross profit
Waterworks gross profit increased $18.8 million, or 119.6%, to $34.6 million in the nine months ended October 28, 2017 from $15.7 million in the nine months ended October 29, 2016. The increase in Waterworks gross profit is primarily due to the nine months ended October 28, 2017 representing thirty-nine weeks of results, whereas the nine months ended October 29, 2016 only includes twenty-two weeks of results as Waterworks was acquired on May 27, 2016. As a percentage of net revenues, Waterworks gross margin increased 6.6% to 38.7% of net revenues in the nine months ended October 28, 2017 from 32.1% of net revenues in the nine months ended October 29, 2016. Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have decreased 1.6% to 41.0% of net revenues in the nine months ended October 28, 2017 from 42.6% of net revenues in the nine months ended October 29, 2016. The decrease in gross margin is primarily due to changes in product mix and deleverage in occupancy costs.
38
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $71.0 million, or 15.5%, to $528.2 million in the nine months ended October 28, 2017 compared to $457.2 million in the nine months ended October 29, 2016.4, 2019.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $56.5decreased $1.1 million, or 13.0%0.7%, to $489.4$149.3 million in the ninethree months ended October 28, 2017May 2, 2020 compared $433.0$150.4 million in the ninethree months ended October 29, 2016.May 4, 2019.
RH Segment selling, general and administrative expenses for the ninethree months ended October 28, 2017May 2, 2020 included $23.9$4.1 million in 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, $3.2 million related to a fully vested option grant made to Mr. Friedman in May 2017, $0.1 million incremental costs associated with product recalls, $1.4 million costs associated with anticipated distribution center closuresasset impairments and a gain of $2.1$1.3 million related to the saleacceleration of building and land.
RH Segment selling, general and administrative expenses for the nine months ended October 29, 2016 included $5.7 million associated withdepreciation due to a reorganization, including severance and related taxes, $2.8 million related to charges and expenses incurred as a result of the Waterworks transaction, and $1.0 million related tochange in the estimated cumulative impactuseful lives of coupons redeemed in connection with a legal claim alleging that the Company violated California’s Song-Beverly Credit Card Act of 1971 by requesting and recording ZIP codes from customers paying with credit cards.
Advertising and marketing costs increased $26.9 million during the nine months ended October 28, 2017 as compared to October 29, 2016, primarily due to the timing of our Source Book mailings. In the nine months ended October 28, 2017 we amortized costs related to our 2016 Interiors Source Book which was circulated in the fall of 2016. The 2016 Interiors Source Book mailing was complete in mid-December and therefore resulted in amortized costs in the nine months ended October 28, 2017, whereas the nine months ended October 29, 2016 did not incur similarly timed expenses. In addition, we had an increase in employment and employment related costs.certain assets.
RH Segment selling, general and administrative expenses were 27.7%30.9% and 28.2%26.6% of net revenues for the ninethree months ended October 28, 2017May 2, 2020 and October 29, 2016,May 4, 2019, respectively, excluding the fully vested option grant made to Mr. Friedman in May 2017, the product recall costs costs associated with anticipated distribution center closures, the gain related to the sale of building and land, the reorganization costs, the charges and expenses incurred as a result of the Waterworks transaction, and the impact of coupons redeemed in connection with the legal claim
43
reorganization, asset impairments and accelerated asset depreciation mentioned above. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by leverage in our employment and employment related costs and, to a lesser extent, leverage in our corporate occupancy costs, partially offset by an increase in advertising and marketing costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased $14.6 million, or 60.0%, to $38.8 million in the nine months ended October 28, 2017 compared $24.2 million in the nine months ended October 29, 2016.
The increase in Waterworks selling, general and administrative expenses is primarily due to the nine months ended October 28, 2017 representing thirty-nine weeks of results, whereas the nine months ended October 29, 2016 only includes twenty-two weeks of results as Waterworks was acquired on May 27, 2016. This increase is partially offset by stock-based compensation of $3.7 million related to the fully vested option grants made in connection with our acquisition of Waterworks during the nine months ended October 29, 2016.
Excluding the fully vested option grants made in connection with our acquisition of Waterworks, Waterworks selling, general and administrative expenses would have been 43.4% and 41.9% of net revenues in the nine months ended October 28, 2017 and October 29, 2016, respectively. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by deleverage in corporate expenses driven by increased professional fees and preopening expenses, as well as deleverage in employment and employment related costs, and corporate occupancy costs.
39Waterworks selling, general and administrative expenses
Interest expense—Waterworks selling, general and administrative expenses increased $1.1 million, or 8.3%, to $14.9 million in the three months ended May 2, 2020 compared to $13.8 million in the three months ended May 4, 2019. Waterworks selling, general and administrative expenses for the three months ended May 2, 2020 included $1.6 million related to asset impairments. Waterworks selling, general and administrative expenses were 47.8% and 39.7% of net revenues for the three months ended May 2, 2020 and May 4, 2019, respectively, excluding the costs incurred in connection with the asset impairments.
Interest expense increased $13.0expense—net
Interest expense—net decreased $1.5 million to $45.5$19.6 million for the ninethree months ended October 28, 2017May 2, 2020 compared to $32.5$21.1 million for the ninethree months ended October 29, 2016.May 4, 2019. Interest expenseexpense—net consisted of the following:
| | | | | | |
| | Three Months Ended | ||||
| | May 2, | | May 4, | ||
|
| 2020 |
| 2019 | ||
| | (in thousands) | ||||
Amortization of convertible senior notes debt discount | | $ | 12,916 | | $ | 12,377 |
Finance lease interest expense | |
| 5,781 | |
| 5,514 |
Promissory notes | | | 1,454 | | | 432 |
Amortization of debt issuance costs and deferred financing fees | |
| 1,013 | |
| 1,090 |
Other interest expense | |
| 443 | |
| 395 |
Asset based credit facility | |
| 102 | |
| 687 |
Term loans | |
| — | |
| 1,724 |
Capitalized interest for capital projects | |
| (1,886) | |
| (819) |
Interest income | |
| (194) | |
| (282) |
Total interest expense—net | | $ | 19,629 | | $ | 21,118 |
|
| Nine Months Ended |
| |||||
|
| October 28, |
|
| October 29, |
| ||
|
| 2017 |
|
| 2016 |
| ||
|
| (in thousands) |
| |||||
Amortization of convertible senior notes debt discount |
| $ | 22,685 |
|
| $ | 21,467 |
|
Build-to-suit lease transactions |
|
| 12,360 |
|
|
| 9,418 |
|
Asset based credit facility |
|
| 4,049 |
|
|
| 1,465 |
|
Amortization of debt issuance costs and deferred financing fees |
|
| 3,933 |
|
|
| 1,884 |
|
Term loans |
|
| 3,545 |
|
|
| — |
|
Other interest expense |
|
| 1,910 |
|
|
| 2,515 |
|
Capitalized interest for capital projects |
|
| (2,547 | ) |
|
| (1,917 | ) |
Interest income |
|
| (439 | ) |
|
| (2,304 | ) |
Total interest expense—net |
| $ | 45,496 |
|
| $ | 32,528 |
|
Loss on extinguishment of debtTradename impairment
We incurred a $4.9$20.5 million loss on extinguishment of debttradename impairment charge in the ninethree months ended October 28, 2017 dueMay 2, 2020 for our Waterworks reporting unit. Refer to the repayment in full of the second lien term loan on October 10, 2017, which includes a prepayment penalty of $3.0 million“Waterworks Tradename Impairment” within Note 4—Goodwill, Trademarks,Trademarks and acceleration of amortization of debt issuance costs of $1.9 million.Domain Names.
Income tax expense (benefit)
Income tax benefit was $1.4 million and income tax expense was $9.9$11.8 million in the ninethree months ended October 28, 2017 compared to an income tax benefit of $2.6 million in the nine months ended October 29, 2016.May 2, 2020 and May 4, 2019, respectively. Our effective tax rate was 83.7%30.7% and 38.9%24.8% for the ninethree months ended October 28, 2017May 2, 2020 and October 29, 2016,May 4, 2019, respectively. The increase in our effective tax rate in the nine months ended October 28, 2017 was significantly impacted by non-deductible stock-based compensation relatedis primarily attributable to the May 2017 grantCompany reporting a loss before income taxes, and, to Mr. Friedman of an optiona lesser extent, discrete tax benefits related to purchase 1,000,000 shares of the Company’s common stock and net excess tax benefits from stock-based compensation of $4.3 million resulting from the Company’s adoption of ASU 2016-09 in the first quarter of fiscal 2017. Refer to Note 15—Stock-Based Compensation in our condensed consolidated financial statements for a description of the option grant to Mr. Friedman.compensation.
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
44
and strategies. WeIn fiscal 2017, we completed our firsttwo share repurchase programprograms in an aggregate amount of $1 billion. A $300 million share repurchase was completed during the first quarter of fiscal 2017 and completed our seconda $700 million share repurchase program in an amount of $700 millionwas completed during the second quarter of fiscal 2017 (refer2017. In October 2018, our Board of Directors approved a new $700 million share repurchase program, of which $250 million in share 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 for an aggregate repurchase amount of approximately $250 million, with $450 million still available under the $700 million repurchase program. Refer to “Share Repurchase Programs” below).below. We intend to evaluate our capital allocation from time to time and may engage in future share repurchases in circumstances where buying shares of our common stock represents a good value and provides a favorable return for our shareholders.
We have $650$985 million in aggregate principal amount of convertible notes outstanding as of May 2, 2020, of which $300 million mature in July 2020, $335 million mature in June 2023 and $350 million mature in June 2019 andSeptember 2024. The $300 million principal amount of convertible notes that we issued in fiscal 2015 mature on July 15, 2020 and are convertible through the close of business on the second scheduled trading day immediately preceding July 15, 2020. We expect to repay the $300 million outstanding principal amount of the convertible notes in cash, whether in connection with a conversion of such notes or repayment at maturity in July 2020. We also expect to repay the outstanding principal amount of our other convertible notes at maturity in June 2020,2023 and September 2024 in cash, in each case to minimize dilution. While we anticipate using excess cash, free cash flow and borrowings on our asset based credit facility to repay the convertible notes in cash to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates.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.
We extended and amended our revolving line of credit in June 2017, which has a total availability of $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 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 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. In addition, we have an $80.0 million last out, delayed draw term loan (“LILO term loan”) facility. The revolving line of credit and LILO term loan facility have a maturity date of June 28, 2022.
40
In July 2017, Restoration Hardware, Inc. entered into a credit agreement (the “second lien credit agreement”) with respect to an initial term loan in an aggregate principal amount equal to $100.0 million with a maturity date of January 7, 2023 (the “second lien term loan”). Refer to Second Lien Credit Agreement below. The proceeds of the second lien term loan were used to support our share repurchase program. We repaid this debt in full in October 2017.
We believe that cash expected to be generated from operations, net cash proceeds from the issuance of the convertible senior notes, borrowing availability under the revolving line of credit, borrowings under our term loan and other financing arrangements will be sufficient to meet working capital requirements, anticipated capital expenditures and other capital needs for the next 12 months.
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. WeOur liquidity may be materially impacted by the outbreak of COVID-19. In response to the public health crisis posed by COVID-19, on March 17, 2020, we temporarily closed our retail locations. While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, since that date we have pursuedbeen able to reopen a large number of our stores based on local market circumstances including the gradual lifting of restrictions on business operations, including shelter-in-place rules. While we have continued to serve our customers and operate our business through this initial phase of retail closures in the past,United States and may pursueCanada, there can be no assurance that future events including additional waves of COVID-19 outbreaks, evolving federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, or other similar issues will not adversely affect our business, results of operations or financial condition in the future, additional strategiesor that the pace of economic activity in the wake of the first wave of COVID-19 outbreaks will not have a negative impact on our business, results of operations or financial condition. We will continue to generate liquidity forclosely manage our operations, including throughexpenses and investments while considering both the strategic sale of assets, utilizationoverall economic environment as well as the needs of our business operations. 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 COVID-19.
The precise impact on our business from the disruption of financial markets and the weakening of overall economic conditions is unknown. We plan to utilize our asset based credit facilities,facility, and entry into new debtwe may pursue other sources of capital that may include other forms of external financing, in order to increase our cash position and preserve financial flexibility in response to the uncertainty in the United States and global markets resulting from COVID-19. We had no outstanding borrowings under our asset based credit facility as of May 29, 2020 and the amount under the revolving line of credit borrowing base that could be available pursuant to the asset based credit facility was $170.4 million, net of reserves for the repayment of the 2020 Notes and outstanding letters of credit. We believe our operating cash flows, in conjunction with available financing arrangements, that present attractive terms.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.
DuringWe extended and amended our asset based credit facility in June 2017, which has a total availability of $600 million, of which $10 million is available to Restoration Hardware Canada, Inc., and includes a $200 million accordion feature under which the first quarterrevolving line of credit may be expanded by agreement of the parties from $600 million to up to $800 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. The revolving line of credit has a maturity date of June 28, 2022.
45
In fiscal 2017,2019, we received cash of $4.9 millionexecuted a sale-leaseback transaction for the saleYountville Design Gallery for sales proceeds of an aircraft, net of $0.3$23.5 million, of costs to dispose of the aircraft, which was classified as asset heldqualified for sale, and during the second quarter of fiscal 2017 we received cash of $10.2 million for the sale of a real estate parcel that we owned on which one of our retail Galleries was located, which was classified as asset held for sale.sale-leaseback accounting in accordance with ASC 842. We may pursue strategies in the future, pursue additional strategies, through the use of existing assets and debt facilities, or through the pursuit of new external sources of liquidity and debt financings,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 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 remodeling 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 next generation Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings. During
Our adjusted net capital expenditures include (i) capital expenditures from investing activities and (ii) cash outflows of capital related to construction activities to design and build landlord 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 2016, we spent $157.62020. We anticipate our adjusted net capital expenditures, net of asset sales, to be $125 million for capital expenditures. Additionally, we made payments of $23.4to $150 million in fiscal 20162020, primarily related to escrow accounts for futureour efforts to continue our growth and expansion, including construction of next generationnew Design Galleries.
We anticipate our grossGalleries and infrastructure investments. During the three months ended May 2, 2020, adjusted net capital expenditures were $24.2 million, net of cash received related to be approximately $120 milliontenant allowances of $6.6 million.
Certain lease arrangements require the landlord to $130 million for fiscal 2017. Our fiscal 2017 capital expenditures will be offset by cash flows from operating activities. Our efforts to optimize inventory and reduce capital spending generated substantial free cash flow in the nine months ended October 28, 2017, and we expect to generate additional free cash flow for the remainderfund a portion of the year.
The majority of the currentconstruction 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 significant contributions directly from our landlords related to the building of our larger format and next generation Design Galleries in fiscal 2017.Galleries. As we develop new Galleries, as well as potentially other potential strategic initiatives in the future like our integrated hospitality experience;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 greater 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. 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. In addition, the effects of COVID-19 on our business, including decisions by us to temporarily curtail the deployment of capital and due to actions taken by federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the outbreak, 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, restaurants and outlets that were temporarily closedor are required to close in the future in the event of future 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, 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 our outstanding convertible senior notes in an aggregate principal amount of $650$985 million at maturity of such senior convertible notes or our terms loan at the maturity dates of such term loan.notes. 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
46
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.
41
Given the fast moving nature of the COVID-19 health crisis, and the corresponding impact on financial markets and the economy as a whole, there is an enhanced degree of uncertainty regarding our capital position and availability of capital to fund our liquidity requirements. In recognition of the significant threat to 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. In addition, retail closures and other operational difficulties faced by us may negatively affect our financial condition and restrict the availability of liquidity for our operational needs, including due to, among other reasons, increased and unforeseeable liquidity needs and limited flexibility to control expenses in line with potential decreases in revenue. Any further weakening of, or other adverse developments in, the U.S. or global credit markets could affect our ability to manage our debt obligations and our ability to access future debt. 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. If we fail to raise sufficient additional funds, we may be required to delay or abandon some of our planned future expenditures or aspects of our current operations.
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the following table:
| | | | | | | |
| | Three Months Ended | |||||
| | May 2, | | May 4, | | ||
|
| 2020 |
| 2019 |
| ||
| | (in thousands) | |||||
Net cash provided by (used in) operating activities | | $ | (16,868) | | $ | 38,824 | |
Net cash used in investing activities | |
| (16,632) | |
| (7,916) | |
Net cash provided by financing activities | |
| 3,182 | |
| 65,833 | |
Net increase (decrease) in cash and cash equivalents and restricted cash | |
| (30,450) | |
| 96,747 | |
Cash, cash equivalents and restricted cash at end of period | |
| 17,208 | |
| 102,550 | |
|
| Nine Months Ended |
| |||||
|
| October 28, |
|
| October 29, |
| ||
|
| 2017 |
|
| 2016 |
| ||
|
|
|
|
|
| As Revised |
| |
|
| (in thousands) |
| |||||
Provided by (used in) operating activities |
| $ | 386,762 |
|
| $ | (18,985 | ) |
Provided by (used in) investing activities |
| $ | 101,324 |
|
| $ | (263,378 | ) |
Used in financing activities |
| $ | (552,969 | ) |
| $ | (2,311 | ) |
Decrease in cash and cash equivalents |
| $ | (64,861 | ) |
| $ | (284,332 | ) |
Cash and cash equivalents at end of period |
| $ | 22,162 |
|
| $ | 47,135 |
|
Net Cash Provided By (Used In) Operating Activities
Operating activities consist primarily of net income (loss) 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.
For the ninethree months ended October 28, 2017,May 2, 2020, net cash provided byused in operating activities was $386.8$16.9 million and consisted of net income of $1.9 million, and an increase in cash provided byused for working capital and other activities of $259.3$105.3 million and a net loss of $3.2 million, partially offset by non-cash items of $125.6$91.7 million. Working capital and other activities consisted primarily of decreases in inventory of $190.6 million due to our SKU rationalization initiative, outlet inventory optimization efforts and revised DC network strategy. We also had decreases in prepaid expense and other current assets of $38.4 million primarily due to amortization of our capitalized catalog costs, reduction of federal and state tax receivables, and a reduction in prepaid rent. In addition, we had increases in deferred revenue and customer depositsmerchandise inventories of $20.6$55.8 million and increasesdecreases in accounts payable and accrued liabilitiesexpense of $10.5$53.0 million duerelated to the timing of payments.payments, partially offset by increases in deferred revenues and customer deposits of $26.7 million.
For the ninethree months ended October 29, 2016,May 4, 2019, net cash used inprovided by operating activities was $19.0$38.8 million and consisted of a net lossincome of $4.0$35.7 million and an increasenon-cash items of $66.4 million, partially offset by a decrease in uses ofcash used for working capital and other activities of $109.8 million, offset by non-cash items of $94.8$63.3 million. Working capital and other activities consisted primarily of
47
decreases in accounts payable and accrued expense of $38.6 million related to timing of payments, decreases in operating lease liabilities of $63.4$27.1 million primarily due to payments made under the timing of payments to our vendors, andagreements, as well as increases in prepaid expenseexpenses and other current assets increased $30.4of $17.8 million dueand landlord assets under construction of $4.5 million. These decreases to an increase in capitalized catalog costs related to our decision to move the mailing of our annual Source Books from the Spring to the Fall. In addition, other current liabilities decreased $25.4 million primarily due to federal and state tax payments, and inventory increased $23.3 million related to the increase in both existing and new products. This wasworking capital were partially offset by increases in deferred revenue and customer deposits of $22.7 million and an increase in other non-current obligations of $8.5 million primarily due to a deferred contract incentive.$21.6 million.
Net Cash Provided By (Used In)Used In Investing Activities
Investing activities consist primarily of investments in capital expenditures related to new Gallery openings, the acquisition of buildings and land, investments in supply chain and systems infrastructure, construction related deposits, acquisition of businesses, as well as activities associated with investing in available-for-sale securities.
For the nine months ended October 28, 2017, net cash provided by investing activities was $101.3 million primarily as a result of sales and maturities of investments in available-for-sale securities of $145.0 million and $46.9 million, respectively, the proceeds of which were used to fund the share repurchases made under the $300 Million Repurchase Program. In addition, we had net proceeds from the sale of building and land and the sale of an aircraft of $10.2 million and $4.9 million, respectively. These increases to cash were partially offset by investments in new Galleries,retail stores, information technology and systems infrastructure, andas well as supply chain investments of $76.8 million, purchases of investments in available-for-sale securities of $16.1 million and payments of $12.8 million to escrow accounts for future construction of next generation Design Galleries.investments.
For the ninethree months ended October 29, 2016,May 2, 2020 and May 4, 2019, net cash used in investing activities was $263.4$16.6 million primarily as a result of our acquisition of Waterworks, net of cash acquired, of $116.1 million. In addition, we made $104.2and $7.9 million, respectively, and was comprised of investments in new
42
galleries,retail stores, information technology and systems infrastructure, supply chain and other corporate assets, as well as payments of $3.8 million to escrow accounts for future construction of next generation Design Galleries. In addition, we made investments in available-for-sale securities of $187.0 million, partially offset by maturities and sales of such investments of $115.9 million and $31.9 million, respectively.infrastructure.
Net Cash Used InProvided By Financing Activities
Financing activities consist primarily of borrowings related to the convertible senior notes, offerings, credit facilities and other financing arrangements, as well as share repurchases, principal payments under finance lease agreements and other equity related transactions.
For the ninethree months ended October 28, 2017,May 2, 2020, net cash used inprovided by financing activities was $553.0$3.2 million, primarily due to $1.0 billion of share repurchases made under the $300 Million Repurchase Program and $700 Million Repurchase Program. Cash funding for the share repurchase programs was provided by available cash balances, net borrowings under the asset based credit facility of $341.0$10.0 million, as well aspartially offset by repayments of $5.2 million on equipment notes and principal payments under finance lease agreements of $2.1 million.
For the three months ended May 4, 2019, net cash provided by financing activities was $65.8 million primarily due to net borrowings underof debt of $321.5 million, including the issuance of a $200.0 million second lien term loansloan, a $120.0 million FILO term loan and $60.0 million of $180.0 million, borrowings under loanspromissory notes secured by certain equipment, of $20.0 million and borrowings under a promissory note secured by our aircraft of $14.0 million. Additionally, proceeds from exercise of employee stock options were $15.4 million. The cash provided by these financing activities was partially offset by repaymentnet repayments of $57.5 million under the second lien term loanasset based credit facility and repayments of $100.0$1.0 million $8.7 million of payments on build-to-suit transactions, debt issuanceour promissory notes. We incurred costs of $8.3$4.5 million and $4.9 million cash paid for employee taxes related to net settlementthe debt issuances. We repurchased approximately 2.2 million shares of equity awards.
For the nine months ended October 29, 2016, net cash used in financing activities was $2.3 million primarily due to tax shortfalls from the exerciseour common stock for an aggregate repurchase amount of stock options of $2.3 million and cash paid for employee taxes related to net settlement of equity awards of $1.4$250.0 million. Principal payments under finance lease agreements totaled $2.1 million.
Non-Cash Transactions
Non-cash transactions consist of non-cash additions of property and equipment.
Build-to-Suit Lease Transactions
The non-cash additionsequipment and landlord assets and issuance of property and equipment duenon-current notes payable related to build-to-suit lease transactions are the result of the accounting requirements of Accounting Standards Codification (“ASC”) 840—Leases (“ASC 840”) for those construction projects for which we are the “deemed owner” of the construction project given the extent to which we are involved in constructing the leased asset. If we are the “deemed owner” for accounting purposes, upon commencement of the construction project, we are required to capitalize contributions by the landlord toward construction as property and equipment on our condensed consolidated balance sheets. The contributions by the landlord toward construction, including the building, existing site improvements at construction commencement and any amounts paid by the landlord to those responsible for construction, are included as property and equipment additions due to build-to-suit lease transactions within the non-cash section of our condensed consolidated statements of cash flows.
Over the lease term, these non-cash additions to property and equipment due to build-to-suit lease transactions do not impact our cash outflows, nor do they impact net income within our condensed consolidated statements of operations.share repurchases from former employees.
Convertible Senior Notes
Refer to Note 8—Convertible Senior Notes in our condensed consolidated financial statements for further information on our 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 are governed by the terms of an indenture between us and U.S. Bank National Association, as the Trustee. The 2020 Notes will mature on July 15, 2020, unless earlier purchased by us or converted. The 2020 Notes will not bear interest, except that the 2020 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 2020 Notes. The 2020 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 2020 Notes, which may result in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes. The 2020 Notes are guaranteed by our primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The guarantee is the unsecured obligation of the Guarantor and is subordinated to the Guarantor’s obligations from time to time with respect to its credit agreement and ranks equal in right of payment with respect to Guarantor’s other obligations.
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The initial conversion rate applicable to the 2020 Notes is 8.4656 shares of common stock per $1,000 principal amount of 2020 Notes, which is equivalent to an initial conversion price of approximately $118.13 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, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2020 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2020, the 2020 Notes will be 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 fiscal 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 five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 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. As of October 28, 2017, none of these conditions have occurred and, as a result, the 2020 Notes are not convertible as of October 28, 2017. On and after March 15, 2020, 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 2020 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2020 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.
We may not redeem the 2020 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 2020 Notes for cash at a price equal to 100% of the principal amount of the 2020 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.
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 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 6.47% over the expected life of the 2020 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
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 are 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 are netted with the equity component in stockholders’ equity.
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. 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 2020 balance on the condensed consolidated balance sheets.
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 have the option to purchase a total of approximately 2.5 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 $68.3 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.5 million shares of our common stock at a 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 5.1 million shares of common stock (which cap may also be subject to adjustment). We received $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 are 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 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.
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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 deferred tax assets on the condensed consolidated balance sheets.
2024, 0.00% Convertible Senior Notes due 2019
In June 2014, we issued $350 million aggregate principal amount of2023, and 0.00% convertible senior notesConvertible Senior Notes due 2019 (the “2019 Notes”) in a private offering. The 2019 Notes are governed by the terms of an indenture between us and U.S. Bank National Association, as the Trustee. The 2019 Notes will mature on June 15, 2019, unless earlier purchased by us or converted. The 2019 Notes will not bear interest, except that the 2019 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 2019 Notes. The 2019 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 2019 Notes, which may result in the acceleration of the maturity of the 2019 Notes, as described in the indenture governing the 2019 Notes.
The initial conversion rate applicable to the 2019 Notes is 8.6143 shares of common stock per $1,000 principal amount of 2019 Notes, which is equivalent to an initial conversion price of approximately $116.09 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,” we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2019 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2019, the 2019 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2014, 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 fiscal 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 five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2019 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 October 28, 2017, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of October 28, 2017. On and after March 15, 2019, 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 2019 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2019 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.
We may not redeem the 2019 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 2019 Notes for cash at a price equal to 100% of the principal amount of the 2019 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.
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 2019 Notes, we separated the 2019 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 2019 Notes and the fair value of the liability component of the 2019 Notes. The debt discount will be amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
In accounting for the debt issuance costs related to the issuance of the 2019 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 2019 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.
Debt issuance costs related to the 2019 Notes were comprised of discounts and commissions payable to the initial purchasers of $4.4 million and third party offering costs of $1.0 million. Discounts, commissions payable to the initial purchasers 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 2019 balance on the condensed consolidated balance sheets.
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2019 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2019 Notes, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 3.0 million shares of our common stock at a price of approximately $116.09 per share. The total cost of the convertible note hedge transactions was $73.3 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 3.0 million shares of our common stock at a price of $171.98 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 6.0 million shares of common stock (which cap may also be subject to adjustment). We received $40.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual dilution from the conversion of the 2019 Notes and to effectively increase the overall conversion price from $116.09 per share to $171.98 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity and are not accounted for as derivatives. 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 $27.5 million in connection with the debt discount associated with the 2019 Notes and recorded a deferred tax asset of $28.6 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.2020.
Asset Based Credit Facility
In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into aRefer to Note 9—Credit Facilities in our condensed consolidated financial statements for further information on our asset based credit agreement with Bank of America, N.A., as administrative agent, and certain other lenders. On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit agreement among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., various 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 (the “credit agreement”). The credit agreement has a revolving line of credit with availability of upfacility.
Equipment Loan Facility
Refer to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 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 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. In addition, the credit agreement establishes an up to $80.0 million LILO termNote 9—Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility.
The availability48
Share Repurchase Programs
We regularly review share repurchase activity and consider various factors in determining whether and when to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable. 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). All obligations under the credit agreement are secured by substantially all of the assets, including accounts receivable, inventory, intangible assets, property, equipment, goods and fixtures of Restoration Hardware, Inc., Restoration Hardware Canada, Inc., RH US, LLC, Waterworks Operating Co., LLC and Waterworks IP Co., LLC.
Borrowings under the revolving line of credit and LILO term loan facility are subject to interest, at the borrowers’ option, at either the bank’s reference rate or LIBOR (or, in the case of the revolving line of credit, the Bank of America “BA” Rate or the Canadian Prime Rate, as such terms are defined in the credit agreement, for Canadian borrowings denominated in Canadian dollars or the United States Index Rate or LIBOR for Canadian borrowings denominated in United States dollars) plus an applicable margin rate, in each case.
The credit agreement contains various restrictive covenants,execute share repurchases, including, among others, limitations oncurrent cash needs, capacity for leverage, cost of borrowings, results of operations and the abilitymarket price of our common stock. We believe that these share repurchase programs will continue to incur liens, make loans orbe an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake 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 typical to credit agreements of this type and size.
The credit agreement does not contain any significant financial or coverage ratio covenants unless the domestic availability under the revolving line of credit is less than the greater of (i) $40.0 million and (ii) 10% of the sum of (a) 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 . If the availability under the credit agreement is less than the foregoing amount, then Restoration Hardware, Inc. is required to maintain a consolidated fixed-charge coverage ratio (“FCCR”) of at least one to one. The consolidated FCCR is based upon the ratio on the last day of each month on a trailing twelve-month basis of (a) (i) consolidated EBITDA (as definedrepurchase programs in the agreement) minus (ii) capital expenditures, minus (iii) the income taxes paid in cash to (b) the sum of (i) debt service charges plus (ii) certain dividends and distributions paid. As of October 28, 2017, Restoration Hardware, Inc. was in compliance with all applicable covenants of the credit agreement.
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The credit agreement requires a daily sweep of cash to prepay the loans under the agreement while (i) an event of default exists or (ii) the availability under the revolving line of credit for extensions of credit is less than the greater of (A) $40.0 million and (B) 10% of the sum of (a) 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.
As of October 28, 2017, Restoration Hardware, Inc. had $341.0 million in outstanding borrowings and $189.0 million of availability under the revolving line of credit, net of $27.7 million in outstanding letters of credit. As of October 28, 2017, the Company had $80.0 million outstanding borrowings under the LILO term loan facility. As a result of the consolidated FCCR restriction that limits the last 10% of borrowing availability, actual incremental borrowing available to the Company and the other affiliated parties under the revolving line of credit would be approximately $125.2 million.
Second Lien Credit Agreement
On July 7, 2017, Restoration Hardware, Inc., a wholly-owned subsidiary of RH, entered into the second lien credit agreement, dated as of July 7, 2017, among Restoration Hardware, Inc., as lead borrower, the guarantors party thereto, the lenders party thereto, each of whom are funds and accounts managed or advised by Apollo Capital Management, L.P., and its affiliated investment managers, and Wilmington Trust, National Association as administrative agent and collateral agentfuture with respect to our securities.
We generated $330 million, $163 million and $415 million in free cash flow in fiscal 2019, 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 second lien term loannon-cash accretion of debt discount upon settlement of debt and proceeds from sale of assets, less capital expenditures and principal payments under finance leases. Free cash flow excludes all non-cash items. Free cash flow is included in an aggregate principal amount equalthis filing because management believes that free cash flow provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to $100.0 million with a maturity datehave comparable financial results to analyze changes in our underlying business from quarter to quarter. A reconciliation of January 7, 2023. The second lien term loan of $100.0 million was repaid in full onour 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 |
$950 Million Share Repurchase Program
On October 10, 2017. As a result2018, our Board of the repayment, we incurred a $4.9 million loss on extinguishment of debt, which includes a prepayment penalty of $3.0 million and acceleration of amortization of debt issuance costs of $1.9 million.
Intercreditor Agreement
On July 7, 2017, in connection with the second lien credit agreement, Restoration Hardware, Inc. entered into an intercreditor agreement (the “intercreditor agreement”) with the administrative agent and collateral agent under the credit agreement and the administrative agent and collateral agent under the second lien credit agreement. 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 October 10, 2017.
Share Repurchase Programs
On February 21, 2017, our board of directorsDirectors authorized a stock repurchase program of up to $300 million (the “$300 Million Repurchase Program”) through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated share repurchases. During the three months ended April 29, 2017, we repurchased approximately 7.8 million shares of our common stock under the $300 Million Repurchase Program at an average price of $38.24 per share, for an aggregate repurchase amount of approximately $300 million. No additional shares will be repurchased in future periods under the $300 Million Repurchase Program.
Following completion of the $300 Million Repurchase Program, our board of directors authorized on May 2, 2017 an additional stock repurchase program of up to $700 million (the “$700 Million Repurchase Program”) through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as 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. Duringderivatives, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700 million authorization amount was replenished by the three months ended July 29, 2017,Board of Directors on March 25, 2019 (as replenished, the “$950 Million Repurchase Program”). In the first quarter of fiscal 2019, we repurchased approximately 12.42.2 million shares of our common stock under the $700$950 Million Repurchase Program at an average price of $56.60$115.36 per share, for an aggregate repurchase amount of approximately $700$250.0 million. No additional shares will be repurchased in future periodsThere were no share repurchases under the $700$950 Million Repurchase Program.Plan during the first quarter of fiscal 2020. As of May 2, 2020, there was $450 million remaining for future share repurchases under this program.
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We enter into long-termAs of May 2, 2020, there were no material changes to our contractual obligations described within Management’s Discussion and commitments, primarily debt obligationsAnalysis of Financial Condition and non-cancelable operating leases,Results of Operations—Contractual Obligations in the normal course of business. As of October 28, 2017, our contractual cash obligations were as follows (in thousands):2019 Form 10-K.
|
| Payments Due by Period |
| |||||||||||||||||
|
| Total |
|
| Remainder of 2017 |
|
| 2018-2019 |
|
| 2020–2021 |
|
| Thereafter |
| |||||
|
| (in thousands) |
| |||||||||||||||||
Convertible senior notes due 2019 |
| $ | 350,000 |
|
| $ | — |
|
| $ | 350,000 |
|
| $ | — |
|
| $ | — |
|
Convertible senior notes due 2020 |
|
| 300,000 |
|
|
| — |
|
|
| — |
|
|
| 300,000 |
|
|
| — |
|
Asset based credit facility (1) |
|
| 341,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 341,000 |
|
Term loan (2) |
|
| 80,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 80,000 |
|
Operating leases (3) |
|
| 683,685 |
|
|
| 23,058 |
|
|
| 163,223 |
|
|
| 122,998 |
|
|
| 374,406 |
|
Other non-current obligations (4) |
|
| 792,723 |
|
|
| 9,335 |
|
|
| 78,971 |
|
|
| 86,513 |
|
|
| 617,904 |
|
Capital lease obligations |
|
| 14,913 |
|
|
| 357 |
|
|
| 2,832 |
|
|
| 2,569 |
|
|
| 9,155 |
|
Equipment security notes |
|
| 19,626 |
|
|
| 1,129 |
|
|
| 10,281 |
|
|
| 8,216 |
|
|
| — |
|
Notes payable for share repurchases |
|
| 19,390 |
|
|
| — |
|
|
| 893 |
|
|
| — |
|
|
| 18,497 |
|
Promissory note |
|
| 13,533 |
|
|
| 350 |
|
|
| 2,800 |
|
|
| 2,800 |
|
|
| 7,583 |
|
Letters of credit |
|
| 27,718 |
|
|
| 27,718 |
|
|
| — |
|
|
| — |
|
|
| — |
|
Total |
| $ | 2,642,588 |
|
| $ | 61,947 |
|
| $ | 609,000 |
|
| $ | 523,096 |
|
| $ | 1,448,545 |
|
|
|
|
|
|
|
|
|
Off Balance Sheet Arrangements
We have no material off balance sheet arrangements as of October 28, 2017.May 2, 2020.
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Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with GAAPaccounting principles generally accepted in the United States requires management 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. Management evaluates itsWe evaluate our accounting policies, estimates, and judgments on an on-going basis. Management bases itsWe 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.
Management evaluatedWe evaluate the development and selection of itsour critical accounting policies and estimates and believesbelieve that the followingcertain 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 |
o | Tradenames, Trademarks and Domain Names |
o | Long-Lived Assets |
● | Lease Accounting |
o | Reasonably Certain Lease Term |
o | Incremental Borrowing Rate |
o | Fair Market Value |
Revenue Recognition
Merchandise Inventories
Advertising Expenses
Impairment of GoodwillThere have been no material changes to the other critical accounting policies and Long-Lived Assets
Lease Accounting
Stock-Based Compensation
Income Taxes
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estimates listed above from the disclosures included in the 2019 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 20162019 Form 10-K. There have been no material changes to the critical accounting policies and estimates listed in the 2016 Form 10-K.
Recent Accounting Pronouncements
Refer to Note 2—Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently proposed accounting standards which may impact our consolidated financial statements in future reporting periods.
Item 3. Quantitative 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.
We are subject to interest rate risk in connection with borrowings under our revolving line of credit under the Credit Agreement which bears interest at variable rates and we may incur additional indebtedness that bears interest at variable rates. At October 28, 2017, $341.0As of May 2, 2020, $10.0 million was outstanding under the revolving line of credit. AsThe Credit Agreement provides for a borrowing amount based on the value of October 28, 2017,eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the undrawn borrowing availabilityterms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of May 2, 2020 was $189.0$356.5 million, net of $27.7$13.2 million in outstanding letters of credit. As a result of the FCCR restriction that limits the last 10% of borrowing availability, actual incremental borrowing available under the revolving line of credit would be approximately $125.2 million. Based on the average interest rate on the revolving line of credit during the three months ended October 28, 2017,May 2, 2020, 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.
We are subject to50
A number of our current debt agreements, including the Credit Agreement, have an interest rate risktied 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 connection with borrowings under our LILO term loan, which bears interest at variable rates. At October 28, 2017, $80.0 million was outstanding under the LILO term loan. Based on the average interest rates on the LILO term loan during the three months ended October 28, 2017, wepayments that are higher than expected or that do not believeotherwise correlate over time with the payments that a 10% change inwould have been made on such indebtedness for the interest periods if the applicable LIBOR rate would have a material effect on our consolidated results of operations or financial condition.was available in its current form.
As of October 28, 2017, we had $350 million principal amount of 0.00% convertible senior notes due 2019 outstanding (the “2019 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.
As of October 28, 2017,May 2, 2020, we had $300 million principal amount of 0.00% convertible senior notes due 2020 outstanding (the “2020 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.
As of May 2, 2020, we had $335 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 May 2, 2020, 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 2019
In connection with the issuance of the 2019 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively, 3.0 million shares of our common stock, which represents the number of shares of our common stock underlying the 2019 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2019 Notes. These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to our common stock upon conversion of the 2019 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion of the 2019 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 $171.98 per share. Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements.
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 convertible note hedge transactions relate to, collectively, 2.5 million shares of our common stock, which represents the number of shares of our common stock underlying the 2020 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2020 Notes. These convertible note hedge transactions are expected to reduce the potential earnings
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dilution with respect to our common stock upon conversion of the 2020 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion 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 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 $189.00 per share. Refer to Note 9—8—Convertible Senior Notes in our condensed consolidated financial statements.
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 8—Convertible Senior Notes in our condensed consolidated financial statements.
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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 8—Convertible Senior Notes in our condensed consolidated financial statements.
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.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, 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, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
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 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II
From time to time, we and/or our management 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 management 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 17—15—Commitments and Contingencies in our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q.
Item 1A. Risk 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 sectionsections entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017February 1, 2020 (“20162019 Form 10-K”). There have been no material changes to the risk factors disclosed in our 2016 Form 10-K.
The risks described herein and those described in our 20162019 Form 10-K 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 coronavirus (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.
Although we have continued to serve our customers and operate our business through the initial phase of retail closures in the U.S. and Canada and are in the process of reopening our retail locations, there can be no assurance that future events including additional waves of COVID-19 outbreaks, evolving federal, state and local restrictions, standards and safety regulations, regulatory or operational restrictions in response to COVID-19 risks, or other similar issues, will not have a significant impact on the way we manage our business in the future. Changes in consumer behavior and health concerns may continue to impact consumer demand for our products and customer traffic at our Galleries,
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restaurants and outlets and may make it more difficult to staff our business operations. In addition, our near term decisions regarding the sources and uses of capital in our business will reflect and adapt to changes in market conditions and changes in our business operations related to COVID-19 and its impact on business conditions. 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 emerging 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 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. 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. Substantially all of our management personnel, including those in our corporate office in Corte Madera, CA, have been subject to shelter-in-place requirements 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.
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. 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, 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
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United Kingdom. In addition, we are in the process of developing a number of new Gallery locations in the U.S. In addition, our RH Guesthouse initiative may be negatively impacted by the disease outbreak as federal, state and local governments have restricted travel, conferences, events and gatherings. Reductions in our liquidity position and the need to use capital for other day to day requirements of our business may 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 the first wave of COVID-19 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 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 precise impact on our business from the disruption of financial markets and the weakening of overall economic conditions cannot be predicted with certainty. 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.
Our operations and those of third parties on whom we depend are subject to risks of natural or man-made disasters, acts of war, civil unrest, terrorism or widespread illness, any one of which could result in a business stoppage and negatively affect our results of operations.
Our business operations depend on our ability to maintain and protect our facilities, computer systems and personnel. Our operations and consumer spending may be affected by natural or man-made disasters or other similar events, including floods, hurricanes, earthquakes, widespread illness, fires, power outages, telecommunications failure, interruption of other utilities, industrial accidents, social or political unrest and riots. In particular, our corporate headquarters is located in Northern California and other parts of our operations are located in Northern and Southern California, each of which is vulnerable to the effects of natural disasters and related matters that could disrupt our operations and adversely affect our results of operations including earthquakes, fires and power outages. Further, there is evidence that extreme weather, extended drought and shifting climate patterns may have affected the frequency and severity of wildfires in California. In addition, we will be subject to the risk of natural and man-made disasters in any of the regions in which we operate as we continue to expand our operations inside the United States and internationally. Many of our third party suppliers and vendors are also located in areas that may be affected by these or similar events. In addition, these kinds of factors including geopolitical, social or political unrest or public safety conditions may affect consumer behavior and spending and therefore could materially and adversely impact our business. Terrorist attacks or other hostilities, or threats thereof, in the United States or in other countries around the world, as well as future events occurring in response to or in connection with them, could result in reduced levels of consumer spending. Any of these occurrences could have a significant impact on our results of operations, revenue and costs.
We have experienced instances in which weather and other natural disasters including power outages related to the risks of wildfires have had an impact on our business. If we encounter difficulties associated with any of our facilities or if any of our facilities were to shut down for any reason, including as a result of a natural disaster, widespread illness, civil unrest, cyberattacks or a prolonged loss of power or telecommunications abilities, we could face shortages of inventory resulting in backorders, significantly higher costs and longer lead times associated with distributing our
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products to both our stores and online customers and the inability to process orders in a timely manner or ship goods to our customers. In addition, inability to access key systems at our corporate headquarters and other facilities, including accounting, finance and payroll, for prolonged periods may adversely affect our business and lead to management distraction and an inability to attract and retain qualified personnel. Further, any significant interruption in the operation of our customer service centers could also reduce our ability to receive and process orders and provide products and services to our stores and customers, which could result in lost sales, cancelled sales and a loss of loyalty to our brand. Any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchases of Common Stock during the Three Months Ended October 28, 2017
During the three months ended October 28, 2017,May 2, 2020, we repurchased the following shares of our common stock:
| | | | | | | | | | |
|
| |
| | |
| Total Number of |
| Approximate Dollar | |
| | | | Average | | Shares Repurchased | | Value of Shares That | ||
| | | | Purchase | | as Part of Publicly | | May Yet Be | ||
| | Number of | | Price Per | | Announced Plans or | | Purchased Under the | ||
| | Shares (1) | | Share | | Programs (2) | | Plans or Programs | ||
| | | | | | | | | (in millions) | |
February 2, 2020 to February 29, 2020 |
| — | | $ | — |
| — | | $ | 450 |
March 1, 2020 to April 4, 2020 |
| 1,929 | | $ | 111.59 |
| — | | $ | 450 |
April 5, 2020 to May 2, 2020 |
| 2,070 | | $ | 114.99 |
| — | | $ | 450 |
Total |
| 3,999 | | | |
| — | |
|
|
|
| Number of Shares (1) |
|
| Average Purchase Price Per Share |
|
| Total Number of shares Repurchased as Part of Publicly Announced Plans or Programs |
|
| Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs |
| ||||
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|
|
|
|
|
|
|
|
|
|
|
| (in millions) |
| |
July 30, 2017 to August 26, 2017 |
|
| — |
|
| $ | — |
|
|
| — |
|
| $ | — |
|
August 27, 2017 to September 30, 2017 |
|
| 40,414 |
|
| $ | 72.18 |
|
|
| — |
|
| $ | — |
|
October 1, 2017 to October 28, 2017 |
|
| 752 |
|
| $ | 77.20 |
|
|
| — |
|
| $ | — |
|
Total |
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| 41,166 |
|
| $ | 72.28 |
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|
| — |
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|
|
|
|
(1) |
|
(2) | Reflects shares repurchased as part of the $950 Million Repurchase Program authorized by the Board of Directors on October 10, 2018 and replenished on March 25, 2019. |
Item 3. Defaults Upon Senior Securities
Not applicable.
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Item 4. Mine SafetySafety Disclosures
Not applicable.
Item 5. Other Information
Not applicable.On April 6, 2020, RH announced organizational changes and expense reductions in response to the business conditions resulting from the novel coronavirus (“COVID-19”) pandemic. These measures included (i) the temporary furlough of approximately 2,300 team members for an indeterminate period of time, (ii) the termination of approximately 440 additional jobs, and (iii) salary reductions for the substantial majority of management positions across the Company. During the three months ended May 2, 2020, RH incurred $4.1 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.
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Item 6.
Exhibits | | | | | | | | | | | | | ||||||||
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31.1 | | | — | | — | | — | | — | | X | |||||||||
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31.2 | | | — | | — | | — | | — | | X | |||||||||
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32.1 | | | — | | — | | — | | — | | X | |||||||||
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32.2 | | | — | | — | | — | | — | | X | |||||||||
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101.INS | | XBRL Instance | | — | | — | | — | | — | | X | ||||||||
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101.SCH | | Inline XBRL Taxonomy Extension Schema Document | | — | | — | | — | | — | | X | ||||||||
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101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase Document | | — | | — | | — | | — | | X | ||||||||
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101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document | | — | | — | | — | | — | | X | ||||||||
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101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase Document | | — | | — | | — | | — | | X | ||||||||
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101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase Document | | — | | — | | — | | — | | X | ||||||||
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104 | | Cover Page Interactive Data File––the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | | — | | — | | — | | — | | X |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Date: | | By: | /s/ Gary Friedman | ||
| | Gary Friedman | |||
| | Chairman and Chief Executive Officer | |||
| | (Principal Executive Officer) | |||
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Date: | | By: | /s/ Jack Preston | ||
| | Jack Preston | |||
| | Chief Financial Officer | |||
| | (Principal Financial Officer) | |||
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Date: June 5, 2020 | | By: | /s/ | ||
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| | ( |
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