UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended August 3, 20191, 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) 924-1005
Securities registered pursuant to Section 12(b) of the Act:
| | ||
---|---|---|---|
Common Stock, $0.0001 par value | | RH | New York Stock Exchange, Inc. |
(Title of each class) | | (Trading symbol) | (Name of each exchange on which registered) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer |
| ☒ |
| Accelerated filer |
| ☐ |
Non-accelerated filer |
| ☐ |
| Smaller reporting company |
| ☐ |
| | | | Emerging growth company | | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of September 6, 2019, 18,676,0384, 2020, 19,514,206 shares of the registrant’s common stock were outstanding.
RH
INDEX TO FORM 10-Q
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6 | ||||
7 | ||||
Notes to Condensed Consolidated Financial Statements (Unaudited) | 8 | |||
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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2
PART I
Item 1. Financial Statements
RH
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)
| | | | | | | ||||||
|
| August 3, |
| February 2, | | | | | | | ||
| | 2019 | | 2019 |
| August 1, |
| February 1, | ||||
| | | | | | | 2020 | | 2020 | |||
ASSETS |
| |
|
| |
|
| |
|
| |
|
Current assets: |
| |
|
| |
|
| |
|
| |
|
Cash and cash equivalents | | $ | 11,555 | | $ | 5,803 | | $ | 17,387 | | $ | 47,658 |
Accounts receivable—net | |
| 44,287 | |
| 40,224 | |
| 55,916 | |
| 48,979 |
Merchandise inventories | |
| 480,688 | |
| 531,947 | |
| 487,639 | |
| 438,696 |
Asset held for sale | | | 21,795 | | | 21,795 | ||||||
Prepaid expense and other current assets | |
| 99,297 | |
| 104,198 | |
| 60,497 | |
| 61,619 |
Total current assets | |
| 657,622 | |
| 703,967 | |
| 621,439 | |
| 596,952 |
Property and equipment—net | |
| 950,594 | |
| 952,957 | |
| 1,053,435 | |
| 967,599 |
Operating lease right-of-use assets | | | 421,001 | | | 440,504 | | | 404,508 | | | 410,904 |
Goodwill | |
| 124,370 | |
| 124,379 | |
| 124,350 | |
| 124,367 |
Tradenames, trademarks and domain names | |
| 86,022 | |
| 86,022 | |
| 66,863 | |
| 86,022 |
Deferred tax assets | |
| 35,946 | |
| 35,603 | |
| 39,013 | |
| 45,005 |
Other non-current assets | |
| 112,253 | |
| 79,586 | |
| 196,801 | |
| 214,845 |
Total assets | | $ | 2,387,808 | | $ | 2,423,018 | | $ | 2,506,409 | | $ | 2,445,694 |
LIABILITIES AND STOCKHOLDERS’ DEFICIT | |
|
| |
|
| ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |
|
| |
|
| ||||||
Current liabilities: | |
|
| |
|
| |
|
| |
|
|
Accounts payable and accrued expenses | | $ | 289,713 | | $ | 320,497 | | $ | 340,266 | | $ | 330,309 |
Deferred revenue and customer deposits | |
| 165,511 | |
| 152,595 | | | 230,089 | |
| 162,433 |
Convertible senior notes due 2019—net | |
| — | |
| 343,789 | ||||||
Convertible senior notes due 2020—net | | | 280,688 | | | — | | | — | | | 290,532 |
Operating lease liabilities | | | 57,162 | | | 66,249 | | | 63,866 | | | 58,924 |
Other current liabilities | |
| 131,883 | |
| 109,456 | |
| 150,759 | |
| 140,714 |
Total current liabilities | |
| 924,957 | |
| 992,586 | |
| 784,980 | |
| 982,912 |
Asset based credit facility | |
| 145,000 | |
| 57,500 | |
| 91,600 | |
| — |
FILO term loan—net | |
| 119,086 | |
| — | ||||||
Second lien term loan—net | | | 197,262 | | | — | ||||||
Equipment promissory notes—net | |
| 42,113 | |
| — | |
| 26,047 | |
| 31,053 |
Convertible senior notes due 2020—net | |
| — | |
| 271,157 | ||||||
Convertible senior notes due 2023—net | |
| 257,766 | |
| 249,151 | |
| 275,837 | |
| 266,658 |
Convertible senior notes due 2024—net | | | 273,100 | | | 264,982 | ||||||
Non-current operating lease liabilities | |
| 415,803 | |
| 437,557 | |
| 406,012 | |
| 409,930 |
Non-current finance lease liabilities | | | 433,591 | | | 421,245 | | | 492,136 | | | 442,988 |
Other non-current obligations | |
| 30,148 | |
| 32,512 | |
| 28,206 | |
| 28,520 |
Total liabilities | |
| 2,565,726 | |
| 2,461,708 | |
| 2,377,918 | |
| 2,427,043 |
Commitments and contingencies (Note 15) | |
| — | |
| — | ||||||
Stockholders’ deficit: | |
|
| |
|
| ||||||
Preferred stock, $0.0001 par value per share, 10,000,000 shares authorized, 0 shares issued or outstanding as of August 3, 2019 and February 2, 2019 | |
| — | |
| — | ||||||
Common stock, $0.0001 par value per share, 180,000,000 shares authorized, 18,591,763 shares issued and outstanding as of August 3, 2019; 20,480,613 shares issued and 20,477,813 shares outstanding as of February 2, 2019 | |
| 2 | |
| 2 | ||||||
Commitments and contingencies (Note 16) | |
| | |
| | ||||||
Stockholders’ equity: | |
|
| |
|
| ||||||
Preferred stock—$0.0001 par value per share, 10,000,000 shares authorized, no shares issued or outstanding as of August 1, 2020 and February 1, 2020 | |
| — | |
| — | ||||||
Common stock—$0.0001 par value per share, 180,000,000 shares authorized, 19,485,843 shares issued and 19,485,826 shares outstanding as of August 1, 2020; 19,236,681 shares issued and outstanding as of February 1, 2020 | |
| 2 | |
| 2 | ||||||
Additional paid-in capital | |
| 355,010 | |
| 356,422 | |
| 444,378 | |
| 430,662 |
Accumulated other comprehensive loss | |
| (2,780) | |
| (2,333) | |
| (1,842) | |
| (2,760) |
Accumulated deficit | |
| (530,150) | |
| (392,538) | |
| (314,042) | |
| (409,253) |
Treasury stock—at cost, 0 shares as of August 3, 2019 and 2,800 shares as of February 2, 2019 | |
| — | |
| (243) | ||||||
Total stockholders’ deficit | |
| (177,918) | |
| (38,690) | ||||||
Total liabilities and stockholders’ deficit | | $ | 2,387,808 | | $ | 2,423,018 | ||||||
Treasury stock—at cost, 17 shares as of August 1, 2020 and 0 shares as of February 1, 2020 | | | (5) | | | — | ||||||
Total stockholders’ equity | |
| 128,491 | |
| 18,651 | ||||||
Total liabilities and stockholders’ equity | | $ | 2,506,409 | | $ | 2,445,694 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
3
RH
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share and per share amounts)
(Unaudited)
| | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended | ||||||||
| | | August 3, | | August 4, | | August 3, | | August 4, | ||||
| |
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
| | | | | | | | | | | | | |
Net revenues | | | $ | 706,514 | | $ | 640,798 | | $ | 1,304,935 | | $ | 1,198,204 |
Cost of goods sold | | |
| 411,556 | |
| 372,454 | |
| 777,163 | |
| 720,527 |
Gross profit | | |
| 294,958 | |
| 268,344 | |
| 527,772 | |
| 477,677 |
Selling, general and administrative expenses | | |
| 190,977 | |
| 186,521 | | | 355,158 | | | 347,707 |
Income from operations | | |
| 103,981 | |
| 81,823 | |
| 172,614 | |
| 129,970 |
Other expenses | | |
|
| |
|
| |
|
| |
|
|
Interest expense—net | | | | 24,513 | | | 15,467 | | | 45,631 | | | 30,565 |
(Gain) loss on extinguishment of debt | | |
| (954) | |
| 917 | |
| (954) | |
| 917 |
Total other expenses | | |
| 23,559 | |
| 16,384 | |
| 44,677 | |
| 31,482 |
Income before income taxes | | |
| 80,422 | |
| 65,439 | |
| 127,937 | |
| 98,488 |
Income tax expense | | |
| 16,665 | |
| 2,533 | |
| 28,458 | |
| 10,121 |
Net income | | | $ | 63,757 | | $ | 62,906 | | $ | 99,479 | | $ | 88,367 |
Weighted-average shares used in computing | | |
| 18,465,876 | |
| 21,925,702 | |
| 19,221,367 | |
| 21,735,364 |
Basic net income per share | | | $ | 3.45 | | $ | 2.87 | | $ | 5.18 | | $ | 4.07 |
Weighted-average shares used in computing | | |
| 22,324,112 | |
| 27,496,561 | |
| 23,629,050 | |
| 26,363,395 |
Diluted net income per share | | | $ | 2.86 | | $ | 2.29 | | $ | 4.21 | | $ | 3.35 |
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 1, | | August 3, | | August 1, | | August 3, | ||||
|
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Net revenues | | $ | 709,282 | | $ | 706,514 | | $ | 1,192,177 | | $ | 1,304,935 |
Cost of goods sold | |
| 376,863 | |
| 411,556 | |
| 660,104 | |
| 777,163 |
Gross profit | |
| 332,419 | |
| 294,958 | |
| 532,073 | |
| 527,772 |
Selling, general and administrative expenses | |
| 195,851 | |
| 190,977 | | | 360,052 | |
| 355,158 |
Income from operations | |
| 136,568 | |
| 103,981 | |
| 172,021 | |
| 172,614 |
Other expenses | | | | | | | |
| | | | |
Interest expense—net | | | 19,418 | | | 24,513 | | | 39,047 | |
| 45,631 |
Tradename impairment | | | — | | | — | | | 20,459 | | | — |
Gain on extinguishment of debt | |
| (152) | |
| (954) | |
| (152) | |
| (954) |
Total other expenses | |
| 19,266 | |
| 23,559 | |
| 59,354 | |
| 44,677 |
Income before income taxes | |
| 117,302 | |
| 80,422 | |
| 112,667 | |
| 127,937 |
Income tax expense | |
| 18,879 | |
| 16,665 | |
| 17,456 | |
| 28,458 |
Net income | | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Weighted-average shares used in computing | |
| 19,386,115 | |
| 18,465,876 | |
| 19,314,479 | |
| 19,221,367 |
Basic net income per share | | $ | 5.08 | | $ | 3.45 | | $ | 4.93 | | $ | 5.18 |
Weighted-average shares used in computing | |
| 26,564,705 | |
| 22,324,112 | |
| 25,383,730 | |
| 23,629,050 |
Diluted net income per share | | $ | 3.71 | | $ | 2.86 | | $ | 3.75 | | $ | 4.21 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
4
RH
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
| | | | | | | | | | | | | | |||||||||||
| | | Three Months Ended | | Six Months Ended | | | | | | | | | | | | ||||||||
| | | August 3, | | August 4, | | August 3, | | August 4, | Three Months Ended | | Six Months Ended | ||||||||||||
| | | 2019 |
| 2018 |
| 2019 |
| 2018 | August 1, | | August 3, | | August 1, | | August 3, | ||||||||
| | | | | | | | | | | | | 2020 |
| 2019 |
| 2020 |
| 2019 | |||||
Net income | | | $ | 63,757 | | $ | 62,906 | | $ | 99,479 | | $ | 88,367 | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Net gains (losses) from foreign currency translation | | |
| 490 | | | (482) | |
| (447) | |
| (1,746) |
| 3,290 | | | 490 | |
| 918 | |
| (447) |
Total comprehensive income | | | $ | 64,247 | | $ | 62,424 | | $ | 99,032 | | $ | 86,621 | $ | 101,713 | | $ | 64,247 | | $ | 96,129 | | $ | 99,032 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
5
RH
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(In thousands, except share amounts)
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||||||
| | | | | | | | |
| Accumulated |
| Retained | | | | | |
| Total | |||
| | | | | |
| Additional |
| Other |
| Earnings | | | | | |
| Stockholders’ | ||||
|
| Common Stock |
| Paid-In |
| Comprehensive |
| (Accumulated |
| Treasury Stock |
| Equity | ||||||||||
|
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit) |
| Shares |
| Amount |
| (Deficit) | ||||||
Balances—May 5, 2018 |
| 21,612,197 |
| $ | 2 |
| $ | 851,228 |
| $ | (1,435) |
| $ | 156,000 |
| 20,222,932 |
| $ | (1,000,569) |
| $ | 5,226 |
Stock-based compensation |
| — |
| | — |
| | 5,988 |
| | — |
| | — |
| — |
| | — |
| | 5,988 |
Issuance of restricted stock |
| 6,405 |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
Vested and delivered restricted stock units |
| 82,906 |
| | — |
| | (7,512) |
| | — |
| | — |
| — |
| | — |
| | (7,512) |
Exercise of stock options |
| 527,931 |
| | — |
| | 26,286 |
| | — |
| | — |
| — |
| | — |
| | 26,286 |
Equity component value of convertible note issuance—net | | — |
| | — |
| | 89,933 |
| | — |
| | — |
| — |
| | — |
| | 89,933 |
Sale of common stock warrant | | — |
| | — |
| | 51,021 |
| | — |
| | — |
| — |
| | — |
| | 51,021 |
Purchase of convertible note hedge | | — |
| | — |
| | (91,857) |
| | — |
| | — |
| — |
| | — |
| | (91,857) |
Net income |
| — |
| | — |
| | — |
| | — |
| | 62,906 |
| — |
| | — |
| | 62,906 |
Net gains (losses) from foreign currency |
| — |
| | — |
| | — |
| | (482) |
| | — |
| — |
| | — |
| | (482) |
Balances—August 4, 2018 |
| 22,229,439 |
| $ | 2 |
| $ | 925,087 |
| $ | (1,917) |
| $ | 218,906 |
| 20,222,932 |
| $ | (1,000,569) |
| $ | 141,509 |
| | | | | | | | | | | | | | | | | | | | | | |
Balances—May 4, 2019 |
| 18,357,816 |
| $ | 2 |
| $ | 362,986 |
| $ | (3,270) |
| $ | (356,816) |
| 2,170,196 |
| $ | (250,275) |
| $ | (247,373) |
Stock-based compensation |
| — |
| | — |
| | 5,191 |
| | — |
| | — |
| — |
| | — |
| | 5,191 |
Issuance of restricted stock |
| 7,014 |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
Vested and delivered restricted stock units |
| 80,400 |
| | — |
| | (5,984) |
| | — |
| | — |
| — |
| | — |
| | (5,984) |
Exercise of stock options |
| 146,491 |
| | — |
| | 5,997 |
| | — |
| | — |
| — |
| | — |
| | 5,997 |
Retirement of treasury stock |
| — |
| | — |
| | (13,180) |
| | — |
| | (237,091) |
| (2,170,154) |
| | 250,271 |
| | — |
Net income |
| — |
| | — |
| | — |
| | — |
| | 63,757 |
| — |
| | — |
| | 63,757 |
Net gains (losses) from foreign currency translation |
| — |
| | — |
| | — |
| | 490 |
| | — |
| — |
| | — |
| | 490 |
Conversion of convertible senior notes | | 42 | | | — | | | — | | | — | | | — | | (42) | | | 4 | | | 4 |
Balances—August 3, 2019 |
| 18,591,763 |
| $ | 2 |
| $ | 355,010 |
| $ | (2,780) |
| $ | (530,150) |
| — |
| $ | — |
| $ | (177,918) |
| | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||||||
| | | | | | | | |
| Accumulated |
| Retained | | | | | |
| Total | |||
| | | | | |
| Additional |
| Other |
| Earnings | | | | | |
| Stockholders’ | ||||
|
| Common Stock |
| Paid-In |
| Comprehensive |
| (Accumulated |
| Treasury Stock |
| Equity | ||||||||||
|
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit) |
| Shares |
| Amount |
| (Deficit) | ||||||
Balances—May 2, 2020 |
| 19,264,127 |
| $ | 2 |
| $ | 436,799 |
| $ | (5,132) |
| $ | (412,465) |
| 600 |
| $ | (72) |
| $ | 19,132 |
Stock-based compensation |
| — | | | — | | | 6,755 | | | — | | | — | | — | | | — |
| | 6,755 |
Issuance of restricted stock |
| 3,192 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units |
| 60,006 | | | — | | | (6,437) | | | — | | | — | | — | | | — |
| | (6,437) |
Exercise of stock options |
| 158,518 | | | — | | | 7,328 | | | — | | | — | | — | | | — |
| | 7,328 |
Retirement of treasury stock |
| — | | | — | | | (72) | | | — | | | — | | (600) | | | 72 |
| | — |
Settlement of convertible senior notes | | 1,131,645 | | | — | | | (315,708) | | | — | | | — | | (1,131,645) | | | 315,708 | | | — |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | (1,131,662) | | | — | | | 315,713 | | | — | | | — | | 1,131,662 | | | (315,713) | | | — |
Net income |
| — | | | — | | | — | | | — | | | 98,423 | | — | | | — |
| | 98,423 |
Net gains from foreign currency translation |
| — | | | — | | | — | | | 3,290 | | | — | | — | | | — |
| | 3,290 |
Balances—August 1, 2020 |
| 19,485,826 |
| $ | 2 |
| $ | 444,378 |
| $ | (1,842) |
| $ | (314,042) |
| 17 |
| $ | (5) |
| $ | 128,491 |
| | | | | | | | | | | | | | | | | | | | | | |
Balances—May 4, 2019 |
| 18,357,816 |
| $ | 2 |
| $ | 362,986 |
| $ | (3,270) |
| $ | (356,816) |
| 2,170,196 |
| $ | (250,275) |
| $ | (247,373) |
Stock-based compensation |
| — | | | — | | | 5,191 | | | — | | | — | | — | | | — |
| | 5,191 |
Issuance of restricted stock |
| 7,014 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock |
| 80,400 | | | — | | | (5,984) | | | — | | | — | | — | | | — |
| | (5,984) |
Exercise of stock options |
| 146,491 | | | — | | | 5,997 | | | — | | | — | | — | | | — |
| | 5,997 |
Retirement of treasury stock |
| — | | | — | | | (13,180) | | | — | | | (237,091) | | (2,170,154) | | | 250,271 |
| | — |
Conversion of convertible senior notes |
| 42 | | | — | | | — | | | — | | | — | | (42) | | | 4 |
| | 4 |
Net income |
| — | | | — | | | — | | | — | | | 63,757 | | — | | | — |
| | 63,757 |
Net gains from foreign currency translation |
| — | | | — | | | — | | | 490 | | | — | | — | | | — |
| | 490 |
Balances—August 3, 2019 |
| 18,591,763 |
| $ | 2 |
| $ | 355,010 |
| $ | (2,780) |
| $ | (530,150) |
| — |
| $ | — |
| $ | (177,918) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Six Months Ended | | Six Months Ended | ||||||||||||||||||||||||||||||||||||||||
| | | | | | | | |
| Accumulated |
| Retained | | | | | |
| Total | | | | | | | | |
| Accumulated |
| Retained | | | | | |
| Total | ||||||
| | | | | |
| Additional |
| Other |
| Earnings | | | | | |
| Stockholders’ | | | | | |
| Additional |
| Other |
| Earnings | | | | | |
| Stockholders’ | ||||||||
|
| Common Stock |
| Paid-In |
| Comprehensive |
| (Accumulated |
| Treasury Stock |
| Equity |
| Common Stock |
| Paid-In |
| Comprehensive |
| (Accumulated |
| Treasury Stock |
| Equity | ||||||||||||||||||||
|
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit) |
| Shares |
| Amount |
| (Deficit) |
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit) |
| Shares |
| Amount |
| (Deficit) | ||||||||||||
Balances—February 3, 2018 |
| 21,517,338 |
| $ | 2 |
| $ | 840,765 |
| $ | (171) |
| $ | 151,575 |
| 20,220,132 |
| $ | (1,000,326) |
| $ | (8,155) | ||||||||||||||||||||||
Balances—February 1, 2020 |
| 19,236,681 |
| $ | 2 |
| $ | 430,662 |
| $ | (2,760) |
| $ | (409,253) |
| — |
| $ | — |
| $ | 18,651 | ||||||||||||||||||||||
Stock-based compensation |
| — |
| | — |
| | 13,879 |
| | — |
| | — |
| — |
| | — |
| | 13,879 |
| — | | | — | | | 12,476 | | | — | | | — | | — | | | — |
| | 12,476 |
Issuance of restricted stock |
| 6,405 |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| 3,192 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units |
| 103,016 |
| | — |
| | (7,863) |
| | — |
| | — |
| — |
| | — |
| | (7,863) |
| 70,292 | | | — | | | (6,818) | | | — | | | — | | — | | | — |
| | (6,818) |
Exercise of stock options |
| 605,480 |
| | — |
| | 29,209 |
| | — |
| | — |
| — |
| | — |
| | 29,209 |
| 176,278 | | | — | | | 8,125 | | | — | | | — | | — | | | — |
| | 8,125 |
Repurchases of common stock |
| (2,800) |
| | — |
| | — |
| | — |
| | — |
| 2,800 |
| | (243) |
| | (243) |
| (600) | | | — | | | — | | | — | | | — | | 600 | | | (72) |
| | (72) |
Equity component value of convertible note issuance—net | | — |
| | — |
| | 89,933 |
| | — |
| | — |
| — |
| | — |
| | 89,933 | ||||||||||||||||||||||
Sale of common stock warrant | | — |
| | — |
| | 51,021 |
| | — |
| | — |
| — |
| | — |
| | 51,021 | ||||||||||||||||||||||
Purchase of convertible note hedge | | — |
| | — |
| | (91,857) |
| | — |
| | — |
| — |
| | — |
| | (91,857) | ||||||||||||||||||||||
Impact of Topic 606 adoption | | — |
| | — |
| | — |
| | — |
| | (21,036) |
| — |
| | — |
| | (21,036) | ||||||||||||||||||||||
Retirement of treasury stock |
| — | | | — | | | (72) | | | — | | | — | | (600) | | | 72 |
| | — | ||||||||||||||||||||||
Settlement of convertible senior notes | | 1,131,645 | | | — | | | (315,708) | | | — | | | — | | (1,131,645) | | | 315,708 | | | — | ||||||||||||||||||||||
Exercise of call option under bond hedge upon settlement of convertible senior notes | | (1,131,662) | | | — | | | 315,713 | | | — | | | — | | 1,131,662 | | | (315,713) | | | — | ||||||||||||||||||||||
Net income |
| — |
| | — |
| | — |
| | — |
| | 88,367 |
| — |
| | — |
| | 88,367 |
| — | | | — | | | — | | | — | | | 95,211 | | — | | | — |
| | 95,211 |
Net gains (losses) from foreign currency translation |
| — |
| | — |
| | — |
| | (1,746) |
| | — |
| — |
| | — |
| | (1,746) | ||||||||||||||||||||||
Balances—August 4, 2018 |
| 22,229,439 |
| $ | 2 |
| $ | 925,087 |
| $ | (1,917) |
| $ | 218,906 |
| 20,222,932 |
| $ | (1,000,569) |
| $ | 141,509 | ||||||||||||||||||||||
Net gains from foreign currency translation |
| — | | | — | | | — | | | 918 | | | — | | — | | | — |
| | 918 | ||||||||||||||||||||||
Balances—August 1, 2020 |
| 19,485,826 |
| $ | 2 |
| $ | 444,378 |
| $ | (1,842) |
| $ | (314,042) |
| 17 |
| $ | (5) |
| $ | 128,491 | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balances—February 2, 2019 |
| 20,477,813 |
| $ | 2 |
| $ | 356,422 |
| $ | (2,333) |
| $ | (392,538) |
| 2,800 |
| $ | (243) |
| $ | (38,690) |
| 20,477,813 |
| $ | 2 |
| $ | 356,422 |
| $ | (2,333) |
| $ | (392,538) |
| 2,800 |
| $ | (243) |
| $ | (38,690) |
Stock-based compensation |
| — |
| | — |
| | 10,779 |
| | — |
| | — |
| — |
| | — |
| | 10,779 |
| — | | | — | | | 10,779 | | | — | | | — | | — | | | — |
| | 10,779 |
Issuance of restricted stock |
| 7,014 |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| 7,014 | | | — | | | — | | | — | | | — | | — | | | — |
| | — |
Vested and delivered restricted stock units |
| 101,641 |
| | — |
| | (6,234) |
| | — |
| | — |
| — |
| | — |
| | (6,234) |
| 101,641 | | | — | | | (6,234) | | | — | | | — | | — | | | — |
| | (6,234) |
Exercise of stock options |
| 172,649 |
| | — |
| | 7,223 |
| | — |
| | — |
| — |
| | — |
| | 7,223 |
| 172,649 | | | — | | | 7,223 | | | — | | | — | | — | | | — |
| | 7,223 |
Repurchases of common stock |
| (2,167,396) |
| | — |
| | — |
| | — |
| | — |
| 2,167,396 |
| | (250,032) |
| | (250,032) |
| (2,167,396) | | | — | | | — | | | — | | | — | | 2,167,396 | | | (250,032) |
| | (250,032) |
Retirement of treasury stock |
| — |
| | — |
| | (13,180) |
| | — |
| | (237,091) |
| (2,170,154) |
| | 250,271 |
| | — |
| — | | | — | | | (13,180) | | | — | | | (237,091) | | (2,170,154) | | | 250,271 |
| | — |
Conversion of convertible senior notes |
| 42 | | | — | | | — | | | — | | | — | | (42) | | | 4 |
| | 4 | ||||||||||||||||||||||
Net income |
| — |
| | — |
| | — |
| | — |
| | 99,479 |
| — |
| | — |
| | 99,479 |
| — | | | — | | | — | | | — | | | 99,479 | | — | | | — |
| | 99,479 |
Net gains (losses) from foreign currency translation |
| — |
| | — |
| | — |
| | (447) |
| | — |
| — |
| | — |
| | (447) | ||||||||||||||||||||||
Conversion of convertible senior notes | | 42 | | | — | | | — | | | — | | | — | | (42) | | | 4 | | | 4 | ||||||||||||||||||||||
Net losses from foreign currency translation |
| — | | | — | | | — | | | (447) | | | — | | — | | | — |
| | (447) | ||||||||||||||||||||||
Balances—August 3, 2019 |
| 18,591,763 |
| $ | 2 |
| $ | 355,010 |
| $ | (2,780) |
| $ | (530,150) |
| — |
| $ | — |
| $ | (177,918) |
| 18,591,763 |
| $ | 2 |
| $ | 355,010 |
| $ | (2,780) |
| $ | (530,150) |
| — |
| $ | — |
| $ | (177,918) |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
6
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| | | | | | | ||||||
| | Six Months Ended | | | | | | | ||||
| | August 3, | | August 4, | | Six Months Ended | ||||||
|
| 2019 |
| 2018 | | August 1, | | August 3, | ||||
| | | | | |
| 2020 |
| 2019 | |||
CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | | | | | | | |
Net income | | $ | 99,479 | | $ | 88,367 | | $ | 95,211 | | $ | 99,479 |
Adjustments to reconcile net income to net cash provided by operating activities: | |
| | |
| | |
| | |
| |
Depreciation and amortization | |
| 52,510 | |
| 41,939 | |
| 50,212 | |
| 52,510 |
Non-cash operating lease cost | | | 33,227 | | | 34,118 | | | 31,355 | | | 33,227 |
Tradename impairment | | | 20,459 | | | — | ||||||
Asset impairments | | | 4,783 | | | — | ||||||
Loss on sale leaseback transaction | | | 9,352 | | | — | ||||||
Amortization of debt discount | |
| 22,962 | |
| 17,645 | |
| 25,378 | |
| 22,962 |
Accretion of debt discount upon settlement of debt | | | (70,482) | | | — | | | (84,003) | | | (70,482) |
Stock-based compensation expense | |
| 10,993 | |
| 14,092 | |
| 12,689 | |
| 10,993 |
Non-cash finance lease interest expense | | | 11,186 | | | 6,411 | | | 11,729 | | | 11,186 |
Product recalls | | | (2,106) | | | — | | | 4,780 | | | (2,106) |
Net non-cash charges resulting from inventory step-up | |
| — | |
| 380 | ||||||
(Gain) loss on extinguishment of debt | | | (954) | | | 917 | ||||||
Other non-cash interest expense | |
| 2,251 | |
| 1,276 | ||||||
Other non-cash items | |
| 2,404 | |
| 1,297 | ||||||
Change in assets and liabilities: | |
| | |
| | |
| | |
| |
Accounts receivable | |
| (504) | |
| (9,050) | |
| (6,431) | |
| (504) |
Merchandise inventories | |
| 51,189 | |
| (24,995) | |
| (48,984) | |
| 51,189 |
Prepaid expense and other assets | |
| (2,882) | |
| (40,646) | |
| (10,307) | |
| (2,882) |
Landlord assets under construction | |
| (27,555) | |
| (27,645) | ||||||
Landlord assets under construction—net of tenant allowances | |
| (22,934) | |
| (27,555) | ||||||
Accounts payable and accrued expenses | |
| (40,073) | |
| (31,707) | |
| (13,127) | |
| (40,073) |
Deferred revenue and customer deposits | |
| 12,987 | |
| 20,800 | |
| 67,647 | |
| 12,987 |
Other current liabilities | |
| 3,179 | |
| 8,179 | |
| 8,777 | |
| 3,179 |
Current and non-current operating lease liability | |
| (44,513) | |
| (43,025) | ||||||
Current and non-current operating lease liabilities | |
| (18,388) | |
| (44,513) | ||||||
Other non-current obligations | |
| (13,761) | |
| (8,036) | |
| (12,327) | |
| (13,761) |
Net cash provided by operating activities | |
| 97,133 | |
| 49,020 | |
| 128,275 | |
| 97,133 |
CASH FLOWS FROM INVESTING ACTIVITIES | |
|
| |
|
| |
|
| |
| |
Capital expenditures | |
| (25,283) | |
| (42,916) | |
| (47,531) | |
| (25,283) |
Investments in joint ventures | |
| (3,050) | |
| — | ||||||
Proceeds from sale of assets | |
| 25,006 | |
| — | ||||||
Net cash used in investing activities | |
| (25,283) | |
| (42,916) | |
| (25,575) | |
| (25,283) |
CASH FLOWS FROM FINANCING ACTIVITIES | |
|
| |
|
| |
|
| |
|
|
Borrowing under asset based credit facility | |
| 302,000 | |
| 510,000 | ||||||
Borrowings under asset based credit facility | |
| 283,200 | |
| 302,000 | ||||||
Repayments under asset based credit facility | |
| (214,500) | |
| (709,970) | |
| (191,600) | |
| (214,500) |
Borrowings under term loans | |
| 320,000 | |
| — | |
| — | |
| 320,000 |
Repayments under term loans | | | — | | | (80,000) | ||||||
Borrowing under equipment security notes | |
| 69,000 | |
| — | ||||||
Borrowings under promissory and equipment security notes | |
| — | |
| 69,000 | ||||||
Repayments under promissory and equipment security notes | |
| (4,993) | |
| (31,974) | |
| (5,408) | |
| (4,993) |
Debt issuance costs | |
| (4,636) | |
| — | |
| — | |
| (4,636) |
Proceeds from issuance of convertible senior notes | |
| — | |
| 335,000 | ||||||
Proceeds from issuance of warrants | |
| — | |
| 51,021 | ||||||
Purchase of convertible note hedges | |
| — | |
| (91,857) | ||||||
Debt issuance costs related to convertible senior notes | |
| — | |
| (6,349) | ||||||
Repayments of convertible senior notes | | | (278,560) | | | — | | | (215,846) | | | (278,560) |
Principal payments under finance leases | | | (4,399) | | | (3,567) | | | (4,641) | | | (4,399) |
Repurchases of common stock—including commissions | |
| (250,032) | |
| — | |
| — | |
| (250,032) |
Proceeds from exercise of stock options | |
| 7,223 | |
| 29,209 | |
| 8,125 | |
| 7,223 |
Tax withholdings related to issuance of stock-based awards | | | (6,234) | |
| (7,863) | | | (6,818) | |
| (6,234) |
Payments under promissory notes related to share repurchases | | | (892) | | | — | | | — | |
| (892) |
Net cash used in financing activities | |
| (66,023) | |
| (6,350) | |
| (132,988) | |
| (66,023) |
Effects of foreign currency exchange rate translation | |
| (75) | |
| (124) | |
| 17 | |
| (75) |
Net increase (decrease) in cash and cash equivalents and restricted cash equivalents | |
| 5,752 | |
| (370) | ||||||
Cash and cash equivalents and restricted cash equivalents | |
|
| |
|
| ||||||
Net increase (decrease) in cash and cash equivalents | |
| (30,271) | |
| 5,752 | ||||||
Cash and cash equivalents | |
|
| |
|
| ||||||
Beginning of period—cash and cash equivalents | |
| 5,803 | |
| 17,907 | | $ | 47,658 | | $ | 5,803 |
Beginning of period—restricted cash equivalents (construction related deposits) | |
| — | |
| 7,407 | ||||||
Beginning of period—cash and cash equivalents and restricted cash equivalents | | $ | 5,803 | | $ | 25,314 | ||||||
| |
|
| |
|
| ||||||
End of period—cash and cash equivalents | |
| 11,555 | |
| 22,199 | | $ | 17,387 | | $ | 11,555 |
End of period—restricted cash equivalents (construction related deposits) | |
| — | |
| 2,745 | ||||||
End of period—cash and cash equivalents and restricted cash equivalents | | $ | 11,555 | | $ | 24,944 | ||||||
Non-cash transactions: | |
| | |
| | |
| | |
| |
Property and equipment additions in accounts payable and accrued expenses at period-end | | $ | 10,875 | | $ | 7,713 | | $ | 19,978 | | $ | 10,875 |
Landlord asset additions in accounts payable and accrued expenses at period-end | | | 21,055 | | | 17,183 | | | 17,515 | | | 21,055 |
Landlord asset additions from unpaid construction related deposits | |
| 195 | |
| 517 | ||||||
Reclassification of assets from landlord assets under construction to finance lease right-of-use assets | | | — | | | 31,131 | | | 68,441 | | | — |
Issuance of non-current notes payable related to share repurchases from former employees | |
| — | |
| 243 | ||||||
Shares issued on settlement of convertible senior notes | | | (315,708) | | | — | ||||||
Shares received on exercise of call option under bond hedge upon settlement of convertible senior notes | | | 315,713 | | | — |
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,” 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, and child and teen furnishings. These products are sold through the Company’sour stores, catalogs and websites.
As of August 3, 2019, the Company1, 2020, we operated a total of 7068 RH Galleries and 4038 RH outlet stores in 3231 states, the District of Columbia and Canada, as well as 15 Waterworks showrooms throughout the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared from the Company’sour records and, in management’sour opinion, include all adjustments, consisting of normal recurring adjustments, and revisions due to the adoption of the new lease accounting standard described in Note 2—Recently Issued Accounting Standards, necessary to fairly state the Company’sour financial position as of August 3, 2019,1, 2020, and the results of operations for the three and six months ended August 3, 20191, 2020 and August 4, 2018. The Company’s3, 2019. Our current fiscal year, which consists of 52 weeks, ends on February 1, 2020January 30, 2021 (“fiscal 2019”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 the novel coronavirus disease (“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 and six months ended August 1, 2020 and August 3, 2019. 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 February 2, 20191, 2020 (the “2018“2019 Form 10-K”). Certain prior year amounts have been adjusted to conform to the current period presentation due to the adoption of the new lease accounting standard. Refer to Note 2—Recently Issued Accounting Standards.
The results of operations for the three and six months ended August 1, 2020 and August 3, 2019 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
RevisionsThe initial wave of the COVID-19 outbreak starting in March 2020 caused disruption to our business operations as we temporarily closed all of our retail locations on March 17, 2020. While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, during the second fiscal quarter we have reopened substantially all of our retail locations. As of the end of the second fiscal quarter on August 1, 2020 we had reopened 66 out of 68 of our Galleries, all of our Outlets, and 8 out of 10 of our restaurants. In addition, our business has substantially recovered during the second fiscal quarter as a result of both the reopening of most of our retail locations and also due to strong consumer demand for our products.
As previously disclosedOur global supply chain has not fully recovered from the impact of the COVID-19 dislocation. Despite the strong growth in consumer demand in our Annual Report on Form 10-K as of and for the year ended February 2, 2019,business during the thirdsecond fiscal quarter, revenue growth has lagged the increase in customer orders. As manufacturing and inventory receipts catch up with this backlog, we expect this demand will convert into revenue in the next several quarters as our supply chain recalibrates to the new level of fiscal 2018, management determinedour business.
While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the Company had incorrectly reportedextent and duration of the impact duringhealth crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ended February 3,ending January 30, 2021.
In our initial response to the COVID-19 health crisis we undertook immediate adjustments to our business operations including curtailing expenses and delaying investments. Our approach to the crisis evolved quickly as our business trends substantially improved during the second fiscal quarter. We will continue to make decisions regarding the sources and uses of capital in our business to reflect and adapt to changes in market conditions including any lasting effects of COVID-19. While we deferred some capital expenditures and other expenses in response to the initial circumstances of the COVID-19 health crisis, we are continuing both long term investments and shorter term initiatives necessary to support our business and the recent increase in consumer demand.
NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS
Cloud Computing
In August 2018, of retiring its common stock in accordance withthe Financial Accounting Standards CodificationBoard (“ASC”FASB”) 505issued —Accounting Standards Update (“ASU”) 2018-15—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract,Equity, which resultedamends Accounting Standards Update 2015-05—Customers Accounting for Fees in a Cloud Computing Agreement. The amendments in this ASU more closely align the Company revising its previously issued financial statementsrequirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license).
We adopted the ASU as of and for the year ended February 3, 2018. The common stock being retired was2, 2020 using a prospective method. We capitalize implementation costs related to shares repurchased under the Company’s equity plans. This error resulted in an overstatement ofhosted arrangements, which typically include three-year service terms with additional paid-in capital of $19.5 million,renewal periods generally ranging from $944.6 million as reportedone to $925.1 million as revised, and an overstatement of treasury stock of $19.5 million, from $1,020.1 million as reported to $1,000.6 million as revised,three years. The related assets are recorded within other non-current assets on theour condensed consolidated balance sheet assheets, net of August 4, 2018. There was no impactaccumulated amortization for assets placed in service. The amortization of assets placed in service is recorded in either cost of goods sold or selling, general and administrative expenses, consistent with the costs of the hosting arrangement, on the condensed consolidated statements of income oron 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 cash flowsconsolidated financial statements. Refer to Note 3—Prepaid Expense and Other Assets.
9
Current Expected Credit Losses
In June 2016, the FASB issued Accounting Standards Update 2016-13—Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments and also issued subsequent amendments to the initial guidance through ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, ASU 2020-02 and ASU 2020-03 (collectively, the “ASUs”). The ASUs amend the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology to result in more timely recognition of losses. The guidance in the ASUs applies to financial assets measured at amortized cost basis, such as receivables that result from revenue transactions.
Accounts receivable consist primarily of receivables from our credit card processors for sales transactions, receivables related to this misstatement. Although this error was not considered to be material to anyour contract business and other miscellaneous receivables. Accounts receivable is presented net of allowance for doubtful accounts as a result of the previouslyassessment of the collectability of customer accounts, which is recorded by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts was $3.0 million and $2.2 million as of August 1, 2020 and February 1, 2020, respectively.
We adopted the ASUs as of February 2, 2020 using a modified retrospective transition method, which requires a cumulative-effect adjustment, if any, to the opening balance of retained earnings. We did not recognize a cumulative-effect adjustment upon adoption as the adoption of the ASUs did not have a material effect on our condensed consolidated financial statements.
Income Taxes
In December 2019, the FASB issued Accounting Standards Update 2019-12—Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The ASU impacts various topic areas within ASC 740, including accounting for taxes under hybrid tax regimes, accounting for increases in goodwill, allocation of tax amounts to separate company financial statements within a group that files a consolidated tax return, intra period tax allocation, interim period accounting, and accounting for ownership changes in investments, among other minor codification improvements. The guidance in this ASU becomes effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We will adopt this standard in the Company has revisedfirst quarter of fiscal 2021 and are currently evaluating the accompanying unauditedeffects that the adoption of this ASU will have on our consolidated financial statements.
Convertible Instruments and Contracts in an Entity’s Own Equity
In August 2020, the FASB issued Accounting Standards Update 2020-06—Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The ASU simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. Specifically, the ASU removes the separation models for convertible debt with a cash conversion feature or convertible instruments with a beneficial conversion feature. As a result, after adopting the ASU’s guidance, we will not separately present in equity an embedded conversion feature of such debt. Instead, we will account for a convertible debt instrument wholly as debt unless (i) a convertible instrument contains features that require bifurcation as a derivative or (ii) a convertible debt instrument was issued at a substantial premium. Additionally, the ASU removes certain conditions for equity classification related to contracts in an entity’s own equity (e.g., warrants) and amends certain guidance related to the computation of earnings per share for convertible instruments and contracts on an entity’s own equity. The guidance in this ASU can be adopted using either a full or modified retrospective approach and becomes effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021. We are currently evaluating the effects that the adoption of this ASU will have on our consolidated financial statements, to reflectincluding the correction of this error.timing and adoption approach.
810
NOTE 3—PREPAID EXPENSE AND OTHER ASSETS
Prepaid expense and other current assets consist of the following (in thousands):
| | | | | | |
|
| August 1, |
| February 1, | ||
| | 2020 | | 2020 | ||
Prepaid expense and other current assets | | $ | 29,625 | | $ | 30,875 |
Capitalized catalog costs | |
| 13,128 | |
| 13,740 |
Vendor deposits | | | 12,518 | | | 11,258 |
Right of return asset for merchandise | |
| 5,226 | |
| 5,746 |
Total prepaid expense and other current assets | | $ | 60,497 | | $ | 61,619 |
Other non-current assets consist of the following (in thousands):
| | | | | | |
|
| August 1, |
| February 1, | ||
| | 2020 | | 2020 | ||
Landlord assets under construction | | $ | 109,549 | | $ | 138,315 |
Deposits on asset under construction | |
| 60,000 | |
| 60,000 |
Promissory note receivable, including interest | |
| 5,479 | |
| 5,354 |
Other deposits | |
| 5,289 | |
| 5,157 |
Investments in joint ventures (Note 5) | | | 3,050 | | | — |
Deferred financing fees | |
| 2,063 | |
| 2,602 |
Other non-current assets | |
| 11,371 | |
| 3,417 |
Total other non-current assets | | $ | 196,801 | | $ | 214,845 |
DuringNOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND DOMAIN NAMES
The following sets forth the adoption process ofgoodwill, tradenames, trademarks and domain names activity for the new lease accounting standard (refer toRH Segment and Waterworks (See Note 2—17—Recently Issued Accounting StandardsSegment Reporting), the Company identified a lease agreement that was incorrectly accounted for as an impaired lease under ASC 420—Exit or Disposal Cost Obligations in fiscal 2017 and the first quarter of fiscal 2018. This error resulted in an overstatement of net income of $1.4 million and $0.9 million for the year ended February 3, 2018 and the six months ended August 4, 2018, respectively. This error also resulted in an overstatement of retained earnings as of February 3, 2018 of $1.4 million, from $152.4 million as reported to $151.0 million as revised, and as of August 4, 2018 of $2.3 million, from $223.5 million as reported to $221.2 million as revised, prior to the impact of the modified retrospective application of the new lease accounting standard as further discussed in Note 2. In addition, as of February 2, 2019, this error resulted in an understatement of other non-current obligations of $3.3 million, an overstatement of other current liabilities of $1.0 million and understatement of accumulated deficit of $2.3 million, from $376.8 million as reported to $379.1 million as revised. Although these errors are not considered to be material to any of the previously issued financial statements, the Company has revised the accompanying unaudited interim financial statements to reflect the correction of these errors.
In addition, during the adoption process of the new lease accounting standard, the Company identified an error in its previously reported consolidated statement of cash flows for the quarterly and annual periods in fiscal 2018. This error resulted in an understatement of $9.2 million of net cash provided by operating activities and an understatement of $9.2 million of net cash used in investing activities for each reporting period in fiscal 2018. There was no impact on the condensed consolidated balance sheets, condensed consolidated statements of income or the condensed consolidated statement of stockholders’ equity (deficit) related to this error. Although these errors are not considered to be material to any of the previously issued financial statements, the Company has revised the accompanying unaudited interim financial statements to reflect the correction of these errors.
The following are selected line items from the Company’s condensed consolidated statements of cash flows illustrating the effect of the corrections, prior to the adoption of the modified retrospective application of the new lease accounting standard1, 2020 (in thousands):
| | | | | | | | | |
| | Six Months Ended August 4, 2018 | |||||||
|
| As Reported |
| Adjustment | | As Revised | |||
Cash flows from operating activities: | | | | | | | | | |
Change in accounts payable and accrued expenses | | $ | (42,717) | | $ | 9,201 | | $ | (33,516) |
Net cash provided by operating activities | |
| 70,229 | |
| 9,201 | |
| 79,430 |
Cash flows from investing activities: | |
| | | | | | | |
Capital expenditures | |
| (61,212) | |
| (9,201) | |
| (70,413) |
Net cash used in investing activities | |
| (61,212) | |
| (9,201) | |
| (70,413) |
| | | | | | | | | |
| | Nine Months Ended November 3, 2018 | |||||||
|
| As Reported |
| Adjustment | | As Revised | |||
Cash flows from operating activities: | | | | | | | | | |
Change in accounts payable and accrued expenses | | $ | (23,601) | | $ | 9,201 | | $ | (14,400) |
Net cash provided by operating activities | |
| 127,592 | |
| 9,201 | |
| 136,793 |
Cash flows from investing activities: | |
| | | | | | | |
Capital expenditures | |
| (104,403) | |
| (9,201) | |
| (113,604) |
Net cash used in investing activities | |
| (104,403) | |
| (9,201) | |
| (113,604) |
| | | | | | | | | | | | | | | |
|
| | |
| |
| |
| Foreign |
| | | |||
| | February 1, | | | | | | Currency | | August 1, | |||||
| | 2020 | | Acquisition | | Impairment (1) | | Translation | | 2020 | |||||
RH Segment |
| |
|
| |
|
| |
|
| |
|
| |
|
Goodwill | | $ | 124,367 | | $ | — | | $ | — | | $ | (17) | | $ | 124,350 |
Tradenames, trademarks and domain names | |
| 48,563 | |
| 1,300 | |
| — | |
| — | |
| 49,863 |
| |
|
| |
|
| |
|
| |
|
| |
| |
Waterworks (1) | |
|
| |
|
| |
|
| |
|
| |
| |
Tradename (2) | |
| 37,459 | |
| — | |
| (20,459) | |
| — | |
| 17,000 |
(1) | Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $17.4 million and $33.7 million of impairment recorded in fiscal 2018 and fiscal 2017, respectively. |
(2) | Presented net of an impairment charge of $35.1 million, with $20.5 million recorded in the first quarter of fiscal 2020 and $14.6 million recorded in fiscal 2018. |
| | | | | | | | | |
| | Fiscal Year Ended February 2, 2019 | |||||||
|
| As Reported |
| Adjustment | | As Revised | |||
Cash flows from operating activities: | | | | | | | | | |
Change in accounts payable and accrued expenses | | $ | (452) | | $ | 9,201 | | $ | 8,749 |
Net cash provided by operating activities | |
| 300,556 | |
| 9,201 | |
| 309,757 |
Cash flows from investing activities: | |
| | | | | | | |
Capital expenditures | |
| (136,736) | |
| (9,201) | |
| (145,937) |
Net cash used in investing activities | |
| (136,736) | |
| (9,201) | |
| (145,937) |
911
Waterworks Tradename Impairment
During the first quarter of fiscal 2020, as a result of the COVID-19 health crisis and related Showroom closures and slowdown in construction activity, management updated the long-term financial projections for the Waterworks reporting unit which resulted in a significant decrease in forecasted revenues and profitability. We performed an interim impairment test on the Waterworks tradename and the estimated future cash flows of the Waterworks reporting unit indicated the fair value of the tradename asset was below its carrying amount. We determined fair value utilizing a discounted cash flow methodology under the relief-from-royalty method. Significant assumptions under this method include forecasted net revenues and the estimated royalty rate, expressed as a percentage of revenues, in addition to the discount rate based on the weighted-average cost of capital. Based on the impairment test performed, we concluded that the Waterworks reporting unit tradename was impaired as of the first quarter of fiscal 2020.
As a result, we recognized a $20.5 million non-cash impairment charge for the Waterworks reporting unit tradename during the first quarter of fiscal 2020, and the carrying value of the Waterworks indefinite-lived tradename asset after the impairment charge was $17.0 million.
NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS5—INVESTMENTS IN JOINT VENTURES
Accounting for Leases
In February 2016,During the FASB issued Accounting Standards Update 2016-02—Leases, which requiressecond quarter of fiscal 2020, we entered into transactions whereby we became a lessee to distinguish all leases as operating leases or finance leases50 percent member of 2 privately held limited liability companies (the “JVs”) that each have the purpose of acquiring, constructing, developing and recognize all leases on the balance sheet as a right-of-use asset with a corresponding lease liability representing the present value of lease payments. The standard also requires a lessee to recognize a single lease cost for operating leases, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. The lease cost for finance leases includes both principal and interest components, and is higher than the corresponding cash payment at the beginning of the lease term and declines over the lease term as the liability is reduced. In July 2018, the FASB issued Accounting Standards Update 2018-10—Codification Improvements to Topic 842 (Leases), and Accounting Standards Update 2018-11—Leases (Topic 842)—Targeted Improvements, which (i) narrows amendments to clarify how to applyultimately selling certain aspects of the new lease standard, (ii) provides entities with an additional transition method to adopt the new standard, and (iii) provides lessors with a practical expedient for separating components of a contract. Accounting Standards Update 2016-02, Accounting Standards Update 2018-10 and Accounting Standards Update 2018-11 are collectively referred to as the “ASUs.”
The Company adopted the ASUs as of February 3, 2019 using a modified retrospective approach. Under this adoption method, the results of prior comparative periods are presented with an adjustment to opening retained earnings of the earliest comparative period presented. In addition, the Company elected to adopt the package of transition practical expedients, which permitted the Company not to reassess its prior conclusions regarding lease identification, lease classification and initial direct costs. The Company adopted the policy election to not separate lease and non-lease components for certain asset classes (such asspecified real estate leases),projects. The JVs are financed by capital contributions from the members on an as-needed basis, as well as via third-party debt secured by the short-term lease policy election offered underunderlying real estate projects and guaranteed by a member other than us. The JVs are considered variable interest entities because the ASUs wherebyequity investment at risk is not sufficient to permit the Company doesJV’s to finance their activities without additional financial support. A variable interest entity is consolidated by its primary beneficiary, which is defined as the party who has a controlling financial interest in the variable interest entity. As we do not recognize righthave a controlling financial interest in the JVs but have the ability to exercise significant influence over the operating and financial policies of use assets and lease liabilities for leases with terms of 12 months or less. The Company did not apply the hindsight practical expedient upon adoption.JVs, we recognized these investments using the equity method.
As a resultof August 1, 2020, we had $3.1 million of investments in the JVs, which is included in other non-current assets on the condensed consolidated balance sheets.
NOTE 6—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accounts payable and accrued expenses consist of the adoptionfollowing (in thousands):
| | | | | | |
|
| August 1, |
| February 1, | ||
| | 2020 | | 2020 | ||
Accounts payable | | $ | 182,944 | | $ | 180,714 |
Accrued compensation | |
| 59,218 | |
| 64,659 |
Accrued freight and duty | |
| 21,620 | |
| 25,170 |
Accrued sales taxes | |
| 21,327 | |
| 19,618 |
Accrued occupancy | |
| 14,086 | |
| 12,067 |
Deferred consideration for asset purchase | | | 13,739 | | | — |
Accrued catalog costs | |
| 6,346 | |
| 8,267 |
Accrued professional fees | |
| 4,810 | |
| 4,381 |
Other accrued expenses | |
| 16,176 | |
| 15,433 |
Total accounts payable and accrued expenses | | $ | 340,266 | | $ | 330,309 |
12
Other current liabilities consist of the ASUs,following (in thousands):
| | | | | | |
|
| August 1, |
| February 1, | ||
| | 2020 | | 2020 | ||
Promissory notes on asset under construction | | $ | 53,000 | | $ | 53,000 |
Current portion of equipment promissory notes | | | 22,235 | |
| 22,009 |
Allowance for sales returns | | | 18,795 | | | 19,206 |
Unredeemed gift card and merchandise credit liability | |
| 17,597 | |
| 16,625 |
Federal and state taxes payable | |
| 15,198 | |
| 13,591 |
Finance lease liabilities | | | 14,117 | | | 9,188 |
Product recall reserve | |
| 6,429 | |
| 2,055 |
Other current liabilities | |
| 3,388 | |
| 5,040 |
Total other current liabilities | | $ | 150,759 | | $ | 140,714 |
Contract Liabilities
We defer revenue associated with merchandise delivered via the Company recorded an increase to the fiscal 2017 (earliest comparative period) opening retained earnings balance of $4.0 million, inclusivehome-delivery channel. We expect that substantially all of the tax impact.deferred revenue, customer deposits and deferred membership fees as of August 1, 2020 will be recognized within the next six months (with the exception of cancelled orders) 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 August 1, 2020 and August 3, 2019, we recognized $6.5 million and $4.6 million, respectively, of revenue related to previous deferrals related to our gift cards and merchandise credits. During the six months ended August 1, 2020 and August 3, 2019, we recognized $10.6 million and $9.3 million, respectively, of revenue related to previous deferrals related to our gift cards and merchandise credits. During the three months ended August 1, 2020 and August 3, 2019, we recorded gift card breakage of $0.2 million and $0.4 million, respectively. During both the six months ended August 1, 2020 and August 3, 2019, we recorded gift card breakage of $0.8 million. We expect that approximately 70% of the remaining gift card and merchandise credit liabilities as of August 1, 2020 will be recognized within the next twelve months as the gift cards are redeemed by customers.
NOTE 7—OTHER NON-CURRENT OBLIGATIONS
Other non-current obligations consist of the following (in thousands):
| | | | | | |
|
| August 1, |
| February 1, | ||
| | 2020 | | 2020 | ||
Notes payable for share repurchases | | $ | 18,813 | | $ | 18,741 |
Rollover units and profit interests (1) | |
| 3,277 | |
| 3,064 |
Unrecognized tax benefits | |
| 3,098 | |
| 3,020 |
Other non-current obligations | |
| 3,018 | |
| 3,695 |
Total other non-current obligations | | $ | 28,206 | | $ | 28,520 |
(1) | Represents rollover units and profit interests associated with the acquisition of Waterworks. Refer to Note 15—Stock-Based Compensation. |
1013
TheNOTE 8—LEASES
Lease costs—net consist of the following table presents the impact of adopting the ASUs, as well as the correction of an immaterial error as discussed in Note 1—The Company, on the Company’s consolidated balance sheet (in thousands):
| | | | | | | | | |
| | February 2, 2019 | |||||||
|
| As Reported | | Adjustments and Other (1) | | As Adjusted and Revised | |||
ASSETS | | |
| | | | | |
|
Current assets: | | |
| | | | | |
|
Cash and cash equivalents | | $ | 5,803 | | $ | — | | $ | 5,803 |
Accounts receivable—net | |
| 40,224 | |
| — | |
| 40,224 |
Merchandise inventories | |
| 531,947 | |
| — | |
| 531,947 |
Asset held for sale | | | — | | | 21,795 | (2) | | 21,795 |
Prepaid expense and other current assets | |
| 104,719 | |
| (521) | (3) |
| 104,198 |
Total current assets | |
| 682,693 | |
| 21,274 | |
| 703,967 |
Property and equipment—net | |
| 863,562 | |
| 89,395 | (4) |
| 952,957 |
Operating lease right-of-use assets | | | — | | | 440,504 | (5) | | 440,504 |
Goodwill | |
| 124,379 | |
| — | |
| 124,379 |
Tradenames, trademarks and domain names | |
| 86,022 | |
| — | |
| 86,022 |
Deferred tax assets | |
| 30,033 | |
| 5,570 | (6) |
| 35,603 |
Other non-current assets | |
| 19,345 | |
| 60,241 | (7) |
| 79,586 |
Total assets | | $ | 1,806,034 | | $ | 616,984 | | $ | 2,423,018 |
LIABILITIES AND STOCKHOLDERS’ DEFICIT | |
|
| | | | |
|
|
Current liabilities: | |
|
| | | | |
|
|
Accounts payable and accrued expenses | | $ | 320,441 | | $ | 56 | (8) | $ | 320,497 |
Deferred revenue and customer deposits | |
| 152,595 | |
| — | |
| 152,595 |
Convertible senior notes due 2019—net | |
| 343,789 | |
| — | |
| 343,789 |
Operating lease liabilities | | | — | | | 66,249 | (5) | | 66,249 |
Other current liabilities | |
| 101,347 | |
| 8,109 | (1)(9) |
| 109,456 |
Total current liabilities | |
| 918,172 | |
| 74,414 | |
| 992,586 |
Asset based credit facility | |
| 57,500 | |
| — | |
| 57,500 |
Convertible senior notes due 2020—net | |
| 271,157 | |
| — | |
| 271,157 |
Convertible senior notes due 2023—net | |
| 249,151 | |
| — | |
| 249,151 |
Financing obligations under build-to-suit lease transactions | | | 228,928 | | | (228,928) | (10) | | — |
Deferred rent and lease incentives | | | 53,742 | | | (53,742) | (10) | | — |
Non-current operating lease liabilities | |
| — | |
| 437,557 | (5) |
| 437,557 |
Non-current finance lease liabilities | | | — | | | 421,245 | (9) | | 421,245 |
Other non-current obligations | |
| 50,346 | |
| (17,834) | (1)(11) |
| 32,512 |
Total liabilities | |
| 1,828,996 | |
| 632,712 | |
| 2,461,708 |
Stockholders’ deficit: | |
|
| |
| | |
|
|
Preferred stock | |
| — | |
| — | |
| — |
Common stock | |
| 2 | |
| — | |
| 2 |
Additional paid-in capital | |
| 356,422 | |
| — | |
| 356,422 |
Accumulated other comprehensive loss | |
| (2,333) | |
| — | |
| (2,333) |
Accumulated deficit | |
| (376,810) | |
| (15,728) | (1)(12) |
| (392,538) |
Treasury stock | |
| (243) | |
| — | |
| (243) |
Total stockholders’ deficit | |
| (22,962) | |
| (15,728) | |
| (38,690) |
Total liabilities and stockholders’ deficit | | $ | 1,806,034 | | $ | 616,984 | | $ | 2,423,018 |
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 1, |
| August 3, | | August 1, |
| August 3, | ||||
|
| 2020 |
| 2019 | | 2020 |
| 2019 | ||||
Operating lease cost (1) | | $ | 20,181 | | $ | 23,259 |
| $ | 40,907 | | $ | 42,376 |
| | | | | | | | | | | | |
Finance lease costs | | | | | | | | | | | | |
Amortization of leased assets (1) | | | 10,125 | | | 9,235 | | | 19,713 | | | 18,087 |
Interest on lease liabilities (2) | | | 5,948 | | | 5,672 | | | 11,729 | | | 11,186 |
| | | | | | | | | | | | |
Variable lease costs (3) | | | 3,920 | | | 5,791 | | | 7,480 | | | 11,398 |
Sublease income (4) | | | (2,119) | | | (1,507) | | | (4,694) | | | (4,789) |
Total lease costs—net | | $ | 38,055 | | $ | 42,450 | | $ | 75,135 | | $ | 78,258 |
(1) |
(2) |
(3) | Represents |
(4) |
11
Refer to Note 7—Leases for discussion of the Company’s revised accounting policy for leases.
Cloud Computing
In August 2018, the FASB issued Accounting Standards Update 2018-15—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which amends Accounting Standards Update 2015-05—Customers Accounting for Fees in a Cloud Computing Agreement. The amendments in this ASU more closely align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of this new accounting standard will have on its consolidated financial statements.
NOTE 3—PREPAID EXPENSE AND OTHER ASSETS
Prepaid expense and other current assets consist of the following (in thousands):
| | | | | | |
|
| August 3, |
| February 2, | ||
| | 2019 | | 2019 | ||
Insurance recovery receivable (1) | | $ | 50,171 | | $ | 50,000 |
Capitalized catalog costs | |
| 12,378 | |
| 16,178 |
Vendor deposits | |
| 11,407 | |
| 11,836 |
Right of return asset for merchandise | |
| 6,645 | |
| 5,883 |
Federal and state tax receivable | | | 1,036 | | | 4,862 |
Prepaid expense and other current assets | |
| 17,660 | |
| 15,439 |
Total prepaid expense and other current assets | | $ | 99,297 | | $ | 104,198 |
12
Other non-current assets consist of the following (in thousands):
| | | | | | |
|
| August 3, |
| February 2, | ||
| | 2019 | | 2019 | ||
Landlord assets under construction | | $ | 94,710 | | $ | 63,159 |
Promissory note receivable, including interest | |
| 5,229 | |
| 5,104 |
Deferred financing fees | |
| 3,722 | |
| 3,415 |
Other deposits | |
| 5,559 | |
| 5,068 |
Other non-current assets | |
| 3,033 | |
| 2,840 |
Total other non-current assets | | $ | 112,253 | | $ | 79,586 |
NOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND DOMAIN NAMES
The following sets forth the goodwill, tradenames, trademarks and domain names activity for the RH Segment and Waterworks for the six months ended August 3, 2019 (in thousands):
| | | | | | | | | |
|
| | |
| Foreign |
| | | |
| | February 2, | | Currency | | August 3, | |||
| | 2019 | | Translation | | 2019 | |||
RH Segment |
| |
|
| |
|
| |
|
Goodwill | | $ | 124,379 | | $ | (9) | | $ | 124,370 |
Tradenames, trademarks and domain names | |
| 48,563 | |
| — | |
| 48,563 |
| |
|
| |
|
| |
|
|
Waterworks (1) | |
|
| |
|
| |
|
|
Tradename (2) | |
| 37,459 | |
| — | |
| 37,459 |
NOTE 5—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accounts payableLease right-of-use assets and accrued expenses consist of the following (in thousands):
| | | | | | |
|
| August 3, |
| February 2, | ||
| | 2019 | | 2019 | ||
Accounts payable | | $ | 145,583 | | $ | 183,039 |
Accrued compensation | |
| 47,979 | |
| 64,192 |
Accrued freight and duty | |
| 24,115 | |
| 20,787 |
Accrued sales taxes | |
| 18,743 | ��� |
| 18,354 |
Accrued catalog costs | |
| 14,490 | |
| 10,276 |
Accrued occupancy | |
| 11,528 | |
| 10,839 |
Accrued professional fees | |
| 3,442 | |
| 2,050 |
Other accrued expenses | |
| 23,833 | |
| 10,960 |
Total accounts payable and accrued expenses | | $ | 289,713 | | $ | 320,497 |
13
Other currentlease liabilities consist of the following (in thousands):
| | | | | | |
|
| August 3, |
| February 2, | ||
| | 2019 | | 2019 | ||
Provision for legal settlement (1) | | $ | 50,171 | | $ | 50,000 |
Allowance for sales returns | | | 22,380 | | | 19,821 |
Current portion of debt | |
| 21,514 | |
| 892 |
Unredeemed gift card and merchandise credit liability | |
| 17,177 | |
| 17,192 |
Finance lease liabilities | | | 8,127 | | | 9,184 |
Product recall reserve | |
| 4,647 | |
| 7,767 |
Federal tax payable | |
| 2,413 | |
| 719 |
Other current liabilities | |
| 5,454 | |
| 3,881 |
Total other current liabilities | | $ | 131,883 | | $ | 109,456 |
| | | | | | | | |
| | | | August 1, | | February 1, | ||
| | | | 2020 | | 2020 | ||
| | Balance Sheet Classification | | | | | | |
Assets | | | | | | | | |
Operating leases | | Operating lease right-of-use assets | | $ | 404,508 | | $ | 410,904 |
Finance leases (1)(2) | | Property and equipment—net | | | 732,047 | | | 642,117 |
Total lease right-of-use assets | | | | $ | 1,136,555 | | $ | 1,053,021 |
| | | | | | | | |
Liabilities | | | | | | | | |
Current (3) | | | | | | | | |
Operating leases | | Operating lease liabilities | | $ | 63,866 | | $ | 58,924 |
Finance leases | | Other current liabilities | | | 14,117 | | | 9,188 |
Total lease liabilities—current | | | | | 77,983 | | | 68,112 |
| | | | | | | | |
Non-current | | | | | | | | |
Operating leases | | Non-current operating lease liabilities | | | 406,012 | | | 409,930 |
Finance leases | | Non-current finance lease liabilities | | | 492,136 | | | 442,988 |
Total lease liabilities—non-current | | | | | 898,148 | | | 852,918 |
Total lease liabilities | | | | $ | 976,131 | | $ | 921,030 |
(1) |
Contract Liabilities
The Company defers revenue associated with merchandise delivered via the home-delivery channel. The Company expects that substantially all of the deferred revenue, customer deposits and deferred membership fees as of August 3, 2019 will be recognized within the next six months as the performance obligations are satisfied.
In addition, the Company defers revenue when cash payments are received in advance of performance for unsatisfied obligations related to its gift cards and merchandise credits. During the three months ended August 3, 2019 and August 4, 2018, the Company recognized $4.6 million and $4.8 million, respectively, of revenue related to previous deferrals related to its gift cards and merchandise credits. During the six months ended August 3, 2019 and August 4, 2018, the Company recognized $9.3 million and $9.7 million, respectively, of revenue related to previous deferrals related to its gift cards and merchandise credits. During both the three months ended August 3, 2019 and August 4, 2018, the Company recorded gift card breakage of $0.4 million. During both the six months ended August 3, 2019 and August 4, 2018, the Company recorded gift card breakage of $0.8 million. The Company expects that approximately 70% of the remaining gift card and merchandise credit liabilities as of August 3, 2019 will be recognized within the next twelve months as the gift cards are redeemed by customers.
NOTE 6—OTHER NON-CURRENT OBLIGATIONS
Other non-current obligations consist of the following (in thousands):
| | | | | | |
|
| August 3, |
| February 2, | ||
| | 2019 | | 2019 | ||
Notes payable for share repurchases | | $ | 18,741 | | $ | 18,741 |
Unrecognized tax benefits | |
| 3,222 | |
| 2,992 |
Rollover units and profit interests (1) | |
| 2,850 | |
| 2,637 |
Deferred contract incentive (2) | |
| 1,786 | |
| 2,976 |
Other non-current obligations | |
| 3,549 | |
| 5,166 |
Total other non-current obligations | | $ | 30,148 | | $ | 32,512 |
(2) |
.
14
NOTE 7—LEASES
Accounting Policy
The Company leases nearly all of its retail and outlet store locations, corporate headquarters, distribution and home delivery facilities, as well as other storage and office space. The initial lease terms of the Company’s real estate leases generally range from ten to fifteen years, and certain leases contain renewal options for up to an additional 25 years, the exercise of which is at the Company’s sole discretion. In recognizing the lease right-of-use assets and lease liabilities, the Company utilizes the lease term for which it is reasonably certain to use the underlying asset, including consideration of options to extend or terminate the lease. The Company also leases certain equipment with lease terms generally ranging from three to seven years. The Company’s lease agreements generally do not contain any material residual value guarantees or material restrictions or covenants.
Leases, or lease extensions, with a term of twelve months or less are not recorded on the condensed consolidated balance sheets, and the Company recognizes lease expense for these leases on a straight-line basis over the lease term.
The Company accounts for lease and non-lease components as a single lease component for real estate leases, and for all other asset classes the Company accounts for the components separately. The Company determines the lease classification and begins to recognize lease and any related financing expenses upon the lease’s commencement, which for real estate leases is generally upon store opening or, to a lesser extent, when the Company takes possession or control of the asset.
As most of the Company’s leases do not include an implicit interest rate, the Company determines the discount rate for each lease based upon the incremental borrowing rate (“IBR”) in order to calculate the present value of lease payments at the commencement date. The IBR is computed as the rate of interest that the Company would have to pay to (i) borrow on a collateralized basis (ii) over a similar term (iii) an amount equal to the total lease payments and (iv) in a similar economic environment. The Company utilizes its asset based credit facility as the basis for determining the applicable IBR for each lease.
Certain of the Company’s lease agreements include rental payments based on a percentage of retail sales over contractual levels. Due to the variable and unpredictable nature of such payments, the Company does not recognize a lease right-of-use asset and lease liability related to such payments. Estimated variable rental payments are included in accounts payable and accrued expenses on the condensed consolidated balance sheets.
The Company has a small group of leases that include rental payments periodically adjusted for inflation (e.g., based on the consumer price index). The Company includes these variable payments in the initial measurement of the lease right-of-use asset and lease liability if such increases have a minimum rent escalation (e.g., floor). However, the Company excludes these variable payments from the initial measurement of the lease right-of-use asset and lease liability in the case of lease arrangements that do not specify a minimum rent escalation.
The Company rents or subleases certain real estate to third parties under operating leases and recognizes rental income received on a straight-line basis over the lease term, which is recorded as an offset to selling, general and administrative expenses on the condensed consolidated statements of income.
Lease arrangements may require the landlord to provide tenant allowances directly to the Company. Standard tenant allowances received from landlords, typically those received under operating lease agreements, are recorded as cash and cash equivalents with an offset recorded in lease right-of-use assets on the condensed consolidated balance sheets. In certain instances tenant allowances are provided for the Company to design and build the leased asset. Tenant allowances received from landlords during the construction phase of a leased asset and prior to lease commencement are recorded as cash and cash equivalents with an offset recorded in other non-current assets (to the extent the Company has incurred related capital expenditure for construction costs) or in other current liabilities (to the extent that payments are received prior to capital construction expenditures by the Company) on the condensed consolidated balance sheets. After the leased asset is constructed and the lease commences, the Company reclassifies the tenant allowance from other non-current assets or other current liabilities to lease right-of-use assets on the condensed consolidated balance sheets.
15
Lease Classification
Certain of the Company’s real estate and property and equipment are held under finance leases. Lease related assets are included in finance lease right-of-use assets within property and equipment—net on the condensed consolidated balance sheets.
Leases that do not meet the definition of a finance lease are considered operating leases. Lease related assets are included in operating lease right-of-use assets on the condensed consolidated balance sheets.
Construction Related Activities
The Company is sometimes involved in the construction of leased stores for certain of its newer Design Galleries. Prior to construction commencement, the Company evaluates whether or not it, as lessee, controls the asset being constructed and, depending on the extent to which it is involved, the Company may be the “deemed owner” of the leased asset for accounting purposes during the construction period.
If the Company is not the “deemed owner” for accounting purposes during the construction period, such lease is classified as either an operating or finance lease upon lease commencement. During the construction period and prior to lease commencement, any capital amounts contributed by the Company toward the construction of the leased asset (excluding normal leasehold improvements, which are recorded within property and equipment—net) are recorded as “Landlord assets under construction” within other non-current assets on the condensed consolidated balance sheets (refer to Note 3—Prepaid Expense and Other Assets). Upon completion of the construction project, and upon lease commencement, the Company reclassifies amounts of the construction project determined to be the landlord asset to lease right-of-use assets on the condensed consolidated balance sheets. The construction costs determined not to be part of the leased asset are classified as property and equipment—net on the condensed consolidated balance sheets.
If the Company is the “deemed owner” for accounting purposes, upon commencement of the construction project, it is required to capitalize (i) costs incurred by the Company and (ii) the cash and non-cash assets contributed by the landlord for construction as property and equipment on its condensed consolidated balance sheets as build-to-suit assets, with an offsetting financing obligation under build-to-suit lease transactions. 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 the consolidated statements of cash flows. Over the lease term, these non-cash additions to property and equipment do not impact the Company’s cash outflows, nor do they impact net income within the consolidated statements of income.
Upon completion of the construction project, the Company performs a sale-leaseback analysis to determine if it can derecognize the build-to-suit asset and corresponding financing obligation. If the asset and liability cannot be derecognized, the Company accounts for the agreement as a debt-like arrangement.
16
(3) | Current portion of lease liabilities represents the reduction of the related lease liability over the next 12 months. |
Lease Disclosures
Lease costs—net consist
The maturities of the followinglease liabilities are as follows as of August 1, 2020 (in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | |||||||||||||||||
| | August 3, |
| August 4, | | August 3, |
| August 4, | |||||||||||||
|
| 2019 |
| 2018 | | 2019 |
| 2018 | |||||||||||||
Operating lease cost (1)(2) | | $ | 23,259 | | $ | 22,743 |
| $ | 42,376 | | $ | 44,089 | |||||||||
| | | | | | | | | | | | | |||||||||
Finance lease costs | | | | | | | | | | | | | |||||||||
Amortization of leased assets (1) | | | 9,235 | | | 6,441 | | | 18,087 | | | 12,340 | |||||||||
Interest on lease liabilities (3) | | | 5,672 | | | 3,319 | | | 11,186 | | | 6,411 | |||||||||
| | | | | | | | | | | | | |||||||||
Sublease income (4) | | | (1,507) | | | (2,261) | | | (4,789) | | | (3,271) | |||||||||
Total lease costs—net | | $ | 36,659 | | $ | 30,242 | | $ | 66,860 | | $ | 59,569 | |||||||||
Fiscal year | | Operating | | Finance | | Total | |||||||||||||||
Remainder of fiscal 2020 | | $ | 41,441 | | $ | 19,253 | | $ | 60,694 | ||||||||||||
2021 | | | 75,412 | | | 38,591 | | | 114,003 | ||||||||||||
2022 | | | 64,215 | | | 39,009 | | | 103,224 | ||||||||||||
2023 | | | 58,766 | | | 39,423 | | | 98,189 | ||||||||||||
2024 | | | 54,712 | | | 39,910 | | | 94,622 | ||||||||||||
2025 | | | 54,447 | | | 41,135 | | | 95,582 | ||||||||||||
Thereafter | | | 218,467 | | | 594,040 | | | 812,507 | ||||||||||||
Total lease payments (1)(2) | | | 567,460 | | | 811,361 | | | 1,378,821 | ||||||||||||
Less—imputed interest (3) | | | (97,582) | | | (305,108) | | | (402,690) | ||||||||||||
Present value of lease liabilities | | $ | 469,878 | | $ | 506,253 | | $ | 976,131 |
(1) |
(2) |
(3) |
Lease right-of-use assets and lease liabilities consist
Supplemental information related to leases consists of the following:
| | | | | | | | | | | | |
| | | | Six Months Ended | ||||||||
| | | | August 1, | | August 3, | ||||||
| | | | 2020 |
| 2019 | ||||||
Weighted-average remaining lease term (years) | | | | | | | | | | | | |
Operating leases | | | | | | | | | 9.0 | | | 8.9 |
Finance leases | | | | | | | | | 18.8 | | | 18.9 |
| | | | | | | | | | | | |
Weighted-average discount rate | | | | | | | | | | | | |
Operating leases | | | | | | | | | 3.91% | | | 3.81% |
Finance leases | | | | | | | | | 5.04% | | | 5.26% |
Other information related to leases consists of the following (in thousandsthousands):
):
| | | | | | | | |
| | | | August 3, | | February 2, | ||
| | | | 2019 | | 2019 | ||
| | Balance Sheet Classification | | | | | | |
Assets | | | | | | | | |
Operating leases | | Operating lease right-of-use assets | | $ | 421,001 | | $ | 440,504 |
Finance leases (1)(2) | | Property and equipment—net | | | 650,699 | | | 646,875 |
Total lease right-of-use assets | | | | | 1,071,700 | | | 1,087,379 |
| | | | | | | | |
Liabilities | | | | | | | | |
Current | | | | | | | | |
Operating leases | | Operating lease liabilities | | $ | 57,162 | | $ | 66,249 |
Finance leases | | Other current liabilities | | | 8,127 | | | 9,184 |
Total lease liabilities—current | | | | | 65,289 | | | 75,433 |
| | | | | | | | |
Non-current | | | | | | | | |
Operating leases | | Non-current operating lease liabilities | | $ | 415,803 | | $ | 437,557 |
Finance leases | | Non-current finance lease liabilities | | | 433,591 | | | 421,245 |
Total lease liabilities—non-current | | | | | 849,394 | | | 858,802 |
Total lease liabilities | | | | $ | 914,683 | | $ | 934,235 |
| | | | | | |
| | Six Months Ended | ||||
| | August 1, |
| August 3, | ||
| | 2020 |
| 2019 | ||
Cash paid for amounts included in the measurement of lease liabilities | | | | | | |
Operating cash flows from operating leases | | $ | (26,413) | | $ | (53,670) |
Operating cash flows from finance leases | | | (6,767) | | | (11,186) |
Financing cash flows from finance leases | | | (4,641) | | | (4,399) |
Total cash outflows from leases | | $ | (37,821) | | $ | (69,255) |
| | | | | | |
Lease right-of-use assets obtained in exchange for lease obligations—net of lease terminations (non-cash) | | | | | | |
Operating leases | | $ | 27,880 | | $ | 17,997 |
Finance leases | | | 57,286 | | | 13,839 |
1715
Sale-Leaseback Transaction
In July 2020, we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $25.5 million, which qualified for sale-leaseback accounting in accordance with ASC 842. Concurrently with the sale, we entered into an operating leaseback arrangement with an initial lease term of 20 years and a renewal option for an additional 10 years. We recognized a loss related to the execution of the sale transaction of $9.4 million in the three months ended August 1, 2020, which was recorded in selling, general and administrative expenses on the condensed consolidated statements of income.
Long-lived Asset Impairment
During the first quarter of fiscal 2020, we recognized long-lived asset impairment charges of $3.5 million related to 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—CONVERTIBLE SENIOR NOTES
$350 million 0.00% Convertible Senior Notes due 2024
In September 2019, we issued in a private offering $350 million principal amount of 0.00% convertible senior notes due 2024 (the “2024 Notes”). The 2024 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2024 Notes will mature on September 15, 2024, unless earlier purchased by us or converted. The 2024 Notes will not bear interest, except that the 2024 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2024 Notes. The 2024 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events are also considered “events of default” under the 2024 Notes, which may result in the acceleration of the maturity of the 2024 Notes, as described in the indenture governing the 2024 Notes. Events of default under the indenture for the 2024 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2024 Notes then outstanding.
The initial conversion rate applicable to the 2024 Notes is 4.7304 shares of common stock per $1,000 principal amount of 2024 Notes, or a total of approximately 1.656 million shares for the total $350 million principal amount. This initial conversion rate is equivalent to an initial conversion price of approximately $211.40 per share, which represents a 25% premium to the $169.12 closing share price on the day the 2024 Notes were priced. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the 2024 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2024 Notes in connection with such make-whole fundamental change.
Prior to June 15, 2024, the 2024 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after December 31, 2019, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the 5 consecutive business day period after any 10 consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2024 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As
16
The maturities of lease liabilities areAugust 1, 2020, none of these conditions have occurred and, as followsa result, the 2024 Notes were not convertible as of August 3, 20191, 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 sheets. During the three months ended August 1, 2020, we recorded $0.1 million related to the amortization of debt issuance costs related to the 2024 Notes. During the six months ended August 1, 2020 we recorded $0.3 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):
| | | | | | | | | |
Fiscal year |
| Operating |
| Finance |
| Total | |||
Remainder of fiscal 2019 | | $ | 33,456 | | $ | 14,014 | | $ | 47,470 |
2020 | | | 78,990 | | | 33,456 | | | 112,446 |
2021 | | | 65,068 | | | 33,908 | | | 98,976 |
2022 | | | 57,226 | | | 34,385 | | | 91,611 |
2023 | | | 53,867 | | | 35,153 | | | 89,020 |
2024 | | | 49,901 | | | 35,689 | | | 85,590 |
Thereafter | | | 228,093 | | | 548,302 | | | 776,395 |
Total lease payments (1) | | | 566,601 | | | 734,907 | | | 1,301,508 |
Less—imputed interest (2) | | | (93,636) | | | (293,189) | | | (386,825) |
Present value of lease liabilities (3) | | $ | 472,965 | | $ | 441,718 | | $ | 914,683 |
| | | | | | |
|
| August 1, |
| February 1, | ||
| | 2020 | | 2020 | ||
Liability component |
| |
|
| |
|
Principal | | $ | 350,000 | | $ | 350,000 |
Less: Debt discount | |
| (73,839) | |
| (81,634) |
Net carrying amount | | $ | 276,161 | | $ | 268,366 |
Equity component (1) | | $ | 87,252 | | $ | 87,252 |
(1) |
Supplemental informationWe recorded interest expense of $3.9 million and $7.8 million for the amortization of the debt discount related to leases consists of the following:
| | | | | | |
| | Six Months Ended | ||||
| | August 3, | | | August 4, | |
|
| 2019 |
| | 2018 | |
Weighted-average remaining lease term (years) | | | | | | |
Operating leases | | | 8.9 | | | 9.6 |
Finance leases | | | 18.9 | | | 18.4 |
| | | | | | |
Weighted-average discount rate | | | | | | |
Operating leases | | | 3.81% | | | 3.74% |
Finance leases | | | 5.26% | | | 4.95% |
Other information related to leases consists of2024 Notes during the following (in thousands):
| | | | | | |
| | Six Months Ended | ||||
| | August 3, | | | August 4, | |
|
| 2019 |
| | 2018 | |
Cash paid for amounts included in the measurement of lease liabilities | | | | | | |
Operating cash flows from operating leases | | $ | (53,670) | | $ | (54,287) |
Operating cash flows from finance leases | | | (11,186) | | | (6,411) |
Financing cash flows from finance leases | | | (4,399) | | | (3,567) |
Total cash outflows from leases | | $ | (69,255) | | $ | (64,265) |
| | | | | | |
Lease right-of-use assets obtained in exchange for lease obligations (non-cash) | | | | | | |
Finance leases | | $ | 17,997 | | $ | 27,874 |
Operating leases | | | 13,839 | | | 15,024 |
three and six months ended August 1, 2020, respectively.
1817
NOTE 8—CONVERTIBLE SENIOR NOTES2024 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, the Companywe 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 the Companyus 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 theour failure of the Company to perform certain of itsour 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 the Companyus or any of itsour subsidiaries. Certain events are also considered “events of default” under the 2023 Notes, which may result in the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes. Events of default under the indenture for the 2023 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2023 Notes then outstanding.
The initial conversion rate applicable to the 2023 Notes is 5.1640 shares of common stock per $1,000 principal amount of 2023 Notes, which is equivalent to an initial conversion price of approximately $193.65 per share. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the Company2023 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 will beare 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 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 5 consecutive business day period after any 10
18
consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2023 Notes for such trading day was less than 98% of the product of the last reported sale price of 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 August 3, 2019,1, 2020, none of these conditions have occurred and, as a result, the 2023 Notes were not convertible as of August 3, 2019.1, 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 the Company’sour election, in cash, shares of the Company’sour common stock, or a combination of cash and shares of the Company’sour 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.
The CompanyWe 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 the Companyus 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, the Companywe 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.
19
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, 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 2023 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity (deficit).equity.
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. Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2023 balance on the condensed consolidated balance sheets. During both the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded $0.3 million and $0.1 million, respectively, related to the amortization of debt issuance costs. During both the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded $0.5 million and $0.1 million related to the amortization of debt issuance costs, respectively.costs.
The carrying values of the 2023 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows (in thousands):
| | | | | | | | | | | | |
|
| August 3, |
| February 2, |
| August 1, |
| February 1, | ||||
| | 2019 | | 2019 | | 2020 | | 2020 | ||||
Liability component |
| |
|
| |
|
| |
|
| |
|
Principal | | $ | 335,000 | | $ | 335,000 | | $ | 335,000 | | $ | 335,000 |
Less: Debt discount | |
| (73,152) | |
| (81,311) | |
| (56,036) | |
| (64,729) |
Net carrying amount | | $ | 261,848 | | $ | 253,689 | | $ | 278,964 | | $ | 270,271 |
Equity component (1) | | $ | 90,990 | | $ | 90,990 | | $ | 90,990 | | $ | 90,990 |
(1) | Included in additional paid-in capital on the condensed consolidated balance sheets. |
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The CompanyTable of Contents
We recorded interest expense of $4.1$4.4 million and $1.8$4.1 million for the amortization of the debt discount related to the 2023 Notes during the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, respectively. The CompanyWe recorded interest expense of $8.2$8.7 million and $1.8$8.2 million for the amortization of the debt discount related to the 2023 Notes during the six months ended August 3, 20191, 2020 and August 4, 2018,3, 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, the Companywe entered into convertible note hedge transactions whereby the Company haswe have the option to purchase a total of approximately 1.71.730 million shares of itsour 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, the Companywe sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.71.730 million shares of the Company’sour 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). The CompanyWe 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 the Company’sour 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.
The CompanyWe 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.
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$300 million 0.00% Convertible Senior Notes due 2020
In June 2015, the Companywe issued in a private offering $250 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, the Companywe issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of itsour June 2015 offering (collectively, the “2020 Notes”). The 2020 Notes arewere 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 the Company or converted. The 2020 Notes willdid not bear interest, except that the 2020 Notes will bewere 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 2020 Notes. The 2020 Notes arewere unsecured obligations and dodid 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 arewere also considered “events of default” under the 2020 Notes, which may resultcould have resulted in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes. The 2020 Notes arewere guaranteed by the Company’sour 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.2020 Notes matured on July 15, 2020.
The initial conversion rate applicable to the 2020 Notes iswas 8.4656 shares of common stock per $1,000 principal amount of 2020 Notes, which iswas equivalent to an initial conversion price of approximately $118.13 per share. The conversion rate will bewas subject to adjustment upon the occurrence of certain specified events, but willwas 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 Company will,2020 Notes, we would, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that electselected 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 calendar 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 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
20
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 August 3,The first condition was satisfied during the calendar quarter ended December 31, 2019 none of these conditions have occurred and, as a result, theaccordingly, holders were eligible to convert their 2020 Notes were not convertible as of August 3, 2019. 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 maycould 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 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 per note to be received upon conversion of $1,000.time.
The Company 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 Company 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.
21
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 debt discount will bewas amortized to interest expense using an effective interest rate of 6.47% over the expected life of the 2020 Notes. The equity component iswas not remeasured as long as it continuescontinued to meet the conditions for equity classification.
In accounting for the debt issuance costs related to the issuance of the 2020 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 2020 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity (deficit).
Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $3.8 million and third party offering costs of $2.3 million. In accounting for the debt issuance costs related to the issuance of the 2020 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component were amortized to interest expense using the effective interest method over the expected life of the 2020 Notes, and debt issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.
Discounts and third party offering costs attributable to the liability component arewere recorded as a contra-liability and arewere presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets. During both the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded $0.3 million related to the amortization of debt issuance costs. During both the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded $0.6 million and $0.5 million related to the amortization of debt issuance costs, respectively.costs.
TheIn May 2020, $9.4 million in aggregate principal amount of 2020 Notes were converted at the option of the noteholders. We paid $9.2 million in cash and delivered 14,927 shares of common stock to settle the converted 2020 Notes. As a result, we recognized a gain on extinguishment of the liability component of $0.2 million in the three months ended August 1, 2020. We also received 14,927 shares of common stock from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes as described below, and therefore, on a net basis did not issue any shares of our common stock in respect to such settlement of the 2020 Notes.
In July 2020, upon the maturity of the 2020 Notes, the remaining $290.6 million in aggregate principal amount of the 2020 Notes were converted at the option of the noteholders. We paid $290.6 million in cash and delivered 1,116,718 shares of common stock to settle the converted 2020 Notes. NaN gain or loss arose on extinguishment of the liability component. We also received 1,116,735 shares of common stock from the exercise of the remainder of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes as described below, and therefore, on a net basis received 17 shares of our common stock (which were recorded as treasury stock within the condensed consolidated statements of stockholders’ equity) in respect to such settlement of the 2020 Notes.
21
As of August 1, 2020, the 2020 Notes are 0 longer outstanding. As of February 1, 2020, the carrying values of the 2020 Notes, excluding the discounts upon original issuance and third party offering costs, arewas as follows (in thousands):
| | | | | | | | | |
|
| August 3, |
| February 2, |
| February 1, | |||
| | 2019 | | 2019 | | 2020 | |||
Liability component | | | |
| |
|
| |
|
Principal | | $ | 300,000 | | $ | 300,000 | | $ | 300,000 |
Less: Debt discount | |
| (18,132) | |
| (27,081) | |
| (8,890) |
Net carrying amount | | $ | 281,868 | | $ | 272,919 | | $ | 291,110 |
Equity component (1) | | $ | 84,003 | | $ | 84,003 | | $ | 84,003 |
(1) | Included in additional paid-in capital on the condensed consolidated balance sheets. |
The Company
We recorded interest expense of $4.5$4.2 million and $4.2$4.5 million for the amortization of the debt discount related to the 2020 Notes during the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, respectively. The CompanyWe recorded interest expense of $8.9 million and $8.4 million for the amortization of the debt discount related to the 2020 Notes during both the six months ended August 3, 20191, 2020 and August 4, 2018, respectively.3, 2019.
22
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 had 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 strike price of $189.00 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 5.1 million shares of common stock (which cap may also be subject to adjustment). 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 the warrants arewere 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 meetmet certain accounting criteria, the convertible note hedges and warrants arewere 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.
As a result of the operation of the bond hedge in connection with the maturity of the 2020 Notes, we were not required to issue any new shares to settle the notes as these shares were delivered to us under the terms of the bond hedge. The Companybond hedge was exercised in connection with the maturity date of the 2020 Notes. The warrants will expire through January 2021. To the extent they are exercised prior to expiration, the warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants.
We recorded a deferred tax liability of $32.8 million in connection with the debt discount associated with the 2020 Notes and recorded a deferred tax asset of $26.6 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.
0.00% Convertible Senior Notes due 2019
In June 2014, the Company issued $350 million principal amount of 0.00% convertible senior notes due 2019 (the “2019 Notes”) in a private offering. The 2019 Notes were governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2019 Notes did not bear interest, except that the 2019 Notes were subject to “special interest” in certain limited circumstances in the event of the failure of the Company to perform certain of its obligations under the indenture governing the 2019 Notes. The 2019 Notes were unsecured obligations and did not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by the Company or any of its subsidiaries. Certain events were also considered “events of default” under the 2019 Notes, which could result in the acceleration of the maturity of the 2019 Notes, as described in the indenture governing the 2019 Notes. The 2019 Notes matured on June 15, 2019.
The initial conversion rate applicable to the 2019 Notes was 8.6143 shares of common stock per $1,000 principal amount of 2019 Notes, which was equivalent to an initial conversion price of approximately $116.09 per share. The conversion rate was subject to adjustment upon the occurrence of certain specified events, but was not adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change,” the Company would, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elected to convert its 2019 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2019, the 2019 Notes were 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 calendar 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 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 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. On and after March 15, 2019, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders could have converted all or a portion of their 2019 Notes at any time, regardless of the foregoing circumstances.
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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 debt discount was amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component was not remeasured as long as it continued to meet the conditions for equity classification.
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 were 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 were netted with the equity component in stockholders’ equity (deficit).
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 were recorded as a contra-liability and were presented net against the convertible senior notes due 2019 balance on the condensed consolidated balance sheets. During the three months ended August 3, 2019 and August 4, 2018, the Company recorded $0.2 million and $0.3 million, respectively, related to the amortization of debt issuance costs. During the six months ended August 3, 2019 and August 4, 2018, the Company recorded $0.4 million and $0.5 million, respectively, related to the amortization of debt issuance costs.
In June 2019, upon the maturity of the 2019 Notes, $350.0 million in aggregate principal amount of the 2019 Notes were settled for $349.0 million in cash and 42 shares of common stock. As a result, the Company recognized a gain on extinguishment of debt of $1.0 million.
As of August 3, 2019, the 2019 Notes are no longer outstanding. As of February 2, 2019, the carrying value of the 2019 Notes, excluding the discounts and commissions payable to the initial purchasers and third party offering costs, was as follows (in thousands):
| | | |
|
| February 2, | |
| | 2019 | |
Liability component |
| |
|
Principal | | $ | 350,000 |
Less: Debt discount | |
| (5,854) |
Net carrying amount | | $ | 344,146 |
Equity component (1) | | $ | 70,482 |
The Company recorded interest expense of $2.0 million and $3.8 million for the amortization of the debt discount related to the 2019 Notes during the three months ended August 3, 2019 and August 4, 2018, respectively. The Company recorded interest expense of $5.9 million and $7.5 million for the amortization of the debt discount related to the 2019 Notes during the six months ended August 3, 2019 and August 4, 2018, 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 had 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. The convertible note hedge terminated upon the maturity date of the 2019 Notes. 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
24
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 warrants will expire through December 2019. 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 met certain accounting criteria, the convertible note hedges were, 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 were included innon-current deferred tax assets on the condensed consolidated balance sheets. There is 0no deferred tax asset or liability remaining as of August 3, 20191, 2020 due to the maturity of the 20192020 Notes.
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NOTE 9—10—CREDIT FACILITIES
The outstanding balances under the Company’sour credit facilities were as follows (in thousands):
| | | | | | | | | | | | | | | | | | |
| | August 3, | | February 2, | ||||||||||||||
| | 2019 | | 2019 | ||||||||||||||
| | Outstanding | | Unamortized Debt | | Net Carrying | | Outstanding | | Unamortized Debt | | Net Carrying | ||||||
|
| Amount |
| Issuance Costs |
| Amount |
| Amount |
| Issuance Costs |
| Amount | ||||||
Asset based credit facility | | $ | 145,000 | | $ | — | | $ | 145,000 | | $ | 57,500 | | $ | — | | $ | 57,500 |
FILO term loan |
| | 120,000 |
| | (914) |
| | 119,086 |
| | — |
| | — |
| | — |
Second lien term loan | | | 200,000 | | | (2,738) | | | 197,262 | | | — |
| | — |
| | — |
Equipment promissory notes (1) |
| | 64,007 |
| | (380) |
| | 63,627 |
| | — |
| | — |
| | — |
Total credit facilities | | $ | 529,007 | | $ | (4,032) | | $ | 524,975 | | $ | 57,500 | | $ | — | | $ | 57,500 |
| | | | | | | | | | | | | | | | | | |
| | August 1, | | 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) | | $ | 91,600 | | $ | — | | $ | 91,600 | | $ | — | | $ | — | | $ | — |
Equipment promissory notes (2) |
| | 48,523 |
| | (240) |
| | 48,283 |
| | 53,372 |
| | (310) |
| | 53,062 |
Total credit facilities | | $ | 140,123 | | $ | (240) | | $ | 139,883 | | $ | 53,372 | | $ | (310) | | $ | 53,062 |
(1) | Deferred financing fees associated with the asset based credit facility as of August 1, 2020 and February 1, 2020 were $2.1 million and $2.6 million, respectively, and are included in other non-current assets on the condensed consolidated balance sheets. The deferred financing fees are amortized on a straight-line basis over the life of the revolving line of credit, which has a maturity date of June 28, 2022. |
(2) | Represents total equipment security notes secured by certain of |
Asset Based Credit Facility & FILO 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 (the(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 “First(“First Lien Administrative Agent”)., which amended and restated the Original Credit Agreement. The Credit Agreement has a revolving line of credit with initial availability of up to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 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, whether existing lenders or new lenders, agree to increase their credit commitments. In addition, the Credit Agreement established an $80.0 million last in, last out (“LILO”) term loan facility, which was repaid in full in June 2018.facility. The maturity date of the Credit Agreement has a maturity date ofis 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)
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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. The
We repaid the full amount of the FILO term loan facility hasas of February 1, 2020. As a maturity date of June 28, 2022.
In addition, under the Credit Agreement, the Company is required to meet specified financial ratios in order to undertake certain actions, and the Company 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 trigger for the FCCR occurs if the domestic availability under the revolving line of credit is less than the greater of (i) $40.0 million and (ii) 10%result of the sumrepayment, we incurred a $0.8 million loss on extinguishment of (a)debt in fiscal 2019, which represents the lesseracceleration of (x)amortization of debt issuance costs. We did not incur any prepayment penalties upon the aggregate revolving commitments under the Credit Agreement and (y) the aggregate revolving borrowing base, plus (b) the lesser of (x) the then outstanding amountearly extinguishment of the LILOFILO 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 subject to certain exceptions to maintain an FCCRloan.
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On May 31, 2019, Restoration Hardware, Inc. entered into a fourth amendment to the Credit Agreement (the “Fourth Amendment”). The Fourth Amendment, among other things, amends the Credit Agreement to (a) extend the time to deliver monthly financial statements to the lenders for the fiscal months ending February 2019 and March 2019 until June 19, 2019;2019, (b) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter;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.
AsThe availability of August 3, 2019, the Company had $145.0 million in outstanding borrowingscredit at any given time under the revolving line of credit. The Credit Agreement provides foris limited by reference to a borrowing amountbase formula based onupon numerous factors, including the value of eligible collateralinventory and eligible accounts receivable. As a result of the borrowing base formula, linked to certainactual borrowing percentages based on certain categories of collateral. Under the terms of such provisions, the amountavailability under the revolving line of credit borrowing base that could be available pursuant toless 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 are subject to interest, at the borrowers’ option, at either the bank’s reference rate or London 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 of August 3, 2019 was $254.6 million, net of $12.8 millionsuch terms are defined in outstanding letters of credit.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 and affirmative covenants, including, among others, required financial reporting, 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. The 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 any matter that has resulted or could reasonably be expected to result in a “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 trigger for the FCCR 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 August 3, 2019,1, 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.
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As of August 1, 2020, we had $91.6 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 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 August 1, 2020 was $259.2 million, net of $14.5 million in outstanding letters of credit.
Second Lien Credit Agreement
On April 10, 2019, Restoration Hardware, Inc., entered into a credit agreement, dated as of April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom are funds and accountswere managed or advised by either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and its affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to a second lien term loan in an aggregate principal amount equal to $200.0 million with a maturity date of April 9, 2024 (the “Second Lien Term Loan”). The Second Lien Term Loan of $200.0 million in principal was repaid in full on September 20, 2019.
The Second Lien Term Loan bearsbore interest at an annual rate generally based on the London Inter-bank Offered Rate (“LIBOR”)LIBOR plus 6.50%. This rate iswas a floating rate that resetsreset periodically based upon changes in LIBOR rates during the life of the Second Lien Term Loan. At the date of the initial borrowing, the rate was set at one-month LIBOR plus 6.50%.
All obligations under the Second Lien Term Loan are secured by a second lien security interest in substantially all of the assets of the loan parties, including inventory, receivables and certain types of intellectual property. The second
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lien security interest encumbers substantially the same collateral that secures the Credit Agreement. The second lien ranks junior in priority and is subordinated to the first lien in favor of the lenders with respect to the Credit Agreement.
The borrowings under the Second Lien Credit Agreement may be prepaid in whole or in part at any time, subject to certain minimum payment requirements, and including (i) a prepayment premium in the amount of 2.0% of the principal amount of the Second Lien Term Loan being prepaid during the first year after the effective date of the Second Lien Credit Agreement, (ii) 1.0% of the principal amount of the Second Lien Term Loan being prepaid during the second year after the effective date of the Second Lien Credit Agreement, and (iii) no prepayment premium after the second anniversary of the effective date of the Second Lien Credit Agreement.
The Second Lien Credit Agreement contains a financial ratio covenant not found in the Credit Agreement based upon a net senior secured leverage ratio of consolidated secured debt to consolidated EBITDA, as defined in The Credit Agreement, as follows:
The Second Lien Credit Agreement also contains certain events of default and other customary terms and conditions typical to a second lien credit agreement.
On May 31, 2019, Restoration Hardware, Inc. entered into a first amendment to the Second Lien Credit Agreement (the “First Amendment”). The First Amendment, among other things, amends the Second Lien Credit Agreement to (a) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter and (b) waive any default or event of default under the Second Lien 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.
As of August 3, 2019, the Company had $200.0 million in outstanding borrowings and 0 availability under the Second Lien Credit Agreement.
The Second Lien Credit Agreement contains 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, 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 a similar type and size. As of August 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the Second Lien Credit Agreement.
Intercreditor Agreement
On April 10, 2019, in connection with the Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an Intercreditor Agreement (the “Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the First Lien Administrative Agent and the Second Lien Administrative Agent. The Intercreditor Agreement
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establishes established various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the Credit Agreement and the Second Lien Credit Agreement without the consent of the other party. The Intercreditor Agreement was terminated upon repayment of the Second Lien Term Loan on September 20, 2019.
Equipment Loan Facility
On September 5, 2017, Restoration Hardware, Inc. entered into a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC (“BAL”) pursuant to which BAL and the Companywe agreed that BAL would finance certain equipment of the Companyours from time to time, with each such equipment financing to be evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each equipment loan is secured by a purchase money security interest in the financed equipment. As of August 3, 2019, the Company had $64.0 million in aggregate amounts outstanding under the equipment security notes. The maturity dates of the equipment security notes vary, but generally have a maturity of three or four years. The Company isWe are required to make monthly installment payments under the equipment security notes.
NOTE 10—11—FAIR VALUE MEASUREMENTS
Certain financial assets and liabilities are required to be carried at fair value. Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. In determining the fair value, the Company utilizeswe utilize market data or assumptions that it believeswe believe market participants would use in pricing the asset or liability, which would maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, including assumptions about risk and the risks inherent in the inputs of the valuation technique.
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The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Financial instruments with readily available active quoted prices for which fair value can be measured generally will have a higher degree of pricing observability and a lesser degree of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.
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. |
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.
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Fair Value Measurements—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 2019 Notes, 2020 Notes, 2023 Notes and 20232024 Notes were as follows (in thousands):
| | | | | | | | | | | | |
| | August 3, | | February 2, | ||||||||
| | 2019 | | 2019 | ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying | ||||
| | Value | | Value (1) | | Value | | Value (1) | ||||
Convertible senior notes due 2019 (2) | | $ | — | | $ | — | | $ | 334,756 | | $ | 344,146 |
Convertible senior notes due 2020 | | | 282,338 | | | 281,868 | |
| 260,258 | |
| 272,919 |
Convertible senior notes due 2023 | |
| 263,595 | |
| 261,848 | |
| 230,684 | |
| 253,689 |
| | | | | | | | | | | | |
| | August 1, | | February 1, | ||||||||
| | 2020 | | 2020 | ||||||||
|
| Fair |
| Carrying |
| Fair |
| Carrying | ||||
| | Value | | Value (1) | | Value | | Value (1) | ||||
Convertible senior notes due 2020 (2) | | $ | — | | $ | — | | $ | 295,573 | | $ | 291,110 |
Convertible senior notes due 2023 | | | 276,106 | | | 278,964 | | | 272,623 | | | 270,271 |
Convertible senior notes due 2024 | |
| 251,670 | |
| 276,161 | |
| 255,849 | |
| 268,366 |
(1) | Carrying value represents the principal amount less the equity component of the |
(2) | The |
The fair value of each of the 2019 Notes, 2020 Notes, 2023 Notes and 20232024 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 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 Companyours (Level 2).
Fair Value Measurements—Non-Recurring
The fair value of the Waterworks reporting unit as of February 2, 2019tradename 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 20182019 Form 10-K. The fair value of the asset held for sale as of August 3, 2019 and February 2, 2019 was determined based on an appraisal prepared using unobservable (Level 3) inputs and valuation techniques.
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NOTE 11—12—INCOME TAXES
The CompanyWe recorded income tax expense of $16.7$18.9 million and $2.5$16.7 million in the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, respectively. The CompanyWe recorded income tax expense of $28.5$17.5 million and $10.1$28.5 million in the six months ended August 3, 20191, 2020 and August 4, 2018,3, 2019, respectively. The effective tax rate was 20.7%16.1% and 3.9%20.7% for the three months ended August 3, 20191, 2020 and August 4, 2018,3, 2019, respectively. The effective tax rate was 15.5% and 22.2% for the six months ended August 1, 2020 and 10.3%August 3, 2019, respectively. The decrease in the effective tax rate for both the three months ended August 1, 2020 as compared to the three months August 3, 2019 and the six months ended August 1, 2020 as compared to the six months ended August 3, 2019 and August 4, 2018, respectively. The increase in the effective tax rate is primarily due to lowerhigher discrete tax benefits related to net excess tax windfalls from stock-based compensation in both the three and six months ended August 3, 20192020 as compared to the three and six months ended August 4, 2018.2019.
As of August 3, 2019, the Company1, 2020, we had $8.6$8.7 million of unrecognized tax benefits, of which $7.4 million would reduce income tax expense and the effective tax rate, if recognized. As of February 2, 2019, the Company had $8.5 million of unrecognized tax benefits, of which $7.3$7.9 million would reduce income tax expense and the effective tax rate, if recognized. The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized. As of August 3, 2019, the Company1, 2020, we had $0.4$6.3 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.
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NOTE 12—13—NET INCOME PER SHARE
The weighted-average shares used for net income per share are as follows:
| | | | | | | | | |
| | | Three Months Ended | | Six Months Ended | ||||
| | | August 3, | | August 4, | | August 3, | | August 4, |
| |
| 2019 |
| 2018 |
| 2019 |
| 2018 |
Weighted-average shares—basic | | | 18,465,876 | | 21,925,702 | | 19,221,367 | | 21,735,364 |
Effect of dilutive stock-based awards | |
| 3,858,236 |
| 5,158,591 |
| 4,165,391 |
| 4,421,897 |
Effect of dilutive convertible senior notes (1) | |
| — |
| 412,268 |
| 242,292 |
| 206,134 |
Weighted-average shares—diluted | |
| 22,324,112 |
| 27,496,561 |
| 23,629,050 |
| 26,363,395 |
| | | | | | | | |
|
| Three Months Ended | | Six Months Ended | ||||
|
| August 1, | | August 3, | | August 1, | | August 3, |
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
Weighted-average shares—basic | | 19,386,115 | | 18,465,876 | | 19,314,479 | | 19,221,367 |
Effect of dilutive stock-based awards | | 5,205,159 |
| 3,858,236 |
| 4,787,988 |
| 4,165,391 |
Effect of dilutive convertible senior notes (1) | | 1,973,431 |
| — |
| 1,281,263 |
| 242,292 |
Weighted-average shares—diluted | | 26,564,705 |
| 22,324,112 |
| 25,383,730 |
| 23,629,050 |
(1) | The |
The following number
Dilutive options of options800,854 and restricted stock units717,627 were excluded from the calculation of diluted net income per share for the three months ended August 1, 2020 and August 3, 2019, respectively, because their inclusion would have been anti-dilutive:anti-dilutive. Dilutive options of 521,717 and 590,567 were excluded from the calculation of diluted net income per share for the six months ended August 1, 2020 and August 3, 2019, respectively, because their inclusion would have been anti-dilutive.
| | | | | | | |
| Three Months Ended | | Six Months Ended | ||||
| August 3, | | August 4, | | August 3, | | August 4, |
| 2019 |
| 2018 |
| 2019 |
| 2018 |
Options | 717,627 | | 209,441 | | 590,567 | | 347,978 |
Restricted stock units | — |
| — |
| — |
| 5,250 |
Total anti-dilutive stock-based awards | 717,627 |
| 209,441 |
| 590,567 |
| 353,228 |
NOTE 13—14—SHARE REPURCHASES AND SHARE RETIREMENTS
Share Repurchase Program
On October 10, 2018, the Company’sour Board of Directors authorized a share repurchase program of up to $700.0 million, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700.0 million authorization amount was replenished by the Board of Directors on March 25, 2019. The Company2019 (as replenished, the “$950 Million Repurchase Program”). We did not make any repurchases under this program during the six months ended August 1, 2020. During the first half of fiscal 2019, we repurchased approximately 2.2 million shares of itsour common stock at an average price of $115.36 per share, for an aggregate repurchase amount of approximately $250.0 million during the first quarter of fiscal 2019 under this share repurchase program. The Company did not make any repurchases under this program during the three months ended August 3, 2019. As of August 3, 2019,1, 2020, there was $450.0 million remaining for future share repurchases under this program.
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Share Repurchases Under Equity Plans
As of August 3, 20191, 2020 and February 2, 2019,1, 2020, the aggregate unpaid principal amount of the notes payable for share repurchases was $18.7$18.8 million and $19.6 million, respectively, of which, as of August 3, 2019, $18.7 million were included in other non-current obligations on the condensed consolidated balance sheets and, as of February 2, 2019, $0.9 million were included in other current liabilities and $18.7 million, respectively, which were included in other non-current obligations on the condensed consolidated balance sheets. During both the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded interest expense on the outstanding notes of $0.3 million. During both the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded interest expense on the outstanding notes of $0.5 million.
Of the $18.7$18.8 million and $19.6$18.7 million notes payable for share repurchases outstanding as of August 3, 20191, 2020 and February 2, 2019, respectively,1, 2020, $15.5 million wasis related to a promissory note due to a current board membermember.
Share Retirements
In the first half of fiscal 2020, we retired 600 shares of our common stock related to shares we had repurchased under equity plans. As a result of this retirement, we reclassified a total of $0.1 million from treasury stock to additional paid-in capital on the Company.condensed consolidated balance sheets and on the condensed consolidated statements of stockholders’ equity (deficit) as of August 1, 2020.
In the first half of fiscal 2019, we retired 2,170,154 shares of our common stock related to shares we had repurchased under the $950 Million Repurchase Program. As a result of this retirement, we reclassified a total of $250.3 million from treasury stock, of which $13.2 million was allocated to additional paid-in capital and $237.1 million was allocated to retained earnings (accumulated deficit) on the condensed consolidated balance sheets as of February 1, 2020 and on the condensed consolidated statements of stockholders’ equity (deficit) as of August 3, 2019.
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NOTE 14—15—STOCK-BASED COMPENSATION
The Company estimates the value of equity grants based upon an option-pricing model (“OPM”) and recognizes this estimated value asWe recorded stock-based compensation expense overof $6.9 million and $5.3 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 August 1, 2020 and August 3, 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 income. The CompanyWe recorded stock-based compensation expense of $5.3$12.7 million and $6.1 million during the three months ended August 3, 2019 and August 4, 2018, respectively. The Company recorded stock-based compensation expense of $11.0 million and $14.1 million during the six months ended August 3, 20191, 2020 and August 4, 2018,3, 2019, respectively. NaN 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 August 3, 2019, 7,611,8161, 2020, 7,697,037 options were outstanding with a weighted-average exercise price of $56.68$69.34 per share and 6,178,6145,954,467 options were vested with a weighted-average exercise price of $52.15$53.83 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of August 3, 20191, 2020 was $610.8$1,678.6 million, $587.6$1,596.4 million, and $521.8$1,391.0 million, respectively. Stock options exercisable as of August 3, 20191, 2020 had a weighted-average remaining contractual life of 4.673.9 years. As of August 3, 2019,1, 2020, the total unrecognized compensation expense related to unvested options was $38.3$75.9 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.534.79 years.
As of August 3, 2019, the Company1, 2020, we had 232,774100,010 restricted stock units outstanding with a weighted-average grant date fair value of $49.53$46.63 per share. During the three months ended August 3, 2019, 139,7541, 2020, 86,650 restricted stock units vested with a weighted-average grant date and vest date fair value of $60.99$49.67 per share. During the six months ended August 3, 2019, 164,8891, 2020, 100,575 restricted stock units vested with a weighted-average grant date and vest date fair value of $59.84$52.29 per share. As of August 3, 2019,1, 2020, there was $7.8$3.6 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 2.001.19 years.
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Rollover Units
In connection with the acquisition of Waterworks in May 2016, $1.5 million rollover units in the Waterworks subsidiary (the “Rollover Units”) were recorded as part of the transaction. The Rollover Units are subject to the terms of the Waterworks LLC agreement, including redemption rights at an amount equal to the greater of (i) the $1.5 million remitted as consideration in the business combination or (ii) an amount based on the percentage interest represented in the overall valuation of the Waterworks subsidiary (the “Appreciation Rights”). The Appreciation Rights are measured at fair value and are subject to fair value measurements during the expected life of the Rollover Units, with changes to fair value recorded in the condensed consolidated statements of income. The fair value of the Appreciation Rights is determined based on an OPM. The Companyoption-pricing model (“OPM”). We did not record any expense related to the Appreciation Rights during both the three and six months ended August 3, 20191, 2020 and August 4, 2018.3, 2019. As of both August 3, 20191, 2020 and February 2, 2019,1, 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.
Profit Interests
In connection with the acquisition of Waterworks in May 2016, profit interests units in the Waterworks subsidiary (the “Profit Interests”) were issued to certain Waterworks associates. The Profit Interests are measured at their grant date fair value and expensed on a straight-line basis over their expected life, or five years. The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of income. The fair value of the Profit Interests is determined based on an OPM. For both the three months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded $0.1 million related to the Profit Interests, which is
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included in selling, general and administrative expenses on the condensed consolidated statements of income. For both the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, the Companywe recorded $0.2 million related to the Profit Interests. As of August 3, 20191, 2020 and February 2, 2019,1, 2020, the liability associated with the Profit Interests was $1.4$1.8 million and $1.1$1.6 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.
NOTE 15—16—COMMITMENTS AND CONTINGENCIES
Commitments
The CompanyWe had 0 material off balance sheet commitments as of August 3, 2019.1, 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.
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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. An amended consolidated complaint was filed in June 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The complaint asserts claims purportedly on behalf of a class of purchasers of Companyour common stock from March 26, 2015 to June 8, 2016. The alleged misstatements relate to statements regarding the roll out of the RH Modern product line and the Company’sour inventory levels. The complaint seeks class certification, monetary damages, and other appropriate relief, including an award of costs and attorneys’ fees. On March 21, 2019, the Companywe 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 amount is towas funded entirely by our understanding covered in full by the Company's insurance policies.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 iswas subject to customary conditions including court approval following notice to the Company'sour 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. A hearingThe 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 August 1, 2020, which settlement is scheduled for October 22, 2019. If a settlement is finally approved by the court, it will resolveresolved all of the claims that were or could have been brought in the action. As a result of signing the settlement agreement and the potential liability becoming probable and estimable, the Company has recorded a provision for legal settlement and unpaid legal fees for $50.2 million within other current liabilities on the condensed
32
consolidated balance sheets as of August 3, 2019. Additionally, the Company has recorded a litigation insurance recovery receivable of $50.2 million as of August 3, 2019 within prepaid expense and other current assets on the condensed consolidated balance sheets, which represents the estimated insurance claims proceeds from the Company’s insurance carriers.
Shareholder Derivative Lawsuit
On April 24, 2018, purported Company shareholder David Magnani filed a purported shareholder derivative suit in the United States District Court, Northern District of California, captioned Magnani v. Friedman et al. (No. 18-cv-02452). On June 29, 2018, Hosrof Izmirliyan filed a similar purported shareholder derivative complaint in the same forum, captioned Izmirliyan v. Friedman et al. (No. 18-cv-03930). On July 29, 2018, the court consolidated both derivative actions, and the consolidated action is captioned In re RH Shareholder Derivative Litigation. On August 24, 2018, plaintiffs filed an amended complaint that names RHthe 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. The Company believesWe believe that plaintiffs lack standing to bring this derivative action. On September 28, 2018, the Companywe filed a motion to stay proceedings and a motion to dismiss the consolidated complaint. On January 23, 2019, the court granted the motion to stay the case.case pending resolution of the securities class action discussed above. On March 19, 2020, the parties reached an agreement in principle to settle the litigation and subsequently entered into a stipulation of settlement that was preliminarily approved by the Court on August 3, 2020. The settlement involves certain non-monetary terms as well as payment of the plaintiffs’ attorneys’ legal fees, which payment is expected to be funded by our insurance carriers. The Court will hold a final settlement hearing on October 6, 2020.
NOTE 17—SEGMENT REPORTING
We define reportable and operating segments on the same basis that we use to evaluate our performance internally by the Chief Operating Decision Maker (the “CODM”), which we have determined is our Chief Executive Officer. We have 2 operating segments: RH Segment and Waterworks. The 2 operating segments include all sales channels accessed by our customers, including sales through catalogs, websites, stores, and the commercial channel.
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NOTE 16—SEGMENT REPORTING
The Company defines reportable and operating segments on the same basis that it uses to evaluate performance internally by the Chief Operating Decision Maker (the “CODM”). The Company has determined that the Chief Executive Officer is its CODM. As of August 3, 2019, the Company hadOur 2 operating segments: RH Segment and Waterworks. The two operating segments include all sales channels accessed by the Company’s customers, including sales through catalogs, sales through the Company’s websites, sales through stores, and sales through the commercial channel.
The Company’s two 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 to evaluate segment profitability. Operating income is defined as net income before interest expense—net, (gain) loss on extinguishment of debttradename impairment and income tax expense.
Segment Information
The following tablestable presents the statements of income metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280—Segment Reporting (in thousands):
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | August 3, | | August 4, | ||||||||||||||
| | 2019 | | 2018 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 672,328 | | $ | 34,186 | | $ | 706,514 | | $ | 607,604 | | $ | 33,194 | | $ | 640,798 |
Gross profit | |
| 280,469 | |
| 14,489 | |
| 294,958 | |
| 255,505 | |
| 12,839 | |
| 268,344 |
Depreciation and amortization | |
| 24,170 | |
| 1,151 | |
| 25,321 | |
| 20,236 | |
| 1,118 | |
| 21,354 |
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 681,387 | | $ | 27,895 | | $ | 709,282 | | $ | 672,328 | | $ | 34,186 | | $ | 706,514 |
Gross profit | |
| 320,481 | |
| 11,938 | |
| 332,419 | |
| 280,469 | |
| 14,489 | |
| 294,958 |
Depreciation and amortization | |
| 24,234 | | | 1,108 | |
| 25,342 | |
| 24,170 | | | 1,151 | |
| 25,321 |
| | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 1,136,344 | | $ | 55,833 | | $ | 1,192,177 | | $ | 1,236,034 | | $ | 68,901 | | $ | 1,304,935 |
Gross profit | |
| 508,243 | |
| 23,830 | |
| 532,073 | |
| 498,412 | |
| 29,360 | |
| 527,772 |
Depreciation and amortization | |
| 47,951 | | | 2,261 | |
| 50,212 | |
| 50,174 | | | 2,336 | |
| 52,510 |
The following table presents the balance sheet metrics as required under ASC 280—Segment Reporting (in thousands):
| | | | | | | | | | | | | | | | | | |
| | August 1, | | February 1, | ||||||||||||||
| | 2020 | | 2020 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Goodwill (1) | | $ | 124,350 | | $ | — | | $ | 124,350 | | $ | 124,367 | | $ | — | | $ | 124,367 |
Tradenames, trademarks and domain names (2) | |
| 49,863 | |
| 17,000 | |
| 66,863 | |
| 48,563 | |
| 37,459 | |
| 86,022 |
Total assets | |
| 2,382,857 | |
| 123,552 | |
| 2,506,409 | |
| 2,301,823 | |
| 143,871 | |
| 2,445,694 |
(1) | The Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $17.4 million and $33.7 million impairment recorded in fiscal 2018 and fiscal 2017, respectively. |
(2) | The Waterworks reporting unit tradename is presented net of an impairment charge of $35.1 million, of which $20.5 million was recorded in the first quarter of fiscal 2020 and $14.6 million was recorded in fiscal 2018. Refer to “Waterworks Tradename Impairment” within Note 4—Goodwill, Trademarks, Trademarks and Domain Names. |
We use segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes (i) asset impairments and change in useful lives, (ii) loss on sale leaseback transaction, (iii) severance costs associated with reorganizations, (iv) product recall accruals and adjustments—net and (v) favorable legal settlements, net of legal expenses. 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 review.
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| | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||
| | August 3, | | August 4, | ||||||||||||||
| | 2019 | | 2018 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Net revenues | | $ | 1,236,034 | | $ | 68,901 | | $ | 1,304,935 | | $ | 1,133,611 | | $ | 64,593 | | $ | 1,198,204 |
Gross profit | |
| 498,412 | |
| 29,360 | |
| 527,772 | |
| 451,211 | |
| 26,466 | |
| 477,677 |
Depreciation and amortization | |
| 50,174 | |
| 2,336 | |
| 52,510 | |
| 39,709 | |
| 2,230 | |
| 41,939 |
The following table presents the balance sheet metrics as required under ASC 280—Segment Reporting (in thousands):
| | | | | | | | | | | | | | | | | | |
| | August 3, | | February 2, | ||||||||||||||
| | 2019 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
Goodwill (1) | | $ | 124,370 | | $ | — | | $ | 124,370 | | $ | 124,379 | | $ | — | | $ | 124,379 |
Tradenames, trademarks and domain names (2) | |
| 48,563 | |
| 37,459 | |
| 86,022 | |
| 48,563 | |
| 37,459 | |
| 86,022 |
Total assets | |
| 2,240,904 | |
| 146,904 | |
| 2,387,808 | |
| 2,273,951 | |
| 149,067 | |
| 2,423,018 |
The Company uses segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes (i) asset impairments and change in useful lives, (ii) product recall accruals and adjustments, (iii) legal settlements, net of legal expenses, (iv) severance costs associated with reorganizations, including the closures of distribution centers and the Dallas customer call center as part of the Company’s supply chain reorganization, (v) non-cash amortization of the inventory fair value adjustment recorded in connection with the acquisition of Waterworks and (vi) reversal of an estimated loss on disposal of asset. 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 management reviews.
The following table presents segment operating income and income before income taxes (in thousands):
| | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | ||||||||
| August 1, | | August 3, | | August 1, | | August 3, | ||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
Operating income: | | | | | | | | | | | |
RH Segment | $ | 153,350 | | $ | 104,093 | | $ | 202,867 | | $ | 173,493 |
Waterworks |
| 1,573 | |
| 920 | |
| 123 | |
| 2,014 |
Asset impairments and change in useful lives |
| (1,339) | |
| (2,545) | |
| (9,810) | |
| (6,021) |
Loss on sale leaseback transaction | | (9,352) | | | — | | | (9,352) | | | — |
Reorganization related costs |
| (2,884) | |
| — | |
| (7,027) | |
| — |
Recall accrual |
| (4,780) | |
| 320 | |
| (4,780) | |
| 1,935 |
Legal settlements |
| — | |
| 1,193 | |
| — | |
| 1,193 |
Income from operations |
| 136,568 | |
| 103,981 | |
| 172,021 | |
| 172,614 |
Interest expense—net |
| 19,418 | |
| 24,513 | |
| 39,047 | |
| 45,631 |
Tradename impairment | | — | | | — | | | 20,459 | | | — |
Gain on extinguishment of debt |
| (152) | |
| (954) | |
| (152) | |
| (954) |
Income before income taxes | $ | 117,302 | | $ | 80,422 | | $ | 112,667 | | $ | 127,937 |
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 3, | | August 4, | | August 3, | | August 4, | ||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
Operating income: | | | | | | | | | | | | |
RH Segment | | $ | 104,093 | | $ | 75,804 | | $ | 173,493 | | $ | 124,852 |
Waterworks | |
| 920 | |
| (338) | |
| 2,014 | |
| (228) |
Asset impairments and change in useful lives | |
| (2,545) | |
| — | |
| (6,021) | |
| — |
Recall accrual | |
| 320 | |
| 1,064 | |
| 1,935 | |
| 1,318 |
Legal settlements | |
| 1,193 | |
| 7,204 | |
| 1,193 | |
| 5,289 |
Reorganization related costs | |
| — | |
| (1,721) | |
| — | |
| (1,721) |
Impact of inventory step-up | |
| — | |
| (190) | |
| — | |
| (380) |
Reversal of loss on asset disposal | |
| — | |
| — | |
| — | |
| 840 |
Income from operations | |
| 103,981 | |
| 81,823 | |
| 172,614 | |
| 129,970 |
Interest expense—net | |
| 24,513 | |
| 15,467 | |
| 45,631 | |
| 30,565 |
(Gain) loss on extinguishment of debt | |
| (954) | |
| 917 | |
| (954) | |
| 917 |
Income before income taxes | | $ | 80,422 | | $ | 65,439 | | $ | 127,937 | | $ | 98,488 |
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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 | | Six Months Ended | Three Months Ended | | Six Months Ended | ||||||||||||||||
| | August 3, | | August 4, | | August 3, | | August 4, | August 1, | | August 3, | | August 1, | | August 3, | ||||||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||||
Furniture | | $ | 485,639 | | $ | 430,196 | | $ | 882,337 | | $ | 782,842 | $ | 488,303 | | $ | 485,639 | | $ | 805,082 | | $ | 882,337 |
Non-furniture | |
| 220,875 | |
| 210,602 | |
| 422,598 | |
| 415,362 |
| 220,979 | |
| 220,875 | |
| 387,095 | |
| 422,598 |
Total net revenues | | $ | 706,514 | | $ | 640,798 | | $ | 1,304,935 | | $ | 1,198,204 | $ | 709,282 | | $ | 706,514 | | $ | 1,192,177 | | $ | 1,304,935 |
The Company isWe are domiciled in the United States and primarily operates itsoperate our retail and outlet stores in the United States. As of August 3, 2019, the Company operates1, 2020, we operated 4 retail and 2 outlet stores in Canada and 1 retail store in the U.K. Revenues from Canadian and U.K. operations, and the long-lived assets in Canada and the U.K., are not material to the Company.material. Canada and U.K. geographic revenues are based upon revenues recognized at the retail store locations in the respective country.
NaN single customer accounted for more than 10% of the Company’sour revenues in the three andor six months ended August 3, 20191, 2020 or August 4, 2018.3, 2019.
NOTE 18—SUBSEQUENT EVENT
On August 28, 2020, we completed the acquisition of a home furnishings brand for a preliminary purchase price of $20 million. Due to the close proximity of the acquisition date to the filing date of our Quarterly Report on Form 10-Q for the quarterly period ended August 1, 2020, the initial accounting for this business combination is incomplete, and therefore we are unable to disclose certain information in accordance with ASC 805—Business Combinations. Such information will be included in our Quarterly Report on Form 10-Q for the quarterly period ending October 31, 2020.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and the results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our 20182019 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 and may relaterelating to our financial condition, results of operations, normalized tax rate, free cash flow, growth, plans, capital expenditures, 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 we have made in light of our experience in the industry and our perceptions of historical trends, current conditions, expected future developments and other factorsassumptions. While we believe that our assumptions are reasonable. However,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 includingand 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, in our Quarterly Report on Form 10-Q for the quarterly period ended May 4, 2019 (the “First2, 2020 (“First Quarter Form 10-Q”), and in our Annual Report on Form 10-K for the fiscal year ended February 2, 1, 2020 (“2019 (“2018 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report, in our First Quarter Form 10-Q and in our 20182019 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, 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. In 2015 we began to introduce an integrated hospitality experience, including cafés, wine vaults and barista bars, into a number of our new Gallery locations. We believe this has created a unique newOur 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.
Our 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 ten of our new Design Gallery locations, which include restaurants and wine vaults.
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As of August 3, 2019,1, 2020, we operated the following number of retail Galleries, outlets and showrooms:
| | |
| | Count |
RH | | |
Design Galleries |
|
|
Legacy Galleries | |
|
Modern Galleries | | 2 |
Baby & Child and Teen Galleries | |
|
Total | |
|
Outlets | |
|
| | |
Waterworks Showrooms | | 15 |
The initial wave of the novel coronavirus disease (“COVID-19”) outbreak starting in March 2020 caused disruption to our business operations as we temporarily closed all of our retail locations on March 17, 2020. While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, during the second fiscal quarter we have reopened substantially all of our retail locations. As of the end of the second fiscal quarter on August 3, 2019, six1, 2020 we had reopened 66 out of 68 of our RH Design Galleries, include an integrated RH Hospitality experienceall of our Outlets, and we plan8 out of 10 of our restaurants. In addition, our business has substantially recovered during the second fiscal quarter as a result of both the reopening of most of our retail locations and also due to incorporate hospitality, including cafés, wine vaults and barista barsstrong consumer demand for our products.
As our business has strengthened during the second fiscal quarter, the reduction in manyinventory receipts together with dislocations in our supply chain has resulted in some delays in our ability to convert business demand into shipped sales. Our global supply chain has not fully recovered from the impact of the new Galleries thatCOVID-19 dislocation. Despite the strong growth in consumer demand in our business during the second fiscal quarter, revenue growth has lagged the increase in customer orders. As manufacturing and inventory receipts catch up with this backlog, we openexpect this demand will convert into revenue in the future.next several quarters as our supply chain recalibrates to the new level of our business.
While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
The COVID-19 pandemic may continue to have an adverse impact on elements of our supply chain including the manufacture, supply, distribution, transportation and delivery of our products and our inventory levels. The presence of the virus and the response to the health crisis in various countries can affect the speed at which the factories that manufacture our products are able to resume normal operations and production levels, and the extent to which business conditions are able to return to normal in areas that affect our supply chain including factories and transportation. Furthermore, our hospitality business may not recover as quickly as other parts of our business, as in most of our retail locations that have reopened, substantial operational restrictions related to COVID-19 health and safety considerations, for example limits to seating capacity, have been imposed on such business by various governmental authorities. Such operational restrictions may cause our hospitality offerings to be less attractive to customers or may lower its margins and profitability.
In our initial response to the COVID-19 health crisis we undertook immediate adjustments to our business operations including curtailing expenses and delaying investments including scaling back some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second fiscal quarter.
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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 and initiatives such as the timing of some construction efforts with respect to opening new Gallery locations and optimizing our inventory in light of Outlet inventory buildup resulting from our temporary retail closures. For example, while we have generally experienced positive and improving business trends during the second quarter of fiscal 2020, counterparties with respect to some of our Gallery development projects may experience capital or liquidity constraints due to COVID-19 related difficulties, which may impact the timing or scope of some of our development projects. The impact of COVID-19 abroad, including travel restrictions imposed by various countries, may affect certain aspects of our planned international expansion. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020.
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 the impact of COVID-19. While we have taken measures to defer some capital expenditures and other expenses in response to the COVID-19 health crisis, we expect to resume those investments as and to the extent that conditions for our business continue to improve during the COVID-19 crisis. For more information, refer to Item 1A—Risk Factors—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 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:
● | Elevate and Expand RH Product. Consistent with our luxury brand positioning, we are driving improvements in our product offering as one of the key value driving strategies of our business. While we have expanded our merchandise assortment substantially over a number of years, we are increasingly focused on efforts to elevate our product as opposed to only increasing the size of our product offering. As part of this effort, we are driving continuing enhancements in the taste, quality and style of our products as well as integrating our product offering to offer our customers authoritative collections of home furnishings at the high end of the market. |
As part of these efforts, we continue to attract and collaborate with the following long-term key strategies:best designers, artisans, and manufacturers in our industry, scaling their work across our integrated platform and thereby rendering it more valuable, enabling us to curate a compelling collection of luxury home furnishings to our customers. Our vision is not only to elevate our merchandise offering, but also to offer a broader ecosystem of products and experiences as we move the brand beyond curating and selling product to conceptualizing and selling spaces by building an integrated platform of products, places, services and spaces that elevate and establish the RH brand as a global thought leader, taste and placemaker.
As an example, our product is elevated and rendered more valuable by our architecturally inspiring Galleries, which are further elevated and rendered more valuable by our seamlessly integrated hospitality experience. Our Hospitality efforts will continue to elevate the RH brand as we move beyond the four walls of our Galleries into RH Guesthouses where our goal is to create a new market for travelers seeking privacy and luxury in the hotel industry. Additionally, we are creating bespoke hospitality experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley. These immersive experiences expose existing and new customers to our evolvoing authority in interior design, architecture, landscape architecture and hospitality.
● | Transform Our Real Estate Platform. We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of $5 to $6 billion in North America. We believe we |
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New Design Gallery sites are identified based on a variety of factors, such as (i) the availability of suitable new site locations based on several store specific aspectsfactors including geographic location, demographics, and proximity to affluent consumers, and(ii) the negotiation ofability to negotiate favorable economic terms, to us for the new location, 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.projects, which we have experienced with some of our new Gallery openings from time to time including in connection with the COVID-19 crisis.
Today we operate 24 Design Galleries, and based on our analysis, we believe we have the opportunity to operate Design Galleries in 60 to 70 locations in the United States and Canada. We opened our PortlandMinneapolis Design Gallery in March 2018,September 2019, our NashvilleColumbus Design Gallery in December 2019, our Charlotte Design Gallery in June 2018, as well as2020 and our New York Design Gallery and ourMarin Design Gallery in Yountville, California in the Napa Valley, in September 2018. OurJuly 2020. Nearly all of our new Design Galleries in Nashville, New York and Yountville include integrated cafés,restaurants and wine vaults and barista bars.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 Our 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 future that is based on key learnings from our recent Gallery openings and will range in size from 33,000 leased selling square feet inclusive of our integrated hospitality experience to 29,000 leased selling square feet without. These new Galleries will represent our assortments from RH Interiors, Modern, Baby & Child, Teen and Outdoor and contain interior design offices and presentation rooms where design professionals can work with clients on their projects. Due to the reduced square footage compared to our recent Design Gallery openings and efficient design, this new model will be more capital efficient with less time and cost risk, but yield similar productivity. We anticipate the newdesigns include (i) prototype Design Galleries will represent approximately two thirds of our target markets. Future prototype location examples include Edina, MN, Corte Madera, CA, Columbus, OHthat are suited to many North American markets, similar to those we opened most recently in Charlotte and Charlotte, NC.
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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,Chicago, and we believe they create a long-term competitive advantage that will be difficult to duplicate.
Third, we will continue to open(iii) 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 indigenous Bespoke Galleries include the Hamptons, Palm Beach,vacation including our location in Yountville, and Aspen.
Fourth, we are developing a newCalifornia as well as our 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 shareunder development in markets currently only served by smaller competitors. Examples of target secondary markets include Hartford, CT, 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 within two years in most instances. 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 targets.
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 commencing in fiscal 2020.
We continue to evaluate potential opportunities for standalone RH Baby & Child, RH Teen and RH Modern Galleries in select markets.Aspen, Colorado.
Like our evolving multi-tier market approach, we have developed a multi-tier real estate strategy that is designed to significantly increase our unit level profitability and return on invested capital. Our threeSeveral of our 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 |
● | Second, in |
● | 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, |
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, and pursuit of global expansion will provide RH access to a substantial long-term market opportunity to build a $20 billion global brand over time. 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 |
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● | Grow Our Integrated Hospitality Experience. |
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 have resumed introducing 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 in fiscal 2019 with a goal of building the leading interior design firm in North America. 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.
● | Architect New Operating Platform. We have spent |
● |
During fiscal 2017, we repurchased approximately 20.2 million shares of our common stock under two separate repurchase programs for an aggregate repurchase amount of approximately $1 billion. During fiscal 2018, we repurchased approximately 2.0 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately $250 million. During fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately $250 million. Our focus on cash also resulted in our generating substantial free cash flow in fiscal 2017 through 2019 and we expect this objective to continue to be a priority in fiscal 2020 and 2021 .
● | Increase Operating Margins. |
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Business Initiatives
We are undertaking a large number of new business initiatives in support of our key value driving strategies. In particular, beginning in fiscal 2016 and continuing through fiscal 2019,2020, we have pursued a range of strategic efforts to improve our business and operations including the following:
● | Introduction of Membership Model. In March 2016, we introduced the RH Members Program, an exclusive |
39
preferred financing plans on the RH Credit Card, among |
We believe that the shift to a membership model has positively affected the financial results of our business. Specifically, we believe some of the benefits include:
Improved customer experience. Our interior design professionals can now work with customers based on their timeline and project deadlines, as opposed to our prior promotional calendar. We believe this will lead to larger overall sales transactions for individual customer design projects.
Lower cancellations and returns. As a result of the elimination of time-limited promotional events and the associated pressure of placing an order before a promotion expires, we believe the shift to a membership model has also resulted in lower rates of cancelled orders and returns.
Improved operational costs. The volume of sales, orders and shipments in our business under the prior promotional model was characterized by large spikes in customer orders based upon promotional events followed by lower orders and sales after the end of an event. This buying pattern also affected numerous other aspects of our business, including staffing and costs as we required elevated staffing levels to service the increased number of customers during peak sales events. Likewise, significant fluctuations in sales had downstream implications for our supply chain related to merchandise orders, manufacturing and production, shipment to our distribution centers and final delivery to our customers. All of these aspects of our operations are experiencing improved efficiencies as a result of the membership model whereby sales are more evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales under the prior model.
● |
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 |
● | Elevate the Customer |
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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. |
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In fiscal 2017, fiscal 2018 and continuing into fiscal 2019, we have focused on 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.
We continue to pursue and test numerous initiatives to improve many aspects of our business including through efforts to optimize inventory, elevate the home delivery experience, simplify our distribution network and improve our organizational design including by streamlining and realigning our home office operations, as well as to expandelevate our product offering, and transform our real estate using a range of different models for specific real estate development projects.projects and expand our brand internationally. Many of these initiatives and other initiatives such as our transition to a direct sourcing model for our rug business have improved our operating margins, but other initiatives such as RH Hospitality, Waterworks and investments to develop our international expansion strategy are expected to offset some planned margin improvement in fiscal 2020 due to our investments in these platforms. There can be no assurance as to the timing and extent of the operational benefits and financial contributions of these strategic efforts. In addition, our pursuit of multiple initiatives with respect to our business in any given period may result in period-to-period changes in, and increased fluctuation in, our results of operations. For example,We have also experienced delays in development timelines for some of our efforts to optimize our distribution network could cause us to incur costsrecent projects, and expenses in the short term with respect to changes in the way in which we operate our business. Delaysdelays in completion of our real estate development projects or costs overruns could also negatively affect our results of operation.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. For example, whileWhile we believe that the tariffs imposed to date on most of our goods sourced from China have not had an adverse effect on our results of operations, including our revenues, margins and earnings, there can be no assurance that the existing tariffs and the additional tarriffstariffs 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. In addition, in recent periods the
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 well as periodsa result of significant decline, which may negatively affect the financial health and demand levels of high-end consumers, and we can provide no assurance as to whether such trends will occurstock market declines including in the future.event that heightened market volatility related to the COVID-19 health crisis or other factors including deterioration in market conditions leads to stock price declines. Our business is also correlated to the housing market. The housing market is affected by a range of factors including home prices and interest rates and slowdowns in the housing market can have a negative impact on demand for our products. Factors that affect the higher end housing market in particular may have an outsized influence on our levels of consumer demand since our business is geared toward the higher end of the home furnishings market. The above factors and other current and future operational initiatives may create additional uncertainty with respect to our consolidated net revenues and profit in the near term.
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Basis of Presentation and Results of Operations
Matters Affecting Comparability
The disruption to our business operations from the initial wave of the COVID-19 outbreak has had a significant impact on the comparability of certain ratios and year-over-year trends for our operating results for the three and six months ended August 1, 2020 as compared to the three and six months ended August 3, 2019. The primary negative impact to our revenues from store closures occurred during the first quarter of fiscal 2020, but despite the reopening of most of our Galleries during the second fiscal quarter and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances related to COVID-19 including delays in inventory receipts and manufacturing as our supply chain recovers from the impact of the global health crisis. We have also changed the cadence of our expenses and investments as we have sought to address the impact of COVID-19 on the business. During the first quarter of fiscal 2020, we implemented a number of short-term and long-term initiatives in response to COVID-19 including the implementation of a business reorganization and the deferral of certain investments. During the second fiscal quarter of 2020 we have resumed many investments and previously deferred expenditures but we anticipate that our decisions regarding these matters will continue to evolve in response to changing business circumstances including further developments with respect to COVID-19.
Results of Operations
The following table sets forth our condensed consolidated statements of income and other financial and operating data.
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | | Three Months Ended | Six Months Ended | ||||||||||||||||
| | August 3, | | August 4, | | August 3, | | August 4, | August 1, | | August 3, | | August 1, | | August 3, | ||||||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||||
| | (in thousands) | (in thousands) | ||||||||||||||||||||
Condensed Consolidated Statements of Income: | | | | | | | | | | | | | | | | | | | | | | | |
Net revenues | | $ | 706,514 | | $ | 640,798 | | $ | 1,304,935 | | $ | 1,198,204 | $ | 709,282 | | $ | 706,514 | | $ | 1,192,177 | | $ | 1,304,935 |
Cost of goods sold | |
| 411,556 | |
| 372,454 | |
| 777,163 | |
| 720,527 |
| 376,863 | |
| 411,556 | |
| 660,104 | |
| 777,163 |
Gross profit | |
| 294,958 | |
| 268,344 | |
| 527,772 | |
| 477,677 |
| 332,419 | |
| 294,958 | |
| 532,073 | |
| 527,772 |
Selling, general and administrative expenses | |
| 190,977 | |
| 186,521 | |
| 355,158 | |
| 347,707 |
| 195,851 | |
| 190,977 | |
| 360,052 | |
| 355,158 |
Income from operations | |
| 103,981 | |
| 81,823 | |
| 172,614 | |
| 129,970 |
| 136,568 | |
| 103,981 | |
| 172,021 | |
| 172,614 |
Other expenses | |
|
| |
|
| |
|
| |
|
|
| | | | | | | | | | |
Interest expense—net | |
| 24,513 | |
| 15,467 | |
| 45,631 | |
| 30,565 |
| 19,418 | |
| 24,513 | |
| 39,047 | |
| 45,631 |
(Gain) loss on extinguishment of debt | |
| (954) | |
| 917 | |
| (954) | |
| 917 | |||||||||||
Tradename impairment | | — | | | — | | | 20,459 | | | — | ||||||||||||
Gain on extinguishment of debt |
| (152) | |
| (954) | |
| (152) | |
| (954) | ||||||||||||
Total other expenses | |
| 23,559 | |
| 16,384 | |
| 44,677 | |
| 31,482 |
| 19,266 | |
| 23,559 | |
| 59,354 | |
| 44,677 |
Income before income taxes | |
| 80,422 | |
| 65,439 | |
| 127,937 | |
| 98,488 |
| 117,302 | |
| 80,422 | |
| 112,667 | |
| 127,937 |
Income tax expense | |
| 16,665 | |
| 2,533 | |
| 28,458 | |
| 10,121 |
| 18,879 | |
| 16,665 | |
| 17,456 | |
| 28,458 |
Net income | | $ | 63,757 | | $ | 62,906 | | $ | 99,479 | | $ | 88,367 | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Other Financial and Operating Data: | |
|
| |
|
| |
|
| |
|
|
|
| |
|
| |
|
| |
|
|
Adjusted net income (1) | | $ | 71,430 | | $ | 54,509 | | $ | 119,671 | | $ | 87,161 | $ | 123,013 | | $ | 71,430 | | $ | 152,962 | | $ | 119,671 |
Adjusted EBITDA (2) | | $ | 133,716 | | $ | 103,054 | | $ | 234,101 | | $ | 180,794 | $ | 185,787 | | $ | 133,716 | | $ | 263,214 | | $ | 234,101 |
| | | | | | | | | | | | | | | | | | | | | | | |
Capital expenditures | | $ | 17,367 | | $ | 25,657 | | $ | 25,283 | | $ | 42,916 | $ | 30,899 | | $ | 17,367 | | $ | 47,531 | | $ | 25,283 |
Landlord assets under construction—net of tenant allowances | | | 23,013 | | | 8,997 | | | 27,555 | | | 27,645 | | 15,334 | | | 23,013 | | | 22,934 | | | 27,555 |
Adjusted net capital expenditures (3) | | $ | 40,380 | | $ | 34,654 | | $ | 52,838 | | $ | 70,561 | |||||||||||
Adjusted capital expenditures (3) | $ | 46,233 | | $ | 40,380 | | $ | 70,465 | | $ | 52,838 |
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(1) | Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, generally accepted accounting principles (“GAAP”). We define adjusted net income as consolidated net income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance. Adjusted net income is included in this filing because management believes that adjusted net income provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of |
40
comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter. The following table presents a reconciliation of net income, the most directly comparable GAAP financial measure, to adjusted net income for the periods indicated below. |
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 3, | | August 4, | | August 3, | | August 4, | ||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
| | (in thousands) | ||||||||||
Net income | | $ | 63,757 | | $ | 62,906 | | $ | 99,479 | | $ | 88,367 |
Adjustments pre-tax: | |
|
| |
|
| |
|
| |
|
|
Amortization of debt discount (a) | |
| 9,918 | |
| 9,000 | |
| 21,607 | |
| 16,272 |
Asset impairments and change in useful lives (b) | | | 2,545 | | | — | | | 6,021 | | | — |
Recall accrual (c) | |
| (320) | |
| (1,064) | |
| (1,935) | |
| (1,318) |
Legal settlements (d) | | | (1,193) | | | (7,204) | | | (1,193) | | | (5,289) |
(Gain) loss on extinguishment of debt (e) | |
| (954) | |
| 917 | |
| (954) | |
| 917 |
Reorganization related costs (f) | |
| — | |
| 1,721 | |
| — | |
| 1,721 |
Impact of inventory step-up (g) | |
| — | |
| 190 | |
| — | |
| 380 |
Reversal of loss on asset disposal (h) | |
| — | |
| — | |
| — | |
| (840) |
Subtotal adjusted items | |
| 9,996 | |
| 3,560 | |
| 23,546 | |
| 11,843 |
Impact of income tax items (i) | |
| (2,323) | |
| (11,957) | |
| (3,354) | |
| (13,049) |
Adjusted net income | | $ | 71,430 | | $ | 54,509 | | $ | 119,671 | | $ | 87,161 |
| | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | ||||||||
| August 1, | | August 3, | | August 1, | | August 3, | ||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
| (in thousands) | ||||||||||
Net income | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Adjustments pre-tax: |
|
| |
|
| |
|
| |
|
|
Amortization of debt discount (a) |
| 11,113 | |
| 9,918 | |
| 22,238 | |
| 21,607 |
Tradename impairment (b) | | — | | | — | | | 20,459 | | | — |
Asset impairments and lease losses (c) | | 1,339 | | | 2,545 | | | 9,810 | | | 6,021 |
Loss on sale leaseback transaction (d) |
| 9,352 | |
| — | | | 9,352 | | | — |
Reorganization related costs (e) |
| 2,884 | |
| — | |
| 7,027 | |
| — |
Recall accrual (f) |
| 4,780 | |
| (320) | |
| 4,780 | |
| (1,935) |
Gain on extinguishment of debt (g) |
| (152) | |
| (954) | |
| (152) | |
| (954) |
Legal settlements (h) | | — | | | (1,193) | | | — | | | (1,193) |
Subtotal adjusted items |
| 29,316 | |
| 9,996 | |
| 73,514 | |
| 23,546 |
Impact of income tax items (i) |
| (4,726) | |
| (2,323) | |
| (15,763) | |
| (3,354) |
Adjusted net income | $ | 123,013 | | $ | 71,430 | | $ | 152,962 | | $ | 119,671 |
(a) | Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were issued in June 2014 (the “2019 Notes”), |
(b) | Represents tradename impairment related to the Waterworks reporting unit. Refer to “Waterworks Tradename Impairment” within Note 4—Goodwill, Trademarks, Trademarks and Domain Names in our condensed consolidated financial statements. |
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(c) | The adjustment includes the acceleration of depreciation expense |
43
Represents |
(e) | Represents severance costs and related payroll taxes associated with reorganizations. |
(f) | Represents adjustments to net revenues, |
| | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | Three Months Ended | | Six Months Ended | ||||||||||||||||
| | August 3, | | August 4, | | August 3, | | August 4, | August 1, | | August 3, | | August 1, | | August 3, | ||||||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||||
| | (in thousands) | (in thousands) | ||||||||||||||||||||
Reduction of net revenues | | $ | — | | $ | 1,853 | | $ | 413 | | $ | 1,853 | |||||||||||
Impact on cost of goods sold | |
| (320) | |
| (3,262) | |
| (2,381) | |
| (3,516) | |||||||||||
Impact on gross profit | |
| (320) | |
| (1,409) | |
| (1,968) | |
| (1,663) | |||||||||||
Incremental selling, general and administrative expenses | |
| — | |
| 345 | |
| 33 | |
| 345 | |||||||||||
Impact on income before income taxes | | $ | (320) | | $ | (1,064) | | $ | (1,935) | | $ | (1,318) | |||||||||||
Decrease to net revenues | $ | 406 | | $ | — | | $ | 406 | | $ | 413 | ||||||||||||
Increase (decrease) to cost of goods sold |
| 4,374 | |
| (320) | |
| 4,374 | |
| (2,381) | ||||||||||||
(Increase) decrease to gross profit |
| 4,780 | |
| (320) | |
| 4,780 | |
| (1,968) | ||||||||||||
Increase (decrease) to selling, general and administrative expenses |
| — | |
| — | |
| — | |
| 33 | ||||||||||||
(Increase) decrease to income before income taxes | $ | 4,780 | | $ | (320) | | $ | 4,780 | | $ | (1,935) |
The adjustment in each of the three and six months ended August 1, 2020 represents a gain on extinguishment of debt of upon the maturity and settlement of the 2020 Notes in July 2020. The adjustment in each of the three and six months ended August 3, 2019 |
(h) | Represents |
(i) |
(2) | EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income before depreciation and amortization, interest |
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The following table presents a reconciliation of net income, the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below.
| | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||||
| | August 3, | | August 4, | | August 3, | | August 4, | ||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
| | (in thousands) | ||||||||||
Net income | | $ | 63,757 | | $ | 62,906 | | $ | 99,479 | | $ | 88,367 |
Depreciation and amortization | |
| 25,321 | |
| 21,354 | |
| 52,510 | |
| 41,939 |
Interest expense—net | |
| 24,513 | |
| 15,467 | |
| 45,631 | |
| 30,565 |
Income tax expense | |
| 16,665 | |
| 2,533 | |
| 28,458 | |
| 10,121 |
EBITDA | |
| 130,256 | |
| 102,260 | |
| 226,078 | |
| 170,992 |
Stock-based compensation (a) | |
| 5,298 | |
| 6,234 | |
| 10,993 | |
| 14,231 |
Asset impairments and change in useful lives (b) | |
| 629 | |
| — | |
| 1,112 | |
| — |
Recall accrual (b) | |
| (320) | |
| (1,064) | |
| (1,935) | |
| (1,318) |
Legal settlements (b) | | | (1,193) | | | (7,204) | | | (1,193) | | | (5,289) |
(Gain) loss on extinguishment of debt (b) | | | (954) | | | 917 | | | (954) | | | 917 |
Reorganization related costs (b) | | | — | | | 1,721 | | | — | | | 1,721 |
Impact of inventory step-up (b) | |
| — | |
| 190 | |
| — | |
| 380 |
Reversal of loss on asset disposal (b) | |
| — | |
| — | |
| — | |
| (840) |
Adjusted EBITDA | | $ | 133,716 | | $ | 103,054 | | $ | 234,101 | | $ | 180,794 |
reconciliation of net income, the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below. |
| | | | | | | | | | | |
| Three Months Ended | | Six Months Ended | ||||||||
| August 1, | | August 3, | | August 1, | | August 3, | ||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||
| (in thousands) | ||||||||||
Net income | $ | 98,423 | | $ | 63,757 | | $ | 95,211 | | $ | 99,479 |
Depreciation and amortization |
| 25,342 | |
| 25,321 | |
| 50,212 | |
| 52,510 |
Interest expense—net |
| 19,418 | |
| 24,513 | |
| 39,047 | |
| 45,631 |
Income tax expense |
| 18,879 | |
| 16,665 | |
| 17,456 | |
| 28,458 |
EBITDA |
| 162,062 | |
| 130,256 | |
| 201,926 | |
| 226,078 |
Tradename impairment (a) | | — | | | — | | | 20,459 | | | — |
Non-cash compensation (b) |
| 6,861 | |
| 5,298 | |
| 12,689 | |
| 10,993 |
Loss on sale leaseback transaction (a) | | 9,352 | | | — | | | 9,352 | | | — |
Asset impairment and lease losses (a) |
| — | |
| 629 | |
| 7,133 | |
| 1,112 |
Reorganization related costs (a) | | 2,884 | | | — | | | 7,027 | | | — |
Recall accrual (a) |
| 4,780 | |
| (320) | |
| 4,780 | |
| (1,935) |
Gain on extinguishment of debt (a) | | (152) | | | (954) | | | (152) | | | (954) |
Legal settlements (a) | | — | | | (1,193) | | | — | | | (1,193) |
Adjusted EBITDA | $ | 185,787 | | $ | 133,716 | | $ | 263,214 | | $ | 234,101 |
(a) |
Refer to the reconciliation of net income to adjusted net income table above and the related footnotes for additional information. |
(b) | Represents non-cash compensation related to equity awards granted to employees. |
(3) | We define adjusted |
4543
The following tables present RH Gallery and Waterworks showroom metrics and exclude outlets:
| | | | | | | | | | | | | | | | | | | | |
| | Six Months Ended | | Six Months Ended | ||||||||||||||||
| | August 3, | | August 4, | | August 1, | | August 3, | ||||||||||||
| | 2019 | | 2018 | | 2020 | | 2019 | ||||||||||||
|
| |
| Total Leased |
| |
| Total Leased |
| |
| Total Leased |
| |
| Total Leased | ||||
| | | | Selling Square | | | | Selling Square | | | | Selling Square | | | | Selling Square | ||||
| | Store Count | | Footage (1) | | Store Count | | Footage (1) | | Count | | Footage (1) | | Count | | Footage (1) | ||||
| | | | | (in thousands) | | | | | (in thousands) | | | | | (in thousands) | | | | | (in thousands) |
Beginning of period |
| 86 |
| | 1,089 |
| 83 |
| | 981 |
| 83 |
| | 1,111 |
| 86 |
| | 1,089 |
Design Galleries: |
|
|
| |
|
|
|
| |
|
|
|
| |
|
|
|
| |
|
Portland Design Gallery |
| — |
| | — |
| 1 |
| | 26.0 | ||||||||||
Nashville Design Gallery | | — |
| | — | | 1 | | | 45.6 | ||||||||||
Marin Design Gallery |
| 1 |
| | 32.9 |
| — |
| | — | ||||||||||
Charlotte Design Gallery |
| 1 |
| | 32.4 |
| — |
| | — | ||||||||||
Modern Galleries: | | | | | | | | | | | | | | | | | | | | |
Dallas RH Modern Gallery (relocation) | | — | | | (4.5) | | — |
| | — | | — | | | — | | — | | | (4.5) |
Dallas RH Modern Gallery |
| — |
| | — |
| 1 |
| | 8.2 | ||||||||||
Baby & Child Galleries: | | | | | | | | | | | | | | | | | | | | |
Dallas RH Baby & Child Gallery | | (1) | | | (3.7) | | 1 |
| | 3.7 | | — | | | — | | (1) | | | (3.7) |
Portland RH Baby & Child Gallery | | — |
| | — | | 1 | | | 4.7 | ||||||||||
Legacy Galleries: | | | | | | | | | | | | | | | | | | | | |
Raleigh legacy Gallery | | 1 | | | 4.4 | | — | | | — | ||||||||||
Charlotte legacy Gallery | | (1) | | | (7.0) | | — | | | — | ||||||||||
Corte Madera legacy Gallery | | (1) | | | (7.0) | | — | | | — | ||||||||||
Westport legacy Gallery | | (1) | | | (6.5) | | | | | | ||||||||||
Dallas legacy Gallery (relocation) | | — | | | (2.6) | | — |
| | — | | — | | | — | | — | | | (2.6) |
San Antonio legacy Gallery (relocation) | | — | | | (3.8) | | — |
| | — | | — | | | — | | — | | | (3.7) |
Portland legacy Gallery |
| — |
| | — |
| (1) |
| | (4.7) | ||||||||||
Nashville legacy Gallery | | — |
| | — | | (1) | | | (7.1) | ||||||||||
Washington DC legacy Gallery | | — |
| | — | | (1) | | | (5.6) | ||||||||||
Waterworks Showrooms: | | | | | | | | | | | ||||||||||
Waterworks Scottsdale Showroom (relocation) |
| — |
| | — |
| — |
| | 1.1 | ||||||||||
End of period |
| 85 |
| | 1,074 |
| 85 |
| | 1,053 |
| 83 |
| | 1,160 |
| 85 |
| | 1,075 |
| | | | | | | | | | | ||||||||||
Total leased square footage at end of period (2) | | | | | 1,560 | | | | | 1,451 | ||||||||||
Weighted-average leased square footage (3) |
| | |
| 1,513 | |
| |
| 1,456 | ||||||||||
Weighted-average leased selling square footage (3) | | | | | 1,123 | | | | | 1,079 |
(1) | Leased selling square footage is retail space at our |
| | | | | | | | | | |
| | Three Months Ended | | Six Months Ended | ||||||
| | August 3, | | August 4, | | August 3, | | August 4, | ||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||
| | (in thousands) | ||||||||
Total leased square footage at end of period (1) | | | 1,451 | | | 1,414 | | 1,451 | | 1,414 |
Weighted-average leased square footage (2) |
| | 1,451 |
| | 1,392 |
| 1,456 |
| 1,362 |
Weighted-average leased selling square footage (2) |
| | 1,075 |
| | 1,035 |
| 1,079 |
| 1,013 |
Total leased square footage includes approximately 5,400 square feet as of August 1, 2020 related to an owned retail location and approximately 16,100 square feet as of August 3, 2019 |
Weighted-average leased square footage and leased selling square footage |
4644
The following table sets forth our condensed consolidated statements of income as a percentage of total net revenues.
| | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| ||||
| | August 3, | | August 4, | | August 3, | | August 4, |
|
|
| 2019 |
| 2018 |
| 2019 |
| 2018 |
|
Condensed Consolidated Statements of Income: | | | | | | | | | |
Net revenues | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of goods sold | | 58.3 |
| 58.1 |
| 59.6 |
| 60.1 | |
Gross profit | | 41.7 |
| 41.9 |
| 40.4 |
| 39.9 | |
Selling, general and administrative expenses | | 27.0 |
| 29.1 |
| 27.2 |
| 29.1 | |
Income from operations | | 14.7 |
| 12.8 |
| 13.2 |
| 10.8 | |
Other expenses | |
|
|
|
|
|
|
| |
Interest expense—net | | 3.4 |
| 2.5 |
| 3.5 |
| 2.5 | |
(Gain) loss on extinguishment of debt | | (0.1) |
| 0.1 |
| (0.1) |
| 0.1 | |
Total other expenses | | 3.3 |
| 2.6 |
| 3.4 |
| 2.6 | |
Income before income taxes | | 11.4 |
| 10.2 |
| 9.8 |
| 8.2 | |
Income tax expense | | 2.4 |
| 0.4 |
| 2.2 |
| 0.8 | |
Net income | | 9.0 | % | 9.8 | % | 7.6 | % | 7.4 | % |
| | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| ||||
| | August 1, | | August 3, | | August 1, | | August 3, |
|
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
|
Condensed Consolidated Statements of Income: | | | | | | | | | |
Net revenues | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of goods sold | | 53.1 |
| 58.3 |
| 55.4 |
| 59.6 | |
Gross profit | | 46.9 |
| 41.7 |
| 44.6 |
| 40.4 | |
Selling, general and administrative expenses | | 27.6 |
| 27.0 |
| 30.2 |
| 27.2 | |
Income from operations | | 19.3 |
| 14.7 |
| 14.4 |
| 13.2 | |
Other expenses | |
|
|
|
| | | | |
Interest expense—net | | 2.8 |
| 3.4 |
| 3.2 |
| 3.5 | |
Tradename impairment | | — | | — | | 1.7 |
| — | |
Gain on extinguishment of debt | | — |
| (0.1) |
| — |
| (0.1) | |
Total other expenses | | 2.8 |
| 3.3 |
| 4.9 |
| 3.4 | |
Income before income taxes | | 16.5 |
| 11.4 |
| 9.5 |
| 9.8 | |
Income tax expense | | 2.6 |
| 2.4 |
| 1.5 |
| 2.2 | |
Net income | | 13.9 | % | 9.0 | % | 8.0 | % | 7.6 | % |
Three Months Ended August 3, 20191, 2020 Compared to Three Months Ended August 4, 20183, 2019
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | August 3, | | August 4, | ||||||||||||||
| | 2019 | | 2018 | ||||||||||||||
|
| RH Segment |
| Waterworks (1) |
| Total |
| RH Segment |
| Waterworks (1) |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 672,328 | | $ | 34,186 | | $ | 706,514 | | $ | 607,604 | | $ | 33,194 | | $ | 640,798 |
Cost of goods sold | |
| 391,859 | |
| 19,697 | |
| 411,556 | |
| 352,099 | |
| 20,355 | |
| 372,454 |
Gross profit | |
| 280,469 | |
| 14,489 | |
| 294,958 | |
| 255,505 | |
| 12,839 | |
| 268,344 |
Selling, general and administrative expenses | |
| 177,408 | |
| 13,569 | |
| 190,977 | |
| 173,154 | |
| 13,367 | |
| 186,521 |
Income (loss) from operations | | $ | 103,061 | | $ | 920 | | $ | 103,981 | | $ | 82,351 | | $ | (528) | | $ | 81,823 |
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 681,387 | | $ | 27,895 | | $ | 709,282 | | $ | 672,328 | | $ | 34,186 | | $ | 706,514 |
Cost of goods sold | |
| 360,906 | |
| 15,957 | |
| 376,863 | |
| 391,859 | |
| 19,697 | |
| 411,556 |
Gross profit | |
| 320,481 | |
| 11,938 | |
| 332,419 | |
| 280,469 | |
| 14,489 | |
| 294,958 |
Selling, general and administrative expenses | |
| 185,486 | |
| 10,365 | |
| 195,851 | |
| 177,408 | |
| 13,569 | |
| 190,977 |
Income from operations | | $ | 134,995 | | $ | 1,573 | | $ | 136,568 | | $ | 103,061 | | $ | 920 | | $ | 103,981 |
Net revenues
Consolidated net revenues increased $65.7$2.8 million, or 10.3%0.4%, to $709.3 million in the three months ended August 1, 2020 compared to $706.5 million in the three months ended August 3, 2019 compared to $640.8 million in the three months ended August 4, 2018.2019.
Consolidated net revenues for the three months ended August 4, 2018 were negatively impacted by $1.9 million related to the reduction of revenue associated with product recalls. Excluding the product recall adjustment, consolidated net revenues increased $63.9 million, or 9.9%, to $706.5 million in the three months ended August 3, 2019 compared to $642.7 million in the three months ended August 4, 2018. Product recalls and the establishment or adjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of our results. No assurance can be provided that any accruals will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time, which could further affect results.
47
RH Segment net revenues
RH Segment net revenues increased $64.7 million, or 10.7%, to $672.3 million in the three months ended August 3, 2019 compared to $607.6 million in the three months ended August 4, 2018. The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude.
RH Segment core net revenues increased primarily due to existing Galleries, as well as an increase in retail weighted-average selling square footage related to new store openings, including New York, Nashville and Yountville, and we experienced better than expected delivered sales in the last few weeks of the quarter. Net revenues also increased from our RH Hospitality operations and Contract business.
RH Segment outlet sales increased $16.0 million to $53.9 million in the three months ended August 3, 2019 compared to $37.9 million in the three months ended August 4, 2018 primarily due to increased promotional activity as a result of our efforts to reduce inventory subsequent to the distribution center closures of as part of the distribution center network redesign, as well as an increase of four outlet locations year over year.
RH Segment net revenues for the three months ended August 4, 2018 were negatively impacted by $1.9 million related to the reduction of revenue associated with product recalls.
Waterworks net revenues
Waterworks net revenues increased $1.0 million, or 3.0%, to $34.2 million in the three months ended August 3, 2019 compared to $33.2 million in the three months ended August 4, 2018.
Gross profit
Consolidated gross profit increased $26.6 million, or 9.9%, to $295.0 million in the three months ended August 3, 2019 from $268.3 million in the three months ended August 4, 2018. As a percentage of net revenues, consolidated gross margin decreased 0.2% to 41.7% of net revenues in the three months ended August 3, 2019 from 41.9% of net revenues in the three months ended August 4, 2018.
RH Segment gross profit for the three months ended August 3, 2019 was negatively impacted by $1.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the three months ended August 3, 2019 and August 4, 2018 was positively impacted by $0.3 million and $1.4 million, respectively, related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the reduction of revenue and incremental costs associated with such product recalls.
Waterworks gross profit for the three months ended August 4, 2018 was negatively impacted by $0.2 million of amortization related to the inventory fair value adjustment recorded in connection with the acquisition.
Excluding the acceleration of depreciation, the product recall adjustments and the impact of the amortization related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased 0.4% to 42.0% of net revenues in the three months ended August 3, 2019 from 41.6% of net revenues in the three months ended August 4, 2018.
RH Segment gross profit
RH Segment gross profit increased $25.0 million, or 9.8%, to $280.5 million in the three months ended August 3, 2019 from $255.5 million in the three months ended August 4, 2018. As a percentage of net revenues, RH Segment gross margin decreased 0.4% to 41.7% of net revenues in the three months ended August 3, 2019 from 42.1% of net revenues in the three months ended August 4, 2018.
Excluding the acceleration of depreciation and product recall adjustments mentioned above, RH Segment gross margin would have increased 0.3% to 42.0% of net revenues in the three months ended August 3, 2019 from 41.7% of net revenues in the three months ended August 4, 2018. The increase was primarily related to improvements in our
48
distribution center network redesign resulting in reduced delivery expense and leverage in occupancy costs. The overall increase was partially offset by lower outlet product margins due to increased promotional activity and higher discounts due to our efforts to reduce inventory subsequent to the distribution center closures.
Waterworks gross profit
Waterworks gross profit increased $1.7 million, or 12.9%, to $14.5 million in the three months ended August 3, 2019 from $12.8 million in the three months ended August 4, 2018. As a percentage of net revenues, Waterworks gross margin increased 3.7% to 42.4% of net revenues in the three months ended August 3, 2019 from 38.7% of net revenues in the three months ended August 4, 2018.
Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have increased 3.1% to 42.4% of net revenues in the three months ended August 3, 2019 from 39.3% of net revenues in the three months ended August 4, 2018.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $4.5 million, or 2.4%, to $191.0 million in the three months ended August 3, 2019 compared to $186.5 million in the three months ended August 4, 2018.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $4.3 million, or 2.5%, to $177.4 million in the three months ended August 3, 2019 compared $173.2 million in the three months ended August 4, 2018.
RH Segment selling, general and administrative expenses for the three months ended August 3, 2019 included a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a $0.6 million asset impairment.
RH Segment selling, general and administrative expenses for the three months ended August 4, 2018 included a favorable $7.2 million legal settlement, net of related legal expenses, partially offset by a $1.7 million charge related to the supply chain reorganization, including the closure of the Dallas customer call center, and $0.3 million related to product recalls.
Excluding the adjustments for the legal settlements, asset impairments, reorganization and product recalls mentioned above, RH Segment selling, general and administrative expenses were 26.5% and 29.3% of net revenues for the three months ended August 3, 2019 and August 4, 2018, respectively. 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 as a result of our organization redesign and, to a lesser extent, leverage in our corporate expenses and advertising and marketing costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased $0.2 million, or 1.5%, to $13.6 million in the three months ended August 3, 2019 compared to $13.4 million in the three months ended August 4, 2018. Waterworks selling, general and administrative expenses were 39.7% and 40.3% of net revenues for the three months ended August 3, 2019 and August 4, 2018, respectively.
49
Interest expense—net
Interest expense—net increased $9.0 million to $24.5 million for the three months ended August 3, 2019 compared to $15.5 million for the three months ended August 4, 2018. Interest expense—net consisted of the following:
| | | | | | |
| | Three Months Ended | ||||
| | August 3, | | August 4, | ||
|
| 2019 |
| 2018 | ||
| | (in thousands) | ||||
Amortization of convertible senior notes debt discount | | $ | 10,585 | | $ | 9,764 |
Term loans | |
| 6,086 | |
| 645 |
Finance lease interest expense | |
| 5,672 | |
| 3,319 |
Amortization of debt issuance costs and deferred financing fees | |
| 1,171 | |
| 881 |
Asset based credit facility | |
| 1,087 | |
| 1,104 |
Promissory notes | | | 988 | | | 471 |
Other interest expense | |
| 388 | |
| 393 |
Capitalized interest for capital projects | |
| (1,184) | |
| (911) |
Interest income | |
| (280) | |
| (199) |
Total interest expense—net | | $ | 24,513 | | $ | 15,467 |
(Gain) loss on extinguishment of debt
We recognized a $1.0 million gain on extinguishment of debt in the three months ended August 3, 2019 due to the maturity and settlement of the 2019 Notes in June 2019. We incurred a $0.9 million loss on extinguishment of debt in the three months ended August 4, 2018 due to the repayment in full of the LILO term loan, the promissory note secured by our aircraft and the equipment security notes in June 2018, which includes acceleration of amortization of debt issuance costs of $0.6 million and a prepayment penalty of $0.3 million.
Income tax expense
Income tax expense was $16.7 million and $2.5 million in the three months ended August 3, 2019 and August 4, 2018, respectively. Our effective tax rate was 20.7% and 3.9% for the three months ended August 3, 2019 and August 4, 2018, respectively. The increase in our effective tax rate is primarily due to lower discrete tax benefits related to net excess tax windfalls from stock-based compensation in the three months ended August 3, 2019 as compared to the three months ended August 4, 2018, as well as a discrete tax impact related to the legal settlement in the three months ended August 4, 2018.
Six Months Ended August 3, 2019 Compared to Six Months Ended August 4, 2018
| | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||
| | August 3, | | August 4, | ||||||||||||||
| | 2019 | | 2018 | ||||||||||||||
|
| RH Segment |
| Waterworks (1) |
| Total |
| RH Segment |
| Waterworks (1) |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 1,236,034 | | $ | 68,901 | | $ | 1,304,935 | | $ | 1,133,611 | | $ | 64,593 | | $ | 1,198,204 |
Cost of goods sold | |
| 737,622 | |
| 39,541 | |
| 777,163 | |
| 682,400 | |
| 38,127 | |
| 720,527 |
Gross profit | |
| 498,412 | |
| 29,360 | |
| 527,772 | |
| 451,211 | |
| 26,466 | |
| 477,677 |
Selling, general and administrative expenses | |
| 327,812 | |
| 27,346 | |
| 355,158 | |
| 320,633 | |
| 27,074 | |
| 347,707 |
Income (loss) from operations | | $ | 170,600 | | $ | 2,014 | | $ | 172,614 | | $ | 130,578 | | $ | (608) | | $ | 129,970 |
50
Net revenues
Consolidated net revenues increased $106.7 million, or 8.9%, to $1,304.9 million in the six months ended August 3, 2019 compared to $1,198.2 million in the six months ended August 4, 2018.
Consolidated net revenues for the six months ended August 3, 2019 and August 4, 20181, 2020 were negatively impacted by $0.4 million and $1.9 million, respectively, related to the reduction of revenue associated with product recalls. Excluding the product recall adjustments, consolidated net revenues increased $105.3$3.2 million, or 8.8%0.4%, to $1,305.3$709.7 million in the sixthree months ended August 1, 2020 compared to $706.5 million in the three months ended August 3, 2019 compared to $1,200.1 million in the six months ended August 4, 2018.2019. Product recalls and the establishment or adjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of our results. No assurance can be provided that any accruals will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time, which could further affect results.
RH Segment net revenues
RH Segment net revenues increased $102.4$9.1 million, or 9.0%1.3%, to $1,236.0$681.4 million in the sixthree months ended August 1, 2020 compared to $672.3 million in the three months ended August 3, 2019 compared to $1,133.6 million in the six months ended August 4, 2018.2019. The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude.
45
RH Segment core net revenues increased primarily due to existinga strong increase in customer demand for our products during the three months ended August 1, 2020. The growth in revenue was much lower than the growth in customer demand for our products during the three month period primarily due to the effects of COVID-19 on our supply chain. It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand. In addition, net revenues were impacted by a 23% reduction in open store days for Galleries due to the pandemic, a decrease in revenues from our Contract business, as well as an increasedecreases in retail weighted-average selling square footage related to new store openings, including New York, Nashville and Yountville. Net revenues also increased from our RH Hospitality operations and Contract business.Outlet business due to COVID-19 related closures during the three months ended August 1, 2020.
Waterworks net revenues
Waterworks net revenues decreased $6.3 million, or 18.4%, to $27.9 million in the three months ended August 1, 2020 compared to $34.2 million in the three months ended August 3, 2019 primarily due to construction delays which negatively impacted demand, as well as temporary showroom COVID-19 related closures.
Gross profit
Consolidated gross profit increased $37.5 million, or 12.7%, to $332.4 million in the three months ended August 1, 2020 compared to $295.0 million in the three months ended August 3, 2019. As a percentage of net revenues, consolidated gross margin increased 5.2% to 46.9% of net revenues in the three months ended August 1, 2020 from 41.7% of net revenues in the three months ended August 3, 2019.
RH Segment outletgross profit for the three months ended August 1, 2020 was negatively impacted by $4.8 million related to product recalls.
RH Segment gross profit for the three months ended August 3, 2019 was negatively impacted by $1.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the three months ended August 3, 2019 was positively impacted by $0.3 million related to reserve adjustments associated with product recalls initiated in prior years.
Excluding the product recall adjustments and accelerated asset depreciation mentioned above, consolidated gross margin would have increased 5.5% to 47.5% of net revenues in the three months ended August 1, 2020 from 42.0% of net revenues in the three months ended August 3, 2019.
RH Segment gross profit
RH Segment gross profit increased $40.0 million, or 14.3%, to $320.5 million in the three months ended August 1, 2020 from $280.5 million in the three months ended August 3, 2019. As a percentage of net revenues, RH Segment gross margin increased 5.3% to 47.0% of net revenues in the three months ended August 1, 2020 from 41.7% of net revenues in the three months ended August 3, 2019.
Excluding the product recall and accelerated asset depreciation adjustments mentioned above, RH Segment gross margin would have increased 5.7% to 47.7% of net revenues in the three months ended August 1, 2020 from 42.0% of net revenues in the three months ended August 3, 2019. The increase was primarily driven by higher product margins in select product categories, as well as price increases in our Core business and lower Outlet promotional activity during the period of operations. In addition, we experienced leverage in occupancy and shipping costs.
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Waterworks gross profit
Waterworks gross profit decreased $2.6 million, or 17.6%, to $11.9 million in the three months ended August 1, 2020 from $14.5 million in the three months ended August 3, 2019. As a percentage of net revenues, Waterworks gross margin increased 0.4% to 42.8% of net revenues in the three months ended August 1, 2020 from 42.4% of net revenues in the three months ended August 3, 2019.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $4.9 million, or 2.6%, to $195.9 million in the three months ended August 1, 2020 compared to $191.0 million in the three months ended August 3, 2019.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $8.1 million, or 4.6%, to $185.5 million in the three months ended August 1, 2020 compared $177.4 million in the three months ended August 3, 2019.
RH Segment selling, general and administrative expenses for the three months ended August 1, 2020 includes a loss of $9.4 million related to a sale leaseback transaction, $2.9 million related to severance costs and related payroll taxes associated with reorganizations and $1.3 million due to accelerated asset depreciation. RH Segment selling, general and administrative expenses for the three months ended August 3, 2019 include a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a $0.6 million asset impairment.
Excluding the loss on the sale leaseback transaction, asset impairments, reorganization costs, accelerated asset depreciation and legal settlement mentioned above, RH Segment selling, general and administrative expenses were 25.2% and 26.5% of net revenues for the three months ended August 1, 2020 and August 3, 2019, respectively. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by a reduction in advertising costs, leverage in employment and employment related costs and travel related expenses, partially offset by increased professional fees, incremental COVID-19 related expenses, preopening costs and other corporate expenses.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased $3.2 million, or 23.6%, to $10.4 million in the three months ended August 1, 2020 compared to $13.6 million in the three months ended August 3, 2019. Waterworks selling, general and administrative expenses were 37.2% and 39.7% of net revenues for the three months ended August 1, 2020 and August 3, 2019, respectively.
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Interest expense—net
Interest expense—net decreased $5.1 million to $19.4 million for the three months ended August 1, 2020 compared to $24.5 million for the three months ended August 3, 2019. Interest expense—net consisted of the following:
| | | | | | |
| | Three Months Ended | ||||
| | August 1, | | August 3, | ||
|
| 2020 |
| 2019 | ||
| | (in thousands) | ||||
Amortization of convertible senior notes debt discount | | $ | 12,462 | | $ | 10,585 |
Finance lease interest expense | |
| 5,948 | |
| 5,672 |
Promissory notes | | | 1,072 | | | 988 |
Amortization of debt issuance costs and deferred financing fees | |
| 982 | |
| 1,171 |
Other interest expense | |
| 436 | |
| 388 |
Asset based credit facility | |
| 130 | |
| 1,087 |
Term loans | |
| — | |
| 6,086 |
Capitalized interest for capital projects | |
| (1,426) | |
| (1,184) |
Interest income | |
| (186) | |
| (280) |
Total interest expense—net | | $ | 19,418 | | $ | 24,513 |
Gain on extinguishment of debt
We recognized a $0.2 million gain on extinguishment of debt in the three months ended August 1, 2020 related to the maturity and settlement of the 2020 Notes in July 2020. We recognized a $1.0 million gain on extinguishment of debt in the three months ended August 3, 2019 related to the maturity and settlement of the 2019 Notes in June 2019.
Income tax expense
Income tax expense was $18.9 million and $16.7 million in the three months ended August 1, 2020 and August 3, 2019, respectively. Our effective tax rate was 16.1% and 20.7% for the three months ended August 1, 2020 and August 3, 2019, respectively. The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the three months ended August 1, 2020 as compared to the three months ended August 3, 2019.
Six Months Ended August 1, 2020 Compared to Six Months Ended August 3, 2019
| | | | | | | | | | | | | | | | | | |
| | Six Months Ended | ||||||||||||||||
| | August 1, | | August 3, | ||||||||||||||
| | 2020 | | 2019 | ||||||||||||||
|
| RH Segment |
| Waterworks |
| Total |
| RH Segment |
| Waterworks |
| Total | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 1,136,344 | | $ | 55,833 | | $ | 1,192,177 | | $ | 1,236,034 | | $ | 68,901 | | $ | 1,304,935 |
Cost of goods sold | |
| 628,101 | |
| 32,003 | |
| 660,104 | |
| 737,622 | |
| 39,541 | |
| 777,163 |
Gross profit | | | 508,243 | | | 23,830 | | | 532,073 | | | 498,412 | | | 29,360 | | | 527,772 |
Selling, general and administrative expenses | |
| 334,762 | |
| 25,290 | |
| 360,052 | |
| 327,812 | |
| 27,346 | |
| 355,158 |
Income (loss) from operations | | $ | 173,481 | | $ | (1,460) | | $ | 172,021 | | $ | 170,600 | | $ | 2,014 | | $ | 172,614 |
Net revenues
Consolidated net revenues decreased $112.8 million, or 8.6%, to $1,192.2 million in the six months ended August 1, 2020 compared to $1,304.9 million in the six months ended August 3, 2019.
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RH Segment net revenues
RH Segment net revenues decreased $99.7 million, or 8.1%, to $1,136.3 million in the six months ended August 1, 2020 compared to $1,236.0 million in the six months ended August 3, 2019. The below discussion highlights several significant factors that resulted in a decrease in RH Segment net revenues, which are listed in order of magnitude.
RH Segment net revenues declined primarily due to the temporary closure of our Outlet and retail locations in response to COVID-19 during the first several months of the six months ended August 1, 2020 and, to a lesser extent, the negative impact to overall customer demand in our business due to macroeconomic conditions resulting from COVID-19, primarily during March and April within the six months ended August 1, 2020. Outlet sales increased $28.4decreased $45.7 million to $63.8 million in the six months ended August 1, 2020 compared to $109.5 million in the six months ended August 3, 2019 compareddue to $81.1COVID-19 related closures. RH Segment net revenues also decreased in our Contract business and RH Hospitality operations due to COVID-19 related factors including extended closures of our RH Hospitality locations.
Waterworks net revenues
Waterworks net revenues decreased $13.1 million, or 19.0%, to $55.8 million in the six months ended August 4, 2018 primarily due to increased promotional activity as a result of our efforts to reduce inventory subsequent to the distribution center closures of as part of the distribution center network redesign, as well as an increase of four outlet locations year over year.
RH Segment net revenues for the six months ended August 3, 2019 and August 4, 2018 were negatively impacted by $0.4 million and $1.9 million, respectively, related to the reduction of revenue associated with product recalls.
Waterworks net revenues
Waterworks net revenues increased $4.3 million, or 6.7%,1, 2020 compared to $68.9 million in the six months ended August 3, 2019 compared2019.
Gross profit
Consolidated gross profit increased $4.3 million, or 0.8%, to $64.6$532.1 million in the six months ended August 4, 2018.
Gross profit
Consolidated gross profit increased $50.1 million, or 10.5%, to1, 2020 from $527.8 million in the six months ended August 3, 2019 from $477.7 million in the six months ended August 4, 2018.2019. As a percentage of net revenues, consolidated gross margin increased 0.5%4.2% to 44.6% of net revenues in the six months ended August 1, 2020 from 40.4% of net revenues in the six months ended August 3, 2019 from 39.9% of net revenues in2019.
RH Segment gross profit for the six months ended August 4, 2018.
1, 2020 was negatively impacted by $4.8 million related to product recalls and includes inventory reserves of $2.4 million related to Outlet inventory build up resulting from retail closures in response to the COVID-19 pandemic. RH Segment gross profit for the six months ended August 3, 2019 was negatively impacted by $4.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the six months ended August 3, 2019 and August 4, 2018 was positively impacted by $2.0 million and $1.7 million, respectively, related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the reduction of revenue and incremental costs associated with such product recalls.
Waterworks gross profit forExcluding the six months ended August 4, 2018 was negatively impacted by $0.4 million of amortization related to theproduct recall, inventory fair value adjustment recorded in connection with the acquisition.
Excluding thereserves and acceleration of depreciation the product recall adjustments and the impact of the amortization related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased 1.0%4.5% to 45.2% of net revenues in the six months ended August 1, 2020 from 40.7% of net revenues in the six months ended August 3, 2019.
RH Segment gross profit
RH Segment gross profit increased $9.8 million, or 2.0%, to $508.2 million in the six months ended August 1, 2020 from $498.4 million in the six months ended August 3, 2019. As a percentage of net revenues, RH Segment gross margin increased 4.4% to 44.7% of net revenues in the six months ended August 1, 2020 from 40.3% of net revenues in the six months ended August 3, 2019.
Excluding the product recall, inventory reserves and acceleration of depreciation adjustments mentioned above, RH Segment gross margin would have increased 4.8% to 45.3% of net revenues in the six months ended August 1, 2020 from 40.5% of net revenues in the six months ended August 3, 2019. The increase was primarily driven by higher product margins in select product categories, as well as price increases in our Core business and lower Outlet promotional activity during the period of operations.
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40.7% of net revenues in the six months ended August 3, 2019 from 39.7% of net revenues in the six months ended August 4, 2018.
RH SegmentWaterworks gross profit
RH SegmentWaterworks gross profit increased $47.2decreased $5.5 million, or 10.5%18.8%, to $498.4$23.8 million in the six months ended August 3, 20191, 2020 from $451.2 million in the six months ended August 4, 2018. As a percentage of net revenues, RH Segment gross margin increased 0.5% to 40.3% of net revenues in the six months ended August 3, 2019 from 39.8% of net revenues in the six months ended August 4, 2018.
Excluding the acceleration of depreciation and product recall adjustments mentioned above, RH Segment gross margin would have increased 0.9% to 40.5% of net revenues in the six months ended August 3, 2019 from 39.6% of net revenues in the six months ended August 4, 2018. The increase was primarily related to improvements in our distribution center network redesign resulting in reduced delivery expense and leverage in occupancy costs, as well as improvements in our core merchandise margins. The overall increase was partially offset by lower outlet product margins due to increased promotional activity and higher discounts due to our efforts to reduce inventory subsequent to the distribution center closures.
Waterworks gross profit
Waterworks gross profit increased $2.9 million, or 10.9%, to $29.4 million in the six months ended August 3, 2019 from $26.5 million in the six months ended August 4, 2018.2019. As a percentage of net revenues, Waterworks gross margin increased 1.6%0.1% to 42.7% of net revenues in the six months ended August 1, 2020 from 42.6% of net revenues in the six months ended August 3, 2019 from 41.0% of net revenues in the six months ended August 4, 2018.
Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have increased 1.0% to 42.6% of net revenues in the six months ended August 3, 2019 from 41.6% of net revenues in the six months ended August 4, 2018.2019.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $7.5$4.9 million, or 2.1%1.4%, to $360.1 million in the six months ended August 1, 2020 compared to $355.2 million in the six months ended August 3, 2019 compared to $347.7 million in the six months ended August 4, 2018.2019.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $7.2$7.0 million, or 2.2%2.1%, to $334.8 million in the six months ended August 1, 2020 compared to $327.8 million in the six months ended August 3, 2019 compared $320.6 million in2019.
RH Segment selling, general and administrative expenses for the six months ended August 4, 2018.1, 2020 include a loss of $9.4 million related to a sale leaseback transaction, $7.0 million related to severance costs and related payroll taxes associated with the termination of associates and a reorganization undertaken in response to the impact of retail closures on our business, $3.3 million related to asset impairments and $2.6 million due to accelerated asset depreciation.
RH Segment selling, general and administrative expenses for the six months ended August 3, 2019 included a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a $0.6 million asset impairment and a $0.5 million loss on disposal of an asset.
Addtionally, RH Segment selling, general and administrative expenses for the six months ended August 3, 2019 included advertising and marketing costs which increased $6.0 million primarily due to an increase in circulation and pages of our Source Books. This was partially offset by a decrease in corporate expenses of $1.7 million, primarily due to reduced preopening expense associated with our Design Gallery openings and other corporate costs.
RH Segment selling, general and administrative expenses for the six months ended August 4, 2018 included a favorable $5.3 million legal settlement, net of related legal expenses and a $0.8 million reversal of an estimated loss on disposal of asset, partially offset by a $1.7 million charge related to the supply chain reorganization, including the closure of the Dallas customer call center, and $0.3 million related to product recalls.
Excluding the adjustments for the legal settlements,reorganizations, asset impairments, reversal of an estimated loss on disposal of asset, reorganizationproduct recalls and product recallslegal settlements mentioned above, RH Segment selling, general and administrative expenses
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were 26.5%27.5% and 28.6%26.5% of net revenues for the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, respectively. The decreaseincrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by leverageincreased professional fees, incremental COVID-19 related expenses, preopening costs and other corporate expenses, partially offset by a reduction in our employmentadvertising costs and employmenttravel related costs as a result of our organization redesign and, to a lesser extent, leverage in our corporate expenses.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased $0.3decreased $2.1 million, or 1.0%7.5%, to $25.3 million in the six months ended August 1, 2020 compared to $27.3 million in the six months ended August 3, 2019 compared to $27.1 million in the six months ended August 4, 2018.2019. Waterworks selling, general and administrative expenses were 39.7%45.3% and 41.9%39.7% of net revenues for the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, respectively.
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Interest expense—net
Interest expense—net increased $15.1decreased $6.6 million to $39.0 million for the six months ended August 1, 2020 compared to $45.6 million for the six months ended August 3, 2019 compared to $30.6 million for the six months ended August 4, 2018.2019. Interest expense—net consisted of the following:
| | | | | | | | | | | | |
| | Six Months Ended | | Six Months Ended | ||||||||
| | August 3, | | August 4, | | August 1, | | August 3, | ||||
|
| 2019 |
| 2018 |
| 2020 |
| 2019 | ||||
| | (in thousands) | | (in thousands) | ||||||||
Amortization of convertible senior notes debt discount | | $ | 22,962 | | $ | 17,645 | | $ | 25,378 | | $ | 22,962 |
Finance lease interest expense | |
| 11,186 | |
| 6,411 | |
| 11,729 | |
| 11,186 |
Promissory notes | | | 2,526 | | | 1,420 | ||||||
Amortization of debt issuance costs and deferred financing fees | |
| 1,995 | |
| 2,261 | ||||||
Other interest expense | |
| 879 | |
| 783 | ||||||
Asset based credit facility | |
| 232 | |
| 1,774 | ||||||
Term loans | |
| 7,810 | |
| 1,649 | |
| — | |
| 7,810 |
Amortization of debt issuance costs and deferred financing fees | |
| 2,261 | |
| 1,668 | ||||||
Asset based credit facility | |
| 1,774 | |
| 3,584 | ||||||
Promissory notes | | | 1,420 | | | 1,047 | ||||||
Other interest expense | |
| 783 | |
| 733 | ||||||
Capitalized interest for capital projects | |
| (2,003) | |
| (1,811) | |
| (3,312) | |
| (2,003) |
Interest income | |
| (562) | |
| (361) | |
| (380) | |
| (562) |
Total interest expense—net | | $ | 45,631 | | $ | 30,565 | | $ | 39,047 | | $ | 45,631 |
(Gain) lossGain on extinguishment of debt
We recognized a $0.2 million gain on extinguishment of debt in the six months ended August 1, 2020 related to the maturity and settlement of the 2020 Notes in July 2020. We recognized a $1.0 million gain on extinguishment of debt in the six months ended August 3, 2019 duerelated to the maturity and settlement of the 2019 Notes in June 2019. We incurred a $0.9 million loss on extinguishment of debt in the six months ended August 4, 2018 due to the repayment in full of the LILO term loan, the promissory note secured by our aircraft and the equipment security notes in June 2018, which includes acceleration of amortization of debt issuance costs of $0.6 million and a prepayment penalty of $0.3 million.
Income tax expense
Income tax expense was $28.5$17.5 million and $10.1$28.5 million in the six months ended August 3, 20191, 2020 and August 4, 2018,3, 2019, respectively. Our effective tax rate was 22.2%15.5% and 10.3%22.2% for the six months ended August 1, 2020 and August 3, 2019, and August 4, 2018, respectively. The increasedecrease in our effective tax rate is primarily due to lowerhigher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the six months ended August 3, 20191, 2020 as compared to the six months August 4, 2018, as well as a discrete tax impact related to the legal settlement in the six months ended August 4, 2018.3, 2019.
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
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managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. In fiscal 2017, we completed two share repurchase programs in an aggregate amount of $1 billion. A $300 million share repurchase was completed during the first quarter of fiscal 2017 and a $700 million share repurchase was completed during the second quarter of fiscal 2017. In October 2018, our Board of Directors approved a new $700 million share repurchase program, of which $250 million in 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. 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.
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We have $635$685 million in aggregate principal amount of convertible notes outstanding as of August 1, 2020, of which $300 million mature in June 2020 and $335 million mature in June 2023.2023 (the “2023 Notes”) and $350 million mature in September 2024 (the “2024 Notes”). Based on the anticipated strong cash flow generation in 20192020 and beyond, we expect to repay the outstanding principal amount of theour convertible notes at maturity in June 20202023 and June 2023September 2024 in cash, in each case to minimize dilution. While we purchased convertible note hedges and sold warrants with respect to each convertible note transaction, which are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately $338.24 per share and from the conversion of the 2023 Notes until our common stock is above approximately $309.84 per share, our shareholders may still experience dilution to the extent our common stock trades above such levels. While we anticipate using excess cash, free cash flow and borrowings on our revolving line ofasset 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.
Our business has historically relied on cash flows from operations, net cash proceeds from the issuance of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity. We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the strengthnext 12 months.
While we have taken measures to defer some capital expenditures and other expenses in response to the COVID-19 health crisis, we expect to resume those investments as and to the extent that conditions for our business continue to improve during the COVID-19 crisis. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs 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 the impact of COVID-19.
While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in the U.S. and Canada, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
In recognition of the significant threat to economic conditions and the reductionliquidity 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 leveragethe 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 have achieved during the past year puts us inmay receive financial, tax or other relief and other benefits under and as a strong position to take advantageresult of the capital markets opportunistically. We believe we have multiple financing alternatives availableCARES Act, it is not possible to us on favorable terms that could provide us with additional financial flexibility with respect to capital allocation.estimate at this time the availability, extent or impact of any future relief.
We extended and amended our revolving line ofasset 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 revolving 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.
We believe that cash expected to be generated from operations, net cash proceeds from the issuance
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In fiscal 2019 we executed a sale-leaseback transaction for the next 12 months.
Our business has relied on cash flows from operations, net cashYountville Design Gallery for sales proceeds fromof $23.5 million and in July 2020 we executed a sale-leaseback transaction for the issuanceMinneapolis Design Gallery for sales proceeds of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources$25.5 million, both of liquidity. We have pursuedwhich qualified for sale-leaseback accounting in the past, and may pursue in the future, additional strategies to generate liquidity for our operations, including through the strategic sale of assets, utilization of our credit facilities, and entry into new debt financing arrangements that present attractive terms.
accordance with ASC 842. We may pursue strategies in the future, through the use of existing assets and debt facilities, or through the pursuit of new external sources of liquidity and debt 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 and uses of capital may change in the future due to changes in our business or new opportunities that we choose to pursue. We have invested significant capital expenditures in 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 Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings.
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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 2020. We anticipate our adjusted net capital expenditures, net of asset sales, to be $160$125 million to $170$150 million in fiscal 2019,2020, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments. We anticipate that our fiscal 2019 adjusted net capital expenditures will be partially offset by proceeds from sales of assets of $50 million to $60 million. During the six months ended August 3, 2019,1, 2020, adjusted net capital expenditures were $52.8$70.5 million, inclusivenet of cash received related to landlord tenant allowances of $15.7$10.2 million. Our fiscal 2020 adjusted capital expenditures are partially offset by net proceeds from sales of assets of $25.0 million.
Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us. Other lease arrangements for our new Design Galleries require the landlord to fund a portion of the construction related costs directly to third parties, rather than through traditional construction allowances and accordingly, under these arrangements we do not expect to receive contributions directly from our landlords related to the building of our Design Galleries. As we develop new Galleries, as well as other potential strategic initiatives in the future like our integrated hospitality experience, we may explore other models for our real estate, which could include longer lease terms or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated with new sites and buildings. These approaches might require 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 leasebacksale-leaseback arrangement resulting in lower capital investment and lower rent. For example, we have used this strategy in fiscal 2019 through the sale-leaseback transaction for the Yountville Design Gallery and in July 2020 through the sale-leaseback transaction for the Minneapolis Design Gallery. In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurances that we will be successful in securing additional funding on attractive terms or at all.
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In addition, we continue to address the effects of COVID-19 on our business with respect to real estate development and the introduction of new Galleries in both the US and internationally. A range of factors involved in the development of new Gallery and RH Hospitality may be affected by the COVID-19 health crisis including delays in construction as well as permitting and other necessary governmental actions. In addition, the scope and cadence of investments by third parties including landlords and other real estate counterparties may be adversely affected by the health crisis. Actions taken by international as well as federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the outbreak, 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 closed or 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 $635$685 million at maturity of such senior convertible notes. To the extent we need to secure additional sources of liquidity, we cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future financing requirements would not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock. Any adverse developments in the U.S. or global credit markets as a result of COVID-19 could affect our ability to manage our debt obligations and our ability to access future debt. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the covenants or other requirements of existing or new debt facilities, any such event could have an impact on our other commitments and obligations including triggering cross defaults or other consequences with respect to other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur, exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks.
Any 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.
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Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the following table:
| | | | | | | | | | | | | | |
| | Six Months Ended | | Six Months Ended | ||||||||||
| | August 3, | | August 4, | | | August 1, | | August 3, | | ||||
|
| 2019 |
| 2018 |
|
| 2020 |
| 2019 |
| ||||
| | (in thousands) | | (in thousands) | ||||||||||
Provided by operating activities | | $ | 97,133 | | $ | 49,020 | | |||||||
Used in investing activities | |
| (25,283) | |
| (42,916) | | |||||||
Used in financing activities | |
| (66,023) | |
| (6,350) | | |||||||
Increase (decrease) in cash and cash equivalents and restricted cash equivalents | |
| 5,752 | |
| (370) | | |||||||
Cash and cash equivalents and restricted cash equivalents at end of period | |
| 11,555 | |
| 24,944 | | |||||||
| | | | | | | | |||||||
Net cash provided by operating activities | | $ | 128,275 | | $ | 97,133 | | |||||||
Net cash used in investing activities | |
| (25,575) | |
| (25,283) | | |||||||
Net cash used in financing activities | |
| (132,988) | |
| (66,023) | | |||||||
Net increase (decrease) in cash and cash equivalents | |
| (30,271) | |
| 5,752 | | |||||||
Cash and cash equivalents at end of period | |
| 17,387 | |
| 11,555 | |
Net Cash Provided By Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items including depreciation and amortization, impairments, stock-based compensation, amortization of debt discount and the effect of changes in working capital and other activities.
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For the six months ended August 1, 2020, net cash provided by operating activities was $128.3 million and consisted of net income of $95.2 million and non-cash items of $89.1 million, partially offset by cash used for working capital and other activities of $56.0 million. Working capital and other activities consisted primarily of an increase in merchandise inventory of $49.0 million, an increase in landlord assets under construction of $22.9 million, a decrease in operating lease liabilities of $18.4 million primarily due to payments made under the related lease agreements, a decrease in accounts payable and accrued expenses of $13.1 million due to timing of payments, and a decrease in other non-current obligations of $12.3 million. These decreases in working capital were partially offset by increases in deferred revenue and customer deposits of $67.6 million.
For the six months ended August 3, 2019, net cash provided by operating activities was $97.1 million and consisted of net income of $99.5 million and non-cash items of $59.6$59.5 million, partially offset by a decrease in cash used for working capital and other activities of $61.9 million. Working capital and other activities consisted primarily of decreasesa decrease in operating lease liabilities of $44.5 million primarily due to payments made under the agreements, decreasesa decrease in accounts payable and accrued expense of $40.1 million related to timing of payments, increasesan increase in landlord assets under construction of $27.6 million, as well as decreasesa decrease in other non-current liabilities of $13.8 million. These decreases to working capital were partially offset by decreasesa decrease in merchandise inventoriesinventory of $51.2 million and increases in deferred revenue and customer deposits of $13.0 million.
For the six months ended August 4, 2018, net cash provided by operating activities was $49.0 million and consisted of net income of $88.4 million and non-cash items of $116.8 million, partially offset by a decrease in cash used for working capital and other activities of $156.1 million. Working capital and other activities consisted primarily of decreases in operating lease liabilities of $43.0 million primarily due to payments made under the agreements, increases in prepaid expenses and other current assets of $40.6 million, decreases in accounts payable and accrued expense of $31.7 million related to timing of payments, increases in landlord assets under construction of $27.6 million, as well as increases in inventory of $25.0 million. These decreases to working capital were partially offset by increases in deferred revenue and customer deposits of $20.8 million.
Net Cash Used In Investing Activities
Investing activities consist primarily of investments in capital expenditures related to investments in retail stores, information technology and systems infrastructure, as well as supply chain investments.
For the six months ended August 1, 2020, net cash used in investing activities was $25.6 million primarily due to investments in information technology and systems infrastructure, supply chain investments and retail stores of $32.1 million, as well as retail stores.
the acquisition of building and land assets of $14.2 million. Net cash used in investing activities was partially offset by net proceeds from the sale of building and land of $25.0 million. For the six months ended August 3, 2019, and August 4, 2018, net cash used in investing activities was $25.3 million and $42.9 million, respectively, due to investments in information technology and systems infrastructure, supply chain investments and retail stores.
Net Cash Used In Financing Activities
Financing activities consist primarily of borrowings related to convertible senior notes, credit facilities and other financing arrangements, as well as share repurchases, principal payments under finance lease agreements and other equity related transactions.
For the six months ended August 1, 2020, net cash used in financing activities was $133.0 million. The $300 million 2020 Notes matured in July 2020, of which $215.8 million is presented within net cash used in financing activities and $84.0 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities. Net cash used in financing activities was partially offset by net borrowings of $91.6 million under the asset based credit facility.
For the six months ended August 3, 2019, net cash used in financing activities was $66.0 million. The $350.0 million 2019 Notes matured in June 2019, of which $278.6 million is presented within net cash used in financing activities and $70.5 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net
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cash provided by operating activities. Additionally, net cash used in financing activities included repurchasesthe repurchase of approximately 2.2 million shares of our common stock for an aggregate repurchase amount of $250.0 million. Net cash providedused by financing activities whichwas partially offset net cash used in financing activities, includedby borrowings under new debt arrangements of $389.0 million, which amount includes the issuance of a $200.0 million second lien term loan, a $120.0 million FILO term loan and $69.0 million of promissory notes secured by certain equipment. We incurred costs of $4.6 million related to the debt issuances. Under the asset based credit facility, we made repayments of $214.5 million in connection with the debt issuances described above pursuant to the terms of such facility, and we subsequently had borrowings of $302.0 million under such faciltyfacility to partially fund the repayment of the 2019 Notes upon maturity.
For the six months ended August 4, 2018, net cash used in financing activities was $6.4 million55
Non-Cash Transactions
Non-cash transactions primarily dueconsist of non-cash additions of property and equipment and landlord assets, and reclassifications of assets from landlord assets from construction to repayments of debt of $821.9 million under the asset based credit facility, LILO term loan, equipment loans and promissory note secured by our aircraft. The repayments of debt described above were partially funded by borrowings under the asset based credit facility of $510.0 million and the $335.0 million convertible senior notes issued in June 2018, which provided net proceeds of $287.8 million after taking into consideration the convertible note hedge and warrant transactions, as well as discounts upon original issuance and offering costs. Equity related transactions provided $21.3 million due to $29.2 million of proceeds from exercise of employee stock options, partially offset by $7.9 million of cash paid for employee taxes related to net settlement of equity awards.finance lease right-of-use assets.
Convertible Senior Notes
Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements for further information on our 0.00% Convertible Senior Notes due 2024, 0.00% Convertible Senior Notes due 2023
In June 2018, we issued in a private offering $300 million principal amount of and 0.00% convertible senior notesConvertible 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 us 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.
The initial conversion rate applicable to the 2023 Notes is 5.1640 shares of common stock per $1,000 principal amount of 2023 Notes, which is equivalent to an initial conversion price of approximately $193.65 per share. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture, 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 will be 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 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 2023 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of August 3, 2019, none of these conditions have occurred and, as a result, the 2023 Notes were not convertible as of August 3, 2019. 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.
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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.
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 (deficit).
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. Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2023 balance on the condensed consolidated balance sheets.
2023 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2023 Notes and the 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 1.7 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 $91.9 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.7 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 3.5 million shares of common stock (which cap may also be subject to adjustment). We received $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 (deficit), 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.
2020. 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
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Trustee. The 2020 Notes will mature matured 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.2020.
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 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 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 August 3, 2019, none of these conditions have occurred and, as a result, the 2020 Notes were not convertible as of August 3, 2019. 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 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 (deficit).
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
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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 (deficit), 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 $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.
0.00% Convertible Senior Notes due 2019
In June 2014, we issued $350 million aggregate principal amount of 0.00% convertible senior notes due 2019 (the “2019 Notes”) in a private offering. The 2019 Notes were governed by the terms of an indenture between us and U.S. Bank National Association, as the Trustee. The 2019 Notes did not bear interest, except that the 2019 Notes were subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2019 Notes. The 2019 Notes were unsecured obligations and did not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events were also considered “events of default” under the 2019 Notes, which could result in the acceleration of the maturity of the 2019 Notes, as described in the indenture governing the 2019 Notes. The 2019 Notes matured on June 15, 2019.
The initial conversion rate applicable to the 2019 Notes was 8.6143 shares of common stock per $1,000 principal amount of 2019 Notes, which was equivalent to an initial conversion price of approximately $116.09 per share. The conversion rate was subject to adjustment upon the occurrence of certain specified events, but was not adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change,” we would, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elected to convert its 2019 Notes in connection with such make-whole fundamental change.
Prior to March 15, 2019, the 2019 Notes were 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 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 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. On and after March 15, 2019, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders could have converted all or a portion of their 2019 Notes at any time, regardless of the foregoing circumstances.
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In June 2019, upon the maturity of the 2019 Notes, $350.0 million in aggregate principal amount of the 2019 Notes were settled for $349.0 million in cash and 42 shares of our common stock. As a result, we recognized a gain on extinguishment of debt of $1.0 million. As of August 3, 2019, the 2019 Notes are no longer outstanding.
Upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders could have required 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 was amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component was not remeasured as long as it continued 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 were 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 were netted with the equity component in stockholders’ equity (deficit).
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 were recorded as a contra-liability and were presented net against the convertible senior notes due 2019 balance on the condensed consolidated balance sheets.
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 had 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. The convertible note hedge terminated upon the maturity date of the 2019 Notes. 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). The warrants will expire through December 2019. 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 met certain accounting criteria, the convertible note hedges were, 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 were recorded in deferred tax assets on the condensed consolidated balance sheets. There is no deferred tax asset or liability remaining as of August 3, 2019 due to the maturity of the 2019 Notes.
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Asset Based Credit Facility
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. On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit agreement (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 (“First Lien Administrative Agent”). The Refer to Note 10—Credit Agreement has a revolving line of credit with initial availability of up to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 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, whether existing lenders or new lenders, agree to increase their credit commitments. In addition, the Credit Agreement established an $80.0 million lastFacilities in last out (“LILO”) term loan facility which was repaid in full in June 2018. The Credit Agreement has a maturity date of June 28, 2022.
On June 12, 2018, Restoration Hardware, Inc. entered into a First Amendment to the Credit Agreement (the “First Amendment”). The First Amendment (i) changed the Credit Agreement’s definition of “Eligible In-Transit Inventory” to clarify the requirements to be fulfilled by the borrowers with respect to such in-transit inventory, and (ii) clarified that no default or event of default was caused by any prior non-compliance with such requirements with respect to in-transit inventory. Eligible In-Transit Inventory consists of inventory being shipped from vendor locations outside of the United States. Qualifying in-transit inventory is included within the borrowing base for eligible collateral for purposes of determining the amount of borrowing available to borrowers under the Credit Agreement.
On November 23, 2018, Restoration Hardware, Inc. entered into a Consent and Second Amendment to the Credit Agreement (the “Second Amendment”). The Second Amendment included certain clarifying changes to, among other things: (a) address the processing of payments from insurance proceeds in connection with casualty or other insured losses with respect to property or assets of a Loan Party, and (b) add an additional category of permitted restricted payment to allow the lead borrower to make annual restricted payments of up to $3.0 million per fiscal year to cover payments of certain administrative and other obligations of RH in the ordinary course of business.
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 under the Credit Agreement, (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. The FILO term loan facility has a maturity date of June 28, 2022.
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 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 are subject to interest, at the borrowers’ option, at either the bank’s reference rate or London 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, 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.
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 specifiedour condensed consolidated fixed-charge coverage ratio (“FCCR”). Subject to certain exceptions, the trigger for the FCCR occurs if the domestic
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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 subject to certain exceptions to maintain an FCCR of at least one to one.
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.
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 otherfurther information to lenders for the fiscal months ending February 2019 and March 2019.
As of August 3, 2019, Restoration Hardware, Inc. had $145.0 million in outstanding borrowings under the revolving line of credit. The Credit Agreement provides for a borrowing amounton our asset based on the value of eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of August 3, 2019 was $254.6 million, net of $12.8 million in outstanding letters of credit.facility.
The Credit Agreement contains various restrictive and affirmative covenants, including, among others, required financial reporting, 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. As of August 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the Credit Agreement.
Second Lien Credit Agreement
On April 10, 2019, Restoration Hardware, Inc., entered into a credit agreement, dated as of April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom are funds and accounts managed or advised by either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and its affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to a second lien term loan in an aggregate principal amount equal to $200.0 million with a maturity date of April 9, 2024 (the “Second Lien Term Loan”).
The Second Lien Term Loan bears interest at an annual rate generally based on LIBOR plus 6.50%. This rate is a floating rate that resets periodically based upon changes in LIBOR rates during the life of the Second Lien Term Loan. At the date of the initial borrowing, the rate was set at one month LIBOR plus 6.50%.
All obligations under the Second Lien Term Loan are secured by a second lien security interest in substantially all of the assets of the loan parties, including inventory, receivables and certain types of intellectual property. The second lien security interest encumbers substantially the same collateral that secures the credit. The second lien ranks junior in priority and is subordinated to the first lien in favor of the lenders with respect to the Credit Agreement.
The borrowings under the Second Lien Credit Agreement may be prepaid in whole or in part at any time, subject to certain minimum payment requirements, and including (i) a prepayment premium in the amount of 2.0% of the
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principal amount of the Second Lien Term Loan being prepaid during the first year after the effective date of the Second Lien Credit Agreement, (ii) 1.0% of the principal amount of the Second Lien Term Loan being prepaid during the second year after the effective date of the Second Lien Credit Agreement, and (iii) no prepayment premium after the second anniversary of the effective date of the Second Lien Credit Agreement.
The Second Lien Credit Agreement contains a financial ratio covenant not found in the Credit Agreement based upon a net senior secured leverage ratio of consolidated secured debt to consolidated EBITDA, as defined in the Credit Agreement, as follows:
The Second Lien Credit Agreement also contains certain events of default and other customary terms and conditions typical to a second lien credit agreement.
On May 31, 2019, Restoration Hardware, Inc. entered into a first amendment to the Second Lien Credit Agreement (the “First Amendment”). The First Amendment, among other things, amends the Second Lien Credit Agreement to (a) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter and (b) waive any default or event of default under the Second Lien 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.
As of August 3, 2019, the Company had $200.0 million in outstanding borrowings and no availability under the Second Lien Credit Agreement.
The Second Lien Credit Agreement contains 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, 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 a similar type and size. As of August 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the Second Lien Credit Agreement.
Intercreditor Agreement
On April 10, 2019, in connection with the Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an Intercreditor Agreement (the “Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the First Lien Administrative Agent and the Second Lien Administrative Agent. The Intercreditor Agreement establishes 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.
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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”) pursuantRefer 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 termsNote 10—Credit Facilities in our condensed consolidated financial statements for each particular equipment loan. Eachfurther information on our equipment loan is secured by a purchase money security interest in the financed equipment. As of August 3, 2019, we had $64.0 million in aggregate amounts outstanding under the equipment security notes, of which $21.5 million was included in other current liabilities and $42.5 million was included in other non-current obligations on the condensed consolidated balance sheets. 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.facility.
Share Repurchase Programs
We regularly review share repurchase activity and consider various factors in determining whether and when to execute share repurchases, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of the our common stock. We believe that these share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities.
$300 Million Repurchase Program (Completed)
On February 21,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 Board of Directors authorized a share repurchase programprograms. Free cash flow is calculated as net cash provided by operating activities, the non-cash accretion 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 throughdebt 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 this filing because management believes that free cash flow provides meaningful supplemental information for investors regarding the use of other techniques such as accelerated share repurchases. During the three months ended April 29, 2017, we repurchased approximately 7.8 million sharesperformance of our common stock under the $300 Million Repurchase Program at an average pricebusiness and facilitates a meaningful evaluation of $38.24 per share, for an aggregate repurchase amount of approximately $300 million. No additional shares will be repurchasedoperating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in future periods under the $300 Million Repurchase Program.
$700 Million Repurchase Program (Completed)
Following completion of the $300 Million Repurchase Program,order to have comparable financial results to analyze changes in our Board of Directors authorized on May 2, 2017 an additional share repurchase program of upunderlying business from quarter 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. During the three months ended July 29, 2017, we repurchased approximately 12.4 million sharesquarter. A reconciliation of our common stock under the $700 Million Repurchase Program at an average pricenet cash provided by operating activities to free cash flow is as follows:
| | | | | | | | | |
|
| Year Ended | |||||||
| | February 2, | | February 2, | | February 3, | |||
| | 2020 | | 2019 | | 2018 | |||
| | (in thousands) | |||||||
Net cash provided by operating activities | | $ | 339,188 | | $ | 249,603 | | $ | 474,505 |
Accretion of debt discount upon settlement of debt | |
| 70,482 | |
| — | |
| — |
Proceeds from sale of assets | |
| 24,078 | |
| — | |
| 15,123 |
Capital expenditures | | | (93,623) | | | (79,992) | | | (68,393) |
Principal payments under finance leases | |
| (9,682) | |
| (6,885) | |
| (6,105) |
Free cash flow | | $ | 330,443 | | $ | 162,726 | | $ | 415,130 |
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$950 Million Share Repurchase Program (Existing)
On October 10, 2018, our Board of Directors authorized a share repurchase program of up to $700 million through open market purchases, privately negotiated transactions or other means, including through Rule 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, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700 million authorization amount was replenished by the Board of Directors on March 25, 2019 (as replenished, the “$950 Million Repurchase Program”). In the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under the $950 Million Repurchase Program at an average price of $115.36 per share, for an aggregate repurchase amount of approximately
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$250.0 $250.0 million. We did not make anyThere were no share repurchases under this programthe $950 Million Repurchase Program during the three months ended August 3, 2019.first quarter of fiscal 2020. As of August 3, 2019,1, 2020, there was $450.0$450 million remaining for future share repurchases under this program.
Contractual Obligations
As of August 3, 2019,1, 2020, there were no material changes to our contractual obligations described in thewithin Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations in the 20182019 Form 10-K.
Off Balance Sheet Arrangements
We have no material off balance sheet arrangements as of August 3, 2019.1, 2020.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting 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 |
● | Impairment |
o | Tradenames, Trademarks and Domain Names |
o | Long-Lived Assets |
● | Lease Accounting |
o | Fair Market Value |
In the first quarter of fiscal 2019, we adopted Accounting Standards Update 2016-02—Leases. The adoption of this standard resulted in a material change to the “Lease Accounting” critical accounting policy in fiscal 2019. Please refer below for our updated “Lease Accounting” critical accounting policy. There have been no material changes to the other critical accounting policies and estimates listed above from the disclosures included in the 20182019 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 20182019 Form 10-K.
Lease Accounting
We lease nearly all of our retail and outlet store locations, corporate headquarters, distribution and home delivery facilities, as well as other storage and office space. The initial lease terms of our real estate leases generally range from ten to fifteen years, and certain leases contain renewal options for up to an additional 25 years, the exercise of which is at our sole discretion. In recognizing the lease right-of-use assets and lease liabilities, we utilize the lease term for which we are reasonably certain to use the underlying asset, including consideration of options to extend or terminate the lease. We also lease certain equipment with lease terms generally ranging from three to seven years. Our lease agreements generally do not contain any material residual value guarantees or material restrictions or covenants.
Leases, or lease extensions, with a term of twelve months or less are not recorded on the condensed consolidated balance sheets, and we recognize lease expense for these leases on a straight-line basis over the lease term.
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We account for lease and non-lease components as a single lease component for real estate leases, and for all other asset classes we account for the components separately. We determine the lease classification and begin to recognize lease and any related financing expenses upon the lease’s commencement, which for real estate leases is generally upon store opening or, to a lesser extent, when we take possession or control of the asset.
As most of our leases do not include an implicit interest rate, we determine the discount rate for each lease based upon the incremental borrowing rate (“IBR”) in order to calculate the present value of lease payments at the commencement date. The IBR is computed as the rate of interest that we would have to pay to (i) borrow on a collateralized basis (ii) over a similar term (iii) an amount equal to the total lease payments and (iv) in a similar economic environment. We utilize our asset based credit facility as the basis for determining the applicable IBR for each lease.
Certain of our lease agreements include rental payments based on a percentage of retail sales over contractual levels. Due to the variable and unpredictable nature of such payments, we do not recognize a lease right-of-use asset and lease liability related to such payments. Estimated variable rental payments are included in accounts payable and accrued expenses on the condensed consolidated balance sheets.
We have a small group of leases that include rental payments periodically adjusted for inflation (e.g., based on the consumer price index). We include these variable payments in the initial measurement of the lease right-of-use asset and lease liability if such increases have a minimum rent escalation (e.g., floor). However, we exclude these variable payments from the initial measurement of the lease right-of-use asset and lease liability in the case of lease arrangements that do not specify a minimum rent escalation.
We rent or sublease certain real estate to third parties under operating leases and recognize rental income received on a straight-line basis over the lease term, which is included in selling, general and administrative expenses on the condensed consolidated statements of income.
Lease arrangements may require the landlord to provide tenant allowances directly to us. Standard tenant allowances received from landlords, typically those received under operating lease agreements, are recorded as cash and cash equivalents with an offset recorded in lease right-of-use assets on the condensed consolidated balance sheets. In certain instances tenant allowances are provided for us to design and build the leased asset. Tenant allowances received from landlords during the construction phase of a leased asset and prior to lease commencement are recorded as cash and cash equivalents with an offset recorded in other non-current assets (to the extent we have incurred related capital expenditure for construction costs) or in other current liabilities (to the extent that payments are received prior to capital construction expenditures by us) on the condensed consolidated balance sheets. After the leased asset is constructed and the lease commences, we reclassify the tenant allowance from other non-current assets or other current liabilities to lease right-of-use assets on the condensed consolidated balance sheets.
Lease Classification
Certain of our real estate and property and equipment are held under finance leases. Lease related assets are included in finance lease right-of-use assets within property and equipment—net on the condensed consolidated balance sheets.
Leases that do not meet the definition of a finance lease are considered operating leases. Lease related assets are included in operating lease right-of-use assets on the condensed consolidated balance sheets.
Construction Related Activities
We are sometimes involved in the construction of leased stores for certain of our newer Design Galleries. Prior to construction commencement, we evaluate whether or not we, as lessee, control the asset being constructed and, depending on the extent to which we are involved, may be the “deemed owner” of the leased asset for accounting purposes during the construction period.
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If we are not the “deemed owner” for accounting purposes during the construction period, such lease is classified as either an operating or finance lease upon lease commencement. During the construction period and prior to lease commencement, any capital amounts contributed by us toward the construction of the leased asset (excluding normal leasehold improvements, which are recorded within property and equipment—net) are recorded as “Landlord assets under construction” within other non-current assets on the condensed consolidated balance sheets (refer to Note 3—Prepaid Expense and Other Assets). Upon completion of the construction project, and upon lease commencement, we reclassify amounts of the construction project determined to be the landlord asset to lease right-of-use assets on the condensed consolidated balance sheets. The construction costs determined not to be part of the leased asset are classified as property and equipment—net on the condensed consolidated balance sheets.
If we are the “deemed owner” for accounting purposes, upon commencement of the construction project, we are required to capitalize (i) costs incurred by us and (ii) the cash and non-cash assets contributed by the landlord for construction as property and equipment on its condensed consolidated balance sheets as build-to-suit assets, with an offsetting financing obligation for the amount funded by the landlord. 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 the consolidated statements of cash flows. Over the lease term, these non-cash additions to property and equipment do not impact our cash outflows, nor do they impact net income within the consolidated statements of income.
Upon completion of the construction project, we perform a sale-leaseback analysis to determine if we can derecognize the build-to-suit asset and corresponding financing obligation. If the asset and liability cannot be derecognized, we account for the agreement as a debt-like arrangement.
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. As of August 3, 2019, $145.01, 2020, $91.6 million was outstanding under the revolving line of credit. The Credit Agreement provides for a borrowing amount based on the value of eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of August 3, 20191, 2020 was $254.6$259.2 million, net of $12.8$14.5 million in outstanding letters of credit. Based on the average interest rate on the revolving line of credit during the three months ended August 3, 2019,1, 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.
A number of our current debt agreements, including the Credit Agreement, have an interest rate tied to LIBOR, which is expected to be discontinued after 2021. A number of alternatives to LIBOR have been proposed or are being developed, but it is not clear which, if any, will be adopted. Any of these alternative methods may result in interest payments that are higher than expected or that do not otherwise correlate over time with the payments that would have been made on such indebtedness for the interest periods if the applicable LIBOR rate was available in its current form.
As of August 3, 2019, we had $300 million principal amount of 0.00% convertible senior notes due1, 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 August 3, 2019, 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.
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TableAs of ContentsAugust 1, 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 20192020
In connection with the issuance of the 0.00% convertible senior notes due 2019 (the “2019 Notes”),2020 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The 20192020 Notes matured on JuneJuly 15, 2019,2020, and the convertible note hedge terminated upon the maturity date of the 20192020 Notes. We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrants will expire through December 2019.January 2021. To the extent they are exercised prior to expiration, the warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants. The strike price of the warrant transactions is initially $171.98$189.00 per share. Refer to Note 8—9—Convertible Senior Notes in our condensed consolidated financial statements.
0.00% Convertible Senior Notes due 202058
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 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—9—Convertible Senior Notes in our condensed consolidated financial statements.
0.00% Convertible Senior Notes due 2024
In connection with the issuance of the 2024 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively, 1.7 million shares of our common stock, which represents the number of shares of our common stock underlying the 2024 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2024 Notes. These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to our common stock upon conversion of the 2024 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion of the 2024 Notes.
We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant transactions is initially $338.24 per share. Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements.
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.
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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.
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Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II
Item 1. Legal Proceedings
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 15—16—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 February 2, 1, 2020 (“2019 (“2018 Form 10-K”) and in our Quarterly Report on Form 10-Q for the quarterly period ended May 2, 2020 (“First Quarter Form 10-Q”).
The risks described herein and those described in our 20182019 Form 10-K and in our First Quarter Form 10-Q are not the only risks we face. We describe in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report certain known trends and uncertainties that affect our business. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business, operating results and financial condition. We have identified additional material changes to our risk factors set forth below.
We are undertaking a large numberRisks 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 business initiatives at the same time, including exploring opportunities to expand into new categoriesnovel coronavirus disease (“COVID-19”) and complementary businesses. If these initiatives are not successful, they may have a negativeresulting health crisis had an immediate and widespread impact on our resultscustomers, our business environment, the economic climate in the U.S. and globally, and financial and consumer markets. The initial wave of operations.
We are undertaking a large number of newthe COVID-19 outbreak caused disruption to our business initiatives at the same time in order to support our future growth. For example,operations, as we have developed and continue to refine and enhance our Gallery format, which involves larger store square footage. We also continue to add new product categories and to expand product assortments. For example, in fiscal 2015 we launched our new RH Modern and RH Teen categories and in fiscal 2019 we are launching RH Beach House and RH Ski House. We are currently contemplating other new product lines and extensions. We introduced RH Hospitality in fiscal 2015 at RH Chicago, The Gallery at the Three Arts Club. As of August 3, 2019, sixtemporarily closed all of our RH Design Galleries include an integrated RH Hospitality experience and, basedretail locations on the success of our hospitality offering to date, we plan to incorporate an integrated RH Hospitality offering, including cafés, wine vaults, and barista bars,March 17, 2020 in many of the new Galleries that we open in the future. We continue to refine and develop the RH Hospitality model as we seek to optimize this part of our business and its integration with the operation of our Gallery locations. RH Hospitality is different from our traditional home furnishings business and involves evolving strategies that are untested and unproven and may expose us to a number of risks including risks relatedresponse to the management and execution of food and hospitality operations in various locations where we operate retail Galleries. Although we have experienced a number ofpublic health crisis.
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positiveWhile we have continued to serve our customers and operate our business outcomes fromthrough the RH Hospitality operations includinginitial phase of the incremental revenue that we believe is drivenCOVID-19 health crisis, and have now substantially reopened our retail locations in Gallery with a hospitality offering,the U.S. and Canada, there can be no assurance that these benefitsfuture events will be sustainednot have an impact on our business, results of operations or that we will avoid operationalfinancial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other complicationssimilar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021.
Volatility in consumer demand and sentiment as the COVID-19 pandemic continues to evolve can also expose us to risks in our operations. In our immediate response to COVID-19, we aggressively scaled back some inventory orders while we assessed the status of our business. As our business has strengthened during the second fiscal quarter, the reduction in inventory receipts together with dislocations in our supply chain resulted in some delays in our ability to convert business demand into shipped sales. In addition, our near term decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business related to the impact of COVID-19. The global scale and scope of COVID-19 is unknown and the duration of the business disruption is uncertain. The extent to which the COVID-19 pandemic impacts our business will depend on future developments that are highly uncertain, including developing information concerning the severity of COVID-19 and the actions taken by governments and private businesses to attempt to contain COVID-19.
We may face operational restrictions with respect to some or all of our physical locations for prolonged periods of time due to, among other factors, evolving international, federal, state and local restrictions, standards and safety regulations including recommendations related to “social distancing.” Public health officials and other governmental authorities have adopted numerous mitigation measures to address the spread of the virus, and in particular to discourage people from congregating in public, commercial or private spaces. Federal, state and local authorities in the U.S. and Canada have implemented a number of different directives that may require changes in our business practices. The scope and duration of these directives is evolving and not entirely clear. In response to future COVID-19 outbreaks or other concerns, states and municipalities in the U.S. where we operate may implement or reinstate temporary closure requirements with respect to non-essential business operations and the duration of these requirements is unknown. Governmental restrictions applicable to our restaurants have different terms and conditions than those that apply to our Galleries. For example, in most of our retail locations that have reopened, substantial operational restrictions related to COVID-19 health and safety considerations, such as limits to seating capacity, have been imposed on our hospitality business by various governmental authorities. Such operational restrictions may cause our hospitality offerings to be less attractive to customers or may lower its margins and profitability. Many of our Galleries are located in malls or otherwise located in proximity to a number of other retail stores. Mall operators and other retailers have imposed, and may continue to impose, additional health and safety practices and procedures and may in the future elect to temporarily cease operations in response to renewed or localized outbreaks.
In addition, new regulation or requirements that governmental authorities may impose with respect to the compensation of our employees or the manner or location in which our employees may work could also have an adverse effect on our business. ThereAt various times since the beginning of the pandemic, substantially all of our management personnel, including those in our corporate office in Corte Madera, CA, have been subject to state and local shelter-in-place requirements, which have varied over time and which have resulted in most of our management team being required to work remotely. These working arrangements as well as other related restrictions including severe limitations on travel may have an impact on our operations and management effectiveness. Although we have technology and other resources to support these new work requirements, there can be no assurance that we will successfully scale RH Hospitality, that we will optimally balance the resources and square footage allocatednot suffer material risks to our hospitality offerings versus our product offerings at our Galleries, or that our hospitality offerings will be attractive to consumers in our market over a sustained period of time.
We have also embarked on an initiative to expand our product sales to international markets and are currently exploring opportunities for Design Galleries in several locations outside the United States, including the United Kingdom and Europe. International expansion would expose us to new risks, including, but not limited to, risks related to currency fluctuation, supply chain and product sourcing, international economic or political events including but not limited to the U.K.’s impending withdrawal from the European Union, commonly referred to as “Brexit,” that may negatively impact the luxury market, and new regulatory regimes applicable to our products, Galleries and employees. We may be unsuccessful in adapting ourbusiness, operations, to address such risks. We also may be unsuccessful in accurately selecting which international markets would support demand for our products or sizing our Gallery openings to such markets. If we are not successful in managing the large number of new initiatives that are underway, we might experience an adverse impact on our financial conditionproductivity and results of operations.
Furthermore, we can provide no assurances that customers will respond favorably to our new product offerings, Galleries or complementary businesses or that we will successfully execute on such business initiatives. Such new business opportunities may not achieve market acceptance or may only achieve market acceptance in limited geographic areas or at certain Design Galleries. In addition, developing and testing new and multiple business opportunities and strategies often requires knowledge in areas of expertise that may be new to our organization and may require significant time of our management and resources. For example, RH Hospitality extended our business into an area where we have had limited historical operating and management experience and where low margins and high customer expectations can put pressure on results and performance. Expanding our business internationally will also require that we develop management expertise in new markets and regulatory regimes, and an inability to adapt our business quickly and efficiently to support our international expansion could materially adversely affect our financial condition and results of operations. We can provide no assurances that we will be successful in expanding our operations into any new businesses and product lines.
Any new businesses we enter may also expose us to additional laws, regulations and risks, including the risk that we may incur ongoing operating expenses in such businesses in excess of revenues, which could harm our financial condition and results of operations. The financial profile of any such new businesses may be different than our current financial profile, which could affect our financial performance and the market price for our common stock. For example, RH Hospitality may expose us to new risks related to consumer litigation and longer lease terms.
We often have in the past, and may in the future, incur significant costs for any new initiative before we realize any corresponding revenue with respect to such initiative. In addition, we may incur costs as we revise, restructure or discontinue existing product categories or business offerings in favor of pursuing new initiatives or retail concepts. For example, as we continue to open larger format Design Galleries in select major metropolitan markets, we expect to close a number of legacy Galleries and replace them with our Design Gallery format. The introduction of an integrated hospitality experience, including roll out of an integrated food and beverage experience at a new Gallery location often requires significant investments by us before the location is open to customers and able to generate revenues, and we anticipate that a number of Galleries to be opened during the next several years will continue to require this form of upfront investment before they generate revenue from the food and beverage offerings. In addition, during the fourth quarter of fiscal 2016, we initiated and executed a plan to integrate the RH Contemporary Art (“RHCA”) product line into the broader RH platform and we no longer operate RHCA as a separate division, and as a result we incurred restructuring related costs. To the extent that these new business opportunities do not generate sufficient revenue to recoup the cost of developing and operating such new concepts, our results of operations could be materially adversely affected.
In addition, we are continuing a number of new initiatives to improve the operations of our business, including ongoing refinements to our management structure and organizational design. Some of the improvements we are pursuing include changing the ways we source and deliver our products to our customers, as well as streamlining and realigning the management structure in our home office operations. We have also focused on elevating the customer experience,
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which includes improving our distribution and delivery of products to our customers and architecting a new fully integrated back-end operating platform, inclusive of the supply chain network, the home delivery experience as well as a new metric-driven quality system and company-wide decision data. We have focused on rationalizing our SKU count and optimizing inventory, which includes selling slower moving, discontinued and other inventory through markdowns and our outlet channel, as well as enhancing and optimizing our product sourcing capabilities and adding new management information systems. We also transitioned from a promotional to a membership model, in the early part of fiscal 2016, by introducing the RH Members Program, which provides a range of benefits to our customers in return for payment of an annual membership fee. We introduced the RH Members Program as an alternative to prior practices involving numerous event-driven promotional programs. Although we are extremely satisfied with the results of the RH Members Program to date, this program is still new to our business, and there can be no certainty as to exactly how our customers may react to this program over time or how the RH Members Program will affect our financial results from quarter to quarter.
Given the large number of organizational initiatives we are pursuing, as well as the complexity and untested nature of many of these efforts, there can be no certainty that we will be successful in executing on these initiatives including changes to our organizational design and management structure. We may not experience the operational or financial benefits we expect these improvements to generate and we may face unanticipated costs related to pursuing these initiatives such as personnel turnover, management distraction, or compliance and quality control risks, any of which could have a material adverse effect on our financial condition or results of operations.
All of the foregoing risks may be compounded due to various factors including any economic downturn. If we fail to achieve the intended results of our current business initiatives, or if the implementation of these initiatives is delayed or abandoned, diverts management’s attention or resources from other aspects of our business or costs more than anticipated (including, as a result of personnel turnoverthese restrictions. If a significant percentage of our workforce is unable to work, including because of illness or compliance and control risks), wetravel or government restrictions in connection with COVID-19, our operations may experience inadequate return on investment for some or all suchbe negatively impacted, potentially materially adversely affecting our business, initiatives, which could have a material adverse effect on ourliquidity, financial condition or results of operations.
We are subject to risks associated with our dependence on foreign manufacturing and imports for our merchandise.
Based on total dollar volume of purchases, in fiscal 2018 we sourced approximately 85% of our merchandise from outside the United States, including 73% from Asia, with approximately 39% of our products sourced from China and approximately 3% of our products sourced from Mexico, and in fiscal 2017 we sourced approximately 85% of our merchandise from outside the United States, including 76% from Asia, with approximately 42% of our products sourced from China and approximately 3% of our products sourced from Mexico. We expect the amount of products that we source from China will be lower in fiscal 2019 compared to fiscal 2018, but the exact product mix in terms of vendor factory locations is subject to a range of different factors and is inherently difficult to predict with accuracy. In addition, some of the merchandise we purchase from vendors in the United States also depends, in whole or in part, on vendors located outside the United States. As a result, our business highly depends on global trade, as well as any trade and or other factors that impact the specific countries where our vendors’ production facilities are located. Our future success will depend in large part upon our ability to maintain our existing foreign vendor relationships and to develop new ones based on the requirements of our business and any changes in trade dynamics that might dictate changes in the locations for sourcing of products. In addition, we face risks related to the ability of our vendors to scale their operations whether in connection with new products we introduce or new production manufacturing locations that may be added to our supply chain, which in some cases would require substantial ongoing investments to support additional capacity. In addition, we have previously encountered difficulties in the ability of our vendors to scale production commensurate with demand from our customers. While we rely on long-term relationships with many of our vendors, we do not rely on long-term contracts with our vendors and generally transact business with them on an order-by-order basis.
Many of our imported products are subject to existing duties, tariffs, anti-dumping duties and other similar trade restrictions that may limit the quantity or affect the price of some types of goods that we import into the United States. In addition, substantial regulatory uncertainty exists regarding international trade relations and trade policy, both in the United States and abroad. An introduction of new duties, tariffs, quotas or other similar trade restrictions, or increases in existing duties or tariff rates, on products imported into the United States, whether actual, pending or threatened, may have a negative impact on our results of operations. Significant uncertainty exists as to whether and when tariffs may be
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imposed, and what countries may be implicated. For example, proposed tariffs on goods imported from Mexico have been introduced and subsequently withdrawn by the U.S. government. Additionally, such uncertainties, even if not directly applicable to our imported products, may have a negative influence on the domestic and international economy generally and indirectly reduce market demand for our products.
A significant subset of our products sourced from China has been affected by increased levels of tariffs that were imposed in 2018 and 2019. The initial round of these increased tariffs became effective on certain products that we source from China including furniture and lighting initially as a 10 percent ad valorem duty on September 24, 2018, which amount increased to 25 percent on May 10, 2019, and is expected to increase further to 30 percent on October 1, 2019. On August 1, 2019, President Trump announced a new 10 percent ad valorem duty on additional categories of goods imported from China, which amount was then increased to 15 percent on August 23, 2019. The new tariff at the rate of 15 percent became effective September 1, 2019 with respect to certain categories of goods and is expected to become effective for additional categories of goods on December 15, 2019.
While we have been working with our vendor partners on mitigation strategies to seek to address the impact of the tariffs on goods imported from China, such efforts may not be fully sufficient to remediate the impact of the existing ad valorem duty on certain products imported from China or the future ad valorem duties to be imposed on products from China. In addition, such mitigation efforts may not be successful with respect to other pending or future increases in tariffs. There is substantial uncertainty regarding the possible application of additional tariffs with respect to China, or the possible imposition of tariffs on trade with additional countries other than China. We may not be able to anticipate the exact contours of tariffs and other burdens on global trade that may become applicable and our efforts to respond to these circumstances may be inadequate. In particular, we may not be able to receive or sustain adequate pricing concessions from our vendors with respect to applicable tariffs and any applicable pricing increases that we seek to pass through to our customers may not be successful in achieving our objectives. Our sales may fall in response to any price increases and our vendors may not be able to support the level of pricing concessions that we seek.
In addition, we are undertaking ongoing efforts to examine our sourcing strategy in a comprehensive way in order to achieve the best possible outcomes for our business. Such efforts include addressing among other factors the country of origin and the current and potential future imposition of tariffs with respect to particular countries of origin. These efforts to optimize our supply chain may not be successful and we may encounter various obstacles to these and other related initiatives. Although we have moved some of our merchandise sourcing away from China to other countries, these efforts may not achieve the desired outcomes. For example, we may not be able to move sufficient quantities of our product manufacturing to new locations outside of China and the quality of products manufactured in new factories may not meet the requirements of our business. In addition, we may encounter logistics and other challenges in moving manufacturing to new jurisdictions including the potential imposition of new tariffs on products sourced from such other jurisdictions.
In addition, there can be no assurance that tariffs that are imposed or proposed will not become effective on a longer term basis. In the event that any tariffs applicable to our business become applicable on a longer term basis, there can be no assurance that our efforts to mitigate the impact of such longer term tariffs will be successful.
There can be no assurance that we will not experience disruption in our business related to tariffs or other changes in trade practices and applicable rules or as a result of our efforts to respond to these matters. Tariffs and other similar trade actions are inherently unpredictable and can change quickly based on political or economic pressures or policy changes. Any changes to tariffs or other rules and practices related to cross border trade, including the possible implementation of additional tariffs, could materially increase our cost of goods sold with respect to merchandise that we purchase from vendors who manufacture products in China or other countries outside the United States, which could in turn require us to increase our prices and, in the event consumer demand declines as a result, negatively impact our financial performance. While we may seek to adopt mitigation measures and changes to our business practices to seek to counteract the effect of such tariffs on our business and results of operations, due to multiple factors that can occur in the context of trade disputes and the inherent unpredictability of how customers and market participants may respond, any mitigation measures we adopt may be not achieve their intended purpose. Certain of our competitors may be better positioned than us to withstand or react to these kinds of changes including border taxes, tariffs or other restrictions on global trade and as a result we may lose market share to such competitors. In addition, to the extent that our competitors, our vendors or companies in other industries that manufacture products in China respond to the tariffs imposed to date or the possibility of future tariffs by shifting production to other countries in Asia or to other regions, the costs of
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production in such countries may increase, which may increase our costs or otherwise have an adverse impact on our product supply chain. Similarly, to the extent that we or our vendors respond to the tariffs imposed to date or the possibility of future tariffs by shifting merchandise purchases or production to other countries in Asia or to other regions, we may face delays or costs associated with developing new vendor relationships and our vendors may face delays or costs associated with bringing online new manufacturing facilities, which may increase the cost of our products or cause delays in the shipment of our merchandise that result in the cancellation of orders by our customers. An interruption or delay in supply from our foreign sources, or the imposition of additional duties, taxes or other charges on these imports, could have a material adverse effect on our business, financial condition and results of operations unless and until alternative supply arrangements are secured. Due to broad uncertainty regarding the timing, content and extent of any regulatory changes in the U.S. or abroad, we cannot predict the impact, if any, that these changes could have to our business, financial condition and results of operations.
Our dependence on foreign imports also makes us vulnerable to risks associated with products manufactured abroad, including, among other things, risks of damage, destruction or confiscation of products while in transit to our distribution centers located in the United States, product quality control charges on or assessment of additional import duties, tariffs, anti-dumping duties and quotas, loss of “most favored nation” trading status by our foreign trading partners with the United States, work stoppages, including without limitation as a result of events such as longshoremen strikes, transportation and other delays in shipments, including without limitation as a result of heightened security screening and inspection processes or other port-of-entry limitations or restrictions in the United States, freight cost increases, political unrest, economic uncertainties, including inflation, foreign government regulations, trade restrictions, increased labor costs and other similar factors that might affect the operations of our vendors in specific countries such as China.
In addition, there is a risk of compliance violations by our vendors, which could lead to adverse consequences related to the failure of our vendors to adhere to applicable manufacturing requirements or other applicable rules or government regulations. Any such noncompliance could have an adverse impact on our business and may result in product recalls, regulatory action, product liabilities, investigation by governmental agencies and other similar adverse consequences. Any failure by our vendors outside the United States to adhere to applicable legal requirements or our global compliance standards such as fair labor standards, prohibitions on child labor and other product safety or manufacturing safety standards could give rise to a range of adverse consequences including the disruption of our supply chain as well as potential liability to us and harm our reputation and brand and could subject us to other adverse consequences including boycotts by our consumer or special interest groups including activists, any of which actions could negatively affect our business and results of operations.
Changes to accounting rules or regulations may adversely affect our results of operations.
New accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. It is difficult to predict the impact of future changes to accounting principles or current accounting practice and the exact impact of such changes may not be what we anticipate. A change in accounting rules or regulations may even affect our reporting of transactions completed before the change is effective and future changes to accounting rules or regulations or the questioning of current accounting practices may adversely affect our results of operations. For example, we adopted Accounting Standards Update 2014-09—Revenue from Contracts with Customers (Topic 606) in the first quarter of fiscal 2018, the adoption of which materially impacted the timing of recognizing advertising expense related to direct response advertising, including costs associated with our Source Books. In addition, we adopted Accounting Standards Update 2016-02—Leases (Topic 842) in the first quarter of fiscal 2019, the adoption of which materially impacted our financial statements including (i) our consolidated balance sheets due to the initial recognition of right of use assets and lease liabilities for our operating and finance lease arrangements, (ii) our consolidated statements of income, specifically cost of goods sold and interest expense—net, primarily due to the change from the build-to-suit lease transactions under the previous accounting guidance to the new finance lease classification treatment, and (iii) our cash flows due to amortization and interest expense for our operating and finance lease arrangements and classification of landlord assets under construction. For information regarding recently issued accounting pronouncements, refer to Note 2—Recently Issued Accounting Standards in our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q.
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The adoptionCOVID-19 outbreak may continue to have an adverse impact on elements of our supply chain including the manufacture, supply, distribution, transportation and applicationdelivery of new accounting standards can expose us to certain risks similar to the risks we faceour products and our inventory levels. There have been substantial disruptions that have already occurred with respect to the global supply chain as a result of the COVID-19 health crisis. Our business depends on the successful operation of a global supply chain. Based on total dollar volume of purchases for fiscal 2019, approximately 70% of our abilityproducts 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 maintain effective internal controlsnumerous other countries throughout the world. The presence of the virus and the response to the health crisis in various countries is likely to have a continuing impact on our supply chain, for example by affecting the speed at which the factories that manufacture our products are able to resume normal operations and production levels after initial or subsequent waves of closures, and the extent that the health crisis may abate in particular countries such as China is uncertain.
Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may further adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020. If we are not able to access capital at the time and on terms that our business requires, we may encounter difficulty funding our business requirements including debt repayments when due. We may not be able to access liquidity or the terms and conditions of available credit may be substantially more expensive than previously expected due to changes in financial reportingconditions and any failurecredit markets. We may require waivers or amendments to our existing credit facilities and these requirements may trigger pricing increases from lenders for available credit. If we are not able to access credit to fund our business requirements for liquidity, or the cost of available credit increases, we may need to curtail our business operations including various business initiatives that require capital investment. We have recently commenced an effort to expand our business internationally by establishing a new retail presence in global markets including Europe and the United Kingdom. The impact of COVID-19 abroad, including travel restrictions imposed by various countries, may affect certain aspects of our planned international expansion. In addition, we are in the process of developing a number of new Gallery locations in the U.S. Counterparties with respect to some of our Gallery development projects may experience capital or liquidity constraints due to COVID-19 related difficulties, which may impact the timing or scope of some of our development projects. In addition, our RH Guesthouse initiative may be negatively impacted by the disease outbreak as international, federal, state and local governments have restricted travel, conferences, events and gatherings. Any reductions in our adoption liquidity position and the need to use capital for other day-to-day requirements of our business could affect a number of our business initiatives and long-term investments and as a result we may be required to curtail and/or applicationpostpone business investments including those related to international expansion, the pace of opening new accounting rulesGalleries 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 maintenanceCOVID-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 effective internal controls overthird parties that are essential to our business operations and we may incur losses and other negative impacts for difficulties experienced by our vendors and other third parties.
The magnitude and duration of the negative impact to general economic and market conditions from the COVID-19 pandemic cannot be predicted with certainty, and there can be no assurance that the pace of economic activity in the wake of COVID-19 outbreaks will not have a negative impact on our business. The COVID-19 pandemic and mitigation measures have had an adverse impact on global economic conditions as well as the business climate in our primary consumer markets in the U.S. and Canada. Our business also depends to some extent on conditions in financial reporting or disclosure controls could expose us to material risksmarkets. We have determined that our customer purchasing patterns are influenced by economic factors including the inabilityhealth and volatility of the stock market. We have seen that previous downturns in the stock market have been correlated with a reduction in consumer demands for our products. The timing, magnitude and duration of disruptions of financial markets and weakening of overall economic conditions as a result of COVID-19 is unknown, and the precise impact of such trends on our business is also unknown. Uncertainties regarding the economic impact of COVID-19 have resulted in, and are likely to accurately report our financial informationcontinue 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 results of operationdeclines in a timely manner. Our results of operations could be materially adversely affected by thesethe stock market and similiar risks including,increasingly pessimistic consumer sentiment due to the extent we experience any increases in costsperceived or diversions in managerial actual economic and/or personnel resources in order to adopt new accounting rules or regulations or to adopt and maintain effective internal controls over financial reporting or disclosure controls.health risks.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchases of Common Stock during the Three Months Ended August 3, 2019
During the three months ended August 3, 2019,1, 2020, we repurchased the following shares of our common stock:
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| Total Number of |
| Approximate Dollar |
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| Total Number of |
| Approximate Dollar | ||
| | | | Average | | Shares Repurchased | | Value of Shares That | | | | Average | | Shares Repurchased | | Value of Shares That | ||||
| | | | Purchase | | as Part of Publicly | | May Yet Be | | | | Purchase | | as Part of Publicly | | May Yet Be | ||||
| | Number of | | Price Per | | Announced Plans or | | Purchased Under the | | Number of | | Price Per | | Announced Plans or | | Purchased Under the | ||||
| | Shares (1) | | Share | | Programs (2) | | Plans or Programs | | Shares (1) | | Share | | Programs (2) | | Plans or Programs | ||||
| | | | | | | | | (in millions) | | | | | | | | | (in millions) | ||
May 5, 2019 to June 1, 2019 |
| 1,355 | | $ | 102.87 |
| — | | $ | 450 | ||||||||||
June 2, 2019 to July 6, 2019 |
| 50,853 | | $ | 111.45 |
| — | | $ | 450 | ||||||||||
July 7, 2019 to August 3, 2019 |
| 132 | | $ | 122.25 |
| — | | $ | 450 | ||||||||||
May 3, 2020 to May 30, 2020 |
| 3,839 | | $ | 150.24 |
| — | | $ | 450 | ||||||||||
May 31, 2020 to July 4, 2020 |
| 22,963 | | $ | 254.80 |
| — | | $ | 450 | ||||||||||
July 5, 2020 to August 1, 2020 |
| — | | $ | — |
| — | | $ | 450 | ||||||||||
Total |
| 52,340 | | | |
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| 26,802 | | | |
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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.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
Not applicable.
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Item 6. Exhibits
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101.INS | | XBRL Instance Document—the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | | — | | — | | — | | — | | 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: September 10, | | By: | /s/ Gary Friedman |
| | Gary Friedman | |
| | Chairman and Chief Executive Officer | |
| | (Principal Executive Officer) | |
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Date: September 10, | | By: | /s/ Jack Preston |
| | Jack Preston | |
| | Chief Financial Officer | |
| | (Principal Financial Officer) | |
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Date: September 10, | | By: | /s/ Glenda Citragno |
| | Glenda Citragno | |
| | SVP, Chief Accounting Officer | |
| | (Principal Accounting Officer) |
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