RH
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 2020 Form 10-K.
FORWARD-LOOKING STATEMENTS AND MARKET DATA
This quarterly report contains forward-looking statements that are subject to
risks and uncertainties. Forward-looking statements give our current
expectations and projections relating to our financial condition, results of
operations, plans, objectives, future performance and business. You can identify
forward-looking statements by the fact that they do not relate strictly to
historical or current facts. These statements may include words such as
"anticipate," "estimate," "expect," "project," "plan," "intend," "believe,"
"may," "will," "short-term," "non-recurring," "one-time," "unusual," "should,"
"likely" and other words and terms of similar meaning in connection with any
discussion of the timing or nature of future operating or financial performance
or other events.
Forward-looking statements are subject to risk and uncertainties that may cause
actual results to differ materially from those that we expected. We derive many
of our forward-looking statements from our operating budgets and forecasts,
which are based upon many detailed assumptions. While we believe that our
assumptions are reasonable, we caution that it is very difficult to predict the
impact of known factors and it is impossible for us to anticipate all factors
that could affect our actual results, and matters that we identify as "short
term," "non-recurring," "unusual," "one-time," or other words and terms of
similar meaning may, in fact, recur in one or more future financial reporting
periods. Important factors that could cause actual results to differ materially
from our expectations, or cautionary statements, include those factors disclosed
under the section entitled Risk Factors in our Annual Report on Form 10-K for
the fiscal year ended January 30, 2021 (the "2020 Form 10-K"), and Management's
Discussion and Analysis of Financial Condition and Results of Operations in
Part I of this quarterly report, in our Quarterly Report on Form 10-Q for the
quarterly period ended May 1, 2021 (the "First Quarter Form 10-Q") and in our
2020 Form 10-K. All forward-looking statements attributable to us, or persons
acting on our behalf, are expressly qualified in their entirety by these
cautionary statements, as well as other cautionary statements. You should
evaluate all forward-looking statements made in this quarterly report in the
context of these risks and uncertainties.
We cannot assure you that we will realize the results or developments we expect
or anticipate or, even if substantially realized, that they will result in the
consequences or affect us or our operations in the way we expect. The
forward-looking statements included in this quarterly report are made only as of
the date hereof. We undertake no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise, except as required by law.
Overview
We are a leading luxury retailer in the home furnishings market. Our curated and fully integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings. We offer merchandise assortments across a number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings. We position our Galleries as showrooms for our brand, while our websites andSource Books act as virtual extensions of our physical spaces. Our retail business is fully integrated across our multiple channels of distribution, consisting of our retail locations, websites andSource Books . We have an integrated RH Hospitality experience in 11 of our locations, which include Restaurants and Wine Bars.
34 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents As ofJuly 31, 2021 , we operated the following number of Galleries, Outlets and Showrooms: COUNT RH Design Galleries 25 Legacy Galleries 37 Modern Galleries 1 Baby & Child and TEEN Galleries 3 Total Galleries 66 Outlets 38 Waterworks Showrooms 14
The COVID-19 outbreak in the first quarter of fiscal 2020 caused disruption to our business operations beginning in the first quarter of fiscal 2020. The pandemic has continued since the initial outbreak and has included spikes and outbreaks in various locations around the world including as a result of new strains of the COVID virus such as the "Delta" variant. In our initial response to the health crisis we undertook immediate adjustments to our business operations including temporarily closing all of our retail locations and Restaurants, curtailing expenses, and delaying investments including scaling back some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second through fourth fiscal quarters of fiscal 2020 as a result of both the reopening of most of our retail locations and also strong consumer demand for our products. Operational restrictions related to the pandemic affecting our Galleries and hospitality locations continued to fluctuate through the second quarter of 2021 based upon changes in local conditions and regulations. As ofSeptember 3, 2021 , all of our Galleries, Outlets and Restaurants were open. Our overall customer demand in specific markets has generally correlated favorably with our customers' ability to experience our Galleries and Outlets. Although our business has strengthened during the period from the second quarter of fiscal 2020 and continuing into fiscal 2021, consumer spending patterns may shift away from spending on the home and home-related categories, such as home furnishings, as pandemic restrictions are lifted and consumers return to pre-COVID consumption trends, such as spending on travel and leisure and other activities. In addition, various constraints in our merchandise supply chain have resulted in some delays in our ability to convert business demand into revenues at normal historical rates. We anticipate that the backlog of orders for merchandise from our vendors, coupled with business conditions related to the pandemic, will continue to adversely affect the capacity of our vendors and supply chain to meet our merchandise demand levels during fiscal 2021. It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand and as a result the exact timing cannot be accurately predicted due to ongoing uncertainty of the continuing impact of the pandemic on our global supply chain. In particular, business circumstances and operational conditions in numerous international locations where our vendors operate are subject to ongoing risks, and regions in which our vendors have production facilities, most notablyVietnam , have experienced various surges in outbreaks and, in some cases, facility closures related to the pandemic. As a result, the ongoing nature of the pandemic may continue to adversely affect our business operations in various jurisdictions, which could, in turn, have a negative impact on our vendors and supply chain, and therefore, our business. Our decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business including further developments with respect to the pandemic. For more information, refer to the section entitled Risk Factors in our 2020 Form 10-K.
Key Value Driving Strategies
In order to drive growth across our business, we are focused on the following long-term key strategies and business initiatives:
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 35
Table of Contents Product Elevation. We have built the most comprehensive and compelling collection of luxury home furnishings under one brand in the world. Our products are presented across multiple collections, categories and channels that we control, and their desirability and exclusivity has enabled us to achieve industry leading revenues and margins. Our customers know them as RH Interiors, RH Modern, RHBeach House , RHSki House , RH Outdoor, RH Rugs, RH Lighting, RH Linens, RH Baby & Child, RH Teen and Waterworks. Our strategy to elevate the design and quality of our product will continue as we introduce RH Contemporary in 2022. We also have plans to introduceRH Couture Upholstery ,RH Bespoke Furniture and RH Color over the next several years. Gallery Transformation. Our product is elevated and rendered more valuable by our architecturally inspiring Galleries. We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of$5 to$6 billion inNorth America . We believe we can significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that is sized to the potential of each market and the size of our assortment. In addition, we plan to incorporate Hospitality into most of the new Design Galleries that we open in the future, which further elevates and renders our product and brand more valuable. We believe Hospitality has created a unique new retail experience that cannot be replicated online, and that the addition of Hospitality will help drive incremental sales of home furnishings in these Galleries. Brand Elevation. We are beginning to evolve the brand beyond curating and selling product, towards conceptualizing and selling spaces, by building an ecosystem of products, services, places and spaces designed to elevate and render our product more valuable while establishing the RH brand as a thought leader, taste and place maker. We believe our seamlessly integrated ecosystem of immersive experiences inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an impression and connection unlike any other brand in the world. Digital Reimagination. Our strategy is to digitally reimagine the RH brand and business model both internally and externally. Internally regarding how we innovate, curate, and integrate all the dynamic aspects of our brand, and externally as we introduce our customers to The World of RH, a new digital portal presenting our Products, Services, Places and Spaces. This multi-year effort began internally last year with the reimagination of our Center of Innovation & Product Leadership, which will incorporate digitally integrated visuals and decision data designed to amplify the creative process from product ideation to product presentation. Our external efforts will begin with the launch of phase one of our new digital portal, The World of RH, which will include rich, immersive content with simplified navigation and search functionality, all designed to enhance the shopping experience and render our product and brand more valuable. We believe an opportunity exists to create similar strategic separation online as we have with our Galleries offline, reconceptualizing what a website can and should be. Global Expansion. We believe that our luxury brand positioning and unique aesthetic have strong international appeal, and that pursuit of global expansion will provide RH a substantial long-term market opportunity to build a$20 to$25 billion global brand over time. Our view is the competitive environment globally is more fragmented and primed for disruption than the North American market, and there is no direct competitor of scale that possesses the product, operational platform, and brand of RH. As such, we are actively pursuing the expansion of the RH brand globally with the objective of launching international locations inEurope beginning in 2022. We have secured a number of locations in various markets in theUnited Kingdom and continentalEurope in which we expect to introduce our first Galleries outside of theU.S. andCanada .
36 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents
Basis of Presentation and Results of Operations
Matters Affecting Comparability
The disruption to our business operations from the pandemic has had a significant impact on the comparability of year-over-year and sequential trends for our operating results for the three and six months endedJuly 31, 2021 , as compared to the three and six months endedAugust 1, 2020 . The ongoing pandemic has resulted in escalating disruption in our supply chain, which continues to negatively impact our revenues and costs. The initial negative impact to our revenues from store closures occurred during the first half of fiscal 2020. Despite the reopening of most of our Galleries during the second and third quarters of fiscal 2020 and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances in the first half of fiscal 2021 related to the pandemic. These circumstances include delays in manufacturing and inventory receipts as our supply chain recovers from the impact of the global health crisis and responds to virus outbreaks and surges, including new strains such as the "Delta" variant, which has had a severe impact in certain jurisdictions, most notablyVietnam . We have also delayed the opening of certain new Gallery locations due to issues related to the pandemic, including the extensive travel restrictions that have been in place with respect to travel to various locations inEurope . Beginning in the second quarter of fiscal 2020, we resumed many investments and previously deferred expenditures, and our decisions regarding these matters will continue to evolve in response to changing business circumstances, including further developments with respect to the pandemic. Although we have experienced strong demand for our products since the second half of fiscal 2020, for example, some of the demand may have been driven by consumers electing to spend more money on home-related purchases due to stay-at-home restrictions that were in place throughout many parts ofthe United States andCanada . The relaxation of COVID-19-related restrictions may trigger a shift in consumer spending patterns toward other categories, such as travel and leisure activities, and away from the purchase of merchandise related to the home, including home furnishings, of which could affect our results of operation in fiscal 2021. Additionally, recent COVID-19 resurgences in various jurisdictions are expected to have direct and indirect effects on our business and operations that will continue to affect the comparability of our results during fiscal 2021.
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 37
Table of Contents 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
JULY 31, AUGUST 1, JULY 31, AUGUST 1,
2021 2020 2021 2020
(in thousands) (in thousands)
Condensed Consolidated Statements of
Income:
Net revenues $ 988,859 $ 709,282 $ 1,849,651 $ 1,192,177
Cost of goods sold 501,183 376,863 954,998 660,104
Gross profit 487,676 332,419 894,653 532,073
Selling, general and administrative 238,688 195,851 457,777 360,052
expenses
Income from operations 248,988 136,568 436,876 172,021
Other expenses
Interest expense-net 13,581 19,418 26,889 39,047
Tradename impairment - - - 20,459
(Gain) loss on extinguishment of debt 3,166 (152) 3,271 (152)
Total other expenses 16,747 19,266 30,160 59,354
Income before income taxes 232,241 117,302 406,716 112,667
Income tax expense 3,009 18,879 44,733 17,456
Income before equity method 229,232 98,423 361,983 95,211
investments
Share of equity method investments (2,486) - (4,581) -
losses
Net income$ 226,746 $ 98,423 $ 357,402 $ 95,211 Other Financial and Operating Data: Adjusted net income (1)$ 251,625 $ 123,013 $ 393,875 $ 152,962 Adjusted EBITDA (2)$ 290,370 $ 185,787 $ 518,628 $ 263,214 Capital expenditures$ 31,887 $ 30,899 $ 82,138 $ 47,531 Landlord assets under construction-net 29,774 15,334 43,352 22,934 of tenant allowances Adjusted capital expenditures (3)$ 61,661 $ 46,233 $ 125,490 $ 70,465
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 our
senior leadership team believes that adjusted net income provides meaningful (1) supplemental information for investors regarding the performance of our
business and facilitates a meaningful evaluation of actual results on a
comparable basis with historical results. Our senior leadership team uses
this non-GAAP financial measure in order to have comparable financial results
to analyze changes in our underlying business from quarter to quarter. 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.
38 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, AUGUST 1, JULY 31, AUGUST 1,
2021 2020 2021 2020
(in thousands) (in thousands)
Net income $ 226,746 $ 98,423 $ 357,402 $ 95,211
Adjustments pre-tax:Amortization of debt discount (a) 5,865 11,113 11,846
22,238
Non-cash compensation (b) 5,864 - 11,728 -
Asset impairments and change in 7,354 1,339 7,354
9,810
useful lives (c) (Gain) loss on extinguishment of 3,166 (152) 3,271
(152)
debt (d) Recall accrual (e) - 4,780 500
4,780
Reorganization related costs (f) 449 2,884 449
7,027
Tradename impairment (g) - - - 20,459
Loss on sale leaseback - 9,352 - 9,352
transaction (h)
Subtotal adjusted items 22,698 29,316 35,148 73,514Impact of income tax items (i) (305) (4,726) (3,256)
(15,763)
Share of equity method 2,486 - 4,581 -
investments losses (j)
Adjusted net income $ 251,625 $ 123,013 $ 393,875 $ 152,962 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 the
notes that were issued in June and
million aggregate principal amount of convertible senior notes that were
issued in
principal amount of convertible senior notes that were issued in
Notes and 2024 Notes into liability (debt) and equity (conversion option)
(a) components and we are amortizing as debt discount an amount equal to the fair
value of the equity components as interest expense on the 2020 Notes, 2023
Notes and 2024 Notes over their expected lives. The equity components
represent the difference between the proceeds from the issuance of the 2020
Notes, 2023 Notes and 2024 Notes and the fair value of the liability
components of the 2020 Notes, 2023 Notes and 2024 Notes, respectively.
Amounts are presented net of interest capitalized for capital projects of
capitalized for capital projects of
six months ended
Notes matured on
discount post-maturity.
(b) Represents the amortization of the non-cash compensation charge related to an
option grant made to Mr. Friedman in October 2020 .
The adjustment in the six months ended July 31, 2021 represents asset
impairments. The adjustments for the three and six months ended August 1 ,2020 include the acceleration of depreciation expense due to a change in the
(c) estimated useful lives of certain assets of
respectively. The adjustment in the six months ended
includes asset impairments of
million related to Outlet inventory resulting from retail closures in
response to the pandemic.
The adjustment in each of the three and six months ended July 31, 2021 represents a loss on extinguishment of debt for a portion of the 2023 Notes
(d) that were early converted at the option of the noteholders. The adjustment in
each of the three and six months ended
extinguishment of debt of upon the maturity and settlement of the 2020 Notes
in July 2020 .
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 39
Table of Contents
Represents adjustments to net revenues, cost of goods sold and inventory
(e) charges associated with product recalls, as well as accrual adjustments. The
recall adjustments had the following effect on our income before taxes:
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, AUGUST 1, JULY 31, AUGUST 1,
2021 2020 2021 2020
(in thousands)
Decrease to net revenues $ - $ 406 $ - $ 406
Increase to cost of goods sold - 4,374 - 4,374
Decrease to gross profit - 4,780 - 4,780
Increase to selling, general and - - 500 -
administrative expenses
Decrease to income before income taxes $ -
(f) Represents severance costs and related payroll taxes associated with
reorganizations.
Represents tradename impairment related to the Waterworks reporting unit.
(g) Refer to "Waterworks Tradename Impairment" within Note 4-
Tradenames, Trademarks and Other Intangible Assets in our condensed
consolidated financial statements.
(h) Represents the loss on a sale leaseback transaction related to one of our
previously owned Design Galleries.
The adjustment for the three and six months ended
an adjusted tax rate of 1.3% and 9.3%, respectively, which excludes the tax
impact associated with our share of equity method investments losses. The
(i) adjustment for the three months ended
effective tax rate of 16.1%. The adjustment for the six months ended August
1, 2020 is based on an adjusted tax rate of 17.8%, which excludes the tax
impact associated with the Waterworks reporting unit tradename impairment
recorded in the first quarter of fiscal 2020.
Represents our proportionate share of the losses of our equity method
(j) investments. Refer to Note 5-Equity Method Investments in our condensed
consolidated financial statements.
40 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents
EBITDA and Adjusted EBITDA are supplemental measures of financial performance
that are not required by, or presented in accordance with, GAAP. We define
EBITDA as consolidated net income before depreciation and amortization,
interest expense-net and income tax expense (benefit). Adjusted EBITDA
reflects further adjustments to EBITDA to eliminate the impact of non-cash
compensation, certain non-recurring, and other items that we do not consider
representative of our underlying operating performance. EBITDA and Adjusted
EBITDA are included in this filing because our senior leadership team
believes that these metrics provide meaningful supplemental information for (2) investors regarding the performance of our business and facilitate a
meaningful evaluation of operating results on a comparable basis with
historical results. Our senior leadership team uses these non-GAAP financial
measures in order to have comparable financial results to analyze changes in
our underlying business from quarter to quarter. Our measures of EBITDA and
Adjusted EBITDA are not necessarily comparable to other similarly titled
captions for other companies due to different methods of calculation. 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
JULY 31, AUGUST 1, JULY 31, AUGUST 1,
2021 2020 2021 2020
Net income $ 226,746 $ 98,423 $ 357,402 $ 95,211 Depreciation and amortization 22,670 25,342 46,556
50,212
Interest expense-net 13,581 19,418 26,889 39,047
Income tax expense 3,009 18,879 44,733 17,456
EBITDA 266,006 162,062 475,580 201,926
Non-cash compensation (a) 10,124 6,861 25,431 12,689
Asset impairments (b) 7,354 - 7,354 7,133Share of equity method investments 2,486 - 4,581 - losses (b) (Gain) loss on extinguishment of 3,166 (152) 3,271
(152)
debt (b) Capitalized cloud computing 785 - 1,462 - amortization (c) Recall accrual (b) - 4,780 500
4,780
Reorganization related costs (b) 449 2,884 449
7,027
Loss on sale leaseback transaction - 9,352 -
9,352
(b)
Tradename impairment (b) - - - 20,459
Adjusted EBITDA $ 290,370 $ 185,787 $ 518,628 $ 263,214 (a) Represents non-cash compensation related to equity awards granted to
employees.
(b) Refer to the reconciliation of net income to adjusted net income table above
and the related footnotes for additional information.
(c) Represents amortization associated with capitalized cloud computing costs.
We define adjusted capital expenditures as capital expenditures from (3) investing activities and cash outflows of capital related to construction
activities to design and build landlord-owned leased assets, net of tenant
allowances received.
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 41
Table of Contents The following table presentsRH Gallery and Waterworks Showroom metrics, and excludes Outlets: SIX MONTHS ENDED JULY 31, AUGUST 1, 2021 2020 TOTAL LEASED TOTAL LEASED SELLING SQUARE SELLING SQUARE COUNT FOOTAGE (1) COUNT FOOTAGE (1) (in thousands) (in thousands) Beginning of period 82 1,162 83 1,111 RH Design Galleries: Dallas Design Gallery 1 38.0 - - Marin Design Gallery - - 1 32.9 Charlotte Design Gallery - - 1 32.4 RH Modern Galleries: Dallas RH Modern Gallery (1) (3.9) - - RH Baby & Child and TEEN Galleries: Santa Monica Baby & Child and TEEN (1) (7.3)
- - Gallery RH Legacy Galleries: Dallas legacy Gallery (1) (8.4) - - 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) End of period 80 1,180 83 1,160
Total leased square footage at end of 1,580 1,560 period (2) Weighted-average leased square footage 1,573 1,513
(3)
Weighted-average leased selling square 1,172 1,123
footage (3)
Leased selling square footage is retail space at our retail locations used to
sell our products, as well as space for our Restaurants. Leased selling
square footage excludes backrooms at retail locations used for storage, (1) office space, food preparation, kitchen space or similar purpose, as well as
exterior sales space located outside a retail location, such as courtyards,
gardens and rooftops. Leased selling square footage includes approximately
4,800 square feet as of both
owned retail location.
(2) Total leased square footage includes approximately 5,400 square feet as of
both
Weighted-average leased square footage and leased selling square footage are (3) calculated based on the number of days a retail location was opened during
the period divided by the total number of days in the period.
42 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents
The following table sets forth our condensed consolidated statements of income as a percentage of total net revenues.
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, AUGUST 1, JULY 31, AUGUST 1,
2021 2020 2021 2020
Condensed Consolidated Statements of Income:
Net revenues 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold 50.7 53.1 51.6 55.4
Gross profit 49.3 46.9 48.4 44.6Selling, general and administrative expenses 24.1 27.6
24.8 30.2 Income from operations 25.2 19.3 23.6 14.4 Other expenses Interest expense-net 1.4 2.8 1.4 3.2 Tradename impairment - - - 1.7
(Gain) loss on extinguishment of debt 0.3 - 0.2 - Total other expenses 1.7 2.8 1.6 4.9 Income before income taxes 23.5 16.5 22.0 9.5 Income tax expense 0.3 2.6 2.4 1.5 Income before equity method investments 23.2 13.9 19.6 8.0 Share of equity method investments losses (0.3) -
(0.3) - Net income 22.9 % 13.9 % 19.3 % 8.0 % Three Months EndedJuly 31, 2021 Compared to Three Months EndedAugust 1, 2020 THREE MONTHS ENDED JULY 31, AUGUST 1, 2021 2020 RH SEGMENT WATERWORKS TOTAL RH SEGMENT WATERWORKS TOTAL (in thousands) Net revenues$ 947,618 $ 41,241 $ 988,859 $ 681,387 $ 27,895 $ 709,282 Cost of goods sold 480,551 20,632 501,183 360,906 15,957 376,863 Gross profit 467,067 20,609 487,676 320,481 11,938 332,419 Selling, general and 223,492 15,196 238,688 185,486 10,365 195,851 administrative expenses Income from operations$ 243,575 $ 5,413 $ 248,988 $ 134,995 $ 1,573 $ 136,568 Net revenues Consolidated net revenues increased$279.6 million , or 39.4%, to$988.9 million in the three months endedJuly 31, 2021 compared to$709.3 million in the three months endedAugust 1, 2020 . RH Segment net revenues RH Segment net revenues increased$266.2 million , or 39.1%, to$947.6 million in the three months endedJuly 31, 2021 compared to$681.4 million in the three months endedAugust 1, 2020 . The below discussion highlights several significant factors that resulted in an increase in RH Segment net revenues, which are listed in order of magnitude.
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 43
Table of Contents
RH Segment net revenues for the three months ended
Outlet sales increased$16.7 million to$68.3 million in the three months endedJuly 31, 2021 compared to$51.6 million in the three months endedAugust 1, 2020 due to pandemic related retail closures in the second quarter of fiscal 2020. Additionally, RH Segment net revenues increased in our RH Hospitality business as COVID-19 operating restrictions continued to ease during the quarter compared to the three months endedAugust 1, 2020 .
Waterworks net revenues
Waterworks net revenues increased$13.3 million , or 47.8%, to$41.2 million in the three months endedJuly 31, 2021 compared to$27.9 million in the three months endedAugust 1, 2020 due to an increase in demand related to resumed construction activity and significant residential investments by high-end homeowners. Waterworks net revenues for the three months endedAugust 1, 2020 was negatively impacted by construction delays, as well as temporary showroom closures, in response to the pandemic.
Gross profit
Consolidated gross profit increased$155.3 million , or 46.7%, to$487.7 million in the three months endedJuly 31, 2021 compared to$332.4 million in the three months endedAugust 1, 2020 . As a percentage of net revenues, consolidated gross margin increased 240 basis points to 49.3% of net revenues in the three months endedJuly 31, 2021 from 46.9% of net revenues in the three months endedAugust 1, 2020 .
RH Segment gross profit for the three months ended
Excluding the product recall adjustment mentioned above, consolidated gross margin would have increased 180 basis points to 49.3% of net revenues in the three months endedJuly 31, 2021 from 47.5% of net revenues in the three months endedAugust 1, 2020 . RH Segment gross profit RH Segment gross profit increased$146.6 million , or 45.7%, to$467.1 million in the three months endedJuly 31, 2021 from$320.5 million in the three months endedAugust 1, 2020 . As a percentage of net revenues, RH Segment gross margin increased 230 basis points to 49.3% of net revenues in the three months endedJuly 31, 2021 from 47.0% of net revenues in the three months endedAugust 1, 2020 . Excluding the product recall adjustment mentioned above, RH Segment gross margin would have increased 160 basis points to 49.3% of net revenues in the three months endedJuly 31, 2021 from 47.7% of net revenues in the three months endedAugust 1, 2020 . The increase in gross margin was primarily driven by higher product margins in the Outlet and Core business. Additionally, we drove higher margins through leveraging our RH Segment occupancy costs in the three months endedJuly 31, 2021 . Waterworks gross profit
Waterworks gross profit increased$8.7 million , or 72.6%, to$20.6 million in the three months endedJuly 31, 2021 from$11.9 million in the three months endedAugust 1, 2020 . As a percentage of net revenues, Waterworks gross margin increased 720 basis points to 50.0% of net revenues in the three months endedJuly 31, 2021 from 42.8% of net revenues in the three months endedAugust 1, 2020 primarily driven by higher revenues, favorable changes in product mix, and leverage in Waterworks occupancy costs, offset by an increase in shipping costs related to customer deliveries.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased$38.0 million , or 20.5%, to$223.5 million in the three months endedJuly 31, 2021 compared$185.5 million in the three months endedAugust 1, 2020 .
44 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents RH Segment selling, general and administrative expenses for the three months endedJuly 31, 2021 include$7.4 million of asset impairments, amortization of the non-cash compensation of$5.8 million related to the option grant made toMr. Friedman inOctober 2020 and$0.4 million related to severance costs and related payroll taxes associated with reorganizations. RH Segment selling, general and administrative expenses for the three months endedAugust 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. Excluding the adjustments mentioned above, RH Segment selling, general and administrative expenses were 22.1% and 25.2% of net revenues for the three months endedJuly 31, 2021 andAugust 1, 2020 , respectively. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by reduction in costs and leverage in advertising, as well as leverage in our corporate occupancy costs, partially offset by deleverage in other corporate costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased$4.8 million , or 46.6%, to$15.2 million in the three months endedJuly 31, 2021 compared to$10.4 million in the three months endedAugust 1, 2020 . Waterworks selling, general and administrative expenses were 36.8% and 37.2% of net revenues for the three months endedJuly 31, 2021 andAugust 1, 2020 , respectively.
Interest expense-net
Interest expense-net decreased
THREE MONTHS ENDED
JULY 31, AUGUST 1,
2021 2020
(in thousands)
Amortization of convertible senior notes debt discount $ 8,791 $ 12,462
Finance lease interest expense 6,607 5,948
Amortization of debt issuance costs and deferred financing fees 797 982
Other interest expense 473 436
Promissory notes 352 1,072
Asset based credit facility - 130
Capitalized interest for capital projects (3,048) (1,426)
Interest income (391) (186)
Total interest expense-net $ 13,581 $ 19,418 (Gain) loss on extinguishment of debt
During the three months endedJuly 31, 2021 we recognized a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders of$3.2 million . During the three months endedAugust 1, 2020 , we recognized a$0.2 million gain on extinguishment of debt related to the maturity and settlement of the 2020 Notes inJuly 2020 .
Income tax expense
Income tax expense was$3.0 million and$18.9 million in the three months endedJuly 31, 2021 andAugust 1, 2020 , respectively. Our effective tax rate was 1.3% and 16.1% for the three months endedJuly 31, 2021 andAugust 1, 2020 , 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 endedJuly 31, 2021 as compared to the three months endedAugust 1, 2020 .
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Equity method investments losses
Equity method investments losses consists of our proportionate share of the
losses of our equity method investments by applying the hypothetical liquidation
at book value methodology, which resulted in a
Six Months EndedJuly 31, 2021 Compared to Six Months EndedAugust 1, 2020
SIX MONTHS ENDED
JULY 31, AUGUST 1,
2021 2020
RH SEGMENT WATERWORKS TOTAL RH SEGMENT WATERWORKS TOTAL
(in thousands)
Net revenues $ 1,767,441 $ 82,210 $ 1,849,651 $ 1,136,344 $ 55,833 $ 1,192,177
Cost of goods sold 913,821 41,177 954,998 628,101 32,003 660,104
Gross profit 853,620 41,033 894,653 508,243 23,830 532,073
Selling, general and 427,899 29,878 457,777 334,762 25,290 360,052
administrative expenses
Income (loss) from $ 425,721 $ 11,155 $ 436,876 $ 173,481 $ (1,460) $ 172,021
operations
Net revenues
Consolidated net revenues increased
RH Segment net revenues
RH Segment net revenues increased$631.1 million , or 55.5%, to$1,767.4 million in the six months endedJuly 31, 2021 compared to$1,136.3 million in the six months endedAugust 1, 2020 . The below discussion highlights several significant factors that resulted in an increase in RH Segment net revenues, which are listed in order of magnitude. RH Segment net revenues for the six months endedAugust 1, 2020 was negatively impacted by Gallery closures and macroeconomic conditions resulting from the COVID-19 pandemic. RH Segment net revenues for the six months endedJuly 31, 2021 increased due to strong customer demand for our products, aided by elements of our supply chain beginning to catch up with customer demand. Outlet sales increased$66.8 million to$130.6 million in the six months endedJuly 31, 2021 compared to$63.8 million in the six months endedAugust 1, 2020 due to pandemic related retail closures in the first half of fiscal 2020. Additionally, RH Segment net revenues increased in our RH Hospitality business as COVID-19 operating restrictions continued to ease during the first half of fiscal 2021 and in our Contract business driven by increased commercial purchasing activities as compared to the first half of fiscal 2020.
Waterworks net revenues
Waterworks net revenues increased$26.4 million , or 47.2%, to$82.2 million in the six months endedJuly 31, 2021 compared to$55.8 million in the six months endedAugust 1, 2020 due to an increase in demand related to resumed construction activity and significant residential investments by high-end homeowners. Waterworks net revenues for the six months endedAugust 1, 2020 was negatively impacted by construction delays, as well as temporary showroom closures, in response to the pandemic.
Gross profit
Consolidated gross profit increased$362.6 million , or 68.1%, to$894.7 million in the six months endedJuly 31, 2021 from$532.1 million in the six months endedAugust 1, 2020 . As a percentage of net revenues, consolidated gross margin increased 380 basis points to 48.4% of net revenues in the six months endedJuly 31, 2021 from 44.6% of net revenues in the six months endedAugust 1, 2020 .
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RH Segment gross profit for the six months ended
Excluding the adjustments mentioned above, consolidated gross margin would have increased 320 basis points to 48.4% of net revenues in the six months endedJuly 31, 2021 from 45.2% of net revenues in the six months endedAugust 1, 2020 .
RH Segment gross profit
RH Segment gross profit increased$345.4 million , or 68.0%, to$853.6 million in the six months endedJuly 31, 2021 from$508.2 million in the six months endedAugust 1, 2020 . As a percentage of net revenues, RH Segment gross margin increased 360 basis points to 48.3% of net revenues in the six months endedJuly 31, 2021 from 44.7% of net revenues in the six months endedAugust 1, 2020 . Excluding the adjustments mentioned above, RH Segment gross margin would have increased 300 basis points to 48.3% of net revenues in the six months endedJuly 31, 2021 from 45.3% of net revenues in the six months endedAugust 1, 2020 . The increase in gross margin was primarily driven by leverage in our RH Segment occupancy costs and higher product margins in the Core and Outlet businesses in the six months endedJuly 31, 2021 .
Waterworks gross profit
Waterworks gross profit increased$17.2 million , or 72.2%, to$41.0 million in the six months endedJuly 31, 2021 from$23.8 million in the six months endedAugust 1, 2020 . As a percentage of net revenues, Waterworks gross margin increased 720 basis points to 49.9% of net revenues in the six months endedJuly 31, 2021 from 42.7% of net revenues in the six months endedAugust 1, 2020 primarily driven by higher revenues, favorable changes in product mix, and leverage in Waterworks occupancy costs, offset by an increase in shipping costs related to customer deliveries.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased$93.1 million , or 27.8%, to$427.9 million in the six months endedJuly 31, 2021 compared to$334.8 million in the six months endedAugust 1, 2020 . RH Segment selling, general and administrative expenses for the six months endedJuly 31, 2021 include amortization of the non-cash compensation of$11.7 million related to the option grant made toMr. Friedman inOctober 2020 ,$7.4 million related to asset impairments and$0.4 million related to severance costs and related payroll taxes associated with reorganizations. RH Segment selling, general and administrative expenses for the six months endedAugust 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. Excluding adjustments mentioned above, RH Segment selling, general and administrative expenses were 23.1% and 27.5% of net revenues for the six months endedJuly 31, 2021 andAugust 1, 2020 , respectively. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by reduction in costs and leverage in advertising costs due to our decision to not mail the Spring 2021Source Books , leverage in employment and employment related costs, as well as leverage in our corporate occupancy costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased$4.6 million , or 18.1%, to$29.9 million in the six months endedJuly 31, 2021 compared to$25.3 million in the six months endedAugust 1, 2020 . Waterworks selling, general and administrative expenses for the six months endedJuly 31, 2021 include$0.5 million related to product recalls and for the six months endedAugust 1, 2020 include$1.6 million related to asset impairments.
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Table of Contents
Excluding the adjustments mentioned above, Waterworks selling, general and
administrative expenses were 35.7% and 42.5% of net revenues for the six months
ended
Interest expense-net
Interest expense-net decreased$12.2 million to$26.9 million for the six months endedJuly 31, 2021 compared to$39.0 million for the six months endedAugust 1, 2020 . Interest expense-net consisted of the following: SIX MONTHS ENDED JULY 31, AUGUST 1, 2021 2020 (in thousands) Amortization of convertible senior notes debt discount$ 17,461 $ 25,378 Finance lease interest expense 12,757 11,729 Amortization of debt issuance costs and deferred financing fees 1,542 1,995 Other interest expense 937 879 Promissory notes 777 2,526 Asset based credit facility - 232 Capitalized interest for capital projects (5,849) (3,312) Interest income (736) (380) Total interest expense-net$ 26,889 $ 39,047
(Gain) loss on extinguishment of debt
During the six months endedJuly 31, 2021 we recognized a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders of$3.3 million . During the six months endedAugust 1, 2020 , we recognized a$0.2 million gain on extinguishment of debt related to the maturity and settlement of the 2020 Notes inJuly 2020 .
Income tax expense
Income tax expense was$44.7 million and$17.5 million in the six months endedJuly 31, 2021 andAugust 1, 2020 , respectively. Our effective tax rate was 11.1% and 15.5% for the six months endedJuly 31, 2021 andAugust 1, 2020 , respectively. The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the six months endedJuly 31, 2021 as compared to the six months endedAugust 1, 2020 .
Equity method investments losses
Equity method investments losses consists of our proportionate share of the losses of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a$4.6 million loss during the
six months endedJuly 31, 2021 .
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Table of Contents
Liquidity and Capital Resources
General
The primary cash needs of our business have historically been for merchandise inventories, payroll,Source Books , store rent, capital expenditures associated with opening new stores and updating existing stores, as well as the development of our infrastructure and information technology. We seek out and evaluate opportunities for effectively managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. In the past we have pursued substantial repurchases of our common stock when we believed that such investments represented a good long term investment for the benefit of our shareholders. Refer to "Share Repurchase Programs" below. We evaluate our capital allocation from time to time and may engage in future investments in connection with existing or new share repurchase programs in circumstances where buying shares of our common stock or related investments, which may include investments in derivatives or other equity linked instruments, represent a good value and provides a favorable return for our shareholders. We have in the past been opportunistic in responding to favorable market conditions regarding both sources and uses of capital. Our use of convertible notes financings has enabled us to pursue various investments, such as our share repurchase programs which we consider to have been an excellent allocation of capital for the benefit of our shareholders. We regularly evaluate various debt and other financing alternatives, including convertible notes and other equity-linked instruments. Financing that we arrange through the sale of equity linked instruments such as our convertible notes financings may lead to substantial dilution to our investors if the price of our common stock exceeds the upper strike exercise price of the warrants in connection with our bond hedge transactions, which has been the case in connection with our convertible notes which matured in 2019 and 2020. At the same time, the investments we have previously made in connection with our share repurchase programs have more than offset the amount of dilution we experienced in relation to these warrants. We expect to continue to take an opportunistic approach regarding both sources and uses of capital in connection with our business. We have$652 million remaining in aggregate principal amount of convertible notes outstanding as ofJuly 31, 2021 , of which$67 million of the 2024 Notes and$174 million of the 2023 Notes will be settled in the third quarter of fiscal 2021 due to early conversions at the option of the noteholders. As a result,$128 million of the remaining 2023 Notes will mature inJune 2023 (absent further early conversion elections) and$283 million of the remaining 2024 Notes will mature inSeptember 2024 (absent further early conversion elections). Based on the strong cash flow generated in fiscal 2020 and first half of fiscal 2021, as well as the continued strong cash flow anticipated in future years, we expect to repay the outstanding principal amount of our convertible notes at maturity inJune 2023 andSeptember 2024 in cash, in each case in order to minimize dilution. Likewise, we expect to pay the principal amount in cash with respect to any convertible notes for which the holder elects early conversion of such convertible notes in order to minimize dilution. While we purchased convertible note hedges and sold warrants with respect to each convertible note transaction, which are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately$338.24 per share and from the conversion of the 2023 Notes until our common stock is above approximately$309.84 per share, our shareholders may still experience dilution to the extent our common stock trades above such levels at the time of the maturity of the warrants with respect to the bond hedge and warrant transactions. While we anticipate using excess cash, free cash flow and borrowings on our asset based credit facility to repay the convertible notes in cash in order to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates or upon early conversion, as applicable. There can be no assurance as to the availability of capital to fund such repayments, or that if capital is available through additional debt issuances or refinancing of the convertible notes, that such capital will be available on terms that are favorable to us. Our business has historically relied on cash flows from operations, net cash proceeds from the issuance of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity. We continue to closely manage our business and our investments while considering both the overall economic environment as well as the needs of our operations. In addition, our near term decisions regarding the sources and uses of capital will continue to reflect and adapt to changes in market conditions and our business including further developments with respect to the pandemic. We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next
12 months.
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 49
Table of Contents While we have continued to serve our customers and operate our business through the ongoing COVID-19 health crisis, 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 pandemic, including waves or resurgences of COVID-19 outbreaks in certain jurisdictions, including with regard to new strains or variants of the virus, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 health crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for fiscal 2021 and beyond. We extended and amended our asset based credit facility inJuly 2021 , which has a total availability of up to$600 million , of which$10 million is available toRestoration Hardware Canada, Inc. , and includes a$300 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from$600 million to up to$900 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. The Amended Credit Agreement provides that the$300 million accordion, or a portion thereof, may be added as a first-in, last-out term loan facility if and to the extent the lenders revise their credit commitments for such facility. The Amended Credit Agreement further provides the borrowers may request a European sub-credit facility under the revolving line of credit or under the accordion feature for borrowing by certain European subsidiaries of RH if certain conditions set out in the Amended Credit Agreement are met. The maturity date of the Amended Credit Agreement isJuly 29, 2026 . While we do not require additional debt to fund our operations, our goal continues to be in a position to take advantage of the many opportunities that we identify in connection with our business and operations. We have pursued in the past, and may pursue in the future, additional strategies to generate capital to pursue opportunities and investments, including through the strategic sale of existing assets, utilization of our credit facilities, entry into various second lien credit agreements and other new debt financing arrangements that present attractive terms. We expect to continue to use additional sources of debt financing in future periods as a source of additional capital to fund our various investments. In addition to funding the normal operations of our business, we have used our liquidity to fund significant investments and strategies such as our share repurchase programs, various acquisitions and growth initiatives, including through joint ventures and real estate investments. For example, in fiscal 2019 we executed a sale-leaseback transaction for theYountville Design Gallery for sales proceeds of$23.5 million and in fiscal 2020 we executed a sale-leaseback transaction for theMinneapolis Design Gallery for sales proceeds of$25.5 million , both of which qualified for sale-leaseback accounting in accordance with ASC 842. 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 developing and opening new Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future periods as we open additional Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings. Our adjusted capital expenditures include capital expenditures from investing activities and cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2021 and beyond. We anticipate our adjusted capital expenditures to be$250 million to$300 million in fiscal 2021, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments. During the six months endedJuly 31, 2021 , adjusted capital expenditures were$125.5 million , net of cash received related to landlord tenant allowances of$11.2 million .
50 | 2021 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents 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 different levels of capital investment on our part than a traditional store lease with a landlord. We also believe there is an opportunity to transition our real estate strategy from a leasing model to a development model, where we potentially buy and develop our Design Galleries then recoup the investments through a sale-leaseback arrangement resulting in lower capital investment and lower rent. For example, we have used this strategy in fiscal 2019 through the sale-leaseback transaction for theYountville Design Gallery and in fiscal 2020 through the sale-leaseback transaction for theMinneapolis 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. In addition, we continue to address the effects of the pandemic on our business with respect to real estate development and the introduction of new Galleries in both theU.S. and internationally. A range of factors involved in the development of new Gallery and RH Hospitality may continue to be affected by the pandemic 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 pandemic, may require changes to our real estate strategy and related capital expenditure and financing plans. In addition, we may continue to be required to make lease payments in whole or in part for our Galleries, Outlets and Restaurants that were temporarily closed or are required to close in the future in the event of resurgences in COVID-19 outbreaks or for other reasons. Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from the pandemic, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence. There can be no assurance that we will have sufficient financial resources, or will be able to arrange financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental debt will be available to us in order to fund our cash payments in respect of the repayment of the remaining outstanding convertible senior notes in an aggregate principal amount of$652 million at maturity or early conversion of such senior convertible notes. To the extent we need to secure additional sources of liquidity, we cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future financing requirements would not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock. Any adverse developments in theU.S. or global credit markets as a result of the pandemic or any other reason could affect our ability to manage our debt obligations and our ability to access future debt. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the covenants or other requirements of existing or new debt facilities, any such event could have an impact on our other commitments and obligations including triggering cross defaults or other consequences with respect to other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur, exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks.
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 51
Table of Contents
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the
following table:
SIX MONTHS ENDED
JULY 31 , AUGUST 1,
2021 2020
(in thousands)Net cash provided by operating activities$ 316,718 $ 128,275 Net cash used in investing activities (84,077)
(25,575)
Net cash used in financing activities (42,968)
(132,988)
Net increase (decrease) in cash and cash equivalents and 189,765
(30,271)
restricted cash equivalents Cash and cash equivalents and restricted cash equivalents 296,836
17,387
at end of period
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. For the six months endedJuly 31, 2021 , net cash provided by operating activities was$316.7 million and consisted of net income of$357.4 million and an increase in non-cash items of$144.1 million , partially offset by a change in working capital and other activities of$184.8 million . The source of cash from working capital was primarily driven by an increase in deferred revenue and customer deposits of$116.5 million primarily due to strong consumer demand for our products. These sources of cash from working capital were partially offset by uses of cash driven by an increase in merchandise inventory of$101.6 million , a decrease in other current liabilities of$51.7 million , an increase in landlord assets under construction of$43.4 million , an increase in prepaid expenses and other assets of$57.9 million , and a decrease in operating lease liabilities of$38.9 million primarily due to payments made under the related lease agreements. For the six months endedAugust 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 .
Investing activities consist primarily of investments in capital expenditures related to investments in retail stores, information technology and systems infrastructure, as well as supply chain investments. Investing activities also include our strategic investments. For the six months endedJuly 31, 2021 , net cash used in investing activities was$84.1 million and was comprised of investments in retail stores, information technology and systems infrastructure of$82.1 million and additional funding of our equity method investments of$1.9 million . For the six months endedAugust 1, 2020 , net cash used in investing activities was$25.6 million primarily due to investments in information technology and systems infrastructure, supply chain investments and retail stores of$32.1 million , as well as the acquisition of building and land assets of$14.2 million . Net cash used in investing activities was partially offset by net proceeds from the sale of building and land of$25.0 million .
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Financing activities consist primarily of borrowings and repayments related to convertible senior notes, credit facilities and other financing arrangements, and cash used in connection with such financing activities include investments in share repurchase programs, repayment of indebtedness including principal payments under finance lease agreements and other equity related transactions such as the convertible note bond hedge and warrant transactions in connection with our convertible notes financings. For the six months endedJuly 31, 2021 , net cash used in financing activities was$43.0 million , partially due to the repayment of$33.2 million of the 2023 Notes in the six months endedJuly 31, 2021 as a result of early conversion at the option of the noteholders, of which$28.1 million is presented as repayments of convertible senior notes within cash from financing activities and$5.1 million is reflected as non-cash accretion of debt discount upon settlement of debt within cash from operating activities. In addition, we made repayments of$11.4 million on our equipment notes,$7.1 million of principal payments under finance lease agreements and incurred$3.6 million of debt issuance costs related to the Amended Credit Agreement. Equity related transactions provided$7.3 million due to$25.9 million of proceeds from exercise of employee stock options, partially offset by$18.6 million of cash paid for employee taxes related to net settlement of equity awards. For the six months endedAugust 1, 2020 , net cash used in financing activities was$133.0 million . The$300 million 2020 Notes matured inJuly 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.
Non-Cash Transactions
Non-cash transactions consist of non-cash additions of property and equipment and landlord assets and reclassification of assets from landlord assets under construction to finance lease right-of-use assets. In addition, non-cash transactions consist of shares issued and received related to the settlement of convertible senior note transactions.
Convertible Senior Notes
Refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements for further information on our 0.00% Convertible Senior Notes due 2024 and 0.00% Convertible Senior Notes due 2023.
Asset Based Credit Facility
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our asset based credit facility.
Equipment Loan Facility
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility.
Share Repurchase Program
We regularly review share repurchase activity and consider various factors in determining whether and when to execute investments in connection with our share repurchase programs, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock. We believe that share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities.
PART I. FINANCIAL INFORMATION 2021 SECOND QUARTER FORM 10-Q | 53
Table of Contents Our free cash flow has historically supported our current and completed share repurchase programs. We generated$405 million ,$330 million and$163 million in free cash flow in fiscal 2020, fiscal 2019 and fiscal 2018, respectively. Free cash flow excludes all non-cash items. Free cash flow is net cash provided by operating activities adjusted by the non-cash accretion of debt discount upon settlement of debt, proceeds from sale of asset, capital expenditures, principal payments under finance leases and equity method investments. Free cash flow is included in this filing because our senior leadership team believes that free cash flow provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our senior leadership team uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business. A reconciliation of our net cash provided by operating activities to free cash flow is as follows: YEAR ENDED JANUARY 30, FEBRUARY 1, FEBRUARY 2, 2021 2020 2019 (in thousands) Net cash provided by operating activities$ 500,770 $ 339,188 $ 249,603 Accretion of debt discount upon settlement of debt 84,003 70,482 - Proceeds from sale of assets 25,006 24,078 - Capital expenditures (111,126) (93,623) (79,992) Principal payments under finance leases (12,498) (9,682) (6,885) Equity method investments (80,723) - - Free cash flow$ 405,432 $ 330,443 $ 162,726
In 2018, our Board of Directors authorized a share repurchase program through open market purchases, privately negotiated transactions or other means, including through Rule 10b-18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as the acquisition of other equity linked instruments, accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives. We completed$250.0 million in share repurchases in fiscal 2018 under this program. In the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock at an average price of$115.36 per share, for an aggregate repurchase amount of approximately$250.0 million under this share repurchase program. We did not make any repurchases under this program during either the three or six months endedJuly 31, 2021 orAugust 1, 2020 . The total current authorized size of this share repurchase program is up to$950 million (the "950 Million Repurchase Program"), of which$450.0 million remained available as ofJuly 31, 2021 for future share investments. Contractual Obligations As ofJuly 31, 2021 , there were no material changes to our contractual obligations described within Management's Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations in the 2020 Form 10-K other than lease agreements entered into in the normal course of business (refer to Note 8-Leases).
Off Balance Sheet Arrangements
We have no material off balance sheet arrangements as of
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Table of Contents
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted inthe United States requires senior leadership to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our accounting policies, estimates, and judgments on an on-going basis. We base our estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions and such differences could be material to the consolidated financial statements. We evaluate the development and selection of our critical accounting policies and estimates and believe that certain of our significant accounting policies involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results of operations and financial position, and are therefore discussed as critical:
Merchandise Inventories-Reserves
Impairment
Tradenames, Trademarks and Other Intangible Assets
Long-Lived Assets Lease Accounting Reasonably Certain Lease Term Incremental Borrowing Rate Fair Market Value
Stock-Based Compensation-Performance-Based Awards
Equity Method Investments
There have been no material changes to the critical accounting policies and estimates listed above from the disclosures included in the 2020 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 2020 Form 10-K.
Recent Accounting Pronouncements
Refer to Note 2-Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently issued accounting standards that may impact us in future reporting periods.
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