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 Annual Report on Form 10-K for the fiscal year endedJanuary 29, 2022 (the "2021 Form 10 K"). Management's discussion and analysis of financial condition and results of operations ("MD&A"), contains forward-looking statements that are subject to risks and uncertainties. Refer to "Forward-Looking Statements and Market Data" below and Item 1A-Risk Factors in our 2021 Form 10-K for a discussion of the risks, uncertainties and assumptions associated with these statements. MD&A should be read in conjunction with our historical consolidated financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed in our 2021 Form 10-K. The discussion of our financial condition and changes in our results of operations, liquidity and capital resources is presented in this section for the three months endedApril 30, 2022 and a comparison to the three months endedMay 1, 2021 . The discussion for related to cash flows for the three months endedMay 1, 2021 has been omitted from this Quarterly Report on Form 10-Q, but is included in Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations on our Form 10-Q for the quarter endedMay 1, 2021 , filed with theSecurities and Exchange Commission ("SEC") onJune 10, 2021 . MD&A is a supplement to our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q and is provided to enhance an understanding of our results of operations and financial condition. Our MD&A is organized as follows:
Overview. This section provides a general description of our business and describes our key value-driving strategies.
Basis of Presentation and Results of Operations. These sections provide our consolidated statements of income and other financial and operating data, including a comparison of our results of operations in the current periods as compared to the prior year's comparative period, as well as non-GAAP measures we use for financial and operational decision making and as a means to evaluate period-to-period comparisons. Liquidity and Capital Resources. This section provides an overview of our sources and uses of cash and our financing arrangements, including our credit facilities and debt arrangements, in addition to the cash requirements for our business, such as our capital expenditures. Critical Accounting Policies and Estimates. This section discusses the accounting policies and estimates that involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results of operations and financial position, including the significant estimates and judgments used in the preparation of our consolidated financial statements.
Recently Issued Accounting Pronouncements. This section provides a summary of
recent authoritative accounting pronouncements that were adopted during the
three months ended
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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 2021 Form 10-K, and Management's Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report and in our 2021 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 curator of design, taste and style in the luxury lifestyle market. Our curated and fully integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings. We offer dominant merchandise assortments across a number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings. Our retail business is fully integrated across our multiple channels of distribution, consisting of our retail locations, websites andSource Books . We position our Galleries as showrooms for our brand, while our websites andSource Books act as virtual and print extensions of our physical spaces. We operate our retail locations throughoutthe United States ,Canada , and theU.K. , and, after the opening of RH San Francisco, The Gallery at theHistoric Bethlehem Steel Building inMay 2022 , we have an integrated RH Hospitality experience in 14 of ourDesign Gallery locations, which includes Restaurants and Wine Bars.
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As ofApril 30, 2022 , we operated the following number of Galleries, Outlets and Showrooms: COUNT RH Design Galleries 27 Legacy Galleries 36 Modern Galleries 1 Baby & Child and TEEN Galleries 3 Total Galleries 67 Outlets 39 Waterworks Showrooms 14
COVID-19 Pandemic and Macro-Economic Factors
The COVID-19 pandemic continues to cause challenges in certain aspects of our business operations primarily related to our supply chain, including delays in our receipt of products from vendors, which have affected our ability to convert demand into revenues at normal historic rates. While our performance during the pandemic demonstrates the desirability of our exclusive products, we may see consumer spending patterns shift away from spending on the home and home-related categories as customers return to pre-COVID consumption trends, such as spending on travel and leisure, and other activities. There are a number of macro-economic factors and uncertainties affecting the overall business climate as well as our business including increased inflation and rising interest rates. These factors may have a number of adverse effects on overall economic conditions and markets in which we operate. A slowdown in the housing market or continued negative trends in stock market prices could have a negative impact on our customers and demand for our products. Our 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. For more information, refer to the section entitled "Risk Factors" in our 2021 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:
Product Elevation. We believe 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 our brand concepts as RH Interiors, RH Modern, RHBeach House , RHSki House , RH Outdoor, 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 drives incremental sales of home furnishings in these Galleries.
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Brand Elevation. We are evolving the brand beyond curating and selling product to conceptualizing and selling spaces by building an ecosystem of Products, Places, Services 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. Our hospitality efforts will continue to elevate the RH brand as we extend 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$200 billion North American hotel industry. Additionally, we are creating bespoke experiences like RH Yountville, an integration of Food, Wine, Art & Design in theNapa Valley , RH1 & RH2, our private jets, and RH3, our luxury yacht that is available for charter in theCaribbean and Mediterranean, where the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design and landscape architecture. Digital Reimagination. Our strategy is to digitally reimagine the RH brand and business model both internally and externally. Internally our multi-year effort began with the reimagination of our Center of Innovation & Product Leadership to incorporate digitally integrated visuals and decision data designed to amplify the creative process from product ideation to product presentation. Externally our strategy is designed to come to life digitally as we launch The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. The World of RH 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 that 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 with the opening of RH England, The Gallery at theHistoric Aynho Park . We have secured a number of locations in various markets in theUnited Kingdom and continentalEurope for future Design Galleries and are in lease or purchase negotiations for additional locations.
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Basis of Presentation and Results of Operations
The following table sets forth our condensed consolidated statements of income:
THREE MONTHS ENDED
APRIL 30, % OF NET MAY 1, % OF NET
2022 REVENUES 2021 REVENUES
(dollars in thousands)
Net revenues $ 957,292 100.0 % $ 860,792 100.0 %
Cost of goods sold 458,709 47.9 453,815 52.7
Gross profit 498,583 52.1 406,977 47.3
Selling, general and administrative expenses 293,295 30.7 219,089 25.5
Income from operations 205,288 21.4 187,888 21.8
Other expenses
Interest expense-net 20,855 2.2 13,308 1.5
Loss on extinguishment of debt 146,116 15.3 105 -
Other income-net (343) - - -
Total other expenses 166,628 17.4 13,413 1.5
Income before income taxes 38,660 4.0 174,475 20.3
Income tax expense (benefit) (163,426) (17.1) 41,724 4.7
Income before equity method investments 202,086 21.1 132,751 15.4
Share of equity method investments losses (1,375) (0.1) (2,095) (0.2)
Net income $ 200,711 21.0 % $ 130,656 15.2 %
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles inthe United States ("GAAP"), we use non-GAAP financial measures, including adjusted operating income, adjusted net income, EBITDA, adjusted EBITDA, and adjusted capital expenditures (collectively, our "non-GAAP financial measures"). We compute these measures by adjusting the applicable GAAP measures to remove the impact of certain recurring and non-recurring charges and gains and the tax effect of these adjustments. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision making and as a means to evaluate period-to-period comparisons. We believe that they provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to key metrics used by senior leadership in its financial and operational decision making. The non-GAAP financial measures used by us in this Quarterly Report on Form 10-Q may be different from the non-GAAP financial measures, including similarly titled measures, used by other companies. For more information on the non-GAAP financial measures, please see the reconciliation of GAAP to non-GAAP financial measures tables outlined below. These accompanying tables include details on the GAAP financial measures that are most directly comparable to non-GAAP financial measures and the related reconciliations between these financial measures.
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Adjusted Operating Income. Adjusted operating income is a supplemental measure
of financial performance that is not required by, or presented in accordance
with, GAAP. We define adjusted operating income as consolidated operating
income, adjusted for the impact of certain non-recurring and other items that we
do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating
Income
THREE MONTHS ENDED
APRIL 30, MAY 1,
2022 2021
(in thousands)
Net income $ 200,711 $ 130,656
Interest expense-net(1) 20,855 13,308
Loss on extinguishment of debt(1) 146,116 105
Other income-net(1) (343) -
Income tax expense (benefit)(1) (163,426) 41,724
Share of equity method investments losses(1) 1,375 2,095 Operating income
205,288 187,888
Employer payroll taxes on option exercise(2) 11,717 -
Professional fee(3) 7,184 -
Asset impairments(4) 5,923 -
Non-cash compensation(5) 5,858 5,864
Recall accrual(6) 560 500
Adjusted operating income $ 236,530 $ 194,252 Refer to discussion "Three Months Ended
for the three months ended
(2) Represents employer payroll tax expense related to the option exercise by Mr.
Friedman in the first quarter of fiscal 2022.
Represents professional fee contingent upon the completion of certain (3) transactions related to the 2023 Notes and 2024 Notes, including bond hedge
and warrant terminations and Notes Repurchase (refer to Note 9-Convertible
Senior Notes in our condensed consolidated financial statements).
(4) Represents asset impairments related to property and equipment of Galleries
under construction.
(5) Represents the amortization of the non-cash compensation charge related to a
fully vested option grant made to
(6) Represents accruals associated with product recalls.
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Adjusted Net Income. Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, 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.
Reconciliation of GAAP Net Income to Adjusted Net Income
THREE MONTHS ENDED
APRIL 30, MAY 1,
2022 2021
(in thousands)
Net income $ 200,711 $ 130,656
Adjustments pre-tax:
Loss on extinguishment of debt(1) 146,116 105
Employer payroll taxes on option exercise(1) 11,717 -
Professional fee(1) 7,184 -
Asset impairments(1) 5,923 -
Non-cash compensation(1) 5,858 5,864
Recall accrual(1) 560 500
Amortization of debt discount(2) - 5,981
Gain on derivative instruments-net(3) (3,177) -
Subtotal adjusted items 174,181 12,450
Impact of income tax items(4) (163,426) (2,951)
Share of equity method investments losses(1) 1,375 2,095
Adjusted net income $ 212,841 $ 142,250 Refer to table titled "Reconciliation of GAAP Net Income to Operating Income (1) and Adjusted Operating Income" and the related footnotes for additional
information.
Prior to the adoption of Accounting Standards Update ("ASU")2020-06-Accounting for Convertible Instruments and Contracts in an Entity's
Own Equity (which was adopted as of the first quarter of fiscal 2022) ("ASU
2020-06"), certain convertible debt instruments that may be settled in cash
on conversion were required to be separately accounted for as liability and
equity components of the instrument in a manner that reflected the issuer's
non-convertible debt borrowing rate. Accordingly, in accounting for GAAP
purposes through fiscal 2021 for the
of convertible senior notes that were issued in
and the
that were issued in
components and we amortized as debt discount an amount equal to the fair
value of the equity components as interest expense on the 2023 Notes and 2024
Notes over their expected lives. The equity components represented the
difference between the proceeds from the issuance of the 2023 Notes and 2024
Notes and the fair value of the liability components of the 2023 Notes and
2024 Notes, respectively. Amounts were presented net of interest capitalized
for capital projects of
2021. No amortization of the debt discounts were recognized during the three
months ended
equity component of the 2023 Notes and 2024 Notes upon the adoption of ASU
2020-06.
Represents net gain on derivative instruments resulting from certain (3) transactions related to the 2023 Notes and 2024 Notes, including bond hedge
and warrant terminations and Notes Repurchase (refer to Note 9-Convertible
Senior Notes in our condensed consolidated financial statements).
The adjustment for the three months ended April 30, 2022 is based on anadjusted tax rate of 0%, which represents our expected cash tax liability
associated with anticipated fiscal 2022 results as we do not expect to pay (4) taxes for fiscal 2022 due to the tax benefits primarily resulting from Mr.
Friedman's option exercise in the first quarter of fiscal 2022. The
adjustment for the three months ended
rate of 23.9%, which excludes the tax impact associated with our share of
equity method investments losses.
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EBITDA and Adjusted EBITDA. 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, as well as certain non-recurring and other items that we do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to EBITDA and Adjusted EBITDA
THREE MONTHS ENDED
APRIL 30, MAY 1,
2022 2021
(in thousands)
Net income $ 200,711 $ 130,656
Depreciation and amortization 24,758 23,886
Interest expense-net 20,855 13,308
Income tax expense (benefit) (163,426) 41,724
EBITDA 82,898 209,574
Loss on extinguishment of debt(1) 146,116 105
Non-cash compensation(1) 12,802 15,307
Employer payroll taxes on option exercise(1) 11,717 -
Professional fee(1) 7,184 -
Asset impairments(1) 5,923 -
Share of equity method investments losses(1) 1,375 2,095 Capitalized cloud computing amortization(2)
1,354 677
Recall accrual(1) 560 500
Other income-net(1) (343) -
Adjusted EBITDA $ 269,586 $ 228,258 Refer to table titled "Reconciliation of GAAP Net Income to Operating Income (1) and Adjusted Operating Income" and the related footnotes for additional
information.
(2) Represents amortization associated with capitalized cloud computing costs.
Adjusted Capital Expenditures. We define adjusted capital expenditures as 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.
Reconciliation of Adjusted Capital Expenditures
THREE MONTHS ENDED
APRIL 30, MAY 1,
2022 2021
(in thousands)
Capital expenditures $ 29,364 $ 50,251 Landlord assets under construction-net of tenant allowances 12,148
13,578
Adjusted capital expenditures$ 41,512
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The following table presentsRH Gallery and Waterworks Showroom metrics, and excludes Outlets: THREE MONTHS ENDED APRIL 30, MAY 1, 2022 2021 TOTAL LEASED TOTAL LEASED SELLING SQUARE SELLING SQUARE COUNT FOOTAGE(1) COUNT FOOTAGE(1) (in thousands) (in thousands) Beginning of period 81 1,254 82 1,162 End of period 81 1,254 82 1,162
Total leased square footage at end of 1,672 1,559
period(2)
Weighted-average leased square 1,672 1,559
footage(3)
Weighted-average leased selling square 1,254 1,162
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 (1) square footage excludes backrooms at retail locations used for storage,
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
(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.
Three Months EndedApril 30, 2022 Compared to Three Months EndedMay 1, 2021 THREE MONTHS ENDED APRIL 30, MAY 1, 2022 2021 RH SEGMENT WATERWORKS TOTAL RH SEGMENT WATERWORKS TOTAL (in thousands) Net revenues$ 908,948 $ 48,344 $ 957,292 $ 819,823 $ 40,969 $ 860,792
Cost of goods sold 436,126 22,583 458,709 433,270 20,545 453,815 Gross profit 472,822 25,761 498,583 386,553 20,424 406,977 Selling, general and 275,519 17,776 293,295 204,407 14,682 219,089 administrative expenses Income from operations$ 197,303 $ 7,985 $ 205,288
$ 182,146 $ 5,742 $ 187,888 Net revenues
Consolidated net revenues increased
RH Segment net revenues
RH Segment net revenues increased$89 million , or 10.9%, to$909 million in the three months endedApril 30, 2022 compared to$820 million in the three months endedMay 1, 2021 . The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude.
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RH Segment net revenues for the three months endedApril 30, 2022 increased due to strong customer demand for our products and fulfillment of orders generated in prior quarters as elements of our supply chain continued to catch up with customer demand. However, during the three monthsApril 30, 2022 we began to experience softening demand trends which began at the time of the Russian invasion ofUkraine and have further slowed during the market disruption over the past several months. RH Segment net revenues increased in our RH Hospitality business compared to the three months endedMay 1, 2021 due to new Restaurant openings in fiscal 2021. Outlet sales increased$7.4 million to$70 million in the three months endedApril 30, 2022 compared to$62 million in the three months endedMay 1, 2021 .
Despite our revenue growth during the three months ended
Waterworks net revenues
Waterworks net revenues increased$7.4 million , or 18.0%, to$48 million in the three months endedApril 30, 2022 compared to$41 million in the three months endedMay 1, 2021 . Gross profit
Consolidated gross profit increased$92 million , or 22.5%, to$499 million in the three months endedApril 30, 2022 compared to$407 million in the three months endedMay 1, 2021 . As a percentage of net revenues, consolidated gross margin increased 480 basis points to 52.1% of net revenues in the three months endedApril 30, 2022 from 47.3% of net revenues in the three months endedMay 1, 2021 . RH Segment gross profit
RH Segment gross profit increased$86 million , or 22.3%, to$473 million in the three months endedApril 30, 2022 from$387 million in the three months endedMay 1, 2021 . As a percentage of net revenues, RH Segment gross margin increased 480 basis points to 52.0% of net revenues in the three months endedApril 30, 2022 from 47.2% of net revenues in the three months endedMay 1, 2021 . The change in gross margin was primarily driven by a 390 basis point increase in product margins in the Core business, as well as leverage in our RH Segment shipping costs during the three month period endedApril 30, 2022 .
Waterworks gross profit
Waterworks gross profit increased$5.3 million , or 26.1%, to$26 million in the three months endedApril 30, 2022 from$20 million in the three months endedMay 1, 2021 . As a percentage of net revenues, Waterworks gross margin increased 340 basis points to 53.3% of net revenues in the three months endedApril 30, 2022 from 49.9% of net revenues in the three months endedMay 1, 2021 .
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased$74 million , or 33.9%, to$293 million in the three months endedApril 30, 2022 from$219 million in the three months endedMay 1, 2021 .
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased$71 million , or 34.8%, to$276 million in the three months endedApril 30, 2022 compared to$204 million in the three months endedMay 1, 2021 . RH Segment selling, general and administrative expenses for the three months endedApril 30, 2022 include$12 million of employer payroll tax expense associated withMr. Friedman's stock option exercise during the first quarter of fiscal 2021, a$7.2 million professional fee which was contingent upon the completion of our debt transactions related to the 2023 Notes and 2024 Notes,$5.9 million of asset impairments, and$0.6 million related to product recalls. RH Segment selling, general and administrative expenses for both the three months endedApril 30, 2022 andMay 1, 2021 included amortization of the non-cash compensation of$5.9 million related to a fully vested option grant made toMr. Friedman inOctober 2020 .
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RH Segment selling, general and administrative expenses were 26.9% and 24.2% of net revenues for the three months endedApril 30, 2022 andMay 1, 2021 , respectively, excluding the costs incurred in connection with the adjustments mentioned above. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by higher pre-opening costs and professional fees, as well as increases in employment and employment-related costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased$3.1 million , or 21.1%, to$18 million in the three months endedApril 30, 2022 compared to$15 million in the three months endedMay 1, 2021 .
Waterworks selling, general and administrative expenses for the three months
ended
Excluding the product recall adjustment mentioned above, Waterworks selling,
general and administrative expenses would have been 36.8% and 34.6% of net
revenues for the three months ended
Interest expense-net
Interest expense-net increased$7.5 million in the three months endedApril 30, 2022 compared to the three months endedMay 1, 2021 , which consisted of the following in each period: THREE MONTHS ENDED APRIL 30, MAY 1, 2022 2021 (in thousands) Term loan interest expense$ 16,001 $ -
Finance lease interest expense 7,071
6,150
Other interest expense 1,073
1,634
Amortization of convertible senior notes debt discount -
8,670
Capitalized interest for capital projects (2,109) (2,801) Interest income (1,181) (345) Total interest expense-net$ 20,855 $ 13,308
Loss on extinguishment of debt
During the three months endedApril 30, 2022 we recognized a loss on extinguishment of debt of$146 million related to the repurchase of$180 million of principal value of convertible senior notes, which includes the acceleration of amortization of debt issuance costs of approximately$1.0 million . The loss represents the difference between the carrying value and the fair value of the convertible senior notes upon entering into the repurchase agreements with the noteholders. Refer to Note 9-Convertible Senior Notes. During the three months endedMay 1, 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$0.1 million . Other income-net Other income-net was$0.3 million during the three months endedApril 30, 2022 , which included a net gain on derivative instruments of$3.2 million , resulting from the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and Notes Repurchase (refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements). The net gain was partially offset by a$2.9 million loss due to unfavorable exchange rate changes affecting foreign currency denominated transactions, primarily between theU.S. dollar as compared to Pound Sterling and Euro, in addition to a foreign exchange loss from the remeasurement of an intercompany loan with aU.K. subsidiary.
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Income tax expense (benefit)
We recorded an income tax benefit of$163 million and income tax expense of$42 million in the three months endedApril 30, 2022 andMay 1, 2021 , respectively. Our effective tax rate was (438.3)% and 24.2% for the three months endedApril 30, 2022 andMay 1, 2021 , respectively. The decrease in our effective tax rate is primarily attributable to significantly higher net excess tax benefits from stock-based compensation partially offset by nondeductible amounts related to the extinguishment of debt.
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$1.4 million and$2.1 million loss during the three months endedApril 30, 2022 andMay 1, 2021 , respectively.
Liquidity and Capital Resources
Overview
Our principal sources of liquidity are cash flows generated from operations, our current balances of cash and cash equivalents, and amounts available under our ABL Credit Agreement. In fiscal 2021, we entered into the ABL Credit Agreement, which amended and extended our asset based credit facility, and issued the Term Loan in the amount of$2.0 billion pursuant to the Term Loan Credit Agreement. The issuance of the Term Loan was assigned a Ba2 rating fromMoody's Investors Service and BB rating from S&P Global. Additionally, inMay 2022 , we entered into the 2022 Incremental Amendment, which amended the Term Loan Credit Agreement and raised an incremental$500 million of Term Debt Financing. The issuance of the 2022 Incremental Amendment was assigned a Ba3 rating from Moody's Investors Service and BB rating from S&P Global. Refer to Note 10-Credit Facilities in our condensed consolidated financial statements.
A summary of our net debt, and availability under the ABL Credit Agreement, is set forth in the following table:
THREE MONTHS ENDED
APRIL 30, JANUARY 29,
2022 2022
(in millions)
Asset based credit facility $ - $ -
Term loan(1) 1,990 1,995
Equipment promissory notes(1) 4 15Convertible senior notes due 2023(1) 20
69
Convertible senior notes due 2024(1) 81
189
Convertible senior notes repurchase obligation(2) 314
-
Notes payable for share repurchases 1
1
Total debt $ 2,410 $ 2,269
Cash and cash equivalents (2,243) (2,178)
Total net debt $ 167 $ 91
Availability under the asset based credit facility-net(3)
347
(1) Amounts exclude discounts upon original issuance and third party offering and
debt issuance cost.
(2) The convertible senior notes repurchase obligation was repaid in full on May
3, 2022. Refer to Note 9-Convertible Senior Notes.
As of both
is presented net of
PART I. FINANCIAL INFORMATION 2022 FIRST QUARTER FORM 10-Q | 41
Table of Contents General The primary cash needs of our business have historically been for merchandise inventories, payroll,Source Books , rent for our retail and outlet locations, capital expenditures associated with opening new locations and updating existing locations, 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. We continuously evaluate our capital allocation strategy and may engage in future investments in connection with existing or new share repurchase programs (refer to "Share Repurchase Program" below), which may include investments in derivatives or other equity linked instruments. We have in the past been, and continue to be, opportunistic in responding to favorable market conditions regarding both sources and uses of capital. Capital raised from debt financings has enabled us to pursue various investments. We expect to continue to take an opportunistic approach regarding both sources and uses of capital in connection with our business.
Credit Facilities and Debt Arrangements
We amended and restated our asset based credit facility inJuly 2021 , which has an initial 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 accordion feature may be added as a first-in, last-out term loan facility. The ABL 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 asset based credit facility are met. The maturity date of the asset based credit facility isJuly 29, 2026 . We entered into a$2.0 billion term debt financing inOctober 2021 (the "October 2021 Term Loans") by means of a Term Loan Credit Agreement through RHI as the borrower,Bank of America, N.A . as administrative agent and collateral agent, and the various lenders party thereto (the "Term Loan Credit Agreement"). TheOctober 2021 Term Loans have a maturity date ofOctober 20, 2028 . As ofApril 30, 2022 , we had$1,990 million outstanding under the Term Loan Credit Agreement. We are required to make quarterly principal payments of$5.0 million with respect to theOctober 2021 Term Loans. OnMay 13, 2022 , we entered into an incremental term debt financing (the "2022 Incremental Term Debt") in an aggregate principal amount equal to$500 million by means of an amendment to the Term Loan Credit Agreement with RHI as the borrower,Bank of America, N.A . as administrative agent and the various lenders parties thereto (the "Amended Term Loan Credit Agreement"). The 2022 Incremental Term Debt has a maturity date ofOctober 20, 2028 . The 2022 Incremental Term Debt constitutes a separate class from the existingOctober 2021 Term Loan under the Term Loan Credit Agreement.
Certain Transactions Related to Convertible Senior Notes
During the three months ended
Warrant Termination Agreements
We entered into agreements with certain financial institutions (collectively, the "Counterparties") to repurchase all of the warrants previously issued in connection with the 2023 Notes and 2024 Notes. Upon closing of these transactions, we paid an aggregate of$391 million in cash to terminate warrants representing 3,385,580 shares of our common stock.
Convertible Bond Hedge Unwind Transactions
We entered into agreements with the Counterparties to terminate all of the remaining convertible note bond hedges previously entered into in connection with the 2023 Notes and 2024 Notes. Upon closing of these transactions, we received an aggregate of$232 million in cash for the termination of the bond hedges.
Convertible Notes Repurchase
We entered into individual privately negotiated transactions with certain holders of the 2023 Notes and 2024 Notes to repurchase$180 million in aggregate principal amount of the convertible senior notes (the "Notes Repurchase") representing$45 million and$135 million in principal amount of 2023 Notes and 2024 Notes, respectively. Upon closing of these transactions, we paid an aggregate of$314 million in cash to repurchase such convertible senior notes.
Result of the Convertible Notes Transactions
In aggregate, we expended a net total amount of approximately
PART I. FINANCIAL INFORMATION 2022 FIRST QUARTER FORM 10-Q | 42
Table of Contents
As a result of the bond hedge termination agreements, all convertible note hedges entered into in connection with the issuance of the 2023 Notes and 2024 Notes have been terminated, including convertible note hedges with respect to any 2023 Notes and 2024 Notes that remain outstanding. As a result of the warrant termination agreements, all warrants entered into in connection with the issuance of the 2023 Notes and 2024 Notes have been terminated, including warrants with respect to any 2023 Notes and 2024 Notes that remain outstanding. Following the completion of the Notes Repurchase, we had$101 million remaining in aggregate principal amount of convertible notes outstanding as ofApril 30, 2022 , comprised of$20 million of 2023 Notes and$81 million of 2024 Notes. The remaining 2023 Notes have a scheduled maturity inJune 2023 and the remaining 2024 Notes have a scheduled maturity inSeptember 2024 . We anticipate having ample cash available in order to repay the principal amount of our convertible notes in cash with respect to any convertible notes for which the holders elect early conversion, as well as upon maturity inJune 2023 andSeptember 2024 , in each case in order to minimize dilution. We believe our capital structure provides us with substantial optionality regarding capital allocation. 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 and macro-economic factors affecting business conditions including inflation. We believe our existing cash balances and operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months. While we 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 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. To the extent we choose to secure additional sources of liquidity through incremental debt financing, there can be no assurances that we will be able to raise such financing on favorable terms, if at all, or that future financing requirements will 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, whether upon stated maturity, early conversion or otherwise of such convertible 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 2022 FIRST QUARTER FORM 10-Q | 43
Table of Contents Capital
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. During the three months endedApril 30, 2022 , adjusted capital expenditures were$42 million in aggregate, net of cash received related to landlord tenant allowances of$2.3 million . We anticipate our adjusted capital expenditures to be$200 million to$250 million in fiscal 2022, primarily related to our growth and expansion, including construction of new Design Galleries and infrastructure investments. Nevertheless, we may elect to pursue additional capital expenditures beyond those that are anticipated during any given fiscal period inasmuch as our strategy is to be opportunistic with respect to our investments and we may choose to pursue certain capital transactions based on the availability and timing of unique opportunities. There are a number of macro-economic factors and uncertainties affecting the overall business climate as well as our business including increased inflation and rising interest rates and we may make adjustments to our allocation of capital in fiscal 2022 or beyond in response to these changing or other circumstances. We may also invest in other uses of our liquidity such as share repurchases, acquisitions, and growth initiatives, including through joint ventures and real estate investments. Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us. As we develop new Galleries, as well as other potential strategic initiatives in the future like our integrated hospitality experience, we are exploring other models for our real estate activities, which include different terms and conditions for real estate transactions. These transactions may involve 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 that we wish to develop for new Gallery locations or other aspects of our business. These approaches might require different levels of capital investment on our part than a traditional store lease with a landlord. We also are pursuing change in our real estate strategy to transition some projects from a leasing model to a development model, where we buy and develop real estate for our Design Galleries either directly or through joint ventures and other structures with the objective of ultimately (i) recouping a majority of the investment through a sale-leaseback arrangement and (ii) resulting in lower capital investment and lower rent. For example, in fiscal 2019 we executed a sale-leaseback transaction for theYountville Design Gallery for sales proceeds of$24 million and in fiscal 2020 we executed a sale-leaseback transaction for theMinneapolis Design Gallery for sales proceeds of$26 million , both of which qualified for sale-leaseback accounting. In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurance that we will be successful in securing additional funding on attractive terms or at all. 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 may pursue. In addition, we continue to address the effects of the COVID-19 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 Galleries 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.
PART I. FINANCIAL INFORMATION 2022 FIRST QUARTER FORM 10-Q | 44
Table of Contents
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the
following table:
THREE MONTHS ENDED
APRIL 30 , MAY 1,
2022 2021
(in thousands)Net cash provided by operating activities$ 135,949 $ 190,875 Net cash used in investing activities (30,479)
(51,423)
Net cash used in financing activities (42,351)
(11,032)
Net increase in cash and cash equivalents and restricted 62,841
128,456
cash equivalents Cash and cash equivalents and restricted cash equivalents 2,244,705
235,527
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, loss on extinguishment of debt, cash paid attributable to accretion of debt discount upon settlement of debt (prior to the adoption of ASU 2020-06 in fiscal 2022) and the effect of changes in working capital and other activities. For the three months endedApril 30, 2022 , net cash provided by operating activities was$136 million and consisted of net income of$201 million and an increase in non-cash items of$221 million , partially offset by a change in working capital and other activities of$286 million . The use of cash from working capital was primarily driven by an increase in prepaid expenses and other assets of$160 million primarily due to federal and state tax receivables, an increase in merchandise inventory of$83 million , a decrease in other current liabilities of$30 million and a decrease in operating lease liabilities of$19 million primarily due to payments made under the related lease agreements. These uses of cash from working capital were partially offset by an increase in deferred revenue and customer deposits of$49 million primarily due to strong consumer demand for our products.
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 three months endedApril 30, 2022 , net cash used in investing activities was$30 million and was comprised of investments in retail stores, information technology and systems infrastructure of$29 million and additional funding of our equity method investments of$1.1 million .
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. For the three months endedApril 30, 2022 , net cash used in financing activities was$42 million , primarily due to certain transactions entered into in the first quarter of fiscal 2022 related to the 2023 Notes and 2024 Notes, and the related bond hedge and warrant agreements. These transactions resulted in payments of$391 million for the termination of all such outstanding common stock warrants, partially offset by proceeds of$232 million from the termination of all of the remaining convertible note bond hedges. In addition, we repaid$13 million in aggregate principal amount of certain 2023 Notes and 2024 Notes as a result of early conversions during the quarter, as well as made payments on equipment notes of$11 million , term loans of$5.0 million and finance lease agreements of$3.6 million . These cash outflows were partially offset by proceeds from option exercises of$150 million , primarily due toMr. Friedman's option exercise activity in the first quarter of fiscal 2022.
PART I. FINANCIAL INFORMATION 2022 FIRST QUARTER FORM 10-Q | 45
Table of Contents 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, as well as promissory notes forgiven in exchange for assets. In addition, non-cash transactions consist of shares issued and received related to convertible senior note transactions, as well as a financing liability and an embedded derivative arising from the Notes Repurchase (refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements).
Cash Requirements from Contractual Obligations
Leases
We lease nearly all of our retail and outlet locations, corporate headquarters, distribution centers and home delivery center locations, as well as other storage and office space. Refer to Note 8-Leases in our condensed consolidated financial statements for further information on our lease arrangements, including the maturities of our operating and finance lease liabilities. Most lease arrangements provide us with the option to renew the leases at defined terms. The table presenting the maturities of our lease liabilities included in Note 8-Leases in our condensed consolidated financial statements includes future obligations for renewal options that are reasonably certain to be exercised and are included in the measurement of the lease liability. Amounts presented therein do not include future lease payments under leases that have not commenced or estimated contingent rent due under operating and finance leases.
Convertible Senior Notes
Refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements for further information on the 2023 Notes and 2024 Notes.
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, including the amount available for borrowing under the revolving line of credit, net of outstanding letters of credit.
Term Loan
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our Term Loan.
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.
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 share repurchase program during fiscal 2020, fiscal 2021 or the first quarter of fiscal 2022.
PART I. FINANCIAL INFORMATION 2022 FIRST QUARTER FORM 10-Q | 46
Table of Contents
The total current authorized size of the share purchase program is up to$950 million (the "Share Repurchase Program"), of which$450 million remained available as ofApril 30, 2022 for future share repurchases under this share repurchase program. OnJune 2, 2022 , the Board of Directors authorized an additional$2.0 billion for the purchase of shares of our outstanding common stock, which is effective immediately and is an addition to the$450 million remaining under the Share Repurchase Program.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with GAAP 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 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 2021 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 2021 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 our consolidated financial statements in future reporting periods.
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