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 and six months endedJuly 30, 2022 and a comparison to the three and six months endedJuly 31, 2021 . The discussion related to cash flows for the six months endedJuly 31, 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 endedJuly 31, 2021 , filed with theSecurities and Exchange Commission ("SEC") onSeptember 9, 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 have been adopted in fiscal
2022 and that will be adopted in future periods.
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.
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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, in our Quarterly Report on Form 10-Q for the quarterly period endedApril 30, 2022 (the "First Quarter Form 10-Q") 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 have an integrated RH Hospitality experience in 14 of ourDesign Gallery locations, which includes Restaurants and Wine Bars. As ofJuly 30, 2022 , we operated the following number of Galleries, Outlets and Showrooms: COUNT RH Design Galleries 28 Legacy Galleries 35 Modern Galleries 1 Baby & Child and TEEN Galleries 3 Total Galleries 67 Outlets 39 Waterworks Showrooms 14
Macro-Economic Factors and COVID-19 Pandemic
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 macro-economic conditions and markets in which we operate, with the potential for an economic recession and a sustained downturn in the housing market. Factors such as a slowdown in the housing market or negative trends in stock market prices could have a negative impact on demand for our products.
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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 toward travel and leisure and other areas. 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 macro-economic factors and 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, RH Contemporary, RH Outdoor, RHBeach House , RHSki House , RH Baby & Child, RH TEEN and Waterworks. Our strategy is to continue to elevate the design and quality of our product. Over the next few years, we plan to introduceRH Couture Upholstery ,RH Bespoke Furniture and RH Color. 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. 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. InSeptember 2022 , we opened our first RH Guesthouse inNew York . 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 comes to life digitally with The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Launched this spring, The World of RH includes 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 expect to continue to elevate the customer experience on The World of RH with further enhancements to content, navigation and search functionality. 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.
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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 with the opening of RH England, The Country House at theHistoric Aynho Park , in the spring of 2023. 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.
Basis of Presentation and Results of Operations
The following table sets forth our condensed consolidated statements of income:
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 30 , % OF NET JULY 31 , % OF NET JULY
30, % OF NET
2022 REVENUES 2021 REVENUES 2022 REVENUES 2021 REVENUES
(dollars in thousands)
Net revenues $ 991,620 100.0 % $ 988,859 100.0 % $ 1,948,912 100.0 % $ 1,849,651 100.0 %
Cost of goods sold 468,402 47.2 501,183 50.7 927,111 47.6 954,998 51.6
Gross profit 523,218 52.8 487,676 49.3 1,021,801 52.4 894,653 48.4
Selling, general and 288,804 29.2 238,688 24.1 582,099 29.8 457,777 24.8
administrative expenses
Income from operations 234,414 23.6 248,988 25.2 439,702 22.6 436,876 23.6
Other expenses
Interest expense-net 26,264 2.6 13,581 1.4 47,119 2.5 26,889 1.4
Loss on extinguishment 23,462 2.4 3,166 0.3 169,578 8.7 3,271 0.2
of debt
Other expense-net 3,195 0.3 - - 2,852 0.1 - -
Total other expenses 52,921 5.3 16,747 1.7 219,549 11.3 30,160 1.6
Income before income 181,493 18.3 232,241 23.5 220,153 11.3 406,716 22.0
taxes
Income tax expense 56,397 5.7 3,009 0.3 (107,029) (5.5) 44,733 2.4
(benefit)
Income before equity 125,096 12.6 229,232 23.2 327,182 16.8 361,983 19.6
method investments
Share of equity method (2,821) (0.3) (2,486) (0.3) (4,196) (0.2) (4,581) (0.3)
investments losses
Net income $ 122,275 12.3 % $ 226,746 22.9 % $ 322,986 16.6 % $ 357,402 19.3 %
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Non-GAAP Financial Measures
To supplement our condensed 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. 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 SIX MONTHS ENDED JULY 30, JULY 31, JULY 30, JULY 31, 2022 2021 2022 2021 (in thousands) Net income$ 122,275 $ 226,746 $ 322,986 $ 357,402 Interest expense-net(1) 26,264 13,581 47,119 26,889 Loss on extinguishment of debt(1) 23,462 3,166 169,578 3,271 Other expense-net(1) 3,195 - 2,852 - Income tax expense (benefit)(1) 56,397 3,009 (107,029) 44,733 Share of equity method investments 2,821 2,486 4,196 4,581 losses(1) Operating income 234,414 248,988 439,702 436,876 Employer payroll taxes on option - - 11,717 - exercise(2) Non-cash compensation(3) 4,321 5,864 10,179 11,728 Asset impairments(4) 2,231 7,354 8,154 7,354 Professional fees(5) 285 - 7,469 - Compensation settlements(6) 3,483 - 3,483 - Recall accrual(7) - - 560 500
Reorganizational related costs(8) - 449
- 449 Adjusted operating income$ 244,734 $ 262,655 $ 481,264 $ 456,907
Refer to discussion "Three Months Ended
Months Ended
operations for the three and six months ended
2021.
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(2) Represents employer payroll tax expense related to the option exercise by Mr.
Friedman in the first quarter of fiscal 2022.
(3) Represents the amortization of the non-cash compensation charge related to a
fully vested option grant made to
Represents asset impairment related to property and equipment of Galleries
(4) under construction. The three and six months ended
lease impairment of
Represents professional fees contingent upon the completion of certain
transactions related to the 2023 Notes and 2024 Notes, including bond hedge (5) and warrant terminations and convertible senior notes repurchases (refer to
Note 9-Convertible Senior Notes in our condensed consolidated financial
statements).
(6) Represents compensation settlements related to the Rollover Units and Profit
Interest Units in the Waterworks subsidiary.
(7) Represents accruals associated with product recalls.
(8) Represents severance costs and related payroll taxes associated with
reorganizations.
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 SIX MONTHS ENDED
JULY 30, JULY 31, JULY 30, JULY 31,
2022 2021 2022 2021
(in thousands)
Net income $ 122,275 $ 226,746 $ 322,986 $ 357,402
Adjustments pre-tax:
Loss on extinguishment of 23,462 3,166 169,578 3,271
debt(1)
Employer payroll taxes on option - - 11,717 -
exercise(1)
Non-cash compensation(1) 4,321 5,864 10,179 11,728
Asset impairments(1) 2,231 7,354 8,154 7,354
Professional fees(1) 285 - 7,469 -
Compensation settlements(1) 3,483 - 3,483 -
Recall accrual(1) - - 560 500
(Gain) loss on derivative 1,453 - (1,724) -
instruments-net(2)Amortization of debt discount(3) - 5,865 - 11,846 Reorganization related costs(1) - 449
- 449 Subtotal adjusted items 35,235 22,698 209,416 35,148 Impact of income tax items(4) 56,397 (305) (107,029) (3,256) Share of equity method 2,821 2,486 4,196 4,581 investments losses(1) Adjusted net income$ 216,728 $ 251,625 $ 429,569 $ 393,875
Refer to table titled "Reconciliation of GAAP Net Income to Operating Income (1) and Adjusted Operating Income" and the related footnotes for additional
information.
Represents net (gain) loss on derivative instruments resulting from certain
transactions related to the 2023 Notes and 2024 Notes, including bond hedge (2) and warrant terminations and convertible senior notes repurchases (refer to
Note 9-Convertible Senior Notes in our condensed consolidated financial
statements).
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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
six months ended
discounts were recognized during the three and six months ended
2022, since we recombined the previously outstanding equity component of the
2023 Notes and 2024 Notes upon the adoption of ASU 2020-06.
The adjustment for both the three and six months ended
on an adjusted tax rate of 0.0%, which represents our expected cash tax
liability associated with anticipated fiscal 2022 results as we do not expect (4) to pay taxes for fiscal 2022 due to the tax benefits primarily resulting from
adjustment for the three and six months ended
adjusted tax rate of 1.3% and 9.3%, respectively, 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 SIX MONTHS ENDED
JULY 30, JULY 31, JULY 30, JULY 31,
2022 2021 2022 2021
(in thousands)
Net income $ 122,275 $ 226,746 $ 322,986 $ 357,402
Depreciation and amortization 26,970 22,670 51,728 46,556
Interest expense-net 26,264 13,581 47,119 26,889
Income tax expense (benefit) 56,397 3,009 (107,029) 44,733
EBITDA 231,906 266,006 314,804 475,580
Loss on extinguishment of debt(1) 23,462 3,166 169,578 3,271
Non-cash compensation(2) 10,736 10,124 23,538 25,431
Employer payroll taxes on option - - 11,717 -
exercise(1)
Asset impairments(1) 2,231 7,354 8,154 7,354
Professional fees(1) 285 - 7,469 -
Share of equity method investments 2,821 2,486 4,196 4,581
losses(1)
Compensation settlements(1) 3,483 - 3,483 -
Capitalized cloud computing 1,699 785 3,053 1,462
amortization(3)
Other expense-net(1) 3,195 - 2,852 -
Recall accrual(1) - - 560 500Reorganization related costs(1) - 449
- 449 Adjusted EBITDA$ 279,818 $ 290,370 $ 549,404 $ 518,628
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 non-cash compensation related to equity awards granted to
employees.
(3) Represents amortization associated with capitalized cloud computing costs.
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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 during the construction period.
Reconciliation of Adjusted Capital Expenditures
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 30, JULY 31, JULY 30, JULY 31,
2022 2021 2022 2021
(in thousands)
Capital expenditures $ 33,194 $ 31,887 $ 62,558 $ 82,138
Landlord assets under construction-net 20,312 29,774 32,460 43,352
of tenant allowances
Adjusted capital expenditures $ 53,506 $ 61,661 $ 95,018 $ 125,490
The following table presents RH Gallery and Waterworks Showroom metrics, and
excludes Outlets:
SIX MONTHS ENDED
JULY 30, JULY 31,
2022 2021
TOTAL LEASED TOTAL LEASED
SELLING SQUARE SELLING SQUARE
COUNT FOOTAGE(1) COUNT FOOTAGE(1)
(in thousands)
Beginning of period 81 1,254 82 1,162
RH Design Galleries:
San Francisco Design Gallery 1 42.1 - -
Dallas Design Gallery - - 1 38.0
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: San Francisco legacy Gallery (1) (4.8)
- - Dallas legacy Gallery - - (1) (8.4) End of period 81 1,291 80 1,180
Total leased square footage at end of 1,737 1,580
period(2)
Weighted-average leased square 1,700 1,573
footage(3)
Weighted-average leased selling square 1,270 1,172
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
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.
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Three Months EndedJuly 30, 2022 Compared to Three Months EndedJuly 31, 2021 THREE MONTHS ENDED JULY 30, JULY 31, 2022 2021 RH SEGMENT WATERWORKS TOTAL RH SEGMENT WATERWORKS TOTAL (in thousands) Net revenues$ 940,182 $ 51,438 $ 991,620 $ 947,618 $ 41,241 $ 988,859 Cost of goods sold 445,108 23,294 468,402 480,551 20,632 501,183 Gross profit 495,074 28,144 523,218 467,067 20,609 487,676 Selling, general and 264,206 24,598 288,804 223,492 15,196 238,688 administrative expenses Income from operations$ 230,868 $ 3,546 $ 234,414 $ 243,575 $ 5,413 $ 248,988 Net revenues
Consolidated net revenues increased
RH Segment net revenues
RH Segment net revenues decreased$7.4 million , or 0.8%, to$940 million in the three months endedJuly 30, 2022 compared to$948 million in the three months endedJuly 31, 2021 . The below discussion highlights several significant factors that resulted in a decrease in RH Segment net revenues, which are listed in order of magnitude. The decrease in RH Segment net revenues for the three months endedJuly 30, 2022 was driven primarily by softening demand trends, which began in the first quarter of fiscal 2022, and have remained below prior year trends during the second quarter of fiscal 2022. This decrease was partially offset by backlog relief, as well as increased revenue in our RH Hospitality business compared to the three months endedJuly 31, 2021 due to new Restaurant openings in fiscal 2021 and fiscal 2022. Outlet sales were$69 million in both the three months endedJuly 30, 2022 andJuly 31, 2021 .
Waterworks net revenues
Waterworks net revenues increased$10 million , or 24.7%, to$51 million in the three months endedJuly 30, 2022 compared to$41 million in the three months endedJuly 31, 2021 . Gross profit Consolidated gross profit increased$36 million , or 7.3%, to$523 million in the three months endedJuly 30, 2022 compared to$488 million in the three months endedJuly 31, 2021 . As a percentage of net revenues, consolidated gross margin increased 350 basis points to 52.8% of net revenues in the three months endedJuly 30, 2022 from 49.3% of net revenues in the three months endedJuly 31, 2021 .
RH Segment gross profit
RH Segment gross profit increased$28 million , or 6.0%, to$495 million in the three months endedJuly 30, 2022 from$467 million in the three months endedJuly 31, 2021 . As a percentage of net revenues, RH Segment gross margin increased 340 basis points to 52.7% of net revenues in the three months endedJuly 30, 2022 from 49.3% of net revenues in the three months endedJuly 31, 2021 . The increase in gross margin was primarily driven by an increase in product margins in the Core business, as well as leverage in our shipping costs during the three month period endedJuly 30, 2022 , offset by increases in retail occupancy costs due to new Gallery openings in fiscal 2021 and fiscal 2022.
Waterworks gross profit
Waterworks gross profit increased$7.5 million , or 36.6%, to$28 million in the three months endedJuly 30, 2022 from$21 million in the three months endedJuly 31, 2021 . As a percentage of net revenues, Waterworks gross margin increased 470 basis points to 54.7% of net revenues in the three months endedJuly 30, 2022 from 50.0% of net revenues in the three months endedJuly 31, 2021 .
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Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased$50 million , or 21.0%, to$289 million in the three months endedJuly 30, 2022 compared to$239 million in the three months endedJuly 31, 2021 .
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased$41 million , or 18.2%, to$264 million in the three months endedJuly 30, 2022 compared$224 million in the three months endedJuly 31, 2021 . RH Segment selling, general and administrative expenses for the three months endedJuly 30, 2022 include amortization of non-cash compensation of$4.3 million related to a fully vested option grant made toMr. Friedman inOctober 2020 ,$2.0 million of asset impairments and a$0.3 million professional fee which was contingent upon the completion of our debt transactions related to the 2023 Notes and 2024 Notes. RH Segment selling, general and administrative expenses for the three months endedJuly 31, 2021 include$7.4 million related to 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. Excluding the adjustments mentioned above, RH Segment selling, general and administrative expenses would have been 27.4% and 22.1% of net revenues for the three months endedJuly 30, 2022 andJuly 31, 2021 , respectively. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by increased advertising costs due to the mailing of the new RH Contemporary Source Book, the launch of The World of RH, as well as higher employment and employment-related costs, occupancy costs, professional fees and pre-opening costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased$9.4 million , or 61.9%, to$25 million in the three months endedJuly 30, 2022 compared to$15 million in the three months endedJuly 31, 2021 . Waterworks selling, general and administrative expenses were 47.8% and 36.8% of net revenues for the three months endedJuly 30, 2022 andJuly 31, 2021 , respectively. Waterworks selling, general and administrative expenses for the three months endedJuly 30, 2022 include$3.5 million in compensation settlements related to the Rollover Units and Profit Interests Units and a$0.2 million asset impairment. Excluding the adjustments, Waterworks Segment selling, general and administrative expenses would have been 40.7% and 36.8% of net revenues for the three months endedJuly 30, 2022 andJuly 31, 2021 , respectively.
42 | 2022 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents Interest expense-net Interest expense-net increased$13 million in the three months endedJuly 30, 2022 compared to the three months endedJuly 31, 2021 consisted of the following in each period: THREE MONTHS ENDED JULY 30, JULY 31, 2022 2021 (in thousands) Term loan interest expense$ 24,982 $ - Finance lease interest expense 7,891 6,607 Other interest expense 832 1,622 Interest income (6,393) (391)
Capitalized interest for capital projects (1,048) (3,048) Total interest expense-net
$ 26,264 $ 13,581
Loss on extinguishment of debt
During the three months endedJuly 30, 2022 , we recognized a loss on extinguishment of debt of$23 million related to the repurchase of$57 million of principal value of convertible senior notes, inclusive of the acceleration of amortization of debt issuance costs of$0.3 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 in our condensed consolidated financial statements. During the three months endedJuly 31, 2021 , we recognized a loss on extinguishment of debt of$3.2 million for a portion of the 2023 Notes that were early converted at the option of the noteholders.
Other expense-net
Other expense-net was$3.2 million during the three months endedJuly 30, 2022 , which included a loss on derivative instruments of$1.5 million resulting from the completion of certain transactions related to the 2023 Notes and 2024 Notes. Refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements. Other expense-net also includes a$1.7 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.
Income tax expense (benefit)
Income tax expense was$56 million and$3.0 million in the three months endedJuly 30, 2022 andJuly 31, 2021 , respectively. Our effective tax rate was 31.6% and 1.3% for the three months endedJuly 30, 2022 andJuly 31, 2021 , respectively. The increase in our effective tax rate is primarily attributable to lower net excess tax benefits from stock-based compensation and amounts related to the loss on extinguishment of debt in the three months endedJuly 30, 2022 .
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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$2.8 million and$2.5 million loss during the three months endedJuly 30, 2022 andJuly 31, 2021 , respectively.
Six Months Ended
SIX MONTHS ENDED
JULY 30, JULY 31,
2022 2021
RH SEGMENT WATERWORKS TOTAL RH SEGMENT WATERWORKS TOTAL
(in thousands)
Net revenues $ 1,849,130 $ 99,782 $ 1,948,912 $ 1,767,441 $ 82,210 $ 1,849,651
Cost of goods sold 881,234 45,877 927,111 913,821 41,177 954,998
Gross profit 967,896 53,905 1,021,801 853,620 41,033 894,653
Selling, general and 539,725 42,374 582,099 427,899 29,878 457,777
administrative expenses
Income from operations $ 428,171 $ 11,531 $ 439,702 $ 425,721 $ 11,155 $ 436,876
Net revenues
Consolidated net revenues increased$99 million , or 5.4%, to$1,949 million in the six months endedJuly 30, 2022 compared to$1,850 million in the six months endedJuly 31, 2021 . RH Segment net revenues RH Segment net revenues increased$82 million , or 4.6%, to$1,849 million in the six months endedJuly 30, 2022 compared to$1,767 million in the six months endedJuly 31, 2021 . 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 endedJuly 30, 2022 increased due to fulfillment of orders generated in prior quarters as elements of our supply chain continued to catch up with customer demand. However, beginning in the first quarter of fiscal 2022, we began to experience softening demand trends that have remained below prior year trends during the first half of fiscal 2022. Additionally, net revenues from our RH Hospitality business increased compared to the six months endedJuly 31, 2021 due to new Restaurant openings in fiscal 2021 and fiscal 2022.
Outlet sales increased
Waterworks net revenues
Waterworks net revenues increased$18 million , or 21.4%, to$100 million in the six months endedJuly 30, 2022 compared to$82 million in the six months endedJuly 31, 2021 . Gross profit Consolidated gross profit increased$127 million , or 14.2%, to$1,022 million in the six months endedJuly 30, 2022 from$895 million in the six months endedJuly 31, 2021 . As a percentage of net revenues, consolidated gross margin increased 400 basis points to 52.4% of net revenues in the six months endedJuly 30, 2022 from 48.4% of net revenues in the six months endedJuly 31, 2021 .
44 | 2022 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents RH Segment gross profit RH Segment gross profit increased$114 million , or 13.4%, to$968 million in the six months endedJuly 30, 2022 from$854 million in the six months endedJuly 31, 2021 . As a percentage of net revenues, RH Segment gross margin increased 400 basis points to 52.3% of net revenues in the six months endedJuly 30, 2022 from 48.3% of net revenues in the six months endedJuly 31, 2021 . The increase in gross margin was primarily driven by an increase in product margins in the Core business, as well as leverage in shipping costs during the six month period endedJuly 30, 2022 , offset by increases in retail occupancy costs driven by new Gallery openings in fiscal 2021 and fiscal 2022.
Waterworks gross profit
Waterworks gross profit increased$13 million , or 31.4%, to$54 million in the six months endedJuly 30, 2022 from$41 million in the six months endedJuly 31, 2021 . As a percentage of net revenues, Waterworks gross margin increased 410 basis points to 54.0% of net revenues in the six months endedJuly 30, 2022 from 49.9% of net revenues in the six months endedJuly 31, 2021 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$112 million , or 26.1%, to$540 million in the six months endedJuly 30, 2022 compared to$428 million in the six months endedJuly 31, 2021 . RH Segment selling, general and administrative expenses for the six months endedJuly 30, 2022 include$12 million of employer payroll tax expense associated withMr. Friedman's stock option exercise during the first quarter of fiscal 2022, amortization of non-cash compensation of$10 million related to a fully vested option grant made toMr. Friedman inOctober 2020 ,$8.0 million related to asset impairments,$7.5 million of professional fees which were contingent upon the completion of our debt transactions related to the 2023 Notes and 2024 Notes and$0.6 million related to product recalls. RH Segment selling, general and administrative expenses for the six months endedJuly 31, 2021 include amortization of the non-cash compensation of$12 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 would have been 27.1% and 23.1% of net revenues for the six months endedJuly 30, 2022 andJuly 31, 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 increased advertising costs due to the mailing of the new RH Contemporary Source Book, the launch of The World of RH, as well as higher employment and employment-related costs, occupancy costs, professional fees and pre-opening costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased$12 million , or 41.8%, to$42 million in the six months endedJuly 30, 2022 compared to$30 million in the six months endedJuly 31, 2021 . Waterworks selling, general and administrative expenses were 42.5% and 36.3% of net revenues for the six months endedJuly 30, 2022 andJuly 31, 2021 , respectively. Waterworks selling, general and administrative expenses for the six months endedJuly 30, 2022 include$3.5 million in compensation settlements related to the Rollover Units and Profit Interest Units and a$0.2 million asset impairment. Waterworks selling, general and administrative expenses for the six months endedJuly 31, 2021 include$0.5 million related to product recalls.
Excluding the adjustments mentioned above, Waterworks selling, general and
administrative expenses would have been 38.8% and 35.7% of net revenues for the
six months ended
PART I. FINANCIAL INFORMATION 2022 SECOND QUARTER FORM 10-Q | 45
Table of Contents Interest expense-net
Interest expense-net increased$20 million in the six months endedJuly 30, 2022 compared to the six months endedJuly 31, 2021 consisted of the following in each period: SIX MONTHS ENDED JULY 30, JULY 31, 2022 2021 (in thousands) Term loan interest expense$ 40,983 $ - Finance lease interest expense 14,962
12,757
Other interest expense 1,905
3,256
Amortization of convertible senior notes debt discount -
17,461
Interest income (7,574)
(736)
Capitalized interest for capital projects (3,157) (5,849) Total interest expense-net$ 47,119 $ 26,889
Loss on extinguishment of debt
During the six months endedJuly 30, 2022 , we recognized a loss on extinguishment of debt of$170 million related to the repurchase of$237 million of principal value of convertible senior notes, inclusive of the acceleration of amortization of debt issuance costs of$1.3 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 in our condensed consolidated financial statements. During the six months endedJuly 31, 2021 , we recognized a loss on extinguishment of debt of$3.3 million for a portion of the 2023 Notes that were early converted at the option of the noteholders.
Other expense-net
Other expense-net was$2.9 million during the six months endedJuly 30, 2022 , which included a$4.6 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. The foreign currency loss was partially offset by a net gain on derivative instruments of$1.7 million during the six months endedJuly 30, 2022 , resulting from the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and convertible senior notes repurchases. Refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements.
Income tax expense (benefit)
Income tax benefit was$107 million and income tax expense was$45 million in the six months endedJuly 30, 2022 andJuly 31, 2021 , respectively. Our effective tax rate was (49.6)% and 11.1% for the six months endedJuly 30, 2022 andJuly 31, 2021 , respectively. The decrease in our effective tax rate is primarily due to significantly higher discrete tax benefits from stock-based compensation in fiscal 2022.
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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$4.2 million and$4.6 million loss during the six months endedJuly 30, 2022 andJuly 31, 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 B in the amount of$2.0 billion pursuant to the Term Loan Credit Agreement. The issuance of the Term Loan B 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 financing by means of the Term Loan B-2. The issuance of the Term Loan B-2 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:
JULY 30, JANUARY 29,
2022 2022
(in millions)
Asset based credit facility $ - $ -
Term loan B(1) 1,985 1,995
Term loan B-2(1) 500 -
Equipment promissory notes(1) 2 15Convertible senior notes due 2023(1) 2
69
Convertible senior notes due 2024(1) 42
189
Notes payable for share repurchases -
1
Total debt $ 2,531 $ 2,269
Cash and cash equivalents (2,085) (2,178)
Total net debt $ 446 $ 91
Availability under the asset based credit facility-net(2)
347
(1) Amounts exclude discounts upon original issuance and third party offering and
debt issuance cost.
The amount available for borrowing under the revolving line of credit under
(2) the ABL Credit Agreement is presented net of
outstanding letters of credit as of
respectively.
General
The primary cash needs of our business have historically been for merchandise
inventories, payroll, rent for our retail and outlet locations, capital
expenditures associated with opening new locations, Source Books 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.
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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 macro-economic factors and the pandemic affecting business conditions including inflation and a rising interest rate environment. 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 program, various acquisitions, and growth initiatives, including through joint ventures and real estate investments. In the second quarter of fiscal 2022, we repurchased 1,000,000 shares of our common stock under the Share Repurchase Program at an average price of$254.72 per share, for an aggregate repurchase amount of approximately$255 million . 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.
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 "Term Loan B") 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"). The Term Loan B has a maturity date ofOctober 20, 2028 . As ofJuly 30, 2022 , we had$1,985 million outstanding under the Term Loan Credit Agreement. We are required to make quarterly principal payments of$5.0 million with respect to the Term Loan B.
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OnMay 13, 2022 , we entered into an incremental term debt financing (the "Term Loan B-2") 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 Term Loan B-2 has a maturity date ofOctober 20, 2028 . The Term Loan B-2 constitutes a separate class from the existing Term Loan B under the Term Loan Credit Agreement. As ofJuly 30, 2022 , we had$500 million outstanding under the Amended Term Loan Credit Agreement. We are not required to make quarterly principal payments with respect to the Term Loan B-2 untilDecember 2022 .
Certain Transactions Related to Convertible Senior Notes
In the first and second quarters of fiscal 2022, we entered into certain transactions in connection with the 2023 Notes and 2024 Notes.
Warrant Termination Agreements
In the first quarter of fiscal 2022, we entered into individual privately negotiated agreements with a limited number of sophisticated 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
In the first quarter of fiscal 2022, we entered into individual privately negotiated 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 Senior Notes Repurchases
In the first and second quarters of fiscal 2022, we entered into individual privately negotiated transactions with certain holders of the 2023 Notes and 2024 Notes to repurchase$237 million in aggregate principal amount of the convertible senior notes representing$63 million and$174 million in principal amount of 2023 Notes and 2024 Notes, respectively. Upon closing of these transactions, we paid an aggregate of$396 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$563 million in cash (inclusive of expenses) in the six months endedJuly 30, 2022 to complete the above transactions. 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 above convertible senior notes repurchases, we had$44 million remaining in aggregate principal amount of convertible notes outstanding as ofJuly 30, 2022 , comprised of$1.7 million of 2023 Notes and$42 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.
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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 construction period. During the six months endedJuly 30, 2022 , adjusted capital expenditures were$95 million in aggregate, net of cash received related to landlord tenant allowances of$5.4 million . In addition, we also received landlord tenant allowances of$4.4 million , which are reflected as a reduction to principal payments under finance leases within financing activities on the condensed consolidated statements of cash flows. We anticipate our adjusted capital expenditures to be$200 million to$225 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$26 million , both of which qualified for sale-leaseback accounting. In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurance that we will be successful in securing additional funding on attractive terms or at all. In addition, our capital needs and uses of capital may change in the future due to changes in our business or new opportunities that we may pursue.
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the
following table:
SIX MONTHS ENDED
JULY 30 , JULY 31,
2022 2021
(in thousands)Net cash provided by operating activities$ 192,516 $ 316,718 Net cash used in investing activities (64,078)
(84,077)
Net cash used in financing activities (224,156)
(42,968)
Net increase (decrease) in cash and cash equivalents and (96,158)
189,765
restricted cash equivalents Cash and cash equivalents and restricted cash 2,085,706
296,836
equivalents at end of period
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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 six months endedJuly 30, 2022 , net cash provided by operating activities was$193 million and consisted of net income of$323 million and an increase in non-cash items of$317 million , partially offset by a change in working capital and other activities of$447 million . The use of cash from working capital was primarily driven by an increase in prepaid expenses and other assets of$153 million primarily due to federal and state tax receivables and the issuance of additional promissory notes receivable, an increase in merchandise inventory of$125 million , a decrease in accounts payable and accrued expenses of$64 million , a decrease in operating lease liabilities of$38 million primarily due to payments made under the related lease agreements, an increase in landlord asset under construction, net of tenant allowances, of$32 million and a decrease in other current liabilities of$25 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 30, 2022 , net cash used in investing activities was$64 million and was comprised of investments in retail stores, information technology and systems infrastructure of$63 million and additional funding of our equity method investments of$1.5 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 our share repurchase program, repayment of indebtedness including principal payments under finance lease agreements and other equity related transactions. For the six months endedJuly 30, 2022 , net cash used in financing activities was$224 million , primarily due to the completion of certain transactions related to the 2023 Notes and 2024 Notes in the first quarter of fiscal 2022. 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. Net cash used in financing activities also included uses of cash of$395 million for the settlement of the convertible senior notes repurchase obligation, as well as payments of$13 million in aggregate principal amount of certain 2023 Notes and 2024 Notes as a result of early conversions by the noteholders. Refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements. These cash outflows were partially offset by the issuance of the Term Loan B-2 inMay 2022 in the amount of$500 million pursuant to the 2022 Incremental Amendment to the Term Loan Credit Agreement, for which we incurred debt issuance costs of$28 million . During the six months endedJuly 30, 2022 , we made payments on equipment notes of$13 million , payments under our term loans of$10 million and net payments under finance lease agreements of$3.1 million . During the six months endedJuly 30, 2022 , we repurchased 1,000,000 shares of our common stock for an aggregate repurchase amount of$255 million and we received proceeds from option exercises of$152 million , primarily due toMr. Friedman's option exercise activity in the first quarter of fiscal 2022.
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 the extinguishment of convertible senior notes related to our repurchase obligations and associated financing liabilities and embedded derivatives arising from the convertible senior notes repurchases (refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements), as well as shares issued and received related to convertible senior note transactions.
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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 Facilities
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our term loans facilities, including our Term Loan B and Term Loan B-2.
Equipment Loan Facility
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility. As ofJuly 30, 2022 , one equipment security note remains outstanding with a maturity date inApril 2023 .
Share Repurchase Program and Share Retirement
We regularly review share repurchase activity and consider various factors in determining whether and when to execute investments in connection with our share repurchase program, 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 our share repurchase program 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.
Share Repurchase Program
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. OnJune 2, 2022 , the Board of Directors authorized an additional$2.0 billion for the purchase of shares of our outstanding common stock, which increased the total authorized size of the share repurchase program to$2,450 million (the "Share Repurchase Program"). In the second quarter of fiscal 2022, we repurchased 1,000,000 shares of our common stock under the Share Repurchase Program at an average price of$254.72 per share, for an aggregate repurchase amount of approximately$255 million . As ofJuly 30, 2022 , approximately$2,195 million remains available for future share repurchases under the Share Repurchase Program.
52 | 2022 SECOND QUARTER FORM 10-Q PART I. FINANCIAL INFORMATION
Table of Contents Share Retirement During the second quarter of fiscal 2022, we retired 1,000,000 shares of common stock related to shares we repurchased under the Share Repurchase Program. As a result of this retirement, we reclassified a total of$255 million from treasury stock to additional paid-in capital on the condensed consolidated balance sheets and condensed consolidated statements of shareholders' equity as ofJuly 30, 2022 .
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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