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 2019 Form 10-K.
FORWARD-LOOKING STATEMENTS AND MARKET DATA
This quarterly report contains forward-looking statements that are subject to
risks and uncertainties. Forward-looking statements give our current
expectations and projections relating to our financial condition, results of
operations, plans, objectives, future performance and business. You can identify
forward-looking statements by the fact that they do not relate strictly to
historical or current facts. These statements may include words such as
"anticipate," "estimate," "expect," "project," "plan," "intend," "believe,"
"may," "will," "short-term," "non-recurring," "one-time," "unusual," "should,"
"likely" and other words and terms of similar meaning in connection with any
discussion of the timing or nature of future operating or financial performance
or other events.
Forward-looking statements are subject to risk and uncertainties that may cause
actual results to differ materially from those that we expected. We derive many
of our forward-looking statements from our operating budgets and forecasts,
which are based upon many detailed assumptions. While we believe that our
assumptions are reasonable, we caution that it is very difficult to predict the
impact of known factors and it is impossible for us to anticipate all factors
that could affect our actual results and matters that we identify as "short
term," "non-recurring," "unusual," "one-time," or other words and terms of
similar meaning may in fact recur in one or more future financial reporting
periods. Important factors that could cause actual results to differ materially
from our expectations, or cautionary statements, include those factors disclosed
under the sections entitled Risk Factors in Part II of this quarterly report,
our Quarterly Report on Form 10-Q for the quarterly period ended May 2, 2020
("First Quarter Form 10-Q") and in our Annual Report on Form 10-K for the
fiscal year ended February 1, 2020 ("2019 Form 10-K"), and Management's
Discussion and Analysis of Financial Condition and Results of Operations in
Part I of this quarterly report, in our First Quarter Form 10-Q and in our 2019
Form 10-K. All forward-looking statements attributable to us, or persons acting
on our behalf, are expressly qualified in their entirety by these cautionary
statements, as well as other cautionary statements. You should evaluate all
forward-looking statements made in this quarterly report in the context of these
risks and uncertainties.
We cannot assure you that we will realize the results or developments we expect
or anticipate or, even if substantially realized, that they will result in the
consequences or affect us or our operations in the way we expect. The
forward-looking statements included in this quarterly report are made only as of
the date hereof. We undertake no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise, except as required by law.
Overview
We are a leading luxury retailer in the home furnishings marketplace. Our curated and fully-integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers. We offer dominant merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings. We position our Galleries as showrooms for our brand, while ourSource Books and websites act as virtual extensions of our stores. Our retail business is fully integrated across our multiple channels of distribution, consisting of our stores,Source Books , and websites. We have an integrated RH Hospitality experience in ten of our newDesign Gallery locations, which include restaurants and wine vaults. 33 Table of Contents As ofAugust 1, 2020 , we operated the following number of retail Galleries, outlets and showrooms: Count RH Design Galleries 24 Legacy Galleries 38 Modern Galleries 2 Baby & Child and Teen Galleries 4 Total Galleries 68 Outlets 38 Waterworks Showrooms 15 The initial wave of the novel coronavirus disease ("COVID-19") outbreak starting inMarch 2020 caused disruption to our business operations as we temporarily closed all of our retail locations onMarch 17, 2020 . While our retail locations were substantially closed at the end of the first fiscal quarter onMay 2, 2020 , during the second fiscal quarter we have reopened substantially all of our retail locations. As of the end of the second fiscal quarter onAugust 1, 2020 we had reopened 66 out of 68 of our Galleries, all of our Outlets, and 8 out of 10 of our restaurants. In addition, our business has substantially recovered during the second fiscal quarter as a result of both the reopening of most of our retail locations and also due to strong consumer demand for our products. As our business has strengthened during the second fiscal quarter, the reduction in inventory receipts together with dislocations in our supply chain has resulted in some delays in our ability to convert business demand into shipped sales. Our global supply chain has not fully recovered from the impact of the COVID-19 dislocation. Despite the strong growth in consumer demand in our business during the second fiscal quarter, revenue growth has lagged the increase in customer orders. As manufacturing and inventory receipts catch up with this backlog, we expect this demand will convert into revenue in the next several quarters as our supply chain recalibrates to the new level of our business. While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in theU.S. andCanada , there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year endingJanuary 30, 2021 . The COVID-19 pandemic may continue to have an adverse impact on elements of our supply chain including the manufacture, supply, distribution, transportation and delivery of our products and our inventory levels. The presence of the virus and the response to the health crisis in various countries can affect the speed at which the factories that manufacture our products are able to resume normal operations and production levels, and the extent to which business conditions are able to return to normal in areas that affect our supply chain including factories and transportation. Furthermore, our hospitality business may not recover as quickly as other parts of our business, as in most of our retail locations that have reopened, substantial operational restrictions related to COVID-19 health and safety considerations, for example limits to seating capacity, have been imposed on such business by various governmental authorities. Such operational restrictions may cause our hospitality offerings to be less attractive to customers or may lower its margins and profitability. In our initial response to the COVID-19 health crisis we undertook immediate adjustments to our business operations including curtailing expenses and delaying investments including scaling back some inventory orders while we assessed the status of our business. Our approach to the crisis evolved quickly as our business trends substantially improved during the second fiscal quarter. 34 Table of Contents While we are pursuing a large number of new business initiatives, the COVID-19 health crisis has had a short-term impact on some of those efforts and initiatives such as the timing of some construction efforts with respect to opening new Gallery locations and optimizing our inventory in light of Outlet inventory buildup resulting from our temporary retail closures. For example, while we have generally experienced positive and improving business trends during the second quarter of fiscal 2020, counterparties with respect to some of our Gallery development projects may experience capital or liquidity constraints due to COVID-19 related difficulties, which may impact the timing or scope of some of our development projects. The impact of COVID-19 abroad, including travel restrictions imposed by various countries, may affect certain aspects of our planned international expansion. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs of our business operations. In addition, our near term decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business related to the impact of COVID-19. While we have taken measures to defer some capital expenditures and other expenses in response to the COVID-19 health crisis, we expect to resume those investments as and to the extent that conditions for our business continue to improve during the COVID-19 crisis. For more information, refer to Item 1A-Risk Factors-The COVID-19 pandemic poses significant and widespread risks to our business as well as to the business environment and the markets in which we operate in Part II of this quarterly report.
Key Value Driving Strategies
In order to drive growth across our business, we are focused on a number of key long-term strategies, including:
Elevate and Expand RH Product. Consistent with our luxury brand positioning, we
are driving improvements in our product offering as one of the key value
driving strategies of our business. While we have expanded our merchandise
assortment substantially over a number of years, we are increasingly focused on
? efforts to elevate our product as opposed to only increasing the size of our
product offering. As part of this effort, we are driving continuing enhancements in the taste, quality and style of our products as well as integrating our product offering to offer our customers authoritative collections of home furnishings at the high end of the market. As part of these efforts, we continue to attract and collaborate with the best designers, artisans, and manufacturers in our industry, scaling their work across our integrated platform and thereby rendering it more valuable, enabling us to curate a compelling collection of luxury home furnishings to our customers. Our vision is not only to elevate our merchandise offering, but also to offer a broader ecosystem of products and experiences as we move the brand beyond curating and selling product to conceptualizing and selling spaces by building an integrated platform of products, places, services and spaces that elevate and establish the RH brand as a global thought leader, taste and placemaker. As an example, our product is elevated and rendered more valuable by our architecturally inspiring Galleries, which are further elevated and rendered more valuable by our seamlessly integrated hospitality experience. Our Hospitality efforts will continue to elevate the RH brand as we move beyond the four walls of our Galleries into RH Guesthouses where our goal is to create a new market for travelers seeking privacy and luxury in the hotel industry. Additionally, we are creating bespoke hospitality experiences like RHYountville , an integration of Food, Wine, Art & Design in theNapa Valley . These immersive experiences expose existing and new customers to our evolvoing authority in interior design, architecture, landscape architecture and hospitality.
Transform Our Real Estate Platform. We believe our strategy to open new Design
Galleries in every major market will unlock the value of our vast assortment,
generating a revenue opportunity for our business of
? 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 are sized to the potential of each market and the size
of our merchandise assortment.
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New sites are identified based on a variety of factors, such as (i) the
availability of suitable new site locations based on several store specific
factors including geographic location, demographics, and proximity to affluent
consumers, (ii) the ability to negotiate favorable economic terms, as well as
(iii) the satisfactory and timely completion of real estate development
including procurement of permits and completion of construction. The number of
Design Galleries we open in any fiscal year is highly dependent upon these
variables and individual new Design Galleries may be subject to delay or
postponement depending on the circumstances of specific projects, which we have
experienced with some of our new Gallery openings from time to time including in
connection with the COVID-19 crisis.
Today we operate 24 Design Galleries, and based on our analysis, we believe we
have the opportunity to operate Design Galleries in 60 to 70 locations in the
United States and Canada . We opened our Minneapolis Design Gallery in September
2019 , our Columbus Design Gallery in December 2019 , our Charlotte Design Gallery
in June 2020 and our Marin Design Gallery in July 2020 . Nearly all of our new
Design Galleries include integrated restaurants and wine vaults.
We have identified key learnings from our real estate transformation that have
supported the development of a multi-tier market approach that we believe will
optimize both market share and return on invested capital. Our Gallery designs
include (i) prototype Design Galleries that are suited to many North American
markets, similar to those we opened most recently in Charlotte and Marin, (ii)
larger Bespoke Design Galleries in the top metropolitan markets, similar to
those we opened in New York and Chicago , and (iii) indigenous Bespoke Galleries
in the best second home markets where the wealthy and affluent visit and
vacation including our location in Yountville, California as well as our Gallery
under development in Aspen, Colorado .
Like our evolving multi-tier market approach, we have developed a multi-tier
real estate strategy that is designed to significantly increase our unit level
profitability and return on invested capital. Several of our primary deal
constructs are outlined below:
First, due to the productivity and proof of concept of our recent new
? Galleries, and the addition of a powerful, traffic-generating hospitality
experience, we are able to negotiate "capital light" leasing deals, where a
substantial portion of the capital requirement would be funded by the landlord.
Second, in select projects we are migrating from a leasing to a development
model. We have two Galleries,
? new model, and have additional projects in the pipeline. In the case of
have allow us to recoup a large portion of our capital.
Third, we are working on joint venture projects, where we share the upside of a
development with the developer/landlord. An example of this new model would be
our future Gallery and Guesthouse in
of our lease to the development in exchange for a profits interest in the
project. The developer will deliver to RH a substantially turnkey Gallery and
? Guesthouse, while we continue to retain a 20% and 25% profits interest in the
properties, respectively. We would expect to monetize the profits interest at
the time of sale of the properties, which we anticipate would occur within five
years of such properties' development. The net result should be a minimal
capital investment to operationalize the business, with the expectation for a
net positive capital benefit at time of monetization of the profits interest.
We anticipate that all of the above deal structures should lead to lower capital requirements, higher unit profitability, and significantly higher return on invested capital versus our prior Gallery development strategies.
Pursue International Expansion. We believe that our luxury brand positioning
and unique aesthetic has strong international appeal, and pursuit of global
expansion will provide RH access to a substantial long-term market opportunity
? to build a
pursuing expanding the RH brand globally with the objective of launching in
several international locations in 2021 or 2022. We have secured a number of
locations in various markets in theUnited Kingdom and continentalEurope in which we 36 Table of Contents
expect to introduce our first Galleries outside of the
believe that expanding our business into these and other international markets
represents a substantial long-term market opportunity given the size and fragmentation of the home furnishings industry in these markets, and are pursuing international expansion as one of our key business priorities.
Grow Our Integrated Hospitality Experience. In 2015 we began to introduce an
integrated hospitality experience, including restaurants and wine vaults, into
a number of our new Gallery locations. The success of our initial hospitality
offering in
? a number of our other new Gallery locations. We believe this has created a
unique new retail experience that cannot be replicated online, and that the
addition of hospitality is helping to drive incremental sales of home
furnishings in these Galleries. We plan to incorporate hospitality in many of
the new Galleries that we open in the future. Architect New Operating Platform. We have spent approximately four years architecting a new operating platform, inclusive of transitioning from a
promotional to membership model, our distribution center network redesign, the
redesign of our reverse logistics and outlet business, and the
? reconceptualization of our home delivery and customer experience, which enables
us to drive lower costs and inventory levels, and higher earnings and inventory
turns. Looking forward, we expect this multi-year effort to result in a
dramatically improved customer experience, continued margin enhancement and
significant cost savings over the next several years.
Maximize Cash Flow and Optimize the Allocation of Capital in the Business. From
fiscal 2017 through and including fiscal 2020, we have increasingly operated
our business with a goal to maximize cash flow and the allocation of capital.
We believe that our operations and current initiatives are providing a
? significant opportunity to optimize the allocation of capital in our business,
including generating free cash flow and optimizing our balance sheet. Our focus
on cash flow and capital allocation has permitted us to make long term
decisions that benefit our business including deploying capital to repay debt
and repurchase shares of our common stock, which we believe creates a benefit
to our shareholders.
During fiscal 2017, we repurchased approximately 20.2 million shares of our common stock under two separate repurchase programs for an aggregate repurchase amount of approximately$1 billion . During fiscal 2018, we repurchased approximately 2.0 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately$250 million . During fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately$250 million . Our focus on cash also resulted in our generating substantial free cash flow in fiscal 2017 through 2019 and we expect this objective to continue to be a priority in fiscal 2020 and 2021 .
Increase Operating Margins. Since fiscal 2016 and continuing through fiscal
2020, we have substantially increased the operating margins in our business.
While the time period during which we have had to adjust our operations to
respond to the COVID-19 crisis will have some negative impact on margins, we
believe that our longer term effort to increase operating margins will continue
? as the business continues to normalize after the effects of COVID-19 moderate.
We anticipate continued improvements in operating margins as a result of our
focus on a number of our strategic initiatives including (i) the occupancy
leverage we expect to gain from our real estate transformation, (ii) product
margin expansion as we continue to drive higher full price selling in our core
business, and (iii) the continued cost savings of improvements to our operating
platform and organizational structure.
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Business Initiatives
We are undertaking a large number of new business initiatives in support of our
key value driving strategies. In particular, beginning in fiscal 2016 and
continuing through fiscal 2020, we have pursued a range of strategic efforts to
improve our business and operations including the following:
Introduction of Membership Model. In
Program, an exclusive program that reimagines and simplifies the shopping
experience. For an annual fee, the RH Members Program provides a set discount
every day across all RH brands, excluding RH Hospitality and Waterworks, in
addition to other benefits including complimentary interior design services
through the RH Interior Design program and eligibility for preferred financing
? plans on the RH Credit Card, among other benefits. The RH Members Program
allows our customers to shop for what they want, when they want, and receive
the greatest value, which has resulted in orders and sales being more evenly
distributed throughout the year as opposed to the peaks and valleys of orders
and sales we experienced under the prior promotional model. We believe the
shift to a membership model has enhanced the customer experience, rendered our
brand more valuable, improved operational execution and reduced costs.
We believe that the shift to a membership model has positively affected the financial results of our business. Specifically, we believe some of the benefits include:
Improved customer experience. Our interior design professionals can now work with customers based on their timeline and project deadlines, as opposed to our prior promotional calendar. We believe this will lead to larger overall sales transactions for individual customer design projects. Lower cancellations and returns. As a result of the elimination of time-limited promotional events and the associated pressure of placing an order before a promotion expires, we believe the shift to a membership model has also resulted in lower rates of cancelled orders and returns. Improved operational costs. The volume of sales, orders and shipments in our business under the prior promotional model was characterized by large spikes in customer orders based upon promotional events followed by lower orders and sales after the end of an event. This buying pattern also affected numerous other aspects of our business, including staffing and costs as we required elevated staffing levels to service the increased number of customers during peak sales events. Likewise, significant fluctuations in sales had downstream implications for our supply chain related to merchandise orders, manufacturing and production, shipment to our distribution centers and final delivery to our customers. All of these aspects of our operations are experiencing improved efficiencies as a result of the membership model whereby sales are more evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales under the prior model.
Luxury In-Home Furniture Delivery Experience. We believe there is an
opportunity to improve the customer experience by enhancing our approach to
services in connection with in-home delivery. We are in the process of
implementing a number of measures that are designed to increase our level of
control and improve service levels throughout the delivery experience to the
? customer's residence. We believe that we are well positioned to develop
improved solutions for in-home delivery to the customer in the luxury market.
We have already adopted a number of service improvements that are yielding
improvements in the customer experience and reductions in product return and
exchange rates. We expect to continue to optimize our service offering to
customers in connection with the in-home delivery experience and are confident
that our efforts in this regard will continue to achieve substantial results.
Elevate the Customer Experience. We are continuing to pursue the positioning of
our business as a luxury brand. As one part of this ongoing initiative, we are
focused on improving the end-to-end customer experience. As we have elevated
our brand, especially at retail, we are also working to enhance the brand
experience in other aspects of our business. We are making changes in many
aspects of our business processes that affect our customers, including the
? in-home delivery experience, improvements in product quality and enhancements
in sourcing, product availability, and all aspects of customer care and
service. We also believe that the introduction of experiential brand-enhancing
products and services, such as expanded design ateliers, the RH Interior Design
program and the launch of an integrated hospitality experience in a number of
our new Galleries, will further enhance our customers' in-store experience,
allowing us to further disrupt the highly fragmented home furnishings landscape
and achieve market share gains.
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We continue to pursue and test numerous initiatives to improve many aspects of our business including through efforts to optimize inventory, elevate the home delivery experience, simplify our distribution network and improve our organizational design including by streamlining and realigning our home office operations, as well as to elevate our product offering, transform our real estate using a range of different models for specific real estate development projects and expand our brand internationally. Many of these initiatives and other initiatives such as our transition to a direct sourcing model for our rug business have improved our operating margins, but other initiatives such as RH Hospitality, Waterworks and investments to develop our international expansion strategy are expected to offset some planned margin improvement in fiscal 2020 due to our investments in these platforms. There can be no assurance as to the timing and extent of the operational benefits and financial contributions of these strategic efforts. In addition, our pursuit of multiple initiatives with respect to our business in any given period may result in period-to-period changes in, and increased fluctuation in, our results of operations. We have also experienced delays in development timelines for some of our recent projects, and delays in completion of our real estate development projects or costs overruns could negatively affect our results of operations and revenues. Further, macroeconomic or political events outside of our control could impact our ability to pursue our initiatives or the success of such initiatives. While we believe that the tariffs imposed to date on most of our goods sourced fromChina have not had an adverse effect on our results of operations, including our revenues, margins and earnings, there can be no assurance that the existing tariffs and the additional tariffs that will become effective, as well as other future tariffs that may be imposed, will not adversely affect our results of operation in future time periods. The stock market has experienced significant increases in volatility during fiscal 2020. In general we have experienced some correlation between stock market performance and consumer spending patterns in our business. Accordingly, we may encounter shifts in consumer spending in future time periods as a result of stock market declines including in the event that heightened market volatility related to the COVID-19 health crisis or other factors including deterioration in market conditions leads to stock price declines. Our business is also correlated to the housing market. The housing market is affected by a range of factors including home prices and interest rates and slowdowns in the housing market can have a negative impact on demand for our products. Factors that affect the higher end housing market in particular may have an outsized influence on our levels of consumer demand since our business is geared toward the higher end of the home furnishings market. The above factors and other current and future operational initiatives may create additional uncertainty with respect to our consolidated net revenues and profit in the near term.
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Basis of Presentation and Results of Operations
Matters Affecting Comparability
The disruption to our business operations from the initial wave of the COVID-19 outbreak has had a significant impact on the comparability of certain ratios and year-over-year trends for our operating results for the three and six months endedAugust 1, 2020 as compared to the three and six months endedAugust 3, 2019 . The primary negative impact to our revenues from store closures occurred during the first quarter of fiscal 2020, but despite the reopening of most of our Galleries during the second fiscal quarter and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances related to COVID-19 including delays in inventory receipts and manufacturing as our supply chain recovers from the impact of the global health crisis. We have also changed the cadence of our expenses and investments as we have sought to address the impact of COVID-19 on the business. During the first quarter of fiscal 2020, we implemented a number of short-term and long-term initiatives in response to COVID-19 including the implementation of a business reorganization and the deferral of certain investments. During the second fiscal quarter of 2020 we have resumed many investments and previously deferred expenditures but we anticipate that our decisions regarding these matters will continue to evolve in response to changing business circumstances including further developments with respect to COVID-19.
Results of Operations
The following table sets forth our condensed consolidated statements of income and other financial and operating data.
Three Months Ended Six Months Ended
August 1, August 3, August 1, August 3,
2020 2019 2020 2019
(in thousands)
Condensed Consolidated Statements of
Income:
Net revenues $ 709,282 $ 706,514 $ 1,192,177 $ 1,304,935
Cost of goods sold 376,863 411,556 660,104 777,163
Gross profit 332,419 294,958 532,073 527,772
Selling, general and administrative
expenses 195,851 190,977 360,052 355,158
Income from operations 136,568 103,981 172,021 172,614
Other expenses
Interest expense-net 19,418 24,513 39,047 45,631
Tradename impairment - - 20,459 -
Gain on extinguishment of debt (152) (954) (152) (954)
Total other expenses 19,266 23,559 59,354 44,677
Income before income taxes 117,302 80,422 112,667 127,937
Income tax expense 18,879 16,665 17,456 28,458
Net income $ 98,423 $ 63,757 $ 95,211 $ 99,479
Other Financial and Operating Data:
Adjusted net income (1) $ 123,013 $ 71,430 $ 152,962 $ 119,671
Adjusted EBITDA (2) $ 185,787 $ 133,716 $ 263,214 $ 234,101
Capital expenditures $ 30,899 $ 17,367 $ 47,531 $ 25,283
Landlord assets under construction-net
of tenant allowances 15,334 23,013
22,934 27,555
Adjusted capital expenditures (3)
Adjusted net income is a supplemental measure of financial performance that
is not required by, or presented in accordance with, generally accepted
accounting principles ("GAAP"). We define adjusted net income as consolidated
net income, adjusted for the impact of certain non-recurring and other items (1) that we do not consider representative of our underlying operating
performance. Adjusted net income is included in this filing because
management believes that adjusted net income provides meaningful supplemental
information for investors regarding the performance of our business and
facilitates a meaningful evaluation of actual results on a
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comparable basis with historical results. Our management uses this non-GAAP
financial measure in order to have comparable financial results to analyze
changes in our underlying business from quarter to quarter. The following table
presents a reconciliation of net income, the most directly comparable GAAP
financial measure, to adjusted net income for the periods indicated below.
Three Months Ended Six Months Ended
August 1, August 3, August 1, August 3,
2020 2019 2020 2019
(in thousands)
Net income $ 98,423 $ 63,757 $ 95,211 $ 99,479
Adjustments pre-tax:
Amortization of debt discount (a) 11,113 9,918 22,238 21,607
Tradename impairment (b) - - 20,459 -
Asset impairments and lease losses (c) 1,339 2,545 9,810 6,021 Loss on sale leaseback transaction (d) 9,352
- 9,352 -
Reorganization related costs (e) 2,884 - 7,027 -
Recall accrual (f) 4,780 (320) 4,780 (1,935)
Gain on extinguishment of debt (g) (152) (954) (152) (954) Legal settlements (h) - (1,193) - (1,193) Subtotal adjusted items 29,316 9,996 73,514 23,546 Impact of income tax items (i) (4,726) (2,323) (15,763) (3,354) Adjusted net income$ 123,013 $ 71,430 $ 152,962 $ 119,671
Under GAAP, certain convertible debt instruments that may be settled in cash
on conversion are required to be separately accounted for as liability and
equity components of the instrument in a manner that reflects the issuer's
non-convertible debt borrowing rate. Accordingly, in accounting for GAAP
purposes for the
senior notes that were issued in
million aggregate principal amount of convertible senior notes that were
issued in June and
principal amount of convertible senior notes that were issued in
(the "2023 Notes") and the
convertible senior notes that were issued in
Notes"), we separated the 2019 Notes, 2020 Notes, 2023 Notes and 2024
Notes into liability (debt) and equity (conversion option) components and we
(a) are amortizing as debt discount an amount equal to the fair value of the
equity components as interest expense on the 2019 Notes, 2020 Notes, 2023
Notes and 2024 Notes over their expected lives. The equity components
represent the difference between the proceeds from the issuance of the 2019
Notes, 2020 Notes, 2023 Notes and 2024 Notes and the fair value of the
liability components of the 2019 Notes, 2020 Notes, 2023 Notes and 2024
Notes, respectively. Amounts are presented net of interest capitalized for
capital projects of
ended
net of interest capitalized for capital projects of
million during the six months ended
respectively. The 2019 Notes matured on
matured on
post-maturity.
Represents tradename impairment related to the Waterworks reporting unit.
(b) Refer to "Waterworks Tradename Impairment" within Note 4-
Trademarks, Trademarks and Domain Names in our condensed consolidated
financial statements.
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The adjustment includes the acceleration of depreciation expense due to a
change in the estimated useful lives of certain assets of
respectively, and
(c) months ended August 1, 2020 also includes asset impairments of
and inventory reserves of
resulting from retail closures in response to the COVID-19 pandemic. Each of
the three and six months ended
includes a
agreement.
(d) Represents the loss on sale leaseback transaction related to one of our
previously owned Design Galleries.
(e) Represents severance costs and related payroll taxes associated with
reorganizations.
Represents adjustments to net revenues, cost of goods sold and inventory
(f) charges associated with product recalls, as well as accrual adjustments, and
vendor and insurance claims. The recall adjustments had the following effect
on our income before taxes:
Three Months Ended Six Months Ended
August 1, August 3, August 1, August 3,
2020 2019 2020 2019
(in thousands)
Decrease to net revenues $ 406 $ - $ 406 $ 413
Increase (decrease) to cost of goods
sold 4,374 (320) 4,374 (2,381)
(Increase) decrease to gross profit 4,780 (320) 4,780 (1,968)
Increase (decrease) to selling,
general and administrative expenses - - - 33
(Increase) decrease to income before
income taxes $ 4,780 $ (320) $ 4,780 $ (1,935) The adjustment in each of the three and six months ended
represents a gain on extinguishment of debt of upon the maturity and
(g) settlement of the 2020 Notes in
three and six months ended
of debt upon the maturity and settlement of the 2019 Notes in
(h) Represents legal settlements, net of related legal expenses.
The adjustment for the three months ended
effective tax rate of 16.1%. The adjustment for the six months ended August
(i) 1, 2020 is based on an adjusted tax rate of 17.8% which excludes the tax
impact associated with the Waterworks reporting unit tradename impairment
recorded in the first quarter of fiscal 2020. Each of the three and six
months ended
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. 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. EBITDA and Adjusted (2) EBITDA are included in this filing because management believes that these
metrics provide meaningful supplemental information for investors regarding
the performance of our business and facilitate a meaningful evaluation of
operating results on a comparable basis with historical results. Our
management uses these non-GAAP financial measures in order to have comparable
financial results to analyze changes in our underlying business from quarter
to quarter. Our measures of EBITDA and Adjusted EBITDA are not necessarily
comparable to other similarly titled captions for other companies due to
different methods of calculation. The following table presents a
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reconciliation of net income, the most directly comparable GAAP financial
measure, to EBITDA and Adjusted EBITDA for the periods indicated below.
Three Months Ended Six Months Ended
August 1, August 3, August 1, August 3,
2020 2019 2020 2019
(in thousands)
Net income $ 98,423 $ 63,757 $ 95,211 $ 99,479
Depreciation and amortization 25,342 25,321 50,212 52,510
Interest expense-net 19,418 24,513 39,047 45,631
Income tax expense 18,879 16,665 17,456 28,458
EBITDA 162,062 130,256 201,926 226,078
Tradename impairment (a) - - 20,459 -
Non-cash compensation (b) 6,861 5,298 12,689 10,993
Loss on sale leaseback transaction (a) 9,352 - 9,352 -
Asset impairment and lease losses (a) - 629 7,133 1,112
Reorganization related costs (a) 2,884 - 7,027 -
Recall accrual (a) 4,780 (320) 4,780 (1,935)
Gain on extinguishment of debt (a) (152) (954) (152) (954)
Legal settlements (a) - (1,193) - (1,193)
Adjusted EBITDA $ 185,787 $ 133,716 $ 263,214 $ 234,101 (a) Refer to the reconciliation of net income to adjusted net income table above
and the related footnotes for additional information.
(b) Represents non-cash compensation related to equity awards granted to
employees.
We define adjusted capital expenditures as (i) capital expenditures from (3) investing activities and (ii) cash outflows of capital related to
construction activities to design and build landlord-owned leased assets, net
of tenant allowances received.
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The following tables present RH Gallery and Waterworks showroom metrics and
exclude outlets:
Six Months Ended
August 1, August 3,
2020 2019
Total Leased Total Leased
Selling Square Selling Square
Count Footage (1) Count Footage (1)
(in thousands) (in thousands)
Beginning of period 83 1,111 86 1,089
Design Galleries:
Marin Design Gallery 1 32.9 - -
Charlotte Design Gallery 1 32.4 - -
Modern Galleries:
Dallas RH Modern Gallery
(relocation) - - - (4.5)
Baby & Child Galleries:Dallas RH Baby & Child Gallery - -
(1) (3.7) Legacy Galleries: Raleigh legacy Gallery 1 4.4 - - Charlotte legacy Gallery (1) (7.0) - - Corte Madera legacy Gallery (1) (7.0) - - Westport legacy Gallery (1) (6.5)
Dallas legacy Gallery (relocation) - -
- (2.6)San Antonio legacy Gallery (relocation) - - - (3.7) End of period 83 1,160 85 1,075 Total leased square footage at end of period (2) 1,560 1,451 Weighted-average leased square footage (3) 1,513 1,456 Weighted-average leased selling square footage (3) 1,123 1,079
Leased selling square footage is retail space at our retail locations used to
sell our products. Leased selling square footage excludes backrooms at retail
locations used for storage, office space, food preparation, kitchen space or (1) 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
to an owned retail location and approximately 11,600 square feet as of
August 3, 2019 related to two owned retail locations.
Total leased square footage includes approximately 5,400 square feet as of
(2)
square feet as of
Weighted-average leased square footage and leased selling square footage are (3) calculated based on the number of days a Gallery location was opened during
the period divided by the total number of days in the period.
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The following table sets forth our condensed consolidated statements of income as a percentage of total net revenues.
Three Months Ended Six Months Ended
August 1, August 3, August 1, August 3,
2020 2019 2020 2019
Condensed Consolidated Statements of Income:
Net revenues 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold 53.1 58.3 55.4 59.6
Gross profit 46.9 41.7 44.6 40.4Selling, general and administrative expenses 27.6 27.0
30.2 27.2 Income from operations 19.3 14.7 14.4 13.2 Other expenses Interest expense-net 2.8 3.4 3.2 3.5 Tradename impairment - - 1.7 -
Gain on extinguishment of debt - (0.1)
- (0.1)
Total other expenses 2.8 3.3 4.9 3.4
Income before income taxes 16.5 11.4 9.5 9.8
Income tax expense 2.6 2.4 1.5 2.2
Net income 13.9 % 9.0 % 8.0 % 7.6 %
Three Months Ended August 1, 2020 Compared to Three Months Ended August 3, 2019
Three Months Ended
August 1, August 3,
2020 2019
RH Segment Waterworks Total RH Segment Waterworks Total
(in thousands)
Net revenues $ 681,387 $ 27,895 $ 709,282 $ 672,328 $ 34,186 $ 706,514
Cost of goods sold 360,906 15,957 376,863 391,859 19,697 411,556
Gross profit 320,481 11,938 332,419 280,469 14,489 294,958
Selling, general and
administrative expenses 185,486 10,365 195,851 177,408 13,569 190,977
Income from operations $ 134,995 $ 1,573 $ 136,568 $ 103,061 $ 920 $ 103,981
Net revenues
Consolidated net revenues increased $2.8 million , or 0.4%, to $709.3 million in
the three months ended August 1, 2020 compared to $706.5 million in the three
months ended August 3, 2019 .
Consolidated net revenues for the three months ended August 1, 2020 were
negatively impacted by $0.4 million related to the reduction of revenue
associated with product recalls. Excluding the product recall adjustments,
consolidated net revenues increased $3.2 million , or 0.4%, to $709.7 million in
the three months ended August 1, 2020 compared to $706.5 million in the three
months ended August 3, 2019 . Product recalls and the establishment or adjustment
of any related recall accruals can affect our results and cause quarterly
fluctuations affecting the period-to-period comparisons of our results. No
assurance can be provided that any accruals will be for the appropriate amount,
and actual losses could be higher or lower than what we accrue from time to
time, which could further affect results.
RH Segment net revenues
RH Segment net revenues increased$9.1 million , or 1.3%, to$681.4 million in the three months endedAugust 1, 2020 compared to$672.3 million in the three months endedAugust 3, 2019 . The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude. 45 Table of Contents RH Segment net revenues increased primarily due to a strong increase in customer demand for our products during the three months endedAugust 1, 2020 . The growth in revenue was much lower than the growth in customer demand for our products during the three month period primarily due to the effects of COVID-19 on our supply chain. It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand. In addition, net revenues were impacted by a 23% reduction in open store days for Galleries due to the pandemic, a decrease in revenues from our Contract business, as well as decreases in our RH Hospitality operations and Outlet business due to COVID-19 related closures during the three months endedAugust 1, 2020 .
Waterworks net revenues
Waterworks net revenues decreased$6.3 million , or 18.4%, to$27.9 million in the three months endedAugust 1, 2020 compared to$34.2 million in the three months endedAugust 3, 2019 primarily due to construction delays which negatively impacted demand, as well as temporary showroom COVID-19 related closures.
Gross profit
Consolidated gross profit increased$37.5 million , or 12.7%, to$332.4 million in the three months endedAugust 1, 2020 compared to$295.0 million in the three months endedAugust 3, 2019 . As a percentage of net revenues, consolidated gross margin increased 5.2% to 46.9% of net revenues in the three months endedAugust 1, 2020 from 41.7% of net revenues in the three months endedAugust 3, 2019 .
RH Segment gross profit for the three months ended
RH Segment gross profit for the three months endedAugust 3, 2019 was negatively impacted by$1.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the three months endedAugust 3, 2019 was positively impacted by$0.3 million related to reserve adjustments associated with product recalls initiated in prior years. Excluding the product recall adjustments and accelerated asset depreciation mentioned above, consolidated gross margin would have increased 5.5% to 47.5% of net revenues in the three months endedAugust 1, 2020 from 42.0% of net revenues in the three months endedAugust 3, 2019 .
RH Segment gross profit
RH Segment gross profit increased$40.0 million , or 14.3%, to$320.5 million in the three months endedAugust 1, 2020 from$280.5 million in the three months endedAugust 3, 2019 . As a percentage of net revenues, RH Segment gross margin increased 5.3% to 47.0% of net revenues in the three months endedAugust 1, 2020 from 41.7% of net revenues in the three months endedAugust 3, 2019 . Excluding the product recall and accelerated asset depreciation adjustments mentioned above, RH Segment gross margin would have increased 5.7% to 47.7% of net revenues in the three months endedAugust 1, 2020 from 42.0% of net revenues in the three months endedAugust 3, 2019 . The increase was primarily driven by higher product margins in select product categories, as well as price increases in our Core business and lower Outlet promotional activity during the period of operations. In addition, we experienced leverage in occupancy and shipping
costs.
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Waterworks gross profit
Waterworks gross profit decreased$2.6 million , or 17.6%, to$11.9 million in the three months endedAugust 1, 2020 from$14.5 million in the three months endedAugust 3, 2019 . As a percentage of net revenues, Waterworks gross margin increased 0.4% to 42.8% of net revenues in the three months endedAugust 1, 2020 from 42.4% of net revenues in the three months endedAugust 3, 2019 .
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$8.1 million , or 4.6%, to$185.5 million in the three months endedAugust 1, 2020 compared$177.4 million in the three months endedAugust 3, 2019 . RH Segment selling, general and administrative expenses for the three months endedAugust 1, 2020 includes a loss of$9.4 million related to a sale leaseback transaction,$2.9 million related to severance costs and related payroll taxes associated with reorganizations and$1.3 million due to accelerated asset depreciation. RH Segment selling, general and administrative expenses for the three months endedAugust 3, 2019 include a favorable$1.2 million legal settlement related to historical freight charges, partially offset by a$0.6 million asset impairment. Excluding the loss on the sale leaseback transaction, asset impairments, reorganization costs, accelerated asset depreciation and legal settlement mentioned above, RH Segment selling, general and administrative expenses were 25.2% and 26.5% of net revenues for the three months endedAugust 1, 2020 andAugust 3, 2019 , respectively. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by a reduction in advertising costs, leverage in employment and employment related costs and travel related expenses, partially offset by increased professional fees, incremental COVID-19 related expenses, preopening costs and other corporate expenses.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased$3.2 million , or 23.6%, to$10.4 million in the three months endedAugust 1, 2020 compared to$13.6 million in the three months endedAugust 3, 2019 . Waterworks selling, general and administrative expenses were 37.2% and 39.7% of net revenues for the three months endedAugust 1, 2020 andAugust 3, 2019 , respectively. 47 Table of Contents Interest expense-net
Interest expense-net decreased
Three Months Ended
August 1 , August 3,
2020 2019
(in thousands)
Amortization of convertible senior notes debt discount
10,585
Finance lease interest expense 5,948
5,672
Promissory notes 1,072
988
Amortization of debt issuance costs and deferred financing fees 982 1,171 Other interest expense 436 388 Asset based credit facility 130 1,087 Term loans - 6,086
Capitalized interest for capital projects (1,426)
(1,184) Interest income (186) (280) Total interest expense-net$ 19,418 $ 24,513
Gain on extinguishment of debt
We recognized a$0.2 million gain on extinguishment of debt in the three months endedAugust 1, 2020 related to the maturity and settlement of the 2020 Notes inJuly 2020 . We recognized a$1.0 million gain on extinguishment of debt in the three months endedAugust 3, 2019 related to the maturity and settlement of
the 2019 Notes inJune 2019 . Income tax expense
Income tax expense was$18.9 million and$16.7 million in the three months endedAugust 1, 2020 andAugust 3, 2019 , respectively. Our effective tax rate was 16.1% and 20.7% for the three months endedAugust 1, 2020 andAugust 3, 2019 , respectively. The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the three months endedAugust 1, 2020 as compared to the three months endedAugust 3, 2019 .
Six Months EndedAugust 1, 2020 Compared to Six Months EndedAugust 3, 2019
Six Months Ended
August 1, August 3,
2020 2019
RH Segment Waterworks Total RH Segment Waterworks Total
(in thousands)
Net revenues $ 1,136,344 $ 55,833 $ 1,192,177 $ 1,236,034 $ 68,901 $ 1,304,935
Cost of goods sold 628,101 32,003 660,104 737,622 39,541 777,163
Gross profit 508,243 23,830 532,073 498,412 29,360 527,772
Selling, general and
administrative expenses 334,762 25,290 360,052 327,812 27,346 355,158
Income (loss) from
operations $ 173,481 $ (1,460) $ 172,021 $ 170,600 $ 2,014 $ 172,614
Net revenues
Consolidated net revenues decreased $112.8 million , or 8.6%, to $1,192.2 million
in the six months ended August 1, 2020 compared to $1,304.9 million in thesix months endedAugust 3, 2019 . 48 Table of Contents RH Segment net revenues RH Segment net revenues decreased$99.7 million , or 8.1%, to$1,136.3 million in the six months endedAugust 1, 2020 compared to$1,236.0 million in the six months endedAugust 3, 2019 . The below discussion highlights several significant factors that resulted in a decrease in RH Segment net revenues, which are listed in order of magnitude. RH Segment net revenues declined primarily due to the temporary closure of our Outlet and retail locations in response to COVID-19 during the first several months of the six months endedAugust 1, 2020 and, to a lesser extent, the negative impact to overall customer demand in our business due to macroeconomic conditions resulting from COVID-19, primarily during March and April within the six months endedAugust 1, 2020 . Outlet sales decreased$45.7 million to$63.8 million in the six months endedAugust 1, 2020 compared to$109.5 million in the six months endedAugust 3, 2019 due to COVID-19 related closures. RH Segment net revenues also decreased in our Contract business and RH Hospitality operations due to COVID-19 related factors including extended closures of our RH Hospitality locations.
Waterworks net revenues
Waterworks net revenues decreased$13.1 million , or 19.0%, to$55.8 million in the six months endedAugust 1, 2020 compared to$68.9 million in the six months endedAugust 3, 2019 . Gross profit Consolidated gross profit increased$4.3 million , or 0.8%, to$532.1 million in the six months endedAugust 1, 2020 from$527.8 million in the six months endedAugust 3, 2019 . As a percentage of net revenues, consolidated gross margin increased 4.2% to 44.6% of net revenues in the six months endedAugust 1, 2020 from 40.4% of net revenues in the six months endedAugust 3, 2019 . RH Segment gross profit for the six months endedAugust 1, 2020 was negatively impacted by$4.8 million related to product recalls and includes inventory reserves of$2.4 million related to Outlet inventory build up resulting from retail closures in response to the COVID-19 pandemic. RH Segment gross profit for the six months endedAugust 3, 2019 was negatively impacted by$4.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the six months endedAugust 3, 2019 was positively impacted by$2.0 million related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the reduction of revenue and incremental costs associated with such product recalls. Excluding the product recall, inventory reserves and acceleration of depreciation adjustments mentioned above, consolidated gross margin would have increased 4.5% to 45.2% of net revenues in the six months endedAugust 1, 2020 from 40.7% of net revenues in the six months endedAugust 3, 2019 .
RH Segment gross profit
RH Segment gross profit increased$9.8 million , or 2.0%, to$508.2 million in the six months endedAugust 1, 2020 from$498.4 million in the six months endedAugust 3, 2019 . As a percentage of net revenues, RH Segment gross margin increased 4.4% to 44.7% of net revenues in the six months endedAugust 1, 2020 from 40.3% of net revenues in the six months endedAugust 3, 2019 . Excluding the product recall, inventory reserves and acceleration of depreciation adjustments mentioned above, RH Segment gross margin would have increased 4.8% to 45.3% of net revenues in the six months endedAugust 1, 2020 from 40.5% of net revenues in the six months endedAugust 3, 2019 . The increase was primarily driven by higher product margins in select product categories, as well as price increases in our Core business and lower Outlet promotional activity during the period of operations. 49 Table of Contents Waterworks gross profit
Waterworks gross profit decreased$5.5 million , or 18.8%, to$23.8 million in the six months endedAugust 1, 2020 from$29.4 million in the six months endedAugust 3, 2019 . As a percentage of net revenues, Waterworks gross margin increased 0.1% to 42.7% of net revenues in the six months endedAugust 1, 2020 from 42.6% of net revenues in the six months endedAugust 3, 2019 .
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$7.0 million , or 2.1%, to$334.8 million in the six months endedAugust 1, 2020 compared to$327.8 million in the six months endedAugust 3, 2019 . RH Segment selling, general and administrative expenses for the six months endedAugust 1, 2020 include a loss of$9.4 million related to a sale leaseback transaction,$7.0 million related to severance costs and related payroll taxes associated with the termination of associates and a reorganization undertaken in response to the impact of retail closures on our business,$3.3 million related to asset impairments and$2.6 million due to accelerated asset depreciation. RH Segment selling, general and administrative expenses for the six months endedAugust 3, 2019 included a favorable$1.2 million legal settlement related to historical freight charges, partially offset by a$0.6 million asset impairment and a$0.5 million loss on disposal of an asset. Excluding the adjustments for the reorganizations, asset impairments, product recalls and legal settlements mentioned above, RH Segment selling, general and administrative expenses were 27.5% and 26.5% of net revenues for the six months endedAugust 1, 2020 andAugust 3, 2019 , respectively. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by increased professional fees, incremental COVID-19 related expenses, preopening costs and other corporate expenses, partially offset by a reduction in advertising costs and travel related expenses.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased$2.1 million , or 7.5%, to$25.3 million in the six months endedAugust 1, 2020 compared to$27.3 million in the six months endedAugust 3, 2019 . Waterworks selling, general and administrative expenses were 45.3% and 39.7% of net revenues for the six months endedAugust 1, 2020 andAugust 3, 2019 , respectively. 50 Table of Contents Interest expense-net
Interest expense-net decreased
Six Months Ended
August 1 , August 3,
2020 2019
(in thousands)
Amortization of convertible senior notes debt discount
22,962
Finance lease interest expense 11,729
11,186
Promissory notes 2,526
1,420
Amortization of debt issuance costs and deferred financing fees 1,995 2,261 Other interest expense 879 783 Asset based credit facility 232 1,774 Term loans - 7,810
Capitalized interest for capital projects (3,312)
(2,003) Interest income (380) (562) Total interest expense-net$ 39,047 $ 45,631
Gain on extinguishment of debt
We recognized a$0.2 million gain on extinguishment of debt in the six months endedAugust 1, 2020 related to the maturity and settlement of the 2020 Notes inJuly 2020 . We recognized a$1.0 million gain on extinguishment of debt in the six months endedAugust 3, 2019 related to the maturity and settlement of the 2019 Notes inJune 2019 . Income tax expense Income tax expense was$17.5 million and$28.5 million in the six months endedAugust 1, 2020 andAugust 3, 2019 , respectively. Our effective tax rate was 15.5% and 22.2% for the six months endedAugust 1, 2020 andAugust 3, 2019 , respectively. The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the six months endedAugust 1, 2020 as compared to the six months endedAugust 3, 2019 .
Liquidity and Capital Resources
General
The primary cash needs of our business have historically been for merchandise inventories, payroll,Source Books , store rent, capital expenditures associated with opening new stores and updating existing stores, as well as the development of our infrastructure and information technology. We seek out and evaluate opportunities for effectively managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. In fiscal 2017, we completed two share repurchase programs in an aggregate amount of$1 billion . A$300 million share repurchase was completed during the first quarter of fiscal 2017 and a$700 million share repurchase was completed during the second quarter of fiscal 2017. InOctober 2018 , our Board of Directors approved a new$700 million share repurchase program, of which$250 million in share repurchases were completed in fiscal 2018, and the$700 million authorization amount was replenished by the Board of Directors inMarch 2019 . During the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock for an aggregate repurchase amount of approximately$250 million , with$450 million still available under the$700 million repurchase program. Refer to "Share Repurchase Programs" below. We evaluate our capital allocation from time to time and may engage in future share repurchases in circumstances where buying shares of our common stock represents a good value and provides a favorable return for our shareholders. 51 Table of Contents We have$685 million in aggregate principal amount of convertible notes outstanding as ofAugust 1, 2020 , of which$335 million mature inJune 2023 (the "2023 Notes") and$350 million mature inSeptember 2024 (the "2024 Notes"). Based on the anticipated strong cash flow generation in 2020 and beyond, we expect to repay the outstanding principal amount of our convertible notes at maturity inJune 2023 andSeptember 2024 in cash, in each case to minimize dilution. While we purchased convertible note hedges and sold warrants with respect to each convertible note transaction, which are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately$338.24 per share and from the conversion of the 2023 Notes until our common stock is above approximately$309.84 per share, our shareholders may still experience dilution to the extent our common stock trades above such levels. While we anticipate using excess cash, free cash flow and borrowings on our asset based credit facility to repay the convertible notes in cash to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates or upon early conversion, as applicable. There can be no assurance as to the availability of capital to fund such repayments, or that if capital is available through additional debt issuances or refinancing of the convertible notes, that such capital will be available on terms that are favorable to us. Our business has historically relied on cash flows from operations, net cash proceeds from the issuance of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity. We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months. While we have taken measures to defer some capital expenditures and other expenses in response to the COVID-19 health crisis, we expect to resume those investments as and to the extent that conditions for our business continue to improve during the COVID-19 crisis. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs of our business operations. In addition, our near term decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business related to the impact of COVID-19. While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis, and have now substantially reopened our retail locations in theU.S. andCanada , there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain. Future adverse developments in connection with the COVID-19 crisis, including additional waves of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year endingJanuary 30, 2021 . In recognition of the significant threat to economic conditions and the liquidity of financial markets posed by COVID-19, theFederal Reserve andCongress have taken dramatic actions to provide liquidity to businesses and the banking system in theU.S. For example, onMarch 27, 2020 , the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), a sweeping stimulus bill intended to bolster theU.S. economy, among other things, and provide emergency assistance to qualifying businesses and individuals. There can be no assurance that these interventions by the government will be successful, and the financial markets may experience significant contractions in available liquidity. While we may receive financial, tax or other relief and other benefits under and as a result of the CARES Act, it is not possible to estimate at this time the availability, extent or impact of any future relief. We extended and amended our asset based credit facility inJune 2017 , which has a total availability of$600 million , of which$10 million is available toRestoration Hardware Canada, Inc. , and includes a$200 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from$600 million to up to$800 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. The revolving line of credit has a maturity date ofJune 28, 2022 . 52 Table of Contents
In fiscal 2019 we executed a sale-leaseback transaction for theYountville Design Gallery for sales proceeds of$23.5 million and inJuly 2020 we executed a sale-leaseback transaction for theMinneapolis Design Gallery for sales proceeds of$25.5 million , both of which qualified for sale-leaseback accounting in accordance with ASC 842. We may pursue strategies in the future, through the use of existing assets and debt facilities, or through the pursuit of new external sources of liquidity and debt financing, to fund our strategies to enhance stockholder value. There can be no assurance that additional capital, whether raised through the sale of assets, utilization of our existing debt financing sources, or pursuit of additional debt financing sources, will be available to us on a timely manner, on favorable terms or at all. To the extent we pursue additional debt as a source of liquidity, our capitalization profile may change and may include significant leverage, and as a result we may be required to use future liquidity to repay such indebtedness and may be subject to additional terms and restrictions which affect our operations and future uses of capital. In addition, our capital needs and uses of capital may change in the future due to changes in our business or new opportunities that we choose to pursue. We have invested significant capital expenditures in remodeling and opening new Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future periods as we open additional Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings. Our adjusted capital expenditures include (i) capital expenditures from investing activities and (ii) cash outflows of capital related to construction activities to design and build landlord leased assets, net of tenant allowances received. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may further adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020. We anticipate our adjusted capital expenditures, net of asset sales, to be$125 million to$150 million in fiscal 2020, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments. During the six months endedAugust 1, 2020 , adjusted capital expenditures were$70.5 million , net of cash received related to landlord tenant allowances of$10.2 million . Our fiscal 2020 adjusted capital expenditures are partially offset by net proceeds from sales of assets of$25.0 million . Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us. Other lease arrangements for our new Design Galleries require the landlord to fund a portion of the construction related costs directly to third parties, rather than through traditional construction allowances and accordingly, under these arrangements we do not expect to receive contributions directly from our landlords related to the building of our Design Galleries. As we develop new Galleries, as well as other potential strategic initiatives in the future like our integrated hospitality experience, we may explore other models for our real estate, which could include longer lease terms or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated with new sites and buildings. These approaches might require greater capital investment on our part than a traditional store lease with a landlord. We also believe there is an opportunity to transition our real estate strategy from a leasing model to a development model, where we potentially buy and develop our Design Galleries then recoup the investments through a sale-leaseback arrangement resulting in lower capital investment and lower rent. For example, we have used this strategy in fiscal 2019 through the sale-leaseback transaction for theYountville Design Gallery and inJuly 2020 through the sale-leaseback transaction for theMinneapolis Design Gallery . In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurances that we will be successful in securing additional funding on attractive terms or at all. 53 Table of Contents
In addition, we continue to address the effects of COVID-19 on our business with respect to real estate development and the introduction of new Galleries in both the US and internationally. A range of factors involved in the development of new Gallery and RH Hospitality may be affected by the COVID-19 health crisis including delays in construction as well as permitting and other necessary governmental actions. In addition, the scope and cadence of investments by third parties including landlords and other real estate counterparties may be adversely affected by the health crisis. Actions taken by international as well as federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the outbreak, may require changes to our real estate strategy and related capital expenditure and financing plans. In addition, we may continue to be required to make lease payments in whole or in part for our Galleries, restaurants and outlets that were temporarily closed or are required to close in the future in the event of future COVID-19 outbreaks or for other reasons. Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from COVID-19, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence. There can be no assurance that we will have sufficient financial resources, or will be able to arrange financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental debt will be available to us in order to fund our cash payments in respect of the repayment of our outstanding convertible senior notes in an aggregate principal amount of$685 million at maturity of such senior convertible notes. To the extent we need to secure additional sources of liquidity, we cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future financing requirements would not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock. Any adverse developments in theU.S. or global credit markets as a result of COVID-19 could affect our ability to manage our debt obligations and our ability to access future debt. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the covenants or other requirements of existing or new debt facilities, any such event could have an impact on our other commitments and obligations including triggering cross defaults or other consequences with respect to other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur, exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks. Cash Flow Analysis A summary of operating, investing, and financing activities is set forth in the following table: Six Months EndedAugust 1 ,August 3, 2020 2019 (in thousands)
Net cash provided by operating activities$ 128,275 $
97,133
Net cash used in investing activities (25,575)
(25,283)
Net cash used in financing activities (132,988)
(66,023)
Net increase (decrease) in cash and cash equivalents (30,271) 5,752 Cash and cash equivalents at end of period
17,387 11,555
Net Cash Provided By Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items including depreciation and amortization, impairments, stock-based compensation, amortization of debt discount and the effect of changes in working capital
and
other activities.
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For the six months ended August 1, 2020 , net cash provided by operating
activities was $128.3 million and consisted of net income of $95.2 million and
non-cash items of $89.1 million , partially offset by cash used for working
capital and other activities of $56.0 million . Working capital and other
activities consisted primarily of an increase in merchandise inventory of $49.0
million , an increase in landlord assets under construction of $22.9 million , a
decrease in operating lease liabilities of $18.4 million primarily due to
payments made under the related lease agreements, a decrease in accounts payable
and accrued expenses of $13.1 million due to timing of payments, and a decrease
in other non-current obligations of $12.3 million . These decreases in working
capital were partially offset by increases in deferred revenue and customer
deposits of $67.6 million .
For the six months ended August 3, 2019 , net cash provided by operating
activities was $97.1 million and consisted of net income of $99.5 million and
non-cash items of $59.5 million , partially offset by cash used for working
capital and other activities of $61.9 million . Working capital and other
activities consisted primarily of a decrease in operating lease liabilities of
$44.5 million primarily due to payments made under the agreements, a decrease in
accounts payable and accrued expense of $40.1 million related to timing of
payments, an increase in landlord assets under construction of $27.6 million , as
well as a decrease in other non-current liabilities of $13.8 million . These
decreases to working capital were partially offset by a decrease in merchandise
inventory of $51.2 million and increases in deferred revenue and customer
deposits of $13.0 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.
For the six months endedAugust 1, 2020 , net cash used in investing activities was$25.6 million primarily due to investments in information technology and systems infrastructure, supply chain investments and retail stores of$32.1 million , as well as the acquisition of building and land assets of$14.2 million . Net cash used in investing activities was partially offset by net proceeds from the sale of building and land of$25.0 million . For the six months endedAugust 3, 2019 , net cash used in investing activities was$25.3 million due to investments in information technology and systems infrastructure, supply chain investments and retail stores.
Financing activities consist primarily of borrowings related to convertible senior notes, credit facilities and other financing arrangements, as well as share repurchases, principal payments under finance lease agreements and other equity related transactions. For the six months endedAugust 1, 2020 , net cash used in financing activities was$133.0 million . The$300 million 2020 Notes matured inJuly 2020 , of which$215.8 million is presented within net cash used in financing activities and$84.0 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities. Net cash used in financing activities was partially offset by net borrowings of$91.6 million under the asset based credit facility. For the six months endedAugust 3, 2019 , net cash used in financing activities was$66.0 million . The$350.0 million 2019 Notes matured inJune 2019 , of which$278.6 million is presented within net cash used in financing activities and$70.5 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities. Additionally, net cash used in financing activities included the repurchase of approximately 2.2 million shares of our common stock for an aggregate repurchase amount of$250.0 million . Net cash used by financing activities was partially offset by borrowings under new debt arrangements of$389.0 million , which includes the issuance of a$200.0 million second lien term loan, a$120.0 million FILO term loan and$69.0 million of promissory notes secured by certain equipment. We incurred costs of$4.6 million related to the debt issuances. Under the asset based credit facility, we made repayments of$214.5 million in connection with the debt issuances described above pursuant to the terms of such facility, and we subsequently had borrowings of$302.0 million under such facility to partially fund the repayment of the 2019 Notes upon maturity. 55 Table of Contents Non-Cash Transactions Non-cash transactions primarily consist of non-cash additions of property and equipment and landlord assets, and reclassifications of assets from landlord assets from construction to finance lease right-of-use assets.
Convertible Senior Notes
Refer to Note 9-Convertible Senior Notes in our condensed consolidated financial statements for further information on our 0.00% Convertible Senior Notes due 2024, 0.00% Convertible Senior Notes due 2023 and 0.00% Convertible Senior Notes due 2020. Our 0.00% Convertible Senior Notes due 2020 matured onJuly 15, 2020 .
Asset Based Credit Facility
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our asset based credit facility.
Equipment Loan Facility
Refer to Note 10-Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility.
Share Repurchase Programs
We regularly review share repurchase activity and consider various factors in determining whether and when to execute share repurchases, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock. We believe that these share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities. We generated$330 million ,$163 million and$415 million in free cash flow in fiscal 2019, fiscal 2018 and fiscal 2017, respectively, which supported our share repurchase programs. Free cash flow is calculated as net cash provided by operating activities, the non-cash accretion of debt discount upon settlement of debt and proceeds from sale of assets, less capital expenditures and principal payments under finance leases. Free cash flow excludes all non-cash items. Free cash flow is included in this filing because management believes that free cash flow provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter. A reconciliation of our net cash provided by operating activities to free cash flow is as follows: Year Ended February 2, February 2, February 3, 2020 2019 2018 (in thousands)
Net cash provided by operating activities$ 339,188 $ 249,603 $ 474,505 Accretion of debt discount upon settlement of debt 70,482 - - Proceeds from sale of assets 24,078 - 15,123 Capital expenditures (93,623) (79,992) (68,393)
Principal payments under finance leases (9,682) (6,885)
(6,105)
Free cash flow $ 330,443 $ 162,726 $ 415,130
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OnOctober 10, 2018 , our Board of Directors authorized a share repurchase program of up to$700 million through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives, of which$250.0 million in share repurchases were completed in fiscal 2018. The$700 million authorization amount was replenished by the Board of Directors onMarch 25, 2019 (as replenished, the "$950 Million Repurchase Program"). In the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under the$950 Million Repurchase Program at an average price of$115.36 per share, for an aggregate repurchase amount of approximately$250.0 million . There were no share repurchases under the$950 Million Repurchase Program during the first quarter of fiscal 2020. As ofAugust 1, 2020 , there was$450 million remaining for future share repurchases under this program.
Contractual Obligations
As ofAugust 1, 2020 , there were no material changes to our contractual obligations described within Management's Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations in the 2019 Form 10-K.
Off Balance Sheet Arrangements
We have no material off balance sheet arrangements as of
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted inthe United States requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. 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
o Tradenames, Trademarks and Domain Names
o Long-Lived Assets ? Lease Accounting
o Reasonably Certain Lease Term
o Incremental Borrowing Rate
o Fair Market Value
There have been no material changes to the other critical accounting policies
and estimates listed above from the disclosures included in the 2019 Form 10-K.
For further discussion regarding these policies, refer to Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Critical Accounting Policies and Estimates in the 2019 Form 10-K.
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Recent Accounting Pronouncements
Refer to Note 2-Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently proposed accounting standards which may impact our consolidated financial statements in future reporting periods.
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