What changed in this filing

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Item 1. Financial Statements

2021-06-10 compared with 2020-12-10 · 282 added, 481 removed, 444 unchanged (63% of the section changed)

1 unchanged sentence

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(In thousands, except share amounts) (Unaudited)

Current assets:

6 unchanged sentences

Operating lease right-of-use assets

Tradenames, trademarks and domain names

Tradenames, trademarks and other intangible assets

Deferred tax assets

Equity method investments

Other non-current assets

3 unchanged sentences

Deferred revenue and customer deposits

Convertible senior notes due 2020—net

Operating lease liabilities

Federal and state tax payable

Other current liabilities

10 unchanged sentences

Stockholders’ equity:

Preferred stock—$ 0.0001 par value per share, 10,000,000 shares authorized, no shares issued or outstanding as of October 31, 2020 and February 1, 2020

Common stock— $ 0.0001 par value per share, 180,000,000 shares authorized, 19,844,455 shares issued and outstanding as of October 31, 2020;

19,236,681 shares issued and outstanding as of February 1, 2020

Preferred stock—$ 0.0001 par value per share, 10,000,000 shares authorized, no shares issued or outstanding as of May 1, 2021 and January 30, 2021

Common stock— $ 0.0001 par value per share, 180,000,000 shares authorized, 21,020,538 shares issued and outstanding as of May 1, 2021;

20,995,387 shares issued and outstanding as of January 30, 2021

Additional paid-in capital

Accumulated other comprehensive loss

Accumulated other comprehensive income

Accumulated deficit

2 unchanged sentences

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except share and per share amounts)

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 3

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts) (Unaudited)

THREE MONTHS ENDED

Nine Months Ended

Cost of goods sold

4 unchanged sentences

Tradename impairment

(Gain) loss on extinguishment of debt—net

Loss on extinguishment of debt

Total other expenses

Income before income taxes

Income tax expense

Weighted-average shares used in computing

basic net income per share

Basic net income per share

Weighted-average shares used in computing

diluted net income per share

Diluted net income per share

Income (loss) before income taxes

Income tax expense (benefit)

Income (loss) before equity method investments

Share of equity method investments losses

Net income (loss)

Weighted-average shares used in computing basic net income (loss) per share

Basic net income (loss) per share

Weighted-average shares used in computing diluted net income (loss) per share

Diluted net income (loss) per share

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 4

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands) (Unaudited)

THREE MONTHS ENDED

Nine Months Ended

Net income (loss)

Net gains (losses) from foreign currency translation

Total comprehensive income

Total comprehensive income (loss)

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 5

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share amounts)

THREE MONTHS ENDED

Stockholders’

Comprehensive

TREASURY STOCK

Income (Loss)

Balances—August 1, 2020

Stock-based compensation

Vested and delivered restricted stock units

Exercise of stock options

Retirement of treasury stock

Shares issued in connection with warrant agreements

Net gains from foreign currency translation

Balances—October 31, 2020

Balances—August 3, 2019

Stock-based compensation

Vested and delivered restricted stock

Exercise of stock options

Shares issued in connection with warrant agreements

Equity component value of convertible note issuance—net

Issuance of warrants

Purchase of convertible note hedge

Net gains from foreign currency translation

Balances—November 2, 2019

Nine Months Ended

Stockholders’

COMPREHENSIVE

Treasury Stock

STOCKHOLDERS'

INCOME (LOSS)

Balances—February 1, 2020

Balances—January 30, 2021

Stock-based compensation

Issuance of restricted stock

Vested and delivered restricted stock units

Exercise of stock options

Repurchases of common stock

Retirement of treasury stock

Shares issued in connection with warrant agreements

Settlement of convertible senior notes

( 1,131,645 )

Exercise of call option under bond hedge upon settlement of convertible senior notes

( 1,131,662 )

Net gains from foreign currency translation

Balances—October 31, 2020

Balances—May 1, 2021

Balances—February 1, 2020

Stock-based compensation

Issuance of restricted stock

Vested and delivered restricted stock units

1 unchanged sentence

Repurchases of common stock

( 2,167,396 )

Retirement of treasury stock

( 2,170,154 )

Shares issued in connection with warrant agreements

Equity component of the convertible notes issuance—net

Issuance of warrants

Purchase of convertible note hedges

Conversion of convertible senior notes

Net losses from foreign currency translation

Balances—November 2, 2019

Balances—May 2, 2020

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 6

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Nine Months Ended

(In thousands) (Unaudited)

THREE MONTHS ENDED

CASH FLOWS FROM OPERATING ACTIVITIES

Adjustments to reconcile net income to net cash provided by operating activities:

Net income (loss)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

Depreciation and amortization

2 unchanged sentences

Asset impairments

(Gain) loss on sale leaseback transaction

Amortization of debt discount

3 unchanged sentences

Product recalls

Deferred income taxes

(Gain) loss on extinguishment of debt—net

Loss on extinguishment of debt

Share of equity method investments losses

Other non-cash items

9 unchanged sentences

Other non-current obligations

Net cash provided by operating activities

Net cash provided by (used in) operating activities

FINANCIAL INFORMATION

2020 FIRST QUARTER FORM 10-Q | 7

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(In thousands) (Unaudited)

THREE MONTHS ENDED

CASH FLOWS FROM INVESTING ACTIVITIES

Capital expenditures

Acquisition of business

Investments in joint ventures

Proceeds from sale of assets

Deposit on asset under construction

Equity method investments

Net cash used in investing activities

2 unchanged sentences

Repayments under asset based credit facility

Borrowings under term loans

Repayments under term loans

Borrowings under promissory and equipment security notes

Repayments under promissory and equipment security notes

Debt issuance costs

Proceeds from issuance of convertible senior notes

Proceeds from issuance of warrants

Purchase of convertible note hedges

Debt issuance costs related to convertible senior notes

Repayments of convertible senior notes

Principal payments under finance leases

Repurchases of common stock—including commissions

Proceeds from exercise of stock options

Tax withholdings related to issuance of stock-based awards

Payments under promissory notes related to share repurchases

Net cash used in financing activities

Net cash provided by (used in) financing activities

Effects of foreign currency exchange rate translation

Net increase in cash and cash equivalents and restricted cash equivalents

Net increase (decrease) in cash and cash equivalents and restricted cash equivalents

Cash and cash equivalents and restricted cash equivalents

Beginning of period—cash and cash equivalents

Beginning of period—restricted cash equivalents (acquisition related escrow deposits)

Beginning of period—cash and cash equivalents

End of period—cash and cash equivalents

4 unchanged sentences

Landlord asset additions in accounts payable and accrued expenses at period-end

Reclassification of assets from landlord assets under construction to finance lease right-of-use assets

Shares issued on settlement of convertible senior notes

1 unchanged sentence

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 8

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1 unchanged sentence

Nature of Business

RH, a Delaware corporation, together with its subsidiaries (collectively, “we,” “us,” or the “Company”), is a luxury home furnishings retailer that offers a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings.

These products are sold through our stores, catalogs and websites.

As of October 31, 2020, we operated a total of 68 RH Galleries and 38 RH outlet stores in 31 states, the District of Columbia and Canada, as well as 14 Waterworks showrooms throughout the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.

RH, a Delaware corporation, together with its subsidiaries (collectively, “we,” “us,” “our” or the “Company”), is a leading luxury retailer in the home furnishings market that offers merchandise assortments across a number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings.

These products are sold through our retail locations, websites and Source Books.

As of May 1, 2021, we operated a total of 68 RH Galleries and 38 RH outlet stores in 30 states, the District of Columbia and Canada, as well as 14 Waterworks Showrooms throughout the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared from our records and, in our opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state our financial position as of October 31, 2020, and the results of operations for the three and nine months ended October 31, 2020 and November 2, 2019.

The accompanying unaudited interim condensed consolidated financial statements have been prepared from the Company’s records and, in our senior leadership team’s opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state our financial position as of May 1, 2021, and the results of operations for the three months ended May 1, 2021, and May 2, 2020.

Our current fiscal year, which consists of 52 weeks, ends on January 29, 2022 (“fiscal 2021”).

Certain information and disclosures normally included in the notes to annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted for purposes of these interim condensed consolidated financial statements.

The preparation of our condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.

The preparation of our condensed consolidated financial statements in conformity with GAAP requires our senior leadership team to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.

Actual results could differ from those estimates and such differences could be material to the condensed consolidated financial statements.

We have assessed various accounting estimates and other matters, including those that require consideration of forecasted financial information, in context of the unknown future impacts of the novel coronavirus disease (“COVID-19”) using information that is reasonably available to us at this time.

We have assessed various accounting estimates and other matters, including those that require consideration of forecasted financial information, in context of the unknown future impacts of the novel coronavirus disease (“COVID-19” or “the pandemic”) using information that is reasonably available to us at this time.

The accounting estimates and other matters we have assessed include, but were not limited to, sales return reserve, inventory reserve, allowance for doubtful accounts, goodwill, intangible and other long-lived assets.

Our current assessment of these estimates are included in our condensed consolidated financial statements as of and for the three and nine months ended October 31, 2020 and November 2, 2019.

Our current assessment of these estimates is included in our condensed consolidated financial statements as of and for the three months ended May 1, 2021.

As additional information becomes available to us, our future assessment of these estimates, including our expectations at the time regarding the duration, scope and severity of the pandemic, as well as other factors, could materially and adversely impact our condensed consolidated financial statements in future reporting periods.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020 (the “2019 Form 10-K”).

The results of operations for the three and nine months ended October 31, 2020 and November 2, 2019 presented herein are not necessarily indicative of the results to be expected for the full fiscal year or future time periods.

The results of operations for the three months ended May 1, 2021, presented herein are not necessarily indicative of the results to be expected for the full fiscal year.

Our business, like the businesses of retailers generally, is subject to uncertainty surrounding the financial impact of the novel coronavirus disease as discussed in Recent Developments—COVID-19 below.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 9

Recent Developments—COVID-19

The initial wave of the COVID-19 outbreak starting in March 2020 caused disruption to our business operations as we temporarily closed all of our retail locations on March 17, 2020.

While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, during the second fiscal quarter we had reopened substantially all of our retail locations.

As of the end of the third fiscal quarter on October 31, 2020 we had reopened all of our Galleries and Outlets, and 8 out of 10 of our restaurants.

Our business substantially recovered during the second and third fiscal quarters as a result of both the reopening of most of our physical locations and also due to strong consumer demand for our products.

During the time period of October through early December of 2020, there has been a spike in reported COVID-19 cases in various parts of both the U.S.

The recent surge in cases has led to the imposition of increasing levels of restriction on our physical operations with respect to Galleries, Outlets and restaurants.

These limitations include restrictions on the level of occupancy that is permitted in some locations as well as full closure requirements for other locations.

Although we have experienced strong demand for our products in connection with prior closure requirements earlier in this year, our overall demand in specific markets correlates favorably with our customers’ ability to access our Galleries and Outlets.

Accordingly, we do anticipate some negative impact to overall demand in connection the restrictions on our physical locations and the duration and extent of these operational limits cannot be predicted with certainty.

While our business strengthened during the second and third fiscal quarters, the lag in inventory receipts together with dislocations in our supply chain has resulted in some delays in our ability to convert business demand into revenues.

Our global supply chain has not fully recovered from the impact of the COVID-19 dislocation.

In light of the recent increase of virus infections and shelter in place orders which continue to negatively impact our manufacturing partners, we anticipate that our supply chain may not catch up to demand until the second half of 2021.

Despite the strong growth in consumer demand in our business during the second and third fiscal quarters, 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.

While we have continued to serve our customers and operate our business through the ongoing COVID-19 health crisis, there can be no assurance that future events will not have an impact on our business, results of operations or financial condition since the extent and duration of the health crisis remains uncertain.

Future adverse developments in connection with the COVID-19 crisis, including additional waves or resurgences of COVID-19 outbreaks, evolving international, federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, the pace of economic activity in the wake of the COVID-19 crisis, or other similar issues could adversely affect our business, results of operations or financial condition in the future, or our financial results and business performance for the fiscal year ending January 30, 2021 and future time periods.

Although the availability of vaccines and various treatments with respect to COVID-19 can be expected to have an overall positive impact on business conditions in the aggregate over time, the exact timing of these positive developments is uncertain and in the meantime reported cases of COVID-19 have surged in the U.S.

and Canada from October through December 2020 resulting in various adverse operating restrictions on our physical locations.

In our initial response to the COVID-19 health crisis we undertook immediate adjustments to our business operations including temporarily closing retail locations and restaurants, curtailing expenses and delaying investments including scaling back some inventory orders while we assessed the status of our business.

Our approach to the crisis evolved quickly as our business trends substantially improved during the second and third fiscal quarters.

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.

During the second and third fiscal quarters 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 development with respect to COVID-19.

The COVID-19 outbreak in the first quarter of fiscal 2020 caused disruption to our business operations.

In our initial response to the health crisis, we undertook immediate adjustments to our business operations including temporarily closing all of our retail locations and Restaurants, curtailing expenses, and delaying investments including scaling back some inventory orders while we assessed the status of our business.

Our approach to the crisis evolved quickly as our business trends substantially improved during the second through fourth fiscal quarters of fiscal 2020 as a result of both the reopening of most of our retail locations and also strong consumer demand for our products.

Operational restrictions related to the COVID-19 pandemic affecting our Galleries and hospitality locations continued to fluctuate in the first quarter of 2021 based upon changes in local conditions and regulations.

As of June 4, 2021, substantially all of our Galleries, Outlets, and Restaurants were open, although many of our Restaurants and Galleries continue to conduct business with occupancy limitations and other operational restrictions.

Our overall customer demand in specific markets has generally correlated favorably with our customers’ ability to access our Galleries and Outlets.

Although our business has strengthened during the period from the second quarter of fiscal 2020 and continuing into fiscal 2021, consumer spending patterns may shift away from spending on the home and home-related categories, such as home furnishings, as pandemic restrictions are lifted and consumers return to pre-COVID consumption trends, such as spending on travel and leisure and other activities.

In addition, various constraints in our merchandise supply chain have resulted in some delays in our ability to convert business demand into revenues at normal historical rates.

We anticipate that the backlog of orders for merchandise from our vendors, coupled with business conditions related to the pandemic, will continue to adversely affect the capacity of our vendors and supply chain to meet our merchandise demand levels during fiscal 2021.

It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand and as a result the exact timing cannot be accurately predicted due to ongoing uncertainty of the continuing impact of the pandemic on our global supply chain.

In particular, business circumstances and operational conditions in numerous international locations where our vendors operate are subject to ongoing risks, and regions in which our vendors have production facilities, such as India, have experienced various spikes in cases related to the pandemic.

As a result, the pandemic may continue to adversely affect business operations in these jurisdictions, which could, in turn, have a negative impact on our vendors and therefore on our business as well, as including our ability to source products.

We will continue to closely manage our 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 including further developments with respect to the pandemic.

For more information, refer to the section entitled “Risk Factors” in our 2020 Form 10-K.

NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS

Cloud Computing

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-15—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40):

Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which amends ASU 2015-05—Customers Accounting for Fees in a Cloud Computing Agreement .

The amendments in this ASU more closely align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license).

We adopted the ASU as of February 2, 2020 using a prospective method.

We capitalize implementation costs related to hosted arrangements, which typically include three-year service terms with additional renewal periods generally ranging from one to three years .

The related assets are recorded within other non-current assets on our condensed consolidated balance sheets, net of accumulated amortization for assets placed in service.

The amortization of assets placed in service is recorded in either cost of goods sold or selling, general and administrative expenses, consistent with the costs of the hosting arrangement, on the condensed consolidated statements of income on a straight-line basis over the term of the hosting arrangement, which includes reasonably certain renewal periods.

The adoption of the ASU did not have a material effect on our condensed consolidated financial statements.

Refer to Note 3— Prepaid Expense and Other Assets .

Current Expected Credit Losses

In June 2016, the FASB issued ASU 2016-13—Financial Instruments—Credit Losses:

Measurement of Credit Losses on Financial Instruments and also issued subsequent amendments to the initial guidance through ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, ASU 2020-02 and ASU 2020-03 (collectively, the “ASUs”).

The ASUs amend the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology to result in more timely recognition of losses.

The guidance in the ASUs applies to financial assets measured at amortized cost basis, such as receivables that result from revenue transactions.

Accounts receivable consist primarily of receivables from our credit card processors for sales transactions, receivables related to our contract business and other miscellaneous receivables.

Accounts receivable is presented net of allowance for doubtful accounts as a result of the assessment of the collectability of customer accounts, which is recorded by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay.

The allowance for doubtful accounts was $ 3.3 million and $ 2.2 million as of October 31, 2020 and February 1, 2020, respectively.

We adopted the ASUs as of February 2, 2020 using a modified retrospective transition method, which requires a cumulative-effect adjustment, if any, to the opening balance of retained earnings.

We did not recognize a cumulative-effect adjustment upon adoption as the adoption of the ASUs did not have a material effect on our condensed consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12—Income Taxes (Topic 740):

New Accounting Standards or Updates Adopted

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12—Income Taxes (Topic 740):

Simplifying the Accounting for Income Taxes .

1 unchanged sentence

The guidance in this ASU becomes effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020.

We will adopt this standard in the first quarter of fiscal 2021 and we do not expect the adoption of the new accounting standard to have a material impact on our consolidated financial statements.

We adopted this standard in the first quarter of fiscal 2021 and the adoption did not have an impact on our condensed consolidated financial statements.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 10

New Accounting Standards or Updates Not Yet Adopted

Convertible Instruments and Contracts in an Entity’s Own Equity

6 unchanged sentences

The guidance in this ASU can be adopted using either a full or modified retrospective approach and becomes effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021.

We are currently evaluating the effects that the adoption of this ASU will have on our consolidated financial statements, including the timing and adoption approach.

We will adopt the ASU in the first quarter of fiscal 2022, and we are evaluating the effects that the adoption of this ASU will have on our condensed consolidated financial statements, including the adoption approach.

NOTE 3—PREPAID EXPENSE AND OTHER ASSETS

1 unchanged sentence

Prepaid expense and other current assets

Promissory note receivable, including interest

Capitalized catalog costs

Promissory notes receivable, including interest (1)

Vendor deposits

Acquisition related escrow deposits

Right of return asset for merchandise

Acquisition related escrow deposits

Total prepaid expense and other current assets

(1) Represents promissory notes, including principal and accrued interest, due from a related party.

Refer to Note 5— Equity Method Investments .

Other non-current assets consist of the following ( in thousands ):

Landlord assets under construction

Deposits on asset under construction

Investments in joint ventures (Note 5)

Promissory note receivable, including interest

Landlord assets under construction—net of tenant allowances

Initial direct costs prior to lease commencement

Capitalized cloud computing costs—net (1)

4 unchanged sentences

Total other non-current assets

NOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND DOMAIN NAMES

The following sets forth the goodwill, tradenames, trademarks and domain names activity for the RH Segment and Waterworks (See Note 17— Segment Reporting ), for the nine months ended October 31, 2020 ( in thousands ):

Impairment (1)

Tradenames, trademarks and domain names

(1) Presented net of accumulated amortization of $ 1.1 million and $ 0.5 million as of May 1, 2021 and January 30, 2021, respectively.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 11

NOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND OTHER INTANGIBLE ASSETS

The following sets forth the goodwill, tradenames, trademarks and other intangible assets activity for the RH Segment and Waterworks (See Note 17— Segment Reporting ), for the three months ended May 1, 2021 (in thousands) :

Tradenames, trademarks and other intangible assets

Waterworks (1)

1 unchanged sentence

(1) Waterworks reporting unit goodwill of $ 51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $ 17.4 million and $ 33.7 million of impairment recorded in fiscal 2018 and fiscal 2017, respectively.

(2) Presented net of an impairment charge of $ 35.1 million, with $ 20.5 million recorded in the first quarter of fiscal 2020 and $ 14.6 million recorded in fiscal 2018.

Acquisition of Goodwill and Tradename

On August 28, 2020, we acquired a furniture business in North America, for total consideration of $ 15.0 million, of which $ 4.8 million was allocated to tradename and $ 10.9 million was allocated to goodwill as a part of the purchase price allocation.

Refer to Note 18— Business Combination .

(2) Presented net of an impairment charge of $ 35.1 million, with $ 20.5 million and $ 14.6 million recorded in fiscal 2020 and fiscal 2018, respectively.

Waterworks Tradename Impairment

3 unchanged sentences

Significant assumptions under this method include forecasted net revenues and the estimated royalty rate, expressed as a percentage of revenues, in addition to the discount rate based on the weighted-average cost of capital.

Based on the impairment test performed, we concluded that the Waterworks reporting unit tradename was impaired as of the first quarter of fiscal 2020.

As a result, we recognized a $ 20.5 million non-cash impairment charge for the Waterworks reporting unit tradename during the first quarter of fiscal 2020, and the carrying value of the Waterworks indefinite-lived tradename asset after the impairment charge was $ 17.0 million.

NOTE 5—INVESTMENTS IN JOINT VENTURES

During the second quarter of fiscal 2020, we entered into transactions whereby we became a 50 percent member of two privately held limited liability companies (the “JVs”) that each have the purpose of acquiring, constructing, developing and ultimately selling certain specified real estate projects.

The JVs are financed by capital contributions from the members on an as-needed basis, as well as via third-party debt secured by the underlying real estate projects and guaranteed by a member other than us.

The JVs are considered variable interest entities because the equity investment at risk is not sufficient to permit the JVs to finance their activities without additional financial support.

A variable interest entity is consolidated by its primary beneficiary, which is defined as the party who has a controlling financial interest in the variable interest entity.

As we do not have a controlling financial interest in the JVs but have the ability to exercise significant influence over the operating and financial policies of the JVs, we recognized these investments using the equity method.

As of October 31, 2020, we had $ 7.5 million of investments in the JVs, which is included in other non-current assets on the condensed consolidated balance sheets.

Our proportional share of the JVs operations for the three and nine months ended October 31, 2020 was not material.

Based on the impairment test performed, we concluded that the Waterworks reporting unit tradename was impaired as of May 2, 2020.

As a result, we recognized a $ 20.5 million non-cash impairment charge for the Waterworks reporting unit tradename during the three months ended May 2, 2020 .

NOTE 5—EQUITY METHOD INVESTMENTS

Equity method investments represent our 50 percent membership interests in three privately-held limited liability companies in Aspen (each, an “Aspen LLC” and collectively, the “Aspen LLCs” or the “equity method investments”) which were formed during fiscal 2020, and have the purpose of acquiring, developing, operating and selling certain real estate projects in Aspen, Colorado.

As we do not have a controlling financial interest in the Aspen LLCs but have the ability to exercise significant influence over the Aspen LLCs, we account for these investments using the equity method of accounting.

During the three months ended May 1, 2021, we recorded our proportionate share of equity method investments losses of $ 2.1 million, which is included in the condensed consolidated statements of operations and a corresponding decrease to the carrying value of equity method investments on the condensed consolidated balance sheets as of May 1, 2021.

As of May 1, 2021, $ 13.8 million of promissory notes receivable are outstanding with the managing member, which are included in prepaid expense and other current assets on the condensed consolidated balance sheets.

These promissory notes are expected to be settled in cash and not converted into additional equity investment in the Aspen LLCs.

An affiliate of the managing member of the Aspen LLCs became the landlord of an additional RH Design Gallery in the first quarter of fiscal 2021.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 12

NOTE 6—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

5 unchanged sentences

Accrued occupancy

Deferred consideration for asset purchase

Accrued professional fees

Accrued catalog costs

Accrued professional fees

Deferred consideration for asset purchase

Other accrued expenses

1 unchanged sentence

Other current liabilities consist of the following ( in thousands ):

Promissory notes on asset under construction

Federal and state taxes payable

Current portion of equipment promissory notes

Allowance for sales returns

Current portion of equipment promissory notes

Unredeemed gift card and merchandise credit liability

5 unchanged sentences

We defer revenue associated with merchandise delivered via the home-delivery channel.

We expect that substantially all of the deferred revenue, customer deposits and deferred membership fees as of October 31, 2020 will be recognized within the next six months (with the exception of cancelled orders) as the performance obligations are satisfied.

In addition, we defer revenue when cash payments are received in advance of performance for unsatisfied obligations related to our gift cards and merchandise credits.

During the three months ended October 31, 2020 and November 2, 2019, we recognized $ 5.6 million and $ 5.1 million, respectively, of revenue related to previous deferrals related to our gift cards and merchandise credits.

During the nine months ended October 31, 2020 and November 2, 2019, we recognized $ 16.2 million and $ 14.4 million, respectively, of revenue related to previous deferrals related to our gift cards and merchandise credits.

During the three months ended October 31, 2020 and November 2, 2019, we recorded gift card breakage of $ 0.2 million and $ 0.5 million, respectively.

During the nine months ended October 31, 2020 and November 2, 2019, we recorded gift card breakage of $ 1.0 million and $ 1.3 million, respectively.

We expect that approximately 70 % of the remaining gift card and merchandise credit liabilities as of October 31, 2020 will be recognized within the next twelve months as the gift cards are redeemed by customers.

We expect that substantially all of the deferred revenue and customer deposits as of May 1, 2021 will be recognized within the next six months as the performance obligations are satisfied.

New membership fees are recorded as deferred revenue when collected from customers and recognized as revenue based on expected product revenues over the annual membership period, based on historical trends of sales to members.

Membership renewal fees are recorded as deferred revenue when collected from customers and are recognized as revenue on a straight-line basis over the membership period, or one year .

In addition, we defer revenue when cash payments are received in advance of performance for unsatisfied obligations related to our gift cards.

During the three months ended May 1, 2021 and May 2, 2020, we recognized $ 4.9 million and $ 4.1 million, respectively, of revenue related to previous deferrals related to our gift cards .

During the three months ended May 1, 2021 and May 2, 2020, we recognized gift card breakage of $ 0.4 million and $ 0.6 million, respectively.

We expect that approximately 75 % of the remaining gift card liabilities as of May 1, 2021 will be recognized when the gift cards are redeemed by customers.

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NOTE 7—OTHER NON-CURRENT OBLIGATIONS

Other non-current obligations consist of the following ( in thousands ):

Notes payable for share repurchases

Deferred payroll taxes

Rollover units and profit interests (1)

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THREE MONTHS ENDED

Nine Months Ended

Operating lease cost (1)

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Total lease costs—net

(1) Operating lease costs and amortization of finance lease right-of-use assets are included in cost of goods sold or selling, general and administrative expenses on the condensed consolidated statements of income based on our accounting policy.

Refer to Note 3— Significant Accounting Policies in the 2020 Form 10-K.

(2) Included in interest expense—net on the condensed consolidated statements of income.

(3) Represents variable lease payments under operating and finance lease agreements, primarily associated with contingent rent based on a percentage of retail sales over contractual levels of $ 4.0 million for both the three months ended October 31, 2020 and November 2, 2019, respectively, and $ 8.3 million and $ 10.8 million for the nine months ended October 31, 2020 and November 2, 2019, respectively.

Other variable costs include single lease cost related to variable lease payments based on an index or rate that were not included in the measurement of the initial lease liability and right-of-use asset were not material for the periods reported.

(4) Included in selling, general and administrative expenses on the condensed consolidated statements of income.

(2) Included in interest expense—net on the condensed consolidated statements of operations.

(3) Represents variable lease payments under operating and finance lease agreements.

The amounts primarily represent contingent rent based on a percentage of retail sales over contractual levels of $ 6.3 million and $ 2.0 million for the three months ended May 1, 2021 and May 2, 2020, respectively, as well as charges associated with common area maintenance of $ 2.1 million and $ 1.6 million for the three months ended May 1, 2021 and May 2, 2020, respectively.

(4) Included in selling, general and administrative expenses on the condensed consolidated statements of operations.

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Lease right-of-use assets and lease liabilities consist of the following ( in thousands ):

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(1) Finance lease right-of-use assets include capitalized amounts related to our completed construction activities to design and build leased assets, which are reclassified from other non-current assets upon lease commencement.

(2) Finance lease right-of-use assets are recorded net of accumulated amortization of $ 122.5 million and $ 92.3 million as of October 31, 2020 and February 1, 2020, respectively.

(2) Finance lease right-of-use assets are recorded net of accumulated amortization of $ 144.0 million and $ 133.0 million as of May 1, 2021 and January 30, 2021, respectively.

(3) Current portion of lease liabilities represents the reduction of the related lease liability over the next 12 months.

The maturities of lease liabilities are as follows as of October 31, 2020 ( in thousands ):

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The maturities of lease liabilities are as follows as of May 1, 2021 ( in thousands ):

Remainder of fiscal 2021

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(1) Total lease payments include future obligations for renewal options that are reasonably certain to be exercised and are included in the measurement of the lease liability.

Total lease payments exclude $ 651.8 million of legally binding payments under the non-cancellable term for leases signed but not yet commenced as of October 31, 2020.

(2) Excludes future commitments under short-term lease agreements of $ 1.4 million as of October 31, 2020.

(3) Calculated using the incremental borrowing rate for each lease at lease commencement.

Total lease payments exclude $ 667.4 million of legally binding payments under the non-cancellable term for leases signed but not yet commenced under our accounting policy as of May 1, 2021, of which $ 24.1 million, $ 32.5 million, $ 37.3 million, $ 38.7 million, $ 40.0 million and $ 39.8 million will be paid in fiscal 2021, fiscal 2022, fiscal 2023, fiscal 2024, fiscal 2025 and fiscal 2026, respectively, and $ 455.0 million will be paid subsequent to fiscal 2026.

(2) Excludes future commitments under short-term lease agreements of $ 1.8 million as of May 1, 2021.

(3) Calculated using the discount rate for each lease at lease commencement.

Supplemental information related to leases consists of the following:

Nine Months Ended

THREE MONTHS ENDED

Weighted-average remaining lease term (years)

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Finance leases

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Other information related to leases consists of the following (in thousands):

Nine Months Ended

THREE MONTHS ENDED

Cash paid for amounts included in the measurement of lease liabilities

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Finance leases

Sale-Leaseback Transaction

During the second quarter of fiscal 2020, we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $ 25.5 million, which qualified for sale-leaseback accounting in accordance with ASC 842.

Concurrently with the sale, we entered into an operating leaseback arrangement with an initial lease term of 20 years and a renewal option for an additional 10 years .

We recognized a loss related to the execution of the sale transaction of $ 9.4 million in the second quarter of fiscal 2020, which was recorded in selling, general and administrative expenses on the condensed consolidated statements of income.

During the third quarter of fiscal 2019, we executed a sale-leaseback transaction for the Yountville Design Gallery for sales proceeds of $ 23.5 million, which qualified for sale-leaseback accounting in accordance with ASC 842.

Concurrently with the sale, we entered into an operating leaseback arrangement with an initial lease term of 15 years and renewal options for up to an additional 30 years .

We recognized a gain related to the execution of the sale transaction of $ 1.2 million in the third quarter of fiscal 2019, which was recorded in selling, general and administrative expenses on the condensed consolidated statements of income.

Long-lived Asset Impairment

During the first quarter of fiscal 2020, we recognized long-lived asset impairment charges of $ 3.5 million related to one RH Baby & Child Gallery and one Waterworks showroom, comprised of lease right-of-use asset impairment of $ 2.0 million and property and equipment impairment of $ 1.5 million.

During the three months ended May 2, 2020, we recognized long-lived asset impairment charges of $ 3.5 million related to one RH Baby & Child and TEEN Gallery and one Waterworks showroom, comprised of lease right-of-use asset impairment of $ 2.0 million and property and equipment impairment of $ 1.5 million.

NOTE 9—CONVERTIBLE SENIOR NOTES

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In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the 2024 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2024 Notes in connection with such make-whole fundamental change.

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Prior to June 15, 2024 , the 2024 Notes are convertible only under the following circumstances:

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or (3) upon the occurrence of specified corporate transactions.

The first condition was satisfied during the calendar quarter ended September 30, 2020 and, accordingly, holders are eligible to convert their 2024 Notes during the calendar quarter ending December 31, 2020.

The first condition was satisfied from the calendar quarter ended September 30, 2020 through the calendar quarter ended March 31, 2021 and, accordingly, holders were eligible to convert their 2024 Notes beginning in the calendar quarter ended December 31, 2020 and are currently eligible to convert their 2024 Notes during the calendar quarter ending June 30, 2021.

On and after June 15, 2024 , until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2024 Notes at any time, regardless of the foregoing circumstances.

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Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2024 balance on the condensed consolidated balance sheets.

During the three months ended October 31, 2020 and November 2, 2019, we recorded $ 0.2 million and $ 0.1 million related to the amortization of debt issuance costs related to the 2024 Notes, respectively.

During the nine months ended October 31, 2020 and November 2, 2019, we recorded $ 0.5 million and $ 0.1 million related to the amortization of debt issuance costs related to the 2024 Notes, respectively.

The carrying value of the 2024 Notes, excluding the discounts upon original issuance and third party offering costs, is as follows ( in thousands ):

During both the three months ended May 1, 2021 and May 2, 2020, we recorded $ 0.2 million related to the amortization of debt issuance costs.

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The carrying values of the 2024 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows ( in thousands ):

Liability component

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(1) Included in additional paid-in capital on the condensed consolidated balance sheets.

We recorded interest expense of $ 4.0 million and $ 1.8 million for the amortization of the debt discount related to the 2024 Notes during the three months ended October 31, 2020 and November 2, 2019, respectively.

We recorded interest expense of $ 11.8 million and $ 1.8 million for the amortization of the debt discount related to the 2024 Notes during the nine months ended October 31, 2020 and November 2, 2019, respectively.

We recorded interest expense of $ 4.1 million and $ 3.9 million for the amortization of the debt discount related to the 2024 Notes during the three months ended May 1, 2021 and May 2, 2020, respectively.

2024 Notes—Convertible Bond Hedge and Warrant Transactions

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We received approximately $ 50.2 million in cash proceeds from the sale of these warrants.

Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings

dilution from the conversion of the 2024 Notes until our common stock is above approximately $ 338.24 per share.

Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately $ 338.24 per share.

As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period.

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The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.

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$ 335 million 0.00 % Convertible Senior Notes due 2023

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or (3) upon the occurrence of specified corporate transactions.

The first condition was satisfied during the calendar quarter ended September 30, 2020 and, accordingly, holders are eligible to convert their 2023 Notes during the calendar quarter ending December 31, 2020.

The first condition was satisfied from the calendar quarter ended September 30, 2020 through the calendar quarter ended March 31, 2021 and, accordingly, holders were eligible to convert their 2023 Notes beginning in the calendar quarter ended December 31, 2020 and are currently eligible to convert their 2023 Notes during the calendar quarter ending June 30, 2021.

On and after March 15, 2023 , until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2023 Notes at any time, regardless of the foregoing circumstances.

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however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require us to purchase all or a portion of their 2023 Notes for cash at a price equal to 100 % of the principal amount of the 2023 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

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Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate.

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Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2023 balance on the condensed consolidated balance sheets.

During both the three months ended October 31, 2020 and November 2, 2019, we recorded $ 0.2 million related to the amortization of debt issuance costs.

During both the nine months ended October 31, 2020 and November 2, 2019, we recorded $ 0.7 million related to the amortization of debt issuance costs.

During the three months ended May 1, 2021 and May 2, 2020, we recorded $ 0.3 million and $ 0.2 million, respectively, related to the amortization of debt issuance costs.

In December 2020, holders of $ 2.4 million in aggregate principal amount of the 2023 Notes elected conversion at the option of the noteholders.

During the three months ended May 1, 2021, we paid $ 2.4 million in cash and delivered 7,307 shares of common stock to settle the converted 2023 Notes.

As a result, we recognized a loss on extinguishment of the liability component of $ 0.1 million in the three months ended May 1, 2021.

We also received 7,305 shares of common stock from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2023 Notes as described below, and therefore, on a net basis issued 2 shares of our common stock in respect to such settlement of the converted 2023 Notes.

In May 2021, holders of $ 30.8 million in aggregate principal amount of the 2023 Notes elected conversion at the option of the noteholders.

During the second quarter of fiscal 2021, we expect to pay $ 30.8 million in cash and to deliver an immaterial number of shares of common stock to settle the converted 2023 Notes, net of the shares of common stock we expect to receive from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2023 Notes as described below.

The carrying values of the 2023 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows ( in thousands ):

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(1) Included in additional paid-in capital on the condensed consolidated balance sheets.

We recorded interest expense of $ 4.4 million and $ 4.1 million for the amortization of the debt discount related to the 2023 Notes during the three months ended October 31, 2020 and November 2, 2019, respectively.

We recorded interest expense of $ 13.1 million and $ 12.3 million for the amortization of the debt discount related to the 2023 Notes during the nine months ended October 31, 2020 and November 2, 2019, respectively.

We recorded interest expense of $ 4.6 million and $ 4.3 million for the amortization of the debt discount related to the 2023 Notes during the three months ended May 1, 2021 and May 2, 2020, respectively.

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2023 Notes—Convertible Bond Hedge and Warrant Transactions

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In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.730 million shares of our common stock at a price of $ 309.84 per share.

The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under

such warrants may be increased up to a cap of approximately 3.5 million shares of common stock (which cap may also be subject to adjustment).

The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 3.5 million shares of common stock (which cap may also be subject to adjustment).

We received approximately $ 51.0 million in cash proceeds from the sale of these warrants.

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The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.

$ 300 million 0.00 % Convertible Senior Notes due 2020

In June 2015 , we issued in a private offering $ 250 million principal amount of 0.00 % convertible senior notes due 2020 and, in July 2015 , we issued an additional $ 50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of our June 2015 offering (collectively, the “2020 Notes”).

The 2020 Notes were governed by the terms of an indenture between the Company and U.S.

Bank National Association, as the Trustee.

The 2020 Notes did not bear interest, except that the 2020 Notes were subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2020 Notes.

The 2020 Notes were unsecured obligations and did not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries.

Certain events were also considered “events of default” under the 2020 Notes, which could have resulted in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes.

The 2020 Notes were guaranteed by our primary operating subsidiary, Restoration Hardware, Inc., as Guarantor.

The 2020 Notes matured on July 15, 2020 .

The initial conversion rate applicable to the 2020 Notes was 8.4656 shares of common stock per $ 1,000 principal amount of 2020 Notes, which was equivalent to an initial conversion price of approximately $ 118.13 per share.

The conversion rate was subject to adjustment upon the occurrence of certain specified events, but was not adjusted for any accrued and unpaid special interest.

In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture governing the 2020 Notes, we would, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elected to convert its 2020 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2020 , the 2020 Notes were convertible only under the following circumstances:

(1) during any calendar quarter commencing after September 30, 2015, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130 % of the applicable conversion price on such trading day;

(2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $ 1,000 principal amount of 2020 Notes for such trading day was less than 98 % of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day;

or (3) upon the occurrence of specified corporate transactions.

The first condition was satisfied during the calendar quarter ended December 31, 2019 and, accordingly, holders were eligible to convert their 2020 Notes during the calendar quarter ending March 31, 2020.

In addition, on and after March 15, 2020 , until the close of business on the second scheduled trading day immediately preceding the maturity date, holders could convert all or a portion of their 2020 Notes at any time.

Accordingly, in accounting for the issuance of the 2020 Notes, we separated the 2020 Notes into liability and equity components.

The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature.

The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the liability component of the 2020 Notes.

The debt discount was amortized to interest expense using an effective interest rate of 6.47 % over the expected life of the 2020 Notes.

The equity component was not remeasured as it continued to meet the conditions for equity classification.

Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $ 3.8 million and third party offering costs of $ 2.3 million.

In accounting for the debt issuance costs related to the issuance of the 2020 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values.

Debt issuance costs attributable to the liability component were amortized to interest expense using the effective interest method over the expected life of the 2020 Notes, and debt issuance costs attributable to the equity component were netted with the equity component in stockholders’ equity.

Discounts and third party offering costs attributable to the liability component were recorded as a contra-liability and were presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets.

We did no t record amortization of debt issuance costs related to the 2020 Notes during the three months ended October 31, 2020.

During the three months ended November 2, 2019, we recorded $ 0.3 million related to the amortization of debt issuance costs.

During the nine months ended October 31, 2020 and November 2, 2019, we recorded $ 0.6 million and $ 0.9 million related to the amortization of debt issuance costs, respectively.

In May 2020, $ 9.4 million in aggregate principal amount of 2020 Notes were converted at the option of the noteholders.

We paid $ 9.2 million in cash and delivered 14,927 shares of common stock to settle the converted 2020 Notes.

As a result, we recognized a gain on extinguishment of the liability component of $ 0.2 million in the second quarter of fiscal 2020.

We also received 14,927 shares of common stock from the exercise of a portion of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes as described below, and therefore, on a net basis did no t issue any shares of our common stock in respect to such settlement of the 2020 Notes.

In July 2020, upon the maturity of the 2020 Notes, the remaining $ 290.6 million in aggregate principal amount of the 2020 Notes were converted at the option of the noteholders.

We paid $ 290.6 million in cash and delivered 1,116,718 shares of common stock to settle the converted 2020 Notes.

No gain or loss arose on extinguishment of the liability component.

We also received 1,116,735 shares of common stock from the exercise of the remainder of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes as described below, and therefore, on a net basis received 17 shares of our common stock (which were recorded as treasury stock within the condensed consolidated statements of stockholders’ equity) in respect to such settlement of the 2020 Notes.

As of October 31, 2020, the 2020 Notes are no longer outstanding.

As of February 1, 2020, the carrying values of the 2020 Notes, excluding the discounts upon original issuance and third party offering costs, was as follows ( in thousands ):

Liability component

Debt discount

Net carrying amount

Equity component (1)

(1) Included in additional paid-in capital on the condensed consolidated balance sheets.

We did no t record amortization of the debt discount related to the 2020 Notes during the three months ended October 31, 2020.

We recorded interest expense of $ 4.6 million for the amortization of the debt discount related to the

2020 Notes during the three months ended November 2, 2019.

We recorded interest expense of $ 8.9 million and $ 13.5 million for the amortization of the debt discount related to the 2020 Notes during the nine months ended October 31, 2020 and November 2, 2019.

2020 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment option in July 2015 , we entered into convertible note hedge transactions whereby we had the option to purchase a total of approximately 2.540 million shares of our common stock at a price of approximately $ 118.13 per share.

The total cost of the convertible note hedge transactions was approximately $ 68.3 million.

In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.540 million shares of our common stock at a strike price of $ 189.00 per share (the “2020 warrants”).

The 2020 warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 5.1 million shares of common stock (which cap may also be subject to adjustment).

We received approximately $ 30.4 million in cash proceeds from the sale of the 2020 warrants.

Taken together, the purchase of the convertible note hedges and sale of the warrants were intended to offset any actual earnings dilution from the conversion of the 2020 Notes until our common stock is above approximately $ 189.00 per share.

As these transactions met certain accounting criteria, the convertible note hedges and warrants were recorded in stockholders’ equity, not accounted for as derivatives and not remeasured each reporting period.

The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

As a result of the operation of the bond hedge in connection with the maturity of the 2020 Notes, we were not required to issue any new shares to settle the notes as these shares were delivered to us under the terms of the bond hedge.

The bond hedge was exercised in connection with the maturity date of the 2020 Notes.

During October 2020, we began settling the 2020 warrants by the delivery of net shares on a weekly basis in accordance with the terms of the warrant agreements, and as of October 31, 2020, we had delivered 290,967 shares of common stock upon exercise of the warrants.

We are continuing to deliver shares on a weekly basis in settlement of the 2020 warrants and, as of December 9, 2020, we have delivered an incremental 552,276 shares of common stock in settlement of the 2020 warrants in our fourth fiscal quarter.

The final settlement of the 2020 warrants will continue through December and the first week of January 2021.

The exact number of shares remaining to be delivered will depend on the extent to which the share price of our common stock remains above the exercise price of $ 189.00 per share under the warrants.

We recorded a deferred tax liability of $ 32.8 million in connection with the debt discount associated with the 2020 Notes and recorded a deferred tax asset of $ 26.6 million in connection with the convertible note hedge transactions.

The deferred tax liability and deferred tax asset are recorded in non-current deferred tax assets on the condensed consolidated balance sheets.

There is no deferred tax asset or liability remaining as of October 31, 2020 due to the maturity of the 2020 Notes.

NOTE 10—CREDIT FACILITIES

The outstanding balances under our credit facilities were as follows ( in thousands ):

Unamortized Debt

Issuance Costs

Asset based credit facility (1)

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Total credit facilities

(1) Deferred financing fees associated with the asset based credit facility as of October 31, 2020 and February 1, 2020 were $ 1.8 million and $ 2.6 million, respectively, and are included in other non-current assets on the condensed consolidated balance sheets.

(1) Deferred financing fees associated with the asset based credit facility as of May 1, 2021 and January 30, 2021 were $ 1.3 million and $ 1.5 million, respectively, and are included in other non-current assets on the condensed consolidated balance sheets.

The deferred financing fees are amortized on a straight-line basis over the life of the revolving line of credit, which has a maturity date of June 28, 2022.

(2) Represents total equipment security notes secured by certain of our property and equipment, of which $ 22.5 million outstanding was included in other current liabilities on the condensed consolidated balance sheets.

The remaining $ 20.6 million outstanding, included in other non-current obligations on the condensed consolidated balance sheets, has principal payments due of $ 5.8 million, $ 13.6 million and $ 1.2 million in fiscal 2021, fiscal 2022 and fiscal 2023, respectively.

(2) Represents total equipment security notes secured by certain of our property and equipment, of which $ 28.1 million outstanding was included in other current liabilities on the condensed consolidated balance sheets as of May 1, 2021.

The remaining $ 3.8 million outstanding, included in equipment promissory notes — net on the condensed consolidated balance sheets, has principal payments due of $ 2.6 million and $ 1.2 million in fiscal 2022 and fiscal 2023, respectively.

Asset Based Credit Facility

In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into a credit agreement with Bank of America, N.A., as administrative agent, and certain other lenders (the “Original Credit Agreement”).

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On June 28, 2017 , Restoration Hardware, Inc.

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We repaid the full amount of the FILO term loan as of February 1, 2020.

As a result of the repayment, we incurred a $ 0.8 million loss on extinguishment of debt in fiscal 2019, which represents the acceleration of amortization of debt issuance costs.

We did not incur any prepayment penalties upon the early extinguishment of the FILO term loan.

On May 31, 2019, Restoration Hardware, Inc.

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is required subject to certain exceptions to maintain an FCCR of at least one to one.

As of October 31, 2020, Restoration Hardware, Inc.

As of May 1, 2021, Restoration Hardware, Inc.

was in compliance with all applicable financial covenants of the Credit Agreement.

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The Credit Agreement requires a daily sweep of all cash receipts and collections to prepay the loans under the agreement while (i) an event of default exists or (ii) the availability under the revolving line of credit for extensions of credit is less than the greater of (A) $ 40.0 million and (B) 10 % of the sum of (a) the lesser of (x) the aggregate revolving commitments under the Credit Agreement and (y) the aggregate revolving borrowing base, plus (b) the lesser of (x) the then outstanding amount of the LILO term loan or (y) the LILO term loan borrowing base.

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The occurrence of an event of default, following the applicable cure period, would permit the lenders to, among other things, terminate any existing commitments under the Credit Agreement and declare the unpaid principal, accrued and unpaid interest and all other amounts payable under the Credit Agreement to be immediately due and payable.

As of October 31, 2020, we had no outstanding borrowings under the revolving credit facility portion of the Credit Agreement.

As of May 1, 2021, we had no outstanding borrowings under the revolving credit facility portion of the Credit Agreement.

The availability of credit at any given time under the Credit Agreement is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable.

As a result of the borrowing base formula, actual borrowing availability under the revolving line of credit could be less than the stated amount of the revolving line of credit (as reduced by the actual borrowings and outstanding letters of credit under the revolving line of credit).

Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of October 31, 2020 was $ 316.4 million, net of $ 14.6 million in outstanding letters of credit.

Second Lien Credit Agreement

On April 10, 2019 , Restoration Hardware, Inc., entered into a credit agreement, dated as of April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom were managed or advised by either Benefit Street Partners L.L.C.

and its affiliated investment managers or Apollo Capital Management, L.P.

and its affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to a second lien term loan in an aggregate principal amount equal to $ 200.0 million with a maturity date of April 9, 2024 (the “Second Lien Term Loan”).

The Second Lien Term Loan of $ 200.0 million in principal was repaid in full on September 20, 2019.

The Second Lien Term Loan bore interest at an annual rate generally based on the LIBOR plus 6.50 % .

This rate was a floating rate that reset periodically based upon changes in LIBOR rates during the life of the Second Lien Term Loan.

At the date of the initial borrowing, the rate was set at one-month LIBOR plus 6.50 % .

Intercreditor Agreement

On April 10, 2019, in connection with the Second Lien Credit Agreement, Restoration Hardware, Inc.

entered into an Intercreditor Agreement (the “Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the First Lien Administrative Agent and the Second Lien Administrative Agent.

The Intercreditor Agreement established various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the Credit Agreement and the Second Lien Credit Agreement without the consent of the other party.

The Intercreditor Agreement was terminated upon repayment of the Second Lien Term Loan on September 20, 2019.

Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of May 1, 2021 was $ 285.6 million, net of $ 20.1 million in outstanding letters of credit.

Equipment Loan Facility

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Each equipment loan is secured by a purchase money security interest in the financed equipment.

As of May 1, 2021, the equipment security notes bore interest at a weighted-average rate of 4.56 %.

The maturity dates of the equipment security notes vary, but generally have a maturity of three or four years .

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The inputs used in the determination of fair value require significant management judgment or estimation.

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2021 FIRST QUARTER FORM 10-Q | 24

A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

2 unchanged sentences

The estimated fair value of the asset based credit facility approximates cost as the interest rate associated with the facility is variable and resets frequently.

The estimated fair value and carrying value of the 2020 Notes, 2023 Notes and 2024 Notes were as follows ( in thousands ):

Convertible senior notes due 2020 (2)

The estimated fair value and carrying value of the 2023 Notes and 2024 Notes are as follows ( in thousands ):

Convertible senior notes due 2023

Convertible senior notes due 2024

(1) Carrying value represents the principal amount less the equity component of the 2020 Notes, 2023 Notes and 2024 Notes classified in stockholders’ equity, and does not exclude the discounts upon original issuance, discounts and commissions payable to the initial purchasers and third party offering costs, as applicable.

(2) The 2020 Notes matured on July 15, 2020.

The fair value of each of the 2020 Notes, 2023 Notes and 2024 Notes was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the trading price of our convertible notes, when available, our common stock price and interest rates based on similar debt issued by parties with credit ratings similar to ours (Level 2).

(1) Carrying value represents the principal amount less the equity component of the 2023 Notes and 2024 Notes classified in stockholders’ equity, and does not exclude the discounts upon original issuance, discounts and commissions payable to the initial purchasers and third party offering costs, as applicable.

The fair value of each of the 2023 Notes and 2024 Notes was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the trading price of our convertible notes, when available, our common stock price and interest rates based on similar debt issued by parties with credit ratings similar to ours (Level 2).

Fair Value Measurements—Non-Recurring

The fair value of the Waterworks reporting unit tradename was determined based on unobservable (Level 3) inputs and valuation techniques, as discussed in Note 4— Goodwill, Trademarks, Trademarks and Domain Names and in “Impairment” within Note 3— Significant Accounting Policies in the 2019 Form 10-K.

The fair value of the acquired goodwill and tradename associated with the acquisition as discussed in Note 18— Business Combination was determined based on unobservable (Level 3) inputs and valuation techniques.

The fair value of the acquired goodwill and tradename associated with acquisitions by the RH Segment in fiscal 2020 were determined based on unobservable (Level 3) inputs and valuation techniques.

The fair value of the real estate assets associated with our investment in the Aspen LLCs in fiscal 2020, as discussed in Note 5— Equity Method Investments , were determined based on unobservable (Level 3) inputs and valuation techniques.

NOTE 12—INCOME TAXES

We recorded income tax expense of $ 49.2 million and $ 8.4 million in the three months ended October 31, 2020 and November 2, 2019, respectively.

We recorded income tax expense of $ 66.6 million and $ 36.8 million in the nine months ended October 31, 2020 and November 2, 2019, respectively.

The effective tax rate was 51.4 % and 13.7 % for the three months ended October 31, 2020 and November 2, 2019, respectively.

The effective tax rate was 32.0 % and 19.5 % for the nine months ended October 31, 2020 and November 2, 2019, respectively.

The increase in our effective tax rate for the three months ended October 31, 2020 was significantly impacted by non-deductible stock-based compensation and lower discrete tax benefits related to net excess tax windfalls from stock-based compensation in the three months ended October 31, 2020 as compared to the three months ended November 2, 2019.

The increase in our effective tax rate for the nine months ended October 31, 2020 was significantly impacted by non-deductible stock-based compensation and higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the nine months ended October 31, 2020 as compared to the nine months ended November 2, 2019.

As of October 31, 2020, we had $ 8.3 million of unrecognized tax benefits, of which $ 7.6 million would reduce income tax expense and the effective tax rate, if recognized.

We recorded income tax expense of $ 41.7 million and an income tax benefit of $ 1.4 million in the three months ended May 1, 2021 and May 2, 2020, respectively.

The effective tax rate was 24.2 % and 30.7 % for the three months ended May 1, 2021 and May 2, 2020, respectively.

The decrease in the effective tax rate for the three months ended May 1, 2021 as compared to the three months ended May 2, 2020 is attributable to higher net excess tax benefits from stock-based compensation and income reported in the current period compared to a reported loss in the prior year.

As of May 1, 2021, we had $ 8.6 million of unrecognized tax benefits, of which $ 7.8 million would reduce income tax expense and the effective tax rate, if recognized.

The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized.

As of October 31, 2020, we had $ 6.1 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months .

NOTE 13—NET INCOME PER SHARE

The weighted-average shares used for net income per share are as follows:

As of May 1, 2021, we had $ 6.2 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months .

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2021 FIRST QUARTER FORM 10-Q | 25

NOTE 13—NET INCOME (LOSS) PER SHARE

The weighted-average shares used for net income (loss) per share are presented in the table below.

As we reported a net loss for the three months ended May 2, 2020, the weighted-average shares outstanding for basic and diluted are the same.

THREE MONTHS ENDED

Nine Months Ended

Weighted-average shares—basic

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Weighted-average shares—diluted

(1) The 2020 Notes, 2023 Notes and 2024 Notes have an impact on our dilutive share count beginning at stock prices of $ 118.13 per share, $ 193.65 per share and $ 211.40 per share, respectively.

The 2020 Notes terminated on July 15, 2020 and did not have an impact on our dilutive share count post-termination.

The warrants associated with our 2020 Notes, 2023 Notes and 2024 Notes have an impact on our dilutive share count beginning at stock prices of $ 189.00 per share, $ 309.84 per share and $ 338.24 per share, respectively.

The warrants associated with our 2020 Notes expire through January 2021.

While the share price for our common stock trades above the applicable conversion price of each series of notes or the applicable exercise price of each series of warrants for the 2020 Notes, the 2023 Notes and the 2024 Notes, these instruments will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock continues to exceeds the applicable conversion or exercise price of the notes and warrants.

(1) The $ 300 million aggregate principal amount of convertible senior notes that were issued in June and July 2015 (the “2020 Notes”), the 2023 Notes and the 2024 Notes would have an impact on our dilutive share count beginning at stock prices at or above $ 118.13 per share, $ 193.65 per share and $ 211.40 per share, respectively .

The 2020 Notes matured on July 15, 2020 and did not have an impact on our dilutive share count post-termination.

The warrants associated with our 2020 Notes, 2023 Notes and 2024 Notes have an impact on our dilutive share count beginning at stock prices at or above $ 189.00 per share, $ 309.84 per share and $ 338.24 per share, respectively.

The warrants associated with our 2020 Notes expired on January 7, 2021.

While the share price for our common stock trades above the applicable conversion price of each series of notes or the applicable exercise price of each series of warrants for the notes, these instruments will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock continues to exceed the applicable conversion or exercise price of the notes and warrants.

Refer to Note 9— Convertible Senior Notes .

Dilutive options of 311,242 and 190,766 were excluded from the calculation of diluted net income per share for the three months ended October 31, 2020 and November 2, 2019, respectively, because their inclusion would have been anti-dilutive.

Dilutive options of 451,559 and 457,300 were excluded from the calculation of diluted net income per share for the nine months ended October 31, 2020 and November 2, 2019, respectively, because their inclusion would have been anti-dilutive.

NOTE 14—SHARE REPURCHASES AND SHARE RETIREMENTS

Share Repurchase Program

On October 10, 2018, our Board of Directors authorized a share repurchase program of up to $ 700.0 million, of which $ 250.0 million in share repurchases were completed in fiscal 2018.

The $ 700.0 million authorization amount was replenished by the Board of Directors on March 25, 2019 (as replenished, the “$ 950 Million Repurchase Program”).

We did not make any repurchases under this program during the nine months ended October 31, 2020.

During the nine months ended November 2, 2019, we repurchased approximately 2.2 million shares of our common stock at an average price of $ 115.36 per share, for an aggregate repurchase amount of approximately $ 250.0 million under this share repurchase program.

As of October 31, 2020, there was $ 450.0 million remaining for future share repurchases under this program.

Share Repurchases Under Equity Plans

As of October 31, 2020 and February 1, 2020, the aggregate unpaid principal amount of the notes payable for share repurchases was $ 18.8 million and $ 18.7 million, respectively, which were included in other non-current obligations on the condensed consolidated balance sheets.

During both the three months ended October 31, 2020 and November 2, 2019, we recorded interest expense on the outstanding notes of $ 0.2 million.

During both the nine months ended October 31, 2020 and November 2, 2019, we recorded interest expense on the outstanding notes of $ 0.7 million.

Of the $ 18.8 million and $ 18.7 million notes payable for share repurchases outstanding as of October 31, 2020 and February 1, 2020, $ 15.5 million is related to a promissory note due to a current board member.

Share Retirements

During the nine months ended October 31, 2020, we retired 600 shares of our common stock related to shares we had repurchased under equity plans and we retired 17 shares of our common stock related to shares we received upon the maturity of the 2020 Notes (refer to Note 9— Convertible Senior Notes ).

As a result of the retirements, we reclassified a total of $ 0.1 million from treasury stock to additional paid-in capital on the condensed consolidated balance sheets and on the condensed consolidated statements of stockholders’ equity (deficit) as of October 31, 2020.

During the nine months ended November 2, 2019, we retired 2,170,154 shares of our common stock related to shares we had repurchased under the $ 950 Million Repurchase Program.

As a result of this retirement, we reclassified a total of $ 250.3 million from treasury stock, of which $ 13.2 million was allocated to additional paid-in capital and $ 237.1 million was allocated to retained earnings (accumulated deficit) on the condensed consolidated balance sheets as of February 1, 2020 and on the condensed consolidated statements of stockholders’ equity (deficit) as of November 2, 2019.

The following number of dilutive options, restricted stock units and convertible senior notes were excluded from the calculation of diluted net income (loss) per share because their inclusion would have been anti-dilutive:

THREE MONTHS ENDED

Restricted stock units

Convertible senior notes

Total anti-dilutive stock-based awards

NOTE 14—SHARE REPURCHASE PROGRAM

In 2018, our Board of Directors authorized a share repurchase program.

In fiscal 2018, we repurchased approximately 2.0 million shares of our common stock under this share repurchase program at an average price of $ 122.10 per share, for an aggregate repurchase amount of approximately $ 250.0 million.

In fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under this program at an average price of $ 115.36 per share, for an aggregate repurchase amount of approximately $ 250.0 million.

We did not make any repurchases under this program during either the three months ended May 1, 2021 or May 2, 2020.

The total current authorized size of the share purchase program is up to $ 950 million (the “950 Million Repurchase Program”), of which $ 450.0 million remained available as of May 1, 2021 for future share investments under this share repurchase program.

NOTE 15—STOCK-BASED COMPENSATION

We recorded stock-based compensation expense of $ 118.8 million and $ 5.1 million during the three months ended October 31, 2020 and November 2, 2019, respectively, which is included in selling, general and administrative expenses on the condensed consolidated statements of income.

We recorded stock-based compensation expense of $ 131.5 million and $ 16.1 million during the nine months ended October 31, 2020 and November 2, 2019, respectively.

We recorded stock-based compensation expense of $ 15.3 million and $ 5.8 million during the three months ended May 1, 2021 and May 2, 2020, respectively, which is included in selling, general and administrative expenses on the

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condensed consolidated statements of operations.

No stock-based compensation cost has been capitalized in the accompanying condensed consolidated financial statements.

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Friedman an option to purchase 700,000 shares of our common stock with an exercise price equal to $ 385.30 per share under the 2012 Stock Incentive Plan.

See Note 18— Stock-Based Compensation in the 2020 Form 10-K.

The option contains selling restrictions on the underlying shares that lapse upon the achievement of both time-based service requirements and stock price performance-based metrics as described further below.

The option is fully

vested on the date of grant but the shares underlying the option remain subject to transfer restrictions to the extent the performance-based and time-based requirements have not been met.

The option will result in aggregate non-cash stock compensation expense of $ 173.6 million, of which $ 111.2 million was recognized during the three months ended October 31, 2020 (which is included in the stock-based compensation expense recorded during the three and nine months ended October 31, 2020 noted above).

As of October 31, 2020, the total unrecognized compensation expense was $ 62.4 million, which will be recognized on an accelerated basis through May 2025.

Time-Based Restrictions

The time-based restrictions are measured over a four-year performance year period which will begin in May 2021, on the anniversary of the option granted to Mr.

Friedman in 2017.

The time-based restrictions will lapse at the end of each of the successive anniversary dates from May 2022 through May 2025 at a rate of 175,000 shares per year if (i) Mr.

Friedman remains in service with us at the end of such year with the authority, duties, or responsibilities of a chief executive officer at such date and (ii) the stock price performance-based metrics have been achieved in such year as described further below.

Performance-Based Restrictions

The stock price performance-based restrictions of the option are measured annually over the performance year period and may lapse as to only one -quarter of the option in each of the first four performance years, with the first performance year beginning in May 2021.

The stock price performance-based metrics for the option are set at $ 500 per share, $ 650 per share and $ 800 per share.

With respect to any given performance year, if the “twenty day average trading price” our common stock exceeds $ 500 per share, $ 650 per share, or $ 800 per share during such performance year, then the selling restrictions will lapse as to 58,333 shares, 58,333 share and 58,334 shares, respectively, on the last day of such performance year, if Mr.

Friedman remains in service with us at such date.

Any selling restrictions that have not lapsed in any performance year during the first four performance years may be achieved in a successive performance year through the end of the eighth performance year which ends in May 2029, provided Mr.

Friedman continues to satisfy the service requirement through the date the performance target is achieved.

Any selling restrictions that have not lapsed by the end of the eighth performance year will thereafter only lapse in May 2041, the 20 th anniversary of the beginning of the first performance year.

The option is fully vested on the date of grant but the shares underlying the option remain subject to transfer restrictions to the extent the performance-based and time-based requirements have not been met.

The option will result in aggregate non-cash stock compensation expense of $ 173.6 million, of which $ 5.9 million was recognized during the three months ended May 1, 2021 (which is included in the stock-based compensation expense recorded during the three months ended May 1, 2021 noted above).

As of May 1, 2021, the total unrecognized compensation expense was $ 50.7 million, which will be recognized on an accelerated basis through May 2025.

2012 Stock Incentive Plan and 2012 Stock Option Plan

As of October 31, 2020, 8,535,569 options were outstanding with a weighted-average exercise price of $ 101.78 per share and 6,611,534 options were vested with a weighted-average exercise price of $ 88.89 per share.

The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of October 31, 2020 was $ 2,028.2 million, $ 1,930.3 million, and $ 1,628.7 million, respectively.

Stock options exercisable as of October 31, 2020 had a weighted-average remaining contractual life of 4.2 years.

As of October 31, 2020, the total unrecognized compensation expense related to unvested options was $ 102.9 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 4.83 years.

In addition, as of October 31, 2020, the total unrecognized compensation expense related to the fully vested option grant made to Mr.

As of May 1, 2021, 8,508,074 options were outstanding with a weighted-average exercise price of $ 106.07 per share and 6,780,119 options were vested with a weighted-average exercise price of $ 89.33 per share.

The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of May 1, 2021 was $ 4,951.3 million, $ 4,755.8 million, and $ 4,059.2 million, respectively.

Stock options exercisable as of May 1, 2021 had a weighted-average remaining contractual life of 3.66 years.

As of May 1, 2021, the total unrecognized compensation expense related to unvested options was $ 114.7 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 4.68 years.

In addition, as of May 1, 2021, the total unrecognized compensation expense related to the fully vested option grant made to Mr.

Friedman in October 2020 was $ 50.7 million, which will be recognized on an accelerated basis through May 2025 (refer to Chairman and Chief Executive Officer Option Grant above).

As of October 31, 2020, we had 94,390 restricted stock units outstanding with a weighted-average grant date fair value of $ 45.93 per share.

During the three months ended October 31, 2020, 4,440 restricted stock units vested with a weighted-average grant date fair value of $ 63.07 per share.

During the nine months ended October 31, 2020, 105,015 restricted stock units vested with a weighted-average grant date fair value of $ 52.75 per share and 3,192 restricted stock shares were delivered with a weighted-average grant date fair value of $ 285.03 .

As of October 31, 2020, there was $ 2.8 million of total unrecognized compensation expense related to unvested restricted stock and restricted stock units, which is expected to be recognized over a weighted-average period of 0.94 years.

As of May 1, 2021, we had 89,830 restricted stock units outstanding with a weighted-average grant date fair value of $ 73.51 per share.

During the three months ended May 1, 2021, 4,420 restricted stock units vested with a weighted-average grant date fair value of $ 51.23 per share.

As of May 1, 2021, there was $ 2.8 million of total unrecognized compensation expense related to unvested restricted stock and restricted stock units which is expected to be recognized over a weighted-average period of 0.68 years.

Rollover Units

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The Rollover Units are subject to the terms of the Waterworks LLC agreement, including redemption rights at an amount equal to the greater of (i) the $ 1.5 million remitted as consideration in the business combination or (ii) an amount based on the percentage interest represented in the overall valuation of the Waterworks subsidiary (the “Appreciation Rights”).

The Appreciation Rights are measured at fair value and are subject to fair value measurements during the expected life of the Rollover Units, with changes to fair value recorded in the condensed consolidated statements of income.

The fair value of the Appreciation Rights is determined based on an option-pricing model (“OPM”).

We did not record any expense related to the Appreciation Rights during both the three and nine months ended October 31, 2020 and November 2, 2019.

As of both October 31, 2020 and February 1, 2020, the liability associated with the Rollover Units and related Appreciation Rights was $ 1.5 million, which is included in other non-current obligations on the condensed consolidated balance sheets.

We did not record any expense related to the Appreciation Rights during either the three months ended May 1, 2021 or May 2, 2020.

As of both May 1, 2021 and January 30, 2021, the liability associated with the Rollover Units and related Appreciation Rights was $ 1.5 million, which is included in other non-current obligations on the condensed consolidated balance sheets.

Profit Interests

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The Profit Interests are measured at their grant date fair value and expensed on a straight-line basis over their expected life, or five years .

The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of income.

The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of operations.

The fair value of the Profit Interests is determined based on an OPM.

For both the three months ended October 31, 2020 and November 2, 2019, we recorded $ 0.1 million related to the Profit Interests, which is included in selling, general and administrative expenses on the condensed consolidated statements of income.

For both the nine months ended October 31, 2020 and November 2, 2019, we recorded $ 0.3 million related to the Profit Interests.

As of October 31, 2020 and February 1, 2020, the liability associated with the Profit Interests was $ 1.9 million and $ 1.6 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.

For both the three months ended May 1, 2021 and May 2, 2020, we recorded $ 0.1 million related to the Profit Interests, which is included in selling, general and administrative expenses on the condensed consolidated statements of operations.

As of May 1, 2021 and

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January 30, 2021, the liability associated with the Profit Interests was $ 2.1 million and $ 2.0 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.

NOTE 16—COMMITMENTS AND CONTINGENCIES

We had no material off balance sheet commitments as of October 31, 2020.

We had no material off balance sheet commitments as of May 1, 2021.

Contingencies

We are involved in lawsuits, claims and proceedings incident to the ordinary course of our business.

We are involved in lawsuits, claims, investigations and other legal proceedings incident to the ordinary course of our business.

These disputes are increasing in number as the business expands and we grow larger.

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As a result, the outcome of matters in which we are involved could result in unexpected expenses and liability that could adversely affect our operations.

In addition, any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources.

We review the need for any loss contingency reserves and establishes reserves when, in the opinion of management, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated.

In addition, any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of our senior leadership team’s time and result in the diversion of significant operational resources.

We review the need for any loss contingency reserves and establish reserves when, in the opinion of our senior leadership team, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated.

Generally, in view of the inherent difficulty of predicting the outcome of those matters, particularly in cases in which claimants seek substantial or indeterminate damages, it is not possible to determine whether a liability has been incurred or to reasonably estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no reserve is established until that time.

When and to the extent that we do establish a reserve, there can be no assurance that any such recorded liability for estimated losses will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time.

We believe that the ultimate resolution of our current matters will not have a material adverse effect on our condensed consolidated financial statements.

Securities Class Action

On February 2, 2017, City of Miami General Employees’ & Sanitation Employees’ Retirement Trust filed a class action complaint in the United States District Court, Northern District of California, against the Company, Gary Friedman, and Karen Boone.

On March 16, 2017, Peter J.

Errichiello, Jr.

filed a similar class action complaint in the same forum and against the same parties.

On April 26, 2017, the court consolidated the two actions.

The consolidated action is captioned In re RH, Inc.

Securities Litigation.

An amended consolidated complaint was filed in June 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

The complaint asserts claims purportedly on behalf of a class of purchasers of our common stock from March 26, 2015 to June 8, 2016.

The alleged misstatements relate to statements regarding the roll out of the RH Modern product line and our inventory levels.

The complaint seeks class certification, monetary damages, and other appropriate relief, including an award of costs and attorneys’ fees.

On March 21, 2019, we and the individual defendants in the case entered into a binding memorandum of understanding to settle the case.

The settlement amount is $ 50 million, which was funded entirely by our insurance carriers.

On May 6, 2019, the plaintiffs filed a motion for preliminary approval of the proposed settlement together with a settlement agreement executed by both parties.

The settlement agreement was subject to customary conditions including court approval following notice to our shareholders, and a hearing at which time the court will consider the fairness, reasonableness and adequacy of the settlement.

On June 21, 2019, the court issued an order preliminarily approving the settlement.

The court granted final approval of the settlement on October 25, 2019.

As a result of the court approval and adjudication of the claims in 2019, as well as our insurance carriers funding the settlement amount, we have derecognized the provision for legal settlement and unpaid legal fees within other current liabilities and the associated litigation insurance recovery receivable on the condensed consolidated balance sheets as of October 31, 2020, which settlement resolved all of the claims that were or could have been brought in the action.

Shareholder Derivative Lawsuit

On April 24, 2018, purported Company shareholder David Magnani filed a purported shareholder derivative suit in the United States District Court, Northern District of California, captioned Magnani v.

Friedman et al.

18-cv-02452).

On June 29, 2018, Hosrof Izmirliyan filed a similar purported shareholder derivative complaint in the same forum, captioned Izmirliyan v.

Friedman et al.

18-cv-03930).

On July 29, 2018, the court consolidated both derivative actions, and the consolidated action is captioned In re RH Shareholder Derivative Litigation.

On August 24, 2018, plaintiffs filed an amended complaint that names the Company as a nominal defendant and Gary Friedman, Karen Boone, Carlos Alberini, Keith Belling, Eri Chaya, Mark Demilio, Katie Mitic, Ali Rowghani and Leonard Schlesinger as defendants.

The allegations substantially track those in the securities class action described above.

Plaintiffs bring claims against all individual defendants under Section 14(a) of the Exchange Act, as well as claims for breach of fiduciary duty, unjust enrichment, and waste of corporate assets.

The plaintiffs also allege insider trading and misappropriation of information claims against two of the individual defendants.

The amended complaint seeks monetary damages, corporate governance changes, restitution, and an award of costs and attorneys’ fees.

We believe that plaintiffs lack standing to bring this derivative action.

On September 28, 2018, we filed a motion to stay proceedings and a motion to dismiss the consolidated complaint.

On January 23, 2019, the court granted the motion to stay the case pending resolution of the securities class action discussed above.

On March 19, 2020, the parties reached an agreement in principle to settle the litigation and subsequently entered into a stipulation of settlement that was preliminarily approved by the Court on August 3, 2020.

The settlement involves certain non-monetary terms as well as payment of the plaintiffs’ attorneys’ legal fees, which payment is expected to be funded by our insurance carriers.

On October 6, 2020, the Court held a final settlement hearing.

Although we believe that the ultimate resolution of our current legal proceedings will not have a material adverse effect on our condensed consolidated financial statements, the outcome of legal matters is subject to inherent uncertainty.

NOTE 17—SEGMENT REPORTING

We define reportable and operating segments on the same basis that we use to evaluate our performance internally by the Chief Operating Decision Maker (the “CODM”), which we have determined is our Chief Executive Officer.

We have two operating segments:

RH Segment and Waterworks.

The two operating segments include all sales channels accessed by our customers, including sales through catalogs, websites, stores, and the commercial channel.

Our two operating segments are strategic business units that offer products for the home furnishings customer.

While RH Segment and Waterworks have a shared management team and customer base, we have determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.

We use operating income to evaluate segment profitability.

Operating income is defined as net income before interest expense—net, tradename impairment and income tax expense.

We have three operating segments:

RH Segment, Waterworks and Real Estate Development.

The RH Segment and Waterworks operating segments (the “retail operating segments”) include all sales channels accessed by our customers, including sales through retail locations and outlets, websites, Source Books, and the commercial channel.

The Real Estate Development segment represents operations associated with our equity method investments entered into in fiscal 2020, as described in Note 5— Equity Method Investments .

The retail operating segments are strategic business units that offer products for the home furnishings customer.

While RH Segment and Waterworks have a shared senior leadership team and customer base, we have determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.

We use operating income to evaluate segment profitability for the retail operating segments.

Operating income is defined as net income (loss) before interest expense—net, tradename impairment, loss on extinguishment of debt, income tax expense (benefit) and our share of equity method investments losses.

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Segment Information

The following table presents the statements of income metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280— Segment Reporting ( in thousands ):

The following table presents the statements of operations metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280— Segment Reporting ( in thousands ):

THREE MONTHS ENDED

Depreciation and amortization

Nine Months Ended

Depreciation and amortization

In the three months ended May 1, 2021, the Real Estate Development segment share of equity method investments losses was $ 2.1 million.

The following table presents the balance sheet metrics as required under ASC 280— Segment Reporting ( in thousands ):

Tradenames, trademarks and domain names (2)

(1) The Waterworks reporting unit goodwill of $ 51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $ 17.4 million and $ 33.7 million impairment recorded in fiscal 2018 and fiscal 2017, respectively.

(2) The Waterworks reporting unit tradename is presented net of an impairment charge of $ 35.1 million, of which $ 20.5 million was recorded in the first quarter of fiscal 2020 and $ 14.6 million was recorded in fiscal 2018.

Refer to “Waterworks Tradename Impairment” within Note 4— Goodwill, Trademarks, Trademarks and Domain Names.

Tradenames, trademarks and other intangible assets (2)

Equity method investments

(1) The Waterworks reporting unit goodwill of $ 51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of February 2, 2019, with $ 17.4 million and $ 33.7 million impairment recorded in fiscal 2018 and fiscal 2017, respectively.

(2) The Waterworks reporting unit tradename is presented net of an impairment charge of $ 35.1 million, with $ 20.5 million and $ 14.6 million recorded in fiscal 2020 and fiscal 2018, respectively.

We use segment operating income to evaluate segment performance and allocate resources.

Segment operating income excludes (i) a non-cash compensation charge related to a fully vested option grant made to Mr.

Friedman in October 2020, (ii) asset impairments and change in useful lives, (iii) gain (loss) on sale leaseback transaction, (iv) severance costs associated with reorganizations, (v) product recall accruals and adjustments—net, (vi) favorable legal settlement and (vii) asset held for sale gain.

Segment operating income excludes (i) non-cash compensation amortization related to the fully vested option grant made to Mr.

Friedman in October 2020, (ii) product recall accruals and adjustments, (iii) asset impairments and changes in useful lives and (iv) severance costs associated with reorganizations.

These items are excluded from segment operating income in order to provide better transparency of segment operating results.

Accordingly, these items are not presented by segment because they are excluded from the segment profitability measure that the CODM and management review.

The following table presents segment operating income and income before income taxes ( in thousands ):

Accordingly, these items are not presented by segment because they are excluded from the segment profitability measure that the CODM and our senior leadership team reviews.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 29

The following table presents segment operating income (loss) and income (loss) before income taxes ( in thousands ):

THREE MONTHS ENDED

Nine Months Ended

Operating income:

Operating income (loss):

Non-cash compensation

Recall accrual

Asset impairments and change in useful lives

Gain (loss) on sale leaseback transaction

Reorganization related costs

Recall accrual

Legal settlements

Asset held for sale gain

Income from operations

Interest expense—net

Loss on extinguishment of debt

Tradename impairment

(Gain) loss on extinguishment of debt—net

Income before income taxes

Income (loss) before income taxes

We classify our sales into furniture and non-furniture product lines.

Furniture includes both indoor and outdoor furniture.

Non-furniture includes lighting, textiles, fittings, fixtures, surfaces, accessories and home décor, as well as hospitality.

Non-furniture includes lighting, textiles, fittings, fixtures, surfaces, accessories and home décor.

Net revenues in each category were as follows ( in thousands ):

THREE MONTHS ENDED

Nine Months Ended

Non-furniture

Total net revenues

During the third fiscal quarter of 2020, we reviewed our segments and product lines and updated certain products and categories in our reporting of furniture and non-furniture product lines.

During the third quarter of fiscal 2020, we reviewed our segments and product lines and updated certain products and categories in our reporting of furniture and non-furniture product lines.

While this reporting change did not impact our consolidated results, prior period segment data has been recast for consistency in reporting.

We are domiciled in the United States and primarily operate our retail and outlet stores in the United States.

As of October 31, 2020, we operated 4 retail and 2 outlet stores in Canada and 1 retail store in the U.K.

Revenues from Canadian and U.K.

operations, and the long-lived assets in Canada and the U.K., are not material.

Canada and U.K.

geographic revenues are based upon revenues recognized at the retail store locations in the respective country.

No single customer accounted for more than 10 % the three and nine months ended October 31, 2020 and November 2, 2019.

NOTE 18—BUSINESS COMBINATION

On August 28, 2020, we acquired a furniture business in North America, for total consideration of $ 15.0 million funded through available cash, of which $ 1.9 million was deposited into an escrow account for any potential post-closing adjustments.

We have deposited into escrow an additional $ 5.0 million, which represents a deferred acquisition related payment subject to mutually agreed to conditions and expected to be paid over two years .

We believe that this addition to the RH platform further positions us as a leader in the luxury design market as we continue to enhance the RH product assortment.

For the three and nine months ended October 31, 2020, we incurred $ 0.6 million and $ 1.3 million, respectively, of acquisition-related costs associated with the transaction.

These costs and expenses include fees associated with financial,

legal and accounting advisors, and employment related costs, and are included in selling, general and administrative expenses on the condensed consolidated statements of income.

The following table summarizes the purchase price allocation based on the fair value of the assets acquired and liabilities assumed ( in thousands ):

Tangible assets acquired and liabilities assumed—net

The tradename has been assigned an indefinite life and therefore is not subject to amortization.

The goodwill, included in the RH Segment, is representative of the benefits and expected synergies from the integration of the acquired company’s products, management and employees, which do not qualify for separate recognition as an intangible asset.

The tradename and goodwill are expected to be deductible for tax purposes.

Results of operations of the acquired company have been included in our condensed consolidated statements of income since the August 28, 2020 acquisition date.

Pro forma results of the acquired business have not been presented as the results were not considered material to our consolidated financial statements for all periods presented and would not have been material had the acquisition occurred at the beginning of fiscal 2020.

We are domiciled in the United States and primarily operate our retail locations and outlets in the United States.

As of May 1, 2021, we operated 4 retail locations and 2 outlets in Canada, and 1 retail location in the U.K.

Geographic revenues in Canada and the U.K.

are based upon revenues recognized at the retail locations in the respective country and were not material in any fiscal period presented.

Long-lived assets held internationally were not material in any fiscal period presented.

No single customer accounted for more than 10 % of our revenues in the three months ended May 1, 2021 or May 2, 2020.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 30

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1. Financial Statements