What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-06-10 compared with 2020-12-10 · 283 added, 464 removed, 161 unchanged (82% of the section changed)

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While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results, and matters that we identify as “short term,” “non-recurring,” “unusual,” “one-time,” or other words and terms of similar meaning may, in fact, recur in one or more future financial reporting periods.

Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the sections entitled Risk Factors in Part II of this quarterly report, our Quarterly Reports on Form 10-Q for the quarterly periods ended May 2, 2020 (“First Quarter Form 10-Q”) and August 1, 2020 (“Second Quarter Form 10-Q”), and in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020 (“2019 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report, in our First Quarter Form 10-Q, Second Quarter Form 10-Q and in our 2019 Form 10-K.

Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the section entitled Risk Factors in our Annual Report on Form 10-K for the fiscal year ended January 30, 2021 (the “2020 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report and in our 2020 Form 10-K.

All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements.

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We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.

We are a leading luxury retailer in the home furnishings marketplace.

Our curated and fully-integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers.

We offer dominant merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings.

We position our Galleries as showrooms for our brand, while our Source Books and websites act as virtual extensions of our stores.

Our retail business is fully integrated across our multiple channels of distribution, consisting of our stores, Source Books, and websites.

We have an integrated RH Hospitality experience in ten of our new Design Gallery locations, which includes restaurants and wine vaults.

As of October 31, 2020, we operated the following number of retail Galleries, outlets and showrooms:

We are a leading luxury retailer in the home furnishings market.

Our curated and fully integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings.

We offer merchandise assortments across a number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings.

We position our Galleries as showrooms for our brand, while our websites and Source Books act as virtual extensions of our physical spaces.

Our retail business is fully integrated across our multiple channels of distribution, consisting of our retail locations, websites and Source Books.

We have an integrated RH Hospitality experience in ten of our locations, which include Restaurants and wine bars.

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As of May 1, 2021, we operated the following number of Galleries, Outlets and Showrooms:

Design Galleries

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Waterworks Showrooms

Our business substantially recovered during the second and third fiscal quarters from effects of the initial wave of the novel coronavirus disease (“COVID-19”) as a result of both the reopening of most of our retail locations and also due to strong consumer demand for our products.

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.

As our business has 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.

During the time period of October through early December 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 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 with the restrictions on our physical locations and the duration and extent of these operational limits cannot be predicted with certainty.

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 2020 through December 2020 resulting in various adverse operating restrictions on our physical locations.

The evolution of the COVID-19 pandemic around the world may continue to have an adverse impact on elements of our supply chain including the manufacture, supply, distribution, transportation and delivery of our products and our inventory levels.

The presence of the virus and the response to the health crisis in various countries can affect the speed at which the factories that manufacture our products are able to resume normal operations and production levels, and the extent to which business conditions are able to return to normal in areas that affect our supply chain including factories and transportation.

Furthermore, our hospitality business may not recover as quickly as other parts of our business, as in most of our retail locations that have reopened, substantial operational restrictions related to COVID-19 health and safety considerations, for example limits to seating capacity, have been imposed on such business by various governmental authorities.

Such operational restrictions may cause our hospitality offerings to be less attractive to customers or may lower its margins and profitability.

While we are pursuing a large number of new business initiatives, the COVID-19 health crisis has had a short-term impact on some of those efforts and initiatives such as the timing of some construction efforts with respect to opening new Gallery locations and optimizing our inventory in light of Outlet inventory buildup resulting from our temporary retail closures.

For example, while we have generally experienced positive and improving business trends during the second and third quarters of fiscal 2020, counterparties with respect to some of our Gallery development projects may experience capital or liquidity constraints due to COVID-19 related difficulties, which may impact the timing or scope of some of our development projects.

The impact of COVID-19 abroad, including travel restrictions imposed by various countries, may continue to affect certain aspects of our planned international expansion and has been a major factor in our decision to delay the timing of our previous plans to open new international locations in 2021.

Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may adjust our investments in various business initiatives including our capital expenditures through the remainder of fiscal 2020 and over the course of fiscal 2021.

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 developments with respect to COVID-19.

For more information, refer to Item 1A—Risk Factors—The COVID-19 pandemic poses significant and widespread risks to our business as well as to the business environment and the markets in which we operate in Part II of this quarterly report .

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.

Key Value Driving Strategies

In order to drive growth across our business, we are focused on a number of key long-term strategies, including:

● Elevate and Expand RH Product.

Consistent with our luxury brand positioning, we are driving improvements in our product offering as one of the key value driving strategies of our business.

We have multiple new growth initiatives in the pipeline, including new collections, new concepts, new galleries, new guesthouses, and new businesses.

For example, we will be introducing RH Contemporary, a new collection that bridges the gap between RH Interiors and RH Modern, while elevating our brand and expanding our market.

While we have expanded our merchandise assortment substantially over a number of years, we are increasingly focused on efforts to elevate our product as opposed to only increasing the size of our product offering.

As part of this effort, we are driving continuing enhancements in the taste, quality and style of our products as well as integrating our product offering to offer our customers authoritative collections of home furnishings at the high end of the market.

We continue to attract and collaborate with the best designers, artisans, and manufacturers in our industry, scaling their work across our integrated platform and thereby rendering it more valuable, enabling us to curate a compelling collection of luxury home furnishings to our customers.

Our vision is not only to elevate our merchandise offering, but also to offer a broader ecosystem of products and experiences as we move the brand beyond curating and selling product to conceptualizing and selling spaces by building an integrated platform

of products, places, services and spaces that elevate and establish the RH brand as a global thought leader, taste and placemaker.

As an example, our product is elevated and rendered more valuable by our architecturally inspiring Galleries, which are further elevated and rendered more valuable by our seamlessly integrated hospitality experience.

Our Hospitality efforts will continue to elevate the RH brand as we move beyond the four walls of our Galleries into RH Guesthouses where our goal is to create a new market for travelers seeking privacy and luxury in the hotel industry.

Additionally, we are creating bespoke hospitality experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley.

These immersive experiences expose existing and new customers to our evolving authority in interior design, architecture, landscape architecture and hospitality.

● Transform Our Real Estate Platform.

In order to drive growth across our business, we are focused on the following long-term key strategies and business initiatives:

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Product Elevation .

We have built the most comprehensive and compelling collection of luxury home furnishings under one brand in the world.

Our products are presented across multiple collections, categories, and channels that we control, and their desirability and exclusivity has enabled us to achieve industry leading revenues and margins.

Our customers know them as RH Interiors, RH Modern, RH Beach House, RH Ski House, RH Outdoor, RH Rugs, RH Lighting, RH Linens, RH Baby & Child, RH Teen, and Waterworks.

Our strategy to elevate the design and quality of our product will continue as we introduce RH Contemporary in 2021 with a 400 page Source Book, dedicated website, national ad campaign, and a freestanding RH Contemporary Gallery in the San Francisco Design District.

We also have plans to introduce RH Couture Upholstery, RH Bespoke Furniture and RH Color over the next several years.

Gallery Transformation .

Our product is elevated and rendered more valuable by our architecturally inspiring Galleries.

We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of $5 to $6 billion in North America.

We believe we can significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that are sized to the potential of each market and the size of our merchandise assortment.

New sites are identified based on a variety of factors, such as (i) the availability of suitable new site locations based on several store specific factors including geographic location, demographics, and proximity to affluent consumers, (ii) the ability to negotiate favorable economic terms, as well as (iii) the satisfactory and timely completion of real estate development including procurement of permits and completion of construction.

The number of Design Galleries we open in any fiscal year is highly dependent upon these variables and individual new Design Galleries may be subject to delay or postponement depending on the circumstances of specific projects, which we have experienced with some of our new Gallery openings from time to time including in connection with the COVID-19 crisis.

Today we operate 24 Design Galleries, and based on our analysis, we believe we have the opportunity to operate Design Galleries in 60 to 70 locations in the United States and Canada.

We opened our Minneapolis Design Gallery in September 2019, our Columbus Design Gallery in December 2019, our Charlotte Design Gallery in June 2020 and our Marin Design Gallery in July 2020.

We have identified key learnings from our real estate transformation that have supported the development of a multi-tier market approach that we believe will optimize both market share and return on invested capital.

Our Gallery designs include (i) prototype Design Galleries that are suited to many North American markets, similar to those we opened most recently in Charlotte and Marin, (ii) larger Bespoke Design Galleries in the top metropolitan markets, similar to those we opened in New York and Chicago, and (iii) indigenous Bespoke Galleries in the best second home markets where the wealthy and affluent visit and vacation including our location in Yountville, California as well as our Gallery under development in Aspen, Colorado.

Like our evolving multi-tier market approach, we have developed a multi-tier real estate strategy that is designed to significantly increase our unit level profitability and return on invested capital.

Several of our primary deal constructs are outlined below:

● First, due to the productivity and proof of concept of our recent new Galleries, and the addition of a powerful, traffic-generating hospitality experience, we are able to negotiate “capital light” leasing deals, where a substantial portion of the capital requirement would be funded by the landlord.

● Second, in select projects we are migrating from a leasing to a development model.

We have two Galleries, Yountville and Minneapolis, that have used this new model, and have additional projects in the pipeline.

In the case of Yountville and Minneapolis, we have completed sale-leaseback transactions that have allow us to recoup a large portion of our capital.

● Third, we are working on joint venture projects, where we share the upside of development with the developer/landlord.

An example of this new model would be our future Gallery and Guesthouse in

Aspen, where the value of our lease has enabled us to secure a profits interest in the project.

The developer will deliver to RH a substantially turnkey Gallery and Guesthouse, while we continue to retain a 20% and 25% profits interest in the properties, respectively.

We would expect to monetize the profits interest at the time of sale of the properties, which we anticipate would occur within five years of such properties’ development.

The net result should be a minimal capital investment to operationalize the business, with the expectation for a net positive capital benefit at time of monetization of the profits interest .

We anticipate that all of the above deal structures should lead to lower capital requirements, higher unit profitability, and significantly higher return on invested capital versus our prior Gallery development strategies.

● Pursue International Expansion.

We believe that our luxury brand positioning and unique aesthetic has strong international appeal, and pursuit of global expansion will provide RH access to a substantial long-term market opportunity to build a $20 billion global brand over time.

As such, we are actively pursuing expanding the RH brand globally with the objective of launching additional international locations beginning in 2022.

We believe we can significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that is sized to the potential of each market and the size of our assortment.

In addition, we plan to incorporate Hospitality into most of the new Design Galleries that we open in the future, which further elevates and renders our product and brand more valuable.

We believe Hospitality has created a unique new retail experience that cannot be replicated online, and that the addition of Hospitality will help drive incremental sales of home furnishings in these Galleries.

Brand Elevation .

We are beginning to evolve the brand beyond curating and selling product, towards conceptualizing and selling spaces, by building an ecosystem of products, services, places, and spaces designed to elevate and render our product more valuable while establishing the RH brand as a thought leader, taste and place maker.

We believe our seamlessly integrated ecosystem of immersive experiences inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an impression and connection unlike any other brand in the world.

Digital Reimagination .

Our strategy is to digitally reimagine the RH brand and business model both internally and externally.

Internally regarding how we innovate, curate, and integrate all the dynamic aspects of our brand, and externally as we introduce our customers to The World of RH, a new digital portal presenting our Products, Services, Places and Spaces.

This multi-year effort began internally last year with the reimagination of our Center of Innovation & Product Leadership, which will incorporate digitally integrated visuals and decision data designed to amplify the creative process from product ideation to product presentation.

Our external efforts will begin this fall with the launch of phase one of our new digital portal, The World of RH, which will include rich, immersive content with simplified navigation and search functionality, all designed to enhance the shopping experience and render our product and brand more valuable.

We believe an opportunity exists to create similar strategic separation online as we have with our Galleries offline, reconceptualizing what a website can and should be.

Global Expansion .

We believe that our luxury brand positioning and unique aesthetic have strong international appeal, and that pursuit of global expansion will provide RH a substantial long-term market opportunity to build a $20 to $25 billion global brand over time.

Our view is the competitive environment globally is more fragmented and primed for disruption than the North American market, and there is no direct competitor of scale that possesses the product, operational platform, and brand of RH.

As such, we are actively pursuing the expansion of the RH brand globally with the objective of launching international locations in Europe beginning in 2022.

We have secured a number of locations in various markets in the United Kingdom and continental Europe in which we expect to introduce our first Galleries outside of the U.S.

We believe that expanding our business into these and other international markets represents a substantial long-term market opportunity given the size and fragmentation of the home furnishings industry in these markets, and are pursuing international expansion as one of our key business priorities.

● Grow Our Integrated Hospitality Experience.

In 2015 we began to introduce an integrated hospitality experience, including restaurants and wine vaults, into a number of our new Gallery locations.

The success of our initial hospitality offering in Chicago led us to broaden this initiative by adding hospitality to a number of our other new Gallery locations.

Ten of our Design Galleries include integrated restaurants and wine vaults, and we expect nearly all of our future Design Galleries will include restaurants and wine vaults.

We believe this has created a unique new retail experience that cannot be replicated online, and that the addition of hospitality is helping to drive incremental sales of home furnishings in these Galleries.

● Architect New Operating Platform.

We have spent approximately four years architecting a new operating platform, inclusive of transitioning from a promotional to membership model, our distribution center network redesign, the redesign of our reverse logistics and outlet business, and the reconceptualization of our home delivery and customer experience, which enables us to drive lower costs and inventory levels, and higher earnings and inventory turns.

Looking forward, we expect this multi-year effort to result in a dramatically improved customer experience, continued margin enhancement and significant cost savings over the next several years.

● Maximize Cash Flow and Optimize the Allocation of Capital in the Business .

From fiscal 2017 through and including fiscal 2020, we have increasingly operated our business with a goal to maximize cash flow and the allocation of capital.

We believe that our operations and current initiatives are providing a significant opportunity to optimize the allocation of capital in our business, including generating free cash flow and optimizing our balance sheet.

Our focus on cash flow and capital allocation has permitted us to make long-term decisions that benefit our business including deploying capital to repay debt and repurchase shares of our common stock, which we believe creates a benefit to our shareholders.

During fiscal 2017, we repurchased approximately 20.2 million shares of our common stock under two separate repurchase programs for an aggregate repurchase amount of approximately $1 billion.

During fiscal 2018, we repurchased approximately 2.0 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately $250 million.

During fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under a separate repurchase program for an aggregate repurchase amount of approximately $250 million.

Our focus on cash also resulted in our generating substantial free cash flow in fiscal 2017 through 2019, and we expect this objective to continue to be a priority in fiscal 2020 and 2021.

● Increase Operating Margins.

Since fiscal 2016 and continuing through fiscal 2020, we have substantially increased the operating margins in our business.

While the time period during which we have had to adjust our operations to respond to the COVID-19 crisis will have some negative impact on margins, we believe that our longer term effort to increase operating margins will continue as the business continues to normalize after the effects of COVID-19 moderate.

We anticipate continued improvements in operating margins as a result of our focus on a number of our strategic initiatives including (i) the occupancy leverage we expect to gain from our real estate transformation, (ii) product margin expansion as we continue to elevate and expand the RH product and drive higher full price selling in our core business, and (iii) the continued cost savings from improvements to our operating platform and organizational structure.

Business Initiatives

We are undertaking a large number of new business initiatives in support of our key value driving strategies.

In particular, beginning in fiscal 2016 and continuing through fiscal 2020, we have pursued a range of strategic efforts to improve our business and operations including the following:

● Introduction of Membership Model.

In March 2016, we introduced the RH Members Program, an exclusive program that reimagines and simplifies the shopping experience.

For an annual fee, the RH Members Program provides a set discount every day across all RH brands, excluding RH Hospitality and Waterworks, in addition to other benefits including complimentary interior design services through the RH Interior Design program and eligibility for preferred financing plans on the RH Credit Card, among other benefits.

The RH Members Program allows our customers to shop for what they want, when they want, and receive the greatest value, which has resulted in orders and sales being more evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales we experienced under the prior promotional model.

We believe the shift to a membership model has enhanced the customer experience, rendered our brand more valuable, improved operational execution and reduced costs.

We believe that the shift to a membership model has positively affected the financial results of our business.

Specifically, we believe some of the benefits include:

Improved customer experience .

Our interior design professionals can now work with customers based on their timeline and project deadlines, as opposed to our prior promotional calendar.

We believe this will lead to larger overall sales transactions for individual customer design projects.

Lower cancellations and returns .

As a result of the elimination of time-limited promotional events and the associated pressure of placing an order before a promotion expires, we believe the shift to a membership model has also resulted in lower rates of cancelled orders and returns.

Improved operational costs .

The volume of sales, orders and shipments in our business under the prior promotional model was characterized by large spikes in customer orders based upon promotional events followed by lower orders and sales after the end of an event.

This buying pattern also affected numerous other aspects of our business, including staffing and costs as we required elevated staffing levels to service the increased number of customers during peak sales events.

Likewise, significant fluctuations in sales had downstream implications for our supply chain related to merchandise orders, manufacturing and production, shipment to our distribution centers and final delivery to our customers.

All of these aspects of our operations are experiencing improved efficiencies as a result of the membership model whereby sales are more evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales under the prior model.

● Luxury In-Home Furniture Delivery Experience.

We believe there is an opportunity to improve the customer experience by enhancing our approach to services in connection with in-home delivery.

We are in the process of implementing a number of measures that are designed to increase our level of control and improve service levels throughout the delivery experience to the customer’s residence.

We believe that we are well positioned to develop improved solutions for in-home delivery to the customer in the luxury market.

We have already adopted a number of service improvements that are yielding improvements in the customer experience and reductions in product return and exchange rates.

We expect to continue to optimize our service offering to customers in connection with the in-home delivery experience and are confident that our efforts in this regard will continue to achieve substantial results.

● Elevate the Customer Experience.

We are continuing to pursue the positioning of our business as a luxury brand.

As one part of this ongoing initiative, we are focused on improving the end-to-end customer experience.

As we have elevated our brand, especially at retail, we are also working to enhance the brand experience in other aspects of our business.

We are making changes in many aspects of our business processes that affect our customers, including the in-home delivery experience, improvements in product quality and enhancements in sourcing, product availability, and all aspects of customer care and service.

We also believe that the introduction of experiential brand-enhancing products and services, such as expanded design ateliers, the RH Interior Design program and the launch of an integrated hospitality experience in a number of our new Galleries, will further enhance our customers’ in-store experience, allowing us to further disrupt the highly fragmented home furnishings landscape and achieve market share gains.

We continue to pursue and test numerous initiatives to improve many aspects of our business including through efforts to optimize inventory, elevate the home delivery experience, simplify our distribution network and improve our organizational design including by streamlining and realigning our home office operations, as well as to elevate and expand our product offering, transform our real estate using a range of different models for specific real estate development projects and expand our brand internationally.

Many of these initiatives and other initiatives such as our transition to a direct sourcing model for our rug business have improved our operating margins, but other initiatives such as RH Hospitality, Waterworks and investments to develop our international expansion strategy are expected to offset some planned margin improvement in fiscal 2020 due to our investments in these platforms.

There can be no assurance as to the timing and extent of the operational benefits and financial contributions of these strategic efforts.

In addition, our pursuit of multiple initiatives with respect to our business in any given period may result in period-to-period changes in, and increased fluctuation in, our results of operations.

We have also experienced delays in development timelines for some of our recent projects, and delays in completion of our real estate development projects or costs overruns could negatively affect our results of operations and revenues.

Further, macroeconomic or political events outside of our control could impact our ability to pursue our initiatives or the success of such initiatives.

While we believe that the tariffs imposed to date on most of our goods sourced from China have not had an adverse effect on our results of operations, including our revenues, margins and earnings, there can be no assurance that the existing tariffs and the additional tariffs that will become effective, as well as other future tariffs that may be imposed, will not adversely affect our results of operation in future time periods.

The stock market has experienced significant increases in volatility during fiscal 2020.

In general we have experienced some correlation between stock market performance and consumer spending patterns in our business.

Accordingly, we may encounter shifts in consumer spending in future time periods as a result of stock market declines including in the event that heightened market volatility related to the COVID-19 health crisis or other factors including deterioration in market conditions leads to stock price declines.

Our business is also correlated to the luxury housing market.

The luxury housing market is affected by a range of factors including home prices and interest rates and slowdowns in the luxury housing market can have a negative impact on demand for our products.

Factors that affect the higher end housing market in particular may have an outsized influence on our levels of consumer demand since our business is geared toward the higher end of the luxury home furnishings market.

The above factors and other current and future operational initiatives may create additional uncertainty with respect to our consolidated net revenues and profit in the near term.

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Basis of Presentation and Results of Operations

Matters Affecting Comparability

The disruption to our business operations from the COVID-19 pandemic has had a significant impact on the comparability of certain ratios and year-over-year trends for our operating results for the three and nine months ended October 31, 2020 as compared to the three and nine months ended November 2, 2019.

The primary negative impact to our revenues from store closures occurred during the first quarter of fiscal 2020, but despite the reopening of most of our Galleries during the second and third fiscal quarters and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances related to COVID-19 including delays in inventory receipts and manufacturing as our supply chain recovers from the impact of the global health crisis.

We have also changed the cadence of our expenses and investments as we have sought to address the impact of COVID-19 on the business.

During the first quarter of fiscal 2020, we implemented a number of short-term and long-term initiatives in response to COVID-19 including the implementation of a business reorganization and the deferral of certain investments.

During the second 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 developments with respect to COVID-19, such as the increase in reported cases of COVID-19 in the U.S.

and Canada during the time period of October through early December 2020.

The disruption to our business operations from the COVID-19 pandemic has had a significant impact on the comparability of certain ratios and year-over-year trends for our operating results for the three months ended May 1, 2021, as compared to the three months ended May 2, 2020.

The primary negative impact to our revenues from store closures occurred during the first half of fiscal 2020, but despite the reopening of most of our Galleries during the second and third fiscal quarters and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances related to the pandemic including delays in manufacturing and inventory receipts as our supply chain recovers from the impact of the global health crisis.

We have also changed the cadence of our expenses and investments as we have sought to address the impact of the pandemic on the business, and delayed the opening of certain new Gallery locations due to issues related to the pandemic including the extensive travel restrictions that have been in place for Europe.

Beginning in the second quarter of fiscal 2020, we resumed many investments and previously deferred expenditures, and our decisions regarding these matters will continue to evolve in response to changing business circumstances, including further developments with respect to the pandemic.

Direct and indirect effects of the pandemic will continue to affect the comparability of our results during fiscal 2021.

Although we have experienced strong demand for our products since the second half of fiscal 2020, for example, some of the demand may have been driven by consumers electing to spend more money on home-related purchases due to stay-at-home restrictions that were in place throughout many parts of the United States and Canada.

The relaxation of COVID-19-related restrictions may trigger a shift in consumer spending patterns toward other categories, such as travel and leisure activities, and away from the purchase of merchandise related to the home including home furnishings which could affect our results of operation in fiscal 2021.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 34

Results of Operations

The following table sets forth our condensed consolidated statements of income and other financial and operating data.

The following table sets forth our condensed consolidated statements of operations and other financial and operating data:

THREE MONTHS ENDED

Nine Months Ended

(in thousands)

Condensed Consolidated Statements of Income:

Condensed Consolidated Statements of Operations:

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

Income (loss) before income taxes

Income tax expense (benefit)

Income (loss) before equity method investments

Share of equity method investments losses

Net income (loss)

Other Financial and Operating Data:

5 unchanged sentences

(1) Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, generally accepted accounting principles (“GAAP”).

We define adjusted net income as consolidated net income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.

Adjusted net income is included in this filing because management believes that adjusted net income provides meaningful supplemental information for investors

regarding the performance of our business and facilitates a meaningful evaluation of actual results on a comparable basis with historical results.

Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

The following table presents a reconciliation of net income, the most directly comparable GAAP financial measure, to adjusted net income for the periods indicated below.

We define adjusted net income as consolidated net income (loss), adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.

Adjusted net income is included in this filing because our senior leadership team believes that adjusted net income provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of actual results on a comparable basis with historical results.

Our senior leadership team uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

The following table presents a reconciliation of net income (loss), the most directly comparable GAAP financial measure, to adjusted net income for the periods indicated below.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 35

THREE MONTHS ENDED

Nine Months Ended

(in thousands)

Net income (loss)

Adjustments pre-tax:

Non-cash compensation (a)

Amortization of debt discount (b)

Tradename impairment (c)

Asset impairments and lease losses (d)

(Gain) loss on sale leaseback transaction (e)

Reorganization related costs (f)

Recall accrual (g)

(Gain) loss on extinguishment of debt—net (h)

Legal settlements (i)

Asset held for sale gain (j)

Amortization of debt discount (a)

Non-cash compensation (b)

Recall accrual (c)

Loss on extinguishment of debt (d)

Tradename impairment (e)

Asset impairments and change in useful lives (f)

Reorganization related costs (g)

Subtotal adjusted items

Impact of income tax items (k)

Impact of income tax items (h)

Share of equity method investments losses (i)

Adjusted net income

(a) Represents a non-cash compensation charge related to an option grant made to Mr.

Friedman in October 2020.

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

Accordingly, in accounting for GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were issued in June 2014 (the “2019 Notes”), the $300 million aggregate principal amount of convertible senior notes that were issued in June and July 2015 (the “2020 Notes”), the $335 million aggregate principal amount of convertible senior notes that were issued in June 2018 (the “2023 Notes”) and the $350 million aggregate principal amount of convertible senior notes that were issued in September 2019 (the “2024 Notes”), we separated the 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes into liability (debt) and equity (conversion option) components and we are amortizing as debt discount an amount equal to the fair value of the equity components as interest expense on the 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes over their expected lives.

The equity components represent the difference between the proceeds from the issuance of the 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes and the fair value of the liability components of the 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes, respectively.

Amounts are presented net of interest capitalized for capital projects of $1.1 million and $0.9 million during the three months ended October 31, 2020 and November 2, 2019, respectively.

Amounts are presented net of interest capitalized for capital projects of $4.2 million and $2.3 million during the nine months ended October 31, 2020 and November 2, 2019, respectively.

The 2019 Notes matured on June 15, 2019 and the 2020 Notes matured on July 15, 2020 and neither impacted amortization of debt discount post-maturity.

Refer to “Waterworks Tradename Impairment” within Note 4— Goodwill, Trademarks, Trademarks and Domain Names in our condensed consolidated financial statements.

(d) The adjustment includes the acceleration of depreciation expense due to a change in the estimated useful lives of certain assets of $1.3 million for the three months ended October 31, 2020, and $3.9 million and $4.9 million for the nine months ended October 31, 2020 and November 2, 2019, respectively.

The adjustment in the three months ended October 31, 2020 also includes asset impairments of $0.8 million and the adjustment in the nine months ended October 31, 2020 also includes asset impairments of $5.6 million and inventory reserves of $2.4 million related to Outlet inventory buildup resulting from retail closures in response to the COVID-19 pandemic.

In addition, the three and nine months ended November 2, 2019 include an asset impairment of $1.0 million and $1.6 million, respectively, and the nine months ended November 2, 2019 also includes a $0.5 million charge related to the termination of a service agreement.

(e) Represents the (gain) loss on sale leaseback transactions related to our previously owned Design Galleries.

(f) Represents severance costs and related payroll taxes associated with reorganizations.

(g) Represents adjustments to net revenues, cost of goods sold and inventory charges associated with product recalls, as well as accrual adjustments, and vendor and insurance claims.

The recall adjustments had the following effect on our income before taxes:

Three Months Ended

Nine Months Ended

(in thousands)

(Increase) decrease to net revenues

Increase (decrease) to cost of goods sold

(Increase) decrease to gross profit

Increase (decrease) to selling, general and administrative expenses

(Increase) decrease to income before income taxes

(h) The adjustment in the nine months ended October 31, 2020 represents a gain on extinguishment of debt of upon the maturity and settlement of the 2020 Notes in July 2020.

The three and nine months ended November 2, 2019 include a $6.7 million loss on extinguishment of debt related to the second lien term loan, which was repaid in full in September 2019, as well as the acceleration of $0.2 million of debt issuance costs related to early repayment of a portion of the FILO term loan.

The nine months ended November 2, 2019 also includes a $1.0 million gain on extinguishment of debt upon the maturity and settlement of the 2019 Notes in June 2019.

(i) Represents legal settlements, net of related legal expenses.

(j) Represents the net gain on real estate related to land sales.

(k) The adjustment for the three months ended October 31, 2020 is based on an adjusted tax rate of 23.3%, which excludes the tax impact associated with the non-cash compensation charge related to an option grant made to Mr.

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

Accordingly, in accounting for GAAP purposes for the $300 million aggregate principal amount of convertible senior notes that were issued in June and July 2015 (the “2020 Notes”), the $335 million aggregate principal amount of convertible senior notes that were issued in June 2018 (the “2023 Notes”) and the $350 million aggregate principal amount of convertible senior notes that were issued in September 2019 (the “2024 Notes”), we separated the 2020 Notes, 2023 Notes and 2024 Notes into liability (debt) and equity (conversion option) components and we are amortizing as debt discount an amount equal to the fair value of the equity components as interest expense on the 2020 Notes, 2023 Notes and 2024 Notes over their expected lives.

The equity components represent the difference between the proceeds from the issuance of the 2020 Notes, 2023 Notes and 2024 Notes and the fair value of the liability components of the 2020 Notes, 2023 Notes and 2024 Notes, respectively.

Amounts are presented net of interest capitalized for capital projects of $2.7 million and $1.8 million during the three months ended May 1, 2021 and May 2, 2020, respectively.

The 2020 Notes matured on July 15, 2020 and did not impact amortization of debt discount post-maturity.

(b) Represents the amortization of the non-cash compensation charge related to an option grant made to Mr.

Friedman in October 2020.

The adjustment for the three months ended November 2, 2019 is based on our effective tax rate of 13.7%.

The adjustment for the nine months ended October 31, 2020 is based on an adjusted tax rate of 20.8%, which excludes the tax impact associated with the non-cash compensation charge related to an option grant made to Mr.

Friedman in October 2020 and the Waterworks reporting unit tradename impairment recorded in the first quarter of fiscal 2020.

The adjustment for the nine months ended November 2, 2019 is based on an adjusted tax rate of 18.6%, which is calculated using a 21% normalized tax rate for the three months ended May 4, 2019 and August 3, 2019, and the effective tax rate of 13.7% for the three months ended November 2, 2019.

(d) Represents a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders.

(e) Represents tradename impairment related to the Waterworks reporting unit.

Refer to “Waterworks Tradename Impairment” within Note 4— Goodwill, Tradenames, Trademarks and Other Intangible Assets in our condensed consolidated financial statements.

(f) Represents asset impairments of $4.8 million, inventory reserves of $2.4 million related to Outlet inventory resulting from retail closures in response to the COVID-19 pandemic and acceleration of depreciation expense of $1.3 million due to a change in the estimated useful lives of certain assets.

(g) Represents severance costs and related payroll taxes associated with a reorganization undertaken in response to the impact of retail closures on our business.

(h) The adjustment for the three months ended May 1, 2021 is based on an adjusted tax rate of 23.9%, which excludes the tax impact associated with our share of equity method investments losses.

The adjustment for the three months ended May 2, 2020 is based on an adjusted tax rate of 24.3%, which excludes the tax impact associated with the Waterworks reporting unit tradename impairment.

(i) Represents our proportionate share of the losses of our equity method investments.

Refer to Note 5— Equity Method Investments in our condensed consolidated financial statements.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 36

(2) EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP.

We define EBITDA as consolidated net income before depreciation and amortization, interest expense—net and income tax expense.

Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the impact of non-cash compensation, as well as certain non-recurring and other items that we do not consider representative of our underlying operating performance.

EBITDA and Adjusted EBITDA are included in this filing because management believes that these metrics provide meaningful supplemental information for investors regarding the performance of our business and facilitate a meaningful evaluation of operating results on a comparable basis with historical results.

Our management uses these non-GAAP financial measures in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

We define EBITDA as consolidated net income (loss) before depreciation and amortization, interest expense—net and income tax expense (benefit).

Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the impact of non-cash compensation, certain non-recurring, and other items that we do not consider representative of our underlying operating performance.

EBITDA and Adjusted EBITDA are included in this filing because our senior leadership team believes that these metrics provide meaningful supplemental information for investors regarding the performance of our business and facilitate a meaningful evaluation of operating results on a comparable basis with historical results.

Our senior leadership team uses these non-GAAP financial measures in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

Our measures of EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions for other companies due to different methods of calculation .

The following table presents a reconciliation of net income, the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below.

The following table presents a reconciliation of net income (loss), the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below.

THREE MONTHS ENDED

Nine Months Ended

(in thousands)

Net income (loss)

Depreciation and amortization

Interest expense—net

Income tax expense

Income tax expense (benefit)

Non-cash compensation (a)

Share of equity method investments losses (b)

Capitalized cloud computing amortization (c)

Recall accrual (b)

Loss on extinguishment of debt (b)

Tradename impairment (b)

(Gain) loss on sale leaseback transaction (b)

Asset impairment and lease losses (b)

Asset impairments (b)

Reorganization related costs (b)

Recall accrual (b)

(Gain) loss on extinguishment of debt—net (b)

Legal settlements (b)

Asset held for sale gain (b)

Adjusted EBITDA

(a) Represents non-cash compensation related to equity awards granted to employees, including the non-cash compensation charge related to an option grant made to Mr.

Friedman in October 2020.

(b) Refer to the reconciliation of net income to adjusted net income table above and the related footnotes for additional information.

(3) We define adjusted capital expenditures as (i) capital expenditures from investing activities and (ii) cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received.

The following tables present RH Gallery and Waterworks showroom metrics and exclude outlets:

Nine Months Ended

(a) Represents non-cash compensation related to equity awards granted to employees.

(b) Refer to the reconciliation of net income (loss) to adjusted net income table above and the related footnotes for additional information.

(3) We define adjusted capital expenditures as capital expenditures from investing activities and cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 37

The following table presents RH Gallery and Waterworks Showroom metrics, and excludes Outlets:

THREE MONTHS ENDED

SELLING SQUARE

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Beginning of period

RH Design Galleries:

Marin Design Gallery

Charlotte Design Gallery

Minneapolis Design Gallery

RH Modern Galleries:

Dallas RH Modern Gallery (relocation)

RH Baby & Child Galleries:

Dallas RH Baby & Child Gallery

RH Legacy Galleries:

Raleigh legacy Gallery

Charlotte legacy Gallery

Corte Madera legacy Gallery

Westport legacy Gallery

Minneapolis legacy Gallery

Dallas legacy Gallery (relocation)

San Antonio legacy Gallery (relocation)

Waterworks Showrooms:

New York 59th Street Showroom

End of period

2 unchanged sentences

Weighted-average leased selling square footage (3)

(1) Leased selling square footage is retail space at our retail locations used to sell our products.

(1) Leased selling square footage is retail space at our retail locations used to sell our products, as well as space for our Restaurants.

Leased selling square footage excludes backrooms at retail locations used for storage, office space, food preparation, kitchen space or similar purpose, as well as exterior sales space located outside a retail location, such as courtyards, gardens and rooftops.

Leased selling square footage includes approximately 4,800 square feet as of October 31, 2020 related to an owned retail location and approximately 37,700 square feet as of November 2, 2019 related to two owned retail locations.

(2) Total leased square footage includes approximately 5,400 square feet as of October 31, 2020 related to an owned retail location and approximately 48,700 square feet as of November 2, 2019 related to two owned retail locations.

(3) Weighted-average leased square footage and leased selling square footage are calculated based on the number of days a Gallery location was opened during the period divided by the total number of days in the period.

The following table sets forth our condensed consolidated statements of income as a percentage of total net revenues.

Leased selling square footage includes approximately 4,800 square feet as of May 1, 2021 related to one owned retail location and 37,700 square feet as of May 2, 2020 related to two owned retail locations.

(2) Total leased square footage includes approximately 5,400 square feet as of May 1, 2021 related to one owned retail location and 48,700 square feet as of May 2, 2020 related to two owned retail locations.

(3) Weighted-average leased square footage and leased selling square footage are calculated based on the number of days a retail location was opened during the period divided by the total number of days in the period.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 38

The following table sets forth our condensed consolidated statements of operations as a percentage of total net revenues:

THREE MONTHS ENDED

Nine Months Ended

Condensed Consolidated Statements of Income:

Condensed Consolidated Statements of Operations:

Cost of goods sold

4 unchanged sentences

Tradename impairment

Gain on extinguishment of debt

Loss on extinguishment of debt

Total other expenses

Income before income taxes

Income tax expense

Three Months Ended October 31, 2020 Compared to Three Months Ended November 2, 2019

Income (loss) before income taxes

Income tax expense (benefit)

Income (loss) before equity method investments

Share of equity method investments losses

Net income (loss)

Three Months Ended May 1, 2021 Compared to Three Months Ended May 2, 2020

THREE MONTHS ENDED

2 unchanged sentences

Selling, general and administrative expenses

Income from operations

Consolidated net revenues increased $166.5 million, or 24.6%, to $844.0 million in the three months ended October 31, 2020 compared to $677.5 million in the three months ended November 2, 2019.

RH Segment net revenues for the three months ended October 31, 2020 were negatively impacted by $0.8 million related to the reduction of revenue associated with product recalls.

RH Segment net revenues for the three months ended November 2, 2019 were favorably impacted by $0.8 million related to product recalls.

Excluding the product recall adjustments, consolidated net revenues increased $168.1 million, or 24.8%, to $844.8 million in the three months ended October 31, 2020 compared to $676.7 million in the three months ended November 2, 2019.

Product recalls and the establishment or adjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of our results.

No assurance can be provided that any accruals will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time, which could further affect results.

Income (loss) from operations

Consolidated net revenues increased $377.9 million, or 78.3%, to $860.8 million in the three months ended May 1, 2021 compared to $482.9 million in the three months ended May 2, 2020.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 39

RH Segment net revenues

RH Segment net revenues increased $167.4 million, or 25.9%, to $812.8 million in the three months ended October 31, 2020 compared to $645.4 million in the three months ended November 2, 2019.

The below discussion highlights several significant factors that resulted in an increase in RH Segment net revenues, which are listed in order of magnitude.

RH Segment net revenues for the three months ended October 31, 2020 was driven primarily by a strong increase in customer demand for our products during the three months ended October 31, 2020.

The growth in revenue was lower than the growth in customer demand for our products during the three month period primarily due to the effects of increased demand on our supply chain.

It may take several quarters for inventory receipts and manufacturing to catch up to the increase in customer demand.

RH Segment net revenues increased $364.9 million, or 80.2%, to $819.8 million in the three months ended May 1, 2021 compared to $455.0 million in the three months ended May 2, 2020.

The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude.

RH Segment net revenues for the three months ended May 1, 2021 was driven by strong customer demand for our products.

RH Segment net revenues for the three months ended May 2, 2020 was negatively impacted by Gallery closures and macroeconomic conditions resulting from the COVID-19 pandemic in March and April of 2020.

Outlet sales increased $50.1 million to $62.3 million in the three months ended May 1, 2021 compared to $12.2 million in the three months ended May 2, 2020 due to pandemic related retail closures in the first quarter of fiscal 2020.

Additionally, RH Segment net revenues increased in our Contract business driven by increased commercial purchasing activities and in our RH Hospitality business as COVID-19 operating restrictions continued to ease during the quarter.

Despite our revenue growth during the three month period, the growth in demand outpaced the growth in revenue for our products primarily due to the effects of higher than anticipated consumer demand and disruptions across our global supply chain related to the pandemic, including difficulties in ramping vendor production, as well as delays in shipments of products.

Waterworks net revenues

Waterworks net revenues decreased $0.9 million, or 2.9%, to $31.2 million in the three months ended October 31, 2020 compared to $32.1 million in the three months ended November 2, 2019 primarily due to construction delays, which negatively impacted demand, as well as temporary showroom COVID-19 related closures.

Consolidated gross profit increased $124.2 million, or 43.7%, to $408.3 million in the three months ended October 31, 2020 compared to $284.2 million in the three months ended November 2, 2019.

As a percentage of net revenues, consolidated gross margin increased 6.5% to 48.4% of net revenues in the three months ended October 31, 2020 from 41.9% of net revenues in the three months ended November 2, 2019.

Waterworks net revenues increased $13.0 million, or 46.6%, to $41.0 million in the three months ended May 1, 2021 compared to $27.9 million in the three months ended May 2, 2020 due to an increase in demand related to resumed construction activity and significant residential investments by high-end homeowners.

Waterworks net revenues for the three months ended May 2, 2020 was negatively impacted by construction delays, as well as temporary showroom closures, in response to the pandemic.

Consolidated gross profit increased $207.3 million, or 103.8%, to $407.0 million in the three months ended May 1, 2021 compared to $199.7 million in the three months ended May 2, 2020.

As a percentage of net revenues, consolidated gross margin increased 600 basis points to 47.3% of net revenues in the three months ended May 1, 2021 from 41.3% of net revenues in the three months ended May 2, 2020.

RH Segment gross profit for the three months ended May 2, 2020 includes inventory reserves of $2.4 million related to Outlet inventory resulting from retail closures in response to the pandemic.

Excluding the inventory reserves adjustment mentioned above, consolidated gross margin would have increased 550 basis points to 47.3% of net revenues in the three months ended May 1, 2021 from 41.8% of net revenues in the three months ended May 2, 2020.

RH Segment gross profit

RH Segment gross profit increased $124.0 million, or 45.8%, to $394.7 million in the three months ended October 31, 2020 from $270.7 million in the three months ended November 2, 2019.

As a percentage of net revenues, RH Segment gross margin increased 6.7% to 48.6% of net revenues in the three months ended October 31, 2020 from 41.9% of net revenues in the three months ended November 2, 2019.

RH Segment gross profit for the three months ended October 31, 2020 was negatively impacted by $0.8 million related to product recalls and RH Segment gross profit for the three months ended November 2, 2019 was favorably impacted by $1.8 million related to reserve adjustments associated with product recalls initiated in prior years.

Excluding the product recall adjustments mentioned above, RH Segment gross margin would have increased 6.9% to 48.6% of net revenues in the three months ended October 31, 2020 from 41.7% of net revenues in the three months ended November 2, 2019.

The increase was primarily driven by price increases and product mix, as well as higher product margins in select categories in our Core business.

Additionally, we had lower Outlet promotional activity during the period and experienced leverage in our RH Segment occupancy costs.

RH Segment gross profit increased $198.8 million, or 105.9%, to $386.6 million in the three months ended May 1, 2021 from $187.8 million in the three months ended May 2, 2020.

As a percentage of net revenues, RH Segment gross margin increased 590 basis points to 47.2% of net revenues in the three months ended May 1, 2021 from 41.3% of net revenues in the three months ended May 2, 2020.

Excluding the inventory reserves adjustment mentioned above related to the first quarter of fiscal 2020, RH Segment gross margin would have increased 540 basis points to 47.2% of net revenues in the three months ended May 1, 2021 from 41.8% of net revenues in the three months ended May 2, 2020.

The increase in gross margin was primarily driven by price increases and product mix in our Core business.

Additionally, we drove higher Outlet margins through price increases and leveraged our RH Segment occupancy costs during the three month period ended May 1, 2021.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 40

Waterworks gross profit

Waterworks gross profit increased $0.2 million, or 1.5%, to $13.6 million in the three months ended October 31, 2020 from $13.4 million in the three months ended November 2, 2019.

As a percentage of net revenues, Waterworks gross margin increased 1.9% to 43.7% of net revenues in the three months ended October 31, 2020 from 41.8% of net revenues in the three months ended November 2, 2019.

Waterworks gross profit increased $8.5 million, or 71.7%, to $20.4 million in the three months ended May 1, 2021 from $11.9 million in the three months ended May 2, 2020.

As a percentage of net revenues, Waterworks gross margin increased 730 basis points to 49.9% of net revenues in the three months ended May 1, 2021 from 42.6% of net revenues in the three months ended May 2, 2020 primarily driven by higher revenues, favorable changes in product mix, and improved efficiency in the Waterworks supply chain.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $102.2 million, or 52.4%, to $297.1 million in the three months ended October 31, 2020 compared to $194.9 million in the three months ended November 2, 2019, primarily due to a non-cash compensation of $111.2 million related to an option grant made to Mr.

Friedman in October 2020.

Consolidated selling, general and administrative expenses increased $54.9 million, or 33.4%, to $219.1 million in the three months ended May 1, 2021 from $164.2 million in the three months ended May 2, 2020.

RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $103.4 million, or 56.7%, to $285.7 million in the three months ended October 31, 2020 compared $182.3 million in the three months ended November 2, 2019.

RH Segment selling, general and administrative expenses for the three months ended October 31, 2020 includes a non-cash compensation of $111.2 million due to an option grant made to Mr.

Friedman in October 2020, $1.3 million due to accelerated asset depreciation and $0.8 million due to asset impairments.

RH Segment selling, general and administrative expenses for the three months ended November 2, 2019 include reorganization related costs of $1.1 million and asset impairments of $1.0 million, partially offset by gain of $1.5 million related to a sale leaseback transaction, gain on asset held for sale of $0.3 million and $0.3 million related to product recalls.

Excluding the option grant made to Mr.

Friedman, accelerated asset depreciation, asset impairments, reorganization costs, gain on sale leaseback transaction and product recalls mentioned above, RH Segment selling, general and administrative expenses were 21.2% and 28.2% of net revenues for the three months ended October 31, 2020 and November 2, 2019, respectively.

The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by a reduction in advertising costs due to our decision to not mail the Fall 2020 Source Books, leverage in employment and employment related costs, and travel related expenses, partially offset by increased professional fees, incremental COVID-19 related expenses, preopening costs and other corporate expenses.

RH Segment selling, general and administrative expenses increased $55.1 million, or 36.9%, to $204.4 million in the three months ended May 1, 2021 compared $149.3 million in the three months ended May 2, 2020.

RH Segment selling, general and administrative expenses for the three months ended May 1, 2021 included amortization of the non-cash compensation of $5.9 million related to the option grant made to Mr.

Friedman in October 2020.

RH Segment selling, general and administrative expenses for the three months ended May 2, 2020 included $4.1 million in severance costs and related payroll taxes associated with the termination of associates and a reorganization undertaken in response to the impact of retail closures on our business, $3.2 million related to asset impairments and $1.3 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets.

RH Segment selling, general and administrative expenses were 24.2% and 30.9% of net revenues for the three months ended May 1, 2021 and May 2, 2020, respectively, excluding the costs incurred in connection with the adjustments mentioned above.

The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by leverage in employment and employment related costs, advertising and corporate occupancy costs.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses decreased $1.2 million, or 9.4%, to $11.4 million in the three months ended October 31, 2020 compared to $12.6 million in the three months ended November 2, 2019.

Waterworks selling, general and administrative expenses were 36.6% and 39.3% of net revenues for the three months ended October 31, 2020 and November 2, 2019, respectively.

Waterworks selling, general and administrative expenses decreased $0.2 million, or 1.6%, to $14.7 million in the three months ended May 1, 2021 compared to $14.9 million in the three months ended May 2, 2020.

Waterworks selling, general and administrative expenses for the three months ended May 1, 2021 included $0.5 million related to product recall and for the three months ended May 2, 2020 included $1.6 million related to asset impairments.

Waterworks selling, general and administrative expenses were 34.6% and 47.8% of net revenues for the three months ended May 1, 2021 and May 2, 2020, respectively, excluding the adjustments mentioned above.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 41

Interest expense—net

Interest expense—net decreased $5.9 million to $15.7 million for the three months ended October 31, 2020 compared to $21.6 million for the three months ended November 2, 2019.

Interest expense—net consisted of the following:

Interest expense—net decreased $6.3 million in the three months ended May 1, 2021 compared to the three months ended May 2, 2020, which consisted of the following in each period:

THREE MONTHS ENDED

2 unchanged sentences

Finance lease interest expense

Promissory notes

Amortization of debt issuance costs and deferred financing fees

Other interest expense

Asset based credit facility

Capitalized interest for capital projects

Interest income

Total interest expense—net

(Gain) loss on extinguishment of debt —net

We did not incur any gain or loss on extinguishment of debt in the three months ended October 31, 2020.

We incurred a $6.9 million loss on extinguishment of debt in the three months ended November 2, 2019 primarily due to the repayment in full of the Second Lien Term Loan in September 2019, which resulted in a prepayment penalty of $4.0 million and acceleration of amortization of debt issuance costs of $2.7 million.

Additionally, $0.2 million of accelerated debt issuance costs were recorded related to the early repayment of a portion of the FILO term loan in the three months ended November 2, 2019.

Income tax expense

Income tax expense was $49.2 million and $8.4 million in the three months ended October 31, 2020 and November 2, 2019, respectively.

Our effective tax rate was 51.4% and 13.7% for the three months ended

October 31, 2020 and November 2, 2019, respectively.

The increase in our effective tax rate 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.

Nine Months Ended October 31, 2020 Compared to Nine Months Ended November 2, 2019

Nine Months Ended

(in thousands)

Cost of goods sold

Selling, general and administrative expenses

Income (loss) from operations

Consolidated net revenues increased $53.7 million, or 2.7%, to $2,036.2 million in the nine months ended October 31, 2020 compared to $1,982.5 million in the nine months ended November 2, 2019.

RH Segment net revenues for the nine months ended October 31, 2020 were negatively impacted by $1.2 million related to product recalls.

RH Segment net revenues for the nine months ended November 2, 2019 were favorably impacted by $0.4 million related to product recalls.

Excluding the product recall adjustments, consolidated net revenues increased $55.3 million, or 2.8%, to $2,037.4 million in the nine months ended October 31, 2020 compared to $1,982.1 million in the nine months ended November 2, 2019.

Product recalls and the establishment or adjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of our results.

RH Segment net revenues

RH Segment net revenues increased $67.7 million, or 3.6%, to $1,949.1 million in the nine months ended October 31, 2020 compared to $1,881.4 million in the nine months ended November 2, 2019.

The below discussion highlights several significant factors that resulted in an increase in RH Segment net revenues, which are listed in order of magnitude.

RH Segment net revenues for the nine months ended October 31, 2020 increased due to strong customer demand for our products primarily during the third quarter of fiscal 2020, offsetting the negative impact to overall customer demand in our business due to macroeconomic conditions resulting from COVID-19 primarily during March and April of 2020.

Outlet sales decreased $43.6 million to $126.6 million in the nine months ended October 31, 2020 compared to $170.2 million in the nine months ended November 2, 2019 due to COVID-19 related closures and a reduction in promotional activity.

RH Segment net revenues also decreased in our Contract business and RH Hospitality operations due to COVID-19 related factors including a slowdown in commercial purchasing activities, as well as closures and reduced capacity in our RH Hospitality locations.

Waterworks net revenues

Waterworks net revenues decreased $14.0 million, or 13.8%, to $87.1 million in the nine months ended October 31, 2020 compared to $101.0 million in the nine months ended November 2, 2019 primarily due to construction delays, which negatively impacted demand, as well as temporary showroom COVID-19 related closures.

Consolidated gross profit increased $128.5 million, or 15.8%, to $940.4 million in the nine months ended October 31, 2020 from $811.9 million in the nine months ended November 2, 2019.

As a percentage of net revenues, consolidated gross margin increased 5.2% to 46.2% of net revenues in the nine months ended October 31, 2020 from 41.0% of net revenues in the nine months ended November 2, 2019.

RH Segment gross profit for the nine months ended October 31, 2020 was negatively impacted by $5.6 million related to product recalls and includes inventory reserves of $2.4 million related to Outlet inventory buildup resulting from retail closures in response to the COVID-19 pandemic.

RH Segment gross profit for the nine months ended November 2, 2019 was negatively impacted by $4.9 million related to the acceleration of depreciation due to a change in the estimated useful lives of certain assets and was favorably impacted by $3.8 million related to reserve adjustments associated with product recalls initiated in prior years.

Excluding the product recall, inventory reserves and accelerated depreciation adjustments mentioned above, consolidated gross margin would have increased 5.5% to 46.5% of net revenues in the nine months ended October 31, 2020 from 41.0% of net revenues in the nine months ended November 2, 2019.

RH Segment gross profit

RH Segment gross profit increased $133.8 million, or 17.4%, to $902.9 million in the nine months ended October 31, 2020 from $769.1 million in the nine months ended November 2, 2019.

As a percentage of net revenues, RH Segment gross margin increased 5.4% to 46.3% of net revenues in the nine months ended October 31, 2020 from 40.9% of net revenues in the nine months ended November 2, 2019.

Excluding the product recall, inventory reserves and acceleration of depreciation adjustments mentioned above, RH Segment gross margin would have increased 5.7% to 46.7% of net revenues in the nine months ended October 31, 2020 from 41.0% of net revenues in the nine months ended November 2, 2019.

The increase was primarily driven by price increases and product mix, as well as higher product margins in select categories in our Core business.

Additionally, we had lower Outlet promotional activity during the period and experienced leverage in our RH Segment occupancy costs.

Waterworks gross profit

Waterworks gross profit decreased $5.3 million, or 12.5%, to $37.5 million in the nine months ended October 31, 2020 from $42.8 million in the nine months ended November 2, 2019.

As a percentage of net revenues, Waterworks gross margin increased 0.6% to 43.0% of net revenues in the nine months ended October 31, 2020 from 42.4% of net revenues in the nine months ended November 2, 2019.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $107.1 million, or 19.5%, to $657.2 million in the nine months ended October 31, 2020 compared to $550.1 million in the nine months ended November 2, 2019, primarily due to a non-cash compensation of $111.2 million related to an option grant made to Mr.

Friedman in October 2020.

RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $110.3 million, or 21.6%, to $620.4 million in the nine months ended October 31, 2020 compared to $510.1 million in the nine months ended November 2, 2019.

RH Segment selling, general and administrative expenses for the nine months ended October 31, 2020 includes a non-cash compensation of $111.2 million due to an option grant made to Mr.

Friedman in October 2020, loss of $9.4 million related to a sale leaseback transaction, $7.0 million related to severance costs and related payroll taxes associated with the termination of associates and a reorganization undertaken in response to the impact of retail closures on our business, $5.6 million related to asset impairments and $3.9 million due to accelerated asset depreciation.

RH Segment selling, general and administrative expenses for the nine months ended November 2, 2019 included asset impairments of $2.1 million and reorganization related costs of $1.1 million, partially offset by gain of $1.5 million related to a sale leaseback transaction, a favorable $1.2 million legal settlement related to historical freight charges, gain on asset held for sale of $0.3 million and $0.2 million related to product recalls.

Excluding the option grant made to Mr.

Friedman in October 2020, gain and loss on sale leaseback transactions, reorganization costs, asset impairments, accelerated depreciation, gain on asset held for sale, legal settlement and product recall adjustments mentioned above, RH Segment selling, general and administrative expenses were 24.9% and 27.1% of net revenues for the nine months ended October 31, 2020 and November 2, 2019, respectively.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses decreased $3.2 million, or 8.1%, to $36.7 million in the nine months ended October 31, 2020 compared to $40.0 million in the nine months ended November 2, 2019.

Waterworks selling, general and administrative expenses for the nine months ended October 31, 2020 included $1.6 million related to asset impairments.

Waterworks selling, general and administrative expenses were 40.4% and 39.6% of net revenues for the nine months ended October 31, 2020 and November 2, 2019, respectively, excluding the asset impairments.

Interest expense—net

Interest expense—net decreased $12.5 million to $54.7 million for the nine months ended October 31, 2020 compared to $67.2 million for the nine months ended November 2, 2019.

Interest expense—net consisted of the following:

Nine Months Ended

(in thousands)

Amortization of convertible senior notes debt discount

Finance lease interest expense

Promissory notes

Amortization of debt issuance costs and deferred financing fees

Other interest expense

Asset based credit facility

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Total interest expense—net

(Gain) loss on extinguishment of debt —net

We recognized a $0.2 million gain on extinguishment of debt in the nine months ended October 31, 2020 related to the maturity and settlement of the 2020 Notes in July 2020.

We incurred a $5.9 million loss on extinguishment of debt in the nine months ended November 2, 2019 primarily due to the repayment in full of the Second Lien Term Loan in September 2019, which resulted in a prepayment penalty of $4.0 million and acceleration of amortization of debt issuance costs of $2.7 million.

In addition, we recognized a $1.0 million gain on extinguishment of debt in the nine months ended November 2, 2019 due to the maturity and settlement of the 2019 Notes in June 2019 and a $0.2 million loss due to accelerated debt issuance costs related to the early repayment of a portion of the FILO term loan.

Income tax expense

Income tax expense was $66.6 million and $36.8 million in the nine months ended October 31, 2020 and November 2, 2019, respectively.

Our 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 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.

Tradename impairment

We incurred a $20.5 million tradename impairment charge during the three months ended May 2, 2020 for our Waterworks reporting unit.

Refer to “Waterworks Tradename Impairment” within Note 4— Goodwill, Tradenames, Trademarks and Other Intangible Assets .

Loss on extinguishment of debt

During the three months ended May 1, 2021 we recognized a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders of $0.1 million.

Income tax expense (benefit)

Our income tax expense was $41.7 million and our income tax benefit was $1.4 million in the three months ended May 1, 2021 and May 2, 2020, respectively.

Our 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 our effective tax rate 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.

Equity method investments losses

Equity method investments losses consists of our proportionate share of the losses of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $2.1 million loss during the three months ended May 1, 2021.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 42

Liquidity and Capital Resources

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We seek out and evaluate opportunities for effectively managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies.

In fiscal 2017, we completed two share repurchase programs in an aggregate amount of $1 billion.

A $300 million share repurchase was completed during the first quarter of fiscal 2017 and a $700 million share repurchase was completed during the second quarter of fiscal 2017.

In October 2018, our Board of Directors approved a new $700 million share repurchase program, of which $250 million in share repurchases were completed in fiscal 2018, and the $700 million authorization amount was replenished by the Board of Directors in March 2019.

During the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock for an aggregate repurchase amount of approximately $250 million, with $450 million still available under the $700 million repurchase program.

In the past we have pursued substantial repurchases of our common stock when we believed that such investments represented a good long term investment for the benefit of our shareholders.

Refer to “Share Repurchase Programs” below.

We evaluate our capital allocation from time to time and may engage in future share repurchases in circumstances where buying shares of our common stock represents a good value and provides a favorable return for our shareholders.

We have $685 million in aggregate principal amount of convertible notes outstanding as of October 31, 2020, of which $335 million mature in June 2023 (the “2023 Notes”) and $350 million mature in September 2024 (the “2024 Notes”).

Based on the anticipated strong cash flow generation in 2020 and beyond, we expect to repay the outstanding principal amount of our convertible notes at maturity in June 2023 and September 2024 in cash, in each case to minimize dilution.

We evaluate our capital allocation from time to time and may engage in future investments in connection with existing or new share repurchase programs in circumstances where buying shares of our common stock or related investments, which may include investments in derivatives or other equity linked instruments, represent a good value and provides a favorable return for our shareholders.

We have in the past been opportunistic in responding to favorable market conditions regarding both sources and uses of capital.

Our use of convertible notes financings has enabled us to pursue various investments, such as our share repurchase programs which we consider to have been an excellent allocation of capital for the benefit of our shareholders.

We regularly evaluate various debt and other financing alternatives, including convertible notes and other equity-linked instruments.

Financing that we arrange through the sale of equity linked instruments such as our convertible notes financings may lead to substantial dilution to our investors if the price of our common stock exceeds the upper strike exercise price of the warrants in connection with our bond hedge transactions, which has been the case in connection with our convertible notes which matured in 2019 and 2020.

At the same time, the investments we have previously made in connection with our share repurchase programs have more than offset the amount of dilution we experienced in relation to these warrants.

We expect to continue to take an opportunistic approach regarding both sources and uses of capital in connection with our business.

We have $683 million remaining in aggregate principal amount of convertible notes outstanding as of May 1, 2021, of which $31 million of the 2023 Notes will be settled in July 2021 due to early conversions at the option of the noteholders, $302 million of the 2023 Notes will mature in June 2023 (absent further early conversion elections) and $350 million of the 2024 Notes will mature in September 2024 (absent any early conversion elections with respect thereto).

Based on the strong cash flow generated in 2020 and continued strong cash flow anticipated in future years, we expect to repay the outstanding principal amount of our convertible notes at maturity in June 2023 and September 2024 in cash, in each case to minimize dilution.

Likewise, we expect to pay the principal amount in cash with respect to any convertible notes for which the holder elects early conversion of such convertible notes in order to minimize dilution.

While we purchased convertible note hedges and sold warrants with respect to each convertible note transaction, which are intended to offset any actual earnings dilution from the conversion of the 2024 Notes until our common stock is above approximately $338.24 per share and from the conversion of the 2023 Notes until our common stock is above approximately $309.84 per share, our shareholders may still experience dilution to the extent our common stock trades above such levels.

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Our business has historically relied on cash flows from operations, net cash proceeds from the issuance of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity.

We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt

obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months.

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.

We continue to closely manage our business and our investments while considering both the overall economic environment as well as the needs of our operations.

In addition, our near term decisions regarding the sources and uses of capital will continue to reflect and adapt to changes in market conditions and our business including further developments with respect to the pandemic.

We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 43

In recognition of the significant threat to economic conditions and the liquidity of financial markets posed by COVID-19, the Federal Reserve and Congress have taken dramatic actions to provide liquidity to businesses and the banking system in the U.S.

For example, on March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), a sweeping stimulus bill intended to bolster the U.S.

economy, among other things, and provide emergency assistance to qualifying businesses and individuals.

There can be no assurance that these interventions by the government will be successful, and the financial markets may experience significant contractions in available liquidity.

While we may receive financial, tax or other relief and other benefits under and as a result of the CARES Act, it is not possible to estimate at this time the availability, extent or impact of any future relief.

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

We extended and amended our asset based credit facility in June 2017, which has a total availability of $600 million, of which $10 million is available to Restoration Hardware Canada, Inc., and includes a $200 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600 million to up to $800 million if and to the extent the lenders revise their credit commitments to encompass a larger facility.

The revolving line of credit has a maturity date of June 28, 2022.

In fiscal 2019 we executed a sale-leaseback transaction for the Yountville Design Gallery for sales proceeds of $23.5 million and in July 2020 we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $25.5 million, both of which qualified for sale-leaseback accounting in accordance with ASC 842.

We may pursue strategies in the future, through the use of existing assets and debt facilities, or through the pursuit of new external sources of liquidity and debt financing, to fund our strategies to enhance stockholder value.

There can be no assurance that additional capital, whether raised through the sale of assets, utilization of our existing debt financing sources, or pursuit of additional debt financing sources, will be available to us on a timely manner, on favorable terms or at all.

To the extent we pursue additional debt as a source of liquidity, our capitalization profile may change and may include significant leverage, and as a result we may be required to use future liquidity to repay such indebtedness and may be subject to additional terms and restrictions which affect our operations and future uses of capital.

While we do not require additional debt to fund our operations, our goal continues to be in a position to take advantage of the many opportunities that we identify in connection with our business and operations.

We have pursued in the past, and may pursue in the future, additional strategies to generate capital to pursue opportunities and investments, including through the strategic sale of existing assets, utilization of our credit facilities, entry into various second lien credit agreements and other new debt financing arrangements that present attractive terms.

In addition to funding the normal operations of our business, we have used our liquidity to fund significant investments and strategies such as our share repurchase programs, various acquisitions and growth initiatives, including through joint ventures and real estate investments.

For example, in fiscal 2019 we executed a sale-leaseback transaction for the Yountville Design Gallery for sales proceeds of $23.5 million and in fiscal 2020 we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $25.5 million, both of which qualified for sale-leaseback accounting in accordance with ASC 842.

In addition, our capital needs and uses of capital may change in the future due to changes in our business or new opportunities that we choose to pursue.

We have invested significant capital expenditures in remodeling and opening new Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future periods as we open additional Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings.

Our adjusted capital expenditures include (i) capital expenditures from investing activities and (ii) cash outflows of capital related to construction activities to design and build landlord leased assets, net of tenant allowances received.

We anticipate our adjusted capital expenditures, net of asset sales, to be $140 million to

$160 million in fiscal 2020, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments.

During the nine months ended October 31, 2020, adjusted capital expenditures were $116.7 million, net of cash received related to landlord tenant allowances of $10.2 million.

Our fiscal 2020 adjusted capital expenditures are partially offset by net proceeds from sales of assets of $25.0 million.

We have invested significant capital expenditures in developing and opening new Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future periods as we open additional Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings.

Our adjusted capital expenditures include capital expenditures from investing activities and cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received.

We anticipate our adjusted capital expenditures to be $250 million to $300 million in fiscal 2021, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments.

During the three months ended May 1, 2021, adjusted capital expenditures were $63.8 million, net of cash received related to landlord tenant allowances of $5.9 million.

Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us.

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As we develop new Galleries, as well as other potential strategic initiatives in the future like our integrated hospitality experience, we may explore other models for our real estate, which could include longer lease terms or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated with new sites and buildings.

These approaches might require greater capital investment on our part than a traditional store lease with a landlord.

These approaches might require different levels of capital investment on our part than a traditional store lease with a landlord.

We also believe there is an opportunity to transition our real estate strategy from a leasing model to a development model, where we potentially buy and develop our Design Galleries then recoup the investments through a sale-leaseback arrangement resulting in lower capital investment and lower rent.

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In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurances that we will be successful in securing additional funding on attractive terms or at all.

In addition, we continue to address the effects of COVID-19 on our business with respect to real estate development and the introduction of new Galleries in both the US and internationally.

A range of factors involved in the development of new Gallery and RH Hospitality may be affected by the COVID-19 health crisis including delays in construction as well as permitting and other necessary governmental actions.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 44

In addition, we continue to address the effects of the pandemic on our business with respect to real estate development and the introduction of new Galleries in both the US and internationally.

A range of factors involved in the development of new Gallery and RH Hospitality may continue to be affected by the pandemic including delays in construction as well as permitting and other necessary governmental actions.

In addition, the scope and cadence of investments by third parties including landlords and other real estate counterparties may be adversely affected by the health crisis.

Actions taken by international as well as federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the outbreak, may require changes to our real estate strategy and related capital expenditure and financing plans.

In addition, we may continue to be required to make lease payments in whole or in part for our Galleries, restaurants and outlets that were temporarily closed or are required to close in the future in the event of future COVID-19 outbreaks or for other reasons.

Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from COVID-19, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence.

There can be no assurance that we will have sufficient financial resources, or will be able to arrange financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental debt will be available to us in order to fund our cash payments in respect of the repayment of our outstanding convertible senior notes in an aggregate principal amount of $685 million at maturity of such senior convertible notes.

Actions taken by international as well as federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the pandemic, may require changes to our real estate strategy and related capital expenditure and financing plans.

In addition, we may continue to be required to make lease payments in whole or in part for our Galleries, Outlets and Restaurants that were temporarily closed or are required to close in the future in the event of resurgences in COVID-19 outbreaks or for other reasons.

Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from the pandemic, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence.

There can be no assurance that we will have sufficient financial resources, or will be able to arrange financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental debt will be available to us in order to fund our cash payments in respect of the repayment of the remaining outstanding convertible senior notes in an aggregate principal amount of $683 million at maturity or early conversion of such senior convertible notes.

To the extent we need to secure additional sources of liquidity, we cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future financing requirements would not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock.

Any adverse developments in the U.S.

or global credit markets as a result of COVID-19 could affect our ability to manage our debt obligations and our ability to access future debt.

or global credit markets as a result of the pandemic or any other reason could affect our ability to manage our debt obligations and our ability to access future debt.

In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such senior notes.

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A summary of operating, investing, and financing activities is set forth in the following table:

Nine Months Ended

THREE MONTHS ENDED

(in thousands)

Net cash provided by operating activities

Net cash provided by (used in) operating activities

Net cash used in investing activities

Net cash used in financing activities

Net increase in cash and cash equivalents and restricted cash equivalents

Net cash provided by (used in) financing activities

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

Cash and cash equivalents and restricted cash equivalents at end of period

Net Cash Provided By Operating Activities

Operating activities consist primarily of net income adjusted for non-cash items including depreciation and amortization, impairments, stock-based compensation, amortization of debt discount and the effect of changes in working capital and other activities.

For the nine months ended October 31, 2020, net cash provided by operating activities was $347.3 million and consisted of net income of $141.6 million and non-cash items of $266.3 million, partially offset by cash used for working capital and other activities of $60.7 million.

Working capital and other activities consisted primarily of an increase in merchandise inventory of $57.8 million, an increase in prepaid expenses and other assets of $47.3 million, an increase in landlord assets under construction of $44.9 million, a decrease in operating lease liabilities of $36.8 million primarily due to payments made under the related lease agreements, and a decrease in other non-current obligations of $20.8 million.

These decreases in working capital were partially offset by increases in deferred revenue and customer deposits of $111.4 million primarily due to strong consumer demand for our products during the second and third fiscal quarters of 2020.

For the nine months ended November 2, 2019, net cash provided by operating activities was $211.0 million and consisted of net income of $151.9 million and non-cash items of $127.3 million, partially offset by a decrease in cash used for working capital and other activities of $68.3 million.

Working capital and other activities consisted primarily of decreases in operating lease liabilities of $61.9 million primarily due to payments made under the related lease agreements, decreases in other current liabilities of $53.0 million, increases in landlord assets under construction of $49.4 million, decreases in accounts payable and accrued expense of $41.5 million related to timing of payments, as well as decreases in other non-current liabilities of $19.1 million.

These decreases to working capital were partially offset by decreases in merchandise inventories of $102.8 million.

Net Cash Provided By (Used In) Operating Activities

Operating activities consist primarily of net income (loss) adjusted for non-cash items including depreciation and amortization, impairments, stock-based compensation, amortization of debt discount and the effect of changes in working capital and other activities.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 45

For the three months ended May 1, 2021, net cash provided by operating activities was $190.9 million and consisted of net income of $130.7 million and an increase in non-cash items of $71.1 million, partially offset by a change in working capital and other activities of $10.9 million.

The source of cash from working capital was primarily driven by an increase in deferred revenue and customer deposits of $82.7 million primarily due to strong consumer demand for our products and an increase in other current liabilities of $42.0 million.

These sources of cash from working capital were partially offset by uses of cash driven by an increase in merchandise inventory of $49.5 million, a decrease in accounts payable and accrued expenses of $32.3 million, a decrease in operating lease liabilities of $19.4 million primarily due to payments made under the related lease agreements, an increase in landlord assets under construction of $13.6 million and an increase in prepaid expenses and other assets of $12.6 million.

For the three months ended May 2, 2020, net cash used in operating activities was $16.9 million and consisted of an increase in cash used for working capital and other activities of $105.3 million and a net loss of $3.2 million, partially offset by non-cash items of $91.7 million.

The uses of cash from working capital and other activities consisted primarily of increases in merchandise inventories of $55.8 million and decreases in accounts payable and accrued expense of $53.0 million related to timing of payments.

These uses of cash from working capital were partially offset by sources of cash driven by increases in deferred revenues and customer deposits of $26.7 million.

Net Cash Used In Investing Activities

Investing activities consist primarily of investments in capital expenditures related to investments in retail stores, information technology and systems infrastructure, as well as supply chain investments.

Investing activities also include strategic investments made by the Company.

For the nine months ended October 31, 2020, net cash used in investing activities was $67.3 million primarily due to investments in retail stores, information technology and systems infrastructure, and supply chain of $57.6 million, as well as the acquisition of building and land assets of $14.2 million.

In August 2020, we completed the acquisition of a business and paid $13.1 million of the $15.0 million purchase price in the nine months ended October 31, 2020.

In addition, we made $7.5 million of investments in joint ventures in the nine months ended October 31, 2020.

Net cash used in investing activities was partially offset by net proceeds from the sale of building and land of $25.0 million.

For the nine months ended November 2, 2019, net cash used in investing activities was $70.5 million, of which $64.6 million related to investments in retail stores, information technology and systems infrastructure, and supply chain.

In addition, we made a deposit on an asset under construction of $30.0 million, offset by net proceeds from the sale of building and land of $24.1 million in the nine months ended November 2, 2019.

Net Cash Used In Financing Activities

Financing activities consist primarily of borrowings related to convertible senior notes, credit facilities and other financing arrangements, as well as share repurchases, principal payments under finance lease agreements and other equity related transactions.

For the nine months ended October 31, 2020, net cash used in financing activities was $230.8 million.

The $300 million 2020 Notes matured in July 2020, of which $215.8 million is presented within net cash used in financing activities and $84.0 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities.

Net cash used in financing activities also included repayments under promissory and equipment notes of $10.9 million.

For the nine months ended November 2, 2019, net cash used in financing activities was $108.0 million.

The $350.0 million 2019 Notes matured in June 2019, of which $278.6 million is presented within net cash used in financing activities and $70.5 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash provided by operating activities.

Net cash used in financing activities included repurchases of approximately 2.2 million shares of our common stock for an aggregate repurchase amount of $250.0 million, as well as net repayments of $57.5 million under the asset based credit facility.

Net cash used in financing activities include borrowings under a $350.0 million convertible senior notes agreement issued in September 2019, which provided net proceeds of $304.1 million after taking into consideration the convertible note hedge and warrant transactions, as well as discounts upon original issuance and offering costs.

Borrowings under finance arrangements also include net borrowings under the FILO term loan of $90.0 million, $58.7 million of promissory notes secured by certain equipment, and $30.0 million related to a promissory note on an asset under construction.

Investing activities also include our strategic investments.

For the three months ended May 1, 2021, net cash used in investing activities was $51.4 million and was comprised of investments in retail stores, information technology and systems infrastructure of $50.3 million and additional funding of our equity method investments of $1.2 million.

For the three months ended May 2, 2020, net cash used in investing activities was $16.6 million and was comprised of investments in retail stores, information technology and systems infrastructure.

Net Cash Provided By (Used In) Financing Activities

Financing activities consist primarily of borrowings related to convertible senior notes, credit facilities and other financing arrangements, and cash used in connection with such financing activities include investments in share repurchase programs, repayment of indebtedness including principal payments under finance lease agreements and other equity related transactions such as the convertible note bond hedge and warrant transactions in connection with our convertible notes financings.

For the three months ended May 1, 2021, net cash used in financing activities was $11.0 million, primarily due to repayments of $5.8 million on equipment notes and principal payments under finance lease agreements of $3.7 million.

In addition, $2.4 million of the 2023 Notes was repaid in the three months ended May 1, 2021 due to early conversion at the option of the noteholders, of which $2.1 million is presented as repayments of convertible senior notes within cash from financing activities and $0.3 million is reflected as non-cash accretion of debt discount upon settlement of debt within cash from operating activities.

For the three months ended May 2, 2020, net cash provided by financing activities was $3.2 million, primarily due to net borrowings under the asset based credit facility of $10.0 million, partially offset by repayments of $5.2 million on equipment notes and principal payments under finance lease agreements of $2.1 million.

Non-Cash Transactions

Non-cash transactions primarily consist of non-cash additions of property and equipment and landlord assets, and reclassifications of assets from landlord assets from construction to finance lease right-of-use assets.

Non- cash transactions consist of non-cash additions of property and equipment and landlord assets and reclassification of assets from landlord assets under construction to finance lease right-of-use assets.

In addition, non-cash transactions consist of shares issued and received related to the settlement of convertible senior note transactions.

Convertible Senior Notes

Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements for further information on our 0.00% Convertible Senior Notes due 2024, 0.00% Convertible Senior Notes due 2023 and 0.00% Convertible Senior Notes due 2020 .

Our 0.00% Convertible Senior Notes due 2020 matured on July 15, 2020.

Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements for further information on our 0.00% Convertible Senior Notes due 2024 and 0.00% Convertible Senior Notes due 2023.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 46

Asset Based Credit Facility

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Refer to Note 10— Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility.

Share Repurchase Programs

We regularly review share repurchase activity and consider various factors in determining whether and when to execute share repurchases, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock.

We believe that these share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders.

Share Repurchase Program

We regularly review share repurchase activity and consider various factors in determining whether and when to execute investments in connection with our share repurchase programs, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock.

We believe that share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders.

We may undertake other repurchase programs in the future with respect to our securities.

We generated $330 million, $163 million and $415 million in free cash flow in fiscal 2019, fiscal 2018 and fiscal 2017, respectively, which supported our share repurchase programs.

Free cash flow is calculated as net cash provided by operating activities, the non-cash accretion of debt discount upon settlement of debt and proceeds from sale of assets, less capital expenditures and principal payments under finance leases.

Our free cash flow has historically supported our current and completed share repurchase programs.

We generated $405 million, $330 million and $163 million in free cash flow in fiscal 2020, fiscal 2019 and fiscal 2018, respectively.

Free cash flow excludes all non-cash items.

Free cash flow is included in this filing because management believes that free cash flow provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results.

Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter.

Free cash flow is net cash provided by operating activities adjusted by the non-cash accretion of debt discount upon settlement of debt, proceeds from sale of asset, capital expenditures, principal payments under finance leases and equity method investments.

Free cash flow is included in this filing because our senior leadership team believes that free cash flow provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of operating results on a comparable basis with historical results.

Our senior leadership team uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business.

A reconciliation of our net cash provided by operating activities to free cash flow is as follows:

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Principal payments under finance leases

Equity method investments

Free cash flow

$950 Million Share Repurchase Program

On October 10, 2018, our Board of Directors authorized a share repurchase program of up to $700 million through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives, of which $250.0 million in share repurchases were completed in fiscal 2018.

The $700 million authorization amount was replenished by the Board of Directors 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 million remaining for future share repurchases under this program.

In 2018, our Board of Directors authorized a share repurchase program through open market purchases, privately negotiated transactions or other means, including through Rule 10b-18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as the acquisition of other equity linked instruments, accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives.

We completed $250.0 million in share repurchases in fiscal 2018 under this program.

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

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

The total current authorized size of this 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.

FINANCIAL INFORMATION

2021 FIRST QUARTER FORM 10-Q | 47

Contractual Obligations

As of October 31, 2020, there were no material changes to our contractual obligations described within Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations in the 2019 Form 10-K other than lease agreements entered into in the normal course of business (refer to Note 8 —Leases ).

As of May 1, 2021, there were no material changes to our contractual obligations described within Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations in the 2020 Form 10-K, other than lease agreements entered into in the normal course of business (refer to Note 8 —Leases ).

Off Balance Sheet Arrangements

We have no material off balance sheet arrangements as of October 31, 2020.

We have no material off balance sheet arrangements as of May 1, 2021.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires senior leadership to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

We evaluate our accounting policies, estimates, and judgments on an on-going basis.

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Merchandise Inventories—Reserves

o Tradenames, Trademarks and Domain Names

o Long-Lived Assets

Tradenames, Trademarks and Other Intangible Assets

Long-Lived Assets

Lease Accounting

o Reasonably Certain Lease Term

o Incremental Borrowing Rate

o Fair Market Value

There have been no material changes to the other critical accounting policies and estimates listed above from the disclosures included in the 2019 Form 10-K other than the stock-based compensation policy discussed below.

For further discussion regarding these policies, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates in the 2019 Form 10-K.

Reasonably Certain Lease Term

Incremental Borrowing Rate

Stock-Based Compensation—Performance-Based Awards

For awards with performance-based criteria, compensation expense is recognized on an accelerated basis over the requisite service period.

The fair value of each performance-based option award granted is estimated on the date of grant using a Monte Carlo simulation option pricing model that requires the input of subjective assumptions regarding the future exercise behavior, expected volatility and a discount for illiquidity.

We determined these assumptions based on consideration of (i) future exercise behavior based on the historical observed exercise pattern of the award recipient, (ii) expected volatility based on our historical observed common stock prices measured over the full trading history of our common stock and implied volatility based on 180-day average trading prices of our common stock, and (iii) a discount for illiquidity estimated using the Finnerty method.

Equity Method Investments

There have been no material changes to the critical accounting policies and estimates listed above from the disclosures included in the 2020 Form 10-K.

Recent Accounting Pronouncements

Refer to Note 2— Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently proposed accounting standards that may impact our consolidated financial statements in future reporting periods.

Refer to Note 2— Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently proposed accounting standards which may impact our consolidated financial statements in future reporting periods.

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 2. Management’s Discussion and Analysis