What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2021-09-09 compared with 2021-06-10 · 277 added, 165 removed, 279 unchanged (61% of the section changed)

9 unchanged sentences

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

Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the section entitled Risk Factors in our 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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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.

We have an integrated RH Hospitality experience in 11 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:

As of July 31, 2021, we operated the following number of Galleries, Outlets and Showrooms:

Design Galleries

4 unchanged sentences

Waterworks Showrooms

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

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

The pandemic has continued since the initial outbreak and has included spikes and outbreaks in various locations around the world including as a result of new strains of the COVID virus such as the “Delta” variant.

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.

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

As of September 3, 2021, all of our Galleries, Outlets and Restaurants were open.

Our overall customer demand in specific markets has generally correlated favorably with our customers’ ability to experience 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.

2 unchanged sentences

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.

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, most notably Vietnam, have experienced various surges in outbreaks and, in some cases, facility closures related to the pandemic.

As a result, the ongoing nature of the pandemic may continue to adversely affect our business operations in various jurisdictions, which could, in turn, have a negative impact on our vendors and supply chain, and therefore, our business.

Our 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 .

2 unchanged sentences

FINANCIAL INFORMATION

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Product Elevation .

2 unchanged sentences

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.

Our strategy to elevate the design and quality of our product will continue as we introduce RH Contemporary in 2022.

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

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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.

Our external efforts will begin 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.

4 unchanged sentences

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.

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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 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.

The disruption to our business operations from the pandemic has had a significant impact on the comparability of year-over-year and sequential trends for our operating results for the three and six months ended July 31, 2021, as compared to the three and six months ended August 1, 2020.

The ongoing pandemic has resulted in escalating disruption in our supply chain, which continues to negatively impact our revenues and costs.

The initial negative impact to our revenues from store closures occurred during the first half of fiscal 2020.

Despite the reopening of most of our Galleries during the second and third quarters of fiscal 2020 and a strong resurgence in customer demand for our products, we have continued to address a range of business circumstances in the first half of fiscal 2021 related to the pandemic.

These circumstances include delays in manufacturing and inventory receipts as our supply chain recovers from the impact of the global health crisis and responds to virus outbreaks and surges, including new strains such as the “Delta” variant, which has had a severe impact in certain jurisdictions, most notably Vietnam.

We have also 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 with respect to travel to various locations in 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.

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, of which could affect our results of operation in fiscal 2021.

Additionally, recent COVID-19 resurgences in various jurisdictions are expected to have direct and indirect effects on our business and operations that will continue to affect the comparability of our results during fiscal 2021.

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Results of Operations

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

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

THREE MONTHS ENDED

SIX MONTHS ENDED

(in thousands)

Condensed Consolidated Statements of Operations:

(in thousands)

Condensed Consolidated Statements of Income:

Cost of goods sold

4 unchanged sentences

Tradename impairment

Loss on extinguishment of debt

(Gain) loss on extinguishment of debt

Total other expenses

Income (loss) before income taxes

Income tax expense (benefit)

Income (loss) before equity method investments

Income before income taxes

Income tax expense

Income 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 (loss), adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.

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 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.

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.

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2021 FIRST QUARTER FORM 10-Q | 35

THREE MONTHS ENDED

SIX MONTHS ENDED

(in thousands)

Net income (loss)

(in thousands)

Adjustments pre-tax:

1 unchanged sentence

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)

Asset impairments and change in useful lives (c)

(Gain) loss on extinguishment of debt (d)

Recall accrual (e)

Reorganization related costs (f)

Tradename impairment (g)

Loss on sale leaseback transaction (h)

Subtotal adjusted items

Impact of income tax items (h)

Share of equity method investments losses (i)

Impact of income tax items (i)

Share of equity method investments losses (j)

Adjusted net income

(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.

Accordingly, in accounting for GAAP purposes 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.

Amounts are presented net of interest capitalized for capital projects of $2.9 million and $1.3 million during the three months ended July 31, 2021 and August 1, 2020, respectively.

Amounts are presented net of interest capitalized for capital projects of $5.6 million and $3.1 million during the six months ended July 31, 2021 and August 1, 2020, respectively.

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

1 unchanged sentence

Friedman in October 2020.

(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.

The adjustments for the three and six months ended August 1, 2020 include the acceleration of depreciation expense due to a change in the estimated useful lives of certain assets of $1.3 million and $2.6 million, respectively.

The adjustment in the six months ended August 1, 2020 also includes asset impairments of $4.8 million and inventory reserves of $2.4 million related to Outlet inventory resulting from retail closures in response to the pandemic.

(d) The adjustment in each of the three and six months ended July 31, 2021 represents a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders.

The adjustment in each of the three and six months ended August 1, 2020 represents a gain on extinguishment of debt of upon the maturity and settlement of the 2020 Notes in July 2020.

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

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

THREE MONTHS ENDED

SIX MONTHS ENDED

(in thousands)

Decrease to net revenues

Increase to cost of goods sold

Decrease to gross profit

Increase to selling, general and administrative expenses

Decrease to income before income taxes

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

(g) 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.

(h) Represents the loss on a sale leaseback transaction related to one of our previously owned Design Galleries.

(i) The adjustment for the three and six months ended July 31, 2021 is based on an adjusted tax rate of 1.3% and 9.3%, respectively, which excludes the tax impact associated with our share of equity method investments losses.

The adjustment for the three months ended August 1, 2020 is based on our effective tax rate of 16.1%.

The adjustment for the six months ended August 1, 2020 is based on an adjusted tax rate of 17.8%, which excludes the tax impact associated with the Waterworks reporting unit tradename impairment recorded in the first quarter of fiscal 2020.

(j) 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.

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(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 (loss) before depreciation and amortization, interest expense—net and income tax expense (benefit).

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

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

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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 (loss), 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, the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below.

THREE MONTHS ENDED

Net income (loss)

SIX MONTHS ENDED

Depreciation and amortization

Interest expense—net

Income tax expense (benefit)

Income tax expense

Non-cash compensation (a)

Asset impairments (b)

Share of equity method investments losses (b)

(Gain) loss on extinguishment of debt (b)

Capitalized cloud computing amortization (c)

Recall accrual (b)

Loss on extinguishment of debt (b)

Tradename impairment (b)

Asset impairments (b)

Reorganization related costs (b)

Loss on sale leaseback transaction (b)

Tradename impairment (b)

Adjusted EBITDA

(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.

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

1 unchanged sentence

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

THREE MONTHS ENDED

SIX MONTHS ENDED

SELLING SQUARE

3 unchanged sentences

Beginning of period

RH Design Galleries:

Dallas Design Gallery

Marin Design Gallery

Charlotte Design Gallery

RH Modern Galleries:

Dallas RH Modern Gallery

RH Baby & Child and TEEN Galleries:

Santa Monica Baby & Child and TEEN Gallery

RH Legacy Galleries:

Dallas legacy Gallery

Raleigh legacy Gallery

Charlotte legacy Gallery

Corte Madera legacy Gallery

Westport legacy Gallery

End of period

4 unchanged sentences

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 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.

Leased selling square footage includes approximately 4,800 square feet as of both July 31, 2021 and August 1, 2020 related to one owned retail location.

(2) Total leased square footage includes approximately 5,400 square feet as of both July 31, 2021 and August 1, 2020 related to one owned retail location.

(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.

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

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

THREE MONTHS ENDED

Condensed Consolidated Statements of Operations:

SIX MONTHS ENDED

Condensed Consolidated Statements of Income:

Cost of goods sold

4 unchanged sentences

Tradename impairment

Loss on extinguishment of debt

(Gain) loss on extinguishment of debt

Total other expenses

Income (loss) before income taxes

Income tax expense (benefit)

Income (loss) before equity method investments

Income before income taxes

Income tax expense

Income 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 July 31, 2021 Compared to Three Months Ended August 1, 2020

THREE MONTHS ENDED

2 unchanged sentences

Selling, general and administrative expenses

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.

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Income from operations

Consolidated net revenues increased $279.6 million, or 39.4%, to $988.9 million in the three months ended July 31, 2021 compared to $709.3 million in the three months ended August 1, 2020.

RH Segment net revenues

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.

RH Segment net revenues increased $266.2 million, or 39.1%, to $947.6 million in the three months ended July 31, 2021 compared to $681.4 million in the three months ended August 1, 2020.

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

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RH Segment net revenues for the three months ended July 31, 2021 was driven primarily by a strong increase in customer demand for our products, aided by elements of our supply chain beginning to catch up with customer demand.

Outlet sales increased $16.7 million to $68.3 million in the three months ended July 31, 2021 compared to $51.6 million in the three months ended August 1, 2020 due to pandemic related retail closures in the second quarter of fiscal 2020.

Additionally, RH Segment net revenues increased in our RH Hospitality business as COVID-19 operating restrictions continued to ease during the quarter compared to the three months ended August 1, 2020.

Waterworks net revenues

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.

Waterworks net revenues increased $13.3 million, or 47.8%, to $41.2 million in the three months ended July 31, 2021 compared to $27.9 million in the three months ended August 1, 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 August 1, 2020 was negatively impacted by construction delays, as well as temporary showroom closures, in response to the pandemic.

Consolidated gross profit increased $155.3 million, or 46.7%, to $487.7 million in the three months ended July 31, 2021 compared to $332.4 million in the three months ended August 1, 2020.

As a percentage of net revenues, consolidated gross margin increased 240 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 46.9% of net revenues in the three months ended August 1, 2020.

RH Segment gross profit for the three months ended August 1, 2020 was negatively impacted by $4.8 million related to product recalls.

Excluding the product recall adjustment mentioned above, consolidated gross margin would have increased 180 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 47.5% of net revenues in the three months ended August 1, 2020.

RH Segment gross profit

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.

RH Segment gross profit increased $146.6 million, or 45.7%, to $467.1 million in the three months ended July 31, 2021 from $320.5 million in the three months ended August 1, 2020.

As a percentage of net revenues, RH Segment gross margin increased 230 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 47.0% of net revenues in the three months ended August 1, 2020.

Excluding the product recall adjustment mentioned above, RH Segment gross margin would have increased 160 basis points to 49.3% of net revenues in the three months ended July 31, 2021 from 47.7% of net revenues in the three months ended August 1, 2020.

The increase in gross margin was primarily driven by higher product margins in the Outlet and Core business.

Additionally, we drove higher margins through leveraging our RH Segment occupancy costs in the three months ended July 31, 2021.

Waterworks gross profit

Waterworks gross profit increased $8.7 million, or 72.6%, to $20.6 million in the three months ended July 31, 2021 from $11.9 million in the three months ended August 1, 2020.

As a percentage of net revenues, Waterworks gross margin increased 720 basis points to 50.0% of net revenues in the three months ended July 31, 2021 from 42.8% of net revenues in the three months ended August 1, 2020 primarily driven by higher revenues, favorable changes in product mix, and leverage in Waterworks occupancy costs, offset by an increase in shipping costs related to customer deliveries.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $42.8 million, or 21.9%, to $238.7 million in the three months ended July 31, 2021 compared to $195.9 million in the three months ended August 1, 2020.

RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $38.0 million, or 20.5%, to $223.5 million in the three months ended July 31, 2021 compared $185.5 million in the three months ended August 1, 2020.

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RH Segment selling, general and administrative expenses for the three months ended July 31, 2021 include $7.4 million of asset impairments, amortization of the non-cash compensation of $5.8 million related to the option grant made to Mr.

Friedman in October 2020 and $0.4 million related to severance costs and related payroll taxes associated with reorganizations.

RH Segment selling, general and administrative expenses for the three months ended August 1, 2020 includes a loss of $9.4 million related to a sale leaseback transaction, $2.9 million related to severance costs and related payroll taxes associated with reorganizations and $1.3 million due to accelerated asset depreciation.

Excluding the adjustments mentioned above, RH Segment selling, general and administrative expenses were 22.1% and 25.2% of net revenues for the three months ended July 31, 2021 and August 1, 2020, respectively.

The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by reduction in costs and leverage in advertising, as well as leverage in our corporate occupancy costs, partially offset by deleverage in other corporate costs.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses increased $4.8 million, or 46.6%, to $15.2 million in the three months ended July 31, 2021 compared to $10.4 million in the three months ended August 1, 2020.

Waterworks selling, general and administrative expenses were 36.8% and 37.2% of net revenues for the three months ended July 31, 2021 and August 1, 2020, respectively.

Interest expense—net

Interest expense—net decreased $5.8 million to $13.6 million for the three months ended July 31, 2021 compared to $19.4 million for the three months ended August 1, 2020.

Interest expense—net consisted of the following:

THREE MONTHS ENDED

(in thousands)

Amortization of convertible senior notes debt discount

Finance lease interest expense

Amortization of debt issuance costs and deferred financing fees

Other interest expense

Promissory notes

Asset based credit facility

Capitalized interest for capital projects

Interest income

Total interest expense—net

(Gain) loss on extinguishment of debt

During the three months ended July 31, 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 $3.2 million.

During the three months ended August 1, 2020, we recognized a $0.2 million gain on extinguishment of debt related to the maturity and settlement of the 2020 Notes in July 2020.

Income tax expense

Income tax expense was $3.0 million and $18.9 million in the three months ended July 31, 2021 and August 1, 2020, respectively.

Our effective tax rate was 1.3% and 16.1% for the three months ended July 31, 2021 and August 1, 2020, respectively.

The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the three months ended July 31, 2021 as compared to the three months ended August 1, 2020.

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Equity method investments losses

Equity method investments losses consists of our proportionate share of the losses of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $2.5 million loss during the three months ended July 31, 2021.

Six Months Ended July 31, 2021 Compared to Six Months Ended August 1, 2020

SIX MONTHS ENDED

(in thousands)

Cost of goods sold

Selling, general and administrative expenses

Income (loss) from operations

Consolidated net revenues increased $657.5 million, or 55.1%, to $1,849.7 million in the six months ended July 31, 2021 compared to $1,192.2 million in the six months ended August 1, 2020.

RH Segment net revenues

RH Segment net revenues increased $631.1 million, or 55.5%, to $1,767.4 million in the six months ended July 31, 2021 compared to $1,136.3 million in the six months ended August 1, 2020.

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

RH Segment net revenues for the six months ended August 1, 2020 was negatively impacted by Gallery closures and macroeconomic conditions resulting from the COVID-19 pandemic.

RH Segment net revenues for the six months ended July 31, 2021 increased due to strong customer demand for our products, aided by elements of our supply chain beginning to catch up with customer demand.

Outlet sales increased $66.8 million to $130.6 million in the six months ended July 31, 2021 compared to $63.8 million in the six months ended August 1, 2020 due to pandemic related retail closures in the first half of fiscal 2020.

Additionally, RH Segment net revenues increased in our RH Hospitality business as COVID-19 operating restrictions continued to ease during the first half of fiscal 2021 and in our Contract business driven by increased commercial purchasing activities as compared to the first half of fiscal 2020.

Waterworks net revenues

Waterworks net revenues increased $26.4 million, or 47.2%, to $82.2 million in the six months ended July 31, 2021 compared to $55.8 million in the six months ended August 1, 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 six months ended August 1, 2020 was negatively impacted by construction delays, as well as temporary showroom closures, in response to the pandemic.

Consolidated gross profit increased $362.6 million, or 68.1%, to $894.7 million in the six months ended July 31, 2021 from $532.1 million in the six months ended August 1, 2020.

As a percentage of net revenues, consolidated gross margin increased 380 basis points to 48.4% of net revenues in the six months ended July 31, 2021 from 44.6% of net revenues in the six months ended August 1, 2020.

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RH Segment gross profit for the six months ended August 1, 2020 was negatively impacted by $4.8 million related to product recalls and includes inventory reserves of $2.4 million related to Outlet inventory resulting from retail closures in response to the COVID-19 pandemic.

Excluding the adjustments mentioned above, consolidated gross margin would have increased 320 basis points to 48.4% of net revenues in the six months ended July 31, 2021 from 45.2% of net revenues in the six months ended August 1, 2020.

RH Segment gross profit

RH Segment gross profit increased $345.4 million, or 68.0%, to $853.6 million in the six months ended July 31, 2021 from $508.2 million in the six months ended August 1, 2020.

As a percentage of net revenues, RH Segment gross margin increased 360 basis points to 48.3% of net revenues in the six months ended July 31, 2021 from 44.7% of net revenues in the six months ended August 1, 2020.

Excluding the adjustments mentioned above, RH Segment gross margin would have increased 300 basis points to 48.3% of net revenues in the six months ended July 31, 2021 from 45.3% of net revenues in the six months ended August 1, 2020.

The increase in gross margin was primarily driven by leverage in our RH Segment occupancy costs and higher product margins in the Core and Outlet businesses in the six months ended July 31, 2021.

Waterworks gross profit

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.

Waterworks gross profit increased $17.2 million, or 72.2%, to $41.0 million in the six months ended July 31, 2021 from $23.8 million in the six months ended August 1, 2020.

As a percentage of net revenues, Waterworks gross margin increased 720 basis points to 49.9% of net revenues in the six months ended July 31, 2021 from 42.7% of net revenues in the six months ended August 1, 2020 primarily driven by higher revenues, favorable changes in product mix, and leverage in Waterworks occupancy costs, offset by an increase in shipping costs related to customer deliveries.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $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.

Consolidated selling, general and administrative expenses increased $97.7 million, or 27.1%, to $457.8 million in the six months ended July 31, 2021 compared to $360.1 million in the six months ended August 1, 2020.

RH Segment selling, general and administrative 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.

RH Segment selling, general and administrative expenses increased $93.1 million, or 27.8%, to $427.9 million in the six months ended July 31, 2021 compared to $334.8 million in the six months ended August 1, 2020.

RH Segment selling, general and administrative expenses for the six months ended July 31, 2021 include amortization of the non-cash compensation of $11.7 million related to the option grant made to Mr.

Friedman in October 2020, $7.4 million related to asset impairments and $0.4 million related to severance costs and related payroll taxes associated with reorganizations.

RH Segment selling, general and administrative expenses for the six months ended August 1, 2020 include a loss of $9.4 million related to a sale leaseback transaction, $7.0 million related to severance costs and related payroll taxes associated with the termination of associates and a reorganization undertaken in response to the impact of retail closures on our business, $3.3 million related to asset impairments and $2.6 million due to accelerated asset depreciation.

Excluding adjustments mentioned above, RH Segment selling, general and administrative expenses were 23.1% and 27.5% of net revenues for the six months ended July 31, 2021 and August 1, 2020, respectively.

The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by reduction in costs and leverage in advertising costs due to our decision to not mail the Spring 2021 Source Books, leverage in employment and employment related costs, as well as leverage in our corporate occupancy costs.

Waterworks selling, general and administrative expenses

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.

Waterworks selling, general and administrative expenses increased $4.6 million, or 18.1%, to $29.9 million in the six months ended July 31, 2021 compared to $25.3 million in the six months ended August 1, 2020.

Waterworks selling, general and administrative expenses for the six months ended July 31, 2021 include $0.5 million related to product recalls and for the six months ended August 1, 2020 include $1.6 million related to asset impairments.

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Excluding the adjustments mentioned above, Waterworks selling, general and administrative expenses were 35.7% and 42.5% of net revenues for the six months ended July 31, 2021 and August 1, 2020.

Interest expense—net

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

Interest expense—net decreased $12.2 million to $26.9 million for the six months ended July 31, 2021 compared to $39.0 million for the six months ended August 1, 2020.

Interest expense—net consisted of the following:

SIX MONTHS ENDED

(in thousands)

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Total interest expense—net

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.

(Gain) loss on extinguishment of debt

During the six months ended July 31, 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 $3.3 million.

During the six months ended August 1, 2020, we recognized a $0.2 million gain on extinguishment of debt related to the maturity and settlement of the 2020 Notes in July 2020.

Income tax expense

Income tax expense was $44.7 million and $17.5 million in the six months ended July 31, 2021 and August 1, 2020, respectively.

Our effective tax rate was 11.1% and 15.5% for the six months ended July 31, 2021 and August 1, 2020, respectively.

The decrease in our effective tax rate is primarily due to higher discrete tax benefits related to net excess tax windfalls from stock-based compensation in the six months ended July 31, 2021 as compared to the six months ended August 1, 2020.

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.

Equity method investments losses consists of our proportionate share of the losses of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $4.6 million loss during the six months ended July 31, 2021.

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FINANCIAL INFORMATION

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Liquidity and Capital Resources

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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.

We have $652 million remaining in aggregate principal amount of convertible notes outstanding as of July 31, 2021, of which $67 million of the 2024 Notes and $174 million of the 2023 Notes will be settled in the third quarter of fiscal 2021 due to early conversions at the option of the noteholders.

As a result, $128 million of the remaining 2023 Notes will mature in June 2023 (absent further early conversion elections) and $283 million of the remaining 2024 Notes will mature in September 2024 (absent further early conversion elections).

Based on the strong cash flow generated in fiscal 2020 and first half of fiscal 2021, as well as the 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 in order 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.

While we anticipate using excess cash, free cash flow and borrowings on our asset based credit facility to repay the convertible notes in cash to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates or upon early conversion, as applicable.

While we anticipate using excess cash, free cash flow and borrowings on our asset based credit facility to repay the convertible notes in cash in order to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates or upon early conversion, as applicable.

There can be no assurance as to the availability of capital to fund such repayments, or that if capital is available through additional debt issuances or refinancing of the convertible notes, that such capital will be available on terms that are favorable to us.

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FINANCIAL INFORMATION

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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, 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.

Future adverse developments in connection with the pandemic, including waves or resurgences of COVID-19 outbreaks in certain jurisdictions, 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 health 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 July 2021, which has a total availability of up to $600 million, of which $10 million is available to Restoration Hardware Canada, Inc., and includes a $300 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600 million to up to $900 million if and to the extent the lenders revise their credit commitments to encompass a larger facility.

The Amended Credit Agreement provides that the $300 million accordion, or a portion thereof, may be added as a first-in, last-out term loan facility if and to the extent the lenders revise their credit commitments for such facility.

The Amended Credit Agreement further provides the borrowers may request a European sub-credit facility under the revolving line of credit or under the accordion feature for borrowing by certain European subsidiaries of RH if certain conditions set out in the Amended Credit Agreement are met.

The maturity date of the Amended Credit Agreement is July 29, 2026.

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.

We expect to continue to use additional sources of debt financing in future periods as a source of additional capital to fund our various investments.

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

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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.

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

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.

During the six months ended July 31, 2021, adjusted capital expenditures were $125.5 million, net of cash received related to landlord tenant allowances of $11.2 million.

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FINANCIAL INFORMATION

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

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

For example, we have used this strategy in fiscal 2019 through the sale-leaseback transaction for the Yountville Design Gallery and in July 2020 through the sale-leaseback transaction for the Minneapolis Design Gallery.

For example, we have used this strategy in fiscal 2019 through the sale-leaseback transaction for the Yountville Design Gallery and in fiscal 2020 through the sale-leaseback transaction for the Minneapolis Design Gallery.

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

FINANCIAL INFORMATION

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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.

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 U.S.

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.

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Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks.

FINANCIAL INFORMATION

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Cash Flow Analysis

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

THREE MONTHS ENDED

SIX MONTHS ENDED

(in thousands)

Net cash provided by (used in) operating activities

Net cash provided by operating activities

Net cash used in investing activities

Net cash provided by (used in) financing activities

Net cash 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 (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.

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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 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 six months ended July 31, 2021, net cash provided by operating activities was $316.7 million and consisted of net income of $357.4 million and an increase in non-cash items of $144.1 million, partially offset by a change in working capital and other activities of $184.8 million.

The source of cash from working capital was primarily driven by an increase in deferred revenue and customer deposits of $116.5 million primarily due to strong consumer demand for our products.

These sources of cash from working capital were partially offset by uses of cash driven by an increase in merchandise inventory of $101.6 million, a decrease in other current liabilities of $51.7 million, an increase in landlord assets under construction of $43.4 million, an increase in prepaid expenses and other assets of $57.9 million, and a decrease in operating lease liabilities of $38.9 million primarily due to payments made under the related lease agreements.

For the six months ended August 1, 2020, net cash provided by operating activities was $128.3 million and consisted of net income of $95.2 million and non-cash items of $89.1 million, partially offset by cash used for working capital and other activities of $56.0 million.

Working capital and other activities consisted primarily of an increase in merchandise inventory of $49.0 million, an increase in landlord assets under construction of $22.9 million, a decrease in operating lease liabilities of $18.4 million primarily due to payments made under the related lease agreements, a decrease in accounts payable and accrued expenses of $13.1 million due to timing of payments, and a decrease in other non-current obligations of $12.3 million.

These decreases in working capital were partially offset by increases in deferred revenue and customer deposits of $67.6 million.

Net Cash Used In Investing Activities

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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.

For the six months ended July 31, 2021, net cash used in investing activities was $84.1 million and was comprised of investments in retail stores, information technology and systems infrastructure of $82.1 million and additional funding of our equity method investments of $1.9 million.

For the six months ended August 1, 2020, net cash used in investing activities was $25.6 million primarily due to investments in information technology and systems infrastructure, supply chain investments and retail stores of $32.1 million, as well as the acquisition of building and land assets of $14.2 million.

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

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FINANCIAL INFORMATION

Net Cash Used In Financing Activities

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

For the six months ended July 31, 2021, net cash used in financing activities was $43.0 million, partially due to the repayment of $33.2 million of the 2023 Notes in the six months ended July 31, 2021 as a result of early conversion at the option of the noteholders, of which $28.1 million is presented as repayments of convertible senior notes within cash from financing activities and $5.1 million is reflected as non-cash accretion of debt discount upon settlement of debt within cash from operating activities.

In addition, we made repayments of $11.4 million on our equipment notes, $7.1 million of principal payments under finance lease agreements and incurred $3.6 million of debt issuance costs related to the Amended Credit Agreement.

Equity related transactions provided $7.3 million due to $25.9 million of proceeds from exercise of employee stock options, partially offset by $18.6 million of cash paid for employee taxes related to net settlement of equity awards.

For the six months ended August 1, 2020, net cash used in financing activities was $133.0 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 was partially offset by net borrowings of $91.6 million under the asset based credit facility.

Non-Cash Transactions

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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

6 unchanged sentences

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

FINANCIAL INFORMATION

2021 SECOND QUARTER FORM 10-Q | 53

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

17 unchanged sentences

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

We did not make any repurchases under this program during either the three or six months ended July 31, 2021 or August 1, 2020.

The total current authorized size of this share repurchase program is up to $950 million (the “950 Million Repurchase Program”), of which $450.0 million remained available as of July 31, 2021 for future share investments.

Contractual Obligations

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 ).

As of July 31, 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 May 1, 2021.

We have no material off balance sheet arrangements as of July 31, 2021.

54 | 2021 SECOND QUARTER FORM 10-Q

FINANCIAL INFORMATION

Critical Accounting Policies and Estimates

10 unchanged sentences

Incremental Borrowing Rate

Fair Market Value

Stock-Based Compensation—Performance-Based Awards

3 unchanged sentences

Recent Accounting Pronouncements

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

Refer to Note 2— Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently issued accounting standards that may impact us 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