Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and the results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended January 29, 2022 (the “2021 Form 10-K”).
Management’s discussion and analysis of financial condition and results of operations (“MD&A”) contains forward-looking statements that are subject to risks and uncertainties. Refer to “Forward-Looking Statements and Market Data” below and Item 1A — Risk Factors in our 2021 Form 10-K for a discussion of the risks, uncertainties and assumptions associated with these statements. MD&A should be read in conjunction with our historical consolidated financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including, but not limited to, those listed in our 2021 Form 10-K.
The discussion of our financial condition and changes in our results of operations, liquidity and capital resources is presented in this section for the three and nine months ended October 29, 2022, and a comparison to the three and nine months ended October 30, 2021. The discussion related to cash flows for the nine months ended October 30, 2021 has been omitted from this Quarterly Report on Form 10-Q, but is included in Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations on our Form 10-Q for the quarter ended October 30, 2021, filed with the Securities and Exchange Commission (“SEC”) on December 9, 2021.
MD&A is a supplement to our condensed consolidated financial statements of this Quarterly Report on Form 10-Q and is provided to enhance an understanding of our results of operations and financial condition. Our MD&A is organized as follows:
Overview . This section provides a general description of our business and describes our key value-driving strategies.
Basis of Presentation and Results of Operations . These sections provide our consolidated statements of income and other financial and operating data, including a comparison of our results of operations in the current periods as compared to the prior year’s comparative period, as well as non-GAAP measures we use for financial and operational decision-making and as a means to evaluate period-to-period comparisons.
Liquidity and Capital Resources . This section provides an overview of our sources and uses of cash and our financing arrangements, including our credit facilities and debt arrangements, in addition to the cash requirements for our business, such as our capital expenditures.
Critical Accounting Policies and Estimates . This section discusses the accounting policies and estimates that involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results of operations and financial position, including the significant estimates and judgments used in the preparation of our consolidated financial statements.
Recently Issued Accounting Pronouncements . This section provides a summary of recent authoritative accounting pronouncements that have been adopted in fiscal 2022 and that will be adopted in future periods.
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FORWARD-LOOKING STATEMENTS AND MARKET DATA
This quarterly report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “short-term,” “non-recurring,” “one-time,” “unusual,” “should,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.
Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those that we expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results, and matters that we identify as “short-term,” “non-recurring,” “unusual,” “one-time,” or other words and terms of similar meaning may, in fact, recur in one or more future financial reporting periods. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the section entitled Risk Factors in our 2021 Form 10-K, and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report, in our Quarterly Report on Form 10-Q for the quarterly periods ended April 30, 2022 (the “First Quarter Form 10-Q”), July 30, 2022 (the “Second Quarter Form 10-Q”) and in our 2021 Form 10-K. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this quarterly report in the context of these risks and uncertainties.
We cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this quarterly report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.
Overview
We are a curator of design, taste and style in the luxury lifestyle market. Our curated and fully integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings. We offer dominant merchandise assortments across a number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and baby, child and teen furnishings. Our retail business is fully integrated across our multiple channels of distribution, consisting of our retail locations, websites and Source Books. We position our Galleries as showrooms for our brand, while our websites and Source Books act as virtual and print extensions of our physical spaces, respectively. We operate our retail locations throughout the United States, Canada, and the U.K., and have an integrated RH Hospitality experience in 14 of our Design Gallery locations, which includes Restaurants and Wine Bars.
In addition, we opened our first RH Guesthouse in New York in September 2022, a first-of-its-kind hospitality experience for travelers seeking privacy and luxury. The property features six guest rooms, three guest suites, a private residence as well as The Dining Room & Terrace. The RH Guesthouse Champagne & Caviar Bar is expected to open in 2023.
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As of October 29, 2022, we operated the following number of locations:
COUNT
RH
Design Galleries
28
Legacy Galleries
35
Modern Galleries
1
Baby & Child and TEEN Galleries
3
Total Galleries
67
Outlets
39
Guesthouse
1
Waterworks Showrooms
14
Macro-Economic Factors and COVID-19 Pandemic
There are a number of macro-economic factors and uncertainties affecting the overall business climate as well as our business, including increased inflation and rising interest rates. These factors may have a number of adverse effects on macro-economic conditions and markets in which we operate, with the potential for an economic recession and a sustained downturn in the housing market. Factors such as a slowdown in the housing market or negative trends in stock market prices could have a negative impact on demand for our products. We believe that these macro-economic factors have contributed to the slowdown in demand that we have experienced in our business over the last several fiscal quarters.
The COVID-19 pandemic continues to cause challenges in certain aspects of our business operations primarily related to our supply chain, including delays in our receipt of products from vendors, which have affected our ability to convert demand into revenues at normal historic rates. While our performance during the pandemic demonstrates the desirability of our exclusive products, consumer spending patterns have shifted away from spending on the home and home-related categories toward travel and leisure and other areas.
Our decisions regarding the sources and uses of capital will continue to reflect and adapt to changes in market conditions and our business including further developments with respect to macro-economic factors and the pandemic. For more information, refer to the section entitled “Risk Factors” in our 2021 Form 10-K.
Key Value-Driving Strategies
In order to drive growth across our business, we are focused on the following long-term key strategies and business initiatives:
Product Elevation . We believe we have built the most comprehensive and compelling collection of luxury home furnishings under one brand in the world. Our products are presented across multiple collections, categories and channels that we control, and their desirability and exclusivity has enabled us to achieve industry-leading revenues and margins. Our customers know our brand concepts as RH Interiors, RH Modern, RH Contemporary, RH Outdoor, RH Beach House, RH Ski House, RH Baby & Child, RH TEEN and Waterworks. Our strategy is to continue to elevate the design and quality of our product. Over the next few years, we plan to introduce RH Couture Upholstery, RH Bespoke Furniture and RH Color.
Gallery Transformation . Our product is elevated and rendered more valuable by our architecturally inspiring Galleries. We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of $5 to $6 billion 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 assortment. In addition, we plan to incorporate hospitality into most of the new Design Galleries that we open in the future, which further elevates and renders our product and brand more valuable. We believe hospitality has created a unique new retail experience that cannot be replicated online, and that the addition of hospitality drives incremental sales of home furnishings in these Galleries.
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Brand Elevation . We are evolving the brand beyond curating and selling product to conceptualizing and selling spaces by building an ecosystem of Products, Places, Services and Spaces designed to elevate and render our product more valuable while establishing the RH brand as a thought leader, taste and place maker. We believe our seamlessly integrated ecosystem of immersive experiences inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an impression and connection unlike any other brand in the world. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our Galleries into RH Guesthouses, where our goal is to create a new market for travelers seeking privacy and luxury in the $200 billion North American hotel industry. In September 2022, we opened our first RH Guesthouse in New York. Additionally, we are creating bespoke experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley, RH1 & RH2, our private jets, and RH3, our luxury yacht that is available for charter in the Caribbean and Mediterranean, where the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design and landscape architecture.
Digital Reimagination . Our strategy is to digitally reimagine the RH brand and business model both internally and externally. Internally, our multi-year effort began with the reimagination of our Center of Innovation & Product Leadership to incorporate digitally integrated visuals and decision data designed to amplify the creative process from product ideation to product presentation. Externally, our strategy comes to life digitally through The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Launched in the spring of 2022, The World of RH includes rich, immersive content with simplified navigation and search functionality, all designed to enhance the shopping experience and render our product and brand more valuable. We expect to continue to elevate the customer experience on The World of RH with further enhancements to content, navigation and search functionality. We believe an opportunity exists to create similar strategic separation online as we have with our Galleries offline, reconceptualizing what a website can and should be.
Global Expansion . We believe that our luxury brand positioning and unique aesthetic have strong international appeal, and that pursuit of global expansion will provide RH a substantial long-term market opportunity to build a $20 to $25 billion global brand over time. Our view is that the competitive environment globally is more fragmented and primed for disruption than the North American market, and there is no direct competitor of scale that possesses the product, operational platform, and brand of RH. As such, we are actively pursuing the expansion of the RH brand globally with the objective of launching international locations in Europe beginning with the opening of RH England, The Country House at the Historic Aynho Park, in the spring of 2023. We have secured a number of locations in various markets in the United Kingdom and continental Europe for future Design Galleries and are in lease or purchase negotiations for additional locations.
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Basis of Presentation and Results of Operations
The following table sets forth our condensed consolidated statements of income:
THREE MONTHS ENDED
NINE MONTHS ENDED
OCTOBER 29,
% OF NET
OCTOBER 30,
% OF NET
OCTOBER 29,
% OF NET
OCTOBER 30,
% OF NET
2022
REVENUE
2021
REVENUE
2022
REVENUE
2021
REVENUE
(dollars in thousands)
Net revenues
$
869,066
100.0
%
$
1,006,428
100.0
%
$
2,817,978
100.0
%
$
2,856,079
100.0
%
Cost of goods sold
448,288
51.6
501,174
49.8
1,375,399
48.8
1,456,172
51.0
Gross profit
420,778
48.4
505,254
50.2
1,442,579
51.2
1,399,907
49.0
Selling, general and administrative expenses
250,528
28.8
232,715
23.1
832,627
29.6
690,492
24.2
Income from operations
170,250
19.6
272,539
27.1
609,952
21.6
709,415
24.8
Other expenses
Interest expense—net
31,417
3.7
13,223
1.4
78,536
2.7
40,112
1.3
Loss on extinguishment of debt
—
—
18,513
1.8
169,578
6.0
21,784
0.8
Other expense—net
1,989
0.2
—
—
4,841
0.2
—
—
Total other expenses
33,406
3.9
31,736
3.2
252,955
8.9
61,896
2.1
Income before income taxes
136,844
15.7
240,803
23.9
356,997
12.7
647,519
22.7
Income tax expense (benefit)
36,162
4.1
54,391
5.4
(70,867)
(2.5)
99,124
3.5
Income before equity method investments
100,682
11.6
186,412
18.5
427,864
15.2
548,395
19.2
Share of equity method investments losses
(1,922)
(0.2)
(2,313)
(0.2)
(6,118)
(0.2)
(6,894)
(0.2)
Net income
$
98,760
11.4
%
$
184,099
18.3
%
$
421,746
15.0
%
$
541,501
19.0
%
Non-GAAP Financial Measures
To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States (“GAAP”), we use non-GAAP financial measures, including adjusted operating income, adjusted net income, EBITDA, adjusted EBITDA, and adjusted capital expenditures (collectively, our “non-GAAP financial measures”). We compute these measures by adjusting the applicable GAAP measures to remove the impact of certain recurring and non-recurring charges and gains and the tax effect of these adjustments. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe that they provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to key metrics used by senior leadership in its financial and operational decision-making. The non-GAAP financial measures used by us in this Quarterly Report on Form 10-Q may be different from the non-GAAP financial measures, including similarly titled measures, used by other companies.
For more information on the non-GAAP financial measures, please see the reconciliation of GAAP to non-GAAP financial measures tables outlined below. These accompanying tables include details on the GAAP financial measures that are most directly comparable to non-GAAP financial measures and the related reconciliations between these financial measures.
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Adjusted Operating Income . Adjusted operating income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted operating income as consolidated operating income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating Income
THREE MONTHS ENDED
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
OCTOBER 29,
OCTOBER 30,
2022
2021
2022
2021
(in thousands)
Net income
98,760
184,099
421,746
541,501
Interest expense—net (1)
31,417
13,223
78,536
40,112
Loss on extinguishment of debt (1)
—
18,513
169,578
21,784
Other expense—net (1)
1,989
—
4,841
—
Income tax expense (benefit) (1)
36,162
54,391
(70,867)
99,124
Share of equity method investments losses (1)
1,922
2,313
6,118
6,894
Operating income
170,250
272,539
609,952
709,415
Asset impairments (2)
10,926
—
19,080
7,354
Non-cash compensation (3)
4,136
5,831
14,315
17,559
Employer payroll taxes on option exercise (4)
—
—
11,717
—
Professional fees (5)
—
—
7,469
—
Compensation settlements (6)
—
—
3,483
—
Recall accrual (7)
—
340
560
840
Legal settlements (8)
(4,188)
—
(4,188)
—
Gain on sale of building and land (9)
(775)
—
(775)
—
Reorganizational related costs (10)
—
—
—
449
Adjusted operating income
$
180,349
$
278,710
$
661,613
$
735,617
(1) Refer to discussion “Three Months Ended October 29, 2022 Compared to Three Months Ended October 30, 2021” and “Nine Months Ended October 29, 2022 Compared to Nine Months Ended October 30, 2021” below for a discussion of our results of operations for the three and nine months ended October 29, 2022 and October 30, 2021.
(2) The three and nine months ended October 29, 2022 include inventory impairment of $11 million. The nine months ended October 29, 2022 also includes asset impairment related to property and equipment of Galleries under construction, as well as lease impairment of $1.0 million due to the early exit of a leased facility. The nine months ended October 30, 2021 represents asset impairments.
(3) Represents the amortization of the non-cash compensation charge related to a fully vested option grant made to Mr. Friedman in October 2020.
(4) Represents employer payroll tax expense related to the option exercise by Mr. Friedman in the first quarter of fiscal 2022.
(5) Represents professional fees contingent upon the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and convertible senior notes repurchases (refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements).
(6) Represents compensation settlements related to the Rollover Units and Profit Interest Units in the Waterworks subsidiary.
(7) Represents accruals associated with product recalls.
(8) Represents a favorable legal settlement associated with a lease arrangement.
(9) Represents gain on sale of building and land.
(10) Represents severance costs and related payroll taxes associated with reorganizations.
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Adjusted Net Income . Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted net income as consolidated net income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to Adjusted Net Income
THREE MONTHS ENDED
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
OCTOBER 29,
OCTOBER 30,
2022
2021
2022
2021
(in thousands)
Net income
$
98,760
$
184,099
$
421,746
$
541,501
Adjustments pre-tax:
Loss on extinguishment of debt (1)
—
18,513
169,578
21,784
Asset impairments (1)
10,926
—
19,080
7,354
Non-cash compensation (1)
4,136
5,831
14,315
17,559
Employer payroll taxes on option exercise (1)
—
—
11,717
—
Professional fees (1)
—
—
7,469
—
Compensation settlements (1)
—
—
3,483
—
Recall accrual (1)
—
340
560
840
Legal settlements (1)
(4,188)
—
(4,188)
—
Gain on derivative instruments—net (2)
—
—
(1,724)
—
Gain on sale of building and land (1)
(775)
—
(775)
—
Amortization of debt discount (3)
—
4,023
—
15,869
Reorganization related costs (1)
—
—
—
449
Subtotal adjusted items
10,099
28,707
219,515
63,855
Impact of income tax items (4)
36,162
(6,518)
(70,867)
(9,774)
Share of equity method investments losses (1)
1,922
2,313
6,118
6,894
Adjusted net income
$
146,943
$
208,601
$
576,512
$
602,476
(1) Refer to table titled “Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating Income” and the related footnotes for additional information.
(2) Represents net gain on derivative instruments resulting from certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and convertible senior notes repurchases (refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements).
(3) Prior to the adoption of Accounting Standards Update (“ASU”) 2020-06—Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (which was adopted as of the first quarter of fiscal 2022) (“ASU 2020-06”), certain convertible debt instruments that may be settled in cash on conversion were required to be separately accounted for as liability and equity components of the instrument in a manner that reflected the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for GAAP purposes through fiscal 2021 for the $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 2023 Notes and 2024 Notes into liability (debt) and equity (conversion option) components and we amortized as debt discount an amount equal to the fair value of the equity components as interest expense on the 2023 Notes and 2024 Notes over their expected lives. The equity components represented the difference between the proceeds from the issuance of the 2023 Notes and 2024 Notes and the fair value of the liability components of the 2023 Notes and 2024 Notes, respectively. Amounts were presented net of interest capitalized for capital projects of $2.8 million and $8.4 million during the three and nine months ended October 30, 2021, respectively. No amortization of the debt discounts were recognized during the three and nine months ended October 29, 2022, since we recombined the previously outstanding equity component of the 2023 Notes and 2024 Notes upon the adoption of ASU 2020-06.
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(4) The adjustment for both the three and nine months ended October 29, 2022 is based on an adjusted tax rate of 0.0%, which represents our expected cash tax liability associated with anticipated fiscal 2022 results as we do not expect to pay taxes for fiscal 2022 due to the tax benefits primarily resulting from Mr. Friedman’s option exercise in the first quarter of fiscal 2022. The adjustment for the three and nine months ended October 30, 2021 is based on an adjusted tax rate of 22.6% and 15.3%, respectively, which excludes the tax impact associated with our share of equity method investments losses.
EBITDA and Adjusted EBITDA . EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income before depreciation and amortization, interest expense—net and income tax expense (benefit). Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the impact of non-cash compensation as well as certain non-recurring and other items that we do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to EBITDA and Adjusted EBITDA
THREE MONTHS ENDED
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
OCTOBER 29,
OCTOBER 30,
2022
2021
2022
2021
(in thousands)
Net income
$
98,760
$
184,099
$
421,746
$
541,501
Depreciation and amortization
28,032
24,819
79,760
71,375
Interest expense—net
31,417
13,223
78,536
40,112
Income tax expense (benefit)
36,162
54,391
(70,867)
99,124
EBITDA
194,371
276,532
509,175
752,112
Loss on extinguishment of debt (1)
—
18,513
169,578
21,784
Non-cash compensation (2)
10,187
11,995
33,725
37,426
Asset impairments (1)
10,926
—
19,080
7,354
Employer payroll taxes on option exercise (1)
—
—
11,717
—
Professional fees (1)
—
—
7,469
—
Share of equity method investments losses (1)
1,922
2,313
6,118
6,894
Capitalized cloud computing amortization (3)
1,747
970
4,800
2,432
Compensation settlements (1)
—
—
3,483
—
Other expense—net (1)
1,989
—
4,841
—
Recall accrual (1)
—
340
560
840
Legal settlements (1)
(4,188)
—
(4,188)
—
Gain on sale of building and land (1)
(775)
—
(775)
—
Reorganization related costs (1)
—
—
—
449
Adjusted EBITDA
$
216,179
$
310,663
$
765,583
$
829,291
(1) Refer to table titled “Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating Income” and the related footnotes for additional information.
(2) Represents non-cash compensation related to equity awards granted to employees.
(3) Represents amortization associated with capitalized cloud computing costs.
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Adjusted Capital Expenditures. We define adjusted capital expenditures as capital expenditures from investing activities and cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received during the construction period.
Reconciliation of Adjusted Capital Expenditures
THREE MONTHS ENDED
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
OCTOBER 29,
OCTOBER 30,
2022
2021
2022
2021
(in thousands)
Capital expenditures
$
47,117
$
71,636
$
109,675
$
153,774
Landlord assets under construction—net of tenant allowances
10,920
6,999
43,380
50,351
Adjusted capital expenditures
$
58,037
$
78,635
$
153,055
$
204,125
The following table presents RH Gallery and Waterworks Showroom metrics, and excludes Outlets:
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
2022
2021
TOTAL LEASED
TOTAL LEASED
SELLING SQUARE
SELLING SQUARE
COUNT
FOOTAGE (1)
COUNT
FOOTAGE (1)
(square footage in thousands)
Beginning of period
81
1,254
82
1,162
RH Design Galleries:
San Francisco Design Gallery
1
42.1
—
—
Dallas Design Gallery
—
—
1
38.0
Oak Brook Design Gallery
—
—
1
37.7
RH Modern Galleries:
Dallas RH Modern Gallery
—
—
(1)
(3.9)
RH Baby & Child and TEEN Galleries:
Santa Monica Baby & Child and TEEN Gallery
—
—
(1)
(7.3)
RH Legacy Galleries:
Tysons legacy Gallery (relocation)
—
—
—
8.5
San Francisco legacy Gallery
(1)
(4.8)
—
—
Dallas legacy Gallery
—
—
(1)
(8.4)
Oak Brook legacy Gallery
—
—
(1)
(10.0)
End of period
81
1,291
80
1,217
Total leased square footage at end of period (2)
1,737
1,624
Weighted-average leased square footage (3)
1,713
1,583
Weighted-average leased selling square footage (3)
1,277
1,180
(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.
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Leased selling square footage includes approximately 4,800 square feet as of October 30, 2021 related to one owned retail location.
(2) Total leased square footage includes approximately 5,400 square feet as of October 30, 2021 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.
In addition, we operated one RH Guesthouse with leased square footage of approximately 24,800 square feet as of October 29, 2022.
Three Months Ended October 29, 2022 Compared to Three Months Ended October 30, 2021
THREE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
2022
2021
RH SEGMENT
WATERWORKS
TOTAL (1)
RH SEGMENT
WATERWORKS
TOTAL
(in thousands)
Net revenues
$
821,260
$
47,806
$
869,066
$
964,859
$
41,569
$
1,006,428
Cost of goods sold
426,313
21,975
448,288
480,496
20,678
501,174
Gross profit
394,947
25,831
420,778
484,363
20,891
505,254
Selling, general and administrative expenses
231,884
18,644
250,528
214,103
18,612
232,715
Income from operations
$
163,063
$
7,187
$
170,250
$
270,260
$
2,279
$
272,539
(1) The results for the Real Estate segment were immaterial in the three months ended October 29, 2022 and, therefore, such results are presented within the RH Segment for such period. There was no income from operations for the Real Estate segment in the three months ended October 29, 2022. Refer to Note 17— Segment Reporting in our condensed consolidated financial statements.
Net revenues
Consolidated net revenues decreased $137 million, or 13.6%, to $869 million in the three months ended October 29, 2022 compared to $1,006 million in the three months ended October 30, 2021.
RH Segment net revenues
RH Segment net revenues decreased $144 million, or 14.9%, to $821 million in the three months ended October 29, 2022 compared to $965 million in the three months ended October 30, 2021. The below discussion highlights several significant factors that resulted in a decrease in RH Segment net revenues, which are listed in order of magnitude.
The decrease in RH Segment net revenues for the three months ended October 29, 2022 was driven primarily by softening demand trends, which began in the first quarter of fiscal 2022, and have remained below prior year trends for the balance of fiscal 2022. This decrease was partially offset by backlog relief, as well as increased revenue in our RH Hospitality business compared to the three months ended October 30, 2021 due to new Restaurant openings in the second half of fiscal 2021 and fiscal 2022. Outlet sales decreased $13 million to $64 million in the three months ended October 29, 2022 compared to $77 million in the three months ended October 30, 2021.
Waterworks net revenues
Waterworks net revenues increased $6.2 million, or 15.0%, to $48 million in the three months ended October 29, 2022 compared to $42 million in the three months ended October 30, 2021.
Gross profit
Consolidated gross profit decreased $85 million, or 16.7%, to $421 million in the three months ended October 29, 2022 compared to $505 million in the three months ended October 30, 2021. As a percentage of net revenues, consolidated gross margin decreased 180 basis points to 48.4% of net revenues in the three months ended October 29, 2022 from 50.2% of net revenues in the three months ended October 30, 2021.
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RH Segment gross profit for the three months ended October 29, 2022 was negatively affected by $11 million of inventory impairment. Excluding the asset impairment adjustment, consolidated gross margin would have decreased 50 basis points to 49.7% of net revenues in the three months ended October 29, 2022 from 50.2% of net revenues in the three months ended October 30, 2021.
RH Segment gross profit
RH Segment gross profit decreased $89 million, or 18.5%, to $395 million in the three months ended October 29, 2022 from $484 million in the three months ended October 30, 2021. As a percentage of net revenues, RH Segment gross margin decreased 210 basis points to 48.1% of net revenues in the three months ended October 29, 2022 from 50.2% of net revenues in the three months ended October 30, 2021.
Excluding the $11 million asset impairment adjustment, RH Segment gross margin would have decreased 80 basis points to 49.4% of net revenues in the three months ended October 29, 2022 from 50.2% of net revenues in the three months ended October 30, 2021. The decrease in gross margin was primarily driven by deleverage in fixed occupancy costs, partially offset by an increase in product margins in the Core business, as well as leverage in our shipping costs during the three months ended October 29, 2022.
Waterworks gross profit
Waterworks gross profit increased $4.9 million, or 23.6%, to $26 million in the three months ended October 29, 2022 from $21 million in the three months ended October 30, 2021. As a percentage of net revenues, Waterworks gross margin increased 370 basis points to 54.0% of net revenues in the three months ended October 29, 2022 from 50.3% of net revenues in the three months ended October 30, 2021.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $18 million, or 7.7%, to $251 million in the three months ended October 29, 2022 compared to $233 million in the three months ended October 30, 2021.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $18 million, or 8.3%, to $232 million in the three months ended October 29, 2022 compared $214 million in the three months ended October 30, 2021. RH Segment selling, general and administrative expenses were 28.2% and 22.2% of net revenues for the three months ended October 29, 2022 and October 30, 2021, respectively.
RH Segment selling, general and administrative expenses for the three months ended October 29, 2022 include amortization of non-cash compensation of $4.1 million related to a fully vested option grant made to Mr. Friedman in October 2020, partially offset by a $4.2 million legal settlement received and a $0.8 million gain on sale of building and land.
RH Segment selling, general and administrative expenses for the three months ended October 30, 2021 include amortization of the non-cash compensation of $5.8 million related to a fully vested option grant made to Mr. Friedman in October 2020.
The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by deleverage due to lower revenues. Additionally, we incurred higher employment and employment-related costs and professional fees, as well as pre-opening and other corporate costs related to the opening of RH Guesthouse New York.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses remained consistent at $19 million in both the three months ended October 29, 2022 and October 30, 2021. Waterworks selling, general and administrative expenses were 39.0% and 44.8% of net revenues for the three months ended October 29, 2022 and October 30, 2021, respectively.
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Interest expense—net
Interest expense—net increased $18 million in the three months ended October 29, 2022 compared to the three months ended October 30, 2021, which consisted of the following in each period:
THREE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
2022
2021
(in thousands)
Term loan interest expense
$
35,300
$
1,935
Finance lease interest expense
8,564
6,711
Other interest expense
916
1,447
Amortization of convertible senior notes debt discount
—
6,775
Interest income
(12,540)
(572)
Capitalized interest for capital projects
(823)
(3,073)
Total interest expense—net
$
31,417
$
13,223
Loss on extinguishment of debt
We did not recognize a loss on extinguishment of debt in the three months ended October 29, 2022. During the three months ended October 30, 2021 we recognized a loss on extinguishment of debt of $19 million for a portion of the 2023 Notes and 2024 Notes that were early converted at the option of the noteholders.
Other expense—net
Other expense—net was $2.0 million during the three months ended October 29, 2022 as a result of a foreign exchange loss from the remeasurement of an intercompany loan with a U.K. subsidiary, as well as a loss due to unfavorable exchange rate changes affecting foreign currency denominated transactions, primarily between the U.S. dollar as compared to Pound Sterling and Euro.
Income tax expense
Income tax expense was $36 million and $54 million in the three months ended October 29, 2022 and October 30, 2021, respectively. Our effective tax rate was 26.8% and 22.8% for the three months ended October 29, 2022 and October 30, 2021, respectively. The increase in our effective tax rate is primarily attributable to lower net excess tax benefits from stock-based compensation in the three months ended October 29, 2022.
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 $1.9 million and $2.3 million loss during the three months ended October 29, 2022 and October 30, 2021, respectively.
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Nine Months Ended October 29, 2022 Compared to Nine Months Ended October 30, 2021
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
2022
2021
RH SEGMENT
WATERWORKS
TOTAL (1)
RH SEGMENT
WATERWORKS
TOTAL
(in thousands)
Net revenues
$
2,670,390
$
147,588
$
2,817,978
$
2,732,300
$
123,779
$
2,856,079
Cost of goods sold
1,307,547
67,852
1,375,399
1,394,317
61,855
1,456,172
Gross profit
1,362,843
79,736
1,442,579
1,337,983
61,924
1,399,907
Selling, general and administrative expenses
771,609
61,018
832,627
642,002
48,490
690,492
Income from operations
$
591,234
$
18,718
$
609,952
$
695,981
$
13,434
$
709,415
(1) The results for the Real Estate segment were immaterial in the nine months ended October 29, 2022 and, therefore, such results are presented within the RH Segment for such period. There was no income from operations for the Real Estate segment in the nine months ended October 29, 2022.Refer to Note 17— Segment Reporting in our condensed consolidated financial statements.
Net revenues
Consolidated net revenues decreased $38 million, or 1.3%, to $2,818 million in the nine months ended October 29, 2022 compared to $2,856 million in the nine months ended October 30, 2021.
RH Segment net revenues
RH Segment net revenues decreased $62 million, or 2.3%, to $2,670 million in the nine months ended October 29, 2022 compared to $2,732 million in the nine months ended October 30, 2021. The below discussion highlights several significant factors that resulted in a decrease in RH Segment net revenues, which are listed in order of magnitude.
The decrease in RH Segment net revenues for the nine months ended October 29, 2022 was driven primarily by softening demand trends, which began in the first quarter of fiscal 2022, and have remained below prior year trends for the balance of fiscal 2022. This decrease was partially offset by backlog relief, as well as increased revenue in our RH Hospitality business compared to the nine months ended October 30, 2021 due to new Restaurant openings in the second half of fiscal 2021 and fiscal 2022. Outlet sales decreased $5.1 million to $203 million in the nine months ended October 29, 2022 compared to $208 million in the nine months ended October 30, 2021.
Waterworks net revenues
Waterworks net revenues increased $24 million, or 19.2%, to $148 million in the nine months ended October 29, 2022 compared to $124 million in the nine months ended October 30, 2021.
Gross profit
Consolidated gross profit increased $43 million, or 3.0%, to $1,443 million in the nine months ended October 29, 2022 from $1,400 million in the nine months ended October 30, 2021. As a percentage of net revenues, consolidated gross margin increased 220 basis points to 51.2% of net revenues in the nine months ended October 29, 2022 from 49.0% of net revenues in the nine months ended October 30, 2021.
RH Segment gross profit for the nine months ended October 29, 2022 was negatively affected by $11 million of inventory impairment. Excluding the asset impairment adjustment, consolidated gross margin would have increased 260 basis points to 51.6% of net revenues in the three months ended October 29, 2022 from 49.0% of net revenues in the three months ended October 30, 2021.
RH Segment gross profit
RH Segment gross profit increased $25 million, or 1.9%, to $1,363 million in the nine months ended October 29, 2022 from $1,338 million in the nine months ended October 30, 2021. As a percentage of net revenues, RH Segment gross margin increased 200 basis points to 51.0% of net revenues in the nine months ended October 29, 2022 from 49.0% of net revenues in the nine months ended October 30, 2021.
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Excluding the $11 million asset impairment adjustment, RH Segment gross margin would have increased 240 basis points to 51.4% of net revenues in the nine months ended October 29, 2022 from 49.0% of net revenues in the nine months ended October 30, 2021. The increase in gross margin was primarily driven by increase in product margins in the Core business, as well as leverage in our shipping costs, partially offset by deleverage in fixed occupancy costs during the nine months ended October 29, 2022.
Waterworks gross profit
Waterworks gross profit increased $18 million, or 28.8%, to $80 million in the nine months ended October 29, 2022 from $62 million in the nine months ended October 30, 2021. As a percentage of net revenues, Waterworks gross margin increased 400 basis points to 54.0% of net revenues in the nine months ended October 29, 2022 from 50.0% of net revenues in the nine months ended October 30, 2021 primarily driven by higher revenues, leverage in shipping and occupancy costs, as well as favorable changes in product mix.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $142 million, or 20.6%, to $833 million in the nine months ended October 29, 2022 compared to $691 million in the nine months ended October 30, 2021.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $130 million, or 20.2%, to $772 million in the nine months ended October 29, 2022 compared to $642 million in the nine months ended October 30, 2021. RH Segment selling, general and administrative expenses were 28.9% and 23.5% of net revenues for the nine months ended October 29, 2022 and October 30, 2021, respectively.
RH Segment selling, general and administrative expenses for the nine months ended October 29, 2022 include amortization of non-cash compensation of $14 million related to a fully vested option grant made to Mr. Friedman in October 2020, $12 million of employer payroll tax expense associated with Mr. Friedman’s stock option exercise during the first quarter of fiscal 2022, $7.5 million of professional fees which were contingent upon the completion of our debt transactions related to the 2023 Notes and 2024 Notes and $0.6 million related to product recalls, partially offset by a $4.2 million legal settlement received and a $0.8 million gain on sale of building and land.
RH Segment selling, general and administrative expenses for the nine months ended October 30, 2021 include amortization of non-cash compensation of $18 million related to a fully vested 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.
The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by higher employment and employment-related costs, increased advertising costs due to the mailing of the new RH Contemporary Source Book, the launch of The World of RH, as well as increases in professional fees. In addition, we incurred increased pre-opening and other corporate costs related to the opening of RH San Francisco and RH Guesthouse New York.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased $13 million, or 25.8%, to $61 million in the nine months ended October 29, 2022 compared to $48 million in the nine months ended October 30, 2021. Waterworks selling, general and administrative expenses were 41.3% and 39.2% of net revenues for the nine months ended October 29, 2022 and October 30, 2021, respectively.
Waterworks selling, general and administrative expenses for the nine months ended October 29, 2022 include $3.5 million in compensation settlements related to the Rollover Units and Profit Interest Units and a $0.2 million asset impairment. Waterworks selling, general and administrative expenses for the nine months ended October 30, 2021 include $0.8 million related to product recalls.
Excluding the adjustments mentioned above, Waterworks selling, general and administrative expenses would have been 38.9% and 38.5% of net revenues for the nine months ended October 29, 2022 and October 30, 2021, respectively.
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Interest expense—net
Interest expense—net increased $38 million in the nine months ended October 29, 2022 compared to the nine months ended October 30, 2021, which consisted of the following in each period:
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
2022
2021
(in thousands)
Term loan interest expense
$
76,283
$
1,935
Finance lease interest expense
23,526
19,468
Other interest expense
2,821
4,703
Amortization of convertible senior notes debt discount
—
24,236
Interest income
(20,114)
(1,308)
Capitalized interest for capital projects
(3,980)
(8,922)
Total interest expense—net
$
78,536
$
40,112
Loss on extinguishment of debt
During the nine months ended October 29, 2022, we recognized a loss on extinguishment of debt of $170 million related to the repurchase of $237 million of principal value of convertible senior notes, inclusive of the acceleration of amortization of debt issuance costs of $1.3 million. The loss represents the difference between the carrying value and the fair value of the convertible senior notes upon entering into the repurchase agreements with the noteholders. Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements. During the nine months ended October 30, 2021 we recognized a loss on extinguishment of debt of $22 million for a portion of the 2023 Notes and 2024 Notes that were early converted at the option of the noteholders.
Other expense—net
Other expense—net was $4.8 million during the nine months ended October 29, 2022, which included a $6.5 million loss due to unfavorable exchange rate changes affecting foreign currency denominated transactions, primarily between the U.S. dollar as compared to Pound Sterling and Euro, in addition to a foreign exchange loss from the remeasurement of an intercompany loan with a U.K. subsidiary. The foreign currency loss was partially offset by a net gain on derivative instruments of $1.7 million during the nine months ended October 29, 2022, resulting from the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and convertible senior notes repurchases. Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements.
Income tax expense (benefit)
Income tax benefit was $71 million and income tax expense was $99 million in the nine months ended October 29, 2022 and October 30, 2021, respectively. Our effective tax rate was (20.2)% and 15.5% for the nine months ended October 29, 2022 and October 30, 2021, respectively. The decrease in our effective tax rate is primarily due to significantly higher discrete tax benefits from stock-based compensation in the nine months ended October 29, 2022.
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 $6.1 million and $6.9 million loss during the nine months ended October 29, 2022 and October 30, 2021, respectively.
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Liquidity and Capital Resources
Overview
Our principal sources of liquidity are cash flows generated from operations, our current balances of cash and cash equivalents, and amounts available under our ABL Credit Agreement. In fiscal 2021, we entered into the ABL Credit Agreement, which amended and extended our asset based credit facility, and issued the Term Loan B in the amount of $2.0 billion pursuant to the Term Loan Credit Agreement. The issuance of the Term Loan B was assigned a Ba2 rating from Moody’s Investors Service and BB rating from S&P Global. Additionally, in May 2022, we entered into the 2022 Incremental Amendment, which amended the Term Loan Credit Agreement and raised an incremental $500 million of financing by means of the Term Loan B-2. The issuance of the Term Loan B-2 was assigned a Ba3 rating from Moody’s Investors Service and BB rating from S&P Global. Refer to Note 10 —Credit Facilities in our condensed consolidated financial statements.
A summary of our net debt, and availability under the ABL Credit Agreement, is set forth in the following table:
OCTOBER 29,
JANUARY 29,
2022
2022
(in millions)
Asset based credit facility
$
—
$
—
Term loan B (1)
1,980
1,995
Term loan B-2 (1)
500
—
Equipment promissory notes (1)
2
15
Convertible senior notes due 2023 (1)
2
69
Convertible senior notes due 2024 (1)
42
189
Notes payable for share repurchases
—
1
Total debt
$
2,526
$
2,269
Cash and cash equivalents
(2,150)
(2,178)
Total net debt (3)
$
376
$
91
Availability under the asset based credit facility—net (2)
$
578
$
347
(1) Amounts exclude discounts upon original issuance and third party offering and debt issuance cost.
(2) The amount available for borrowing under the revolving line of credit under the ABL Credit Agreement is presented net of $25 million and $20 million in outstanding letters of credit as of October 29, 2022 and January 29, 2022, respectively.
(3) Net debt excludes restricted cash of $3.9 million and non-recourse real estate loans of $18 million as of October 29, 2022 related to our consolidated variable interest entities from our joint venture activities. These real estate loans are secured by the assets of such entities and the associated creditors do not have recourse against RH’s general assets. Refer to Note 5— Variable Interest Entities in our condensed consolidated financial statements.
General
The primary cash needs of our business have historically been for merchandise inventories, payroll, rent for our retail and outlet locations, capital expenditures associated with opening new locations, updating existing locations, as well as the development of our infrastructure and information technology, and Source Books. We seek out and evaluate opportunities for effectively managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. We continuously evaluate our capital allocation strategy and may engage in future investments in connection with existing or new share repurchase programs (refer to “Share Repurchase Program” below), which may include investments in derivatives or other equity linked instruments. We have in the past been, and continue to be, opportunistic in responding to favorable market conditions regarding both sources and uses of capital. Capital raised from debt financings has enabled us to pursue various investments, including our investments in joint ventures. We expect to continue to take an opportunistic approach regarding both sources and uses of capital in connection with our business.
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We believe our capital structure provides us with substantial optionality regarding capital allocation. Our near-term decisions regarding the sources and uses of capital will continue to reflect and adapt to changes in market conditions and our business, including further developments with respect to macro-economic factors and the pandemic affecting business conditions, as well as inflation and a rising interest rate environment. We believe our existing cash balances and operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months.
While we do not require additional debt to fund our operations, our goal continues to be in a position to take advantage of the many opportunities that we identify in connection with our business and operations. We have pursued in the past, and may pursue in the future, additional strategies to generate capital to pursue opportunities and investments, including through the strategic sale of existing assets, utilization of our credit facilities, entry into various credit agreements and other new debt financing arrangements that present attractive terms. We expect to continue to use additional sources of debt financing in future periods as a source of additional capital to fund our various investments.
To the extent we choose to secure additional sources of liquidity through incremental debt financing, there can be no assurances that we will be able to raise such financing on favorable terms, if at all, or that future financing requirements will not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock. Any adverse developments in the U.S. or global credit markets as a result of the pandemic or any other reason could affect our ability to manage our debt obligations and our ability to access future debt. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash, whether upon stated maturity, early conversion or otherwise of such convertible senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the covenants or other requirements of existing or new debt facilities, any such event could have an impact on our other commitments and obligations including triggering cross defaults or other consequences with respect to other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur, exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks.
Credit Facilities and Debt Arrangements
We amended and restated our asset based credit facility in July 2021, which has an initial 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 accordion feature may be added as a first-in, last-out term loan facility. The ABL Credit Agreement further provides the borrowers may request a European sub-credit facility under the revolving line of credit or under the accordion feature for borrowing by certain European subsidiaries of RH if certain conditions set out in the asset based credit facility are met. The maturity date of the asset based credit facility is July 29, 2026.
We entered into a $2.0 billion term debt financing in October 2021 (the “Term Loan B”) by means of a Term Loan Credit Agreement through RHI as the borrower, Bank of America, N.A. as administrative agent and collateral agent, and the various lenders party thereto (the “Term Loan Credit Agreement”). The Term Loan B has a maturity date of October 20, 2028. As of October 29, 2022, we had $1,980 million outstanding under the Term Loan Credit Agreement. We are required to make quarterly principal payments of $5.0 million with respect to the Term Loan B.
In May 2022, we entered into an incremental term debt financing (the “ Term Loan B-2”) in an aggregate principal amount equal to $500 million by means of an amendment to the Term Loan Credit Agreement with RHI as the borrower, Bank of America, N.A. as administrative agent and the various lenders parties thereto (the “Amended Term Loan Credit Agreement”). The Term Loan B-2 has a maturity date of October 20, 2028. The Term Loan B-2 constitutes a separate class from the existing Term Loan B under the Term Loan Credit Agreement. As of October 29, 2022, we had $500 million outstanding under the Amended Term Loan Credit Agreement. Beginning in December 2022, we are required to make quarterly principal payments of $1.3 million with respect to the Term Loan B-2.
Certain Transactions Related to Convertible Senior Notes
In the first and second quarters of fiscal 2022, we entered into certain transactions in connection with the 2023 Notes and 2024 Notes.
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Warrant Termination Agreements
In the first quarter of fiscal 2022, we entered into individual privately negotiated agreements with a limited number of sophisticated financial institutions (collectively, the “Counterparties”) to repurchase all of the warrants previously issued in connection with the 2023 Notes and 2024 Notes. Upon closing of these transactions, we paid an aggregate of $391 million in cash to terminate warrants representing 3,385,580 shares of our common stock.
Convertible Bond Hedge Unwind Transactions
In the first quarter of fiscal 2022, we entered into individual privately negotiated agreements with the Counterparties to terminate all of the remaining convertible note bond hedges previously entered into in connection with the 2023 Notes and 2024 Notes. Upon closing of these transactions, we received an aggregate of $232 million in cash for the termination of the bond hedges.
Convertible Senior Notes Repurchases
In the first and second quarters of fiscal 2022, we entered into individual privately negotiated transactions with certain holders of the 2023 Notes and 2024 Notes to repurchase $237 million in aggregate principal amount of the convertible senior notes representing $63 million and $174 million in principal amount of 2023 Notes and 2024 Notes, respectively. Upon closing of these transactions, we paid an aggregate of $396 million in cash to repurchase such convertible senior notes .
Result of the Convertible Notes Transactions
In aggregate, we expended a net total amount of approximately $563 million in cash (inclusive of expenses) in the first half of fiscal 2022 to complete the above transactions.
As a result of the bond hedge termination agreements, all convertible note hedges entered into in connection with the issuance of the 2023 Notes and 2024 Notes have been terminated, including convertible note hedges with respect to any 2023 Notes and 2024 Notes that remain outstanding.
As a result of the warrant termination agreements, all warrants entered into in connection with the issuance of the 2023 Notes and 2024 Notes have been terminated, including warrants with respect to any 2023 Notes and 2024 Notes that remain outstanding.
We had $44 million remaining in aggregate principal amount of convertible notes outstanding as of October 29, 2022, comprised of $1.7 million of 2023 Notes and $42 million of 2024 Notes. The remaining 2023 Notes have a scheduled maturity in June 2023 and the remaining 2024 Notes have a scheduled maturity in September 2024. We anticipate having ample cash available in order to repay the principal amount of our convertible notes in cash with respect to any convertible notes for which the holders elect early conversion, as well as upon maturity in June 2023 and September 2024, in each case in order to minimize dilution.
Capital
We have invested significant capital expenditures in developing and opening new Design Galleries, and these capital expenditures have increased in the past, and may continue to increase in future periods, as we open additional Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings. Our adjusted capital expenditures include capital expenditures from investing activities and cash outflows of capital related to construction activities to design and build landlord-owned leased assets, net of tenant allowances received during the construction period. During the nine months ended October 29, 2022, adjusted capital expenditures were $153 million in aggregate, net of cash received related to landlord tenant allowances of $10 million. In addition, we also received landlord tenant allowances after construction completion of $4.4 million, which are reflected as a reduction to principal payments under finance leases within financing activities on the condensed consolidated statements of cash flows. We anticipate our adjusted capital expenditures to be $200 million to $225 million in fiscal 2022, primarily related to our growth and expansion, including construction of new Design Galleries and infrastructure investments. Nevertheless, we may elect to pursue additional capital expenditures beyond those that are anticipated during any given fiscal period inasmuch as our strategy is to be opportunistic with respect to our investments and we may choose to pursue certain capital transactions based on the availability and timing of unique opportunities. There are a number of macro-economic factors and uncertainties affecting the overall business climate as well as our business, including increased inflation and rising interest rates and we may make adjustments to our allocation of capital in fiscal 2022 or beyond in response to these changing or other circumstances. We may also invest in other uses of our liquidity such as share repurchases, acquisitions and growth initiatives, including through joint ventures and real estate investments.
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Certain lease arrangements require the landlord to fund a portion of the construction related costs through payments directly to us. As we develop new Galleries, as well as other potential strategic initiatives in the future like our integrated hospitality experience, we are exploring other models for our real estate activities, which include different terms and conditions for real estate transactions. These transactions may involve longer lease terms or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated with new sites and buildings that we wish to develop for new Gallery locations or other aspects of our business. These approaches might require different levels of capital investment on our part than a traditional store lease with a landlord. We have also begun executing changes in our real estate strategy to transition some projects from a leasing model to a development model, where we buy and develop real estate for our Design Galleries either directly or through joint ventures and other structures with the objective of ultimately (i) recouping a majority of the investment through a sale-leaseback arrangement and (ii) resulting in lower capital investment and lower rent. For example, in fiscal 2019 we executed a sale-leaseback transaction for the Yountville Design Gallery for sales proceeds of $24 million and in fiscal 2020 we executed a sale-leaseback transaction for the Minneapolis Design Gallery for sales proceeds of $26 million, both of which qualified for sale-leaseback accounting. Additionally, we have entered into arrangements with a third-party development partner to develop real estate for future RH Design Galleries. In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurance that we will be successful in securing additional funding on attractive terms or at all. In addition, our capital needs and uses of capital may change in the future due to changes in our business or new opportunities that we may pursue.
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the following table:
NINE MONTHS ENDED
OCTOBER 29,
OCTOBER 30,
2022
2021
(in thousands)
Net cash provided by operating activities
$
336,021
$
533,682
Net cash used in investing activities
(106,701)
(158,590)
Net cash provided by (used in) financing activities
(255,681)
1,721,514
Net increase (decrease) in cash and cash equivalents, restricted cash and restricted cash equivalents
(27,516)
2,096,640
Cash and cash equivalents, restricted cash and restricted cash equivalents at end of period
2,154,348
2,203,711
Net Cash Provided By Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items including depreciation and amortization, impairments, stock-based compensation, loss on extinguishment of debt, cash paid attributable to accretion of debt discount upon settlement of debt (prior to the adoption of ASU 2020-06 in fiscal 2022) and the effect of changes in working capital and other activities.
For the nine months ended October 29, 2022, net cash provided by operating activities was $336 million and consisted of net income of $422 million and an increase in non-cash items of $397 million, partially offset by a change in working capital and other activities of $483 million. The use of cash from working capital was primarily driven by an increase in prepaid expenses and other assets of $153 million primarily due to federal and state tax receivables and the issuance of additional promissory notes receivable, an increase in merchandise inventory of $97 million, a decrease in operating lease liabilities of $57 million primarily due to payments made under the related lease agreements, a decrease in accounts payable and accrued expenses of $45 million, an increase in landlord asset under construction, net of tenant allowances, of $43 million and a decrease in other current liabilities of $37 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 our strategic investments.
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For the nine months ended October 29, 2022, net cash used in investing activities was $107 million and was comprised of investments in retail stores, information technology and systems infrastructure of $110 million and additional funding of our equity method investments of $2.3 million, partially offset by proceeds from sale of assets of $5.3 million.
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 our share repurchase program, repayment of indebtedness including principal payments under finance lease agreements and other equity related transactions.
For the nine months ended October 29, 2022, net cash used in financing activities was $256 million, primarily due to the completion of certain transactions related to the 2023 Notes and 2024 Notes in the first quarter of fiscal 2022. These transactions resulted in payments of $391 million for the termination of all such outstanding common stock warrants, partially offset by proceeds of $232 million from the termination of all of the remaining convertible note bond hedges. Net cash used in financing activities also included uses of cash of $395 million for the settlement of the convertible senior notes repurchase obligation and payments of $13 million in aggregate principal amount of certain 2023 Notes and 2024 Notes as a result of early conversions by the noteholders. Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements.
These cash outflows were partially offset by the issuance of the Term Loan B-2 in May 2022 in the amount of $500 million pursuant to the 2022 Incremental Amendment to the Term Loan Credit Agreement, for which we incurred debt issuance costs of $28 million. In addition, we received proceeds of $16 million from the issuance of real estate loans related to our consolidated variable interest entities. During the nine months ended October 29, 2022, we made payments under our term loans of $15 million, payments on equipment notes of $13 million, net payments under finance lease agreements of $6.8 million and paid debt extinguishment costs of $8.1 million.
During the nine months ended October 29, 2022, we repurchased 1,127,557 shares of our common stock for an aggregate repurchase amount of $286 million and we received proceeds from option exercises of $154 million, primarily due to Mr. Friedman’s option exercise activity in the first quarter of fiscal 2022.
Non-Cash Transactions
Non-cash transactions consist of non-cash additions of property and equipment and landlord assets and reclassification of assets from landlord assets under construction to finance lease right-of-use assets, as well as conversion of loan receivables into equity of VIEs. In addition, non-cash transactions consist of the extinguishment of convertible senior notes related to our repurchase obligations and associated financing liabilities and embedded derivatives arising from the convertible senior notes repurchases (refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements), as well as shares issued and received related to convertible senior note transactions.
Cash Requirements from Contractual Obligations
Leases
We lease nearly all of our retail and outlet locations, corporate headquarters, distribution centers and home delivery center locations, as well as other storage and office space. Refer to Note 8— Leases in our condensed consolidated financial statements for further information on our lease arrangements, including the maturities of our operating and finance lease liabilities.
Most lease arrangements provide us with the option to renew the leases at defined terms. The table presenting the maturities of our lease liabilities included in Note 8— Leases in our condensed consolidated financial statements includes future obligations for renewal options that are reasonably certain to be exercised and are included in the measurement of the lease liability. Amounts presented therein do not include future lease payments under leases that have not commenced or estimated contingent rent due under operating and finance leases.
Convertible Senior Notes
Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements for further information on the 2023 Notes and 2024 Notes.
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Asset Based Credit Facility
Refer to Note 10— Credit Facilities in our condensed consolidated financial statements for further information on our asset based credit facility, including the amount available for borrowing under the revolving line of credit, net of outstanding letters of credit.
Term Loan Facilities
Refer to Note 10— Credit Facilities in our condensed consolidated financial statements for further information on our term loans facilities, including our Term Loan B and Term Loan B-2.
Equipment Loan Facility
Refer to Note 10— Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility. As of October 29, 2022, one equipment security note remains outstanding with a maturity date in April 2023.
Real Estate Loans
Refer to Note 5— Variable Interest Entities in our condensed consolidated financial statements for further information on the real estate loans held as part of our joint ventures with a third-party development partner.
Share Repurchase Program and Share Retirement
We regularly review share repurchase activity and consider various factors in determining whether and when to execute investments in connection with our share repurchase program, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock. We believe that our share repurchase program will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities.
Share Repurchase Program
In 2018, our Board of Directors authorized a share repurchase program through open market purchases, privately negotiated transactions or other means, including through Rule 10b-18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as the acquisition of other equity linked instruments, accelerated share repurchases including through privately negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives.
On June 2, 2022, the Board of Directors authorized an additional $2.0 billion for the purchase of shares of our outstanding common stock, which increased the total authorized size of the share repurchase program to $2,450 million (the “Share Repurchase Program”). During the nine months ended October 29, 2022, we repurchased 1,127,557 shares of our common stock under the Share Repurchase Program at an average price of $254.02 per share, for an aggregate repurchase amount of approximately $286 million. As of October 29, 2022, approximately $2,164 million remains available for future share repurchases under the Share Repurchase Program.
Share Retirement
During the nine months ended October 29, 2022, we retired 1,127,557 shares of common stock related to shares we repurchased under the Share Repurchase Program. As a result of this retirement, we reclassified a total of $286 million from treasury stock to additional paid-in capital on the condensed consolidated balance sheets and condensed consolidated statements of stockholders’ equity as of October 29, 2022.
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Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with GAAP requires senior leadership to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our accounting policies, estimates, and judgments on an on-going basis. We base our estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions and such differences could be material to the consolidated financial statements.
We evaluate the development and selection of our critical accounting policies and estimates and believe that certain of our significant accounting policies involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results of operations and financial position, and are therefore discussed as critical:
Merchandise Inventories—Reserves
Impairment
Tradenames, Trademarks and Other Intangible Assets
Long-Lived Assets
Lease Accounting
Reasonably Certain Lease Term
Incremental Borrowing Rate
Fair Value
Stock-Based Compensation—Performance-Based Awards
Equity Method Investments
There have been no material changes to the critical accounting policies and estimates listed above from the disclosures included in the 2021 Form 10-K. For further discussion regarding these policies, refer to “ Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” in the 2021 Form 10-K.
Recent Accounting Pronouncements
Refer to Note 2— Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently issued accounting standards that may impact our consolidated financial statements in future reporting periods.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.