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 2022 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 2022 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 2022 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 six months ended July 29, 2023 and a comparison to the three and six months ended July 30, 2022. The discussion related to cash flows for the six months ended July 30, 2022 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/A for the quarter ended July 30, 2022, filed with the Securities and Exchange Commission (“SEC”) on March 27, 2023.
MD&A is a supplement to our condensed consolidated financial statements within Part I 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, including our key value-driving strategies and an overview of certain known trends and uncertainties.
Basis of Presentation and Results of Operations . This section provides our condensed consolidated statements of income and other financial and operating data, including a comparison of our results of operations in the current period 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 condensed consolidated financial statements.
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SPECIAL NOTE REGARDING 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. Matters that we identify as “short term,” “non-recurring,” “unusual,” “one-time,” or other words and terms of similar meaning may, in fact, not be short term and may recur in one or more future financial reporting periods. 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, or that future developments affecting us will be those that we have anticipated. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, are disclosed under the section entitled Risk Factors in our 2022 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 period ended April 29, 2023 (the “First Quarter Form 10-Q”) and in our 2022 Form 10-K. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this quarterly report in the context of these risks and uncertainties.
We cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this quarterly report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.
Overview
We are a leading retailer and luxury lifestyle brand operating primarily in the home furnishings market. Our curated and fully integrated assortments are presented consistently across our sales channels, including our retail locations, websites and Sourcebooks. We offer 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. We position our Galleries as showrooms for our brand, while our websites and Sourcebooks act as virtual and print extensions of our physical spaces, respectively. We operate our retail locations throughout the United States, Canada, and the United Kingdom, and have an integrated RH Hospitality experience in 15 of our Design Gallery locations, which includes Restaurants and Wine Bars.
We opened the 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 and a private residence, as well as The Dining Room & Terrace.
In June 2023, we opened RH England, The Gallery at the Historic Aynho Park, a 400-year-old landmark estate representing the most inspiring and immersive physical expression of the brand to date. RH England marks the beginning of our global expansion beyond North America and our continued foray into hospitality with two primary restaurants: The Orangery, a live fire concept; and The Loggia, an outdoor venue featuring wood-fired pizzas. The Gallery also includes a Wine Lounge and Tea Salon, as well as a Juicery. Spanning 73 acres and over 60 rooms, RH England seamlessly integrates luxury home furnishings collections from RH Interiors, Contemporary, Modern and Outdoor.
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We have recently undertaken substantial efforts to introduce the most prolific collection of new products in our history, with over 70 new furniture and upholstery collections across RH Interiors, Contemporary, Modern, Outdoor, Baby & Child and TEEN. These new collections reflect a level of design and quality inaccessible in our current market, and a value proposition that will be disruptive across multiple markets. Over the next several quarters we will be increasing our investment in Sourcebooks in connection with the introduction of these new products.
As of July 29, 2023, we operated the following number of locations:
COUNT
RH
Design Galleries
28
Legacy Galleries
36
Modern Gallery
1
Baby & Child and TEEN Galleries
3
Total Galleries
68
Outlets
40
Guesthouse
1
Waterworks Showrooms
14
Business Conditions
There are a number of macroeconomic factors and uncertainties affecting the overall business climate as well as our business, including increased inflation, substantially higher interest and mortgage rates, and unpredictability in the global financial markets related to the foregoing as well as, among other things, the recent failures of several financial institutions. We experienced increased demand for our products during the pandemic and there have been significant shifts in consumer consumption patterns with the easing of the pandemic, including increases in travel and services rather than spending on home furnishings. These and other macroeconomic factors may have a number of adverse effects on macroeconomic conditions and markets in which we operate, including the housing market, 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 an adverse impact on demand for our products. We believe that these macroeconomic and other factors have contributed to the slowdown in demand that we have experienced in our business over the last several fiscal quarters.
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 macroeconomic factors.
We also face uncertainties related to the large number of new business initiatives that we are undertaking at the same time, including efforts to grow our business through (i) international expansion, (ii) developing innovative new Gallery designs and locations for our business, (iii) pursuing new areas of business operations including real estate development and real estate joint ventures, as well as the expansion of RH Hospitality, and (iv) substantial enhancement of our merchandise assortment and improvements to the quality of our products and services as we seek to climb the luxury mountain.
For more information, refer to the section entitled “Risk Factors” in our 2022 Form 10-K.
Key Value-Driving Strategies
In order to achieve our long-term strategies of Product Elevation, Platform Expansion and Cash Generation as well as drive growth across our business, we are focused on the following key strategies and business initiatives:
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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 year we will be introducing a large number of new products as we have continued our efforts to enhance our merchandise assortment. In addition, over the next few years, we plan to introduce RH Couture, RH Bespoke 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 in North America will unlock the value of our vast assortment, generating an expected annual revenue opportunity for our business of $5 to $6 billion. 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 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.
Brand Elevation . We are evolving the RH 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. We entered this industry with the opening of the RH Guesthouse in New York in September 2022, and are in the process of constructing our second RH Guesthouse in Aspen. 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 with a substantial opportunity to build over time a projected $20 to $25 billion global brand in terms of annual revenues. 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, which began with the opening of RH England, The Gallery at the Historic Aynho Park, in June 2023. We have secured a number of locations in various markets in the U.K. and continental Europe for future Design Galleries and are currently 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
SIX MONTHS ENDED
JULY 29,
% OF NET
JULY 30,
% OF NET
JULY 29,
% OF NET
JULY 30,
% OF NET
2023
REVENUES
2022
REVENUES
2023
REVENUES
2022
REVENUES
(dollars in thousands)
Net revenues
$
800,479
100.0
%
$
991,620
100.0
%
$
1,539,641
100.0
%
$
1,948,912
100.0
%
Cost of goods sold
420,406
52.5
468,402
47.2
812,023
52.7
927,111
47.6
Gross profit
380,073
47.5
523,218
52.8
727,618
47.3
1,021,801
52.4
Selling, general and administrative expenses
228,733
28.6
288,804
29.2
477,038
31.0
582,099
29.8
Income from operations
151,340
18.9
234,414
23.6
250,580
16.3
439,702
22.6
Other expenses
Interest expense—net
44,422
5.5
26,264
2.6
84,238
5.5
47,119
2.5
Loss on extinguishment of debt
—
—
23,462
2.4
—
—
169,578
8.7
Other (income) expense—net
(186)
—
3,195
0.3
(839)
(0.1)
2,852
0.1
Total other expenses
44,236
5.5
52,921
5.3
83,399
5.4
219,549
11.3
Income before income taxes and equity method investments
107,104
13.4
181,493
18.3
167,181
10.9
220,153
11.3
Income tax expense (benefit)
27,245
3.4
56,397
5.7
43,830
2.9
(107,029)
(5.5)
Income before equity method investments
79,859
10.0
125,096
12.6
123,351
8.0
327,182
16.8
Share of equity method investments loss
3,382
0.4
2,821
0.3
4,984
0.3
4,196
0.2
Net income
$
76,477
9.6
%
$
122,275
12.3
%
$
118,367
7.7
%
$
322,986
16.6
%
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we use non-GAAP financial measures, including adjusted operating income, adjusted net income, EBITDA, adjusted EBITDA, and adjusted capital expenditures. We compute these measures by adjusting the applicable GAAP measures to remove the impact of certain recurring and non-recurring charges and gains and to adjust for the impact of income tax items related to such adjustments to our GAAP financial statements. 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
SIX MONTHS ENDED
JULY 29,
JULY 30,
JULY 29,
JULY 30,
2023
2022
2023
2022
(in thousands)
Net income
$
76,477
$
122,275
$
118,367
$
322,986
Interest expense—net (1)
44,422
26,264
84,238
47,119
Loss on extinguishment of debt (1)
—
23,462
—
169,578
Other (income) expense—net (1)
(186)
3,195
(839)
2,852
Income tax expense (benefit) (1)
27,245
56,397
43,830
(107,029)
Share of equity method investments loss (1)
3,382
2,821
4,984
4,196
Operating income
151,340
234,414
250,580
439,702
Legal settlements (2)
8,000
—
8,000
—
Reorganization related costs (3)
—
—
7,621
—
Non-cash compensation (4)
2,024
4,321
5,555
10,179
Employer payroll taxes on option exercise (5)
—
—
—
11,717
Asset impairments (6)
—
2,231
—
8,154
Professional fees (7)
—
285
—
7,469
Compensation settlements (8)
—
3,483
—
3,483
Recall accrual (9)
—
—
—
560
Adjusted operating income
$
161,364
$
244,734
$
271,756
$
481,264
(1) Refer to discussion “Three Months Ended July 29, 2023 Compared to Three Months Ended July 30, 2022” and “July 29, 2023 Compared to July 30, 2022” below for a discussion of our results of operations for the three and six months ended July 29, 2023 and July 30, 2022.
(2) Represents certain legal settlements associated with class action litigation matters. Refer to Note 16 — Commitments and Contingencies in our condensed consolidated financial statements.
(3) Represents severance costs and related payroll taxes associated with a reorganization.
(4) Represents the amortization of the non-cash compensation charge related to an option grant made to Mr. Friedman in October 2020.
(5) Represents employer payroll tax expense related to the option exercise by Mr. Friedman in the first quarter of fiscal 2022.
(6) Represents asset impairments related to property and equipment of Galleries under construction. The three and six months ended July 30, 2022 includes lease impairment of $1.0 million due to the early exit of a leased facility.
(7) Represents professional fees contingent upon the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge terminations and warrant and convertible senior notes repurchase (refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements).
(8) Represents compensation settlements related to the Rollover Units and Profit Interest Units in the Waterworks subsidiary.
(9) Represents accruals associated with product recalls.
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.
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Reconciliation of GAAP Net Income to Adjusted Net Income
THREE MONTHS ENDED
SIX MONTHS ENDED
JULY 29,
JULY 30,
JULY 29,
JULY 30,
2023
2022
2023
2022
(in thousands)
Net income
$
76,477
$
122,275
$
118,367
$
322,986
Adjustments pre-tax:
Legal settlements (1)
8,000
—
8,000
—
Reorganization related costs (1)
—
—
7,621
—
Non-cash compensation (1)
2,024
4,321
5,555
10,179
Loss on extinguishment of debt (1)
—
23,462
—
169,578
Employer payroll taxes on option exercise (1)
—
—
—
11,717
Asset impairments (1)
—
2,231
—
8,154
Professional fees (1)
—
285
—
7,469
Compensation settlements (1)
—
3,483
—
3,483
Recall accrual (1)
—
—
—
560
(Gain) loss on derivative instruments—net (2)
—
1,453
—
(1,724)
Subtotal adjusted items
10,024
35,235
21,176
209,416
Impact of income tax items (3)
(1,203)
3,732
(3,636)
(191,194)
Share of equity method investments loss (1)
3,382
2,821
4,984
4,196
Adjusted net income
$
88,680
$
164,063
$
140,891
$
345,404
(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) loss on derivative instruments resulting from certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge terminations and warrant and convertible senior notes repurchase (refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements).
(3) We exclude the GAAP tax provision and apply a non-GAAP tax provision based upon (i) adjusted pre-tax net income, (ii) the projected annual adjusted tax rate and (iii) the exclusion of material discrete tax items that are unusual or infrequent, such as tax benefits related to the option exercise by Mr. Friedman in first quarter of fiscal 2022. The adjustments for both the three months ended July 29, 2023 and July 30, 2022 are based on an adjusted tax rate of 24.3%, and the adjustments for the six months ended July 29, 2023 and July 30, 2022 are based on adjusted tax rates of 25.2% and 19.6%, respectively.
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.
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Reconciliation of GAAP Net Income to EBITDA and Adjusted EBITDA
THREE MONTHS ENDED
SIX MONTHS ENDED
JULY 29,
JULY 30,
JULY 29,
JULY 30,
2023
2022
2023
2022
(in thousands)
Net income
$
76,477
$
122,275
$
118,367
$
322,986
Depreciation and amortization
28,136
26,970
55,906
51,728
Interest expense—net
44,422
26,264
84,238
47,119
Income tax expense (benefit)
27,245
56,397
43,830
(107,029)
EBITDA
176,280
231,906
302,341
314,804
Non-cash compensation (1)
8,538
10,736
18,718
23,538
Legal settlements (2)
8,000
—
8,000
—
Reorganization related costs (2)
—
—
7,621
—
Share of equity method investments loss (2)
3,382
2,821
4,984
4,196
Capitalized cloud computing amortization (3)
1,923
1,699
3,772
3,053
Other (income) expense—net (2)
(186)
3,195
(839)
2,852
Loss on extinguishment of debt (2)
—
23,462
—
169,578
Employer payroll taxes on option exercise (2)
—
—
—
11,717
Asset impairments (2)
—
2,231
—
8,154
Professional fees (2)
—
285
—
7,469
Compensation settlements (2)
—
3,483
—
3,483
Recall accrual (2)
—
—
—
560
Adjusted EBITDA
$
197,937
$
279,818
$
344,597
$
549,404
(1) Represents non-cash compensation related to equity awards granted to employees, including the amortization of the non-cash compensation charge related to an option grant made to Mr. Friedman in October 2020.
(2) Refer to table titled “Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating Income” and the related footnotes for additional information.
(3) Represents amortization associated with capitalized cloud computing costs.
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.
Reconciliation of Adjusted Capital Expenditures
THREE MONTHS ENDED
SIX MONTHS ENDED
JULY 29,
JULY 30,
JULY 29,
JULY 30,
2023
2022
2023
2022
(in thousands)
Capital expenditures
$
47,406
$
33,194
$
81,596
$
62,558
Landlord assets under construction—net of tenant allowances
4,376
20,312
13,959
32,460
Adjusted capital expenditures
$
51,782
$
53,506
$
95,555
$
95,018
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In addition, we also received landlord tenant allowances subsequent to lease commencement of $2.4 million and $4.2 million for the three and six months ended July 29, 2023 and July 30, 2022, respectively, which are reflected as a reduction to principal payments under finance leases within financing activities on the condensed consolidated statements of cash flows.
The following table presents RH Gallery and Waterworks Showroom metrics, and excludes Outlets:
SIX MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
TOTAL LEASED
TOTAL LEASED
SELLING SQUARE
SELLING SQUARE
COUNT
FOOTAGE (1)
COUNT
FOOTAGE (1)
(square footage in thousands)
Beginning of period
81
1,286
81
1,254
RH Design Galleries:
England Design Gallery
1
35.1
—
—
Indianapolis Design Gallery
(1)
(13.0)
—
—
San Francisco Design Gallery
—
—
1
42.1
RH Legacy Galleries:
Indianapolis temporary Gallery
1
5.7
—
—
San Francisco legacy Gallery
—
—
(1)
(4.8)
Detroit legacy Gallery (relocation)
—
1.5
—
—
End of period
82
1,315
81
1,291
Total leased square footage at end of period (2)
1,791
1,737
Weighted-average leased square footage (3)
1,747
1,700
Weighted-average leased selling square footage (3)
1,292
1,270
(1) Leased selling square footage is retail space at our retail locations used to sell our products, as well as space for our Restaurants. Leased selling square footage excludes backrooms at retail locations used for storage, office space, food preparation, kitchen space or similar purpose as well as exterior sales space located outside a retail location, such as courtyards, gardens and rooftops.
Leased selling square footage includes approximately 35,000 square feet as of July 29, 2023 related to one owned retail location.
(2) Total leased square footage includes approximately 56,000 square feet as of July 29, 2023 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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Three Months Ended July 29, 2023 Compared to Three Months Ended July 30, 2022
THREE MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
RH SEGMENT
WATERWORKS
TOTAL (1)
RH SEGMENT
WATERWORKS
TOTAL (1)
(in thousands)
Net revenues
$
753,550
$
46,929
$
800,479
$
940,182
$
51,438
$
991,620
Cost of goods sold
399,125
21,281
420,406
445,108
23,294
468,402
Gross profit
354,425
25,648
380,073
495,074
28,144
523,218
Selling, general and administrative expenses
211,080
17,653
228,733
264,206
24,598
288,804
Income from operations
$
143,345
$
7,995
$
151,340
$
230,868
$
3,546
$
234,414
(1) The results for the Real Estate segment were immaterial in the three months ended July 29, 2023 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 July 30, 2022. Refer to Note 17— Segment Reporting in our condensed consolidated financial statements.
Net revenues
Consolidated net revenues decreased $191 million, or 19.3%, to $800 million in the three months ended July 29, 2023 compared to $992 million in the three months ended July 30, 2022.
RH Segment net revenues
RH Segment net revenues decreased $187 million, or 19.9%, to $754 million in the three months ended July 29, 2023 compared to $940 million in the three months ended July 30, 2022. The below discussion highlights several significant factors that resulted in a decrease in RH Segment net revenues, which are listed in order of magnitude.
RH Segment net revenues for the three months ended July 29, 2023 decreased primarily due to lower demand compared to the second quarter of fiscal 2022, during which demand and net revenues still benefited from the elevated pandemic-driven home spending. Outlet sales decreased $9.7 million to $59 million in the three months ended July 29, 2023 compared to $69 million in the three months ended July 30, 2022.
Waterworks net revenues
Waterworks net revenues decreased $4.5 million, or 8.8%, to $47 million in the three months ended July 29, 2023 compared to $51 million in the three months ended July 30, 2022.
Gross profit
Consolidated gross profit decreased $143 million, or 27.4%, to $380 million in the three months ended July 29, 2023 compared to $523 million in the three months ended July 30, 2022. As a percentage of net revenues, consolidated gross margin decreased 530 basis points to 47.5% of net revenues in the three months ended July 29, 2023 from 52.8% of net revenues in the three months ended July 30, 2022.
RH Segment gross profit
RH Segment gross profit decreased $141 million, or 28.4%, to $354 million in the three months ended July 29, 2023 compared to $495 million in the three months ended July 30, 2022. As a percentage of net revenues, RH Segment gross margin decreased 570 basis points to 47.0% of net revenues in the three months ended July 29, 2023 from 52.7% of net revenues in the three months ended July 30, 2022. The decrease in RH Segment gross margin was primarily attributable to a decrease in product margins in the Core business, primarily driven by higher discounts on discontinued product collections, as well as lower net revenues resulting in deleverage in occupancy costs.
Waterworks gross profit
Waterworks gross profit decreased $2.5 million, or 8.9%, to $26 million in the three months ended July 29, 2023 compared to $28 million in the three months ended July 30, 2022. As a percentage of net revenues, Waterworks gross margin was 54.7% of net revenues in both the three months ended July 29, 2023 and July 30, 2022.
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Selling, general and administrative expenses
Consolidated selling, general and administrative expenses decreased $60 million, or 20.8%, to $229 million in the three months ended July 29, 2023 compared to $289 million in the three months ended July 30, 2022.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses decreased $53 million, or 20.1%, to $211 million in the three months ended July 29, 2023 compared to $264 million in the three months ended July 30, 2022.
RH Segment selling, general and administrative expenses for the three months ended July 29, 2023 include legal settlements of $8.0 million and non-cash compensation of $2.0 million related to an option grant made to Mr. Friedman in October 2020.
RH Segment selling, general and administrative expenses for the three months ended July 30, 2022 include amortization of non-cash compensation of $4.3 million related to an option grant made to Mr. Friedman in October 2020, $2.0 million of asset impairments and a $0.3 million professional fee which was contingent upon the completion of our debt transactions related to the 2023 Notes and 2024 Notes.
RH Segment selling, general and administrative expenses would have been 26.6% and 27.4% of net revenues for the three months ended July 29, 2023 and July 30, 2022, 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 due to lower advertising costs compared to the second quarter of fiscal 2022 driven by the mailing of the new RH Contemporary Sourcebook, partially offset by lower net revenues resulting in leverage in deleverage in occupancy and other corporate costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased $6.9 million, or 28.2%, to $18 million in the three months ended July 29, 2023 compared to $25 million in the three months ended July 30, 2022. Waterworks selling, general and administrative expenses were 37.6% and 47.8% of net revenues for the three months ended July 29, 2023 and July 30, 2022, respectively.
Waterworks selling, general and administrative expenses for the three months ended July 30, 2022 include $3.5 million in compensation settlements related to the Rollover Units and Profit Interests Units and a $0.2 million asset impairment. Excluding the adjustments, Waterworks selling, general and administrative expenses would have been 37.6% and 40.7% of net revenues for the three months ended July 29, 2023 and July 30, 2022, respectively.
Interest expense—net
Interest expense—net increased $18 million in the three months ended July 29, 2023 compared to the three months ended July 30, 2022, which consisted of the following in each period:
THREE MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
(in thousands)
Term loan interest expense
$
50,435
$
24,982
Finance lease interest expense
8,794
7,891
Other interest expense
1,198
832
Interest income
(14,741)
(6,393)
Capitalized interest for capital projects
(1,264)
(1,048)
Total interest expense—net
$
44,422
$
26,264
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Loss on extinguishment of debt
During the three months ended July 30, 2022, we recognized a loss on extinguishment of debt of $23 million related to the repurchase of $57 million of principal value of convertible senior notes, inclusive of the acceleration of amortization of debt issuance costs of $0.3 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.
Other (income) expense—net
Other (income) expense—net was income of $0.2 million in the three months ended July 29, 2023, which represents a foreign exchange gain from the remeasurement of intercompany loans with U.K. and Switzerland subsidiaries, partially offset by 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.
Other (income) expense—net was an expense of $3.2 million during the three months ended July 30, 2022, which included a loss on derivative instruments of $1.5 million resulting from the completion of certain transactions related to the 2023 Notes and 2024 Notes. Refer to Note 9— Convertible Senior Notes in our condensed consolidated financial statements. Other (income) expense—net also includes a $1.7 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.
Income tax expense
Our income tax expense and effective tax rates were as follows:
THREE MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
(dollars in thousands)
Income tax expense
$
27,245
$
56,397
Effective tax rate
26.3%
31.6%
The decrease in our effective tax rate for the three months ended July 29, 2023 compared to the three months ended July 30, 2022 is primarily attributable to net excess tax benefits from stock-based compensation and amounts related to the loss on extinguishment of debt in the three months ended July 30, 2022.
Equity method investments loss
Equity method investments loss consists of our proportionate share of the loss of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $3.4 million and $2.8 million loss during the three months ended July 29, 2023 and July 30, 2022, respectively.
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Six Months Ended July 29, 2023 Compared to Six Months Ended July 30, 2022
SIX MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
RH SEGMENT
WATERWORKS
TOTAL (1)
RH SEGMENT
WATERWORKS
TOTAL
(in thousands)
Net revenues
$
1,444,066
$
95,575
$
1,539,641
$
1,849,130
$
99,782
$
1,948,912
Cost of goods sold
768,057
43,966
812,023
881,234
45,877
927,111
Gross profit
676,009
51,609
727,618
967,896
53,905
1,021,801
Selling, general and administrative expenses
440,095
36,943
477,038
539,725
42,374
582,099
Income from operations
$
235,914
$
14,666
$
250,580
$
428,171
$
11,531
$
439,702
(1) The results for the Real Estate segment were immaterial in the six months ended July 29, 2023 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 six months ended July 30, 2022. Refer to Note 17— Segment Reporting in our condensed consolidated financial statements.
Net revenues
Consolidated net revenues decreased $409 million, or 21.0%, to $1,540 million in the six months ended July 29, 2023 compared to $1,949 million in the six months ended July 30, 2022.
RH Segment net revenues
RH Segment net revenues decreased $405 million, or 21.9%, to $1,444 million in the six months ended July 29, 2023 compared to $1,849 million in the six months ended July 30, 2022. The below discussion highlights several significant factors that impacted RH Segment net revenues, which are listed in order of magnitude.
RH Segment net revenues for the six months ended July 29, 2023 decreased primarily due to lower demand compared to the first half of fiscal 2022, during which demand still benefited from the elevated pandemic-driven home spending. Outlet sales decreased $23 million to $116 million in the six months ended July 29, 2023 compared to $139 million in the six months ended July 30, 2022.
Waterworks net revenues
Waterworks net revenues decreased $4.2 million, or 4.2%, to $96 million in the six months ended July 29, 2023 compared to $100 million in the six months ended July 30, 2022.
Gross profit
Consolidated gross profit decreased $294 million, or 28.8%, to $728 million in the six months ended July 29, 2023 compared to $1,022 million in the six months ended July 30, 2022. As a percentage of net revenues, consolidated gross margin decreased 510 basis points to 47.3% of net revenues in the six months ended July 29, 2023 from 52.4% of net revenues in the six months ended July 30, 2022.
RH Segment gross profit
RH Segment gross profit decreased $292 million, or 30.2%, to $676 million in the six months ended July 29, 2023 from $968 million in the six months ended July 30, 2022. As a percentage of net revenues, RH Segment gross margin decreased 550 basis points to 46.8% of net revenues in the six months ended July 29, 2023 from 52.3% of net revenues in the six months ended July 30, 2022. The decrease in RH Segment gross margin was primarily attributable to a decrease in product margins in the Core business, primarily driven by higher discounts on discontinued product collections, as well as lower net revenues resulting in deleverage in occupancy costs.
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Waterworks gross profit
Waterworks gross profit decreased $2.3 million, or 4.3%, to $52 million in the six months ended July 29, 2023 from $54 million in the six months ended July 30, 2022. As a percentage of net revenues, Waterworks gross margin was 54.0% of net revenues in both the six months ended July 29, 2023 and July 30, 2022.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses decreased $105 million, or 18.0%, to $477 million in the six months ended July 29, 2023 compared to $582 million in the six months ended July 30, 2022.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses decreased $100 million, or 18.5%, to $440 million in the six months ended July 29, 2023 compared to $540 million in the six months ended July 30, 2022.
RH Segment selling, general and administrative expenses for the six months ended July 29, 2023 include legal settlements of $8.0 million, severance expense and other payroll related costs associated with a reorganization of $7.6 million and non-cash compensation of $5.6 million related to an option grant made to Mr. Friedman in October 2020.
RH Segment selling, general and administrative expenses for the six months ended July 30, 2022 include $12 million of employer payroll tax expense associated with Mr. Friedman’s stock option exercise during the first quarter of fiscal 2022, amortization of non-cash compensation of $10 million related to an option grant made to Mr. Friedman in October 2020, $8.0 million related to asset impairments, $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.
RH Segment selling, general and administrative expenses would have been 29.0% and 27.1% of net revenues for the six months ended July 29, 2023 and July 30, 2022, respectively, excluding the costs incurred in connection with the adjustments mentioned above. The increase in selling, general and administrative expenses as a percentage of net revenues was primarily driven by lower net revenues resulting in deleverage in compensation, occupancy and other corporate costs, partially offset by lower advertising costs due to the mailing of the new RH Contemporary Sourcebook in the second quarter of fiscal 2022 and lower pre-opening costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses decreased $5.4 million, or 12.8%, to $37 million in the six months ended July 29, 2023 compared to $42 million in the six months ended July 30, 2022. Waterworks selling, general and administrative expenses were 38.7% and 42.5% of net revenues for the six months ended July 29, 2023 and July 30, 2022, respectively.
Waterworks selling, general and administrative expenses for the six months ended July 30, 2022 include $3.5 million in compensation settlements related to the Rollover Units and Profit Interest Units and a $0.2 million asset impairment. Excluding the adjustments, Waterworks selling, general and administrative expenses would have been 38.7% and 38.8% of net revenues for the six months ended July 29, 2023 and July 30, 2022, respectively.
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Interest expense—net
Interest expense—net increased $37 million in the six months ended July 29, 2023 compared to the six months ended July 30, 2022, which consisted of the following in each period:
SIX MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
(in thousands)
Term loan interest expense
$
98,228
$
40,983
Finance lease interest expense
17,280
14,962
Other interest expense
2,414
1,905
Interest income
(31,365)
(7,574)
Capitalized interest for capital projects
(2,319)
(3,157)
Total interest expense—net
$
84,238
$
47,119
Loss on extinguishment of debt
During the six months ended July 30, 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.
Other (income) expense—net
Other income (expense)—net was income of $0.8 million in the six months ended July 29, 2023, which represents a foreign exchange gain from the remeasurement of intercompany loans with U.K. and Switzerland subsidiaries, offset by 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.
Other income (expense)—net was an expense of $2.9 million during the six months ended July 30, 2022, which included a $4.6 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 six months ended July 30, 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)
Our income tax expense (benefit) and effective tax rates were as follows:
SIX MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
(dollars in thousands)
Income tax expense (benefit)
$
43,830
$
(107,029)
Effective tax rate
27.0%
(49.6)%
The increase in our effective tax rate for the six months ended July 29, 2023 compared to the six months ended July 30, 2022 is primarily attributable to significantly lower net excess tax benefits from stock-based compensation in fiscal 2023 as compared to fiscal 2022.
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Equity method investments loss
Equity method investments loss consists of our proportionate share of the loss of our equity method investments by applying the hypothetical liquidation at book value methodology, which resulted in a $5.0 million and $4.2 million loss during the six months ended July 29, 2023 and July 30, 2022, respectively.
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.
A summary of our net debt, and availability under the ABL Credit Agreement, is set forth in the following table:
JULY 29,
JANUARY 28,
2023
2023
(in thousands)
Asset based credit facility
$
—
$
—
Term loan B (1)
1,965,000
1,975,000
Term loan B-2 (1)
496,250
498,750
Equipment promissory notes (1)
—
1,160
Convertible senior notes due 2023 (1)
—
1,696
Convertible senior notes due 2024 (1)
41,904
41,904
Notes payable for share repurchases
315
315
Total debt (2)
$
2,503,469
$
2,518,825
Cash and cash equivalents
(417,047)
(1,508,101)
Total net debt
$
2,086,422
$
1,010,724
Availability under the asset based credit facility—net (3)
$
453,792
$
533,482
(1) Amounts exclude discounts upon original issuance and third party offering and debt issuance cost.
(2) Net debt as of July 29, 2023 and January 28, 2023 excludes restricted cash of $3.5 million and $3.7 million, respectively, as well as non-recourse real estate loans of $18 million as of both periods 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.
(3) As of both July 29, 2023 and January 28, 2023, the amount available for borrowing under the revolving line of credit under the ABL Credit Agreement is presented net of $27 million in outstanding letters of credit.
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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 Sourcebooks. 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. During the three months ended July 29, 2023, we invested $1,208 million of cash, inclusive of excise taxes paid, in the purchase of shares of our common stock pursuant to our Share Repurchase Program (refer to Item 2 ¾ Unregistered Sales of Equity Securities and Use of Proceeds within Part II of this Quarterly Report on Form 10-Q for information related to timing). 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 and Share Retirement” 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.
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 macroeconomic factors affecting business conditions, such as the pandemic, inflation and increases in interest rates. 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 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.
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We entered into a $2,000 million 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 July 29, 2023, we had $1,965 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 July 29, 2023, we had $496 million outstanding under the Amended Term Loan Credit Agreement. We are required to make quarterly principal payments of $1.3 million with respect to the Term Loan B-2 from December 2022.
Convertible Senior Notes
In September 2019, we issued in a private offering $350 million principal amount of 0.00% convertible senior notes due 2024 (the “2024 Notes”).
As of July 29, 2023, we had $42 million remaining in aggregate principal amount of the 2024 Notes, which have a scheduled maturity in September 2024. We anticipate having sufficient cash available to repay the principal amount of the 2024 Notes in cash with respect to any convertible notes for which the holders elect early conversion, as well as upon maturity of the 2024 Notes in September 2024.
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 six months ended July 29, 2023, adjusted capital expenditures were $96 million in aggregate, net of cash received related to landlord tenant allowances of $4.1 million. In addition, we also received landlord tenant allowances subsequent to lease commencement of $2.4 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 $225 million to $275 million in fiscal 2023, 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 macroeconomic factors and uncertainties affecting the overall business climate as well as our business, including increased inflation and higher interest rates and we may make adjustments to our allocation of capital in fiscal 2023 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 ultimate objective of (i) recouping a majority of the investment through a sale-leaseback arrangement and (ii) resulting in lower capital investment and lower rent. For example, 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:
SIX MONTHS ENDED
JULY 29,
JULY 30,
2023
2022
(in thousands)
Net cash provided by operating activities
$
248,355
$
192,516
Net cash used in investing activities
(115,323)
(64,078)
Net cash used in financing activities
(1,224,481)
(224,156)
Net decrease in cash and cash equivalents, restricted cash and restricted cash equivalents
(1,091,178)
(96,158)
Cash and cash equivalents, restricted cash and restricted cash equivalents at end of period
420,585
2,085,706
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 and the effect of changes in working capital and other activities.
For the six months ended July 29, 2023, net cash provided by operating activities was $248 million and consisted of net income of $118 million and an increase in non-cash items of $188 million, partially offset by a change in working capital and other activities of $57 million. The use of cash from working capital was primarily driven by a decrease in operating lease liabilities of $42 million primarily due to payments made under the related lease agreements, a decrease in accounts payable and accrued expenses of $32 million, an increase in prepaid expenses and other current assets of $25 million, a decrease in other non-current obligations of $17 million and an increase in landlord assets under construction, net of tenant allowances, of $14 million. These uses of cash from working capital were partially offset by a decrease in merchandise inventory of $65 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.
For the six months ended July 29, 2023, net cash used in investing activities was $115 million and was comprised of investments in retail stores, information technology and systems infrastructure of $82 million and additional contributions to our equity method investments of $34 million.
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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 six months ended July 29, 2023, net cash used in financing activities was $1,224 million, primarily due to the repurchase of 3,698,887 shares of our common stock for an aggregate repurchase amount of $1,205 million, payments on term loans of $13 million, net payments under finance lease agreements of $5.5 million and repayments of the 2023 Notes of $1.7 million and equipment notes of $1.2 million. In addition, we paid $3.7 million of excise taxes related to share repurchases made in fiscal 2022. These cash outflows were partially offset by proceeds from option exercises of $4.7 million.
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. In addition, non-cash transactions consist of excise tax from share repurchases included in accounts payable and accrued expenses at period-end, the extinguishment of convertible senior notes related to our repurchase obligations and associated financing liabilities and embedded derivatives arising from the convertible senior notes repurchase (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. The 2023 Notes matured in June 2023.
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
Refer to Note 10— Credit Facilities in our condensed consolidated financial statements for further information on our Term Loan.
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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 stockholders. 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 $2,000 million 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”). In the six months ended July 29, 2023, we repurchased 3,698,887 shares of our common stock under the Share Repurchase Program at an average price of $325.65 per share, for an aggregate repurchase amount of approximately $1,205 million. As of July 29, 2023, $245 million remains available for future share repurchases under the Share Repurchase Program.
Share Retirement
During the six months ended July 29, 2023, we retired 3,698,887 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 $8.6 million and $1,208 million from treasury stock to additional paid-in capital and retained earnings (accumulated deficit) , respectively, on the condensed consolidated balance sheets and condensed consolidated statements of stockholders’ equity (deficit) as of and for the three and six months ended July 29, 2023.
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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 condensed 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 our condensed 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
Variable Interest Entities
There have been no material changes to the critical accounting policies and estimates listed above from the disclosures included in our 2022 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 our 2022 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 results 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.