Rh 10-Q/A for FY2023 Q1
Rh (RH)
About this 10-Q/A
Rh filed this 10-Q/A on March 27, 2023, covering the quarter ended April 30, 2022 (FY2023 Q1).
Headline figures
Quarter ended April 30, 2022, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $957.29M
- up 11.2% from $860.79M a year earlier
- Net income
- $200.71M
- up 53.6% from net income of $130.66M a year earlier
- Diluted EPS
- $7.22
- up 72.3% from $4.19 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
Amendment No. 1
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number:
(Exact name of registrant as specified in its charter)
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(State or other jurisdiction of |
| (I.R.S. Employer |
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(Address of principal executive offices) |
| (Zip Code) |
Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Act:
(Title of each class) | | (Trading symbol) | (Name of each exchange on which registered) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| ☒ |
| Accelerated filer |
| ☐ | |
Non-accelerated filer |
| ☐ |
| Smaller reporting company |
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| | | | Emerging growth company | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
As of May 27, 2022,
EXPLANATORY NOTE
As previously reported, the Audit Committee of the Board of Directors, after discussion with our senior leadership and independent registered public accountants, determined that (i) our previously filed unaudited financial statements for the three months ended April 30, 2022, the three and six months ended July 30, 2022, and the three and nine months ended October 29, 2022 (collectively the “Prior Financial Statements”) should no longer be relied upon due to material unintentional errors in certain of these financial periods with respect to our calculation of basic and diluted net income per share and (ii) a restatement would be required to correct these errors in our Prior Financial Statements (the “Restatement”) for each of the quarterly periods ended April 30, 2022, July 30, 2022, and October 29, 2022 (the “Non-Reliance Periods”) included in the associated Form 10-Qs previously filed with the SEC. For more information about the Restatement, refer to the Company’s Current Report on Form 8-K (Item 4.02) filed on February 3, 2023.
The purpose of this Amendment is to restate the calculation of basic and diluted net income per share in order to effect the Restatement with respect to the financial statements that appear in the Original Report. The Restatement is also being effected by amendments to each of the Company’s other Quarterly Reports on Form 10-Q with respect to the Non-Reliance Periods (collectively, the “10-Q Amendments”). The Restatement has no impact on other previously reported GAAP financial information other than as corrected in the 10-Q Amendments, including assets, liabilities, equity, revenues, gross profit, income from operations, net income or cash flows, and the related non-GAAP financial measures, as well as EBITDA and adjusted EBITDA.
In connection with the Restatement, we have also identified a material weakness in internal control over financial reporting and concluded that our disclosure controls and procedures were not effective as of April 30, 2022, including through the date of this Amendment. Refer to Item 4—Controls and Procedures of this Amendment.
Adjustments to Non-GAAP Adjusted Effective Tax Rate
In addition to the Restatement, we have also modified how we determine the applicable adjusted effective tax rate for purposes of calculating non-GAAP adjusted net income disclosed as a non-GAAP financial measure (the “Adjustments to Non-GAAP Adjusted Effective Tax Rate”) within Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
Items Amended in this Filing
For the convenience of the reader, this Amendment sets forth the Original Report in its entirety, as amended.
This Amendment amends only the following items in the Original Report and only with respect to the matters described with respect to the Restatement and the Adjustments to Non-GAAP Adjusted Effective Tax Rate discussed above:
1. Part I, Item 1. Financial Statements. The Financial Statements are amended to correct the errors in the financial statements as a result of the Restatement and the related financial and other information affected by the Restatement, which changes are reflected in the following sections:
Condensed Consolidated Statements of Income (unaudited)
Note 1—The Company—“Restatement of Condensed Consolidated Financial Statements”
Note 13—Net Income Per Share
2. Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. “MD&A—Reconciliation of GAAP Net Income to Adjusted Net Income” is amended to provide the Adjustments to Non-GAAP Adjusted Effective Tax Rate referred to above.
3. Part I, Item 4. Controls and Procedures. The description of Controls and Procedures is amended to reflect the Company’s conclusion that its disclosure controls and procedures were not effective as of April 30, 2022, including through the date of this Amendment as a result of a material weakness in its internal control over financial reporting.
In accordance with applicable Commission rules, this Amendment includes new certifications from our Chief Executive Officer and our Chief Financial Officer dated as of the date of filing this Amendment, and restates the financial statements formatted in Extensible Business Reporting Language (XBRL) in Exhibits 101.
While all required items on Form 10-Q have been included herein for these matters, no other sections were affected.
Except as described above, this Amendment does not amend, update, or change any other items or disclosures in the Original Report and does not purport to reflect any information or events subsequent to the filing date of the Original Report. As such, this Amendment and the forward-looking statements contained herein speak only as of the date the Original Report was filed, and the Company has not undertaken herein to amend, supplement or update any information contained in the Original Report to give effect to any subsequent events. Accordingly, this Amendment should be read in conjunction with our filings made with the SEC subsequent to the filing of the Original Report, including any amendment to those filings.
RH
INDEX TO FORM 10-Q/A
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| Page |
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5 | ||||
Condensed Consolidated Balance Sheets (Unaudited) | 5 | |||
6 | ||||
7 | ||||
8 | ||||
9 | ||||
Notes to Condensed Consolidated Financial Statements (Unaudited) | 11 | |||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 33 | |||
50 | ||||
52 | ||||
| | | | |
54 | ||||
54 | ||||
| | 56 | ||
| | 56 | ||
| | 56 | ||
| | 56 | ||
57 | ||||
58 | ||||
PART I
ITEM 1. FINANCIAL STATEMENTS
RH
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
c | | | | | | |
|
| APRIL 30, |
| JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | (in thousands) | ||||
ASSETS |
| |
|
| |
|
Cash and cash equivalents | | $ | | | $ | |
Accounts receivable—net | |
| | |
| |
Merchandise inventories | |
| | |
| |
Prepaid expense and other current assets | |
| | |
| |
Total current assets | |
| | |
| |
Property and equipment—net | |
| | |
| |
Operating lease right-of-use assets | | | | | | |
Goodwill | |
| | |
| |
Tradenames, trademarks and other intangible assets | |
| | |
| |
Deferred tax assets | |
| | |
| |
Equity method investments | | | | | | |
Other non-current assets | |
| | |
| |
Total assets | | $ | | | $ | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | |
|
| |
|
|
Accounts payable and accrued expenses | | $ | | | $ | |
Deferred revenue and customer deposits | | | | |
| |
Convertible senior notes due 2023 | | | — | | | |
Convertible senior notes due 2024 | | | — | | | |
Convertible senior notes repurchase obligation (Note 9) | | | | | | — |
Operating lease liabilities | | | | | | |
Other current liabilities | |
| | |
| |
Total current liabilities | |
| | |
| |
Asset based credit facility | |
| — | |
| — |
Term loan—net | |
| | |
| |
Convertible senior notes due 2023—net | |
| | |
| |
Convertible senior notes due 2024—net | | | | | | |
Non-current operating lease liabilities | |
| | |
| |
Non-current finance lease liabilities | | | | | | |
Other non-current obligations | |
| | |
| |
Total liabilities | |
| | |
| |
Commitments and contingencies (Note 16) | |
| | |
| |
Stockholders’ equity: | |
|
| |
|
|
Preferred stock—$ | |
| | | ||
Common stock—$ | |
| | |
| |
Additional paid-in capital | |
| | |
| |
Accumulated other comprehensive income (loss) | |
| ( | |
| ( |
Retained earnings | |
| | |
| |
Total stockholders’ equity | |
| | |
| |
Total liabilities and stockholders’ equity | | $ | | | $ | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
RH
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
|
| (restated) |
| | ||
| | (in thousands, except share and per share amounts) | ||||
Net revenues | | $ | | | $ | |
Cost of goods sold | |
| | |
| |
Gross profit | |
| | |
| |
Selling, general and administrative expenses | | | | |
| |
Income from operations | |
| | |
| |
Other expenses | |
| | | | |
Interest expense—net | | | | |
| |
Loss on extinguishment of debt | |
| | |
| |
Other income—net | | | ( | | | — |
Total other expenses | |
| | |
| |
Income before income taxes and equity method investments | |
| | |
| |
Income tax expense (benefit) | |
| ( | |
| |
Income before equity method investments | | | | | | |
Share of equity method investments losses | | | ( | | | ( |
Net income | | $ | | | $ | |
Weighted-average shares used in computing basic net income per share | |
| | |
| |
Basic net income per share (Note 13) | | $ | | | $ | |
Weighted-average shares used in computing diluted net income per share | |
| | |
| |
Diluted net income per share (Note 13) | | $ | | | $ | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 6 |
RH
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (in thousands) | ||||
Net income | | $ | | | $ | |
Net gains (losses) from foreign currency translation | |
| ( | |
| |
Total comprehensive income | | $ | | | $ | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 7 |
RH
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
| | THREE MONTHS ENDED | ||||||||||||||||||||
| | COMMON STOCK | | | | | | | | | | | TREASURY STOCK | | | | ||||||
| | | | | | | | |
| ACCUMULATED |
| RETAINED | | | | | |
| | |||
| | | | | |
| ADDITIONAL |
| OTHER |
| EARNINGS | | | | | |
| TOTAL | ||||
| | |
| PAID-IN |
| COMPREHENSIVE |
| (ACCUMULATED |
| |
| STOCKHOLDERS' | ||||||||||
| | SHARES |
| AMOUNT |
| CAPITAL |
| INCOME (LOSS) |
| DEFICIT) |
| SHARES |
| AMOUNT |
| EQUITY | ||||||
| | (in thousands, except share amounts) | ||||||||||||||||||||
Balances—January 29, 2022 | |
| $ | |
| $ | |
| $ | ( |
| $ | |
| — |
| $ | — |
| $ | | |
Stock-based compensation | | — | | | — | | | | | | — | | | — | | — | | | — |
| | |
Vested and delivered restricted stock units | | | | | — | | | ( | | | — | | | — | | — | | | — |
| | ( |
Exercise of stock options | | | | | — | | | | | | — | | | — | | — | | | — |
| | |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | ( | | | — | | | | | | — | | | — | | | | | ( | | | — |
Settlement of convertible senior notes | | | | | — | | | ( | | | — | | | — | | ( | | | | | | — |
Termination of common stock warrants | | — | | | — | | | ( | | | — | | | — | | — | | | — |
| | ( |
Termination of convertible note hedge | | — | | | — | | | | | | — | | | — | | — | | | — |
| | |
Impact of ASU 2020-06 adoption | | — | | | — | | | ( | | | — | | | | | — | | | — |
| | ( |
Net income | | — | | | — | | | — | | | — | | | | | — | | | — |
| | |
Net losses from foreign currency translation | | — | | | — | | | — | | | ( | | | — | | — | | | — |
| | ( |
Balances—April 30, 2022 | | |
| $ | |
| $ | |
| $ | ( |
| $ | |
| — |
| $ | — |
| $ | |
| | | | | | | | | | | | | | | | | | | | | | |
Balances—January 30, 2021 | |
| $ | |
| $ | |
| $ | |
| $ | ( |
| — |
| $ | — |
| $ | | |
Stock-based compensation | | — | | | — | | | | | | — | | | — | | — | | | — |
| | |
Vested and delivered restricted stock units | | | | | — | | | ( | | | — | | | — | | — | | | — |
| | ( |
Exercise of stock options | | | | | — | | | | | | — | | | — | | — | | | — |
| | |
Exercise of call option under bond hedge upon settlement of convertible senior notes | | ( | | | — | | | | | | — | | | — | | | | | ( | | | — |
Settlement of convertible senior notes | | | | | — | | | ( | | | — | | | — | | ( | | | | | | ( |
Net income | | — | | | — | | | — | | | — | | | | | — | | | — |
| | |
Net losses from foreign currency translation | | — | | | — | | | — | | | | | | — | | — | | | — |
| | |
Balances—May 1, 2021 | | |
| $ | |
| $ | |
| $ | |
| $ | ( |
| — |
| $ | — |
| $ | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 8 |
RH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | THREE MONTHS ENDED | ||||
|---|---|---|---|---|---|---|
| | APRIL 30, | | MAY 1, | ||
| | 2022 |
| 2021 | ||
| | (in thousands) | ||||
CASH FLOWS FROM OPERATING ACTIVITIES | | | | | | |
Net income | | $ | | | $ | |
Adjustments to reconcile net income to net cash provided by operating activities: | |
| | |
| |
Depreciation and amortization | |
| | | | |
Non-cash operating lease cost | | | | | | |
Asset impairments | | | | | | — |
Amortization of debt discount | |
| — | | | |
Stock-based compensation expense | |
| | | | |
Non-cash finance lease interest expense | | | | | | |
Product recalls | | | | | | |
Deferred income taxes | | | | | | — |
Loss on extinguishment of debt | | | | | | |
Gain on derivative instruments—net | | | ( | | | — |
Share of equity method investments losses | | | | | | |
Other non-cash items | |
| | | | ( |
Cash paid attributable to accretion of debt discount upon settlement of debt | | | — | | | ( |
Change in assets and liabilities: | |
| | | | |
Accounts receivable | |
| ( | | | ( |
Merchandise inventories | |
| ( | | | ( |
Prepaid expense and other assets | |
| ( | | | ( |
Landlord assets under construction—net of tenant allowances | |
| ( | | | ( |
Accounts payable and accrued expenses | |
| ( | | | ( |
Deferred revenue and customer deposits | |
| | | | |
Other current liabilities | |
| ( | | | |
Current and non-current operating lease liabilities | |
| ( | | | ( |
Other non-current obligations | |
| ( | | | ( |
Net cash provided by operating activities | |
| | |
| |
| | THREE MONTHS ENDED | ||||
|---|---|---|---|---|---|---|
| | APRIL 30, | | MAY 1, | ||
| | 2022 |
| 2021 | ||
| | (in thousands) | ||||
CASH FLOWS FROM INVESTING ACTIVITIES | |
|
| |
| |
Capital expenditures | |
| ( | | | ( |
Equity method investments | |
| ( | | | ( |
Net cash used in investing activities | |
| ( | |
| ( |
CASH FLOWS FROM FINANCING ACTIVITIES | |
|
| |
|
|
Repayments under term loans | | | ( | | | — |
Repayments under promissory and equipment security notes | |
| ( | | | ( |
Repayments of convertible senior notes | | | ( | | | ( |
Principal payments under finance leases | | | ( | | | ( |
Proceeds from termination of convertible senior note hedges | | | | | | — |
Payments for termination of common stock warrants | | | ( | | | — |
Proceeds from exercise of stock options | |
| | | | |
Tax withholdings related to issuance of stock-based awards | | | ( | | | ( |
Net cash used in financing activities | |
| ( | |
| ( |
Effects of foreign currency exchange rate translation | |
| ( | | | |
Net increase in cash and cash equivalents and restricted cash equivalents | |
| | |
| |
Cash and cash equivalents and restricted cash equivalents | |
| | |
|
|
Beginning of period—cash and cash equivalents | |
| | |
| |
Beginning of period—restricted cash equivalents (acquisition related escrow deposits) | |
| | | | |
Beginning of period—cash and cash equivalents | | $ | | | $ | |
End of period—cash and cash equivalents | |
| | |
| |
End of period—restricted cash equivalents (acquisition related escrow deposits) | |
| | |
| |
End of period—cash and cash equivalents and restricted cash equivalents | | $ | | | $ | |
Non-cash transactions: | |
| | |
| |
Property and equipment additions in accounts payable and accrued expenses at period-end | | $ | | | $ | |
Landlord asset additions in accounts payable and accrued expenses at period-end | | | | | | |
Reclassification of assets from landlord assets under construction to finance lease right-of-use assets | | | | | | — |
Extinguishment of convertible senior notes related to repurchase obligation (Note 9) | | | ( | | | — |
Financing liability and embedded derivative arising from convertible senior notes repurchase (Note 9) | | | | | | — |
Shares issued on settlement of convertible senior notes | | | ( | | | ( |
Shares received on exercise of call option under bond hedge upon settlement of convertible senior notes | | | | | | |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 10 |
RH
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—THE COMPANY
Nature of Business
RH, a Delaware corporation, together with its subsidiaries (collectively, “we,” “us,” “our” or the “Company”), is 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 Source Books. We offer merchandise assortments across a number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and child and teen furnishings.
As of April 30, 2022, we operated a total of
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared from our records and, in our senior leadership team’s opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state our financial position as of April 30, 2022, and the results of operations for the three months ended April 30, 2022, and May 1, 2021. Our current fiscal year, which consists of 52 weeks, ends on January 28, 2023 (“fiscal 2022”).
Certain information and disclosures normally included in the notes to annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted for purposes of these interim condensed consolidated financial statements.
The preparation of our condensed consolidated financial statements in conformity with GAAP requires our senior leadership team to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and such differences could be material to the condensed consolidated financial statements.
We have assessed various accounting estimates and other matters, including those that require consideration of forecasted financial information, in context of the unknown future impacts of the novel coronavirus disease (“COVID-19” or “the pandemic”) using information that is reasonably available to us at this time. The accounting estimates and other matters we have assessed include, but were not limited to, sales return reserve, inventory reserve, allowance for doubtful accounts, goodwill, intangible and other long-lived assets. Our current assessment of these estimates is included in our condensed consolidated financial statements as of and for the three months ended April 30, 2022. As additional information becomes available to us, our future assessment of these estimates, including our expectations at the time regarding the duration, scope and severity of the pandemic, as well as other factors, could materially and adversely impact our condensed consolidated financial statements in future reporting periods.
These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended January 29, 2022 (the “2021 Form 10-K”).
The results of operations for the three months ended April 30, 2022, presented herein are not necessarily indicative of the results to be expected for the full fiscal year. Our business, like the businesses of retailers generally, is subject to uncertainty surrounding the financial impact of the pandemic and other factors as discussed in COVID-19 Pandemic and Macro-Economic Factors below.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 11 |
COVID-19 Pandemic and Macro-Economic Factors
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, we may see consumer spending patterns shift away from spending on the home and home-related categories as customers return to pre-COVID consumption trends, such as spending on travel and leisure, and other activities.
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 overall economic conditions and markets in which we operate. A slowdown in the housing market or continued negative trends in stock market prices could have a negative impact on our customers and demand for our products.
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 the pandemic. For more information, refer to the section entitled “Risk Factors” in our 2021 Form 10-K.
Restatement of Previously Issued Condensed Consolidated Financial Statements
We have restated the previously filed unaudited interim condensed consolidated financial statements to correct errors in our prior calculations of net income per share for the three months ended April 30, 2022.
We incorrectly added back the loss on extinguishment of debt in connection with the repurchase of a portion of the convertible senior notes in the computation of net income available to common stockholders used in calculating basic net income per share. The computation of diluted net income per share was incorrect as a result of the anti-dilutive impact of (i) adding back the loss on extinguishment of debt and (ii) including the potential shares related to the extinguished convertible senior notes in the calculation of weighted-average diluted shares.
The following table presents previously reported and restated financial statement line items in the condensed consolidated statements of income and Note 13—Net Income Per Share:
| | | | THREE MONTHS ENDED | |
| | | | APRIL 30, | |
| | | | 2022 | |
| | | | (in thousands, except share and per share amounts) | |
Net income - No impact | | | | $ | |
| | | | | |
Net income available to common stockholders - As reported | | | | $ | |
Net income available to common stockholders - As restated | | | | $ | |
| | | | | |
Basic net income per share - As reported | | | | $ | |
Basic net income per share - As restated | | | | $ | |
| | | | | |
Weighted-average shares—diluted - As reported | | | |
| |
Weighted-average shares—diluted - As restated | | | |
| |
| | | | | |
Diluted net income per share - As reported | | | | $ | |
Diluted net income per share - As restated | | | | $ | |
This restatement has no impact on any other financial statement line items.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 12 |
NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS
New Accounting Standards or Updates Adopted
Convertible Instruments and Contracts in an Entity’s Own Equity
In August 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2020-06—Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (“ASU 2020-06”). ASU 2020-06 simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts in an entity’s own equity. Specifically, ASU 2020-06 removes the separation models for convertible debt with a cash conversion feature or convertible instruments with a beneficial conversion feature. As a result, after adopting ASU 2020-06’s guidance, we no longer separately present in equity an embedded conversion feature of such debt. Instead, we will account for a convertible debt instrument wholly as debt unless (i) a convertible instrument contains features that require bifurcation as a derivative or (ii) a convertible debt instrument was issued at a substantial premium. Additionally, ASU 2020-06 removes certain conditions for equity classification related to contracts in an entity’s own equity (e.g., warrants) and amends certain guidance related to the computation of earnings per share for convertible instruments and contracts on an entity’s own equity.
We adopted ASU 2020-06 in the first quarter of fiscal 2022 using a modified retrospective transition method. Accordingly, the cumulative effect of the adoption on our opening fiscal 2022 condensed consolidated balance sheets was as follows:
|
| |
| ASU 2020-06 |
| | | |||
| | JANUARY 29, | | ADOPTION | | JANUARY 29, | | |||
| | 2022 | | ADJUSTMENTS | | 2022 | | |||
| | (in thousands) | | |||||||
Assets |
| |
|
| |
|
| |
| |
Property and equipment—net | | $ | | | $ | ( | | $ | | |
Deferred tax assets | | | | | | | | | | |
Liabilities |
| |
|
| |
|
| |
| |
Convertible senior notes due 2023—net | | | | | | | | | | |
Convertible senior notes due 2024—net | | | | | | | | | | |
Equity |
| |
|
| | |
| |
| |
Additional paid-in capital | | | | | | ( | | | | |
Retained earnings | | | | | | | | | | |
Reference Rate Reform
In March 2020, the FASB issued ASU 2020-04—Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). In January 2021, the FASB issued ASU 2021-01—Reference Rate Reform (Topic 848): Scope, (“ASU 2021-01” and, together with ASU 2020-04, the “ASUs”). The ASUs provide optional expedients and exceptions, if certain criteria are met, for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by the expected market transition from the London Interbank Offered Rate (“LIBOR”) and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate (“SOFR”). These transactions include contract modifications, hedge accounting, and the sale or transfer of debt securities classified as held-to-maturity. The primary contracts for which we currently use LIBOR include our asset based credit facility and certain term loan debt arrangements. The guidance was effective upon issuance and allows entities to adopt the amendments on a prospective basis through December 31, 2022. All new arrangements are using alternative reference rates and we are evaluating the impact of adoption on our existing contracts.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 13 |
NOTE 3—PREPAID EXPENSE AND OTHER ASSETS
Prepaid expense and other current assets consist of the following:
|
| APRIL 30, |
| JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | (in thousands) | ||||
Federal and state tax receivable(1) | | $ | | | $ | — |
Prepaid expense and other current assets | | | | | | |
Vendor deposits | | | | | | |
Capitalized catalog costs | |
| | |
| |
Tenant allowance receivable | | | | | | |
Promissory notes receivable, including interest(2) | |
| | |
| |
Right of return asset for merchandise | |
| | |
| |
Acquisition related escrow deposits | | | | | | |
Total prepaid expense and other current assets | | $ | | | $ | |
| (1) | Refer to Note 12—Income Taxes. |
| (2) | Represents promissory notes, including principal and accrued interest, due from a related party. Refer to Note 5—Equity Method Investments. |
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 14 |
Other non-current assets consist of the following:
|
| APRIL 30, |
| JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | (in thousands) | ||||
Landlord assets under construction—net of tenant allowances | | $ | | | $ | |
Initial direct costs prior to lease commencement | | | | |
| |
Capitalized cloud computing costs—net(1) | | | | | | |
Other deposits | |
| | |
| |
Deferred financing fees | |
| | |
| |
Other non-current assets | |
| | |
| |
Total other non-current assets | | $ | | | $ | |
| (1) | Presented net of accumulated amortization of $ |
NOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND OTHER INTANGIBLE ASSETS
The following sets forth the goodwill, tradenames, trademarks and other intangible assets activity for the RH Segment and Waterworks (Refer to Note 17—Segment Reporting), for the three months ended April 30, 2022:
|
| | |
| |
| FOREIGN |
| | | ||
| | JANUARY 29, | | | | CURRENCY | | APRIL 30, | ||||
| | 2022 | | ADDITIONS | | TRANSLATION | | 2022 | ||||
| | (in thousands) | ||||||||||
RH Segment |
| |
|
| |
|
| |
|
| |
|
Goodwill | | $ | | | $ | — | | $ | ( | | $ | |
Tradenames, trademarks and other intangible assets | |
| | |
| | |
| — | |
| |
Waterworks(1) | |
| | |
|
| |
|
| |
| |
Tradename(2) | |
| | |
| — | |
| — | |
| |
| (1) | Waterworks reporting unit goodwill of $ |
| (2) | Presented net of an impairment charge of $ |
NOTE 5—EQUITY METHOD INVESTMENTS
Equity method investments represent our
As of April 30, 2022 and January 29, 2022, $
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 15 |
During the three months ended April 30, 2022 and January 29, 2022, we recorded our proportionate share of equity method investments losses of $
NOTE 6—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accounts payable and accrued expenses consist of the following:
| | | | | | |
|
| APRIL 30, |
| JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | (in thousands) | ||||
Accounts payable | | $ | | | $ | |
Accrued compensation | |
| | |
| |
Accrued freight and duty | |
| | |
| |
Accrued sales taxes | |
| | |
| |
Accrued occupancy | |
| | |
| |
Accrued professional fees | |
| | |
| |
Accrued catalog costs | |
| | |
| |
Other accrued expenses | |
| | |
| |
Total accounts payable and accrued expenses | | $ | | | $ | |
Other current liabilities consist of the following:
| | | | | | |
|
| APRIL 30, |
| JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | (in thousands) | ||||
Unredeemed gift card and merchandise credit liability | | $ | | | $ | |
Allowance for sales returns | | | | | | |
Current portion of term loan | | | | | | |
Finance lease liabilities | | | | | | |
Current portion of equipment promissory notes | | | | | | |
Federal and state tax payable(1) | | | — | | | |
Other current liabilities | |
| | |
| |
Total other current liabilities | | $ | | | $ | |
| (1) | Refer to Note 12—Income Taxes. |
Contract Liabilities
We defer revenue associated with merchandise delivered via the home-delivery channel. We expect that substantially all of the deferred revenue and customer deposits as of April 30, 2022 will be recognized within the next six months as the performance obligations are satisfied. Deferred revenue also includes the unrecognized portion of the annual RH Members Program fee. New membership fees are recorded as deferred revenue when collected from customers and recognized as revenue based on expected product revenues over the annual membership period, based on historical trends of sales to members. Membership renewal fees are recorded as deferred revenue when collected from customers and are recognized as revenue on a straight-line basis over the membership period, or
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 16 |
In addition, we defer revenue when cash payments are received in advance of performance for unsatisfied obligations related to our gift cards. During the three months ended April 30, 2022 and May 1, 2021, we recognized $
We recognize breakage associated with gift cards proportional to actual gift card redemptions. Breakage of $
We expect that approximately
NOTE 7—OTHER NON-CURRENT OBLIGATIONS
Other non-current obligations consist of the following:
|
| APRIL 30, |
| JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | (in thousands) | ||||
Unrecognized tax benefits | | $ | | | $ | |
Non-current portion of equipment promissory notes—net | | | — | | | |
Other non-current obligations | |
| | |
| |
Total other non-current obligations | | $ | | | $ | |
.
NOTE 8—LEASES
| | | THREE MONTHS ENDED | ||||
| | | APRIL 30, |
| MAY 1, | ||
| | | 2022 |
| 2021 | ||
| | | (in thousands) | ||||
Operating lease cost(1) | |
| $ | | | $ | |
Finance lease costs | | | | | | | |
Amortization of leased assets(1) | | | | | | | |
Interest on lease liabilities(2) | | | | | | | |
Variable lease costs(3) | | | | | | | |
Sublease income(4) | | | | ( | | | ( |
Total lease costs—net | | | $ | | | $ | |
| (1) | Operating lease costs and amortization of finance lease right-of-use assets are included in cost of goods sold or selling, general and administrative expenses on the condensed consolidated statements of income based on our accounting policy. Refer to Note 3—Significant Accounting Policies in the 2021 Form 10-K. |
| (2) | Included in interest expense—net on the condensed consolidated statements of income. |
| (3) | Represents variable lease payments under operating and finance lease agreements, primarily associated with contingent rent based on a percentage of retail sales over contractual levels of $ |
| (4) | Included as an offset to selling, general and administrative expenses on the condensed consolidated statements of income. |
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 17 |
| | | | | | | | |
| | | | APRIL 30, | | JANUARY 29, | ||
| | |
| 2022 |
| 2022 | ||
| | | | (in thousands) | ||||
| | Balance Sheet Classification | | | | | | |
Assets | | | | | | | | |
Operating leases | | | $ | | | $ | | |
Finance leases(1)(2) | | | | | | | | |
Total lease right-of-use assets | | | | $ | | | $ | |
Liabilities | | | | | | | | |
Current(3) | | | | | | | | |
Operating leases | | | $ | | | $ | | |
Finance leases | | | | | | | | |
Total lease liabilities—current | | | | | | | | |
Non-current | | | | | | | | |
Operating leases | | | | | | | | |
Finance leases | | | | | | | | |
Total lease liabilities—non-current | | | | | | | | |
Total lease liabilities | | | | $ | | | $ | |
| (1) | Finance lease right-of-use assets include capitalized amounts related to our completed construction activities to design and build leased assets, which are reclassified from other non-current assets upon lease commencement. |
| (2) | Finance lease right-of-use assets are recorded net of accumulated amortization of $ |
| (3) | Current portion of lease liabilities represents the reduction of the related lease liability over the next 12 months. |
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 18 |
The maturities of lease liabilities are as follows as of April 30, 2022:
| | | | OPERATING | | FINANCE | | | |||
FISCAL YEAR | | |
| LEASES |
| LEASES |
| TOTAL | |||
| | | | (in thousands) | |||||||
Remainder of fiscal 2022 | | | | $ | | | $ | | | $ | |
2023 | | | | | | | | | | | |
2024 | | | | | | | | | | | |
2025 | | | | | | | | | | | |
2026 | | | | | | | | | | | |
2027 | | | | | | | | | | | |
Thereafter | | | | | | | | | | | |
Total lease payments(1)(2) | | | | | | | | | | | |
Less—imputed interest(3) | | | | | ( | | | ( | | | ( |
Present value of lease liabilities | | | | $ | | | $ | | | $ | |
| (1) | Total lease payments include future obligations for renewal options that are reasonably certain to be exercised and are included in the measurement of the lease liability. Total lease payments exclude $ |
| (2) | Excludes future commitments under |
| (3) | Calculated using the discount rate for each lease at lease commencement. |
Supplemental information related to leases consists of the following:
| | | THREE MONTHS ENDED | ||||
| | | APRIL 30, | | MAY 1, | ||
| | | 2022 | | 2021 | ||
| | | (in thousands) | ||||
Weighted-average remaining lease term (years) | | | | | | | |
Operating leases | | | | | | ||
Finance leases | | | | | | ||
Weighted-average discount rate | | | | | | | |
Operating leases | | | | | | ||
Finance leases | | | | | | ||
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 19 |
Other information related to leases consists of the following:
| | | THREE MONTHS ENDED | ||||
| | | APRIL 30, | | MAY 1, | ||
| | | 2022 | | 2021 | ||
| | | (in thousands) | ||||
Cash paid for amounts included in the measurement of lease liabilities | | | | | | | |
Operating cash flows from operating leases | | | $ | ( | | $ | ( |
Operating cash flows from finance leases | | | | ( | | | ( |
Financing cash flows from finance leases | | | | ( | | | ( |
Total cash outflows from leases | | | $ | ( | | $ | ( |
Lease right-of-use assets obtained in exchange for lease obligations—net of lease terminations (non-cash) | | | | | | | |
Operating leases | | | $ | | | $ | |
Finance leases | | | | | | | |
NOTE 9—CONVERTIBLE SENIOR NOTES
In June 2018, we issued in a private offering $
The outstanding balances under the 2023 Notes and 2024 Notes were as follows:
| | APRIL 30, | | | JANUARY 29, | ||||||||||||||
| | 2022 | | | 2022 | ||||||||||||||
| | | | UNAMORTIZED | | | | | | | | UNAMORTIZED | | | |||||
| | | | DEBT | | NET | | | | | DEBT | | NET | ||||||
| | PRINCIPAL | | ISSUANCE | | CARRYING | | | PRINCIPAL | | ISSUANCE | | CARRYING | ||||||
| | AMOUNT |
| COST(1) |
| AMOUNT |
| | AMOUNT |
| COST(1) | | AMOUNT | ||||||
| | (in thousands) | |||||||||||||||||
Convertible senior notes due 2023(2) | | $ | | | $ | ( | | $ | | | $ | | | $ | ( | | $ | | |
Convertible senior notes due 2024(3) | | | | | | ( | | | | | | | | | ( | | | | |
Total convertible senior notes | | $ | | | $ | ( | | $ | | | $ | | | $ | ( | | $ | | |
| (1) | As of April 30, 2022, the balance includes debt issuance costs inclusive of original issuers’ discount. As of January 29, 2022, the balance includes debt issuance costs inclusive of original issuers’ discount, as well as the previously outstanding equity component that was recombined upon the adoption of ASU 2020-06 in the first quarter of fiscal 2022, which was $ |
| (2) | As of April 30, 2022, $ |
| (3) | As of April 30, 2022, $ |
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 20 |
2023 Notes and 2024 Notes—Bond Hedge and Warrant Terminations and Notes Repurchase
During the three months ended April 30, 2022, we entered into agreements with certain financial institutions (collectively, the “Counterparties”) to repurchase all of the warrants issued in connection with the 2023 Notes and 2024 Notes at an aggregate purchase price of $
During the three months ended April 30, 2022, we entered into agreements with the Counterparties to terminate all of the convertible note bond hedges issued in connection with the 2023 Notes and 2024 Notes to receive an aggregate closing price of $
During the three months ended April 30, 2022, we entered into individual privately negotiated transactions with certain holders of the 2023 Notes and 2024 Notes to repurchase in cash $
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 21 |
$
Prior to June 15, 2024, the 2024 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after December 31, 2019, if, for at least
During the three months ended April 30, 2022, holders of $
The remaining liability for the 2024 Notes is classified as a non-current obligation on our condensed consolidated balance sheets since the settlement of the outstanding 2024 Notes will be made, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock.
$
Prior to March 15, 2023, the 2023 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2018, if, for at least
During the three months ended April 30, 2022, holders of $
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 22 |
The remaining liability for the 2023 Notes is classified as a non-current obligation on our condensed consolidated balance sheets since the settlement of the outstanding 2023 Notes will be made, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock.
NOTE 10—CREDIT FACILITIES
The outstanding balances under our credit facilities were as follows:
| | APRIL 30, | | JANUARY 29, | ||||||||||||||
| | 2022 | | 2022 | ||||||||||||||
| | | | UNAMORTIZED | | | | | | UNAMORTIZED | | | ||||||
| | | | | DEBT | | NET | | | | | DEBT | | NET | ||||
| | OUTSTANDING | | ISSUANCE | | CARRYING | | OUTSTANDING | | ISSUANCE | | CARRYING | ||||||
| | AMOUNT |
| COSTS |
| AMOUNT |
| AMOUNT |
| COSTS |
| AMOUNT | ||||||
| | (in thousands) | ||||||||||||||||
Asset based credit facility(1) | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — |
Term loan credit agreement(2) | | | | | | ( | | | | | | | | | ( | | | |
Equipment promissory notes(3) |
| | | | | ( | | | |
| | |
| | ( |
| | |
Total credit facilities | | $ | | | $ | ( | | $ | | | $ | | | $ | ( | | $ | |
| (1) | Deferred financing fees associated with the asset based credit facility as of April 30, 2022 and January 29, 2022, were $ |
| (2) | Represents the Term Loan Credit Agreement (defined below), of which outstanding amounts of $ |
| (3) | Represents total equipment security notes secured by certain of our property and equipment, all of which was included in other current liabilities on the condensed consolidated balance sheets as of April 30, 2022. |
Asset Based Credit Facility & Term Loan Facilities
On August 3, 2011, Restoration Hardware, Inc. (“RHI”), a wholly-owned subsidiary of RH, along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into the Ninth Amended and Restated Credit Agreement (as amended prior to June 28, 2017, the “Original Credit Agreement”) by and among RHI, Restoration Hardware Canada, Inc., certain other subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and Bank of America, N.A., as administrative agent and collateral agent (the “ABL Agent”).
On June 28, 2017, RHI entered into the Eleventh Amended and Restated Credit Agreement (as amended prior to July 29, 2021, the “11th A&R Credit Agreement”) by and among RHI, Restoration Hardware Canada, Inc., certain other subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and the ABL Agent, which amended and restated the Original Credit Agreement.
On July 29, 2021, RHI entered into the Twelfth Amended and Restated Credit Agreement (as amended, the “ABL Credit Agreement”) by and among RHI, Restoration Hardware Canada, Inc., certain other subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and the ABL Agent, which amended and restated the 11th A&R Credit Agreement. The ABL Credit Agreement has a revolving line of credit with initial availability of up to $
The availability of credit at any given time under the ABL Credit Agreement will be constrained by the terms and conditions of the ABL Credit Agreement, including the amount of collateral available, a borrowing base formula based
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 23 |
upon numerous factors, including the value of eligible inventory and eligible accounts receivable, and other restrictions contained in the ABL Credit Agreement. All obligations under the ABL Credit Agreement are secured by substantial assets of the loan parties, including inventory, receivables and certain types of intellectual property.
Borrowings under the revolving line of credit (other than swing line loans, which are subject to interest at the base rate) bear interest, at the borrower’s option, at either the base rate or LIBOR subject to a
The ABL Credit Agreement contains various restrictive and affirmative covenants, including required financial reporting, limitations on granting certain liens, limitations on making certain loans or investments, limitations on incurring additional debt, restricted payment limitations limiting the payment of dividends and certain other transactions and distributions, limitations on transactions with affiliates, along with other restrictions and limitations similar to those frequently found in credit agreements of a similar type and size.
The ABL Credit Agreement does not contain any significant financial ratio covenants or coverage ratio covenants other than a consolidated fixed charge coverage ratio (“FCCR”) covenant based on the ratio of (i) consolidated EBITDA to the amount of (ii) debt service costs plus certain other amounts, including dividends and distributions and prepayments of debt as defined in the ABL Credit Agreement (the “FCCR Covenant”). The FCCR Covenant only applies in certain limited circumstances, including when the unused availability under the ABL Credit Agreement drops below the greater of (A) $
The ABL Credit Agreement requires a daily sweep of all cash receipts and collections to prepay the loans under the agreement while (i) an event of default exists or (ii) when the unused availability under the ABL Credit Agreement drops below the greater of (A) $
The ABL Credit Agreement contains customary representations and warranties, events of defaults and other customary terms and conditions for an asset based credit facility.
The availability of the revolving line of credit at any given time under the ABL Credit Agreement is limited by the terms and conditions of the ABL Credit Agreement, including the amount of collateral available, a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, and other restrictions contained in the ABL Credit Agreement. As a result, actual borrowing availability under the revolving line of credit could be less than the stated amount of the revolving line of credit (as reduced by the actual borrowings and outstanding letters of credit under the revolving line of credit). As of April 30, 2022, the amount available for borrowing under the revolving line of credit under the ABL Credit Agreement was $
Term Loan Credit Agreement
On October 20, 2021, RHI entered into a Term Loan Credit Agreement (the “Term Loan Credit Agreement”) by and among RHI as the borrower, the lenders party thereto and Bank of America, N.A. as administrative agent and collateral agent (in such capacities, the “Term Agent”) with respect to an initial term loan (the “Term Loan”) in an aggregate principal amount equal to $
The Term Loan bears interest at an annual rate based on LIBOR subject to a
All obligations under the Term Loan are guaranteed by certain domestic subsidiaries of RHI. Further, RHI and such subsidiaries have granted a security interest in substantially all of their assets (subject to customary and other exceptions) to secure the Term Loan. Substantially all of the collateral securing the Term Loan also secures the loans and other credit extensions under the ABL Credit Agreement. On October 20, 2021, in connection with the Term Loan Credit Agreement, RHI and certain other subsidiaries of RH party to the Term Loan Credit Agreement and the ABL Credit Agreement, as the
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 24 |
case may be, entered into an Intercreditor Agreement (the “Intercreditor Agreement”) with the Term Agent and the ABL Agent. The Intercreditor Agreement establishes various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the ABL Credit Agreement and the Term Loan Credit Agreement without the consent of the other parties.
The borrowings under the Term Loan Credit Agreement may be prepaid in whole or in part at any time, subject to a prepayment premium of
The Term Loan Credit Agreement contains various restrictive and affirmative covenants, including required financial reporting, limitations on granting certain liens, limitations on making certain loans or investments, limitations on incurring additional debt, restricted payment limitations limiting the payment of dividends and certain other transactions and distributions, limitations on transactions with affiliates, along with other restrictions and limitations similar to those frequently found in credit agreements of a similar type and size, but provides for unlimited exceptions in the case of incurring indebtedness, granting of liens and making investments, dividend payments, and payments of material junior indebtedness, subject to satisfying specified leverage ratio tests.
The Term Loan Credit Agreement does not contain a financial maintenance covenant.
The Term Loan Credit Agreement contains customary representations and warranties, events of defaults and other customary terms and conditions for a term loan credit agreement.
On May 13, 2022, subsequent to our first quarter of fiscal 2022, RHI entered into a 2022 Incremental Amendment (the “2022 Incremental Amendment”) with Bank of America, N.A., as administrative agent, amending the Term Loan Credit Agreement (the Term Loan Credit Agreement as amended by the 2022 Incremental Amendment, the “Amended Term Loan Credit Agreement”). Pursuant to the terms of the 2022 Incremental Amendment, RHI incurred incremental term loans (the “2022 Incremental Term Debt”) in an aggregate principal amount equal to $
The 2022 Incremental Term Debt bears interest at an annual rate based on the SOFR subject to a
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 25 |
Equipment Loan Facility
On September 5, 2017, RHI entered into a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC (“BAL”) pursuant to which BAL and RHI agreed that BAL would finance certain equipment of ours from time to time, with each such equipment financing to be evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each equipment loan is secured by a purchase money security interest in the financed equipment. As of April 30, 2022, the equipment security notes bore interest at a weighted-average rate of
NOTE 11—FAIR VALUE MEASUREMENTS
Fair Value Measurements—Recurring
Amounts reported as cash and equivalents, receivables, and accounts payable and accrued expenses approximate fair value due to the short-term nature of activity within these accounts. The estimated fair value of the asset based credit facility approximates cost as the interest rate associated with the facility is variable and resets frequently (Level 2). The estimated fair value of the Term Loan Credit Agreement approximates cost as it was recently issued and the interest rate associated with the credit agreement is variable and resets frequently (Level 2). The estimated fair value and carrying value of the 2023 Notes and 2024 Notes were as follows:
| | APRIL 30, | | JANUARY 29, | ||||||||
| | 2022 | | 2022 | ||||||||
|
| |
| PRINCIPAL |
| |
| PRINCIPAL | ||||
| | FAIR | | CARRYING | | FAIR | | CARRYING | ||||
| | VALUE | | VALUE(1) | | VALUE | | VALUE(1) | ||||
| | (in thousands) | ||||||||||
Convertible senior notes due 2023 | | $ | | | $ | | | $ | | | $ | |
Convertible senior notes due 2024 | |
| | | | | |
| | |
| |
| (1) | The carrying value as of April 30, 2022 represents the principal amount of the 2023 Notes and 2024 Notes following our adoption of ASU 2020-06 in the first quarter of fiscal 2022 (refer to Note 2—Recently Issued Accounting Standards). The carrying value as of January 29, 2022 represents the principal amount less the equity component of the 2023 Notes and 2024 Notes classified in stockholders’ equity, which was required prior to the adoption of ASU 2020-06. The carrying value in both periods excludes the discounts upon original issuance, discounts and commissions payable to the initial purchasers and third party offering costs, as applicable. |
The fair value of each of the 2023 Notes and 2024 Notes was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the trading price of our convertible notes, when available, our stock price and interest rates based on similar debt issued by parties with credit ratings similar to ours (Level 2).
Fair Value Measurements—Non-Recurring
The fair value of the Waterworks reporting unit tradename was determined based on unobservable (Level 3) inputs and valuation techniques.
The fair value of the real estate assets associated with our investment in the Aspen LLCs in fiscal 2020, as discussed in Note 5—Equity Method Investments, were determined based on unobservable (Level 3) inputs and valuation techniques.
Prior to the adoption of ASU 2020-06 and through fiscal 2021, upon settlement of our convertible senior notes, including the settlements in which holders of the 2023 Notes and 2024 Notes elected to exercise the early conversion option, we recognized a gain or loss on extinguishment of debt in the condensed consolidated statements of income, which represented the difference between the carrying value and fair value of the convertible senior notes immediately prior to the settlement date. The fair value of each of the 2023 Notes and 2024 Notes related to the settlement of the early conversions was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the trading price of our convertible notes, when available, our common stock price and interest rates based on similar debt issued by parties with credit ratings similar to ours (Level 2).
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 26 |
NOTE 12—INCOME TAXES
We recorded an income tax benefit of $
As of April 30, 2022, we had $
NOTE 13—NET INCOME PER SHARE
The calculation of our net income per share is as follows:
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (restated) | | | ||
| | (in thousands, except share and per share amounts) | ||||
Net income available to common stockholders | | $ | | | $ | |
| | | | | | |
Weighted-average shares—basic | | | | | | |
Effect of dilutive stock-based awards |
| | |
| | |
Effect of dilutive convertible senior notes(1) |
| | |
| | |
Weighted-average shares—diluted |
| | |
| | |
Basic net income per share | | $ | | | $ | |
Diluted net income per share |
| $ | |
| $ | |
| (1) | We adopted ASU 2020-06 in the first quarter of fiscal 2022, and the adoption requires the dilutive impact of the 2023 Notes and 2024 Notes for diluted net income per share purposes to be determined under the if-converted method which assumes share settlement of the entire convertible debt instrument. Prior to adoption of ASU 2020-06, we applied the treasury stock method to determine the dilutive impact of the 2023 Notes and 2024 Notes for diluted net income per share purposes, and the 2023 Notes and the 2024 Notes had an impact on our dilutive share count beginning at stock prices of $ |
The warrants associated with the 2023 Notes and 2024 Notes had an impact on our dilutive share count beginning at stock prices of $
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 27 |
The following number of options and restricted stock units, as well as shares issuable under convertible senior notes prior to extinguishment during the period, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive:
| | THREE MONTHS ENDED | ||
| | APRIL 30, | | MAY 1, |
|
| 2022 |
| 2021 |
|
| (restated) |
| |
| | (in thousands) | ||
Options | | | | |
Restricted stock units |
| |
| — |
Convertible senior notes | | | | — |
NOTE 14—SHARE REPURCHASE PROGRAM
In 2018, our Board of Directors authorized a share repurchase program. In fiscal 2018, we repurchased approximately
On June 2, 2022, the Board of Directors authorized an additional $
NOTE 15—STOCK-BASED COMPENSATION
We recorded stock-based compensation expense of $
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 28 |
2012 Stock Incentive Plan and 2012 Stock Option Plan
Information about stock options outstanding, vested or expected to vest, and exercisable as of April 30, 2022 is as follows:
| | | | | | | | | | | | |
| | OPTIONS OUTSTANDING | | OPTIONS EXERCISABLE | ||||||||
|
| |
| WEIGHTED- |
| | |
| |
| | |
| | | | AVERAGE | | WEIGHTED- | | | | WEIGHTED- | ||
| | | | REMAINING | | AVERAGE | | | | AVERAGE | ||
| | NUMBER OF | | CONTRACTUAL | | EXERCISE | | NUMBER OF | | EXERCISE | ||
RANGE OF EXERCISE PRICES | | OPTIONS | | LIFE (IN YEARS) | | PRICE | | OPTIONS | | PRICE | ||
$ |
| | | | $ | | | | | $ | | |
$ |
| | | | | | | | | | | |
$ | | | | | | | | | | | | |
$ |
| | | | | | | | | | | |
$ | | | | | | | | | | | | |
$ | | | | | | | | | | | | |
$ | | | | | | | | | | | | |
Total |
| |
| | | $ | |
| | | $ | |
Vested or expected to vest |
| |
| | | $ | |
|
| |
|
|
The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of April 30, 2022 was $
As of April 30, 2022, we had
Chairman and Chief Executive Officer Option Grant
On October 18, 2020, our Board of Directors granted Mr. Friedman an option to purchase
NOTE 16—COMMITMENTS AND CONTINGENCIES
Commitments
We had
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 29 |
Contingencies
We are involved in lawsuits, claims, investigations and other legal proceedings incident to the ordinary course of our business. These disputes are increasing in number as the business expands and we grow larger. Litigation is inherently unpredictable. As a result, the outcome of matters in which we are involved could result in unexpected expenses and liability that could adversely affect our operations. In addition, any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of our senior leadership team’s time and result in the diversion of significant operational resources.
We review the need for any loss contingency reserves and establish reserves when, in the opinion of our senior leadership team, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. Generally, in view of the inherent difficulty of predicting the outcome of those matters, particularly in cases in which claimants seek substantial or indeterminate damages, it is not possible to determine whether a liability has been incurred or to reasonably estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no reserve is established until that time. When and to the extent that we do establish a reserve, there can be no assurance that any such recorded liability for estimated losses will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time. Although we believe that the ultimate resolution of our current legal proceedings will not have a material adverse effect on our condensed consolidated financial statements, the outcome of legal matters is subject to inherent uncertainty.
NOTE 17—SEGMENT REPORTING
We define reportable and operating segments on the same basis that we use to evaluate our performance internally by the Chief Operating Decision Maker (the “CODM”), which we have determined is our Chief Executive Officer. We have
The retail operating segments are strategic business units that offer products for the home furnishings customer. While RH Segment and Waterworks have a shared senior leadership team and customer base, we have determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.
Segment Information
We use operating income to evaluate segment profitability for the retail operating segments and allocate resources. Operating income is defined as net income before interest expense—net, loss on extinguishment of debt, other income—net, income tax expense (benefit) and our share of equity method investments losses. Segment operating income excludes (i) employer payroll tax expense related to the option exercise by Mr. Friedman, (ii) asset impairments, (iii) non-cash compensation amortization related to the fully vested option grant made to Mr. Friedman in October 2020 and (iv) professional fee related to the 2023 Notes and 2024 Notes transactions (refer to Note 9—Convertible Senior Notes). These items are excluded from segment operating income in order to provide better transparency of segment operating results. Accordingly, these items are not presented by segment because they are excluded from the segment profitability measure that the CODM and our senior leadership team reviews.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 30 |
The following table presents segment operating income and income before income taxes and equity method investments:
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (in thousands) | ||||
Operating income: | | | | | | |
RH Segment | | $ | | | $ | |
Waterworks | |
| | |
| |
Employer payroll taxes on option exercise | | | ( | | | — |
Professional fee | |
| ( | |
| — |
Asset impairments | |
| ( | |
| — |
Non-cash compensation | | | ( | | | ( |
Recall accrual | |
| ( | |
| ( |
Income from operations | |
| | |
| |
Interest expense—net | |
| | |
| |
Loss on extinguishment of debt | |
| | |
| |
Other income—net | | | ( | | | — |
Income before income taxes and equity method investments | | $ | | | $ | |
The following table presents the statements of income metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280—Segment Reporting:
| | THREE MONTHS ENDED | ||||||||||||||||
| | APRIL 30, | | MAY 1, | ||||||||||||||
| | 2022 | | 2021 | ||||||||||||||
|
| RH SEGMENT |
| WATERWORKS |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| TOTAL | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | | | $ | | | $ | | | $ | | | $ | | | $ | |
Gross profit | |
| | |
| | |
| | |
| | |
| | |
| |
Depreciation and amortization | |
| | | | | |
| | |
| | |
| | |
| |
In the three months ended April 30, 2022 and May 1, 2021, the Real Estate Development segment share of equity method investments losses were $
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 31 |
The following table presents the balance sheet metrics as required under ASC 280—Segment Reporting:
| | APRIL 30, | | JANUARY 29, | ||||||||||||||||||||
| | 2022 | | 2022 | ||||||||||||||||||||
| | | | | | | | REAL ESTATE | | | | | | | | | | | REAL ESTATE | | | | ||
|
| RH SEGMENT |
| WATERWORKS |
| DEVELOPMENT |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| DEVELOPMENT |
| TOTAL | ||||||||
(in thousands) | ||||||||||||||||||||||||
Goodwill(1) | | $ | | | $ | — | | $ | — | | $ | | | $ | | | $ | — | | $ | — | | $ | |
Tradenames, trademarks and other intangible assets(2) | |
| | |
| | |
| — | |
| | |
| | |
| | |
| — | |
| |
Equity method investments | | | — | | | | | | | | | | | | — | | | — | | | | | | |
Total assets | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
| (1) | The Waterworks reporting unit goodwill of $ |
| (2) | Presented net of an impairment charge of $ |
We classify our sales into furniture and non-furniture product lines. Furniture includes both indoor and outdoor furniture. Non-furniture includes lighting, textiles, fittings, fixtures, surfaces, accessories and home décor. Net revenues in each category were as follows:
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (in thousands) | ||||
Furniture | | $ | | | $ | |
Non-furniture | |
| | |
| |
Total net revenues | | $ | | | $ | |
We are domiciled in the United States and primarily operate our retail locations and outlets in the United States. As of April 30, 2022, we operated
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 32 |
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 months ended April 30, 2022 and a comparison to the three months ended May 1, 2021. The discussion for related to cash flows for the three months ended May 1, 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 May 1, 2021, filed with the Securities and Exchange Commission (“SEC”) on June 10, 2021.
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 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 were adopted during the three months ended April 30, 2022 and that will be adopted in future periods.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 33 |
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 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 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. We operate our retail locations throughout the United States, Canada, and the U.K., and, after the opening of RH San Francisco, The Gallery at the Historic Bethlehem Steel Building in May 2022, we have an integrated RH Hospitality experience in 14 of our Design Gallery locations, which includes Restaurants and Wine Bars.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 34 |
As of April 30, 2022, we operated the following number of Galleries, Outlets and Showrooms:
| | COUNT |
RH | | |
Design Galleries | | 27 |
Legacy Galleries | | 36 |
Modern Galleries | | 1 |
Baby & Child and TEEN Galleries | | 3 |
Total Galleries | | 67 |
Outlets | | 39 |
Waterworks Showrooms | | 14 |
COVID-19 Pandemic and Macro-Economic Factors
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, we may see consumer spending patterns shift away from spending on the home and home-related categories as customers return to pre-COVID consumption trends, such as spending on travel and leisure, and other activities.
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 overall economic conditions and markets in which we operate. A slowdown in the housing market or continued negative trends in stock market prices could have a negative impact on our customers and demand for our products.
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 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 Beach House, RH Ski House, RH Outdoor, RH Baby & Child, RH TEEN and Waterworks. Our strategy to elevate the design and quality of our product will continue as we introduce RH Contemporary in 2022. We also have plans to introduce RH Couture Upholstery, RH Bespoke Furniture and RH Color over the next several years.
Gallery Transformation. Our product is elevated and rendered more valuable by our architecturally inspiring Galleries. We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of $5 to $6 billion in North America. We believe we can significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that is sized to the potential of each market and the size of our assortment. In addition, we plan to incorporate hospitality into most of the new Design Galleries that we open in the future, which further elevates and renders our product and brand more valuable. We believe hospitality has created a unique new retail experience that cannot be replicated online, and that the addition of hospitality drives incremental sales of home furnishings in these Galleries.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 35 |
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. 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 is designed to come to life digitally as we launch The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. The World of RH will include rich, immersive content with simplified navigation and search functionality, all designed to enhance the shopping experience and render our product and brand more valuable. We believe an opportunity exists to create similar strategic separation online as we have with our Galleries offline, reconceptualizing what a website can and should be.
Global Expansion. We believe that our luxury brand positioning and unique aesthetic have strong international appeal, and that pursuit of global expansion will provide RH a substantial long-term market opportunity to build a $20 to $25 billion global brand over time. Our view is 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 in 2022 with the opening of RH England, The Gallery at the Historic Aynho Park. 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.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 36 |
Basis of Presentation and Results of Operations
The following table sets forth our condensed consolidated statements of income:
| | THREE MONTHS ENDED | |||||||
| APRIL 30, | % OF NET | MAY 1, | % OF NET | |||||
| (dollars in thousands) | ||||||||
Net revenues | | $ | 957,292 | 100.0 | % | $ | 860,792 | 100.0 | % |
Cost of goods sold | |
| 458,709 | 47.9 | |
| 453,815 | 52.7 | |
Gross profit | |
| 498,583 | 52.1 | |
| 406,977 | 47.3 | |
Selling, general and administrative expenses | |
| 293,295 | 30.7 | |
| 219,089 | 25.5 | |
Income from operations | |
| 205,288 | 21.4 | |
| 187,888 | 21.8 | |
Other expenses | |
|
| | |
|
| | |
Interest expense—net | |
| 20,855 | 2.2 | |
| 13,308 | 1.5 | |
Loss on extinguishment of debt | |
| 146,116 | 15.3 | |
| 105 | — | |
Other income—net | | | (343) | — | | | — | — | |
Total other expenses | |
| 166,628 | 17.4 | |
| 13,413 | 1.5 | |
Income before income taxes and equity method investments | |
| 38,660 | 4.0 | |
| 174,475 | 20.3 | |
Income tax expense (benefit) | |
| (163,426) | (17.1) | |
| 41,724 | 4.7 | |
Income before equity method investments | | | 202,086 | 21.1 | | | 132,751 | 15.4 | |
Share of equity method investments losses | | | (1,375) | (0.1) | | | (2,095) | (0.2) | |
Net income | | $ | 200,711 | 21.0 | % | $ | 130,656 | 15.2 | % |
Non-GAAP Financial Measures
To supplement our 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.
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.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 37 |
Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating Income
| | THREE MONTHS ENDED | ||||
|
| APRIL 30, |
| MAY 1, | ||
| | 2022 | | 2021 | ||
| | (in thousands) | ||||
Net income | | $ | 200,711 | | $ | 130,656 |
Interest expense—net(1) | |
| 20,855 | |
| 13,308 |
Loss on extinguishment of debt(1) | |
| 146,116 | |
| 105 |
Other income—net(1) | | | (343) | |
| — |
Income tax expense (benefit)(1) | |
| (163,426) | |
| 41,724 |
Share of equity method investments losses(1) | | | 1,375 | | | 2,095 |
Operating income | |
| 205,288 | |
| 187,888 |
Employer payroll taxes on option exercise(2) | | | 11,717 | | | — |
Professional fee(3) | |
| 7,184 | |
| — |
Asset impairments(4) | |
| 5,923 | |
| — |
Non-cash compensation(5) | | | 5,858 | | | 5,864 |
Recall accrual(6) | |
| 560 | |
| 500 |
Adjusted operating income | | $ | 236,530 | | $ | 194,252 |
| (1) | Refer to discussion “Three Months Ended April 30, 2022 Compared to Three Months Ended May 1, 2021” below for a discussion of our results of operations for the three months ended April 30, 2022 and May 1, 2021. |
| (2) | Represents employer payroll tax expense related to the option exercise by Mr. Friedman in the first quarter of fiscal 2022. |
| (3) | Represents professional fee contingent upon the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and Notes Repurchase (refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements). |
| (4) | Represents asset impairments related to property and equipment of Galleries under construction. |
| (5) | Represents the amortization of the non-cash compensation charge related to a fully vested option grant made to Mr. Friedman in October 2020. |
| (6) | 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.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 38 |
Reconciliation of GAAP Net Income to Adjusted Net Income
| | | THREE MONTHS ENDED | ||||
| | | APRIL 30, | | MAY 1, | ||
| |
| 2022 |
| 2021 | ||
| | | (in thousands) | ||||
Net income | | | $ | 200,711 | | $ | 130,656 |
Adjustments pre-tax: | | |
|
| |
|
|
Loss on extinguishment of debt(1) | | |
| 146,116 | |
| 105 |
Employer payroll taxes on option exercise(1) | | |
| 11,717 | |
| — |
Professional fee(1) | | |
| 7,184 | |
| — |
Asset impairments(1) | | | | 5,923 | | | — |
Non-cash compensation(1) | | |
| 5,858 | |
| 5,864 |
Recall accrual(1) | | |
| 560 | |
| 500 |
Amortization of debt discount(2) | | |
| — | |
| 5,981 |
Gain on derivative instruments—net(3) | | | | (3,177) | | | — |
Subtotal adjusted items | | |
| 174,181 | |
| 12,450 |
Impact of income tax items(4) | | |
| (194,926) | |
| (2,951) |
Share of equity method investments losses(1) | | |
| 1,375 | |
| 2,095 |
Adjusted net income | | | $ | 181,341 | | $ | 142,250 |
| (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) | 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 $2.7 million during the three months ended May 1, 2021. No amortization of the debt discounts were recognized during the three months ended April 30, 2022, since we recombined the previously outstanding equity component of the 2023 Notes and 2024 Notes upon the adoption of ASU 2020-06. |
| (3) | 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 Notes Repurchase (refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements). |
| (4) | For fiscal 2022, 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 the first quarter of fiscal 2022. The adjustment for the three months ended April 30, 2022 is based on adjusted tax rates of 14.8%. Our previously reported adjustment for the three months ended April 30, 2022 in our Original Report was based on an adjusted tax rate of 0.0%. Refer to the Explanatory Note in this Amendment. |
The adjustment for the three months ended May 1, 2021 is based on an adjusted tax rate of 23.9%, which excludes the tax impact associated with our share of equity method investments losses.
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.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 39 |
Reconciliation of GAAP Net Income to EBITDA and Adjusted EBITDA
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (in thousands) | ||||
Net income | | $ | 200,711 | | $ | 130,656 |
Depreciation and amortization | |
| 24,758 | |
| 23,886 |
Interest expense—net | |
| 20,855 | |
| 13,308 |
Income tax expense (benefit) | |
| (163,426) | |
| 41,724 |
EBITDA | |
| 82,898 | |
| 209,574 |
Loss on extinguishment of debt(1) | | | 146,116 | | | 105 |
Non-cash compensation(1) | |
| 12,802 | |
| 15,307 |
Employer payroll taxes on option exercise(1) | | | 11,717 | | | — |
Professional fee(1) | | | 7,184 | | | — |
Asset impairments(1) | |
| 5,923 | |
| — |
Share of equity method investments losses(1) | |
| 1,375 | |
| 2,095 |
Capitalized cloud computing amortization(2) | | | 1,354 | | | 677 |
Recall accrual(1) | |
| 560 | |
| 500 |
Other income—net(1) | | | (343) | | | — |
Adjusted EBITDA | | $ | 269,586 | | $ | 228,258 |
| (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 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 | ||||
| | APRIL 30, |
| MAY 1, | ||
| | 2022 | | 2021 | ||
|
| (in thousands) | ||||
Capital expenditures | | $ | 29,364 | | $ | 50,251 |
Landlord assets under construction—net of tenant allowances | | | 12,148 | | | 13,578 |
Adjusted capital expenditures | | $ | 41,512 | | $ | 63,829 |
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 40 |
The following table presents RH Gallery and Waterworks Showroom metrics, and excludes Outlets:
| | THREE MONTHS ENDED | ||||||||
| | APRIL 30, | | MAY 1, | ||||||
| | 2022 | | 2021 | ||||||
|
| |
| TOTAL LEASED |
| |
| TOTAL LEASED | ||
| | | | SELLING SQUARE | | | | SELLING SQUARE | ||
| | COUNT | | FOOTAGE(1) | | COUNT | | FOOTAGE(1) | ||
| | | | (in thousands) | | | | (in thousands) | ||
Beginning of period |
| 81 |
| | 1,254 |
| 82 |
| | 1,162 |
End of period |
| 81 |
| | 1,254 |
| 82 |
| | 1,162 |
Total leased square footage at end of period(2) | | | | | 1,672 | | | | | 1,559 |
Weighted-average leased square footage(3) |
| | |
| 1,672 | |
| |
| 1,559 |
Weighted-average leased selling square footage(3) | | | | | 1,254 | | | | | 1,162 |
| (1) | Leased selling square footage is retail space at our retail locations used to sell our products, as well as space for our Restaurants. Leased selling square footage excludes backrooms at retail locations used for storage, office space, food preparation, kitchen space or similar purpose, as well as exterior sales space located outside a retail location, such as courtyards, gardens and rooftops. |
Leased selling square footage includes approximately 4,800 square feet as of April 30, 2022 and May 1, 2021 related to one owned retail location.
| (2) | Total leased square footage includes approximately 5,400 square feet as of both April 30, 2022 and May 1, 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. |
Three Months Ended April 30, 2022 Compared to Three Months Ended May 1, 2021
| | THREE MONTHS ENDED | ||||||||||||||||
| | APRIL 30, | | MAY 1, | ||||||||||||||
| | 2022 | | 2021 | ||||||||||||||
|
| RH SEGMENT |
| WATERWORKS |
| TOTAL |
| RH SEGMENT |
| WATERWORKS |
| TOTAL | ||||||
| | (in thousands) | ||||||||||||||||
Net revenues | | $ | 908,948 | | $ | 48,344 | | $ | 957,292 | | $ | 819,823 | | $ | 40,969 | | $ | 860,792 |
Cost of goods sold | |
| 436,126 | |
| 22,583 | |
| 458,709 | |
| 433,270 | |
| 20,545 | |
| 453,815 |
Gross profit | |
| 472,822 | |
| 25,761 | |
| 498,583 | |
| 386,553 | |
| 20,424 | |
| 406,977 |
Selling, general and administrative expenses | |
| 275,519 | |
| 17,776 | |
| 293,295 | |
| 204,407 | |
| 14,682 | |
| 219,089 |
Income from operations | | $ | 197,303 | | $ | 7,985 | | $ | 205,288 | | $ | 182,146 | | $ | 5,742 | | $ | 187,888 |
Net revenues
Consolidated net revenues increased $97 million, or 11.2%, to $957 million in the three months ended April 30, 2022 compared to $861 million in the three months ended May 1, 2021.
RH Segment net revenues
RH Segment net revenues increased $89 million, or 10.9%, to $909 million in the three months ended April 30, 2022 compared to $820 million in the three months ended May 1, 2021. The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude.
RH Segment net revenues for the three months ended April 30, 2022 increased due to strong customer demand for our products and fulfillment of orders generated in prior quarters as elements of our supply chain continued to catch up with
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 41 |
customer demand. However, during the three months April 30, 2022 we began to experience softening demand trends which began at the time of the Russian invasion of Ukraine and have further slowed during the market disruption over the past several months.
RH Segment net revenues increased in our RH Hospitality business compared to the three months ended May 1, 2021 due to new Restaurant openings in fiscal 2021. Outlet sales increased $7.4 million to $70 million in the three months ended April 30, 2022 compared to $62 million in the three months ended May 1, 2021.
Despite our revenue growth during the three months ended April 30, 2022, the slowdown in customer demand during the quarter, together with the overall uncertainty about macro-economic conditions, has caused us to take a conservative view about our near-term revenue trends for fiscal 2022.
Waterworks net revenues
Waterworks net revenues increased $7.4 million, or 18.0%, to $48 million in the three months ended April 30, 2022 compared to $41 million in the three months ended May 1, 2021.
Gross profit
Consolidated gross profit increased $92 million, or 22.5%, to $499 million in the three months ended April 30, 2022 compared to $407 million in the three months ended May 1, 2021. As a percentage of net revenues, consolidated gross margin increased 480 basis points to 52.1% of net revenues in the three months ended April 30, 2022 from 47.3% of net revenues in the three months ended May 1, 2021.
RH Segment gross profit
RH Segment gross profit increased $86 million, or 22.3%, to $473 million in the three months ended April 30, 2022 from $387 million in the three months ended May 1, 2021. As a percentage of net revenues, RH Segment gross margin increased 480 basis points to 52.0% of net revenues in the three months ended April 30, 2022 from 47.2% of net revenues in the three months ended May 1, 2021. The change in gross margin was primarily driven by a 390 basis point increase in product margins in the Core business, as well as leverage in our RH Segment shipping costs during the three month period ended April 30, 2022.
Waterworks gross profit
Waterworks gross profit increased $5.3 million, or 26.1%, to $26 million in the three months ended April 30, 2022 from $20 million in the three months ended May 1, 2021. As a percentage of net revenues, Waterworks gross margin increased 340 basis points to 53.3% of net revenues in the three months ended April 30, 2022 from 49.9% of net revenues in the three months ended May 1, 2021.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses increased $74 million, or 33.9%, to $293 million in the three months ended April 30, 2022 from $219 million in the three months ended May 1, 2021.
RH Segment selling, general and administrative expenses
RH Segment selling, general and administrative expenses increased $71 million, or 34.8%, to $276 million in the three months ended April 30, 2022 compared to $204 million in the three months ended May 1, 2021.
RH Segment selling, general and administrative expenses for the three months ended April 30, 2022 include $12 million of employer payroll tax expense associated with Mr. Friedman’s stock option exercise during the first quarter of fiscal 2021, a $7.2 million professional fee which was contingent upon the completion of our debt transactions related to the 2023 Notes and 2024 Notes, $5.9 million of asset impairments, and $0.6 million related to product recalls. RH Segment selling, general and administrative expenses for both the three months ended April 30, 2022 and May 1, 2021 included amortization of the non-cash compensation of $5.9 million related to a fully vested option grant made to Mr. Friedman in October 2020.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 42 |
RH Segment selling, general and administrative expenses were 26.9% and 24.2% of net revenues for the three months ended April 30, 2022 and May 1, 2021, 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 higher pre-opening costs and professional fees, as well as increases in employment and employment-related costs.
Waterworks selling, general and administrative expenses
Waterworks selling, general and administrative expenses increased $3.1 million, or 21.1%, to $18 million in the three months ended April 30, 2022 compared to $15 million in the three months ended May 1, 2021.
Waterworks selling, general and administrative expenses for the three months ended May 1, 2021 included $0.5 million related to product recalls.
Excluding the product recall adjustment mentioned above, Waterworks selling, general and administrative expenses would have been 36.8% and 34.6% of net revenues for the three months ended April 30, 2022 and May 1, 2021, respectively.
Interest expense—net
Interest expense—net increased $7.5 million in the three months ended April 30, 2022 compared to the three months ended May 1, 2021, which consisted of the following in each period:
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (in thousands) | ||||
Term loan interest expense | | $ | 16,001 | | $ | — |
Finance lease interest expense | |
| 7,071 | |
| 6,150 |
Other interest expense | |
| 1,073 | |
| 1,634 |
Amortization of convertible senior notes debt discount | | | — | | | 8,670 |
Capitalized interest for capital projects | |
| (2,109) | |
| (2,801) |
Interest income | |
| (1,181) | |
| (345) |
Total interest expense—net | | $ | 20,855 | | $ | 13,308 |
Loss on extinguishment of debt
During the three months ended April 30, 2022 we recognized a loss on extinguishment of debt of $146 million related to the repurchase of $180 million of principal value of convertible senior notes, which includes the acceleration of amortization of debt issuance costs of approximately $1.0 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. During the three months ended May 1, 2021, we recognized a loss on extinguishment of debt for a portion of the 2023 Notes that were early converted at the option of the noteholders of $0.1 million.
Other income—net
Other income—net was $0.3 million during the three months ended April 30, 2022, which included a net gain on derivative instruments of $3.2 million, resulting from the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge and warrant terminations and Notes Repurchase (refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements). The net gain was partially offset by a $2.9 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.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 43 |
Income tax expense (benefit)
We recorded an income tax benefit of $163 million and income tax expense of $42 million in the three months ended April 30, 2022 and May 1, 2021, respectively. Our effective tax rate was (438.3)% and 24.2% for the three months ended April 30, 2022 and May 1, 2021, respectively. The decrease in our effective tax rate is primarily attributable to significantly higher net excess tax benefits from stock-based compensation partially offset by nondeductible amounts related to the extinguishment of debt.
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 $1.4 million and $2.1 million loss during the three months ended April 30, 2022 and May 1, 2021, 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. In fiscal 2021, we entered into the ABL Credit Agreement, which amended and extended our asset based credit facility, and issued the Term Loan in the amount of $2.0 billion pursuant to the Term Loan Credit Agreement. The issuance of the Term Loan 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 Term Debt Financing. The issuance of the 2022 Incremental Amendment 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:
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | JANUARY 29, | ||
| | 2022 | | 2022 | ||
| | | (in millions) | |||
Asset based credit facility | | $ | — | | $ | — |
Term loan(1) | | | 1,990 | | | 1,995 |
Equipment promissory notes(1) | | | 4 | | | 15 |
Convertible senior notes due 2023(1) | | | 20 | | | 69 |
Convertible senior notes due 2024(1) | | | 81 | | | 189 |
Convertible senior notes repurchase obligation(2) | | | 314 | | | — |
Notes payable for share repurchases | | | 1 | | | 1 |
Total debt | | $ | 2,410 | | $ | 2,269 |
Cash and cash equivalents | | | (2,243) | | | (2,178) |
Total net debt | | $ | 167 | | $ | 91 |
Availability under the asset based credit facility—net(3) | | $ | 444 | | $ | 347 |
| (1) | Amounts exclude discounts upon original issuance and third party offering and debt issuance cost. |
| (2) | The convertible senior notes repurchase obligation was repaid in full on May 3, 2022. Refer to Note 9—Convertible Senior Notes. |
| (3) | As of both April 30, 2022 and January 29, 2022, the amount available for borrowing under the revolving line of credit under the ABL Credit Agreement is presented net of $20 million in outstanding letters of credit. |
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 44 |
General
The primary cash needs of our business have historically been for merchandise inventories, payroll, Source Books, rent for our retail and outlet locations, capital expenditures associated with opening new locations and updating existing locations, as well as the development of our infrastructure and information technology. 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. We expect to continue to take an opportunistic approach regarding both sources and uses of capital in connection with our business.
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 “October 2021 Term Loans”) 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 October 2021 Term Loans have a maturity date of October 20, 2028. As of April 30, 2022, we had $1,990 million outstanding under the Term Loan Credit Agreement. We are required to make quarterly principal payments of $5.0 million with respect to the October 2021 Term Loans.
On May 13, 2022, we entered into an incremental term debt financing (the “2022 Incremental Term Debt”) 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 2022 Incremental Term Debt has a maturity date of October 20, 2028. The 2022 Incremental Term Debt constitutes a separate class from the existing October 2021 Term Loan under the Term Loan Credit Agreement.
Certain Transactions Related to Convertible Senior Notes
During the three months ended April 30, 2022, we entered into certain transactions in connection with the 2023 Notes and 2024 Notes.
Warrant Termination Agreements
We entered into agreements with certain 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
We entered into 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 Notes Repurchase
We entered into individual privately negotiated transactions with certain holders of the 2023 Notes and 2024 Notes to repurchase $180 million in aggregate principal amount of the convertible senior notes (the “Notes Repurchase”) representing $45 million and $135 million in principal amount of 2023 Notes and 2024 Notes, respectively. Upon closing of these transactions, we paid an aggregate of $314 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 $481 million in cash (inclusive of expenses) to complete the above transactions.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 45 |
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.
Following the completion of the Notes Repurchase, we had $101 million remaining in aggregate principal amount of convertible notes outstanding as of April 30, 2022, comprised of $20 million of 2023 Notes and $81 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.
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 the pandemic and macro-economic factors affecting business conditions including inflation. 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. In addition to funding the normal operations of our business, we have used our liquidity to fund significant investments and strategies such as our share repurchase programs, various acquisitions, and growth initiatives, including through joint ventures and real estate investments.
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.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 46 |
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 three months ended April 30, 2022, adjusted capital expenditures were $42 million in aggregate, net of cash received related to landlord tenant allowances of $2.3 million. We anticipate our adjusted capital expenditures to be $200 million to $250 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.
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 also are pursuing change 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. 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.
In addition, we continue to address the effects of the COVID-19 pandemic on our business with respect to real estate development and the introduction of new Galleries in both the U.S. and internationally. A range of factors involved in the development of new Galleries and RH Hospitality may continue to be affected by the pandemic, including delays in construction as well as permitting and other necessary governmental actions. In addition, the scope and cadence of investments by third parties, including landlords and other real estate counterparties, may be adversely affected by the health crisis. Actions taken by international as well as federal, state and local government authorities, and in some instances mall and shopping center owners, in response to the pandemic, may require changes to our real estate strategy and related capital expenditure and financing plans. In addition, we may continue to be required to make lease payments in whole or in part for our Galleries, Outlets and Restaurants that were temporarily closed or are required to close in the future in the event of resurgences in COVID-19 outbreaks or for other reasons. Any efforts to mitigate the costs of construction delays and deferrals, retail closures and other operational difficulties, including any such difficulties resulting from the pandemic, such as by negotiating with landlords and other third parties regarding the timing and amount of payments under existing contractual arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant liquidity needs even as we make changes to our planned operations and expansion cadence.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 47 |
Cash Flow Analysis
A summary of operating, investing, and financing activities is set forth in the following table:
| | THREE MONTHS ENDED | ||||
| | APRIL 30, | | MAY 1, | ||
|
| 2022 |
| 2021 | ||
| | (in thousands) | ||||
Net cash provided by operating activities | | $ | 135,949 | | $ | 190,875 |
Net cash used in investing activities | |
| (30,479) | |
| (51,423) |
Net cash used in financing activities | |
| (42,351) | |
| (11,032) |
Net increase in cash and cash equivalents and restricted cash equivalents | |
| 62,841 | |
| 128,456 |
Cash and cash equivalents and restricted cash equivalents at end of period | |
| 2,244,705 | |
| 235,527 |
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 three months ended April 30, 2022, net cash provided by operating activities was $136 million and consisted of net income of $201 million and an increase in non-cash items of $221 million, partially offset by a change in working capital and other activities of $286 million. The use of cash from working capital was primarily driven by an increase in prepaid expenses and other assets of $160 million primarily due to federal and state tax receivables, an increase in merchandise inventory of $83 million, a decrease in other current liabilities of $30 million and a decrease in operating lease liabilities of $19 million primarily due to payments made under the related lease agreements. These uses of cash from working capital were partially offset by an increase in deferred revenue and customer deposits of $49 million primarily due to strong consumer demand for our products.
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 three months ended April 30, 2022, net cash used in investing activities was $30 million and was comprised of investments in retail stores, information technology and systems infrastructure of $29 million and additional funding of our equity method investments of $1.1 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 share repurchase programs, repayment of indebtedness including principal payments under finance lease agreements and other equity related transactions.
For the three months ended April 30, 2022, net cash used in financing activities was $42 million, primarily due to certain transactions entered into in the first quarter of fiscal 2022 related to the 2023 Notes and 2024 Notes, and the related bond hedge and warrant agreements. 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. In addition, we repaid $13 million in aggregate principal amount of certain 2023 Notes and 2024 Notes as a result of early conversions during the quarter, as well as made payments on equipment notes of $11 million, term loans of $5.0 million and finance lease agreements of $3.6 million. These cash outflows were partially offset by proceeds from option exercises of $150 million, primarily due to Mr. Friedman’s option exercise activity in the first quarter of fiscal 2022.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 48 |
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 promissory notes forgiven in exchange for assets. In addition, non-cash transactions consist of shares issued and received related to convertible senior note transactions, as well as a financing liability and an embedded derivative arising from the Notes Repurchase (refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements).
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.
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.
Equipment Loan Facility
Refer to Note 10—Credit Facilities in our condensed consolidated financial statements for further information on our equipment loan facility.
Share Repurchase Program
We regularly review share repurchase activity and consider various factors in determining whether and when to execute investments in connection with our share repurchase programs, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of our common stock. We believe that share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities.
$950 Million 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. We completed $250.0 million in share repurchases in fiscal 2018 under this program. In the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock at an average price of $115.36 per share, for an aggregate repurchase amount of approximately $250.0 million under this share repurchase program. We did not make any repurchases under this share repurchase program during fiscal 2020, fiscal 2021 or the first quarter of fiscal 2022.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 49 |
The total current authorized size of the share purchase program is up to $950 million (the “Share Repurchase Program”), of which $450 million remained available as of April 30, 2022 for future share repurchases under this share repurchase program.
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 is effective immediately and is an addition to the $450 million remaining under the Share Repurchase Program.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISKS
Interest Rate Risk
We currently do not engage in any interest rate hedging activity and we have no intention to do so in the foreseeable future.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 50 |
We are subject to interest rate risk in connection with borrowings under the ABL Credit Agreement and the Term Loan Credit Agreement, as amended, in each case bearing interest at variable rates and we may incur additional indebtedness that bears interest at variable rates. The Federal Reserve continued increasing short-term interest rates in the first quarter of 2022, compared to the historically low levels in the same period in 2021 and there is widespread expectation in the market for rate increases to continue during the remainder of 2022. Such interest rate increases, if they continue, may increase the interest rate applicable to our borrowings that have rates that are subject to adjustment pursuant to floating rate indices such as LIBOR or SOFR. As of April 30, 2022, we had no outstanding borrowings under the revolving line of credit and $1,990 million outstanding under the Term Loan Credit Agreement. In May, 2022, we issued an additional $500 million in principal amount of term debt under the Term Loan Credit Agreement, as amended. The ABL Credit Agreement provides for a borrowing amount based on the value of eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the ABL Credit Agreement as of April 30, 2022 was $444 million, net of $20 million in outstanding letters of credit. Based on the average interest rate on the revolving line of credit under the ABL Credit Agreement and the Term Loan under the Term Loan Credit Agreement during the three months ended April 30, 2022, and to the extent that borrowings were outstanding under any facility, we do not believe that a 10% change in the interest rate would have a material effect on our consolidated results of operations or financial condition. To the extent that we incur additional indebtedness, we may increase our exposure to risk from interest rate fluctuations.
Following announcements by the United Kingdom’s Financial Conduct Authority (the “FCA”), which regulates LIBOR, and the Intercontinental Exchange Benchmark Administration, the administrator of LIBOR, publication of 1-week and 2-month U.S. Dollar LIBOR settings and all tenors for other currencies ceased after December 31, 2021. While publication of the remaining U.S. Dollar settings (overnight and 1, 3, 6 and 12 month U.S. Dollar LIBOR) is expected to cease after June 20, 2023. U.S. banking and other global financial services regulators have directed regulated institutions to cease entering into new LIBOR-based contracts as soon as practicable and in any event by the end of 2021.
A number of our current debt facilities entered into prior to the end of 2021, including the facilities under the ABL Credit Agreement and the Term Loan Credit Agreement, have an interest rate tied to LIBOR. At this time, it is not possible to predict the effect of transitioning from LIBOR. SOFR, which is currently published by the Federal Reserve Bank of New York based on overnight U.S. Treasury repurchase agreement transactions, has been recommended as the alternative to LIBOR by the Alternative Reference Rates Committee convened by the Federal Reserve Board and the Federal Reserve Bank of New York and is provided as an alternative rate for our current debt facilities having an interest rate tied to LIBOR. However, SOFR or any other alternative rates may result in interest payments that are higher than expected or that do not otherwise correlate over time with the payments that would have been made on such indebtedness for the interest periods if the applicable LIBOR rate was available in its current form. We intend to continue to evaluate and monitor the risks associated with the LIBOR transition which include identifying and monitoring our exposure to LIBOR and ensuring operational processes are updated to accommodate alternative rates. Due to uncertainty surrounding alternative rates, we are unable to predict the overall impact of this change at this time.
As of April 30, 2022, we had $20 million principal amount of 0.00% convertible senior notes due 2023 outstanding (the “2023 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.
As of April 30, 2022, we had $81 million principal amount of 0.00% convertible senior notes due 2024 outstanding (the “2024 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.
Foreign Currency Risk
Our revenues are predominately denominated in U.S. dollars, and accordingly, our net revenues are not currently subject to significant foreign currency risk. However, as we are currently expanding our operations into select European markets, fluctuations in foreign currency exchange rates are beginning to impact our results of operations. Certain of our operating expenses are denominated in the currencies of the countries in which our operations exist or are expanding, and accordingly, we have exposure to adverse movements in foreign currency exchange rates, particularly changes in the Pound sterling, Euro and Canadian Dollar, as our international operations are translated from local currency, or functional currency, into U.S. dollars upon consolidation. Fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our consolidated statements of income, which are presented in other income—net on the consolidated statements of income. We minimize this exposure by managing cash balances at levels appropriate to meet forthcoming expenses in U.S. dollars and applicable foreign currencies.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 51 |
To date, we have not engaged in foreign currency hedging transactions because our foreign currency transaction gains and losses have not been material to our consolidated financial statements, but we may begin foreign currency risk management strategies in the future.
Market Price Sensitive Instruments
Convertible Senior Notes
In connection with the issuance of the 2023 Notes and 2024 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. During the first quarter of fiscal 2022, we have entered into agreements to repurchases $180 million in aggregate principal amount of convertible senior notes consisting of approximately $45 million and $135 million in aggregate principal amount of the 2023 Notes and 2024 Notes, respectively. In addition to such notes repurchase, we have also terminated all of the remaining bond hedges as well as all of the outstanding warrants originally issued in conjunction with the 2023 Notes and the 2024 Notes. Refer to Note 9—Convertible Senior Notes in our condensed consolidated financial statements for further information on these transactions related to the 2023 Notes and 2024 Notes.
Impact of Inflation
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the historical impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our consolidated results of operations and financial condition have been immaterial to date. However, there can be no assurance that our results of operations and financial condition will not be materially impacted by inflation in the future, including by heightened levels of inflation that were being experienced globally at the end of our first fiscal quarter. We may be unable to overcome these issues through measures such as price increases for our products. Risks related to inflation could include increased costs for many products and services that are necessary for the operation of our business, as well as the impact of interest rate increases, which could have among other consequences a negative effect on the housing market and impact to consumer demand for our products.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our senior leadership team, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report. At the time our Form 10-Q for the fiscal quarter ended April 30, 2022 was originally filed on June 3, 2022, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that the information required to be disclosed by us in such reports is accumulated and communicated to our senior leadership team, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Subsequent to that evaluation, and in connection with the restatement discussed in Note 1 to the condensed consolidated financial statements included in Item 1 of this report and the filing of this Form 10-Q/A, our senior leadership team, with the participation of our Chief Executive Officer and Chief Financial Officer, re-evaluated the effectiveness of the design and operation of our disclosure controls and procedures, and concluded that, in connection with the matter that caused the restatement, our disclosure controls and procedures were not effective as of April 30, 2022.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 52 |
Material Weakness in Internal Control Over Financial Reporting
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In connection with the restatement discussed in Note 1 to the condensed consolidated financial statements included in Item 1 of this report and the filing of this Form 10-Q/A, we identified the following material weakness:
We did not design and maintain an effective control activity over the presentation and disclosure of net income per share, specifically the application of authoritative guidance, including new accounting standards, to the net income per share computations.
This material weakness resulted in errors in the unaudited condensed consolidated financial statements for the three months ended April 30, 2022 that are restated in this Form 10-Q/A. Additionally, this material weakness could result in misstatements of the related accounts or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.
Plan for Remediation of Material Weakness in Internal Control Over Financial Reporting
Our senior leadership team is committed to remediating the material weakness in our internal control over financial reporting in a timely manner and, with oversight from the Audit Committee. We have among other actions implemented a remediation plan to address the root cause of the material weakness in order fully to remediate the material weakness. We plan to enhance the design of our control activity related to the presentation and disclosure of net income per share, including the application of authoritative guidance and new accounting standards, to the net income per share computations.
While we believe the above remediation plan will address and remediate the material weakness, the process will take time. The material weakness will not be considered remediated until the remediation plan has been implemented and there has been appropriate time for us to conclude through testing that the controls are designed and operating effectively. Such remediation is anticipated to be completed in the first half of fiscal 2023.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our fiscal quarter ended April 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART I. FINANCIAL INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 53 |
PART II
ITEM 1. LEGAL PROCEEDINGS
From time to time, we and/or our senior leadership team are involved in litigation, claims and other proceedings relating to the conduct of our business, including purported class action litigation, as well as securities class action litigation. Such legal proceedings may include claims related to our employment practices, wage and hour claims, claims of intellectual property infringement, including with respect to trademarks and trade dress, claims asserting unfair competition and unfair business practices, claims with respect to our collection and sale of reproduction products, and consumer class action claims relating to our consumer practices including the collection of zip code or other information from customers. In addition, from time to time, we are subject to product liability and personal injury claims for the products that we sell and the stores we operate. Subject to certain exceptions, our purchase orders generally require the vendor to indemnify us against any product liability claims; however, if the vendor does not have insurance or becomes insolvent, we may not be indemnified. In addition, we could face a wide variety of employee claims against us, including general discrimination, privacy, labor and employment, ERISA and disability claims. Any claims could result in litigation against us and could also result in regulatory proceedings being brought against us by various federal and state agencies that regulate our business, including the U.S. Equal Employment Opportunity Commission. Often these cases raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant senior leadership team’s time. Litigation and other claims and regulatory proceedings against us could result in unexpected expenses and liability and could also materially adversely affect our operations and our reputation.
For additional information refer to Note 16—Commitments and Contingencies in our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q.
ITEM 1A. RISK FACTORS
We operate in a rapidly changing environment that involves a number of risks that could materially and adversely affect our business, financial condition, prospects, operating results or cash flows. For a detailed discussion of certain risks that affect our business, refer to the section entitled “Risk Factors” in our 2021 Form 10-K. There have been no material changes to the risk factors disclosed in our 2021 Form 10-K, other than as described below, wherein we amend and update the risk factor captioned “If we are unable to implement and maintain effective internal control over financial reporting in the future, the accuracy and timeliness of our financial reporting may be adversely affected.”
The risks described in our 2021 Form 10-K are not the only risks we face. We describe in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this Quarterly Report on Form 10-Q certain known trends and uncertainties that affect our business. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business, operating results and financial condition.
We have identified a material weakness in our internal control over financial reporting and such weakness led to a conclusion that our internal control over financial reporting and disclosure controls and procedures were not effective. If we are unable to remediate the deficiencies in our internal control over financial reporting and disclosure controls and procedures and maintain effective controls in the future, the accuracy and timeliness of our financial reporting and disclosures may be adversely affected.
We are subject to Section 404 of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), which requires us to maintain internal control over financial reporting and to report any material weaknesses in such internal control. In addition, our independent registered public accounting firm is required to attest to the effectiveness of our internal control over financial reporting.
On February 1, 2023, the Audit Committee of the Board of Directors, after discussion with our senior leadership and independent registered public accountants, determined that the Prior Financial Statements should no longer be relied upon due to material unintentional errors in certain of these financial periods with respect to our calculation of basic and diluted net income per share, and that the Restatement would be required to correct these errors. Our senior leadership team, with the participation of our Chief Executive Officer and Chief Financial Officer, re-evaluated the effectiveness of our disclosure controls and procedures and internal control over financial reporting. As a result of the errors that gave rise to the need for the Restatement, our senior leadership team has identified a material weakness in our internal control over financial reporting and has concluded that our disclosure controls and procedures were not effective as of April 30, 2022, July 30, 2022 and October 29, 2022. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in its reports filed with the SEC is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
The measures we take to remediate the material weakness in our internal control over financial reporting and to implement and maintain effective disclosure controls and procedures in the future may not be sufficient to satisfy our obligations as a public company and produce reliable financial reports, which may result in additional material misstatements of our consolidated financial statements and adverse impacts on our business, financial condition, and results of operations.
Our reporting obligations as a public company place significant requirements on our senior leadership team and we are required to devote substantial operational and financial resources and systems in order to meet those obligations and will continue to do so for the foreseeable future. In addition, we have experienced changes in personnel who are involved in our financial reporting. Changes in personnel, systems or procedures, as well as other events may have an adverse impact on our internal controls and our disclosure controls and procedures.
A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. Therefore, our internal control over financial reporting and disclosure controls and procedures may not prevent or detect misstatements because of their inherent limitations, including the possibility of human error, the circumvention or overriding of controls or fraud. There can be no assurance that our reporting infrastructure and personnel involved in financial reporting and disclosure controls and procedures have in the past complied, or will continue in the future to comply, with all of our applicable reporting obligations. If we fail to timely achieve and maintain the adequacy of our internal control over financial reporting and effective disclosure controls and procedures, we may not be able to produce reliable financial or SEC reports. Our failure to maintain the adequacy and effectiveness of our internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be harmed and we could fail to meet our financial and other reporting obligations.
PART II. OTHER INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 55 |
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Repurchases of Common Stock
During the three months ended April 30, 2022, we repurchased the following shares of our common stock:
|
| |
| | |
| APPROXIMATE DOLLAR | |
| | | | AVERAGE | | VALUE OF SHARES THAT | ||
| | | | PURCHASE | | MAY YET BE | ||
| | NUMBER OF | | PRICE PER | | PURCHASED UNDER THE | ||
| | SHARES (1) | | SHARE | | PLANS OR PROGRAMS(2) | ||
| | | | | | | (in millions) | |
January 30, 2022 to February 26, 2022 |
| — | | $ | — | | $ | 450 |
February 27, 2022 to April 2, 2022 |
| 811 | | $ | 328.57 | | $ | 450 |
April 3, 2022 to April 30, 2022 |
| 35 | | $ | 335.07 | | $ | 450 |
Total |
| 846 | | | | |
|
|
| (1) | Reflects shares withheld from delivery to satisfy exercise price and tax withholding obligations of employee recipients that occur upon the vesting of restricted stock units granted under our 2012 Stock Incentive Plan. |
| (2) | Reflects the dollar value of shares that may yet be repurchased under the Share Repurchase Program authorized by the Board of Directors on October 10, 2018 and replenished on March 25, 2019. |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
PART II. OTHER INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 56 |
ITEM 6. EXHIBITS
| | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
| | | | INCORPORATED BY REFERENCE | | | | | ||
EXHIBIT |
| EXHIBIT DESCRIPTION |
| FORM |
| FILE |
| DATE OF |
| EXHIBIT |
| FILED |
10.1 | | | 8-K | | 001-35720 | | April 13, 2022 | | 10.1 | | | |
10.2 | | | 8-K | | 001-35720 | | April 13, 2022 | | 10.2 | | | |
10.3 | | | 8-K | | 001-35720 | | April 18, 2022 | | 10.1 | | | |
10.4 | | Form of Bond Hedge Termination Agreement by and between RH and the applicable Hedge Counterparty. | | 8-K | | 001-35720 | | April 18, 2022 | | 10.2 | | |
31.1 | | | — | | — | | — | | — | | X | |
31.2 | | | — | | — | | — | | — | | X | |
32.1 | | | — | | — | | — | | — | | X | |
32.2 | | | — | | — | | — | | — | | X | |
101.INS | | XBRL Instance Document—the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | | — | | — | | — | | — | | X |
101.SCH | | Inline XBRL Taxonomy Extension Schema Document | | — | | — | | — | | — | | X |
101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase Document | | — | | — | | — | | — | | X |
101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document | | — | | — | | — | | — | | X |
101.LAB | | Inline XBRL Taxonomy Extension Label Linkbase Document | | — | | — | | — | | — | | X |
101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase Document | | — | | — | | — | | — | | X |
104 | | Cover Page Interactive Data File––the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | | — | | — | | — | | — | | X |
PART II. OTHER INFORMATION | 2022 FIRST QUARTER FORM 10-Q | 57 |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | | |
|
|
| |
| | | |
Date: March 27, 2023 | | By: | /s/ Gary Friedman |
| | Gary Friedman | |
| | Chairman and Chief Executive Officer | |
| | (Principal Executive Officer) | |
| | | |
| | | |
Date: March 27, 2023 | | By: | /s/ Jack Preston |
| | Jack Preston | |
| | Chief Financial Officer | |
| | (Principal Financial Officer) | |
| | | |
| | | |
Date: March 27, 2023 | | By: | /s/ Christina Hargarten |
| | Christina Hargarten | |
| | Chief Accounting Officer | |
| | (Principal Accounting Officer) | |
Exhibit 31.1
CERTIFICATION OF PERIODIC REPORT UNDER SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Gary Friedman, certify that:
1. | I have reviewed this Amendment No. 1 to the Quarterly Report on Form 10-Q of RH; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
a. | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b. | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c. | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d. | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
a. | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
b. | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: March 27, 2023 | | |
/s/ Gary Friedman | | |
Gary Friedman Chairman and Chief Executive Officer | | |
Exhibit 31.2
CERTIFICATION OF PERIODIC REPORT UNDER SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Jack Preston, certify that:
1. | I have reviewed this Amendment No. 1 to the Quarterly Report on Form 10-Q of RH; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
a. | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b. | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c. | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d. | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
a. | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
b. | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
| |
Date: March 27, 2023 | |
| |
/s/ Jack Preston | |
Jack Preston | |
Chief Financial Officer | |
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Gary Friedman, Chairman and Chief Executive Officer of RH (the “Company”), do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
| ● | this Amendment No. 1 to the Quarterly Report of the Company on Form 10-Q for the fiscal quarter ended April 30, 2022 (the “Quarterly Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| ● | the information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein. |
| ||
Date: March 27, 2023 | | |
| | |
| By: | /s/ Gary Friedman |
| Name: | Gary Friedman |
| Title: | Chairman and Chief Executive Officer |
This certification accompanies this Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Jack Preston, Chief Financial Officer of RH (the “Company”), do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
| ● | this Amendment No. 1 to the Quarterly Report of the Company on Form 10-Q for the fiscal quarter ended April 30, 2022 (the “Quarterly Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| ● | the information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein. |
| | |
Date: March 27, 2023 | | |
| | |
| By: | /s/ Jack Preston |
| Name: | Jack Preston |
| Title: | Chief Financial Officer |
This certification accompanies this Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the Company specifically incorporates it by reference.