(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and the results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended January 29, 2022 (the "2021 Form 10-K").
Management's discussion and analysis of financial condition and results of operations ("MD&A") contains forward-looking statements that are subject to risks and uncertainties. Refer to "Forward-Looking Statements and Market Data" below and Item 1A-Risk Factors in our 2021 Form 10-K for a discussion of the risks, uncertainties and assumptions associated with these statements. MD&A should be read in conjunction with our historical consolidated financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed in our 2021 Form 10-K.
The discussion of our financial condition and changes in our results of operations, liquidity and capital resources is presented in this section for the three and six months ended July 30, 2022 and a comparison to the three and six months ended July 31, 2021. The discussion related to cash flows for the six months ended July 31, 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 July 31, 2021, filed with the Securities and Exchange Commission ("SEC") on September 9, 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 have been adopted in fiscal 2022 and that will be adopted in future periods.
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.
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Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those that we expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results, and matters that we identify as "short term," "non-recurring," "unusual," "one-time," or other words and terms of similar meaning may, in fact, recur in one or more future financial reporting periods. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the section entitled Risk Factors in our 2021 Form 10-K, and Management's Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report, in our Quarterly Report on Form 10-Q for the quarterly period ended April 30, 2022 (the "First Quarter Form 10-Q") and in our 2021 Form 10-K. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this quarterly report in the context of these risks and uncertainties.
We cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this quarterly report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.
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, decor, 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 have an integrated RH Hospitality experience in 14 of our Design Gallery locations, which includes Restaurants and Wine Bars.
As of July 30, 2022, we operated the following number of Galleries, Outlets and Showrooms:
COUNT RH Design Galleries 28 Legacy Galleries 35 Modern Galleries 1 Baby & Child and TEEN Galleries 3 Total Galleries 67 Outlets 39 Waterworks Showrooms 14
Macro-Economic Factors and COVID-19 Pandemic
There are a number of macro-economic factors and uncertainties affecting the overall business climate as well as our business, including increased inflation and rising interest rates. These factors may have a number of adverse effects on macro-economic conditions and markets in which we operate, with the potential for an economic recession and a sustained downturn in the housing market. Factors such as a slowdown in the housing market or negative trends in stock market prices could have a negative impact on demand for our products.
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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 toward travel and leisure and other areas.
Our decisions regarding the sources and uses of capital will continue to reflect and adapt to changes in market conditions and our business including further developments with respect to macro-economic factors and the pandemic. For more information, refer to the section entitled "Risk Factors" in our 2021 Form 10-K.
Key Value-Driving Strategies
In order to drive growth across our business, we are focused on the following long-term key strategies and business initiatives:
Product Elevation. We believe we have built the most comprehensive and compelling collection of luxury home furnishings under one brand in the world. Our products are presented across multiple collections, categories and channels that we control, and their desirability and exclusivity has enabled us to achieve industry-leading revenues and margins. Our customers know our brand concepts as RH Interiors, RH Modern, RH Contemporary, RH Outdoor, RH Beach House, RH Ski House, RH Baby & Child, RH TEEN and Waterworks. Our strategy is to continue to elevate the design and quality of our product. Over the next few years, we plan to introduce RH Couture Upholstery, RH Bespoke Furniture and RH Color.
Gallery Transformation. Our product is elevated and rendered more valuable by our architecturally inspiring Galleries. We believe our strategy to open new Design Galleries in every major market will unlock the value of our vast assortment, generating a revenue opportunity for our business of $5 to $6 billion in North America. We believe we can significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that 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.
Brand Elevation. We are evolving the brand beyond curating and selling product to conceptualizing and selling spaces by building an ecosystem of Products, Places, Services and Spaces designed to elevate and render our product more valuable while establishing the RH brand as a thought leader, taste and place maker. We believe our seamlessly integrated ecosystem of immersive experiences inspires customers to dream, design, dine, travel and live in a world thoughtfully curated by RH, creating an impression and connection unlike any other brand in the world. Our hospitality efforts will continue to elevate the RH brand as we extend beyond the four walls of our Galleries into RH Guesthouses, where our goal is to create a new market for travelers seeking privacy and luxury in the $200 billion North American hotel industry. In September 2022, we opened our first RH Guesthouse in New York. Additionally, we are creating bespoke experiences like RH Yountville, an integration of Food, Wine, Art & Design in the Napa Valley, RH1 & RH2, our private jets, and RH3, our luxury yacht that is available for charter in the Caribbean and Mediterranean, where the wealthy and affluent visit and vacation. These immersive experiences expose new and existing customers to our evolving authority in architecture, interior design and landscape architecture.
Digital Reimagination. Our strategy is to digitally reimagine the RH brand and business model both internally and externally. Internally, our multi-year effort began with the reimagination of our Center of Innovation & Product Leadership to incorporate digitally integrated visuals and decision data designed to amplify the creative process from product ideation to product presentation. Externally, our strategy comes to life digitally with The World of RH, an online portal where customers can explore and be inspired by the depth and dimension of our brand. Launched this spring, The World of RH includes rich, immersive content with simplified navigation and search functionality, all designed to enhance the shopping experience and render our product and brand more valuable. We expect to continue to elevate the customer experience on The World of RH with further enhancements to content, navigation and search functionality. We believe an opportunity exists to create similar strategic separation online as we have with our Galleries offline, reconceptualizing what a website can and should be.
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Global Expansion. We believe that our luxury brand positioning and unique aesthetic have strong international appeal, and that pursuit of global expansion will provide RH a substantial long-term market opportunity to build a $20 to $25 billion global brand over time. Our view is that the competitive environment globally is more fragmented and primed for disruption than the North American market, and there is no direct competitor of scale that possesses the product, operational platform, and brand of RH. As such, we are actively pursuing the expansion of the RH brand globally with the objective of launching international locations in Europe beginning with the opening of RH England, The Country House at the Historic Aynho Park, in the spring of 2023. We have secured a number of locations in various markets in the United Kingdom and continental Europe for future Design Galleries and are in lease or purchase negotiations for additional locations.
Basis of Presentation and Results of Operations The following table sets forth our condensed consolidated statements of income: THREE MONTHS ENDED SIX MONTHS ENDED JULY 30, % OF NET JULY 31, % OF NET JULY 30, % OF NET JULY 31, % OF NET 2022 REVENUES 2021 REVENUES 2022 REVENUES 2021 REVENUES (dollars in thousands) Net revenues $ 991,620 100.0 % $ 988,859 100.0 % $ 1,948,912 100.0 % $ 1,849,651 100.0 % Cost of goods sold 468,402 47.2 501,183 50.7 927,111 47.6 954,998 51.6 Gross profit 523,218 52.8 487,676 49.3 1,021,801 52.4 894,653 48.4 Selling, general and 288,804 29.2 238,688 24.1 582,099 29.8 457,777 24.8 administrative expenses Income from operations 234,414 23.6 248,988 25.2 439,702 22.6 436,876 23.6 Other expenses Interest expense-net 26,264 2.6 13,581 1.4 47,119 2.5 26,889 1.4 Loss on extinguishment 23,462 2.4 3,166 0.3 169,578 8.7 3,271 0.2 of debt Other expense-net 3,195 0.3 - - 2,852 0.1 - - Total other expenses 52,921 5.3 16,747 1.7 219,549 11.3 30,160 1.6 Income before income 181,493 18.3 232,241 23.5 220,153 11.3 406,716 22.0 taxes Income tax expense 56,397 5.7 3,009 0.3 (107,029) (5.5) 44,733 2.4 (benefit) Income before equity 125,096 12.6 229,232 23.2 327,182 16.8 361,983 19.6 method investments Share of equity method (2,821) (0.3) (2,486) (0.3) (4,196) (0.2) (4,581) (0.3) investments losses Net income $ 122,275 12.3 % $ 226,746 22.9 % $ 322,986 16.6 % $ 357,402 19.3 %
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Non-GAAP Financial Measures
To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States ("GAAP"), we use non-GAAP financial measures, including adjusted operating income, adjusted net income, EBITDA, adjusted EBITDA, and adjusted capital expenditures (collectively, our "non-GAAP financial measures"). We compute these measures by adjusting the applicable GAAP measures to remove the impact of certain recurring and non-recurring charges and gains and the tax effect of these adjustments. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. We use these non-GAAP financial measures for financial and operational decision making and as a means to evaluate period-to-period comparisons. We believe that they provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to key metrics used by senior leadership in its financial and operational decision making. The non-GAAP financial measures used by us in this Quarterly Report on Form 10-Q may be different from the non-GAAP financial measures, including similarly titled measures, used by other companies.
For more information on the non-GAAP financial measures, please see the reconciliation of GAAP to non-GAAP financial measures tables outlined below. These accompanying tables include details on the GAAP financial measures that are most directly comparable to non-GAAP financial measures and the related reconciliations between these financial measures.
Adjusted Operating Income. Adjusted operating income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted operating income as consolidated operating income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to Operating Income and Adjusted Operating
Income THREE MONTHS ENDED SIX MONTHS ENDED JULY 30, JULY 31, JULY 30, JULY 31, 2022 2021 2022 2021 (in thousands) Net income $ 122,275 $ 226,746 $ 322,986 $ 357,402 Interest expense-net(1) 26,264 13,581 47,119 26,889 Loss on extinguishment of debt(1) 23,462 3,166 169,578 3,271 Other expense-net(1) 3,195 - 2,852 - Income tax expense (benefit)(1) 56,397 3,009 (107,029) 44,733 Share of equity method investments 2,821 2,486 4,196 4,581 losses(1) Operating income 234,414 248,988 439,702 436,876 Employer payroll taxes on option - - 11,717 - exercise(2) Non-cash compensation(3) 4,321 5,864 10,179 11,728 Asset impairments(4) 2,231 7,354 8,154 7,354 Professional fees(5) 285 - 7,469 - Compensation settlements(6) 3,483 - 3,483 - Recall accrual(7) - - 560 500 Reorganizational related costs(8) - 449 - 449 Adjusted operating income $ 244,734 $ 262,655 $ 481,264 $ 456,907
Refer to discussion "Three Months Ended July 30, 2022 Compared to Three Months Ended July 31, 2021" and "Six Months Ended July 30, 2022 Compared to
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(2) Represents employer payroll tax expense related to the option exercise by Mr. Friedman in the first quarter of fiscal 2022.
(3) Represents the amortization of the non-cash compensation charge related to a fully vested option grant made to Mr. Friedman in October 2020.
Represents asset impairment related to property and equipment of Galleries
Represents professional fees contingent upon the completion of certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge
(6) Represents compensation settlements related to the Rollover Units and Profit Interest Units in the Waterworks subsidiary.
(7) Represents accruals associated with product recalls.
(8) Represents severance costs and related payroll taxes associated with reorganizations.
Adjusted Net Income. Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We define adjusted net income as consolidated net income, adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance.
Reconciliation of GAAP Net Income to Adjusted Net Income THREE MONTHS ENDED SIX MONTHS ENDED JULY 30, JULY 31, JULY 30, JULY 31, 2022 2021 2022 2021 (in thousands) Net income $ 122,275 $ 226,746 $ 322,986 $ 357,402 Adjustments pre-tax: Loss on extinguishment of 23,462 3,166 169,578 3,271 debt(1) Employer payroll taxes on option - - 11,717 - exercise(1) Non-cash compensation(1) 4,321 5,864 10,179 11,728 Asset impairments(1) 2,231 7,354 8,154 7,354 Professional fees(1) 285 - 7,469 - Compensation settlements(1) 3,483 - 3,483 - Recall accrual(1) - - 560 500 (Gain) loss on derivative 1,453 - (1,724) - instruments-net(2) Amortization of debt discount(3) - 5,865 - 11,846 Reorganization related costs(1) - 449 - 449 Subtotal adjusted items 35,235 22,698 209,416 35,148 Impact of income tax items(4) 56,397 (305) (107,029) (3,256) Share of equity method 2,821 2,486 4,196 4,581 investments losses(1) Adjusted net income $ 216,728 $ 251,625 $ 429,569 $ 393,875
Refer to table titled "Reconciliation of GAAP Net Income to Operating Income
Represents net (gain) loss on derivative instruments resulting from certain transactions related to the 2023 Notes and 2024 Notes, including bond hedge
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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
The adjustment for both the three and six months ended July 30, 2022 is based on an adjusted tax rate of 0.0%, which represents our expected cash tax liability associated with anticipated fiscal 2022 results as we do not expect
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Sep 08, 2022
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