rh-10q_20180505.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 5, 2018

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: 001-35720

 

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

45-3052669

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

 

15 Koch Road, Suite K

Corte Madera, CA

 

94925

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (415) 924-1005

 

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.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes      No  

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. (Check one):

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

 

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      No  

As of June 8, 2018, 21,634,290 shares of registrant’s common stock were outstanding.

 

 


 

RH

INDEX TO FORM 10-Q

 

 

 

 

 

Page

 

 

 

 

 

PART I. FINANCIAL INFORMATION

Item 1.

  

Financial Statements

 

3

 

  

Condensed Consolidated Balance Sheets (Unaudited) as of May 5, 2018, and February 3, 2018

 

3

 

  

Condensed Consolidated Statements of Operations (Unaudited) for the three months ended May 5, 2018, and April 29, 2017

 

4

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three months ended May 5, 2018, and April 29, 2017

 

5

 

  

Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended May 5, 2018, and April 29, 2017

 

6

 

  

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

7

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

 

40

Item 4.

  

Controls and Procedures

 

41

 

 

 

 

 

PART II. OTHER INFORMATION

Item 1.

  

Legal Proceedings

 

43

Item 1A.

  

Risk Factors

 

43

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

44

Item 3.

 

Defaults Upon Senior Securities

 

44

Item 4.

 

Mine Safety Disclosures

 

44

Item 5.

 

Other Information

 

44

Item 6.

  

Exhibits

 

45

Signatures

 

46

 

 

2


 

PART I

 

Item 1. Financial Statements

RH

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

20,796

 

 

$

17,907

 

Accounts receivable—net

 

 

38,614

 

 

 

31,412

 

Merchandise inventories

 

 

530,657

 

 

 

527,026

 

Prepaid expense and other current assets

 

 

60,064

 

 

 

68,585

 

Total current assets

 

 

650,131

 

 

 

644,930

 

Property and equipment—net

 

 

811,369

 

 

 

800,698

 

Goodwill

 

 

141,849

 

 

 

141,893

 

Trademarks and other intangible assets

 

 

100,678

 

 

 

100,702

 

Deferred tax assets

 

 

30,014

 

 

 

23,311

 

Other non-current assets

 

 

14,920

 

 

 

21,332

 

Total assets

 

$

1,748,961

 

 

$

1,732,866

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

264,173

 

 

$

318,765

 

Deferred revenue and customer deposits

 

 

172,379

 

 

 

149,404

 

Other current liabilities

 

 

59,944

 

 

 

51,166

 

Total current liabilities

 

 

496,496

 

 

 

519,335

 

Asset based credit facility

 

 

219,000

 

 

 

199,970

 

Term loan—net

 

 

79,528

 

 

 

79,499

 

Convertible senior notes due 2019—net

 

 

331,678

 

 

 

327,731

 

Convertible senior notes due 2020—net

 

 

257,425

 

 

 

252,994

 

Financing obligations under build-to-suit lease transactions

 

 

227,979

 

 

 

229,323

 

Deferred rent and lease incentives

 

 

54,965

 

 

 

54,983

 

Other non-current obligations

 

 

73,248

 

 

 

76,367

 

Total liabilities

 

 

1,740,319

 

 

 

1,740,202

 

Commitments and contingencies (Note 14)

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value per share, 10,000,000 shares authorized, no shares

   issued or outstanding as of May 5, 2018 and February 3, 2018

 

 

 

 

 

 

Common stock, $0.0001 par value per share, 180,000,000 shares authorized,

   41,835,129 shares issued and 21,612,197 shares outstanding as of May 5, 2018;

   41,737,470 shares issued and 21,517,338 shares outstanding as of February 3, 2018

 

 

2

 

 

 

2

 

Additional paid-in capital

 

 

870,751

 

 

 

860,288

 

Accumulated other comprehensive loss

 

 

(1,436

)

 

 

(171

)

Retained earnings

 

 

159,417

 

 

 

152,394

 

Treasury stock—at cost, 20,222,932 shares as of May 5, 2018 and 20,220,132 shares

   as of February 3, 2018

 

 

(1,020,092

)

 

 

(1,019,849

)

Total stockholders’ equity (deficit)

 

 

8,642

 

 

 

(7,336

)

Total liabilities and stockholders’ equity (deficit)

 

$

1,748,961

 

 

$

1,732,866

 

 

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

3


 

RH

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

May 5,

 

 

April 29,

 

 

 

2018

 

 

2017

 

Net revenues

 

$

557,406

 

 

$

562,080

 

Cost of goods sold

 

 

345,371

 

 

 

391,824

 

Gross profit

 

 

212,035

 

 

 

170,256

 

Selling, general and administrative expenses

 

 

158,434

 

 

 

163,360

 

Income from operations

 

 

53,601

 

 

 

6,896

 

Interest expense—net

 

 

17,035

 

 

 

12,179

 

Income (loss) before income taxes

 

 

36,566

 

 

 

(5,283

)

Income tax expense (benefit)

 

 

8,507

 

 

 

(1,913

)

Net income (loss)

 

$

28,059

 

 

$

(3,370

)

Weighted-average shares used in computing basic net income (loss) per share

 

 

21,545,025

 

 

 

37,609,516

 

Basic net income (loss) per share

 

$

1.30

 

 

$

(0.09

)

Weighted-average shares used in computing diluted net income (loss) per share

 

 

25,230,228

 

 

 

37,609,516

 

Diluted net income (loss) per share

 

$

1.11

 

 

$

(0.09

)

 

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

 

 

4


 

RH

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

May 5,

 

 

April 29,

 

 

 

2018

 

 

2017

 

Net income (loss)

 

$

28,059

 

 

$

(3,370

)

Net losses from foreign currency translation

 

 

(1,265

)

 

 

(1,192

)

Net unrealized holding gains on available-for-sale investments

 

 

 

 

 

11

 

Total comprehensive income (loss)

 

$

26,794

 

 

$

(4,551

)

 

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

 

 

5


 

RH

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

May 5,

 

 

April 29,

 

 

 

2018

 

 

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income (loss)

 

$

28,059

 

 

$

(3,370

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

17,047

 

 

 

16,020

 

Lease impairment adjustment

 

 

(1,157

)

 

 

 

Non-cash charges resulting from inventory step-up

 

 

190

 

 

 

1,380

 

Amortization of debt discount

 

 

7,881

 

 

 

7,458

 

Stock-based compensation expense

 

 

7,997

 

 

 

5,289

 

Other non-cash interest expense

 

 

938

 

 

 

884

 

Change in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(7,243

)

 

 

8

 

Merchandise inventories

 

 

(4,032

)

 

 

66,067

 

Prepaid expense and other assets

 

 

(26,181

)

 

 

7,547

 

Accounts payable and accrued expenses

 

 

(57,215

)

 

 

1,219

 

Deferred revenue and customer deposits

 

 

28,159

 

 

 

22,232

 

Other current liabilities

 

 

13,838

 

 

 

(1,086

)

Deferred rent and lease incentives

 

 

44

 

 

 

726

 

Other non-current obligations

 

 

(569

)

 

 

(426

)

Net cash provided by operating activities

 

 

7,756

 

 

 

123,948

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(27,121

)

 

 

(21,173

)

Proceeds from sale of assets held for sale—net

 

 

 

 

 

4,900

 

Purchase of investments

 

 

 

 

 

(16,109

)

Maturities of investments

 

 

 

 

 

46,890

 

Sales of investments

 

 

 

 

 

145,020

 

Net cash provided by (used in) investing activities

 

 

(27,121

)

 

 

159,528

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Borrowing under asset based credit facility

 

 

334,000

 

 

 

 

Repayments under asset based credit facility

 

 

(314,970

)

 

 

 

Repayments under promissory and equipment security notes

 

 

(1,491

)

 

 

 

Repurchases of common stock—including commissions

 

 

 

 

 

(300,140

)

Payments on build-to-suit lease transactions

 

 

(3,207

)

 

 

(1,289

)

Proceeds from exercise of stock options

 

 

2,923

 

 

 

2,567

 

Tax withholdings related to issuance of stock-based awards

 

 

(351

)

 

 

(149

)

Payments on capital leases

 

 

(112

)

 

 

(76

)

Net cash provided by (used in) financing activities

 

 

16,792

 

 

 

(299,087

)

Effects of foreign currency exchange rate translation

 

 

(62

)

 

 

(86

)

Net decrease in cash and cash equivalents and restricted cash equivalents

 

 

(2,635

)

 

 

(15,697

)

Cash and cash equivalents

 

 

 

 

 

 

 

 

Beginning of period—cash and cash equivalents

 

 

17,907

 

 

 

87,023

 

Beginning of period—restricted cash equivalents (construction related deposits)

 

 

7,407

 

 

 

28,044

 

Beginning of period—cash and cash equivalents and restricted cash equivalents

 

 

25,314

 

 

 

115,067

 

 

 

 

 

 

 

 

 

 

End of period—cash and cash equivalents

 

 

20,796

 

 

 

80,150

 

End of period—restricted cash equivalents (construction related deposits)

 

 

1,883

 

 

 

19,220

 

End of period—cash and cash equivalents and restricted cash equivalents

 

$

22,679

 

 

$

99,370

 

 

 

 

 

 

 

 

 

 

Non-cash transactions:

 

 

 

 

 

 

 

 

Property and equipment additions in accounts payable and accrued expenses at period-end

 

$

18,560

 

 

$

14,498

 

Property and equipment additions from unpaid construction related deposits

 

$

2,650

 

 

$

4,913

 

Property and equipment additions due to build-to-suit lease transactions

 

$

1,887

 

 

$

18,283

 

Issuance of non-current notes payable related to share repurchases from former employees

 

$

243

 

 

$

 

 

The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.

6


 

RH

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

NOTE 1—THE COMPANY

Nature of Business

RH, a Delaware corporation, together with its subsidiaries (collectively, the “Company”), is a luxury home furnishings retailer that offers a growing number of categories including furniture, lighting, textiles, bathware, décor, outdoor and garden, tableware, and child and teen furnishings. These products are sold through the Company’s stores, catalogs and websites.

As of May 5, 2018, the Company operated a total of 84 retail Galleries and 32 outlet stores in 32 states, the District of Columbia and Canada, and includes 15 Waterworks showrooms in the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared from the Company’s records and, in management’s opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the Company’s financial position as of May 5, 2018, and the results of operations for the three months ended May 5, 2018 and April 29, 2017. The Company’s current fiscal year, which consists of 52 weeks, ends on February 2, 2019 (“fiscal 2018”).

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.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2018 (the “2017 Form 10-K”). Certain prior year amounts have been reclassified for consistency with the current period presentation. This reclassification had no effect on the previously reported consolidated financial position or consolidated results of operations, and did not have a material effect on the previously reported consolidated cash flows.

The results of operations for the three months ended May 5, 2018 presented herein are not necessarily indicative of the results to be expected for the full fiscal year.

 

NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS

Revenue from Contracts with Customers

In May 2014, the FASB and International Accounting Standards Board issued their converged accounting standards update on revenue recognition, Accounting Standards Update 2014-09—Revenue from Contracts with Customers (Topic 606). This guidance outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Under the new guidance, transfer of control is no longer the same as transfer of risks and rewards as indicated in the prior guidance.

Adoption and Accounting Policy

The Company adopted Topic 606 on February 4, 2018 using the modified retrospective transition method and recorded a decrease to opening retained earnings of $21.0 million, inclusive of the tax impact. Results reported within the Company’s condensed consolidated financial statements for reporting periods beginning February 4, 2018 are presented under Topic 606 while prior periods are not adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC 605—Revenue Recognition (Topic 605).

7


 

Under Topic 606, changes were made to the recognition timing or classification of revenues and expenses for the following:

 

Description

Policy under Topic 605

Policy under Topic 606

Advertising expenses

Costs associated with Source Books were capitalized and amortized over their expected period of future benefit. Expense was amortized based upon the ratio of actual revenues to the total of actual and estimated future revenues on an individual Source Book basis, generally over a twelve-month period after they were mailed.

Costs associated with Source Books are expensed upon the delivery of the Source Books to the carrier. In the case of multiple printings of a Source Book, the creative costs will be expensed in full upon the initial delivery of Source Books to the carrier.

Gift card breakage

Recognized gift card breakage (amounts not expected to be redeemed) within selling, general and administrative expenses.

Recognize gift card breakage within net revenues proportional to actual gift card redemptions.

Membership revenue

Annual fees for new memberships in the RH Members Program and renewals were recorded as deferred revenue when collected from customers and recognized as revenue on a straight-line basis over the twelve month membership period.

Annual fees for new memberships in the RH Members Program are recorded as deferred revenue when collected from customers and recognized as revenue based on expected product revenues over the annual membership period, using historical trends of sales to members.

 

RH Members Program renewal fees are recorded as deferred revenue when collected from customers and will continue to be recognized as revenue on a straight-line basis over the twelve month membership period.

Revenue recognition

Revenue for merchandise that is not delivered via the home-delivery channel was recognized upon delivery.

Revenue for merchandise that is not delivered via the home-delivery channel will be recognized upon shipment.

Allowance for sales returns

Recognized an allowance for sales returns as a net liability within other current liabilities.

Recognize an allowance for sales returns on a gross basis as a liability within other current liabilities and a right of return asset for merchandise within prepaid expense and other current assets.

 

Advertising expensesThe adoption of Topic 606 materially impacts the timing of recognizing advertising expense related to direct response advertising, including costs associated with the Company’s Source Books. Under Topic 606, the Company will recognize expense associated with the Source Books upon the delivery of the Source Books to the carrier. In the case of multiple printings of a Source Book, the creative costs will be expensed in full upon the initial delivery of Source Books to the carrier. Prior to adoption of Topic 606, costs associated with Source Books were capitalized and amortized over their expected period of future benefit. Such amortization was based upon the ratio of actual revenues to the total of actual and estimated future revenues on an individual Source Book basis. Each Source Book was generally fully amortized within a twelve-month period after they were mailed and the majority of the amortization occurred within the first five to nine months, with the exception of the Holiday Source Books, which were generally fully amortized within a three-month period after they were mailed. Upon adoption of Topic 606, capitalized costs associated with Source Books of $37.8 million that had been delivered to the carrier prior to or on February 3, 2018 were reclassified to retained earnings on the consolidated balance sheets, resulting in a decrease to the opening retained earnings balance.

Gift card breakageUnder Topic 606, the Company recognizes gift card breakage proportional to actual gift card redemptions and such breakage is recorded within net revenues on the condensed consolidated statements of operations. Gift card breakage was previously recorded as a reduction to selling, general and administrative expenses when the likelihood of redemption was remote. Upon adoption of Topic 606, gift card liabilities of $6.0 million were reclassified to retained earnings on the consolidated balance sheets, resulting in an increase to the opening retained earnings balance.

Membership revenueUnder Topic 606, the annual fee for new memberships in the RH Members Program is recorded as deferred revenue when collected from customers and recognized as revenue based on expected product revenues over the annual membership period, using historical trends of sales to members. Prior to the adoption of Topic 606, new memberships were recorded as deferred revenue when collected from customers and recognized as revenue on a straight-line basis over the twelve month membership period. This will result in a majority of revenue being recognized during the first six months of the membership period. The adoption of Topic 606 will not have an impact on membership renewal fees, which will continue to be recognized as revenue on a straight-line basis over the twelve month membership period, until the Company has more information regarding membership renewal purchasing trends. Upon adoption of Topic 606, deferred membership revenue of $3.8 million was reclassified to retained earnings on the consolidated balance sheets, resulting in an increase to the opening retained earnings balance.

8


 

Revenue recognitionUnder Topic 606, the Company will continue to recognize revenue for merchandise delivered via the home-delivery channel upon delivery. Under Topic 606, revenue for merchandise delivered via all other delivery channels will be recognized upon shipment, whereas previously such revenue was recognized upon delivery. Upon adoption of Topic 606, deferred revenue (net of cost of goods sold) of $1.3 million was reclassified to retained earnings on the consolidated balance sheets, resulting in an increase to the opening retained earnings balance.

The Company adopted the practical expedient related to shipping and handling activities. Under this option, in instances where revenue is recognized for the related merchandise prior to delivery to customers (i.e., revenue recognized upon shipment), the related costs of shipping and handling activities will be accrued for in the same period. Costs of shipping and handling continue to be included in cost of goods sold.

Allowance for sales returnsIn connection with adoption of Topic 606, the Company is required to recognize its allowance for sales returns on a gross basis rather than as a net liability. Upon adoption, this resulted in an increase to prepaid and other current assets (“right of return asset for merchandise”), with a corresponding increase to other current liabilities on the consolidated balance sheets, and did not impact the consolidated statements of operations. As of May 5, 2018, the right of return asset for merchandise was $5.3 million.

Sales tax collection from customersUnder Topic 606, the Company has not changed its policy regarding sales tax collected from customers. Sales tax collected is not recognized as revenue but is included in accounts payable and accrued expenses on the consolidated balance sheets as it is ultimately remitted to governmental authorities.

In connection with adoption of Topic 606, the Company recorded a $6.6 million tax adjustment associated with the charges listed above to retained earnings on the consolidated balance sheets, resulting in an increase to the opening retained earnings balance.

Contract Liabilities

The Company defers revenue associated with merchandise delivered via the home-delivery channel. As the Company recognizes revenue when the merchandise is delivered to our customers, it is included as deferred revenue on the consolidated balance sheets while in-transit. Customer deposits represent payments made by customers on custom orders. At the time of order placement the Company collects deposits for all custom orders equivalent to 50% of the purchase price. Custom order deposits are recognized as revenue when a customer obtains control of the merchandise. In addition, the Company collects annual membership fees related to the RH Members Program. 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, using 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 one year. The Company expects that substantially all of the deferred revenue, customer deposits and deferred membership fees as of May 5, 2018 will be recognized within the next six months as the performance obligations are satisfied.

In addition, the Company defers revenue when cash payments are received in advance of performance for unsatisfied obligations related to its gift cards and merchandise credits. Customer liabilities related to gift cards and merchandise credits was $17.7 million and $24.1 million as of May 5, 2018 and February 3, 2018, respectively. As discussed above, $6.0 million of the decrease was due to the reclassification of gift card liabilities to retained earnings upon adoption of Topic 606. During the three months ended May 5, 2018, the Company recognized $4.9 million of revenue related to previous deferrals related to its gift cards and merchandise credits and recorded gift card breakage of $0.4 million. The Company expects that approximately 70% of the remaining gift card and merchandise credit liabilities will be recognized when the gift cards are redeemed by customers.

Disaggregated Revenue

The Company recognizes revenue from its stores and direct sales channels. Stores net revenues represent sales originating in retail stores, including Waterworks showrooms, and outlet stores. Direct net revenues include sales through the Company’s Source Books, websites, and phone orders, including its Contract business and a portion of its Trade business. During the three months ended May 5, 2018, net revenues recognized from the stores and direct sales channels were $314.5 million and $242.9 million, respectively.

9


 

Adoption Impact on Fiscal 2018 Results

The following table summarizes the impact of adopting Topic 606 on the Company’s condensed consolidated statements of operations (in thousands):

 

 

 

Three Months Ended May 5, 2018

 

 

 

As Reported

 

 

Adjustments

 

 

Balances without Adoption of Topic 606

 

Net revenues

 

$

557,406

 

 

$

(7,610

)

 

$

549,796

 

Cost of goods sold

 

 

345,371

 

 

 

(2,988

)

 

 

342,383

 

Gross profit

 

 

212,035

 

 

 

(4,622

)

 

 

207,413

 

Selling, general and administrative expenses

 

 

158,434

 

 

 

3,803

 

 

 

162,237

 

Income from operations

 

 

53,601

 

 

 

(8,425

)

 

 

45,176

 

Interest expense—net

 

 

17,035

 

 

 

 

 

 

17,035

 

Income before income taxes

 

 

36,566

 

 

 

(8,425

)

 

 

28,141

 

Income tax expense

 

 

8,507

 

 

 

(1,950

)

 

 

6,557

 

Net income

 

$

28,059

 

 

$

(6,475

)

 

$

21,584

 

 

The following table summarizes the impact of adopting Topic 606 on certain line items of the Company’s condensed consolidated balance sheets (in thousands):

 

 

 

As of May 5, 2018

 

 

 

As Reported

 

 

Adjustments

 

 

Balances without Adoption of Topic 606

 

Prepaid expense and other current assets

 

$

60,064

 

 

$

27,652

 

 

$

87,716

 

Deferred tax assets

 

 

30,014

 

 

 

(6,561

)

 

 

23,453

 

Accounts payable and accrued expenses

 

 

264,173

 

 

 

(638

)

 

 

263,535

 

Deferred revenue and customer deposits

 

 

172,379

 

 

 

9,463

 

 

 

181,842

 

Other current liabilities

 

 

59,944

 

 

 

(2,295

)

 

 

57,649

 

Retained earnings

 

 

159,417

 

 

 

14,561

 

 

 

173,978

 

Financial Instruments

In January 2016, the FASB issued Accounting Standards Update 2016-01—Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends various aspects of the recognition, measurement, presentation and disclosure for financial instruments. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted only for certain provisions. The Company adopted this new accounting standard in the first quarter of fiscal 2018 and such adoption did not have an impact on its consolidated financial statements.

Cash Flow Classification

In August 2016, the FASB issued Accounting Standards Update No. 2016-15—Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The new guidance addresses eight specific cash flow issues with the objective of reducing existing diversity in practice regarding the manner in which certain cash receipts and payments are presented and classified in the consolidated statements of cash flows. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company adopted this new accounting standard in the first quarter of fiscal 2018 and such adoption did not have a material impact on its consolidated financial statements.

In November 2016, the FASB issued Accounting Standards Update No. 2016-18—Statement of Cash Flows (Topic 230): Restricted Cash. The new guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts on the statement of cash flows. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. Adoption of the standard will be applied using a retrospective transition method to each period presented. The Company adopted this new accounting standard in the first quarter of fiscal 2018 which resulted in a change to the presentation of the construction related deposits within the statement of cash flows. The Company considers the construction related deposits to be “restricted cash equivalents” and therefore, under the new accounting guidance, is required to include such deposits in beginning and ending “cash and cash equivalents and restricted cash

10


 

equivalents” on the statement of cash flows. Previously, funding of the construction related deposit accounts was included within the “investing” section of the statement of cash flows and usage of the deposits was presented as a non-cash transaction. Under the new accounting guidance, funding of the construction related deposit accounts will not be presented within the statement of cash flows and the usage of the deposits will be presented within the “capital expenditures” line item under the “investing” section. Adoption of this new accounting standard resulted in an increase of the beginning and ending “cash and cash equivalents and restricted cash equivalents” amounts for the three months ended April 29, 2017 of $28.0 million and $19.2 million, respectively, as well as resulted in an increase in capital expenditures for the three months ended April 29, 2017 of $7.7 million.

Income Taxes: Intra-Entity Asset Transfers

In October 2016, the FASB issued Accounting Standards Update No. 2016-16—Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The new guidance requires the recognition of the income tax consequences of an intercompany asset transfer, other than transfers of inventory, when the transfer occurs. For intercompany transfers of inventory, the income tax effects will continue to be deferred until the inventory has been sold to a third party. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company adopted this new accounting standard in the first quarter of fiscal 2018 and such adoption did not have an impact on its consolidated financial statements.

Stock-Based Compensation

In May 2017, the FASB issued Accounting Standards Update No. 2017-09—Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. The new guidance clarifies when modification accounting should be applied for changes to terms or conditions of a share-based payment award. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted. The standard will be applied prospectively. The Company adopted this new accounting standard in the first quarter of fiscal 2018 and such adoption did not have an impact on its consolidated financial statements.

Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update 2016-02—Leases, which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of ASU 2016-02 will have on its consolidated financial statements and anticipates the new guidance will significantly impact its consolidated financial statements given that the Company has a significant number of leases.

 

NOTE 3—PREPAID EXPENSE AND OTHER ASSETS

Prepaid expense and other current assets consist of the following (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Vendor deposits

 

$

20,896

 

 

$

9,701

 

Capitalized catalog costs

 

 

15,965

 

 

 

44,122

 

Right of return asset for merchandise

 

 

5,296

 

 

 

 

Prepaid expense and other current assets

 

 

17,907

 

 

 

14,762

 

Total prepaid expense and other current assets

 

$

60,064

 

 

$

68,585

 

 

Other non-current assets consist of the following (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Deferred financing fees

 

$

4,194

 

 

$

4,446

 

Construction related deposits

 

 

1,883

 

 

 

7,407

 

Other deposits

 

 

5,006

 

 

 

4,997

 

Other non-current assets

 

 

3,837

 

 

 

4,482

 

Total other non-current assets

 

$

14,920

 

 

$

21,332

 

11


 

 

NOTE 4—GOODWILL AND TRADEMARKS AND DOMAIN NAMES

The following sets forth the goodwill and trademarks and domain names activity for the RH Segment and Waterworks for the three months ended May 5, 2018 (in thousands):

 

 

 

 

 

 

 

Foreign

 

 

 

 

 

 

 

February 3,

 

 

Currency

 

 

May 5,

 

 

 

2018

 

 

Translation

 

 

2018

 

RH Segment

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

124,448

 

 

$

(44

)

 

$

124,404

 

Trademarks and domain names

 

 

48,563

 

 

 

 

 

 

48,563

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Waterworks

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill (1)

 

 

17,445

 

 

 

 

 

 

17,445

 

Trademarks

 

 

52,100

 

 

 

 

 

 

52,100

 

 

(1)

The Waterworks reporting unit goodwill is presented net of an impairment charge of $33.7 million, which was recorded in fiscal 2017.

 

NOTE 5—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accounts payable and accrued expenses consist of the following (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Accounts payable

 

$

166,044

 

 

$

195,313

 

Accrued compensation

 

 

31,250

 

 

 

47,534

 

Accrued freight and duty

 

 

18,219

 

 

 

23,757

 

Accrued sales taxes

 

 

17,674

 

 

 

19,525

 

Accrued occupancy

 

 

9,909

 

 

 

8,612

 

Accrued catalog costs

 

 

7,037

 

 

 

9,000

 

Accrued professional fees

 

 

2,960

 

 

 

3,555

 

Other accrued expenses

 

 

11,080

 

 

 

11,469

 

Total accounts payable and accrued expenses

 

$

264,173

 

 

$

318,765

 

 

Other current liabilities consist of the following (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Allowance for sales returns

 

$

17,887

 

 

$

10,565

 

Unredeemed gift card and merchandise credit liability

 

 

17,673

 

 

 

24,138

 

Federal and state tax payable

 

 

13,478

 

 

 

5,391

 

Current portion of non-current debt

 

 

6,080

 

 

 

6,033

 

Product recall reserves

 

 

1,029

 

 

 

1,201

 

Other current liabilities

 

 

3,797

 

 

 

3,838

 

Total other current liabilities

 

$

59,944

 

 

$

51,166

 

 

12


 

NOTE 6—OTHER NON-CURRENT OBLIGATIONS

Other non-current obligations consist of the following (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Notes payable for share repurchases

 

$

19,633

 

 

$

19,390

 

Equipment security notes (1)

 

 

12,676

 

 

 

13,864

 

Promissory note (2)

 

 

11,285

 

 

 

11,627

 

Lease loss liabilities

 

 

8,344

 

 

 

9,684

 

Capital lease obligations—non-current

 

 

7,389

 

 

 

7,509

 

Deferred contract incentive (3)

 

 

4,762

 

 

 

5,358

 

Unrecognized tax benefits

 

 

3,764

 

 

 

3,728

 

Rollover units and profit interests (4)

 

 

2,317

 

 

 

2,211

 

Other non-current obligations

 

 

3,078

 

 

 

2,996

 

Total other non-current obligations

 

$

73,248

 

 

$

76,367

 

 

(1)

Represents the non-current portion of equipment security notes secured by certain of the Company’s distribution center property and equipment.

(2)

Represents the non-current portion of a promissory note secured by the Company’s aircraft.

(3)

Represents the non-current portion of an incentive payment received in relation to a 5-year service agreement. The amount will be amortized over the term of the agreement.

(4)

Represents rollover units and profit interests associated with the acquisition of Waterworks. Refer to Note 13Stock-Based Compensation.

 

NOTE 7—CONVERTIBLE SENIOR NOTES

0.00% Convertible Senior Notes due 2020

In June 2015, the Company issued in a private offering $250 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, the Company issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of its June 2015 offering (collectively, the “2020 Notes”). The 2020 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2020 Notes will mature on July 15, 2020, unless earlier purchased by the Company or converted. The 2020 Notes will not bear interest, except that the 2020 Notes will be subject to “special interest” in certain limited circumstances in the event of the failure of the Company to perform certain of its obligations under the indenture governing the 2020 Notes. The 2020 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by the Company or any of its subsidiaries. Certain events are also considered “events of default” under the 2020 Notes, which may result in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes. The 2020 Notes are guaranteed by the Company’s primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The guarantee is the unsecured obligation of the Guarantor and is subordinated to the Guarantor’s obligations from time to time with respect to its credit agreement and ranks equal in right of payment with respect to Guarantor’s other obligations.

The initial conversion rate applicable to the 2020 Notes is 8.4656 shares of common stock per $1,000 principal amount of 2020 Notes, which is equivalent to an initial conversion price of approximately $118.13 per share. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change” as defined in the indenture, the Company will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2020 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2020, the 2020 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2015, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sale price of the Company’s common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2020 Notes for such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of May 5, 2018, none of these conditions have occurred and, as a result, the 2020 Notes are not convertible as of May 5, 2018. On and after March 15, 2020, until the close of business on the second scheduled trading

13


 

day immediately preceding the maturity date, holders may convert all or a portion of their 2020 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2020 Notes will be settled, at the Company’s election, in cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock. If the Company has not delivered a notice of its election of settlement method prior to the final conversion period it will be deemed to have elected combination settlement with a dollar amount per note to be received upon conversion of $1,000.

The Company may not redeem the 2020 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require the Company to purchase all or a portion of their 2020 Notes for cash at a price equal to 100% of the principal amount of the 2020 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2020 Notes, the Company separated the 2020 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the liability component of the 2020 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 6.47% over the expected life of the 2020 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the debt issuance costs related to the issuance of the 2020 Notes, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2020 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.

Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $3.8 million and third party offering costs of $2.3 million. Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets. During both the three months ended May 5, 2018 and April 29, 2017, the Company recorded $0.3 million related to the amortization of debt issuance costs.

The carrying values of the 2020 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

300,000

 

 

$

300,000

 

Less: Debt discount

 

 

(39,974

)

 

 

(44,135

)

Net carrying amount

 

$

260,026

 

 

$

255,865

 

Equity component (1)

 

$

84,003

 

 

$

84,003

 

 

(1)

Included in additional paid-in capital on the condensed consolidated balance sheets.

The Company recorded interest expense of $4.2 million and $3.9 million for the amortization of the debt discount related to the 2020 Notes during the three months ended May 5, 2018 and April 29, 2017, respectively.

2020 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment option in July 2015, the Company entered into convertible note hedge transactions whereby the Company has the option to purchase a total of approximately 2.5 million shares of its common stock at a price of approximately $118.13 per share. The total cost of the convertible note hedge transactions was $68.3 million. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.5 million shares of the Company’s common stock at a price of $189.00 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 5.1 million shares of common stock (which cap may also be subject to adjustment). The Company received $30.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of

14


 

the warrants are intended to offset any actual earnings dilution from the conversion of the 2020 Notes until the Company’s common stock is above approximately $189.00 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

The Company recorded a deferred tax liability of $32.8 million in connection with the debt discount associated with the 2020 Notes and recorded a deferred tax asset of $26.6 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.

0.00% Convertible Senior Notes due 2019

In June 2014, the Company issued $350 million principal amount of 0.00% convertible senior notes due 2019 (the “2019 Notes”) in a private offering. The 2019 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2019 Notes will mature on June 15, 2019, unless earlier purchased by the Company or converted. The 2019 Notes will not bear interest, except that the 2019 Notes will be subject to “special interest” in certain limited circumstances in the event of the failure of the Company to perform certain of its obligations under the indenture governing the 2019 Notes. The 2019 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by the Company or any of its subsidiaries. Certain events are also considered “events of default” under the 2019 Notes, which may result in the acceleration of the maturity of the 2019 Notes, as described in the indenture governing the 2019 Notes.

The initial conversion rate applicable to the 2019 Notes is 8.6143 shares of common stock per $1,000 principal amount of 2019 Notes, which is equivalent to an initial conversion price of approximately $116.09 per share. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole fundamental change,” the Company will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2019 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2019, the 2019 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2014, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sale price of the Company’s common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2019 Notes for such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of May 5, 2018, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of May 5, 2018. On and after March 15, 2019, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2019 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2019 Notes will be settled, at the Company’s election, in cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock. If the Company has not delivered a notice of its election of settlement method prior to the final conversion period it will be deemed to have elected combination settlement with a dollar amount per note to be received upon conversion of $1,000.

The Company may not redeem the 2019 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require the Company to purchase all or a portion of their 2019 Notes for cash at a price equal to 100% of the principal amount of the 2019 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2019 Notes, the Company separated the 2019 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2019 Notes and the fair value of the liability component of the 2019 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

15


 

In accounting for the debt issuance costs related to the issuance of the 2019 Notes, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2019 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.

Debt issuance costs related to the 2019 Notes were comprised of discounts and commissions payable to the initial purchasers of $4.4 million and third party offering costs of $1.0 million. Discounts, commissions payable to the initial purchasers and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2019 balance on the condensed consolidated balance sheets. During both the three months ended May 5, 2018 and April 29, 2017, the Company recorded $0.2 million related to the amortization of debt issuance costs.

The carrying values of the 2019 Notes, excluding the discounts and commissions payable to the initial purchasers and third party offering costs, are as follows (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

350,000

 

 

$

350,000

 

Less: Debt discount

 

 

(17,268

)

 

 

(20,988

)

Net carrying amount

 

$

332,732

 

 

$

329,012

 

Equity component (1)

 

$

70,482

 

 

$

70,482

 

 

(1)

Included in additional paid-in capital on the condensed consolidated balance sheets.

The Company recorded interest expense of $3.7 million and $3.6 million for the amortization of the debt discount related to the 2019 Notes during the three months ended May 5, 2018 and April 29, 2017, respectively.

2019 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2019 Notes, the Company entered into convertible note hedge transactions whereby the Company has the option to purchase a total of approximately 3.0 million shares of its common stock at a price of approximately $116.09 per share. The total cost of the convertible note hedge transactions was $73.3 million. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 3.0 million shares of the Company’s common stock at a price of $171.98 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 6.0 million shares of common stock (which cap may also be subject to adjustment). The Company received $40.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual dilution from the conversion of the 2019 Notes and to effectively increase the overall conversion price from $116.09 per share to $171.98 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

The Company recorded a deferred tax liability of $27.5 million in connection with the debt discount associated with the 2019 Notes and recorded a deferred tax asset of $28.6 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax assets are included in deferred tax assets on the condensed consolidated balance sheets.

 

NOTE 8—CREDIT FACILITIES

The Company’s outstanding credit facilities were as follows (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

 

 

Outstanding

 

 

Unamortized Debt

 

 

Net Carrying

 

 

Outstanding

 

 

Unamortized Debt

 

 

Net Carrying

 

 

 

Amount

 

 

Issuance Costs

 

 

Amount

 

 

Amount

 

 

Issuance Costs

 

 

Amount

 

Asset based credit facility

 

$

219,000

 

 

$

 

 

$

219,000

 

 

$

199,970

 

 

$

 

 

$

199,970

 

LILO term loan

 

 

80,000

 

 

 

(472

)

 

 

79,528

 

 

 

80,000

 

 

 

(501

)

 

 

79,499

 

Total credit facilities

 

$

299,000

 

 

$

(472

)

 

$

298,528

 

 

$

279,970

 

 

$

(501

)

 

$

279,469

 

16


 

Asset Based Credit Facility & LILO Term Loan

In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into a credit agreement with Bank of America, N.A., as administrative agent, and certain other lenders.

On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit agreement among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., various 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 “credit agreement”). The credit agreement has a revolving line of credit with availability of up to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600.0 million to up to $800 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. In addition, the credit agreement establishes an $80.0 million LILO term loan facility. The credit agreement has a maturity date of June 28, 2022.

On June 12, 2018, Restoration Hardware, Inc. entered into a First Amendment (the “Amendment”) to credit agreement. The Amendment (i) changes the credit agreement’s definition of “Eligible In-Transit Inventory” to clarify the requirements to be fulfilled by the borrowers with respect to such in-transit inventory, and (ii) clarifies that no Default or Event of Default was caused by any prior non-compliance with such requirements with respect to in-transit inventory. Eligible In-Transit Inventory consists of inventory being shipped from vendor locations outside of the United States. Qualifying in-transit inventory is included within the Company’s borrowing base for eligible collateral for purposes of determining the amount of borrowing available to borrowers under the credit agreement.

Borrowings under the revolving line of credit and LILO term loan facility are subject to interest, at the borrowers’ option, at either the bank’s reference rate or LIBOR (or, in the case of the revolving line of credit, the Bank of America “BA” Rate or the Canadian Prime Rate, as such terms are defined in the credit agreement, for Canadian borrowings denominated in Canadian dollars or the United States Index Rate or LIBOR for Canadian borrowings denominated in United States dollars) plus an applicable margin rate, in each case.

The credit agreement contains various restrictive covenants, including, among others, limitations on the ability to incur liens, make loans or other investments, incur additional debt, issue additional equity, merge or consolidate with or into another person, sell assets, pay dividends or make other distributions, or enter into transactions with affiliates, along with other restrictions and limitations typical to credit agreements of this type and size. As of May 5, 2018, Restoration Hardware, Inc. was in compliance with all applicable covenants of the credit agreement.

As of May 5, 2018, the Company had $219.0 million in outstanding borrowings and $138.8 million of availability under the revolving line of credit, net of $27.8 million in outstanding letters of credit. As of May 5, 2018, the Company had $80.0 million outstanding borrowings under the LILO term loan facility. As a result of the consolidated fixed-charge coverage ratio (“FCCR”) restriction that limits the last 10% of borrowing availability, actual incremental borrowing available to the Company and the other affiliated parties under the revolving line of credit was approximately $92.2 million as of May 5, 2018.

 

NOTE 9—FAIR VALUE OF FINANCIAL INSTRUMENTS

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 and carrying value of the 2019 Notes and 2020 Notes were as follows (in thousands):

 

 

 

May 5,

 

 

February 3,

 

 

 

2018

 

 

2018

 

 

 

Fair

Value

 

 

Carrying

Value (1)

 

 

Fair

Value

 

 

Carrying

Value (1)

 

Convertible senior notes due 2019

 

$

327,352

 

 

$

332,732

 

 

$

324,866

 

 

$

329,012

 

Convertible senior notes due 2020

 

$

261,653

 

 

$

260,026

 

 

$

261,047

 

 

$

255,865

 

 

(1)

Carrying value represents the principal amount less the equity component of the 2019 Notes and 2020 Notes classified in stockholders’ equity (deficit), and does not exclude 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 2019 Notes and 2020 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 the Company’s convertible

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notes, when available, the Company’s stock price and interest rates based on similar debt issued by parties with credit ratings similar to the Company (Level 2).

The estimated fair values of the asset based credit facility and LILO term loan were $219.0 million and $80.0 million, respectively, each of which approximates cost, as of May 5, 2018. Fair value approximates cost for both the asset based credit facility and LILO term loan as the interest rate associated with each facility is variable and resets frequently.

 

NOTE 10—INCOME TAXES

The Company recorded income tax expense of $8.5 million and an income tax benefit of $1.9 million in the three months ended May 5, 2018 and April 29, 2017, respectively. The effective tax rate was 23.3% and 36.2% for the three months ended May 5, 2018 and April 29, 2017, respectively. The decrease in the effective tax rate is primarily due to the reduction in the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018 due to the passage of the Tax Cuts and Jobs Act (the “Tax Act”).

On December 22, 2017, the Tax Act was enacted in the United States. The Company recognized the income tax effects of the Tax Act in its fiscal 2017 financial statements in accordance with Staff Accounting Bulletin 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the Tax Act was signed into law. As noted in its fiscal 2017 consolidated financial statements, the Company was able to reasonably estimate certain effects and, therefore, recorded provisional amounts associated with the one-time transition tax on indefinitely reinvested foreign earnings and the adjustment to our deferred tax assets and liabilities for the reduction in the corporate income tax rate.

The Company has not made any additional measurement period adjustments related to these items during the three months ended May 5, 2018. As the Company continues its analysis of the Tax Act and interprets any additional guidance, it may make adjustments to the provisional amounts that have been recorded that may materially impact the Company's provision for income taxes.

As of May 5, 2018 and February 3, 2018, the Company had $8.2 million of unrecognized tax benefits, of which $6.5 million would reduce income tax expense and the effective tax rate, if recognized. The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized. As of May 5, 2018, the Company had $0.4 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.

 

NOTE 11—NET INCOME (LOSS) PER SHARE

The weighted-average shares used for net income (loss) per share is presented in the table below. As the Company was in a net loss position for the three months ended April 29, 2017, the weighted-average shares outstanding for basic and diluted are the same.

 

 

 

Three Months Ended

 

 

 

May 5,

 

 

April 29,

 

 

 

2018

 

 

2017

 

Weighted-average shares—basic

 

 

21,545,025

 

 

 

37,609,516

 

Effect of dilutive stock-based awards

 

 

3,685,203

 

 

 

 

Effect of dilutive convertible senior notes (1)

 

 

 

 

 

 

Weighted-average shares—diluted

 

 

25,230,228

 

 

 

37,609,516

 

  

(1)

The 2019 Notes and 2020 Notes will have an impact on the Company’s dilutive share count beginning at stock prices of $116.09 per share and $118.13 per share, respectively.

 

The following number of options and restricted stock units were excluded from the calculation of diluted net income (loss) per share because their inclusion would have been anti-dilutive:

 

 

 

Three Months Ended

 

 

 

May 5,

 

 

April 29,

 

 

 

2018

 

 

2017

 

Options

 

 

486,516

 

 

 

8,221,249

 

Restricted stock units

 

 

10,500

 

 

 

1,029,740

 

Total anti-dilutive stock-based awards

 

 

497,016

 

 

 

9,250,989

 

 

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NOTE 12—SHARE REPURCHASES

$300 Million Share Repurchase Program

On February 21, 2017, the Company’s Board of Directors authorized a stock repurchase program of up to $300 million (the “$300 Million Repurchase Program”). Under the $300 Million Repurchase Program, the Company repurchased approximately 7.8 million shares of its common stock at an average price of $38.24 per share, for an aggregate repurchase amount of approximately $300 million, during the three months ended April 29, 2017. As the $300 Million Repurchase Program was completed during the three months ended April 29, 2017 there will be no repurchases in future periods under this repurchase authorization.

Share Repurchases Under Equity Plans

As of May 5, 2018 and February 3, 2018, the aggregate unpaid principal amount of the notes payable for share repurchases was $19.6 million and $19.4 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets. During both the three months ended May 5, 2018 and April 29, 2017, the Company recorded interest expense on the outstanding notes of $0.2 million.

Of the $19.6 million and $19.4 million notes payable for share repurchases outstanding as of May 5, 2018 and February 3, 2018, respectively, $15.5 million was due to a current board member of the Company.

 

NOTE 13—STOCK-BASED COMPENSATION

The Company estimates the value of equity grants based upon an option-pricing model and recognizes this estimated value as compensation expense over the vesting periods. The Company recognizes expense associated with performance-based awards when it becomes probable that the performance condition will be met. Once it becomes probable that an award will vest, the Company recognizes compensation expense equal to the number of shares which are probable to vest multiplied by the fair value of the related shares measured at the grant date.

Stock-based compensation expense is included in selling, general and administrative expenses on the condensed consolidated statements of operations. The Company recorded stock-based compensation expense of $8.0 million and $5.3 million during the three months ended May 5, 2018 and April 29, 2017, respectively. No stock-based compensation cost has been capitalized in the accompanying condensed consolidated financial statements.

2012 Stock Incentive Plan and 2012 Stock Option Plan

As of May 5, 2018, 8,564,739 options were outstanding with a weighted-average exercise price of $50.66 per share and 6,295,895 options were vested with a weighted-average exercise price of $51.95 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of May 5, 2018 was $429.8 million, $388.2 million, and $307.0 million, respectively. Stock options exercisable as of May 5, 2018 had a weighted-average remaining contractual life of 5.90 years. As of May 5, 2018, the total unrecognized compensation expense related to unvested options was $23.4 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 2.86 years.

As of May 5, 2018, the Company had 768,463 restricted stock units outstanding with a weighted-average grant date fair value of $52.81 per share. During the three months ended May 5, 2018, 30,615 restricted stock units vested with a weighted-average grant date and vest date fair value of $52.36 per share and $97.09 per share, respectively. As of May 5, 2018, there was $18.9 million of total unrecognized compensation expense related to unvested restricted stock and restricted stock units which is expected to be recognized over a weighted-average period of 2.81 years.

Rollover Units

In connection with the acquisition of Waterworks in May 2016, $1.5 million rollover units in the Waterworks subsidiary (the “Rollover Units”) were recorded as part of the transaction. The Rollover Units are subject to the terms of the Waterworks LLC agreement, including redemption rights at an amount equal to the greater of (i) the $1.5 million remitted as consideration in the business combination or (ii) an amount based on the percentage interest represented in the overall valuation of the Waterworks subsidiary (the “Appreciation Rights”). The Appreciation Rights are measured at fair value and are subject to fair value measurements during the expected life of the Rollover Units, with changes to fair value recorded in the condensed consolidated statements of operations. The fair value of the Appreciation Rights is determined based on an option pricing method (“OPM”). The Company did not record any expense related to the Appreciation Rights during the three months ended May 5, 2018 or April 29, 2017. As of both

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May 5, 2018 and February 3, 2018, the liability associated with the Rollover Units and related Appreciation Rights was $1.5 million, which is included in other non-current obligations on the condensed consolidated balance sheets.

Profit Interests

In connection with the acquisition of Waterworks in May 2016, profit interests units in the Waterworks subsidiary (the “Profit Interests”) were issued to certain Waterworks associates. The Profit Interests are measured at their grant date fair value and expensed on a straight-line basis over their expected life, or five years. The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of operations. The fair value of the Profit Interests is determined based on an OPM. For both the three months ended May 5, 2018 and April 29, 2017, the Company recorded $0.1 million related to the Profit Interests, which is included in selling, general and administrative expenses on the condensed consolidated statements of operations. As of May 5, 2018 and February 3, 2018, the liability associated with the Profit Interests was $0.8 million and $0.7 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.

 

NOTE 14—COMMITMENTS AND CONTINGENCIES

Commitments

The Company had no material off balance sheet commitments as of May 5, 2018.

Contingencies

The Company is involved in lawsuits, claims and proceedings incident to the ordinary course of its business. These disputes are increasing in number as the business expands and the Company grows larger. Litigation is inherently unpredictable. As a result, the outcome of matters in which the Company is involved could result in unexpected expenses and liability that could adversely affect the Company’s operations. In addition, any claims against the Company, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources.

The Company reviews the need for any loss contingency reserves and establishes reserves when, in the opinion of management, 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 the Company does 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 the Company accrues from time to time. The Company believes that the ultimate resolution of its current matters will not have a material adverse effect on its condensed consolidated financial statements.

Securities Class Action

On February 2, 2017, City of Miami General Employees’ & Sanitation Employees’ Retirement Trust filed a class action complaint in the United States District Court, Northern District of California, against the Company, Gary Friedman, and Karen Boone. On March 16, 2017, Peter J. Errichiello, Jr. filed a similar class action complaint in the same forum and against the same parties. On April 26, 2017, the court consolidated the two actions. The consolidated action is captioned In re RH, Inc. Securities Litigation. An amended consolidated complaint was filed in June 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The complaint asserts claims pu