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The Company (Policies)

6 Months Ended

Aug. 03, 2019

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, and child and teen furnishings. These products are sold through the Company’s stores, catalogs and websites.

As of August 3, 2019, the Company operated a total of 70 RH Galleries and 40 RH outlet stores in 32 states, the District of Columbia and Canada, as well as 15 Waterworks showrooms throughout 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, and revisions due to the adoption of the new lease accounting standard described in Note 2—Recently Issued Accounting Standards, necessary to fairly state the Company’s financial position as of August 3, 2019, and the results of operations for the three and six months ended August 3, 2019 and August 4, 2018. The Company’s current fiscal year, which consists of 52 weeks, ends on February 1, 2020 (“fiscal 2019”).

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 2, 2019 (the “2018 Form 10-K”). Certain prior year amounts have been adjusted to conform to the current period presentation due to the adoption of the new lease accounting standard. Refer to Note 2—Recently Issued Accounting Standards.

The results of operations for the three and six months ended August 3, 2019 presented herein are not necessarily indicative of the results to be expected for the full fiscal year.

Revision

Revisions

As previously disclosed in our Annual Report on Form 10-K as of and for the year ended February 2, 2019, during the third quarter of fiscal 2018, management determined that the Company had incorrectly reported the impact during the fiscal year ended February 3, 2018 of retiring its common stock in accordance with Accounting Standards Codification (“ASC”) 505—Equity, which resulted in the Company revising its previously issued financial statements as of and for the year ended February 3, 2018. The common stock being retired was related to shares repurchased under the Company’s equity plans. This error resulted in an overstatement of additional paid-in capital of $19.5 million, from $944.6 million as reported to $925.1 million as revised, and an overstatement of treasury stock of $19.5 million, from $1,020.1 million as reported to $1,000.6 million as revised, on the condensed consolidated balance sheet as of August 4, 2018. There was no impact on the condensed consolidated statements of income or condensed cash flows related to this misstatement. Although this error was not considered to be material to any of the previously issued financial statements, the Company has revised the accompanying unaudited interim financial statements to reflect the correction of this error.

During the adoption process of the new lease accounting standard (refer to Note 2—Recently Issued Accounting Standards), the Company identified a lease agreement that was incorrectly accounted for as an impaired lease under ASC 420—Exit or Disposal Cost Obligations in fiscal 2017 and the first quarter of fiscal 2018. This error resulted in an overstatement of net income of $1.4 million and $0.9 million for the year ended February 3, 2018 and the six months ended August 4, 2018, respectively. This error also resulted in an overstatement of retained earnings as of February 3, 2018 of $1.4 million, from $152.4 million as reported to $151.0 million as revised, and as of August 4, 2018 of $2.3 million, from $223.5 million as reported to $221.2 million as revised, prior to the impact of the modified retrospective application of the new lease accounting standard as further discussed in Note 2. In addition, as of February 2, 2019, this error resulted in an understatement of other non-current obligations of $3.3 million, an overstatement of other current liabilities of $1.0 million and understatement of accumulated deficit of $2.3 million, from $376.8 million as reported to $379.1 million as revised. Although these errors are not considered to be material to any of the previously issued financial statements, the Company has revised the accompanying unaudited interim financial statements to reflect the correction of these errors.

In addition, during the adoption process of the new lease accounting standard, the Company identified an error in its previously reported consolidated statement of cash flows for the quarterly and annual periods in fiscal 2018. This error resulted in an understatement of $9.2 million of net cash provided by operating activities and an understatement of $9.2 million of net cash used in investing activities for each reporting period in fiscal 2018. There was no impact on the condensed consolidated balance sheets, condensed consolidated statements of income or the condensed consolidated statement of stockholders’ equity (deficit) related to this error. Although these errors are not considered to be material to any of the previously issued financial statements, the Company has revised the accompanying unaudited interim financial statements to reflect the correction of these errors.

The following are selected line items from the Company’s condensed consolidated statements of cash flows illustrating the effect of the corrections, prior to the adoption of the modified retrospective application of the new lease accounting standard (in thousands):


	Six Months Ended August 4, 2018
	As Reported		Adjustment		As Revised
Cash flows from operating activities:
Change in accounts payable and accrued expenses	$	(42,717)	$	9,201	$	(33,516)
Net cash provided by operating activities		70,229		9,201		79,430
Cash flows from investing activities:
Capital expenditures		(61,212)		(9,201)		(70,413)
Net cash used in investing activities		(61,212)		(9,201)		(70,413)


	Nine Months Ended November 3, 2018
	As Reported		Adjustment		As Revised
Cash flows from operating activities:
Change in accounts payable and accrued expenses	$	(23,601)	$	9,201	$	(14,400)
Net cash provided by operating activities		127,592		9,201		136,793
Cash flows from investing activities:
Capital expenditures		(104,403)		(9,201)		(113,604)
Net cash used in investing activities		(104,403)		(9,201)		(113,604)


	Fiscal Year Ended February 2, 2019
	As Reported		Adjustment		As Revised
Cash flows from operating activities:
Change in accounts payable and accrued expenses	$	(452)	$	9,201	$	8,749
Net cash provided by operating activities		300,556		9,201		309,757
Cash flows from investing activities:
Capital expenditures		(136,736)		(9,201)		(145,937)
Net cash used in investing activities		(136,736)		(9,201)		(145,937)

Recently Issued Accounting Standards

Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update 2016-02—Leases, which requires a lessee to distinguish all leases as operating leases or finance leases and recognize all leases on the balance sheet as a right-of-use asset with a corresponding lease liability representing the present value of lease payments. The standard also requires a lessee to recognize a single lease cost for operating leases, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. The lease cost for finance leases includes both principal and interest components, and is higher than the corresponding cash payment at the beginning of the lease term and declines over the lease term as the liability is reduced. In July 2018, the FASB issued Accounting Standards Update 2018-10—Codification Improvements to Topic 842 (Leases), and Accounting Standards Update 2018-11—Leases (Topic 842)—Targeted Improvements, which (i) narrows amendments to clarify how to apply certain aspects of the new lease standard, (ii) provides entities with an additional transition method to adopt the new standard, and (iii) provides lessors with a practical expedient for separating components of a contract. Accounting Standards Update 2016-02, Accounting Standards Update 2018-10 and Accounting Standards Update 2018-11 are collectively referred to as the “ASUs.”

The Company adopted the ASUs as of February 3, 2019 using a modified retrospective approach. Under this adoption method, the results of prior comparative periods are presented with an adjustment to opening retained earnings of the earliest comparative period presented. In addition, the Company elected to adopt the package of transition practical expedients, which permitted the Company not to reassess its prior conclusions regarding lease identification, lease classification and initial direct costs. The Company adopted the policy election to not separate lease and non-lease components for certain asset classes (such as real estate leases), as well as the short-term lease policy election offered under the ASUs whereby the Company does not recognize right of use assets and lease liabilities for leases with terms of 12 months or less. The Company did not apply the hindsight practical expedient upon adoption.

As a result of the adoption of the ASUs, the Company recorded an increase to the fiscal 2017 (earliest comparative period) opening retained earnings balance of $4.0 million, inclusive of the tax impact.

The following table presents the impact of adopting the ASUs, as well as the correction of an immaterial error as discussed in Note 1—The Company, on the Company’s consolidated balance sheet (in thousands):


	February 2, 2019
	As Reported		Adjustments and Other⁽¹⁾			As Adjusted and Revised
ASSETS
Current assets:
Cash and cash equivalents	$	5,803	$	—		$	5,803
Accounts receivable—net		40,224		—			40,224
Merchandise inventories		531,947		—			531,947
Asset held for sale		—		21,795	⁽²⁾		21,795
Prepaid expense and other current assets		104,719		(521)	⁽³⁾		104,198
Total current assets		682,693		21,274			703,967
Property and equipment—net		863,562		89,395	⁽⁴⁾		952,957
Operating lease right-of-use assets		—		440,504	⁽⁵⁾		440,504
Goodwill		124,379		—			124,379
Tradenames, trademarks and domain names		86,022		—			86,022
Deferred tax assets		30,033		5,570	⁽⁶⁾		35,603
Other non-current assets		19,345		60,241	⁽⁷⁾		79,586
Total assets	$	1,806,034	$	616,984		$	2,423,018
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable and accrued expenses	$	320,441	$	56	⁽⁸⁾	$	320,497
Deferred revenue and customer deposits		152,595		—			152,595
Convertible senior notes due 2019—net		343,789		—			343,789
Operating lease liabilities		—		66,249	⁽⁵⁾		66,249
Other current liabilities		101,347		8,109	⁽¹⁾⁽⁹⁾		109,456
Total current liabilities		918,172		74,414			992,586
Asset based credit facility		57,500		—			57,500
Convertible senior notes due 2020—net		271,157		—			271,157
Convertible senior notes due 2023—net		249,151		—			249,151
Financing obligations under build-to-suit lease transactions		228,928		(228,928)	⁽¹⁰⁾		—
Deferred rent and lease incentives		53,742		(53,742)	⁽¹⁰⁾		—
Non-current operating lease liabilities		—		437,557	⁽⁵⁾		437,557
Non-current finance lease liabilities		—		421,245	⁽⁹⁾		421,245
Other non-current obligations		50,346		(17,834)	^(1)(11)		32,512
Total liabilities		1,828,996		632,712			2,461,708
Stockholders’ deficit:
Preferred stock		—		—			—
Common stock		2		—			2
Additional paid-in capital		356,422		—			356,422
Accumulated other comprehensive loss		(2,333)		—			(2,333)
Accumulated deficit		(376,810)		(15,728)	^(1)(12)		(392,538)
Treasury stock		(243)		—			(243)
Total stockholders’ deficit		(22,962)		(15,728)			(38,690)
Total liabilities and stockholders’ deficit	$	1,806,034	$	616,984		$	2,423,018

(1)	During the adoption process of the ASUs, the Company identified a lease agreement that was incorrectly accounted for as an impaired lease under ASC 420—Exit or Disposal Cost Obligations in fiscal 2017 and the first quarter of fiscal 2018. Refer to “Revisions” within Note 1—The Company.

(2)	Represents recognition of asset held for sale under a sale-leaseback transaction.

(3)	Represents reclassification of prepaid rent to operating lease liabilities and other current liabilities (for finance leases).

(4)

Represents (i) recognition of finance lease right-of-use assets, partially offset by (ii) derecognition of non-Company owned properties that were capitalized under previously existing build-to-suit accounting policies, (iii) reclassification of construction in progress assets determined to be landlord assets to other non-current assets and (iv) reclassification of initial direct costs related to operating leases to operating lease right-of-use assets.

(5)

Represents recognition of operating lease right-of-use assets and corresponding current and non-current lease liabilities. The operating lease right-of-use asset also includes the reclassification of deferred rent and unamortized lease incentives related to operating leases and the reclassification of initial direct costs from property and equipment—net.

(6)	Represents recognition of net deferred tax assets related to the adoption of the ASUs.

(7)	Primarily represents reclassification from property and equipment—net of construction in progress assets determined to be landlord assets for which the lease has not yet commenced.

(8)	Represents a reclassification of an accrual for real estate taxes.

(9)	Represents recognition of the current and non-current finance lease liabilities. The other current liabilities line item also includes the reclassification of current obligations associated with leases previously reported as capital leases to finance lease liabilities.

(10)

Represents (i) derecognition of liabilities related to non-Company owned properties that were consolidated under previously existing build-to-suit accounting policies and (ii) reclassification of deferred rent and unamortized lease incentives to operating lease right-of-use assets upon adoption of the ASUs.

(11)

Represents (i) derecognition of the net lease loss liabilities as such balances were reclassified to operating lease right-of-use assets and operating current and non-current liabilities and (ii) the reclassification of non-current obligations associated with leases previously reported as capital leases to finance lease liabilities.

(12)	Represents a decrease to the consolidated net income for fiscal 2017 and fiscal 2018, as well as an increase of $4.0 million to beginning fiscal 2017 retained earnings related to the adoption of the ASUs.

Refer to Note 7—Leases for discussion of the Company’s revised accounting policy for leases.

Cloud Computing

In August 2018, the FASB issued Accounting Standards Update 2018-15—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which amends Accounting Standards Update 2015-05—Customers Accounting for Fees in a Cloud Computing Agreement. The amendments in this ASU more closely align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of this new accounting standard will have on its consolidated financial statements.

Commitments and Contingencies

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.