10-Q 1 rh-10q_20161029.htm FORM 10-Q rh-10q_20161029.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 October 29, 2016

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

 

RESTORATION HARDWARE HOLDINGS, INC.

(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, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting 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

 

 

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 December 2, 2016, 40,802,548 shares of registrant’s common stock were outstanding.

 

 

 


RESTORATION HARDWARE HOLDINGS, INC.

INDEX TO FORM 10-Q

 

 

 

 

 

Page

 

 

 

 

 

PART I. FINANCIAL INFORMATION

Item 1.

  

Financial Statements

 

3

 

  

Condensed Consolidated Balance Sheets (Unaudited) as of October 29, 2016, and January 30, 2016

 

3

 

  

Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended October 29, 2016, and October 31, 2015

 

4

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and nine months ended October 29, 2016, and October 31, 2015

 

5

 

  

Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended October 29, 2016 and October 31, 2015

 

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

 

39

Item 4.

  

Controls and Procedures

 

40

 

 

 

 

 

PART II. OTHER INFORMATION

Item 1.

  

Legal Proceedings

 

41

Item 1A.

  

Risk Factors

 

41

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

41

Item 3.

 

Defaults Upon Senior Securities

 

41

Item 4.

 

Mine Safety Disclosures

 

41

Item 5.

 

Other Information

 

41

Item 6.

  

Exhibits

 

42

Signatures

 

43

 

 

2


PART I

 

 

Item 1. Financial Statements

RESTORATION HARDWARE HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

55,426

 

 

$

349,897

 

Short-term investments

 

 

170,153

 

 

 

130,801

 

Accounts receivable—net

 

 

35,974

 

 

 

28,567

 

Merchandise inventories

 

 

776,586

 

 

 

725,392

 

Prepaid expense and other current assets

 

 

113,665

 

 

 

79,020

 

Total current assets

 

 

1,151,804

 

 

 

1,313,677

 

Long-term investments

 

 

21,056

 

 

 

22,054

 

Property and equipment—net

 

 

656,569

 

 

 

515,605

 

Goodwill

 

 

175,946

 

 

 

124,301

 

Trademarks and other intangible assets

 

 

100,622

 

 

 

48,536

 

Non-current deferred tax assets

 

 

25,647

 

 

 

36,739

 

Other non-current assets

 

 

24,657

 

 

 

25,462

 

Total assets

 

$

2,156,301

 

 

$

2,086,374

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

231,079

 

 

$

280,714

 

Deferred revenue and customer deposits

 

 

144,574

 

 

 

106,769

 

Other current liabilities

 

 

43,768

 

 

 

65,072

 

Total current liabilities

 

 

419,421

 

 

 

452,555

 

Convertible senior notes due 2019—net

 

 

308,649

 

 

 

297,703

 

Convertible senior notes due 2020—net

 

 

231,876

 

 

 

220,000

 

Financing obligations under build-to-suit lease transactions

 

 

193,277

 

 

 

146,621

 

Deferred rent and lease incentives

 

 

59,516

 

 

 

53,986

 

Other non-current obligations

 

 

41,384

 

 

 

29,349

 

Total liabilities

 

 

1,254,123

 

 

 

1,200,214

 

Commitments and contingencies (Note 16)

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

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

   issued or outstanding as of October 29, 2016 and January 30, 2016

 

 

 

 

 

 

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

   41,055,353 shares issued and 40,760,465 shares outstanding as of October 29, 2016;

   40,878,163 shares issued and 40,583,275 shares outstanding as of January 30, 2016

 

 

4

 

 

 

4

 

Additional paid-in capital

 

 

783,050

 

 

 

763,566

 

Accumulated other comprehensive loss

 

 

(2,131

)

 

 

(2,700

)

Retained earnings

 

 

140,778

 

 

 

144,813

 

Treasury stock—at cost, 294,888 shares as of both October 29, 2016 and January

   30, 2016

 

 

(19,523

)

 

 

(19,523

)

Total stockholders’ equity

 

 

902,178

 

 

 

886,160

 

Total liabilities and stockholders’ equity

 

$

2,156,301

 

 

$

2,086,374

 

 

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

 

3


RESTORATION HARDWARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 29,

 

 

October 31,

 

 

October 29,

 

 

October 31,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Net revenues

 

$

549,328

 

 

$

532,411

 

 

$

1,548,165

 

 

$

1,461,798

 

Cost of goods sold

 

 

373,509

 

 

 

341,661

 

 

 

1,065,032

 

 

 

933,367

 

Gross profit

 

 

175,819

 

 

 

190,750

 

 

 

483,133

 

 

 

528,431

 

Selling, general and administrative expenses

 

 

160,433

 

 

 

145,874

 

 

 

457,207

 

 

 

410,103

 

Income from operations

 

 

15,386

 

 

 

44,876

 

 

 

25,926

 

 

 

118,328

 

Interest expense—net

 

 

11,091

 

 

 

11,003

 

 

 

32,528

 

 

 

24,058

 

Income (loss) before income taxes

 

 

4,295

 

 

 

33,873

 

 

 

(6,602

)

 

 

94,270

 

Income tax expense (benefit)

 

 

1,778

 

 

 

13,163

 

 

 

(2,567

)

 

 

36,469

 

Net income (loss)

 

$

2,517

 

 

$

20,710

 

 

$

(4,035

)

 

$

57,801

 

Weighted-average shares used in computing basic net income

   (loss) per share

 

 

40,730,059

 

 

 

40,282,734

 

 

 

40,653,091

 

 

 

40,080,843

 

Basic net income (loss) per share

 

$

0.06

 

 

$

0.51

 

 

$

(0.10

)

 

$

1.44

 

Weighted-average shares used in computing diluted net income

   (loss) per share

 

 

40,926,450

 

 

 

42,413,657

 

 

 

40,653,091

 

 

 

42,237,967

 

Diluted net income (loss) per share

 

$

0.06

 

 

$

0.49

 

 

$

(0.10

)

 

$

1.37

 

 

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

 

 

4


RESTORATION HARDWARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 29,

 

 

October 31,

 

 

October 29,

 

 

October 31,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Net income (loss)

 

$

2,517

 

 

$

20,710

 

 

$

(4,035

)

 

$

57,801

 

Net gains (losses) from foreign currency translation

 

 

(915

)

 

 

(18

)

 

 

485

 

 

 

(872

)

Net unrealized holding gains (losses) on available-for-sale

   investments

 

 

(59

)

 

 

(13

)

 

 

84

 

 

 

(18

)

Total comprehensive income (loss)

 

$

1,543

 

 

$

20,679

 

 

$

(3,466

)

 

$

56,911

 

 

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

 

 

5


RESTORATION HARDWARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

October 29,

 

 

October 31,

 

 

 

2016

 

 

2015

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(4,035

)

 

$

57,801

 

Adjustments to reconcile net income (loss) to net cash used in operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

41,248

 

 

 

32,105

 

Amortization of debt discount

 

 

21,467

 

 

 

15,153

 

Excess tax (benefit) shortfall from exercise of stock options

 

 

2,275

 

 

 

(6,564

)

Stock-based compensation expense

 

 

21,711

 

 

 

17,655

 

Net non-cash charges resulting from inventory step-up

 

 

5,187

 

 

 

 

Other non-cash interest expense

 

 

2,971

 

 

 

2,070

 

Change in assets and liabilities—net of acquisition:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(1,445

)

 

 

(6,405

)

Merchandise inventories

 

 

(23,261

)

 

 

(201,674

)

Prepaid expense and other assets

 

 

(30,378

)

 

 

(3,679

)

Accounts payable and accrued expenses

 

 

(73,574

)

 

 

48,015

 

Deferred revenue and customer deposits

 

 

22,652

 

 

 

15,295

 

Other current liabilities

 

 

(25,372

)

 

 

10,317

 

Deferred rent and lease incentives

 

 

2,953

 

 

 

2,208

 

Other non-current obligations

 

 

8,477

 

 

 

73

 

Net cash used in operating activities

 

 

(29,124

)

 

 

(17,630

)

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(104,152

)

 

 

(76,801

)

Acquisition of building and land

 

 

 

 

 

(13,999

)

Construction related deposits

 

 

(3,829

)

 

 

(8,855

)

Purchase of trademarks and domain names

 

 

(164

)

 

 

(218

)

Purchase of investments

 

 

(186,967

)

 

 

(156,055

)

Maturities of investments

 

 

115,938

 

 

 

73,087

 

Sales of investments

 

 

31,896

 

 

 

 

Acquisition of business—net of cash acquired

 

 

(116,100

)

 

 

 

Net cash used in investing activities

 

 

(263,378

)

 

 

(182,841

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Proceeds from issuance of convertible senior notes

 

 

 

 

 

296,250

 

Proceeds from issuance of warrants

 

 

 

 

 

30,390

 

Purchase of convertible note hedges

 

 

 

 

 

(68,250

)

Debt issuance costs related to convertible senior notes

 

 

 

 

 

(2,382

)

Payments on capital leases

 

 

(262

)

 

 

(202

)

Proceeds from exercise of stock options

 

 

1,591

 

 

 

20,465

 

Excess tax benefit (shortfall) from exercise of stock options

 

 

(2,275

)

 

 

6,564

 

Tax withholdings related to issuance of stock-based awards

 

 

(1,365

)

 

 

(4,295

)

Net cash provided by (used in) financing activities

 

 

(2,311

)

 

 

278,540

 

Effects of foreign currency exchange rate translation

 

 

342

 

 

 

(24

)

Net increase (decrease) in cash and cash equivalents

 

 

(294,471

)

 

 

78,045

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

Beginning of period

 

 

349,897

 

 

 

148,934

 

End of period

 

$

55,426

 

 

$

226,979

 

Non-cash transactions:

 

 

 

 

 

 

 

 

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

 

$

46,193

 

 

$

81,333

 

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

 

 

23,440

 

 

 

28,440

 

Property and equipment additions from use of construction related deposits

 

 

3,965

 

 

 

8,000

 

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

 

 

 

 

 

238

 

 

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

 

6


RESTORATION HARDWARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

NOTE 1—THE COMPANY

Nature of Business

Restoration Hardware Holdings, Inc., 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.

On May 27, 2016, the Company acquired a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name “Waterworks”. Refer to Note 3—Business Combination.

As of October 29, 2016, the Company operated a total of 85 retail stores and 28 outlet stores in 32 states, the District of Columbia, Canada and 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 October 29, 2016, and the results of operations for the three and nine months ended October 29, 2016 and October 31, 2015. The Company’s current fiscal year ends on January 28, 2017 (“fiscal 2016”).

Certain information and disclosures normally included in the notes to annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America 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 January 30, 2016 (the “2015 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 results of operations or cash flows, and did not have a material effect on the previously reported consolidated financial position.

The results of operations for the three and nine months ended October 29, 2016 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 Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board issued their converged accounting standard update on revenue recognition, Accounting Standards Update 2014-09Revenue 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. The Company will also need to apply the new guidance to determine whether revenue should be recognized over time or at a point in time. This guidance can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The FASB deferred the effective date for the new revenue reporting standard for entities reporting under U.S. GAAP for one year from the original effective date. In accordance with the deferral, ASU 2014-09 will become effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application is permitted for annual reporting periods ending after December 15, 2016. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, which clarifies the guidance in the new revenue standard regarding an entity’s identification of its performance obligations in a contract, as well as an entity’s evaluation of the nature of its promise to grant a license of intellectual property and whether or not that revenue is recognized over time or at a point in time. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with CustomersNarrow-Scope Improvements and Practical Expedients, which amends the guidance in the new revenue standard on collectability, noncash consideration, presentation of sales tax, and transition.

7


The amendments are intended to address implementation issues that were raised by stakeholders and provide additional practical expedients to reduce the cost and complexity of applying the new revenue standard. These amendments have the same effective date as the new revenue standard. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements and has not selected an adoption date or a transition method.

Consolidation Accounting

In February 2015, the FASB issued Accounting Standards Update No. 2015-02—Consolidation (Topic 810): Amendments to the Consolidation Analysis, which improves targeted areas of the consolidation guidance and reduces the number of consolidation models. The amendments to the guidance are effective for fiscal years beginning after December 15, 2015 (the Company’s first quarter of fiscal 2016), and interim periods within those years, with early adoption permitted. The Company adopted this guidance in the first quarter of fiscal 2016. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

Classification of Debt Issuance Costs

In April 2015, the FASB issued Accounting Standards Update 2015-03—Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Costs associated with line-of-credit arrangements may continue to be recorded as deferred assets. The update requires retrospective application and represents a change in accounting principle. The debt issuance costs guidance is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company adopted the guidance on a retrospective basis in the first quarter of fiscal 2016. This is a change from the Company’s historical presentation whereby third party offering costs of the Company’s convertible senior notes were classified within other non-current asset on the consolidated balance sheets. To conform to the current period presentation, the Company reclassified $2.1 million as of January 30, 2016 from non-current assets to non-current liabilities on the condensed consolidated balance sheets.

Software Licenses in Cloud Computing Arrangements

In April 2015, the FASB issued Accounting Standards Update No. 2015-05—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. The amendments in ASU 2015-05 provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments in ASU 2015-05 are effective for fiscal years beginning after December 15, 2015, and interim periods within those years. The guidance may be applied either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company adopted this guidance on a prospective basis in the first quarter of fiscal 2016. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

Measurement of Inventory

In July 2015, the FASB issued Accounting Standards Update 2015-11—Inventory (Topic 330): Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. ASU 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance must be applied on a prospective basis and is effective for periods beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance on a prospective basis in the first quarter of fiscal 2016. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

Business Combinations

In September 2015, the FASB issued Accounting Standards Update 2015-16—Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The guidance requires the acquirer to recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which the adjustment amounts are determined. The business combination guidance is effective for interim and annual periods beginning after December 15, 2015, with early adoption permitted, and is to be applied on a prospective basis. The Company adopted this guidance on a prospective basis in the first quarter of fiscal 2016. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

8


Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update 2016-02Leases, 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 the Company has a significant number of leases.

Financial Instruments

In January 2016, the FASB issued Accounting Standards Update 2016-01Financial InstrumentsOverall (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 is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

Recognition of Breakage

In March 2016, the FASB issued Accounting Standard Update No. 2016-04Recognition of Breakage for Certain Prepaid Stored-Value Products. The new guidance creates an exception under ASC 405-20Liabilities-Extinguishments of Liabilities, to derecognize financial liabilities related to certain prepaid stored-value products using a revenue-like breakage model. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. This guidance can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

Stock-Based Compensation

In March 2016, the FASB issued Accounting Standard Update No. 2016-09Improvements to Employee Share Based Payment Accounting. The new guidance simplifies several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. One provision requires that the excess income tax benefits and tax deficiencies related to share-based payments be recognized within income tax expense in the statement of operations, rather than within additional paid-in capital on the balance sheet. The Company is currently evaluating the potential impact that this provision will have on its consolidated financial statements, which is to be applied prospectively. The Company does not expect the other provisions within the pronouncement to have a material impact on its consolidated financial statements. The new guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal year 2017.

Cash Flow Classification

In August 2016, the FASB issued Accounting Standard 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 an existing diversity in practices regarding the matter in which certain cash receipts and payments are presented and classified in 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. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

Income Taxes: Intra-Entity Asset Transfers

In October 2016, the FASB issued Accounting Standard 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 is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

 

9


 

NOTE 3—BUSINESS COMBINATION

On May 27, 2016, the Company acquired a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name “Waterworks”. The purchase price of the acquisition was approximately $119.9 million consisting of $118.4 million funded with available cash and $1.5 million representing the fair value of rollover units, which amount is subject to adjustment for changes in working capital and other items. The rollover units are included in non-current liabilities on the condensed consolidated balance sheets (refer to Note 14—Stock-Based Compensation). After the transaction, and giving effect to equity interests acquired by management in the business, the Company owns in excess of 90% of the total equity interest in Waterworks.

The addition of Waterworks to the RH platform further positions the Company as an authority in two of the most important and high value rooms of the home—the bath and kitchen—and creates one of the first fully integrated luxury home brands in the world. Furthermore, the Company believes that the Waterworks brand renders the RH brand more valuable and opens RH up to additional high net worth clients, designers and contractors at a much earlier stage in the home project lifecycle. In addition, Waterworks’ long focus and service of the luxury customer is valuable to RH as it continues to elevate the RH brand and customer experience.

For the nine months ended October 29, 2016, the Company incurred $2.8 million of acquisition-related costs associated with the transaction. For the three months ended October 29, 2016, the Company did not incur any acquisition-related costs. These costs and expenses include fees associated with financial, legal and accounting advisors, and employment related costs, and are included in selling, general and administrative expenses on the condensed consolidated statements of operations.

The following table summarizes the purchase price allocation based on the estimated fair value of the acquired assets and assumed liabilities (in thousands):

 

Tangible assets acquired and liabilities assumed

 

$

16,249

 

Intangible assets

 

 

52,100

 

Goodwill

 

 

51,595

 

Total

 

$

119,944

 

 

Under purchase accounting rules, the Company valued the acquired finished goods inventory to fair value, which is defined as the estimated selling price less the sum of (a) costs of disposal and (b) a reasonable profit allowance for the Company’s selling effort. This valuation resulted in an increase in inventory carrying value of approximately $10.8 million for marketable inventory.

Intangible assets represent trade names which have been assigned an indefinite life and therefore are not subject to amortization. The goodwill is representative of the benefits and expected synergies from the integration of Waterworks products and Waterworks’ management and employees, which do not qualify for separate recognition as an intangible asset. The trade names and goodwill are not expected to be deductible for tax purposes.

Results of operations of Waterworks have been included in the Company’s condensed consolidated statements of operations since the May 27, 2016 acquisition date. Pro forma results of the acquired business have not been presented as the results were not considered material to the Company’s consolidated financial statements for all periods presented and would not have been material had the acquisition occurred at the beginning of fiscal 2016.

 

 

NOTE 4—PREPAID EXPENSE AND OTHER ASSETS

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

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Capitalized catalog costs

 

$

62,391

 

 

$

35,836

 

Vendor deposits

 

 

20,399

 

 

 

22,959

 

Federal and state tax receivable

 

 

3,977

 

 

 

 

Prepaid expense and other current assets

 

 

26,898

 

 

 

20,225

 

Total prepaid expense and other current assets

 

$

113,665

 

 

$

79,020

 

 

10


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

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Construction related deposits

 

$

15,248

 

 

$

15,384

 

Other deposits

 

 

4,741

 

 

 

3,635

 

Deferred financing fees

 

 

1,706

 

 

 

2,236

 

Other non-current assets

 

 

2,962

 

 

 

4,207

 

Total other non-current assets

 

$

24,657

 

 

$

25,462

 

 

 

NOTE 5—GOODWILL AND INTANGIBLE ASSETS

The following sets forth the goodwill and intangible assets as of October 29, 2016 (in thousands):

 

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Foreign

Currency

Translation

 

 

Net Book

Value

 

Intangible assets subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of leases (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair market write-up

 

$

1,924

 

 

$

(1,768

)

 

$

 

 

$

156

 

Fair market write-down (2)

 

 

(1,467

)

 

 

1,336

 

 

 

 

 

 

(131

)

Total intangible assets subject to amortization

 

$

457

 

 

$

(432

)

 

$

 

 

$

25

 

Intangible assets not subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

176,056

 

 

$

 

 

$

(110

)

 

$

175,946

 

Trademarks and domain names

 

$

100,466

 

 

$

 

 

$

 

 

$

100,466

 

 

(1)

The fair value of each lease is amortized over the life of the respective lease.

(2)

The fair market write-down of leases is included in other non-current obligations on the condensed consolidated balance sheets.

The following sets forth the goodwill and intangible assets as of January 30, 2016 (in thousands):

 

 

 

Gross

Carrying

Amount

 

 

Accumulated

Amortization

 

 

Foreign

Currency

Translation

 

 

Net Book

Value

 

Intangible assets subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of leases (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair market write-up

 

$

1,924

 

 

$

(1,697

)

 

$

 

 

$

227

 

Fair market write-down (2)

 

 

(1,467

)

 

 

1,289

 

 

 

 

 

 

(178

)

Total intangible assets subject to amortization

 

$

457

 

 

$

(408

)

 

$

 

 

$

49

 

Intangible assets not subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

124,461

 

 

$

 

 

$

(160

)

 

$

124,301

 

Trademarks and domain names

 

$

48,309

 

 

$

 

 

$

 

 

$

48,309

 

 

(1)

The fair value of each lease is amortized over the life of the respective lease.

(2)

The fair market write-down of leases is included in other non-current obligations on the condensed consolidated balance sheets.

 

 

11


NOTE 6—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

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

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Accounts payable

 

$

121,517

 

 

$

175,024

 

Accrued compensation

 

 

32,290

 

 

 

27,698

 

Accrued freight and duty

 

 

25,037

 

 

 

27,230

 

Accrued sales taxes

 

 

14,757

 

 

 

19,269

 

Accrued catalog costs

 

 

13,342

 

 

 

5,988

 

Accrued occupancy

 

 

13,196

 

 

 

15,095

 

Accrued professional fees

 

 

2,466

 

 

 

2,736

 

Accrued legal settlements

 

 

695

 

 

 

3,000

 

Other accrued expenses

 

 

7,779

 

 

 

4,674

 

Total accounts payable and accrued expenses

 

$

231,079

 

 

$

280,714

 

 

Accounts payable included negative cash balances due to outstanding checks of $8.3 million and $18.4 million as of October 29, 2016 and January 30, 2016, respectively.

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

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Unredeemed gift card and merchandise credit liability

 

$

27,750

 

 

$

24,364

 

Allowance for sales returns

 

 

12,780

 

 

 

12,688

 

Capital lease obligations—current

 

 

285

 

 

 

182

 

Federal and state tax payable

 

 

 

 

 

27,838

 

Other current liabilities

 

 

2,953

 

 

 

 

Total other current liabilities

 

$

43,768

 

 

$

65,072

 

 

 

NOTE 7—OTHER NON-CURRENT OBLIGATIONS

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

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Notes payable for share repurchases

 

$

19,523

 

 

$

19,523

 

Deferred contract incentive (1)

 

 

8,334

 

 

 

 

Capital lease obligations—non-current

 

 

7,306

 

 

 

7,399

 

Unrecognized tax benefits

 

 

1,952

 

 

 

1,125

 

Rollover units and profit interests

 

 

1,678

 

 

 

 

Other non-current obligations

 

 

2,591

 

 

 

1,302

 

Total other non-current obligations

 

$

41,384

 

 

$

29,349

 

 

(1)

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.

 

 

NOTE 8—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

12


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 October 29, 2016, none of these conditions have occurred and, as a result, the 2020 Notes are not convertible as of October 29, 2016. On and after March 15, 2020, 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 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 composed 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 the three months ended October 29, 2016 and October 31, 2015, the Company recorded $0.2 million and $0.2 million, related to the amortization of debt issuance costs, respectively. During the nine months ended October 29, 2016 and October 31, 2015, the Company recorded $0.7 million and $0.3 million related to the amortization of debt issuance costs, respectively.

13


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

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

300,000

 

 

$

300,000

 

Less: Debt discount

 

 

(63,962

)

 

 

(75,113

)

Net carrying amount

 

$

236,038

 

 

$

224,887

 

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 $3.8 million and $3.6 million for the amortization of the debt discount related to the 2020 Notes during the three months ended October 29, 2016 and October 31, 2015, respectively. The Company recorded interest expense of $11.2 million and $5.3 million for the amortization of the debt discount related to the 2020 Notes during the nine months ended October 29, 2016 and October 31, 2015, 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 5.1 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 5.1 million shares of the Company’s common stock at a price of $189.00 per share. 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 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 non-current 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

14


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 October 29, 2016, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of October 29, 2016. 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 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.

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 composed 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 October 29, 2016 and October 31, 2015, the Company recorded $0.2 million related to the amortization of debt issuance costs. During both the nine months ended October 29, 2016 and October 31, 2015, the Company recorded $0.6 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):

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

350,000

 

 

$

350,000

 

Less: Debt discount

 

 

(38,973

)

 

 

(49,289

)

Net carrying amount

 

$

311,027

 

 

$

300,711

 

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 $3.5 million and $3.3 million for the amortization of the debt discount related to the 2019 Notes during the three months ended October 29, 2016 and October 31, 2015, respectively. The Company recorded interest expense of $10.3 million and $9.9 million for the amortization of the debt discount related to the 2019 Notes during the nine months ended October 29, 2016 and October 31, 2015, respectively.

15


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 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 non-current deferred tax assets on the condensed consolidated balance sheets.

 

 

NOTE 9—LINE OF CREDIT

In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into a credit agreement (the “prior credit agreement”) with Bank of America, N.A., as administrative agent, and certain other lenders. On November 24, 2014, the Company amended its existing revolving line of credit by entering into an amended and restated credit agreement with the lenders party thereto and Bank of America, N.A. as administrative agent and collateral agent. The amended and restated credit agreement increased the existing revolving line of credit by $182.5 million, while eliminating the $15.0 million term loan facility under the existing revolving line of credit. Under the amended and restated credit agreement, which has a maturity date of November 24, 2019, the Company has the option to increase the amount of the revolving line of credit by up to an additional $200.0 million, subject to satisfaction of certain customary conditions at the time of such increase.

On August 12, 2015, Restoration Hardware, Inc. and Restoration Hardware Canada, Inc. entered into a First Amendment (the “Amendment”) to the amended and restated credit agreement. The Amendment changes the amended and restated credit agreement definition of “Change of Control” (the occurrence of which triggers a default under the amended and restated credit agreement) so that changes in the composition of the board of directors due to actual or threatened proxy solicitations are treated in the same way as other changes in the composition of the board of directors.

As of October 29, 2016, the Company did not have any amounts outstanding under the revolving line of credit. As of October 29, 2016, the Company had $586.3 million undrawn borrowing availability under the revolving line of credit. As of October 29, 2016 and January 30, 2016, the Company had $13.7 million and $15.0 million in outstanding letters of credit, respectively.

Borrowings under the revolving line of credit are subject to interest, at the borrowers’ option, at either the bank’s reference rate or LIBOR (or 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 October 29, 2016, the Company was in compliance with all covenants contained in the credit agreement.

 

 

NOTE 10—FAIR VALUE OF FINANCIAL INSTRUMENTS

Financial Assets and Liabilities

Certain financial assets and liabilities are required to be carried at fair value. Fair value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. In determining the fair value, the Company utilizes market data or assumptions that it believes market participants would use in pricing the asset or liability, which would maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, including assumptions about risk and the risks inherent in the inputs of the valuation technique.

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The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Financial instruments with readily available active quoted prices for which fair value can be measured generally will have a higher degree of pricing observability and a lesser degree of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.

The Company’s financial assets and liabilities measured and reported at fair value are classified and disclosed in one of the following categories:

 

Level 1—Quoted prices are available in active markets for identical investments as of the reporting date.

 

Level 2—Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies.

 

Level 3—Pricing inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment. The inputs used in the determination of fair value require significant management judgment or estimation.

A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Fair Value Measurements

All of the Company’s investments are classified as available-for-sale and are carried at fair value. Assets measured at fair value were as follows (in thousands):

 

 

 

October 29,

 

 

January 30,

 

 

 

2016

 

 

2016

 

 

 

Level 1

 

 

Level 2

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Total

 

Cash equivalents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

6,443

 

 

$

 

 

$

6,443

 

 

$

70

 

 

$

 

 

$

70

 

Commercial paper

 

 

 

 

 

999

 

 

 

999

 

 

 

 

 

 

46,726

 

 

 

46,726

 

Total cash equivalents

 

 

6,443

 

 

 

999

 

 

 

7,442

 

 

 

70

 

 

 

46,726

 

 

 

46,796

 

Short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

 

 

 

 

35,213

 

 

 

35,213

 

 

 

 

 

 

15,488

 

 

 

15,488

 

Government agency obligations

 

 

29,785

 

 

 

105,155

 

 

 

134,940

 

 

 

22,011

 

 

 

93,302

 

 

 

115,313

 

Total short-term investments

 

 

29,785

 

 

 

140,368

 

 

 

170,153

 

 

 

22,011

 

 

 

108,790

 

 

 

130,801

 

Long-term investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Government agency obligations

 

 

 

 

 

21,056

 

 

 

21,056

 

 

 

7,829

 

 

 

14,225

 

 

 

22,054

 

Total long-term investments