NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1THE 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 childrens furnishings. These products are sold through the
Companys stores, catalogs and websites. As of May 3, 2014, the Company operated a total of 69 retail stores and 17 outlet stores in 29 states, the District of Columbia and Canada, 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 Companys records and, in managements opinion, include all adjustments necessary to fairly state the Companys financial position
as of May 3, 2014, and the results of operations for the three months ended May 3, 2014 and May 4, 2013. The Companys current fiscal year ends on January 31, 2015 (fiscal 2014).
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 Companys Annual Report on Form 10-K for the fiscal year ended February 1, 2014 (2013 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, financial position or cash flows.
The results of operations for the three months ended May 3, 2014 presented herein are not necessarily indicative of the results to be
expected for the full fiscal year.
Acquisition
On February 3, 2014, the Company completed a business acquisition from an entity that is owned by an employee of the Company for an
aggregate purchase price of $2.5 million. The Company accounted for this acquisition utilizing the purchase method. In accordance with the purchase method, all assets and liabilities were recorded at fair value, including goodwill and other
intangible assets acquired. Goodwill and other intangible assets related to this acquisition are included in these condensed consolidated financial statements.
NOTE 2RECENT ACCOUNTING PRONOUNCEMENTS
Accounting for Leases
The Financial Accounting Standards Board (FASB) is currently working on amendments to existing accounting standards governing a
number of areas including, but not limited to, accounting for leases. In May 2013, the FASB issued a new exposure draft,
Leases (Topic 841)
(the Exposure Draft), which would replace the existing guidance in ASC 840. Under the
Exposure Draft, among other changes in practice, a lessees rights and obligations under most leases, including existing and new arrangements, would be recognized as assets and liabilities, respectively, on the balance sheet. Other significant
provisions of the Exposure Draft include (i) defining the lease term to include the noncancellable period together with periods for which there is a significant economic incentive for the lessee to extend or not terminate the lease;
(ii) defining the initial lease liability to be recorded on the balance sheet to contemplate only those variable lease payments that depend on an index or that are in substance fixed; and (iii) a dual approach for determining
whether lease expense is recognized on a straight-line or accelerated basis, depending on whether the lessee is expected to consume more than an insignificant portion of the leased assets economic benefits. The comment period for the Exposure
Draft ended on September 13, 2013. If and when effective, this Exposure Draft will likely have a significant impact on the Companys consolidated financial statements. However, as the standard-setting process is still ongoing, the Company
is unable to determine the impact this proposed change in accounting standards will have on its consolidated financial statements.
Presentation of Unrecognized Tax Benefits
In July 2013, the FASB issued an Accounting Standards Update, which requires that an unrecognized tax benefit, or a portion of an unrecognized
tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with certain exceptions. This guidance is effective for
annual and interim reporting periods beginning after December 15, 2013, with early adoption permitted. The Company adopted this guidance in the first quarter of fiscal 2014 and adoption did not have a material impact on its consolidated
financial statements.
6
Revenue from Contracts with Customers
In May 2014, the FASB and International Accounting Standards Board issued their converged standard on revenue recognition,
Accounting
Standards Update 2014-09 Revenue from Contracts with Customers (Topic 606)
. This standard 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. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance. The Company will also need to apply new guidance to
determine whether revenue should be recognized over time or at a point in time. This standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016, with no early adoption permitted,
and is required to be applied retrospectively. The Company has reviewed the standard and does not believe it will have a material impact on its consolidated financial statements.
NOTE 3PREPAID EXPENSE AND OTHER CURRENT ASSETS
Prepaid expense and other current assets consist of the following (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
May 3,
2014
|
|
|
February 1,
2014
|
|
Capitalized catalog costs
|
|
$
|
73,718
|
|
|
$
|
49,274
|
|
Vendor deposits
|
|
|
31,611
|
|
|
|
36,694
|
|
Prepaid expense and other current assets
|
|
|
21,543
|
|
|
|
17,185
|
|
|
|
|
|
|
|
|
|
|
Total prepaid expense and other current assets
|
|
$
|
126,872
|
|
|
$
|
103,153
|
|
|
|
|
|
|
|
|
|
|
NOTE 4GOODWILL AND INTANGIBLE ASSETS
The following sets forth the goodwill and intangible assets as of May 3, 2014 (
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
|
|
$
|
10,643
|
|
|
$
|
(9,411
|
)
|
|
$
|
43
|
|
|
$
|
1,275
|
|
Fair market write-down
(2)
|
|
|
(2,591
|
)
|
|
|
2,119
|
|
|
|
|
|
|
|
(472
|
)
|
Customer relationships
(3)
|
|
|
80
|
|
|
|
(20
|
)
|
|
|
|
|
|
|
60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets subject to amortization
|
|
|
8,132
|
|
|
|
(7,312
|
)
|
|
|
43
|
|
|
|
863
|
|
Intangible assets not subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
124,461
|
|
|
|
|
|
|
|
166
|
|
|
|
124,627
|
|
Trademarks and domain names
|
|
|
47,410
|
|
|
|
|
|
|
|
|
|
|
|
47,410
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
180,003
|
|
|
$
|
(7,312
|
)
|
|
$
|
209
|
|
|
$
|
172,900
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 long-term obligations on the condensed consolidated balance sheets.
|
(3)
|
Customer relationships are amortized over a one-year period.
|
7
The following sets forth the goodwill and intangible assets as of February 1, 2014 (
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
|
|
$
|
10,443
|
|
|
$
|
(9,187
|
)
|
|
$
|
42
|
|
|
$
|
1,298
|
|
Fair market write-down
(2)
|
|
|
(2,591
|
)
|
|
|
2,072
|
|
|
|
|
|
|
|
(519
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets subject to amortization
|
|
|
7,852
|
|
|
|
(7,115
|
)
|
|
|
42
|
|
|
|
779
|
|
Intangible assets not subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
|
122,285
|
|
|
|
|
|
|
|
139
|
|
|
|
122,424
|
|
Trademarks and domain names
|
|
|
47,410
|
|
|
|
|
|
|
|
|
|
|
|
47,410
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$
|
177,547
|
|
|
$
|
(7,115
|
)
|
|
$
|
181
|
|
|
$
|
170,613
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 long-term obligations on the condensed consolidated balance sheets.
|
NOTE 5OTHER CURRENT LIABILITIES
Other current liabilities consist of the following (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
May 3,
2014
|
|
|
February 1,
2014
|
|
Unredeemed gift certificate and merchandise credit liability
|
|
$
|
19,470
|
|
|
$
|
18,830
|
|
Allowance for sales returns
|
|
|
10,892
|
|
|
|
12,142
|
|
Capital lease obligationcurrent
|
|
|
903
|
|
|
|
1,807
|
|
Federal, state and foreign tax payable
|
|
|
161
|
|
|
|
22,254
|
|
Other liabilities
|
|
|
1,801
|
|
|
|
1,897
|
|
|
|
|
|
|
|
|
|
|
Total other current liabilities
|
|
$
|
33,227
|
|
|
$
|
56,930
|
|
|
|
|
|
|
|
|
|
|
NOTE 6OTHER LONG-TERM OBLIGATIONS
Other long-term obligations consist of the following (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
May 3,
2014
|
|
|
February 1,
2014
|
|
Financing obligations under build-to-suit transactions
|
|
$
|
45,752
|
|
|
$
|
33,165
|
|
Long-term notes payable for share repurchases
|
|
|
18,392
|
|
|
|
2,710
|
|
Unrecognized tax benefits
|
|
|
1,793
|
|
|
|
1,739
|
|
Other long-term obligations
|
|
|
1,606
|
|
|
|
1,617
|
|
|
|
|
|
|
|
|
|
|
Total other long-term obligations
|
|
$
|
67,543
|
|
|
$
|
39,231
|
|
|
|
|
|
|
|
|
|
|
NOTE 7LINE OF CREDIT
As of May 3, 2014, the Company had $149.1 million outstanding and $229.4 million undrawn borrowing availability under
the revolving line of credit. As of May 3, 2014 and February 1, 2014, there were $18.5 million and $18.9 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 banks reference rate
or LIBOR (or the 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 weighted-average interest rate for the revolving line of credit was 2.32% as of May 3, 2014.
8
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 3, 2014, the Company was in compliance with all covenants contained in the credit agreement.
NOTE 8INCOME TAXES
The effective tax rate was 34.04% and 51.06% for the three months ended May 3, 2014, and May 4, 2013,
respectively. During the three months ended May 3, 2014, the Company received a Canadian tax refund of $0.2 million which reduced its effective tax rate. The effective tax rate for the three months ended May 4, 2013 was significantly
impacted by (i) the Company reporting a loss before income taxes, (ii) non-deductible stock-based compensation and (iii) other non-deductible expenses.
As of May 3, 2014, the Company has retained a valuation allowance of $0.2 million against deferred tax assets for its Shanghai
operations.
As of both May 3, 2014 and February 1, 2014, $1.4 million of the exposures related to unrecognized tax benefits
would affect the effective tax rate if realized and are included in other long-term obligations on the condensed consolidated balance sheets. These amounts are primarily associated with foreign tax exposures that would, if realized, reduce the
amount of net operating losses that would ultimately be utilized. As of May 3, 2014, $0.4 million of the exposures related to unrecognized tax benefits are expected to decrease in the next 12 months due to the lapse of the statute of
limitations.
Adjustments required upon adoption of accounting for uncertainty in income taxes related to deferred tax asset accounts were
offset by the related valuation allowance. Future changes to the Companys assessment of the realizability of those deferred tax assets will impact the effective tax rate. The Company accounts for interest and penalties related to exposures as
a component of income tax expense. The Company has accrued $0.4 million and $0.3 million of interest associated with exposures as of May 3, 2014 and February 1, 2014, respectively.
NOTE 9EARNINGS PER SHARE
The weighted-average shares used for earnings per share is as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
May 3,
2014
|
|
|
May 4,
2013
|
|
Weighted-average sharesbasic
|
|
|
39,152,923
|
|
|
|
38,076,026
|
|
Effect of dilutive stock-based awards
|
|
|
1,634,803
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average sharesdiluted
|
|
|
40,787,726
|
|
|
|
38,076,026
|
|
|
|
|
|
|
|
|
|
|
For the three months ended May 3, 2014, options and restricted stock units of 1,362,462 and 22,750,
respectively, were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive. For the three months ended May 4, 2013, options and restricted stock units of 8,246,577 and 41,713,
respectively, were excluded from the calculation of diluted net loss per share because their inclusion would have been anti-dilutive due to the Companys net loss in the period.
NOTE 10SHARE REPURCHASES
Certain options and awards granted under the Companys equity plans contain a repurchase right, which may be exercised
at the Companys discretion in the event of the termination of an employees employment with the Company. During the three months ended May 3, 2014, the Company repurchased 241,322 shares of common stock from former employees pursuant
to such repurchase right. The shares were repurchased for fair value at a weighted-average price of $64.98 per share and were settled with the issuance of promissory notes bearing interest at 5%, paid annually, with principal due at the end of an
8-year term. During the three months ended May 4, 2013, the Company did not repurchase any common stock.
As of May 3, 2014, the
aggregate unpaid principal amount of the promissory notes was $18.4 million, which is included in other long-term obligations on the condensed consolidated balance sheets.
9
NOTE 11STOCK-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 have vested 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 $2.2 million and $3.6 million in the three months ended May 3, 2014 and May 4, 2013, respectively. No stock-based compensation cost has been capitalized in the
accompanying condensed consolidated financial statements.
2012 Stock Option Plan and 2012 Stock Incentive Plan
As of May 3, 2014, 6,134,091 options were outstanding with a weighted-average exercise price of $47.15 per share and 5,599,966 options
were vested with a weighted-average exercise price of $46.18 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of May 3, 2014 was $112.5 million, $112.1 million,
and $108.2 million, respectively. Stock options exercisable as of May 3, 2014 had a weighted-average remaining contractual life of 8.57 years. As of May 3, 2014, the total unrecognized compensation expense related to unvested options was
$9.4 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.90 years.
As of May 3,
2014, the Company had 377,819 restricted stock awards outstanding with a weighted-average grant date fair value of $64.01 per share. During the three months ended May 3, 2014, 6,249 restricted stock awards with a weighted-average grant date
fair value of $38.36 per share vested. As of May 3, 2014, there was $17.1 million of total unrecognized compensation expense related to unvested restricted stock awards which is expected to be recognized over a weighted-average period of
3.54 years.
2012 Equity Replacement Plan
In November 2012, in connection with the Companys initial public offering, Mr. Friedman and Mr. Alberini received unvested
restricted shares under the Restoration Hardware 2012 Equity Replacement Plan in replacement of certain of their performance-based units granted under the Team Resto Ownership Plan. With respect to the 1,331,548 shares received by Mr. Friedman
and Mr. Alberini in replacement of certain of their performance-based units, such shares began to vest during the period following the initial public offering when the price of the Companys common stock reached a 10-day average closing
price per share of $31.00 for at least 10 consecutive trading days, and such shares fully vested when the price of the Companys common stock reached a 10-day average closing price per share of $46.50 for at least 10 consecutive trading days.
For Mr. Friedman, these units were marked to market every period through the satisfaction of the vesting criteria in accordance with
ASC Topic 718
Stock Compensation
, due to his advisory role of Creator and Curator from October 2012 to June 2013.
Prior to the three months ended May 4, 2013, 1,191,091 shares of the 1,331,548 shares received by Mr. Friedman and Mr. Alberini
in replacement of certain of their performance-based units had vested in accordance with the performance objectives as described above. During three months ended May 4, 2013, the remaining unvested 140,457 shares of the 1,331,548 shares
received by Mr. Alberini and Mr. Friedman had vested in accordance with the performance objectives as described above. The Company recorded a non-cash compensation charge of $3.4 million related to these awards in the three months ended
May 4, 2013, which is included in the total stock-based compensation amount above. In May 2013, all shares received by Mr. Friedman and Mr. Alberini in replacement of certain of their performance-based units had vested in accordance
with the performance objectives. No additional compensation expense will be recorded in future periods related to these awards.
NOTE 12COMMITMENTS AND CONTINGENCIES
Commitments
The
Company has no off balance sheet commitments as of May 3, 2014.
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 Companys 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.
10
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. As of May 3, 2014, the Company has recorded a liability for the estimated loss related to these disputes. There is a possibility that additional losses may be incurred in
excess of the amounts that the Company has accrued. However, the Company believes that the ultimate resolution of these current matters will not have a material adverse effect on its condensed consolidated financial statements.
In the three month period ended May 3, 2014, material developments occurred in an ongoing legal proceeding involving the Company. On
October 21, 2008, Mike Hernandez, individually and on behalf of others similarly situated, filed a class action in the Superior Court of the State of California for the County of San Diego against Restoration Hardware, Inc. alleging principally
that the Company violated Californias Song-Beverly Credit Card Act of 1971 by requesting and recording ZIP codes from customers paying with credit cards. On May 23, 2014, in response to a directive from the Court, the parties filed a
joint statement as to the parties agreed-upon claims process for the class members as well as to other matters related to this proceeding, all of which remain subject to Court approval. As a result of these developments, the Company recorded a
$9.2 million charge related to this matter during the three months ended May 3, 2014.
NOTE 13SEGMENT REPORTING
The Company defines an operating segment on the same basis that it uses to evaluate performance internally by the Chief
Operating Decision Maker (CODM). The Company has determined that the Chief Executive Officer is its CODM and there is one operating segment. Therefore, the Company reports as a single segment. This includes all sales channels accessed by
the Companys customers, including sales through catalogs, sales through the Companys website and sales through the Companys stores.
The Company classifies its sales into furniture and non-furniture product lines. Furniture includes both indoor and outdoor furniture.
Non-furniture includes lighting, textiles, accessories and home décor. Net revenues in each category were as follows (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
May 3,
2014
|
|
|
May 4,
2013
|
|
Furniture
|
|
$
|
209,741
|
|
|
$
|
171,373
|
|
Non-furniture
|
|
|
156,513
|
|
|
|
129,964
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
$
|
366,254
|
|
|
$
|
301,337
|
|
|
|
|
|
|
|
|
|
|
The Company is domiciled in the United States and operates stores in the United States and Canada. Revenues
from Canadian operations, and the long-lived assets in Canada, are not material to the Company. Geographic revenues are determined based upon where service is rendered.
No single customer accounted for more than 10% of the Companys revenues in the three months ended May 3, 2014 or May 4, 2013.
11