Table of Contents

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 28, 2017August 3, 2019

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

Graphic

(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) (415924-1005

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, $0.0001 par value

RH

New York Stock Exchange, Inc.

(Title of each class)

(Trading symbol)

(Name of each exchange on which registered)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes     No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes      No  

As of December 1, 2017, 21,309,941September 6, 2019, 18,676,038 shares of registrant’s common stock were outstanding.


Table of Contents

RH

INDEX TO FORM 10-Q

    

    

Page

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

3

Condensed Consolidated Balance Sheets (Unaudited) as of October 28, 2017,August 3, 2019 and January 28, 2017February 2, 2019

3

Condensed Consolidated Statements of OperationsIncome (Unaudited) for the three and ninesix months ended October 28, 2017,August 3, 2019 and October 29, 2016August 4, 2018

4

Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and ninesix months ended October 28, 2017,August 3, 2019 and October 29, 2016August 4, 2018

5

Condensed Consolidated Statements of Stockholders’ Equity (Deficit) (Unaudited) for the three and six months ended August 3, 2019 and August 4, 2018

6

Condensed Consolidated Statements of Cash Flows (Unaudited) for the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016August 4, 2018

67

Notes to Condensed Consolidated Financial Statements (Unaudited)

78

Item 2.

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

2736

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

49

Item 4.

Controls and Procedures

50

68

Item 4.

Controls and Procedures

70

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

5171

Item 1A.

Risk Factors

5171

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

5177

Item 3.

Defaults Upon Senior Securities

51

Item 4.

Mine Safety Disclosures

52

Item 5.

Other Information

52

Item 6.

Exhibits

5377

SignaturesItem 4.

54Mine Safety Disclosures

77

Item 5.

Other Information

77

Item 6.

Exhibits

78

Signatures

79

2


Table of Contents

PART I

PART
I

Item 1. Financial Statements

RH

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

    

August 3,

    

February 2,

2019

2019

ASSETS

 

  

 

  

Current assets:

 

  

 

  

Cash and cash equivalents

$

11,555

$

5,803

Accounts receivable—net

 

44,287

 

40,224

Merchandise inventories

 

480,688

 

531,947

Asset held for sale

21,795

21,795

Prepaid expense and other current assets

 

99,297

 

104,198

Total current assets

 

657,622

 

703,967

Property and equipment—net

 

950,594

 

952,957

Operating lease right-of-use assets

421,001

440,504

Goodwill

 

124,370

 

124,379

Tradenames, trademarks and domain names

 

86,022

 

86,022

Deferred tax assets

 

35,946

 

35,603

Other non-current assets

 

112,253

 

79,586

Total assets

$

2,387,808

$

2,423,018

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

  

 

  

Current liabilities:

 

  

 

  

Accounts payable and accrued expenses

$

289,713

$

320,497

Deferred revenue and customer deposits

 

165,511

 

152,595

Convertible senior notes due 2019—net

 

 

343,789

Convertible senior notes due 2020—net

280,688

Operating lease liabilities

57,162

66,249

Other current liabilities

 

131,883

 

109,456

Total current liabilities

 

924,957

 

992,586

Asset based credit facility

 

145,000

 

57,500

FILO term loan—net

 

119,086

 

Second lien term loan—net

197,262

Equipment promissory notes—net

 

42,113

 

Convertible senior notes due 2020—net

 

 

271,157

Convertible senior notes due 2023—net

 

257,766

 

249,151

Non-current operating lease liabilities

 

415,803

 

437,557

Non-current finance lease liabilities

433,591

421,245

Other non-current obligations

 

30,148

 

32,512

Total liabilities

 

2,565,726

 

2,461,708

Commitments and contingencies (Note 15)

 

 

Stockholders’ deficit:

 

  

 

  

Preferred stock, $0.0001 par value per share, 10,000,000 shares authorized, 0 shares issued or outstanding as of August 3, 2019 and February 2, 2019

 

 

Common stock, $0.0001 par value per share, 180,000,000 shares authorized, 18,591,763 shares issued and outstanding as of August 3, 2019; 20,480,613 shares issued and 20,477,813 shares outstanding as of February 2, 2019

 

2

 

2

Additional paid-in capital

 

355,010

 

356,422

Accumulated other comprehensive loss

 

(2,780)

 

(2,333)

Accumulated deficit

 

(530,150)

 

(392,538)

Treasury stock—at cost, 0 shares as of August 3, 2019 and 2,800 shares as of February 2, 2019

 

 

(243)

Total stockholders’ deficit

 

(177,918)

 

(38,690)

Total liabilities and stockholders’ deficit

$

2,387,808

$

2,423,018

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

22,162

 

 

$

87,023

 

Short-term investments

 

 

 

 

 

142,677

 

Accounts receivable—net

 

 

34,447

 

 

 

34,191

 

Merchandise inventories

 

 

557,345

 

 

 

752,304

 

Asset held for sale

 

 

 

 

 

4,900

 

Prepaid expense and other current assets

 

 

75,041

 

 

 

117,162

 

Total current assets

 

 

688,995

 

 

 

1,138,257

 

Long-term investments

 

 

 

 

 

33,212

 

Property and equipment—net

 

 

778,320

 

 

 

682,056

 

Goodwill

 

 

175,553

 

 

 

173,603

 

Trademarks and other intangible assets

 

 

100,726

 

 

 

100,757

 

Deferred tax assets

 

 

29,214

 

 

 

28,466

 

Other non-current assets

 

 

28,758

 

 

 

36,169

 

Total assets

 

$

1,801,566

 

 

$

2,192,520

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

252,569

 

 

$

226,980

 

Deferred revenue and customer deposits

 

 

166,579

 

 

 

145,918

 

Other current liabilities

 

 

50,609

 

 

 

43,271

 

Total current liabilities

 

 

469,757

 

 

 

416,169

 

Asset based credit facility

 

 

341,000

 

 

 

 

Term loan—net

 

 

79,471

 

 

 

 

Convertible senior notes due 2019—net

 

 

323,828

 

 

 

312,379

 

Convertible senior notes due 2020—net

 

 

248,633

 

 

 

235,965

 

Financing obligations under build-to-suit lease transactions

 

 

230,259

 

 

 

203,015

 

Deferred rent and lease incentives

 

 

63,499

 

 

 

60,439

 

Other non-current obligations

 

 

70,395

 

 

 

44,684

 

Total liabilities

 

 

1,826,842

 

 

 

1,272,651

 

Commitments and contingencies (Note 17)

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

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

   issued or outstanding as of October 28, 2017 and January 28, 2017

 

 

 

 

 

 

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

   41,525,393 shares issued and 21,305,261 shares outstanding as of October 28, 2017;

   41,123,521 shares issued and 40,828,633 shares outstanding as of January 28, 2017

 

 

2

 

 

 

4

 

Additional paid-in capital

 

 

843,965

 

 

 

790,866

 

Accumulated other comprehensive loss

 

 

(1,527

)

 

 

(1,692

)

Retained earnings

 

 

152,133

 

 

 

150,214

 

Treasury stock—at cost, 20,220,132 shares as of October 28, 2017 and 294,888 shares

   as of January 28, 2017

 

 

(1,019,849

)

 

 

(19,523

)

Total stockholders’ equity (deficit)

 

 

(25,276

)

 

 

919,869

 

Total liabilities and stockholders’ equity (deficit)

 

$

1,801,566

 

 

$

2,192,520

 

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

3


Table of Contents

RH

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSINCOME

(In thousands, except share and per share amounts)

(Unaudited)

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

Net revenues

$

706,514

$

640,798

$

1,304,935

$

1,198,204

Cost of goods sold

 

411,556

 

372,454

 

777,163

 

720,527

Gross profit

 

294,958

 

268,344

 

527,772

 

477,677

Selling, general and administrative expenses

 

190,977

 

186,521

355,158

347,707

Income from operations

 

103,981

 

81,823

 

172,614

 

129,970

Other expenses

 

  

 

  

 

  

 

  

Interest expense—net

24,513

15,467

45,631

30,565

(Gain) loss on extinguishment of debt

 

(954)

 

917

 

(954)

 

917

Total other expenses

 

23,559

 

16,384

 

44,677

 

31,482

Income before income taxes

 

80,422

 

65,439

 

127,937

 

98,488

Income tax expense

 

16,665

 

2,533

 

28,458

 

10,121

Net income

$

63,757

$

62,906

$

99,479

$

88,367

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

 

18,465,876

 

21,925,702

 

19,221,367

 

21,735,364

Basic net income per share

$

3.45

$

2.87

$

5.18

$

4.07

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

 

22,324,112

 

27,496,561

 

23,629,050

 

26,363,395

Diluted net income per share

$

2.86

$

2.29

$

4.21

$

3.35

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net revenues

 

$

592,473

 

 

$

549,328

 

 

$

1,769,879

 

 

$

1,548,165

 

Cost of goods sold

 

 

378,148

 

 

 

373,509

 

 

 

1,179,485

 

 

 

1,065,032

 

Gross profit

 

 

214,325

 

 

 

175,819

 

 

 

590,394

 

 

 

483,133

 

Selling, general and administrative expenses

 

 

171,163

 

 

 

160,433

 

 

 

528,213

 

 

 

457,207

 

Income from operations

 

 

43,162

 

 

 

15,386

 

 

 

62,181

 

 

 

25,926

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense—net

 

 

18,915

 

 

 

11,091

 

 

 

45,496

 

 

 

32,528

 

Loss on extinguishment of debt

 

 

4,880

 

 

 

 

 

 

4,880

 

 

 

 

Total other expenses

 

 

23,795

 

 

 

11,091

 

 

 

50,376

 

 

 

32,528

 

Income (loss) before income taxes

 

 

19,367

 

 

 

4,295

 

 

 

11,805

 

 

 

(6,602

)

Income tax expense (benefit)

 

 

6,216

 

 

 

1,778

 

 

 

9,886

 

 

 

(2,567

)

Net income (loss)

 

$

13,151

 

 

$

2,517

 

 

$

1,919

 

 

$

(4,035

)

Weighted-average shares used in computing

   basic net income (loss) per share

 

 

21,221,848

 

 

 

40,730,059

 

 

 

29,076,556

 

 

 

40,653,091

 

Basic net income (loss) per share

 

$

0.62

 

 

$

0.06

 

 

$

0.07

 

 

$

(0.10

)

Weighted-average shares used in computing

   diluted net income (loss) per share

 

 

23,535,617

 

 

 

40,926,450

 

 

 

30,593,382

 

 

 

40,653,091

 

Diluted net income (loss) per share

 

$

0.56

 

 

$

0.06

 

 

$

0.06

 

 

$

(0.10

)

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

4


Table of Contents

RH

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

2019

    

2018

    

2019

    

2018

Net income

$

63,757

$

62,906

$

99,479

$

88,367

Net gains (losses) from foreign currency translation

 

490

(482)

 

(447)

 

(1,746)

Total comprehensive income

$

64,247

$

62,424

$

99,032

$

86,621

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net income (loss)

 

$

13,151

 

 

$

2,517

 

 

$

1,919

 

 

$

(4,035

)

Net gains (losses) from foreign currency translation

 

 

(723

)

 

 

(915

)

 

 

154

 

 

 

485

 

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

   investments

 

 

 

 

 

(59

)

 

 

11

 

 

 

84

 

Total comprehensive income (loss)

 

$

12,428

 

 

$

1,543

 

 

$

2,084

 

 

$

(3,466

)

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

5


Table of Contents

RH

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSSTOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands)thousands, except share amounts)

(Unaudited)

Three Months Ended

 

Accumulated

 

Retained

 

Total

 

Additional

 

Other

 

Earnings

 

Stockholders’

 

Common Stock

 

Paid-In

 

Comprehensive

 

(Accumulated

 

Treasury Stock

 

Equity

    

Shares

    

Amount

    

Capital

    

Income (Loss)

    

Deficit)

    

Shares

    

Amount

    

(Deficit)

Balances—May 5, 2018

 

21,612,197

 

$

2

 

$

851,228

 

$

(1,435)

 

$

156,000

 

20,222,932

 

$

(1,000,569)

 

$

5,226

Stock-based compensation

 

 

 

5,988

 

 

 

 

 

5,988

Issuance of restricted stock

 

6,405

 

 

 

 

 

 

 

Vested and delivered restricted stock units

 

82,906

 

 

(7,512)

 

 

 

 

 

(7,512)

Exercise of stock options

 

527,931

 

 

26,286

 

 

 

 

 

26,286

Equity component value of convertible note issuance—net

 

 

89,933

 

 

 

 

 

89,933

Sale of common stock warrant

 

 

51,021

 

 

 

 

 

51,021

Purchase of convertible note hedge

 

 

(91,857)

 

 

 

 

 

(91,857)

Net income

 

 

 

 

 

62,906

 

 

 

62,906

Net gains (losses) from foreign currency
translation

 

 

 

 

(482)

 

 

 

 

(482)

Balances—August 4, 2018

 

22,229,439

 

$

2

 

$

925,087

 

$

(1,917)

 

$

218,906

 

20,222,932

 

$

(1,000,569)

 

$

141,509

Balances—May 4, 2019

 

18,357,816

 

$

2

 

$

362,986

 

$

(3,270)

 

$

(356,816)

 

2,170,196

 

$

(250,275)

 

$

(247,373)

Stock-based compensation

 

 

 

5,191

 

 

 

 

 

5,191

Issuance of restricted stock

 

7,014

 

 

 

 

 

 

 

Vested and delivered restricted stock units

 

80,400

 

 

(5,984)

 

 

 

 

 

(5,984)

Exercise of stock options

 

146,491

 

 

5,997

 

 

 

 

 

5,997

Retirement of treasury stock

 

 

 

(13,180)

 

 

(237,091)

 

(2,170,154)

 

250,271

 

Net income

 

 

 

 

 

63,757

 

 

 

63,757

Net gains (losses) from foreign currency translation

 

 

 

 

490

 

 

 

 

490

Conversion of convertible senior notes

42

(42)

4

4

Balances—August 3, 2019

 

18,591,763

 

$

2

 

$

355,010

 

$

(2,780)

 

$

(530,150)

 

 

$

 

$

(177,918)

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

 

 

 

 

As Revised

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,919

 

 

$

(4,035

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

51,092

 

 

 

41,248

 

Non-cash charges resulting from inventory step-up

 

 

2,108

 

 

 

5,187

 

Amortization of debt discount

 

 

22,685

 

 

 

21,467

 

Excess tax shortfall from exercise of stock options

 

 

 

 

 

2,275

 

Stock-based compensation expense

 

 

42,929

 

 

 

21,711

 

Non-cash loss on extinguishment of debt

 

 

1,880

 

 

 

 

Other non-cash interest expense

 

 

4,914

 

 

 

2,971

 

Change in assets and liabilities—net of acquisition:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(319

)

 

 

(1,445

)

Merchandise inventories

 

 

190,620

 

 

 

(23,261

)

Prepaid expense and other assets

 

 

38,419

 

 

 

(30,378

)

Accounts payable and accrued expenses

 

 

10,491

 

 

 

(63,435

)

Deferred revenue and customer deposits

 

 

20,617

 

 

 

22,652

 

Other current liabilities

 

 

448

 

 

 

(25,372

)

Deferred rent and lease incentives

 

 

846

 

 

 

2,953

 

Other non-current obligations

 

 

(1,887

)

 

 

8,477

 

Net cash provided by (used in) operating activities

 

 

386,762

 

 

 

(18,985

)

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(76,789

)

 

 

(104,152

)

Construction related deposits

 

 

(12,772

)

 

 

(3,829

)

Purchase of trademarks and domain names

 

 

(39

)

 

 

(164

)

Proceeds from sale of assets held for sale—net

 

 

15,123

 

 

 

 

Purchase of investments

 

 

(16,109

)

 

 

(186,967

)

Maturities of investments

 

 

46,890

 

 

 

115,938

 

Sales of investments

 

 

145,020

 

 

 

31,896

 

Acquisition of business—net of cash acquired

 

 

 

 

 

(116,100

)

Net cash provided by (used in) investing activities

 

 

101,324

 

 

 

(263,378

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Borrowing under asset based credit facility

 

 

446,000

 

 

 

 

Repayments under asset based credit facility

 

 

(105,000

)

 

 

 

Borrowings under term loans

 

 

180,000

 

 

 

 

Repayments under term loans

 

 

(100,000

)

 

 

 

Borrowing under promissory and equipment security notes

 

 

34,000

 

 

 

 

Repayments under promissory and equipment security notes

 

 

(841

)

 

 

 

Debt issuance costs

 

 

(8,298

)

 

 

 

Repurchases of common stock—including commissions

 

 

(1,000,326

)

 

 

 

Payments on build-to-suit lease transactions

 

 

(8,734

)

 

 

 

Proceeds from exercise of stock options

 

 

15,369

 

 

 

1,591

 

Excess tax shortfall from exercise of stock options

 

 

 

 

 

(2,275

)

Tax withholdings related to issuance of stock-based awards

 

 

(4,881

)

 

 

(1,365

)

Payments on capital leases

 

 

(258

)

 

 

(262

)

Net cash used in financing activities

 

 

(552,969

)

 

 

(2,311

)

Effects of foreign currency exchange rate translation

 

 

22

 

 

 

342

 

Net decrease in cash and cash equivalents

 

 

(64,861

)

 

 

(284,332

)

Cash and cash equivalents

 

 

 

 

 

 

 

 

Beginning of period

 

 

87,023

 

 

 

331,467

 

End of period

 

$

22,162

 

 

$

47,135

 

Non-cash transactions:

 

 

 

 

 

 

 

 

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

 

$

35,463

 

 

$

46,193

 

Property and equipment additions from use of construction related deposits

 

$

27,077

 

 

$

3,965

 

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

 

$

24,081

 

 

$

23,440

 

Property and equipment acquired under capital lease

 

$

753

 

 

$

 

Six Months Ended

 

Accumulated

 

Retained

 

Total

 

Additional

 

Other

 

Earnings

 

Stockholders’

 

Common Stock

 

Paid-In

 

Comprehensive

 

(Accumulated

 

Treasury Stock

 

Equity

    

Shares

    

Amount

    

Capital

    

Income (Loss)

    

Deficit)

    

Shares

    

Amount

    

(Deficit)

Balances—February 3, 2018

 

21,517,338

 

$

2

 

$

840,765

 

$

(171)

 

$

151,575

 

20,220,132

 

$

(1,000,326)

 

$

(8,155)

Stock-based compensation

 

 

 

13,879

 

 

 

 

 

13,879

Issuance of restricted stock

 

6,405

 

 

 

 

 

 

 

Vested and delivered restricted stock units

 

103,016

 

 

(7,863)

 

 

 

 

 

(7,863)

Exercise of stock options

 

605,480

 

 

29,209

 

 

 

 

 

29,209

Repurchases of common stock

 

(2,800)

 

 

 

 

 

2,800

 

(243)

 

(243)

Equity component value of convertible note issuance—net

 

 

89,933

 

 

 

 

 

89,933

Sale of common stock warrant

 

 

51,021

 

 

 

 

 

51,021

Purchase of convertible note hedge

 

 

(91,857)

 

 

 

 

 

(91,857)

Impact of Topic 606 adoption

 

 

 

 

(21,036)

 

 

 

(21,036)

Net income

 

 

 

 

 

88,367

 

 

 

88,367

Net gains (losses) from foreign currency translation

 

 

 

 

(1,746)

 

 

 

 

(1,746)

Balances—August 4, 2018

 

22,229,439

 

$

2

 

$

925,087

 

$

(1,917)

 

$

218,906

 

20,222,932

 

$

(1,000,569)

 

$

141,509

Balances—February 2, 2019

 

20,477,813

 

$

2

 

$

356,422

 

$

(2,333)

 

$

(392,538)

 

2,800

 

$

(243)

 

$

(38,690)

Stock-based compensation

 

 

 

10,779

 

 

 

 

 

10,779

Issuance of restricted stock

 

7,014

 

 

 

 

 

 

 

Vested and delivered restricted stock units

 

101,641

 

 

(6,234)

 

 

 

 

 

(6,234)

Exercise of stock options

 

172,649

 

 

7,223

 

 

 

 

 

7,223

Repurchases of common stock

 

(2,167,396)

 

 

 

 

 

2,167,396

 

(250,032)

 

(250,032)

Retirement of treasury stock

 

 

 

(13,180)

 

 

(237,091)

 

(2,170,154)

 

250,271

 

Net income

 

 

 

 

 

99,479

 

 

 

99,479

Net gains (losses) from foreign currency translation

 

 

 

 

(447)

 

 

 

 

(447)

Conversion of convertible senior notes

42

(42)

4

4

Balances—August 3, 2019

 

18,591,763

 

$

2

 

$

355,010

 

$

(2,780)

 

$

(530,150)

 

 

$

 

$

(177,918)

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

6


Table of Contents

RH

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

Six Months Ended

August 3,

August 4,

    

2019

    

2018

CASH FLOWS FROM OPERATING ACTIVITIES

Net income

$

99,479

$

88,367

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

Depreciation and amortization

 

52,510

 

41,939

Non-cash operating lease cost

33,227

34,118

Amortization of debt discount

 

22,962

 

17,645

Accretion of debt discount upon settlement of debt

(70,482)

Stock-based compensation expense

 

10,993

 

14,092

Non-cash finance lease interest expense

11,186

6,411

Product recalls

(2,106)

Net non-cash charges resulting from inventory step-up

 

 

380

(Gain) loss on extinguishment of debt

(954)

917

Other non-cash interest expense

 

2,251

 

1,276

Change in assets and liabilities:

 

 

Accounts receivable

 

(504)

 

(9,050)

Merchandise inventories

 

51,189

 

(24,995)

Prepaid expense and other assets

 

(2,882)

 

(40,646)

Landlord assets under construction

 

(27,555)

 

(27,645)

Accounts payable and accrued expenses

 

(40,073)

 

(31,707)

Deferred revenue and customer deposits

 

12,987

 

20,800

Other current liabilities

 

3,179

 

8,179

Current and non-current operating lease liability

 

(44,513)

 

(43,025)

Other non-current obligations

 

(13,761)

 

(8,036)

Net cash provided by operating activities

 

97,133

 

49,020

CASH FLOWS FROM INVESTING ACTIVITIES

 

  

 

  

Capital expenditures

 

(25,283)

 

(42,916)

Net cash used in investing activities

 

(25,283)

 

(42,916)

CASH FLOWS FROM FINANCING ACTIVITIES

 

  

 

  

Borrowing under asset based credit facility

 

302,000

 

510,000

Repayments under asset based credit facility

 

(214,500)

 

(709,970)

Borrowings under term loans

 

320,000

 

Repayments under term loans

(80,000)

Borrowing under equipment security notes

 

69,000

 

Repayments under promissory and equipment security notes

 

(4,993)

 

(31,974)

Debt issuance costs

 

(4,636)

 

Proceeds from issuance of convertible senior notes

 

 

335,000

Proceeds from issuance of warrants

 

 

51,021

Purchase of convertible note hedges

 

 

(91,857)

Debt issuance costs related to convertible senior notes

 

 

(6,349)

Repayments of convertible senior notes

(278,560)

Principal payments under finance leases

(4,399)

(3,567)

Repurchases of common stock—including commissions

 

(250,032)

 

Proceeds from exercise of stock options

 

7,223

 

29,209

Tax withholdings related to issuance of stock-based awards

(6,234)

 

(7,863)

Payments under promissory notes related to share repurchases

(892)

Net cash used in financing activities

 

(66,023)

 

(6,350)

Effects of foreign currency exchange rate translation

 

(75)

 

(124)

Net increase (decrease) in cash and cash equivalents and restricted cash equivalents

 

5,752

 

(370)

Cash and cash equivalents and restricted cash equivalents

 

  

 

  

Beginning of period—cash and cash equivalents

 

5,803

 

17,907

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

 

 

7,407

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

$

5,803

$

25,314

 

  

 

  

End of period—cash and cash equivalents

 

11,555

 

22,199

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

 

 

2,745

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

$

11,555

$

24,944

Non-cash transactions:

 

 

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

$

10,875

$

7,713

Landlord asset additions in accounts payable and accrued expenses at period-end

21,055

17,183

Landlord asset additions from unpaid construction related deposits

 

195

 

517

Reclassification of assets from landlord assets under construction to finance lease right-of-use assets

31,131

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

 

 

243

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

7

Table of Contents

RH

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—THE COMPANY

Nature of Business

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

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 28, 2017,August 3, 2019, the Company operated a total of 84 retail70 RH Galleries and 3140 RH outlet stores in 32 states, the District of Columbia and Canada, and includesas well as 15 Waterworks showrooms inthroughout 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 October 28, 2017,August 3, 2019, and the results of operations for the three and ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016.August 4, 2018. The Company’s current fiscal year, which consists of 5352 weeks, ends on February 3, 20181, 2020 (“fiscal 2017”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 January 28, 2017February 2, 2019 (the “2016“2018 Form 10-K”). Certain prior year amounts have been reclassified for consistency withadjusted to conform to the current period presentation.presentation due to the adoption of the new lease accounting standard. Refer to “Revision” below.Note 2—Recently Issued Accounting Standards.

The results of operations for the three and ninesix months ended October 28, 2017August 3, 2019 presented herein are not necessarily indicative of the results to be expected for the full fiscal year.

RevisionRevisions

DuringAs previously disclosed in our Annual Report on Form 10-K as of and for the fourthyear ended February 2, 2019, during the third quarter of fiscal 2016,2018, management determined that the Company had incorrectly reported negative cash balances due to outstanding checks in the accounts payable and accrued expenses financial statement line item inimpact during the fiscal year ended February 3, 2018 of retiring its condensed consolidated balance sheets without properly applying the limited right of offset against cash and cash equivalentscommon stock in accordance with ASC 210Accounting Standards Codification (“ASC”) 505Balance Sheet.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 cash and cash equivalentsadditional paid-in capital of $19.5 million, from $944.6 million as reported to $925.1 million as revised, and an overstatement of accounts payable and accrued expenses on its condensed consolidated balance sheets,treasury stock of $19.5 million, from $1,020.1 million as wellreported to $1,000.6 million as a misstatement of the cash provided by operating activitiesrevised, on the condensed consolidated statementsbalance sheet as of cash flows.August 4, 2018. There was no impact on the condensed consolidated statements of income or stockholders’ equitycondensed cash flows related to these misstatements.

The Company assessed the materiality of these misstatements on prior periods financial statements in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 99Materiality, codified in Accounting Standards Codification (“ASC”) 250Presentation of Financial Statements, and concluded that these misstatements werethis misstatement. Although this error was not considered to be material to any prior annual orof the previously issued financial statements, the Company has revised the accompanying unaudited interim periods. Accordingly, in accordance with ASC 250 (SAB No. 108Consideringfinancial statements to reflect the Effectscorrection of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statementsthis error.

8

Table of Contents

During the adoption process of the new lease accounting standard (refer to Note 2—Recently Issued Accounting Standards), the amounts have beenCompany 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 cash flows.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.

7


The following are selected line items from the Company’s unaudited 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)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)

9

Table of Contents

 

 

Nine Months Ended

 

 

 

October 29,

 

 

 

2016

 

 

 

As Reported

 

 

Adjustment

 

 

As Revised

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

Change in accounts payable and accrued expenses

 

$

(73,574

)

 

$

10,139

 

 

$

(63,435

)

Net cash used in operating activities

 

$

(29,124

)

 

$

10,139

 

 

$

(18,985

)

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

Beginning of period

 

$

349,897

 

 

$

(18,430

)

 

$

331,467

 

End of period

 

$

55,426

 

 

$

(8,291

)

 

$

47,135

 

NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS

Stock-Based Compensation

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update No. 2016-09Improvements to Employee Share Based Payment Accounting (“ASU 2016-09”). 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 new guidance was effective for the Company beginning on January 29, 2017. As a result of the adoption of this new guidance, the Company recognized an excess tax benefit of $1.9 million and $4.3 million in the provision for income taxes as a discrete item during the three and nine months ended October 28, 2017, respectively. These amounts may not necessarily be indicative of future amounts that may be recognized as any excess tax benefits recognized would be dependent on future stock price, employee exercise behavior and applicable tax rates. As permitted, the Company elected to classify excess tax benefits (shortfalls) as an operating activity in the condensed consolidated statements of cash flows instead of as a financing activity on a prospective basis and did not retrospectively adjust prior periods.

In May 2017, the FASB issued Accounting Standard Update No. 2017-09—Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. The new guidance clarifies when modification accounting should be applied for changes to terms or conditions of a share-based payment award. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted. The standard will be applied prospectively. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

Revenue from Contracts with Customers

In May 2014, the FASB and International Accounting Standards Board issued their converged accounting standard update on revenue recognition, Accounting Standards Update 2014-09—Revenue from Contracts with Customers (Topic 606). This guidance outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Under the new guidance, transfer of control is no longer the same as transfer of risks and rewards as indicated in the prior guidance. The FASB deferred the effective date for the new revenue reporting standard for entities reporting under GAAP for one year from the original effective date. In 2016, the FASB issued several amendments to the standard, including principal versus agent considerations when another party is involved in providing goods or services to a customer, the application of identifying performance obligations, and the recognition of expected breakage amounts.

The Company continues to assess all potential impacts of the standard. In applying the guidance under Topic 606, specifically related to the indicators of transfer of control, the Company continues to assess the guidance and has not yet concluded how such guidance will be applied to its revenue streams. The Company plans to elect to adopt the practical expedient related to shipping and handling activities. The Company has concluded that the new standard will have an impact related to the accounting for gift card breakage. Under Topic 606 the Company expects to recognize breakage, which is currently recorded as a reduction to selling, general and administrative expenses, as revenue and breakage will be recognized proportional to actual gift card redemptions.

Topic 606 is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted for annual reporting periods beginning after December 15, 2016. The Company will adopt Topic 606 in

8


the first quarter of fiscal 2018. The Company has elected to adopt using a modified retrospective approach with the cumulative effect of initially applying the new standard recognized in retained earnings at the date of adoption.

Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update 2016-022016-02—Leases, which for operating leases, 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 andwith a corresponding lease liability initially measured atrepresenting the present value of the lease payments, in its balance sheet.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 generally 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.

10

Table of Contents

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.

11

Table of Contents

(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 public companies for fiscal years beginning after December 15, 2018,2019, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of ASU 2016-02this new accounting standard 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.

Cash Flow Classification

In August 2016, the FASB issued Accounting Standard Update No. 2016-15Statement 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 consolidated statements of cash flows. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company 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. 2016-16Income 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.

Goodwill and Intangibles

In January 2017, the FASB issued Accounting Standard Update No. 2017-04IntangiblesGoodwill and Other (Topic 350). The updated guidance simplifies the measurement of goodwill impairment by removing step two of the goodwill impairment test, which requires the determination of the fair value of individual assets and liabilities of a reporting unit. The new guidance requires goodwill impairment to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments should be applied on a prospective basis. The new standard is effective for fiscal years beginning after December 15, 2019 with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

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, which are classified as a liability, are included in non-current liabilities on the condensed consolidated balance sheets (refer to Note 15—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, and owns 100% of the voting equity interest.

9


During the nine months ended October 29, 2016, the Company incurred $2.8 million, of acquisition-related costs associated with the transaction. The Company did not incur any acquisition-related costs during the three months ended October 29, 2016. 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 Company recorded a purchase price allocation adjustment of $1.9 million during the first half of 2017. The adjustment primarily related to a subset of inventory acquired for which the Company completed a fair value analysis based on the facts and circumstances that existed as of the acquisition date. Subsequent to the acquisition date, only a small portion of such inventory had been sold and therefore the impact on the Company’s results of operations for historical periods since the acquisition was insignificant. The following table summarizes the purchase price allocation based on the estimated fair value of the acquired assets and assumed liabilities, prior to and after the purchase price allocation adjustments (in thousands):

 

 

 

 

 

 

Purchase Price

 

 

 

 

 

 

 

January 28,

 

 

Allocation

 

 

October 28,

 

 

 

2017

 

 

Adjustments

 

 

2017

 

Tangible assets acquired and liabilities assumed

 

$

18,615

 

 

$

(1,916

)

 

$

16,699

 

Trademarks

 

 

52,100

 

 

 

 

 

 

52,100

 

Goodwill

 

 

49,229

 

 

 

1,916

 

 

 

51,145

 

Total

 

$

119,944

 

 

$

 

 

$

119,944

 

Any future changes to the purchase price will be recorded directly to the consolidated statements of operations and will not impact the goodwill recorded as a result of this acquisition.

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 $9.7 million for marketable inventory.

Trademarks 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. A portion of the trademarks and goodwill are not 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 condensed 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—ASSET HELD FOR SALE

Building and Land

During the first quarter of fiscal 2017, the Company committed to a plan to sell the building and land at one of its owned retail Galleries, resulting in a reclassification of building and land of $8.2 million from property and equipment to asset held for sale on the condensed consolidated balance sheets as of April 29, 2017. In May 2017, the Company completed the sale of the building and land for approximately $10.2 million and entered into a short-term five month lease agreement to lease the property. As a result, the gain associated with the sale of this property was amortized over a five month period. During the three and nine months ended October 28, 2017, the Company recorded a gain of $0.8 million and $2.1 million, respectively, which is included as a reduction of selling, general and administrative expenses on the condensed consolidated statements of operations. No additional gain associated with this transaction will be recognized in future periods.

Aircraft

During the fourth quarter of fiscal 2016, the Company committed to a plan to sell an aircraft, which resulted in a reclassification of such aircraft from property and equipment to asset held for sale on the condensed consolidated balance sheets as of January 28, 2017. The asset held for sale had a carrying value of $4.9 million as of January 28, 2017. In April 2017, the sale of the aircraft was completed for a purchase price of $5.2 million and the Company incurred costs of $0.3 million to dispose of the asset.

10


NOTE 5—PREPAID EXPENSE AND OTHER ASSETS

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

    

August 3,

    

February 2,

2019

2019

Insurance recovery receivable (1)

$

50,171

$

50,000

Capitalized catalog costs

 

12,378

 

16,178

Vendor deposits

 

11,407

 

11,836

Right of return asset for merchandise

 

6,645

 

5,883

Federal and state tax receivable

1,036

4,862

Prepaid expense and other current assets

 

17,660

 

15,439

Total prepaid expense and other current assets

$

99,297

$

104,198

(1)Refer to Note 15—Commitments and Contingencies.

12

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Capitalized catalog costs

 

$

44,252

 

 

$

61,258

 

Vendor deposits

 

 

8,374

 

 

 

13,276

 

Federal and state tax receivable

 

 

5,598

 

 

 

13,124

 

Prepaid expense and other current assets

 

 

16,817

 

 

 

29,504

 

Total prepaid expense and other current assets

 

$

75,041

 

 

$

117,162

 

Table of Contents

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

    

August 3,

    

February 2,

2019

2019

Landlord assets under construction

$

94,710

$

63,159

Promissory note receivable, including interest

 

5,229

 

5,104

Deferred financing fees

 

3,722

 

3,415

Other deposits

 

5,559

 

5,068

Other non-current assets

 

3,033

 

2,840

Total other non-current assets

$

112,253

$

79,586

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Construction related deposits

 

$

13,739

 

 

$

28,044

 

Other deposits

 

 

4,926

 

 

 

4,706

 

Deferred financing fees

 

 

4,698

 

 

 

1,530

 

Other non-current assets

 

 

5,395

 

 

 

1,889

 

Total other non-current assets

 

$

28,758

 

 

$

36,169

 

NOTE 6—4—GOODWILL, TRADENAMES, TRADEMARKS AND INTANGIBLE ASSETSDOMAIN NAMES

The following sets forth the goodwill, tradenames, trademarks and intangible assets as of October 28, 2017domain names activity for the RH Segment and Waterworks for the six months ended August 3, 2019 (in thousands):

    

    

Foreign

    

February 2,

Currency

August 3,

2019

Translation

2019

RH Segment

 

  

 

  

 

  

Goodwill

$

124,379

$

(9)

$

124,370

Tradenames, trademarks and domain names

 

48,563

 

 

48,563

 

  

 

  

 

  

Waterworks (1)

 

  

 

  

 

  

Tradename (2)

 

37,459

 

 

37,459

 

 

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

 

$

1,925

 

 

$

(1,862

)

 

$

 

 

$

63

 

Fair market write-down (2)

 

 

(1,467

)

 

 

1,393

 

 

 

 

 

 

(74

)

Total intangible assets subject to amortization

 

$

458

 

 

$

(469

)

 

$

��

 

 

$

(11

)

Intangible assets not subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill (3)(4)

 

$

175,605

 

 

$

 

 

$

(52

)

 

$

175,553

 

Trademarks and domain names (4)

 

$

100,663

 

 

$

 

 

$

 

 

$

100,663

 

(1)

The fair valueWaterworks reporting unit goodwill 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.

(3)

Waterworks goodwill increased $1.9$51.1 million during the nine months ended October 28, 2017 due to purchase price accounting adjustments. Refer to Note 3—Business Combination.

(4)

Refer to Note 18—Segment Reporting for goodwill and trademarks and domain names by reportable segment.

11


The following sets forth the goodwill and intangible assets as of January 28, 2017 (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

 

$

1,925

 

 

$

(1,792

)

 

$

 

 

$

133

 

Fair market write-down (2)

 

 

(1,467

)

 

 

1,350

 

 

 

 

 

 

(117

)

Total intangible assets subject to amortization

 

$

458

 

 

$

(442

)

 

$

 

 

$

16

 

Intangible assets not subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill (3)(4)

 

$

173,690

 

 

$

 

 

$

(87

)

 

$

173,603

 

Trademarks and domain names (3)(4)

 

$

100,624

 

 

$

 

 

$

 

 

$

100,624

 

(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.

(3)

The Company recorded goodwill and trademarks of $49.2 million and $52.1 million, respectively,recognized upon acquisition in fiscal 2016 related to its acquisitionwas fully impaired as of Waterworks. Refer to Note 3—Business Combination.

February 2, 2019, with $17.4 million and $33.7 million impairment recorded in fiscal 2018 and fiscal 2017, respectively.

(4)

(2)

Refer to Note 18—Segment Reporting for goodwill and trademarks and domain names by reportable segment.

The Waterworks reporting unit tradename is presented net of an impairment charge of $14.6 million recorded in fiscal 2018.

NOTE 7—5—ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

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

    

August 3,

    

February 2,

2019

2019

Accounts payable

$

145,583

$

183,039

Accrued compensation

 

47,979

 

64,192

Accrued freight and duty

 

24,115

 

20,787

Accrued sales taxes

 

18,743

���

 

18,354

Accrued catalog costs

 

14,490

 

10,276

Accrued occupancy

 

11,528

 

10,839

Accrued professional fees

 

3,442

 

2,050

Other accrued expenses

 

23,833

 

10,960

Total accounts payable and accrued expenses

$

289,713

$

320,497

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Accounts payable

 

$

130,902

 

 

$

134,720

 

Accrued compensation

 

 

43,697

 

 

 

26,886

 

Accrued freight and duty

 

 

21,952

 

 

 

27,955

 

Accrued sales taxes

 

 

15,517

 

 

 

14,908

 

Accrued catalog costs

 

 

13,296

 

 

 

3,874

 

Accrued occupancy

 

 

11,422

 

 

 

8,137

 

Accrued professional fees

 

 

3,801

 

 

 

2,082

 

Other accrued expenses

 

 

11,982

 

 

 

8,418

 

Total accounts payable and accrued expenses

 

$

252,569

 

 

$

226,980

 

13

Table of Contents

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

    

August 3,

    

February 2,

2019

2019

Provision for legal settlement (1)

$

50,171

$

50,000

Allowance for sales returns

22,380

19,821

Current portion of debt

 

21,514

 

892

Unredeemed gift card and merchandise credit liability

 

17,177

 

17,192

Finance lease liabilities

8,127

9,184

Product recall reserve

 

4,647

 

7,767

Federal tax payable

 

2,413

 

719

Other current liabilities

 

5,454

 

3,881

Total other current liabilities

$

131,883

$

109,456

(1)Refer to Note 15—Commitments and Contingencies.

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Unredeemed gift card and merchandise credit liability

 

$

27,448

 

 

$

24,524

 

Allowance for sales returns

 

 

10,999

 

 

 

10,077

 

Current portion of non-current debt

 

 

5,986

 

 

 

 

Product recall reserves

 

 

2,218

 

 

 

4,324

 

Other current liabilities

 

 

3,958

 

 

 

4,346

 

Total other current liabilities

 

$

50,609

 

 

$

43,271

 

Contract Liabilities

12The Company defers revenue associated with merchandise delivered via the home-delivery channel. The Company expects that substantially all of the deferred revenue, customer deposits and deferred membership fees as of August 3, 2019 will be recognized within the next six months as the performance obligations are satisfied.


In addition, the Company defers revenue when cash payments are received in advance of performance for unsatisfied obligations related to its gift cards and merchandise credits. During the three months ended August 3, 2019 and August 4, 2018, the Company recognized $4.6 million and $4.8 million, respectively, of revenue related to previous deferrals related to its gift cards and merchandise credits. During the six months ended August 3, 2019 and August 4, 2018, the Company recognized $9.3 million and $9.7 million, respectively, of revenue related to previous deferrals related to its gift cards and merchandise credits. During both the three months ended August 3, 2019 and August 4, 2018, the Company recorded gift card breakage of $0.4 million. During both the six months ended August 3, 2019 and August 4, 2018, the Company recorded gift card breakage of $0.8 million. The Company expects that approximately 70% of the remaining gift card and merchandise credit liabilities as of August 3, 2019 will be recognized within the next twelve months as the gift cards are redeemed by customers.

NOTE 8—6—OTHER NON-CURRENT OBLIGATIONS

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

    

August 3,

    

February 2,

2019

2019

Notes payable for share repurchases

$

18,741

$

18,741

Unrecognized tax benefits

 

3,222

 

2,992

Rollover units and profit interests (1)

 

2,850

 

2,637

Deferred contract incentive (2)

 

1,786

 

2,976

Other non-current obligations

 

3,549

 

5,166

Total other non-current obligations

$

30,148

$

32,512

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Notes payable for share repurchases

 

$

19,390

 

 

$

19,390

 

Equipment security notes (1)

 

 

15,040

 

 

 

 

Promissory note (2)

 

 

11,968

 

 

 

 

Capital lease obligations—non-current

 

 

7,553

 

 

 

7,242

 

Deferred contract incentive (3)

 

 

5,953

 

 

 

7,739

 

Unrecognized tax benefits

 

 

2,617

 

 

 

2,508

 

Rollover units and profit interests (4)

 

 

2,104

 

 

 

1,784

 

Other non-current obligations

 

 

5,770

 

 

 

6,021

 

Total other non-current obligations

 

$

70,395

 

 

$

44,684

 

(1)

Represents rollover units and profit interests associated with the non-current portionacquisition of equipment security notes secured by certain of the Company’s distribution center property and equipment.

Waterworks. Refer to Note 14Stock-Based Compensation.

(2)

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

(3)

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

.

14

NOTE 7—LEASES

Accounting Policy

The Company leases nearly all of its retail and outlet store locations, corporate headquarters, distribution and home delivery facilities, as well as other storage and office space. The initial lease terms of the Company’s real estate leases generally range from ten to fifteen years, and certain leases contain renewal options for up to an additional 25 years, the exercise of which is at the Company’s sole discretion. In recognizing the lease right-of-use assets and lease liabilities, the Company utilizes the lease term for which it is reasonably certain to use the underlying asset, including consideration of options to extend or terminate the lease. The Company also leases certain equipment with lease terms generally ranging from three to seven years. The Company’s lease agreements generally do not contain any material residual value guarantees or material restrictions or covenants.

Leases, or lease extensions, with a term of twelve months or less are not recorded on the condensed consolidated balance sheets, and the Company recognizes lease expense for these leases on a straight-line basis over the lease term.

The Company accounts for lease and non-lease components as a single lease component for real estate leases, and for all other asset classes the Company accounts for the components separately. The Company determines the lease classification and begins to recognize lease and any related financing expenses upon the lease’s commencement, which for real estate leases is generally upon store opening or, to a lesser extent, when the Company takes possession or control of the asset.

As most of the Company’s leases do not include an implicit interest rate, the Company determines the discount rate for each lease based upon the incremental borrowing rate (“IBR”) in order to calculate the present value of lease payments at the commencement date. The IBR is computed as the rate of interest that the Company would have to pay to (i) borrow on a collateralized basis (ii) over a similar term (iii) an amount equal to the total lease payments and (iv) in a similar economic environment. The Company utilizes its asset based credit facility as the basis for determining the applicable IBR for each lease.

Certain of the Company’s lease agreements include rental payments based on a percentage of retail sales over contractual levels. Due to the variable and unpredictable nature of such payments, the Company does not recognize a lease right-of-use asset and lease liability related to such payments. Estimated variable rental payments are included in accounts payable and accrued expenses on the condensed consolidated balance sheets.

The Company has a small group of leases that include rental payments periodically adjusted for inflation (e.g., based on the consumer price index). The Company includes these variable payments in the initial measurement of the lease right-of-use asset and lease liability if such increases have a minimum rent escalation (e.g., floor). However, the Company excludes these variable payments from the initial measurement of the lease right-of-use asset and lease liability in the case of lease arrangements that do not specify a minimum rent escalation.

The Company rents or subleases certain real estate to third parties under operating leases and recognizes rental income received on a straight-line basis over the lease term, which is recorded as an offset to selling, general and administrative expenses on the condensed consolidated statements of income.

Lease arrangements may require the landlord to provide tenant allowances directly to the Company. Standard tenant allowances received from landlords, typically those received under operating lease agreements, are recorded as cash and cash equivalents with an offset recorded in lease right-of-use assets on the condensed consolidated balance sheets. In certain instances tenant allowances are provided for the Company to design and build the leased asset. Tenant allowances received from landlords during the construction phase of a leased asset and prior to lease commencement are recorded as cash and cash equivalents with an offset recorded in other non-current assets (to the extent the Company has incurred related capital expenditure for construction costs) or in other current liabilities (to the extent that payments are received prior to capital construction expenditures by the Company) on the condensed consolidated balance sheets. After the leased asset is constructed and the lease commences, the Company reclassifies the tenant allowance from other non-current assets or other current liabilities to lease right-of-use assets on the condensed consolidated balance sheets.

15

Lease Classification

Certain of the Company’s real estate and property and equipment are held under finance leases. Lease related assets are included in finance lease right-of-use assets within property and equipment—net on the condensed consolidated balance sheets.

Leases that do not meet the definition of a finance lease are considered operating leases. Lease related assets are included in operating lease right-of-use assets on the condensed consolidated balance sheets.

Construction Related Activities

The Company is sometimes involved in the construction of leased stores for certain of its newer Design Galleries. Prior to construction commencement, the Company evaluates whether or not it, as lessee, controls the asset being constructed and, depending on the extent to which it is involved, the Company may be the “deemed owner” of the leased asset for accounting purposes during the construction period.

If the Company is not the “deemed owner” for accounting purposes during the construction period, such lease is classified as either an operating or finance lease upon lease commencement. During the construction period and prior to lease commencement, any capital amounts contributed by the Company toward the construction of the leased asset (excluding normal leasehold improvements, which are recorded within property and equipment—net) are recorded as “Landlord assets under construction” within other non-current assets on the condensed consolidated balance sheets (refer to Note 3—Prepaid Expense and Other Assets). Upon completion of the construction project, and upon lease commencement, the Company reclassifies amounts of the construction project determined to be the landlord asset to lease right-of-use assets on the condensed consolidated balance sheets. The construction costs determined not to be part of the leased asset are classified as property and equipment—net on the condensed consolidated balance sheets.

If the Company is the “deemed owner” for accounting purposes, upon commencement of the construction project, it is required to capitalize (i) costs incurred by the Company and (ii) the cash and non-cash assets contributed by the landlord for construction as property and equipment on its condensed consolidated balance sheets as build-to-suit assets, with an offsetting financing obligation under build-to-suit lease transactions. The contributions by the landlord toward construction, including the building, existing site improvements at construction commencement and any amounts paid by the landlord to those responsible for construction, are included as property and equipment additions due to build-to-suit lease transactions within the non-cash section of the consolidated statements of cash flows. Over the lease term, these non-cash additions to property and equipment do not impact the Company’s cash outflows, nor do they impact net income within the consolidated statements of income.

Upon completion of the construction project, the Company performs a sale-leaseback analysis to determine if it can derecognize the build-to-suit asset and corresponding financing obligation. If the asset and liability cannot be derecognized, the Company accounts for the agreement as a debt-like arrangement.

16

Lease Disclosures

Lease costs—net consist of the following (in thousands):

Three Months Ended

Six Months Ended

August 3,

    

August 4,

August 3,

    

August 4,

    

2019

    

2018

2019

    

2018

Operating lease cost (1)(2)

$

23,259

$

22,743

 

$

42,376

$

44,089

Finance lease costs

Amortization of leased assets (1)

9,235

6,441

18,087

12,340

Interest on lease liabilities (3)

5,672

3,319

11,186

6,411

Sublease income (4)

(1,507)

(2,261)

(4,789)

(3,271)

Total lease costs—net

$

36,659

$

30,242

$

66,860

$

59,569

(4)

(1)

Represents rollover unitsOperating lease costs and profit interests associated withamortization of finance lease right-of-use assets are included in cost of goods sold or selling, general and administrative expenses on the acquisitioncondensed consolidated statements of Waterworks.income based on the Company’s policy. Refer to Note 15Stock-Based Compensation.

3—Significant Accounting Policies in the 2018 Form 10-K.
(2)Includes short-term leases and variable lease costs.
(3)Included in interest expense—net on the condensed consolidated statements of income.
(4)Included in selling, general and administrative expenses on the condensed consolidated statements of income.

Lease right-of-use assets and lease liabilities consist of the following (in thousands):

August 3,

February 2,

2019

2019

Balance Sheet Classification

Assets

Operating leases

Operating lease right-of-use assets

$

421,001

$

440,504

Finance leases (1)(2)

Property and equipment—net

650,699

646,875

Total lease right-of-use assets

1,071,700

1,087,379

Liabilities

Current

Operating leases

Operating lease liabilities

$

57,162

$

66,249

Finance leases

Other current liabilities

8,127

9,184

Total lease liabilities—current

65,289

75,433

Non-current

Operating leases

Non-current operating lease liabilities

$

415,803

$

437,557

Finance leases

Non-current finance lease liabilities

433,591

421,245

Total lease liabilities—non-current

849,394

858,802

Total lease liabilities

$

914,683

$

934,235

(1)Finance lease right-of-use assets include capitalized amounts related to the Company’s construction activities to design and build leased assets, as well as rent payments made to landlords for which the respective Galleries are not yet opened.
(2)Finance lease right-of-use assets are recorded net of accumulated amortization of $73.3 million and $55.5 million as of August 3, 2019 and February 2, 2019, respectively.

17

Table of Contents

The maturities of lease liabilities are as follows as of August 3, 2019 (in thousands):

Fiscal year

    

Operating
Leases

    

Finance
Leases

    

Total

Remainder of fiscal 2019

$

33,456

$

14,014

$

47,470

2020

78,990

33,456

112,446

2021

65,068

33,908

98,976

2022

57,226

34,385

91,611

2023

53,867

35,153

89,020

2024

49,901

35,689

85,590

Thereafter

228,093

548,302

776,395

Total lease payments (1)

566,601

734,907

1,301,508

Less—imputed interest (2)

(93,636)

(293,189)

(386,825)

Present value of lease liabilities (3)

$

472,965

$

441,718

$

914,683

(1)Total lease payments exclude $369.1 million of legally binding payments for leases signed but not yet commenced as of August 3, 2019.
(2)Calculated using the incremental borrowing rate for each lease at lease commencement.
(3)Excludes future commitments under short-term lease agreements of $1.4 million as of August 3, 2019.

Supplemental information related to leases consists of the following:

Six Months Ended

August 3,

August 4,

    

2019

    

2018

Weighted-average remaining lease term (years)

Operating leases

8.9

9.6

Finance leases

18.9

18.4

Weighted-average discount rate

Operating leases

3.81%

3.74%

Finance leases

5.26%

4.95%

Other information related to leases consists of the following (in thousands):

Six Months Ended

August 3,

August 4,

    

2019

    

2018

Cash paid for amounts included in the measurement of lease liabilities

Operating cash flows from operating leases

$

(53,670)

$

(54,287)

Operating cash flows from finance leases

(11,186)

(6,411)

Financing cash flows from finance leases

(4,399)

(3,567)

Total cash outflows from leases

$

(69,255)

$

(64,265)

Lease right-of-use assets obtained in exchange for lease obligations (non-cash)

Finance leases

$

17,997

$

27,874

Operating leases

13,839

15,024

18

Table of Contents

NOTE 9—8—CONVERTIBLE SENIOR NOTES

0.00% Convertible Senior Notes due 2023

In June 2018, the Company issued in a private offering $300 million principal amount of 0.00% convertible senior notes due 2023 and issued an additional $35 million principal amount in connection with the overallotment option granted to the initial purchasers as part of the offering (collectively, the “2023 Notes”). The 2023 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2023 Notes will mature on June 15, 2023, unless earlier purchased by the Company or converted. The 2023 Notes will not bear interest, except that the 2023 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 2023 Notes. The 2023 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 2023 Notes, which may result in the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes.

The initial conversion rate applicable to the 2023 Notes is 5.1640 shares of common stock per $1,000 principal amount of 2023 Notes, which is equivalent to an initial conversion price of approximately $193.65 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 2023 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2023, the 2023 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2018, 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 calendar 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 5 consecutive business day period after any 10 consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2023 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 August 3, 2019, none of these conditions have occurred and, as a result, the 2023 Notes were not convertible as of August 3, 2019. On and after March 15, 2023, 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 2023 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2023 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 2023 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 2023 Notes for cash at a price equal to 100% of the principal amount of the 2023 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 2023 Notes, the Company separated the 2023 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 2023 Notes and the fair value of the liability component of the 2023 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 6.35% over the expected life of the 2023 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

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Table of Contents

In accounting for the debt issuance costs related to the issuance of the 2023 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 2023 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity (deficit).

Debt issuance costs related to the 2023 Notes were comprised of discounts upon original issuance of $1.7 million and third party offering costs of $4.6 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 2023 balance on the condensed consolidated balance sheets. During the three months ended August 3, 2019 and August 4, 2018, the Company recorded $0.3 million and $0.1 million, respectively, related to the amortization of debt issuance costs. During the six months ended August 3, 2019 and August 4, 2018, the Company recorded $0.5 million and $0.1 million related to the amortization of debt issuance costs, respectively.

The carrying values of the 2023 Notes, excluding the discounts upon original issuance and third party offering costs, are as follows (in thousands):

    

August 3,

    

February 2,

2019

2019

Liability component

 

  

 

  

Principal

$

335,000

$

335,000

Less: Debt discount

 

(73,152)

 

(81,311)

Net carrying amount

$

261,848

$

253,689

Equity component (1)

$

90,990

$

90,990

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

The Company recorded interest expense of $4.1 million and $1.8 million for the amortization of the debt discount related to the 2023 Notes during the three months ended August 3, 2019 and August 4, 2018, respectively. The Company recorded interest expense of $8.2 million and $1.8 million for the amortization of the debt discount related to the 2023 Notes during the six months ended August 3, 2019 and August 4, 2018, respectively.

2023 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2023 Notes and exercise of the overallotment option in June 2018, the Company entered into convertible note hedge transactions whereby the Company has the option to purchase a total of approximately 1.7 million shares of its common stock at a price of approximately $193.65 per share. The total cost of the convertible note hedge transactions was $91.9 million. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.7 million shares of the Company’s common stock at a price of $309.84 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 3.5 million shares of common stock (which cap may also be subject to adjustment). The Company received $51.0 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 2023 Notes until the Company’s common stock is above approximately $309.84 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 $22.3 million in connection with the debt discount associated with the 2023 Notes and recorded a deferred tax asset of $22.5 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.

20

Table of Contents

0.00% Convertible Senior Notes due 2020

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

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

Prior to March 15, 2020, the 2020 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2015, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscalcalendar 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 five5 consecutive business day period after any ten10 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 28, 2017,August 3, 2019, none of these conditions have occurred and, as a result, the 2020 Notes arewere not convertible as of October 28, 2017.August 3, 2019. 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

13


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.

21

Table of Contents

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”)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.equity (deficit).

Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $3.8 million and third party offering costs of $2.3 million. Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets. During both the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, the Company recorded $0.3 million and $0.2 million, respectively, related to the amortization of debt issuance costs. During the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, the Company recorded $0.8$0.6 million and $0.7$0.5 million respectively, related to the amortization of debt issuance costs.costs, respectively.

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

    

August 3,

    

February 2,

2019

2019

Liability component

 

  

Principal

$

300,000

$

300,000

Less: Debt discount

 

(18,132)

 

(27,081)

Net carrying amount

$

281,868

$

272,919

Equity component (1)

$

84,003

$

84,003

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

300,000

 

 

$

300,000

 

Less: Debt discount

 

 

(48,229

)

 

 

(60,124

)

Net carrying amount

 

$

251,771

 

 

$

239,876

 

Equity component (1)

 

$

84,003

 

 

$

84,003

 

(1)

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

The Company recorded interest expense of $4.0$4.5 million and $3.8$4.2 million for the amortization of the debt discount related to the 2020 Notes during the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The Company recorded interest expense of $11.9$8.9 million and $11.2$8.4 million for the amortization of the debt discount related to the 2020 Notes during the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively.

22

2020 Notes—Convertible Bond Hedge and Warrant Transactions

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

14


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

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

0.00% Convertible Senior Notes due 2019

In June 2014, the Company issued $350 million principal amount of 0.00% convertible senior notes due 2019 (the “2019 Notes”) in a private offering. The 2019 Notes arewere 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 willdid not bear interest, except that the 2019 Notes will bewere 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 arewere unsecured obligations and dodid 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 arewere also considered “events of default” under the 2019 Notes, which maycould result in the acceleration of the maturity of the 2019 Notes, as described in the indenture governing the 2019 Notes. The 2019 Notes matured on June 15, 2019.

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

Prior to March 15, 2019, the 2019 Notes will bewere 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 fiscalcalendar 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 five5 consecutive business day period after any ten10 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 28, 2017, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of October 28, 2017. On and after March 15, 2019, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convertcould have converted 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

23

Table 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.Contents

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 bediscount was amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component iswas not remeasured as long as it continuescontinued to meet the conditions for equity classification.

15


In accounting for the debt issuance costs related to the issuance of the 2019 Notes, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component arewere 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 arewere netted with the equity component in stockholders’ equity.equity (deficit).

Debt issuance costs related to the 2019 Notes were comprised of discounts and commissions payable to the initial purchasers of $4.4 million and third party offering costs of $1.0 million. Discounts, commissions payable to the initial purchasers and third party offering costs attributable to the liability component arewere recorded as a contra-liability and arewere presented net against the convertible senior notes due 2019 balance on the condensed consolidated balance sheets. During both the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, the Company recorded $0.2 million and $0.3 million, respectively, related to the amortization of debt issuance costs. During both the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, the Company recorded $0.6$0.4 million and $0.5 million, respectively, related to the amortization of debt issuance costs.

TheIn June 2019, upon the maturity of the 2019 Notes, $350.0 million in aggregate principal amount of the 2019 Notes were settled for $349.0 million in cash and 42 shares of common stock. As a result, the Company recognized a gain on extinguishment of debt of $1.0 million.

As of August 3, 2019, the 2019 Notes are no longer outstanding. As of February 2, 2019, the carrying valuesvalue of the 2019 Notes, excluding the discounts and commissions payable to the initial purchasers and third party offering costs, arewas as follows (in thousands):

    

February 2,

2019

Liability component

 

  

Principal

$

350,000

Less: Debt discount

 

(5,854)

Net carrying amount

$

344,146

Equity component (1)

$

70,482

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

350,000

 

 

$

350,000

 

Less: Debt discount

 

 

(24,666

)

 

 

(35,457

)

Net carrying amount

 

$

325,334

 

 

$

314,543

 

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 $3.6$2.0 million and $3.5$3.8 million for the amortization of the debt discount related to the 2019 Notes during the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The Company recorded interest expense of $10.8$5.9 million and $10.3$7.5 million for the amortization of the debt discount related to the 2019 Notes during the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively.

2019 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2019 Notes, the Company entered into convertible note hedge transactions whereby the Company hashad 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. The convertible note hedge terminated upon the maturity date of the 2019 Notes. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 3.0 million shares of the Company’s common stock at a price of $171.98 per share. The warrants contain certain adjustment mechanisms

24

whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 6.0 million shares of common stock (which cap may also be subject to adjustment). The warrants will expire through December 2019. 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 meetmet certain accounting criteria, the convertible note hedges were, 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 arewere included in deferred tax assets on the condensed consolidated balance sheets. There is 0 deferred tax asset or liability remaining as of August 3, 2019 due to the maturity of the 2019 Notes.

NOTE 10—9—CREDIT FACILITIES

The followingoutstanding balances under the Company’s credit facilities were outstanding as of October 28, 2017follows (in thousands):

August 3,

February 2,

2019

2019

Outstanding

Unamortized Debt

Net Carrying

Outstanding

Unamortized Debt

Net Carrying

    

Amount

    

Issuance Costs

    

Amount

    

Amount

    

Issuance Costs

    

Amount

Asset based credit facility

$

145,000

$

$

145,000

$

57,500

$

$

57,500

FILO term loan

 

120,000

 

(914)

 

119,086

 

 

 

Second lien term loan

200,000

(2,738)

197,262

 

 

Equipment promissory notes (1)

 

64,007

 

(380)

 

63,627

 

 

 

Total credit facilities

$

529,007

$

(4,032)

$

524,975

$

57,500

$

$

57,500

 

 

Outstanding

 

 

Unamortized Debt

 

 

Net Carrying

 

 

 

Amount

 

 

Issuance Costs

 

 

Amount

 

Asset based credit facility

 

$

341,000

 

 

$

 

 

$

341,000

 

LILO term loan

 

 

80,000

 

 

 

(529

)

 

 

79,471

 

Total credit facilities

 

$

421,000

 

 

$

(529

)

 

$

420,471

 

(1)Represents total equipment security notes secured by certain of the Company’s property and equipment, of which $21.5 million outstanding was included in other current liabilities and $42.5 million outstanding was included in other non-current obligations on the condensed consolidated balance sheets.

There were no amounts outstanding under any credit facilities as of January 28, 2017.

Asset Based Credit Facility & LILOFILO Term Loan

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

On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit agreement (the “Credit Agreement”) among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., various subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and Bank of America, N.A., as administrative agent and collateral agent (the “credit agreement”“First Lien Administrative Agent”). The credit agreementCredit Agreement has a revolving line of credit with initial availability of up to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600.0 million to up to $800$800.0 million if and to the extent the lenders, revisewhether existing lenders or new lenders, agree to increase their credit commitments to encompass a larger facility.commitments. In addition, the credit agreement establishesCredit Agreement established an up to $80.0 million LILOlast in, last out (“LILO”) term loan facility.

facility, which was repaid in full in June 2018. The Company incurred $3.9 million of deferred financing fees related to the credit agreement, which are included in other non-current assets on the condensed consolidated balance sheets, and will be amortized on a straight line basis over the life of the revolving line of credit, whichCredit Agreement has a maturity date of June 28, 2022. As

On April 4, 2019, Restoration Hardware, Inc., entered into a result of the credit agreement, unamortized deferred financing fees of $0.1 million relatedthird amendment to the previous facility were expensed during the nine months ended October 28, 2017 and $1.1Credit Agreement (the “Third Amendment”). The Third Amendment, among other things, (a) established a $120.0 million related to the previous facility will be amortized over the life of the new revolving line of credit.

The Company incurred $0.6 million of debt issuance costs related to the LILOfirst in, last out (“FILO”) term loan facility, which are presented net againstamount was fully borrowed as of April 4, 2019 and which incurs interest at a rate that is 1.25% greater than the term loans balance on the condensed consolidated balance sheets, and will be amortized over the life ofinterest rate applicable to the revolving lineloans provided for under the Credit Agreement at any time, (b)

25

provided for additional permitted indebtedness, as defined in the Credit Agreement, that the loan parties can incur, and (c) modified the borrowing availability under the Credit Agreement in certain circumstances. The FILO term loan facility has a maturity date of June 28, 2022.

BorrowingsIn addition, under the Credit Agreement, the Company is required to meet specified financial ratios in order to undertake certain actions, and the Company may be required to maintain certain levels of excess availability or meet a specified consolidated fixed-charge coverage ratio (“FCCR”). Subject to certain exceptions, the trigger for the FCCR occurs if the domestic availability under the revolving line of credit is less than the greater of (i) $40.0 million and (ii) 10% of the sum of (a) the lesser of (x) the aggregate revolving commitments under the Credit Agreement and (y) the aggregate revolving borrowing base, plus (b) the lesser of (x) the then outstanding amount of the LILO term loan facility areor (y) the LILO term loan borrowing base. If the availability under the Credit Agreement is less than the foregoing amount, then Restoration Hardware, Inc. is required subject to interest,certain exceptions to maintain an FCCR of at least 1 to one.

On May 31, 2019, Restoration Hardware, Inc. entered into a fourth amendment to the borrowers’ option, at eitherCredit Agreement (the “Fourth Amendment”). The Fourth Amendment, among other things, amends the bank’s reference rateCredit Agreement to (a) extend the time to deliver monthly financial statements to the lenders for the fiscal months ending February 2019 and March 2019 until June 19, 2019; (b) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter; and (c) waive any default or LIBOR (or,event of default under the Credit Agreement relating to the delivery of monthly financial statements or other information to lenders for the fiscal months ending February 2019 and March 2019.

As of August 3, 2019, the Company had $145.0 million in outstanding borrowings under the caserevolving line of credit. The Credit Agreement provides for a borrowing amount based on the value of eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the BankCredit Agreement as of America “BA” Rate or the Canadian Prime Rate, as such terms are definedAugust 3, 2019 was $254.6 million, net of $12.8 million 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.outstanding letters of credit.

The credit agreementCredit Agreement contains various restrictive and affirmative covenants, including, among others, required financial reporting, 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 28, 2017, August 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the credit agreement.Credit Agreement.

As of October 28, 2017, the Company had $341.0 million in outstanding borrowings and $189.0 million of availability under the revolving line of credit, net of $27.7 million in outstanding letters of credit. As of October 28, 2017, the Company had $80.0 million outstanding borrowings under the LILO term loan facility. As a result of the consolidated fixed-charge coverage ratio (“FCCR”) restriction that limits the last 10% of borrowing availability, actual incremental borrowing available to the Company and the other affiliated parties under the revolving line of credit is approximately $125.2 million as of October 28, 2017.

Second Lien Credit Agreement

On July 7, 2017,April 10, 2019, Restoration Hardware, Inc., a wholly-owned subsidiary of RH, entered into a credit agreement, (the “second lien credit agreement”), dated as of July 7, 2017,April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom are funds and accounts managed or advised by Apollo Capital Management, L.P.,either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and Wilmington Trust, National Associationits affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to an initiala second lien term loan in an aggregate principal amount equal to $100.0$200.0 million with a maturity date of January 7, 2023April 9, 2024 (the “second lien term loan”“Second Lien Term Loan”). The second lien term loan of $100.0 million was repaid in full on October 10, 2017. As a result of the repayment, the Company incurred a $4.9 million loss on extinguishment of debt, which includes a prepayment penalty of $3.0 million and acceleration of amortization of debt issuance costs of $1.9 million.

The Company incurred $3.6 million of debt issuance costs related to the second lien credit agreement.

The second lien term loan boreSecond Lien Term Loan bears interest at an annual rate generally based on LIBORthe London Inter-bank Offered Rate (“LIBOR”) plus 8.25%6.50%. This rate wasis a floating rate that resetresets periodically based upon changes in LIBOR rates during the life of the second lien term loan.Second Lien Term Loan. At the date of the initial borrowing, the rate was set at one monthone-month LIBOR plus 8.25%6.50%.

17


All obligations under the second lien term loan wereSecond Lien Term Loan are secured by a second lien security interest in substantially all of the assets of the loan parties, including inventory, receivables and certain types of intellectual property. The second

26

lien security interest was granted with respect toencumbers substantially the same collateral that secures the credit agreement.Credit Agreement. The second lien rankedranks junior in priority and is subordinated to the first lien in favor of the lenders with respect to the credit agreement.Credit Agreement.

The borrowings under the Second Lien Credit Agreement may be prepaid in whole or in part at any time, subject to certain minimum payment requirements, and including (i) a prepayment premium in the amount of 2.0% of the principal amount of the Second Lien Term Loan being prepaid during the first year after the effective date of the Second Lien Credit Agreement, (ii) 1.0% of the principal amount of the Second Lien Term Loan being prepaid during the second year after the effective date of the Second Lien Credit Agreement, and (iii) no prepayment premium after the second anniversary of the effective date of the Second Lien Credit Agreement.

The Second Lien Credit Agreement contains a financial ratio covenant not found in the Credit Agreement based upon a net senior secured leverage ratio of consolidated secured debt to consolidated EBITDA, as defined in The Credit Agreement, as follows:

The net senior secured leverage ratio test is based on the ratio of (i) the sum of (a) all obligations outstanding under the Second Lien Term Loan and the Credit Agreement plus (b) all other secured indebtedness of RH and certain of its subsidiaries that is (x) senior or pari passu to the lien on the Second Lien Term Loan collateral or (y) secured by property that does not constitute Second Lien Term Loan collateral under the Second Lien Term Loan, less (c) all unrestricted cash and cash equivalents of RH and certain of its subsidiaries subject to a blocked account control agreement, to (ii) consolidated EBITDA of RH and certain of its subsidiaries (the “Net Senior Secured Leverage Ratio”).
The Net Senior Secured Leverage Ratio may not exceed 3.50 to 1.00 as of the last day of any fiscal quarter. The Second Lien Credit Agreement also contains a consolidated fixed charge coverage ratio generally based on the same formulation set forth in the Credit Agreement such that the borrower may not make certain “restricted payments” in the event that the ratio of (i) consolidated EBITDA minus certain costs to the amount of (ii) debt service costs plus certain other costs is not less than 1.00 to 1.00 and the level of unused availability under the Credit Agreement meets certain levels.

The Second Lien Credit Agreement also contains certain events of default and other customary terms and conditions typical to a second lien credit agreement containedagreement.

On May 31, 2019, Restoration Hardware, Inc. entered into a first amendment to the Second Lien Credit Agreement (the “First Amendment”). The First Amendment, among other things, amends the Second Lien Credit Agreement to (a) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter and (b) waive any default or event of default under the Second Lien Credit Agreement relating to the delivery of monthly financial statements or other information to lenders for the fiscal months ending February 2019 and March 2019.

As of August 3, 2019, the Company had $200.0 million in outstanding borrowings and 0 availability under the Second Lien Credit Agreement.

The Second Lien Credit Agreement contains various restrictive and affirmative covenants generally in line with the covenants and restrictions contained in the credit agreementCredit Agreement, including required financial reporting, 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 certain restricted payments,other distributions, or enter into transactions with affiliates, along with other restrictions and limitations typical to credit agreements of thisa similar type and size. As of August 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the Second Lien Credit Agreement.

The second lien credit agreement also contained a financial ratio covenant not found in the credit agreement based upon a senior secured leverage ratio of consolidated secured debt to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”).

The second lien credit agreement also contained a consolidated fixed charge coverage ratio generally based on the same formulation set forth in the credit agreement such that the borrower may not make certain “restricted payments” in the event that certain ratios were not met and contained certain events of default and other customary terms and conditions for a second lien credit agreement.

Intercreditor Agreement

On July 7, 2017,April 10, 2019, in connection with the second lien credit agreement,Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an intercreditor agreementIntercreditor Agreement (the “intercreditor agreement”“Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the administrative agent and collateral agent under the credit agreementFirst Lien Administrative Agent and the administrative agent and collateral agent under the second lien credit agreement.Second Lien Administrative Agent. The intercreditor agreement establishedIntercreditor Agreement

27

establishes various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the credit agreementCredit Agreement and the second lien credit agreementSecond Lien Credit Agreement without the consent of the other party. The intercreditor agreement was terminated upon repayment

Equipment Loan Facility

On September 5, 2017, Restoration Hardware, Inc. entered into a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC (“BAL”) pursuant to which BAL and the Company agreed that BAL would finance certain equipment of the second lien termCompany from time to time, with each such equipment financing to be evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each equipment loan on October 10, 2017.is secured by a purchase money security interest in the financed equipment. As of August 3, 2019, the Company had $64.0 million in aggregate amounts outstanding under the equipment security notes. The maturity dates of the equipment security notes vary, but generally have a maturity of three or four years. The Company is required to make monthly installment payments under the equipment security notes.

NOTE 11—10—FAIR VALUE OF FINANCIAL INSTRUMENTS

Financial Assets and LiabilitiesMEASUREMENTS

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.

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.

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.

1828


Fair Value Measurements

All of the Company’s investments are classified as available-for-sale and are carried at fair value. The Company did not hold any short-term or long-term investments as of October 28, 2017. Assets measured at fair value were as follows as of January 28, 2017 (in thousands):

 

 

Level 1

 

 

Level 2

 

 

Total

 

Cash equivalents

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

2,510

 

 

$

 

 

$

2,510

 

Commercial paper

 

 

 

 

 

5,493

 

 

 

5,493

 

Total cash equivalents

 

 

2,510

 

 

 

5,493

 

 

 

8,003

 

Short-term investments

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

 

 

 

 

34,534

 

 

 

34,534

 

Government agency obligations

 

 

2,553

 

 

 

105,590

 

 

 

108,143

 

Total short-term investments

 

 

2,553

 

 

 

140,124

 

 

 

142,677

 

Long-term investments

 

 

 

 

 

 

 

 

 

 

 

 

Government agency obligations

 

 

 

 

 

33,212

 

 

 

33,212

 

Total long-term investments

 

 

 

 

 

33,212

 

 

 

33,212

 

Total

 

$

5,063

 

 

$

178,829

 

 

$

183,892

 

The following table summarizes the amortized cost and estimated fair value of the available-for-sale securities within the Company’s investment portfolio as of January 28, 2017 based on stated maturities, which are recorded within cash and cash equivalents, short-term investments and long-term investments on the condensed consolidated balance sheets (in thousands):

 

 

Cost

 

 

Fair Value

 

Range of maturity

 

 

 

 

 

 

 

 

Due within 1 year

 

$

148,155

 

 

$

148,170

 

Due in 1 to 2 years

 

$

33,238

 

 

$

33,212

 

The Company invests excess cash primarily in investment-grade interest-bearing securities such as money market funds, certificates of deposit, commercial paper, government agency obligations and guaranteed obligations of the U.S. government, all of which are subject to minimal credit and market risks. The Company estimates the fair value of its commercial paper and U.S. government agency bonds by taking into consideration valuations obtained from third party pricing services. The pricing services utilize industry standard valuation models, including both income and market based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trade dates of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities, prepayment/default projections based on historical data; and other observable inputs.

There were no purchases, sales, issuances, or settlements related to recurring level 3 measurements during the three and nine months ended October 28, 2017 or October 29, 2016. There were no transfers into or out of level 1 and level 2 during the three and nine months ended October 28, 2017 or October 29, 2016.

Fair Value of Financial InstrumentsRecurring

Amounts reported as cash and equivalents, receivables, and accounts payable and accrued expenses approximate fair value due to the short-term nature of activity within these accounts. The estimated fair value and carrying value of the 2019 Notes, and 2020 Notes (carrying value excludes the equity component of the 2019and 2023 Notes and 2020 Notes classified in stockholders’ equity) were as follows (in thousands):

August 3,

February 2,

2019

2019

    

Fair

    

Carrying

    

Fair

    

Carrying

Value

Value (1)

Value

Value (1)

Convertible senior notes due 2019 (2)

$

$

$

334,756

$

344,146

Convertible senior notes due 2020

282,338

281,868

 

260,258

 

272,919

Convertible senior notes due 2023

 

263,595

 

261,848

 

230,684

 

253,689

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

 

 

Fair

Value

 

 

Carrying

Value

 

 

Fair

Value

 

 

Carrying

Value

 

Convertible senior notes due 2019

 

$

312,281

 

 

$

325,334

 

 

$

295,381

 

 

$

314,543

 

Convertible senior notes due 2020

 

$

247,300

 

 

$

251,771

 

 

$

232,463

 

 

$

239,876

 

(1)Carrying value represents the principal amount less the equity component of the 2019 Notes, 2020 Notes and 2023 Notes classified in stockholders’ equity (deficit), and does not exclude the discounts upon original issuance, discounts and commissions payable to the initial purchasers and third party offering costs, as applicable.
(2)The 2019 Notes matured on June 15, 2019.

The fair value of each of the 2019 Notes, 2020 Notes and 20202023 Notes was determined based on inputs that are observable in the market or that could be derived from, or corroborated with, observable market data, including the trading price of the Company’s convertible

19


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

Fair Value MeasurementsNon-Recurring

The estimatedfair value of the Waterworks reporting unit as of February 2, 2019 was determined based on unobservable (Level 3) inputs and valuation techniques, as discussed in “Impairment” within Note 3—Significant Accounting Policies in the 2018 Form 10-K. The fair value of the asset based credit facility was $341.0 million, which approximates cost,held for sale as of October 28, 2017. Fair value approximates cost as the interest rate associated with the facility is variableAugust 3, 2019 and resets frequently.February 2, 2019 was determined based on an appraisal prepared using unobservable (Level 3) inputs and valuation techniques.

The estimated fair value of the LILO term loan is $80.0 million, which approximates cost, as of October 28, 2017. Fair value approximates cost as the interest rate associated with the facility is variable and resets frequently.

NOTE 12—11—INCOME TAXES

The Company recorded income tax expense of $6.2$16.7 million and $1.8$2.5 million in the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The Company recorded income tax expense of $9.9$28.5 million and an income tax benefit of $2.6$10.1 million in the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The effective tax rate was 32.1%20.7% and 41.4%3.9% for the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The effective tax rate was 83.7%22.2% and 38.9%10.3% for the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The increase in the effective tax rates forrate is primarily due to lower discrete tax benefits related to net excess tax windfalls from stock-based compensation in both the three and ninesix months ended October 28, 2017 were impacted by net excess tax benefits from stock-based compensation of $1.9 millionAugust 3, 2019 as compared to the three and $4.3 million, respectively, resulting from the Company’s adoption of ASU 2016-09 in the first quarter of fiscal 2017. The effective tax rate for the ninesix months ended October 28, 2017 was also significantly impacted by non-deductible stock-based compensation.August 4, 2018.

As of October 28, 2017 and January 28, 2017, $6.8August 3, 2019, the Company had $8.6 million and $1.4 million, respectively, of the exposures related to unrecognized tax benefits, of which $7.4 million would affectreduce income tax expense and the effective tax rate, if realized,recognized. As of February 2, 2019, the Company had $8.5 million of unrecognized tax benefits, of which as$7.3 million would reduce income tax expense and the effective tax rate, if recognized. The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized. As of both October 28, 2017 and January 28, 2017, $1.4 million is included in other non-current obligations on the condensed consolidated balance sheets. In October 2017,August 3, 2019, the Company filed an amended federal tax return claiming a $5.4had $0.4 million refund, however, no income tax benefit was recorded during the three months ended October 28, 2017 given the technical nature and amount of the refund claim. An income tax benefit related to this refund claim could be recorded in a future period upon settlement with the respective taxing authority. As of October 28, 2017, the Company does not have any exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.

29

NOTE 13—12—NET INCOME (LOSS) PER SHARE

The weighted-average shares used for net income (loss) per share is presented in the table below. As the Company was in a net loss position for the nine months ended October 29, 2016, the weighted-average shares outstanding for basic and diluted are the same.as follows:

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

Weighted-average shares—basic

18,465,876

21,925,702

19,221,367

21,735,364

Effect of dilutive stock-based awards

 

3,858,236

 

5,158,591

 

4,165,391

 

4,421,897

Effect of dilutive convertible senior notes (1)

 

 

412,268

 

242,292

 

206,134

Weighted-average shares—diluted

 

22,324,112

 

27,496,561

 

23,629,050

 

26,363,395

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Weighted-average shares—basic

 

 

21,221,848

 

 

 

40,730,059

 

 

 

29,076,556

 

 

 

40,653,091

 

Effect of dilutive stock-based awards

 

 

2,313,769

 

 

 

196,391

 

 

 

1,516,826

 

 

 

 

Weighted-average shares—diluted

 

 

23,535,617

 

 

 

40,926,450

 

 

 

30,593,382

 

 

 

40,653,091

 

(1)The 2019 Notes, 2020 Notes and 2023 Notes have an impact on the Company’s dilutive share count beginning at stock prices of $116.09 per share, $118.13 per share and $193.65 per share, respectively. The 2019 Notes matured on June 15, 2019 and did not have an impact of the Company’s dilutive share count post-maturity.

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

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

2019

    

2018

    

2019

    

2018

Options

717,627

209,441

590,567

347,978

Restricted stock units

 

 

 

5,250

Total anti-dilutive stock-based awards

717,627

 

209,441

 

590,567

 

353,228

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Options

 

 

2,222,103

 

 

 

7,995,703

 

 

 

3,701,484

 

 

 

8,594,487

 

Restricted stock units

 

 

128,723

 

 

 

892,279

 

 

 

305,744

 

 

 

1,151,993

 

Total anti-dilutive stock-based awards

 

 

2,350,826

 

 

 

8,887,982

 

 

 

4,007,228

 

 

 

9,746,480

 

20


NOTE 14—13—SHARE REPURCHASES

$700 Million Share Repurchase Program

On May 2, 2017,October 10, 2018, the Company’s Board of Directors authorized a stockshare repurchase program of up to $700$700.0 million, (the “$700 Million Repurchase Program”). Underof which $250.0 million in share repurchases were completed in fiscal 2018. The $700.0 million authorization amount was replenished by the $700 Million Repurchase Program, theBoard of Directors on March 25, 2019. The Company repurchased approximately 12.42.2 million shares of its common stock at an average price of $56.60$115.36 per share, for an aggregate repurchase amount of approximately $700$250.0 million, during the first quarter of fiscal 2019 under this share repurchase program. The Company did not make any repurchases under this program during the three months ended July 29, 2017.August 3, 2019. As the $700 Million Repurchase Programof August 3, 2019, there was completed during the three months ended July 29, 2017, no additional shares were repurchased during the three months ended October 28, 2017 and there will be no$450.0 million remaining for future share repurchases in future periods under this repurchase authorization.program.

$300 Million Share Repurchase Program

On February 21, 2017, the Company’s Board of Directors authorized a stock repurchase program of up to $300 million (the “$300 Million Repurchase Program”). Under the $300 Million Repurchase Program, the Company repurchased approximately 7.8 million shares of its common stock at an average price of $38.24 per share, for an aggregate repurchase amount of approximately $300 million, during the three months ended April 29, 2017. As the $300 Million Repurchase Program was completed during the three months ended April 29, 2017, no additional shares were repurchased during the three months ended October 28, 2017 and there will be no repurchases in future periods under this repurchase authorization.

Share Repurchases Under Equity Plans

Certain options and awards granted under the Company’s equity plans contain a repurchase right, which may be exercised at the Company’s discretion in the event of the termination of an employee’s employment with the Company. No shares were repurchased under equity plans during either the three and nine months ended October 28, 2017 or October 29, 2016. As of both October 28, 2017August 3, 2019 and January 28, 2017,February 2, 2019, the aggregate unpaid principal amount of the notes payable for share repurchases was $19.4$18.7 million and $19.6 million, respectively, of which, isas of August 3, 2019, $18.7 million were included in other non-current obligations on the condensed consolidated balance sheets and, as of February 2, 2019, $0.9 million were included in other current liabilities and $18.7 million were included in other non-current obligations on the condensed consolidated balance sheets. During both the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, the Company recorded interest expense on the outstanding notes of $0.2$0.3 million. During both the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, the Company recorded interest expense on the outstanding notes of $0.7$0.5 million.

Of the $19.4$18.7 million and $19.6 million notes payable for share repurchases outstanding as of both October 28, 2017August 3, 2019 and January 28, 2017,February 2, 2019, respectively, $15.5 million was due to a current board member of the Company.

30

NOTE 15—14—STOCK-BASED COMPENSATION

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

Stock-based compensation expense is included in selling, general and administrative expenses on the condensed consolidated statements of operations.income. The Company recorded stock-based compensation expense of $6.7$5.3 million and $7.4$6.1 million during the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The Company recorded stock-based compensation expense of $42.9$11.0 million and $21.7$14.1 million during the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. NoNaN stock-based compensation cost has been capitalized in the accompanying condensed consolidated financial statements.

2012 Stock Incentive Plan and 2012 Stock Option Plan

As of October 28, 2017, 8,837,586August 3, 2019, 7,611,816 options were outstanding with a weighted-average exercise price of $50.20$56.68 per share and 6,318,9806,178,614 options were vested with a weighted-average exercise price of $51.96$52.15 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of October 28, 2017August 3, 2019 was $323.7$610.8 million, $283.8$587.6 million, and $220.6$521.8 million, respectively. Stock options exercisable as of October 28, 2017August 3, 2019 had a weighted-average remaining contractual life of 6.374.67 years. As of October 28, 2017,August 3, 2019, the total unrecognized compensation expense related to unvested options was $26.8$38.3 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.333.53 years.

As of October 28, 2017,August 3, 2019, the Company had 825,307232,774 restricted stock units outstanding with a weighted-average grant date fair value of $52.20$49.53 per share. During the three months ended October 28, 2017, 18,590August 3, 2019, 139,754 restricted stock units vested with a weighted-average grant date and vest date fair value of $73.95$60.99 per share and $73.06 per share, respectively.share. During the ninesix months ended

21


October 28, 2017, 264,843 August 3, 2019, 164,889 restricted stock units vested with a weighted-average grant date and vest date fair value of $59.11$59.84 per share and $54.71 per share, respectively.share. As of October 28, 2017,August 3, 2019, there was $22.5$7.8 million of total unrecognized compensation expense related to unvested restricted stock and restricted stock units which is expected to be recognized over a weighted-average period of 3.262.00 years.

Chairman and Chief Executive Officer Option Grant

On May 2, 2017, the Company’s Board of Directors granted Mr. Friedman an option to purchase 1,000,000 shares of the Company’s common stock with an exercise price equal to $50 per share.

The option contains dual-condition restrictions consisting of both time-based service restrictions over four years and performance-based restrictions linked to achieving the Company’s common stock price objectives of $100, $125 and $150 per share. The option is fully vested on the date of grant but the shares underlying the option remain subject to transfer restrictions to the extent the performance-based and time-based requirements have not been met. The option resulted in a one-time non-cash stock compensation charge of $23.9 million in the nine months ended October 28, 2017. The Company did not record any expense related to this grant in the three months ended October 28, 2017.

Time-Based Restrictions

The time-based restrictions are measured over an initial four year service period from the date of the award and these restrictions will lapse at the end of each of these first four years at a rate of 250,000 shares per year if (i) Mr. Friedman remains employed at the end of such year, and (ii) the stock price goals have been achieved in such year as described further below.

Performance-Based Restrictions

The stock price objectives are measured each year and are set at prices for the Company’s common stock of $100, $125 and $150 per share. If all three stock price objectives are met in the first performance year, restrictions will lapse as to 250,000 shares in aggregate at the end of such year, with 83,333 shares tied to a $100 price per share, 83,333 shares tied to a $125 price per share and 83,334 shares tied to a $150 price per share.

The same price performance tests are applied in the second year of performance such that restrictions will lapse for an additional 250,000 shares at the end of the second year and then again as to an additional 250,000 shares at the end of each of the third and fourth years so long as Mr. Friedman remains employed at the end of each year.

To the extent that any of the price performance objectives is not reached within one of these first four performance years, the stock price objective can be achieved in any subsequent year until the 8th anniversary of the date of grant.

2012 Stock Incentive Plan Grant to Waterworks Associates

On May 27, 2016, on the date of our acquisition of Waterworks, the Company granted stock options to certain Waterworks associates under the 2012 Stock Incentive Plan to purchase 322,784 shares of its common stock, with an exercise price of $33.54 per share, which is equal to the closing price of the Company’s common stock on the date of grant. These options are fully vested as of the date of grant but any shares issued upon exercise of such options will be subject to selling restrictions which are scheduled to lapse in five equal installments on the first, second, third, fourth and fifth anniversaries of the grant date. The fully vested options resulted in a one-time non-cash stock-based compensation charge of $3.7 million in the second quarter of fiscal 2016.

Rollover Units

In connection with the acquisition of Waterworks in May 2016, $1.5 million rollover units in the Waterworks subsidiary (the “Rollover Units”) were recorded as part of the transaction. The Rollover Units are subject to the terms of the Waterworks LLC agreement, including redemption rights at an amount equal to the greater of (i) the $1.5 million remitted as consideration in the business combination or (ii) an amount based on the percentage interest represented in the overall valuation of the Waterworks subsidiary (the “Appreciation Rights”). The Appreciation Rights are measured at fair value and are subject to fair value measurements during the expected life of the Rollover Units, with changes to fair value recorded in the condensed consolidated statements of operations.income. The fair value of the Appreciation Rights is determined based on an option pricing method (“OPM”).OPM. The Company did not record any expense related to the Appreciation Rights during both the three or nineand six months ended October 28, 2017 or October 29, 2016.August 3, 2019 and August 4, 2018. As of both October 28, 2017August 3, 2019 and January 28, 2017,February 2, 2019, the liability associated with the Rollover Units and related Appreciation Rights was $1.5 million, which is included in other non-current obligations on the condensed consolidated balance sheets.

22


Profit Interests

In connection with the acquisition of Waterworks in May 2016, profit interests units in the Waterworks subsidiary (the “Profit Interests”) were issued to certain Waterworks associates. The Profit Interests are measured at their grant date fair value and expensed on a straight-line basis over their expected life, or five years. The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of operations.income. The fair value of the Profit Interests is determined based on an OPM. For both the three and nine months ended October 28, 2017,August 3, 2019 and August 4, 2018, the Company recorded $0.1 million and $0.3 million, respectively, related to the Profit Interests, which is

31

included in selling, general and administrative expenses on the condensed consolidated statements of operations.income. For both the three and ninesix months ended October 29, 2016August 3, 2019 and August 4, 2018, the Company recorded $0.1 million and $0.2 million respectively, related to the Profit Interests. As of October 28, 2017August 3, 2019 and January 28, 2017,February 2, 2019, the liability associated with the Profit Interests was $0.6$1.4 million and $0.3$1.1 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.

NOTE 16—RELATED PARTY TRANSACTIONS

Aircraft Time Sharing Agreement

On March 29, 2016, Restoration Hardware, Inc., a wholly-owned subsidiary of the Company entered into an Amended and Restated Aircraft Time Sharing Agreement (the “Time Sharing Agreement”) with Gary Friedman, its Chairman and Chief Executive Officer. The Time Sharing Agreement governs use of any of the Company’s aircraft (“Corporate Aircraft”) by Mr. Friedman for personal trips and provides that Mr. Friedman will lease such Corporate Aircraft and pay Restoration Hardware, Inc. an amount equal to the aggregate actual expenses of each personal use flight based on the variable costs of the flight, with the amount of such lease payments not to exceed the maximum payment level established under the Federal Aviation Administration rules. Mr. Friedman maintains a deposit with the Company, to be used towards payment of amounts due under the Time Sharing Agreement. The amount of the deposit is immaterial to the condensed consolidated financial statements.

NOTE 17—15—COMMITMENTS AND CONTINGENCIES

Commitments

The Company had no0 material off balance sheet commitments as of October 28, 2017.August 3, 2019.

Contingencies

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

The Company reviews the need for any loss contingency reserves and establishes reserves when, in the opinion of management, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. Generally, in view of the inherent difficulty of predicting the outcome of those matters, particularly in cases in which claimants seek substantial or indeterminate damages, it is not possible to determine whether a liability has been incurred or to reasonably estimate the ultimate or minimum amount of that liability until the case is close to resolution, in which case no reserve is established until that time. When and to the extent that the Company does establish a reserve, there can be no assurance that any such recorded liability for estimated losses will be for the appropriate amount, and actual losses could be higher or lower than what the Company accrues from time to time. The Company believes that the ultimate resolution of its current matters will not have a material adverse effect on its condensed consolidated financial statements.

RH Modern Securities Class Action

On February 2, 2017, City of Miami General Employees’ & Sanitation Employees’ Retirement Trust filed a class action complaint in the United States District Court, Northern District of California, against the Company, Gary Friedman, and Karen Boone. On March 16, 2017, Peter J. Errichiello, Jr. filed a similar class action complaint in the same forum and against the same parties. On April 26, 2017, the court consolidated the two actions. The consolidated action is captioned In re RH, Inc. Securities Litigation. The complaints allege, among other things, fraudAn amended consolidated complaint was filed in connection with alleged misstatementsJune 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. Both complaints purport to makeamended (the “Exchange Act”). The complaint asserts claims purportedly on behalf of a class of purchasers of Company common stock from March 26, 2015 to June 8, 2016. The alleged misstatements relate to forward looking statements regarding the roll out of the RH Modern product line.line and the Company’s inventory levels. The claims are currently atcomplaint seeks class certification, monetary damages, and other appropriate relief, including an early stageaward of costs and it is not possible to estimate the amount or range of any potential loss at this time. An amended consolidated complaint was filed in June 2017 andattorneys’ fees. On March 21, 2019, the Company and its officersthe individual defendants in the case entered into a binding memorandum of understanding to settle the case. The settlement amount is $50 million, which amount is to our understanding covered in full by the Company's insurance policies. On May 6, 2019, the plaintiffs filed a motion for preliminary approval of the proposed settlement together with a settlement agreement executed by both parties. The settlement agreement is subject to customary conditions including court approval following notice to the Company's shareholders, and a hearing at which time the court will consider the fairness, reasonableness and adequacy of the settlement. On June 21, 2019, the court issued an order preliminarily approving the settlement. A hearing on the settlement is scheduled for October 22, 2019. If a settlement is finally approved by the court, it will resolve all of the claims that were or could have movedbeen brought in the action. As a result of signing the settlement agreement and the potential liability becoming probable and estimable, the Company has recorded a provision for legal settlement and unpaid legal fees for $50.2 million within other current liabilities on the condensed

32

consolidated balance sheets as of August 3, 2019. Additionally, the Company has recorded a litigation insurance recovery receivable of $50.2 million as of August 3, 2019 within prepaid expense and other current assets on the condensed consolidated balance sheets, which represents the estimated insurance claims proceeds from the Company’s insurance carriers.

23Shareholder Derivative Lawsuit


On April 24, 2018, purported Company shareholder David Magnani filed a purported shareholder derivative suit in the United States District Court, Northern District of California, captioned Magnani v. Friedman et al. (No. 18-cv-02452). On June 29, 2018, Hosrof Izmirliyan filed a similar purported shareholder derivative complaint in the same forum, captioned Izmirliyan v. Friedman et al. (No. 18-cv-03930). On July 29, 2018, the court consolidated both derivative actions, and the consolidated action is captioned In re RH Shareholder Derivative Litigation. On August 24, 2018, plaintiffs filed an amended complaint that names RH as a nominal defendant and Gary Friedman, Karen Boone, Carlos Alberini, Keith Belling, Eri Chaya, Mark Demilio, Katie Mitic, Ali Rowghani and Leonard Schlesinger as defendants. The allegations substantially track those in the securities class action described above. Plaintiffs bring claims against all individual defendants under Section 14(a) of the Exchange Act, as well as claims for breach of fiduciary duty, unjust enrichment, and waste of corporate assets. The plaintiffs also allege insider trading and misappropriation of information claims against two of the individual defendants. The amended complaint seeks monetary damages, corporate governance changes, restitution, and an award of costs and attorneys’ fees. The Company believes that plaintiffs lack standing to bring this derivative action. On September 28, 2018, the Company filed a motion to stay proceedings and a motion to dismiss the consolidated complaint. WhileOn January 23, 2019, the outcome of litigation is inherently uncertain,court granted the Company and its officers intendmotion to vigorously defendstay the claims and believe the complaints lack merit.case.

NOTE 18—16—SEGMENT REPORTING

The Company defines reportable and operating segments on the same basis that it uses to evaluate performance internally by the Chief Operating Decision Maker (the “CODM”). The Company has determined that the Chief Executive Officer is its CODM. As of October 28, 2017,August 3, 2019, the Company had two2 operating segments: RH Segment and Waterworks. The two operating segments include all sales channels accessed by the Company’s customers, including sales through catalogs, sales through the Company’s websites, sales through stores, and sales through the commercial channel.channel.

The Company’s two operating segments are strategic business units that offer products for the home furnishings customer. While RH Segment and Waterworks have a shared management team and customer base, the Company has determined that their results cannot be aggregated as they do not share similar economic characteristics, as well as due to other quantitative factors.

The Company uses operating income to evaluate segment profitability. Operating income is defined as net income (loss) before interest expense—net, (gain) loss on extinguishment of debt and income taxes.tax expense.

Prior to the Waterworks acquisition, the Company had one reportable segment. As the Company’s acquisition of Waterworks was completed on May 27, 2016, reportable segment financial information for Waterworks below represents twenty-two weeks of results for the nine months ended October 29, 2016, whereas the RH Segment results represent thirty-nine weeks for the nine months ended October 29, 2016. The results for both the three months ended October 28, 2017 and October 29, 2016 include thirteen weeks for both the RH Segment and Waterworks.

Segment Information

The following tabletables presents the statements of operationsincome metrics reviewed by the CODM to evaluate performance internally or as required under ASC 280—Segment Reporting (in thousands)thousands):

Three Months Ended

August 3,

August 4,

2019

2018

    

RH Segment

    

Waterworks

    

Total

    

RH Segment

    

Waterworks

    

Total

Net revenues

$

672,328

$

34,186

$

706,514

$

607,604

$

33,194

$

640,798

Gross profit

 

280,469

 

14,489

 

294,958

 

255,505

 

12,839

 

268,344

Depreciation and amortization

 

24,170

 

1,151

 

25,321

 

20,236

 

1,118

 

21,354

33

 

 

Three Months Ended

 

 

Three Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

RH Segment

 

 

Waterworks

 

 

Total

 

 

RH Segment

 

 

Waterworks

 

 

Total

 

Net revenues

 

$

563,174

 

 

$

29,299

 

 

$

592,473

 

 

$

521,027

 

 

$

28,301

 

 

$

549,328

 

Gross profit

 

$

203,221

 

 

$

11,104

 

 

$

214,325

 

 

$

166,124

 

 

$

9,695

 

 

$

175,819

 

Depreciation and amortization

 

$

17,474

 

 

$

1,072

 

 

$

18,546

 

 

$

13,966

 

 

$

1,070

 

 

$

15,036

 

 

 

Nine Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

RH Segment

 

 

Waterworks

 

 

Total

 

 

RH Segment

 

 

Waterworks

 

 

Total

 

Net revenues

 

$

1,680,495

 

 

$

89,384

 

 

$

1,769,879

 

 

$

1,499,101

 

 

$

49,064

 

 

$

1,548,165

 

Gross profit

 

$

555,844

 

 

$

34,550

 

 

$

590,394

 

 

$

467,402

 

 

$

15,731

 

 

$

483,133

 

Depreciation and amortization

 

$

47,761

 

 

$

3,331

 

 

$

51,092

 

 

$

39,484

 

 

$

1,764

 

 

$

41,248

 

Six Months Ended

August 3,

August 4,

2019

2018

    

RH Segment

    

Waterworks

    

Total

    

RH Segment

    

Waterworks

    

Total

Net revenues

$

1,236,034

$

68,901

$

1,304,935

$

1,133,611

$

64,593

$

1,198,204

Gross profit

 

498,412

 

29,360

 

527,772

 

451,211

 

26,466

 

477,677

Depreciation and amortization

 

50,174

 

2,336

 

52,510

 

39,709

 

2,230

 

41,939

24


The following table presents the balance sheet metrics reviewed by the CODM to evaluate performance internally as required under ASC 280—Segment Reporting (in thousands)thousands):

August 3,

February 2,

2019

2019

    

RH Segment

    

Waterworks

    

Total

    

RH Segment

    

Waterworks

    

Total

Goodwill (1)

$

124,370

$

$

124,370

$

124,379

$

$

124,379

Tradenames, trademarks and domain names (2)

 

48,563

 

37,459

 

86,022

 

48,563

 

37,459

 

86,022

Total assets

 

2,240,904

 

146,904

 

2,387,808

 

2,273,951

 

149,067

 

2,423,018

 

 

October 28,

 

 

January 28,

 

 

 

2017

 

 

2017

 

 

 

RH Segment

 

 

Waterworks

 

 

Total

 

 

RH Segment

 

 

Waterworks

 

 

Total

 

Goodwill (1)

 

$

124,409

 

 

$

51,144

 

 

$

175,553

 

 

$

124,374

 

 

$

49,229

 

 

$

173,603

 

Trademarks and domain names

 

$

48,563

 

 

$

52,100

 

 

$

100,663

 

 

$

48,524

 

 

$

52,100

 

 

$

100,624

 

Total assets

 

$

1,649,057

 

 

$

152,509

 

 

$

1,801,566

 

 

$

2,040,346

 

 

$

152,174

 

 

$

2,192,520

 

(1)

The Waterworks reporting unit goodwill increased $1.9of $51.1 million during the nine months ended October 28,recognized upon acquisition in fiscal 2016 was fully impaired as of February 2, 2019, with $17.4 million and $33.7 million impairment recorded in fiscal 2018 and fiscal 2017, due to purchase price accounting adjustments. Refer to Note 3—Business Combination.

respectively.
(2)The Waterworks reporting unit tradename is presented net of an impairment charge of $14.6 million recorded in fiscal 2018.

The Company uses segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes (i) non-cash compensation charges related to a fully vested option grant made to Mr. Friedmanasset impairments and change in useful lives, (ii) product recall accruals and adjustments, (iii) legal settlements, net of legal expenses, (iv) severance costs associated with reorganizations, including the closures of distribution centers and the fully vested option grants made in connection withDallas customer call center as part of the acquisition of Waterworks, (ii) reduction of net revenues, incremental costs and inventory charges associated with product recalls, (iii)Company’s supply chain reorganization, (v) non-cash amortization of the inventory fair value adjustment recorded in connection with the acquisition of Waterworks (iv) costs associated with anticipated distribution center closures, (v) gain on sale of building and land, (vi) charges incurred for the estimated cumulative impact of coupons redeemed in connection with a legal claim, (vii) costs associated with a reorganization, which include severance costs and related taxes, partially offset by a reversal of stock-based compensation expense related to unvested equity awards, and (viii) costs incurred in connection with the acquisitionan estimated loss on disposal of Waterworks including professional fees.asset. These items are excluded from segment operating income in order to provide better transparency of segment operating results. Accordingly, these items are not presented by segment because they are excluded from the segment profitability measure that management reviews.

The following table showspresents segment operating income (loss) and income (loss) before taxincome taxes (in thousands):

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

Operating income:

RH Segment

$

104,093

$

75,804

$

173,493

$

124,852

Waterworks

 

920

 

(338)

 

2,014

 

(228)

Asset impairments and change in useful lives

 

(2,545)

 

 

(6,021)

 

Recall accrual

 

320

 

1,064

 

1,935

 

1,318

Legal settlements

 

1,193

 

7,204

 

1,193

 

5,289

Reorganization related costs

 

 

(1,721)

 

 

(1,721)

Impact of inventory step-up

 

 

(190)

 

 

(380)

Reversal of loss on asset disposal

 

 

 

 

840

Income from operations

 

103,981

 

81,823

 

172,614

 

129,970

Interest expense—net

 

24,513

 

15,467

 

45,631

 

30,565

(Gain) loss on extinguishment of debt

 

(954)

 

917

 

(954)

 

917

Income before income taxes

$

80,422

$

65,439

$

127,937

$

98,488

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RH Segment

 

$

48,724

 

 

$

18,660

 

 

$

98,332

 

 

$

51,687

 

Waterworks

 

 

(719

)

 

 

(514

)

 

 

(2,143

)

 

 

344

 

Non-cash compensation

 

 

 

 

 

 

 

 

(23,872

)

 

 

(3,672

)

Recall accrual

 

 

(3,552

)

 

 

 

 

 

(8,285

)

 

 

 

Impact of inventory step-up

 

 

(248

)

 

 

(1,786

)

 

 

(2,108

)

 

 

(5,187

)

Distribution center closures

 

 

(1,862

)

 

 

 

 

 

(1,862

)

 

 

 

Gain on sale of building and land

 

 

819

 

 

 

 

 

 

2,119

 

 

 

 

Legal claim

 

 

 

 

 

 

 

 

 

 

 

(8,701

)

Reorganization related costs

 

 

 

 

 

(974

)

 

 

 

 

 

(5,698

)

Acquisition related costs

 

 

 

 

 

 

 

 

 

 

 

(2,847

)

Operating income

 

 

43,162

 

 

 

15,386

 

 

 

62,181

 

 

 

25,926

 

Interest expense—net

 

 

18,915

 

 

 

11,091

 

 

 

45,496

 

 

 

32,528

 

Loss on extinguishment of debt

 

 

4,880

 

 

 

 

 

 

4,880

 

 

 

 

Income (loss) before tax

 

$

19,367

 

 

$

4,295

 

 

$

11,805

 

 

$

(6,602

)

34

The Company classifies its sales into furniture and non-furniture product lines. Furniture includes both indoor and outdoor furniture. Non-furniture includes lighting, textiles, fittings, fixtures, surfaces, accessories and home décor. Net revenues in each category were as follows (in thousands):

 

Three Months Ended

 

 

Nine Months Ended

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

Furniture

 

$

383,281

 

 

$

343,946

 

 

$

1,125,220

 

 

$

985,639

 

$

485,639

$

430,196

$

882,337

$

782,842

Non-furniture

 

 

209,192

 

 

 

205,382

 

 

 

644,659

 

 

 

562,526

 

 

220,875

 

210,602

 

422,598

 

415,362

Total net revenues

 

$

592,473

 

 

$

549,328

 

 

$

1,769,879

 

 

$

1,548,165

 

$

706,514

$

640,798

$

1,304,935

$

1,198,204

The Company is domiciled in the United States and primarily operates its retail and outlet stores in the United States. As of October 28, 2017,August 3, 2019, the Company operates 4 retail and 2 outlet stores in Canada and 1 retail store in the U.K. Revenues from Canadian

25


and U.K. operations, and the long-lived assets in Canada and the U.K., are not material to the Company. GeographicCanada and U.K. geographic revenues are determined based upon where service is rendered.revenues recognized at the retail store locations in the respective country.

NoNaN single customer accounted for more than 10% of the Company’s revenues in the three or nineand six months ended October 28, 2017August 3, 2019 or October 29, 2016.August 4, 2018.

NOTE 19—SUBSEQUENT EVENT

Distribution Center Closures35

During the third quarterTable of fiscal 2017, the Company committed to a plan to close its Mira Loma, CA and Dallas, TX furniture distribution centers by the end of fiscal 2017, prior to the end of the respective lease terms. The Mira Loma, CA distribution center closed in November 2017 and the Dallas, TX distribution center is expected to close by the end of fiscal 2017. During the three months ended October 28, 2017, the Company incurred costs in its RH Segment of $1.9 million associated with the distribution center closures, including $1.4 million of severance which is included in selling, general and administrative expenses on the condensed consolidated statements of operations and $0.5 million of inventory transfers costs which is included in cost of goods sold on the condensed consolidated statements of operations. As of October 28, 2017, the remaining accrual associated with these closures was $1.7 million which is included in accounts payable and accrued expenses on the condensed consolidated balance sheets. The Company expects to record additional expenses related to the distribution center closures during the fourth quarter of fiscal 2017, primarily related to liabilities for lease losses and losses on disposal of capitalized property and equipment. The Company estimates that the remaining charge will be approximately $0.5 million to $1.0 million for the Mira Loma, CA distribution center closure. The Company is not currently able to estimate the remaining charge expected to be incurred upon the Dallas, TX distribution center closure due to the uncertainty in the timing and the market rental rates the Company will be able to obtain for a sublease agreement for the space.Contents

26


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of theour financial condition and the results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our 20162018 Form 10-K.

FORWARD-LOOKING STATEMENTS AND MARKET DATA

This quarterly report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations and projections relatingand may relate to our financial condition, results of operations, normalized tax rate, free cash flow, growth, plans, capital expenditures, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “short-term,” “non-recurring,” “one-time,” “unusual,” “should,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.

Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those that we expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. Whileassumptions we have made in light of our experience in the industry and our perceptions of historical trends, current conditions, expected future developments and other factors we believe that our assumptions are reasonable,reasonable. However, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results andincluding matters that we identify as “short term,” “non-recurring,” “unusual,” “one-time,” or other words and terms of similar meaning may in fact recur in one or more future financial reporting periods. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, include those factors disclosed under the sections entitled Risk Factors in Part II of this quarterly report, in our Quarterly Report on Form 10-Q for the quarterly period ended May 4, 2019 (the “First Quarter Form 10-Q”), in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017February 2, 2019 (“20162018 Form 10-K”), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report, in our First Quarter Form 10-Q and in our 20162018 Form 10-K. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this quarterly report in the context of these risks and uncertainties.

We cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this quarterly report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

Overview

We are a leading luxury retailer in the home furnishings marketplace. Our curated and fully-integrated assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers. We offer dominant merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, tableware, and child and teen furnishings. We position our Galleries as showrooms for our brand, while our Source Books and websites act as virtual extensions of our stores. In 2015 we began to introduce an integrated hospitality experience, including cafés, wine vaults and barista bars, into a number of our new Gallery locations. We believe this has created a unique new retail experience that cannot be replicated online, and that the addition of hospitality is helping to drive incremental sales of home furnishings in these Galleries.

Our business is fully integrated across our multiple channels of distribution, consisting of our stores, Source Books and websites.

36

As of October 28, 2017,August 3, 2019, we operated a totalthe following number of 84 retail Galleries, consistingoutlets and showrooms:

RH

Design Galleries

20

Legacy Galleries

43

Modern Galleries

2

Baby & Child Galleries

5

Total RH Galleries

70

Outlets

40

Waterworks Showrooms

15

As of 48 legacy Galleries, 6 larger formatAugust 3, 2019, six of our RH Design Galleries 9 next generationinclude an integrated RH Hospitality experience and we plan to incorporate hospitality, including cafés, wine vaults and barista bars in many of the new Galleries that we open in the future.

Key Value Driving Strategies

In order to drive growth across our business, we are focused on the following long-term key strategies:

Transform Our Real Estate Platform. We believe we have an opportunity to significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of Design Galleries that are sized to the potential of each market and the size of our assortment.

New Design Gallery sites are identified based on a variety of factors, such as the availability of suitable new site locations based on several store specific aspects including geographic location, demographics, and proximity to affluent consumers, and the negotiation of favorable economic terms to us for the new location, as well as satisfactory and timely completion of real estate development including procurement of permits and completion of construction. Based on our analysis, we believe we have the opportunity to operate Design Galleries 1 RH Modern Gallery and 5 RH Baby & Child Galleries throughout the United States and Canada, and 15 Waterworks showroomsin 60 to 70 locations in the United States and Canada. The number of Design Galleries we open in any fiscal year is highly dependent upon these variables and individual new Design Galleries may be subject to delay or postponement depending on the circumstances of specific projects.

We opened our Portland Design Gallery in March 2018, our Nashville Design Gallery in June 2018, as well as our New York Design Gallery and our Design Gallery in Yountville, California in the U.K.Napa Valley, in September 2018. Our Galleries in Nashville, New York and Yountville include integrated cafés, wine vaults and barista bars.

We have identified key learnings from our real estate transformation that have supported the development of a new multi-tier market approach that we believe will optimize both market share and return on invested capital.

First, we have developed a new RH prototype Design Gallery that is an innovative and flexible blueprint which we believe will enable us to more quickly place our disruptive product assortment and immersive retail experience into the market. The new model is a standard we will utilize in the future that is based on key learnings from our recent Gallery openings and will range in size from 33,000 leased selling square feet inclusive of our integrated hospitality experience to 29,000 leased selling square feet without. These new Galleries will represent our assortments from RH Interiors, Modern, Baby & Child, Teen and Outdoor and contain interior design offices and presentation rooms where design professionals can work with clients on their projects. Due to the reduced square footage compared to our recent Design Gallery openings and efficient design, this new model will be more capital efficient with less time and cost risk, but yield similar productivity. We anticipate the new prototype Design Galleries will represent approximately two thirds of our target markets. Future prototype location examples include Edina, MN, Corte Madera, CA, Columbus, OH and Charlotte, NC.

37

Second, we will continue to develop and open larger Bespoke Design Galleries in the top metropolitan markets, similar to those we opened in New York and Chicago. These iconic locations are highly profitable statements for our brand, and we believe they create a long-term competitive advantage that will be difficult to duplicate.

Third, we will continue to open indigenous Bespoke Galleries in the best second home markets where the wealthy and affluent visit and vacation. These Galleries are tailored to reflect the local culture and are sized to the potential of each market. Examples of indigenous Bespoke Galleries include the Hamptons, Palm Beach, Yountville and Aspen.

Fourth, we are developing a new Gallery model tailored to secondary markets. Targeted to be 10,000 to 18,000 square feet, we believe these smaller expressions of our brand will enable us to gain share in markets currently only served by smaller competitors. Examples of target secondary markets include Hartford, CT, Oklahoma City, OK and Milwaukee, WI, among others. We expect these Galleries to require a substantially smaller net investment than our larger Design Galleries and to pay back our capital investment within two years in most instances. Our plan is to test a few of these Galleries over the next several years, and if proven successful, this format could lead to an increase in our long-term Gallery targets.

We believe our multi-tier market approach to transforming our real estate will enable us to ramp our opening cadence from 3 to 5 new Galleries per year, to a pace of 5 to 7 new Galleries per year commencing in fiscal 2020.

We continue to evaluate potential opportunities for standalone RH Baby & Child, RH Teen and RH Modern Galleries in select markets.

Like our evolving multi-tier market approach, we have developed a multi-tier real estate strategy that is designed to significantly increase our unit level profitability and return on invested capital. Our three primary deal constructs are outlined below:

First, due to the productivity and proof of concept of our recent new Galleries, and the addition of a powerful, traffic-generating hospitality experience, we are able to negotiate “capital light” leasing deals, where as much as 65% to 100% of the capital requirement would be funded by the landlord, versus 35% to 50% previously.
Second, in several of our current projects, we are migrating from a leasing to a development model. We currently have two Galleries, Yountville and Edina, using this new model, and have additional projects in the pipeline. In the case of Yountville and Edina, we expect to complete a sale-leaseback that should allow us to recoup all or a large portion of our capital. In some cases we believe we may be able to pre-sell the property and structure the transaction where the capital to build the project is advanced by the buyer during construction, which could require zero upfront capital from us.
Third, we are working on joint venture projects, where we share the upside of a development with the developer/landlord. An example of this new model would be our future Gallery and Guesthouse in Aspen, where we are contributing the value of our lease to the development in exchange for a profits interest in the project. The developer will deliver to RH a substantially turnkey Gallery and Guesthouse, while we continue to retain a 20% and 25% profits interest in the properties, respectively. We would expect to monetize the profits interest at the time of sale of the properties during the first five years. The net result should be a minimal capital investment to operationalize the business, with the expectation for a net positive capital benefit at time of monetization of the profits interest.

We anticipate that all of the above deal structures should lead to lower capital requirements, higher unit profitability, and significantly higher return on invested capital versus our prior Gallery development strategies.

38

Expand Our Offering and Increase Our Market Share. We believe we have a significant opportunity to increase our market share by:
transforming our real estate platform;
growing our merchandise assortment and introducing new products and categories;
expanding our service offerings, including design services and cafes, wine vaults and coffee bars at our Design Galleries;
exploring and testing new business opportunities complementary to our core business; and
increasing our brand awareness and customer loyalty through our Source Book circulation strategy, membership program, our digital marketing initiatives, advertising, and public relations activities and events.

During fiscal 2017 and fiscal 2018 we deferred the introduction of major new product category expansions other than the ongoing development of RH Hospitality in conjunction with new Design Galleries. In addition,fiscal 2019, we have resumed introducing expansions in our merchandise assortment including a number of new merchandise collections in both RH Interiors and RH Modern, as well as the launch of October 28, 2017,RH Beach House in the Spring and RH Ski House in the Fall.

We also plan to increase our investment in RH Interior Design in fiscal 2019 with a goal of building the leading interior design firm in North America. We believe there is a significant revenue opportunity by offering world class design and installation services as we operated 31 outlet storesmove the brand beyond creating and selling products, to conceptualizing and selling spaces.

Architect New Operating Platform. We have spent the last three years architecting a new operating platform, inclusive of transitioning from a promotional to membership model, our distribution center network redesign, the redesign of our reverse logistics and outlet business, and the reconceptualization of our home delivery and customer experience, which enables us to drive lower costs and inventory levels, and higher earnings and inventory turns. Looking forward, we expect this multi-year effort to result in a dramatically improved customer experience, continued margin enhancement and significant cost savings over the next several years.
Grow Our Integrated Hospitality Experience. In 2015 we began to introduce an integrated hospitality experience, including cafés, wine vaults and barista bars, into a number of our new Gallery locations. The success of our initial hospitality offering in Chicago led us to broaden this initiative by adding hospitality to a number of our other new Gallery locations. We believe this has created a unique new retail experience that cannot be replicated online, and that the addition of hospitality is helping to drive incremental sales of home furnishings in these Galleries.
Pursue International Expansion. We believe that our luxury brand positioning and unique aesthetic will have strong international appeal. As such, we believe there is tremendous opportunity for the RH brand to expand globally and are currently exploring opportunities for Design Galleries in several locations outside the United States, including the United Kingdom and Europe.

Business Initiatives

We are undertaking a large number of new business initiatives in support of our key value driving strategies. In particular, beginning in fiscal 2016 and continuing through fiscal 2019, we have pursued a range of strategic efforts to improve our business and operations including the following:

Introduction of Membership Model. In March 2016, we introduced the RH Members Program, an exclusive membership model that reimagines and simplifies the shopping experience. For an annual fee, the RH Members Program provides a set discount every day across all RH brands in addition to other benefits including complimentary interior design services through the RH Interior Design program and eligibility for

39

preferred financing plans on the RH Credit Card, among others. We believe that transitioning our business from a promotional to membership model has enhanced our brand, simplified and streamlined our business as well as allowed us to develop deeper connections with our customers.
We believe that the shift to a membership model has positively affected the financial results of our business. Specifically, we believe some of the benefits include:

Improved customer experience. Our interior design professionals can now work with customers based on their timeline and project deadlines, as opposed to our prior promotional calendar. We believe this will lead to larger overall sales transactions for individual customer design projects.

Lower cancellations and returns. As a result of the elimination of time-limited promotional events and the associated pressure of placing an order before a promotion expires, we believe the shift to a membership model has also resulted in lower rates of cancelled orders and returns.

Improved operational costs. The volume of sales, orders and shipments in our business under the prior promotional model was characterized by large spikes in customer orders based upon promotional events followed by lower orders and sales after the end of an event. This buying pattern also affected numerous other aspects of our business, including staffing and costs as we required elevated staffing levels to service the increased number of customers during peak sales events. Likewise, significant fluctuations in sales had downstream implications for our supply chain related to merchandise orders, manufacturing and production, shipment to our distribution centers and final delivery to our customers. All of these aspects of our operations are experiencing improved efficiencies as a result of the membership model whereby sales are more evenly distributed throughout the United Statesyear as opposed to the peaks and Canada.valleys of orders and sales under the prior model.

Distribution Center Network Redesign. As a result of our work to redesign our distribution network and optimize inventory, in fiscal 2017 we were able to forego building a fifth furniture distribution center planned to open and consolidate our current furniture distribution center network from four primary locations to two primary locations (Northern California and Baltimore, Maryland area). In fiscal 2017, we completed the closure of our furniture distribution centers in Los Angeles and Dallas, eliminating 1.75 million square feet of distribution center space, resulting in savings in excess of $20 million annually. In fiscal 2018, we completed the closure of a smaller furniture distribution center in Essex, Maryland, eliminating 500,000 square feet of distribution center space, resulting in savings in excess of $5 million annually. We believe managing our business in fewer facilities while decreasing our on-hand inventory will reduce fulfillment complexity, lower inventory transfer costs, increase inventory turns, improve working capital and should result in higher gross margins over time.
Reconceptualize Reverse Logistics Business. In fiscal 2017, we implemented initiatives to re-conceptualize our Outlet and reverse logistics business. Previously, returns of furniture would be transferred via our home delivery hubs back to a furniture distribution center, then eventually to one of our Outlet locations. Now, returns of furniture are transferred directly from our home delivery hubs to Outlets, which has reduced transportation and handling costs, and improved selling margins across our Outlet network. We believe this initiative yielded substantial savings and margin enhancement of approximately $20 million annually.
Luxury In-Home Furniture Delivery Experience. We believe there is an opportunity to improve the customer experience by enhancing our approach to services in connection with in-home delivery. We are in the process of implementing a number of measures that are designed to increase our level of control and improve services levels over the delivery experience to the customer’s residence. We believe that we are well positioned to develop improved solutions for in-home delivery to the customer in the luxury market. We have already adopted a number of service improvements that are yielding improvements in the customer experience and reductions in product return and exchange rates. We expect to continue to optimize our service offering to customers in connection with the in-home delivery experience and are confident that our efforts in this regard will continue to achieve substantial results.
Elevate the Customer Experience. We are focused on improving the end-to-end customer experience. As we have elevated our brand, especially at retail, we are also working to enhance the brand experience in other aspects of our business. We are making changes in many aspects of our business processes that affect our

40

customers, including the in-home delivery experience, improvements in product quality and enhancements in sourcing, product availability, and all aspects of customer care and service. We also believe that the introduction of experiential brand-enhancing products and services, such as expanded design ateliers, the RH Interior Design program and the launch of an integrated hospitality experience in a number of our new Galleries, will further enhance our customers’ in-store experience, allowing us to further disrupt the highly fragmented home furnishings landscape and achieve market share gains.

In fiscal 2016,2017, fiscal 2018 and continuing into fiscal 2019, we experienced a slowdown in sales and substantially lower level of profits than in prior periods. We have undertaken initiatives to specifically address the temporal factors affecting our results in fiscal 2016, in addition to the other numerous initiatives we are undertaking to improve our business and financial performance in fiscal 2017 and beyond. If these initiatives are successful, we may return to rates of growth in revenues and improvements in margins and profitability that are more in line with our historical growth patterns prior to the downturn that we experienced in fiscal 2016. However, there can be no assurance that these efforts will be successful or that we will not encounter other operational difficulties during fiscal 2017 and future time periods that may have a negative impact on growth and profitability. For further informationfocused on the temporal factors affecting our results and our initiatives, see Item 2—Management’s Discussion and Analysisallocation of Financial Condition and Results of Operations—Overview—Key Value Driving Strategies in this Quarterly Report on Form 10-Q and Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting our Results of Operations in our 2016 Form 10-K.

Over the past 18 months, we transformed our business from a promotional to a membership modelcapital. We believe that is enhancing our brand, streamlining our operations and improvingcurrent initiatives are providing a significant opportunity to optimize the customer experience. We believe that the transition to a membership model has had a

27


favorable impact onallocation of capital in our business, including generating free cash flow and financial performance including through a reduction inoptimizing our return rate, exchange ratebalance sheet, as well as deploying capital to repay debt and cancel rate resulting in higher conversion of demand into revenues. As of October 28, 2017, we had approximately 380,000 members which drove approximately 95% of salesrepurchase shares of our core RH business during the three months ended October 28, 2017.

Simultaneouslycommon stock, which we began the redesign ofbelieve creates a long-term benefit to our supply chain network, rationalizing our product offerings, and transitioning inventory into fewer facilities, creating a more capital efficient model. As a result, we were able to forego building a fifth furniture distribution center planned to open in 2017 and we expect to consolidate our current furniture distribution center network from four to two locations by the fourth quarter of 2017. We anticipate that managing our business in fewer facilities will reduce inventory risk, increase turns, improve merchandise margins and eliminate the occupancy and overhead of approximately 1.75 million square feet of distribution space.shareholders.

We continue to pursue and test numerous initiatives to improve many aspects of our business including through efforts to optimize inventory, elevate the home delivery experience, and simplify our distribution network and improve our organizational design including by streamlining and realigning our home office operations, as well as to expand our product offering and transform our real estate.estate using a range of different models for specific real estate development projects. There can be no assurance as to the timing and extent of the operational benefits and financial contributions of these strategic efforts. In addition, our pursuit of multiple initiatives with respect to our business in any given period may result in period-to-period changes in, and increased fluctuation in, our results of operations. For example, our efforts to optimize our distribution network could cause us to incur costs and expenses in the short term with respect to changes in the way in which we operate our business. Delays in completion of our real estate development projects or costs overruns could also negatively affect our results of operation. Further, macroeconomic or political events outside of our control could impact our ability to pursue our initiatives or the success of such initiatives. For example, while we believe that the tariffs imposed to date have not had an adverse effect on our results of operations, including our revenues, margins and earnings, there can be no assurance that the existing tariffs and the additional tarriffs that will become effective, as well as other future tariffs that may be imposed, will not adversely affect our results of operation in future time periods. In addition, in recent periods the stock market has experienced significant volatility as well as periods of significant decline, which may negatively affect the financial health and demand levels of high-end consumers, and we can provide no assurance as to whether such trends will occur in the future. The housing market is affected by a range of factors including home prices and interest rates and slowdowns in the housing market can have a negative impact on demand for our products. Factors that affect the higher end housing market in particular may have an outsized influence on our levels of consumer demand since our business such as charges related to closureis geared toward the higher end of distribution centers.the home furnishings market. The above factors and other current and future operational initiatives of the Company may create additional uncertainty with respect to our consolidated net revenues and profit in the near term.

Acquisition of Waterworks

On May 27, 2016, we acquired a controlling interest in Design Investors WW Acquisition Company, LLC, which owns the business operating under the name “Waterworks,” for consideration consisting of 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. After the transaction, and giving effect to equity interests acquired by management in the business, we own in excess of 90% of the total equity interests in Waterworks.

Waterworks has long been the definition of the well-appointed bath, and is the only complete bath and kitchen business offering fittings, fixtures, furniture, furnishings, accessories, lighting, hardware and surfaces under one brand in the market. Waterworks is composed of the Waterworks, Waterworks Kitchen and Waterworks Studio brands, all built on a foundation of impeccable style, design integrity, quality and craftsmanship. Waterworks prides itself on its deep relationships in the design community and the technical expertise and tenure of its people.

Waterworks products are sold through its 15 showrooms in the United States and in the U.K., as well as through its boutique retail partners, hospitality division and online.

Key Value Driving Strategies

In order to drive growth across our business, we are focused on the following long-term key strategies:

Transform Our Real Estate Platform. We believe we have an opportunity to significantly increase our sales by transforming our real estate platform from our existing legacy retail footprint to a portfolio of next generation Design Galleries that are sized to the potential of each market and the size of our assortment. New next generation Design Gallery sites are identified based on a variety of factors, including timing of legacy Gallery lease expiration, availability of suitable new site locations, the negotiation of favorable economic terms to the Company for the new location, as well as satisfactory and timely completion of real estate development including procurement of permits and completion of construction. The number of next generation Design Galleries we open in any fiscal year is highly dependent upon these variables and individual new Design Galleries may be subject to delay or postponement depending on the circumstances of specific projects. We opened RH Toronto in October 2017 and RH West Palm in November 2017, both with integrated food and beverage offerings, and expect to open at least three Design Galleries in fiscal 2018.

Expand Our Offering and Increase Our Market Share. We believe we have a significant opportunity to increase our market share by:41

growing our merchandise assortment;Table of Contents

introducing new products and categories, including our introduction of RH Modern, RH TEEN and the addition of the Waterworks business;

28


expanding our service offerings, including the introduction of the RH Interior Design program and cafes, wine vaults and coffee bars at our next generation Design Galleries;

exploring and testing new business opportunities complementary to our core business; and

increasing our brand awareness and customer loyalty through our Source Book circulation strategy, our digital marketing initiatives and our advertising and public relations activities and events.

Elevate the Customer Experience. We are focused on improving the end-to-end customer experience. As we have elevated our brand, especially at retail, we are also working to enhance the brand experience in other aspects of our business. We are making changes in many aspects of our business processes that affect our customers, including improvements in product quality and enhancements in sourcing, product availability, in-home delivery and all aspects of customer care and service. We have invested significant time in fiscal 2017 architecting a new fully integrated back-end operating platform, inclusive of the supply chain network, the home delivery experience as well as a new metric driven quality system and company-wide decision data. We also believe that the introduction of experiential brand-enhancing products and services, such as expanded design ateliers, the RH Interior Design program and the planned launch of an integrated food and beverage experience in a number of our new Galleries, will further enhance our customers’ in-store experience, in addition to allowing us to further disrupt the highly fragmented home furnishings landscape and achieve market share gains.

Increase Operating Margins. We have the opportunity to continue to improve our operating margins by leveraging our fixed occupancy, advertising and corporate general and administrative costs, as well as leveraging our scalable infrastructure. Key areas in which we believe we will increase operating margins include:

Occupancy leverage;

Advertising cost leverage;

Improved product margin and shipping efficiencies; and

Other selling, general and administrative expenses.

Optimize the Allocation of Capital in the Business. We believe that our operations and current initiatives present a significant opportunity to optimize the allocation of capital in our business, including generating free cash flow and optimizing cash on our balance sheet as well as deploying capital to repurchase shares of our common stock which we believe creates a long term benefit to our shareholders. We have also incurred additional debt to fund a portion of our share repurchase programs and we believe that was a good capital allocation given favorable interest rates on debt and the ability of our business to generate cash in light of current business initiatives in order to paydown and service such debt. During fiscal 2017, one of our initiatives has been to generate additional cash flow through the optimization of inventory and other efforts to make our business more efficient in its use of capital to support operations. Our current efforts to generate more cash flow in our business include rationalizing our SKU count and reducing overall levels of inventory, which involves selling slower moving, discontinued and other inventory through markdowns and through our outlet channel. We have also undertaken initiatives to optimize our distribution network and make significant improvements in the way that we handle merchandise in the distribution and delivery part of our business. We expect that these improvements will result in operational efficiencies in the handling and transportation of merchandise and will enable us to achieve greater efficiency and lower requirements for carrying inventory to meet customer demand. We plan to lower our new Gallery opening cadence to three to five Galleries per year, which we believe will result in improved deal economics, lower build out costs and higher returns and will lower our capital requirements and execution risk over the course of our real estate transformation. We also believe the slower opening cadence will put less pressure on our infrastructure, enabling greater capital discipline throughout the organization. In addition, we have a number of assets that can be sold to third parties in order to generate cash. We expect to transition from a lease to a development model and may enter into sale leaseback transactions with respect to certain real estate that we own, for example, and may enter into capital or operating leases in lieu of purchasing or holding certain assets that are used in our business. We intend to continue to seek out and evaluate opportunities for effectively managing and deploying capital in ways that support and enhance our business initiatives and strategies.

Pursue International Expansion. We plan to strategically expand our business into select countries outside of the United States, Canada and the U.K. in the future. We believe that our luxury brand positioning and unique aesthetic will have strong international appeal.

In fiscal 2016, we made several strategic investments and changes to our business model in order to strengthen our brand and position the business for growth in the future. Our fiscal 2016 results also reflected the effect of temporal issues that we faced, including the costs related to the launch of RH Modern; the timing of recognizing Membership revenues related to the transition from

29


a promotional to a membership model; efforts to reduce inventories and rationalize our SKU count; and the decision to move our 2016 Source Book mailing from the spring to the fall.

In fiscal 2017, we have continued our efforts to optimize inventory and rationalize our SKU count. In the nine months ended October 28 2017, net revenues increased 14%, of which 3 points of growth was related to higher outlet and warehouse sales stemming from our accelerated inventory optimization efforts. While our higher outlet revenues and inventory optimization efforts had a positive impact on revenues and working capital in the first nine months of the year, they had a negative impact on margins and earnings.

Additionally, in fiscal 2017, we expect incremental revenues from the four new Design Galleries opened in 2016, our new Design Gallery in Toronto which opened in October 2017, and the Design Gallery in West Palm Beach which opened in November 2017. The majority of our new Design Galleries under development include a dedicated floor for RH Modern as well as an RH Hospitality offering including restaurants, wine vaults, and pantries, similar to our successful hospitality offering at RH Chicago, The Gallery at the Three Arts Club.

Basis of Presentation and Results of Operations

The following table sets forth our condensed consolidated statements of operationsincome and other financial and operating data.

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

(in thousands)

Condensed Consolidated Statements of Income:

Net revenues

$

706,514

$

640,798

$

1,304,935

$

1,198,204

Cost of goods sold

 

411,556

 

372,454

 

777,163

 

720,527

Gross profit

 

294,958

 

268,344

 

527,772

 

477,677

Selling, general and administrative expenses

 

190,977

 

186,521

 

355,158

 

347,707

Income from operations

 

103,981

 

81,823

 

172,614

 

129,970

Other expenses

 

  

 

  

 

  

 

  

Interest expense—net

 

24,513

 

15,467

 

45,631

 

30,565

(Gain) loss on extinguishment of debt

 

(954)

 

917

 

(954)

 

917

Total other expenses

 

23,559

 

16,384

 

44,677

 

31,482

Income before income taxes

 

80,422

 

65,439

 

127,937

 

98,488

Income tax expense

 

16,665

 

2,533

 

28,458

 

10,121

Net income

$

63,757

$

62,906

$

99,479

$

88,367

Other Financial and Operating Data:

 

  

 

  

 

  

 

  

Adjusted net income (1)

$

71,430

$

54,509

$

119,671

$

87,161

Adjusted EBITDA (2)

$

133,716

$

103,054

$

234,101

$

180,794

Capital expenditures

$

17,367

$

25,657

$

25,283

$

42,916

Landlord assets under construction—net of tenant allowances

23,013

8,997

27,555

27,645

Adjusted net capital expenditures (3)

$

40,380

$

34,654

$

52,838

$

70,561

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

 

(dollars in thousands)

 

Condensed Consolidated Statements of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

592,473

 

 

$

549,328

 

 

$

1,769,879

 

 

$

1,548,165

 

Cost of goods sold

 

 

378,148

 

 

 

373,509

 

 

 

1,179,485

 

 

 

1,065,032

 

Gross profit

 

 

214,325

 

 

 

175,819

 

 

 

590,394

 

 

 

483,133

 

Selling, general and administrative expenses

 

 

171,163

 

 

 

160,433

 

 

 

528,213

 

 

 

457,207

 

Income from operations

 

 

43,162

 

 

 

15,386

 

 

 

62,181

 

 

 

25,926

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense—net

 

 

18,915

 

 

 

11,091

 

 

 

45,496

 

 

 

32,528

 

Loss on extinguishment of debt

 

 

4,880

 

 

 

 

 

 

4,880

 

 

 

 

Total other expenses

 

 

23,795

 

 

 

11,091

 

 

 

50,376

 

 

 

32,528

 

Income (loss) before income taxes

 

 

19,367

 

 

 

4,295

 

 

 

11,805

 

 

 

(6,602

)

Income tax expense (benefit)

 

 

6,216

 

 

 

1,778

 

 

 

9,886

 

 

 

(2,567

)

Net income (loss)

 

$

13,151

 

 

$

2,517

 

 

$

1,919

 

 

$

(4,035

)

Other Financial and Operating Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stores (1)

 

$

343,222

 

 

$

306,800

 

 

$

1,010,120

 

 

$

872,662

 

Direct

 

$

249,251

 

 

$

242,528

 

 

$

759,759

 

 

$

675,503

 

Direct as a percentage of net revenues (2)

 

 

42

%

 

 

44

%

 

 

43

%

 

 

44

%

Growth in net revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stores (1)

 

 

12

%

 

 

9

%

 

 

16

%

 

 

14

%

Direct

 

 

3

%

 

 

-3

%

 

 

12

%

 

 

-3

%

Total

 

 

8

%

 

 

3

%

 

 

14

%

 

 

6

%

Comparable brand revenue growth (3)

 

 

6

%

 

 

-6

%

 

 

7

%

 

 

-2

%

Adjusted net income (4)

 

$

24,424

 

 

$

8,019

 

 

$

45,919

 

 

$

23,861

 

Capital:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

37,427

 

 

$

58,876

 

 

$

76,789

 

 

$

104,152

 

Construction related deposits (5)

 

 

7,487

 

 

 

168

 

 

 

12,772

 

 

 

3,829

 

Total capital

 

$

44,914

 

 

$

59,044

 

 

$

89,561

 

 

$

107,981

 

(1)

42

Stores data represents retail stores, including Waterworks showrooms, plus outlet stores. Net revenues for outlet stores, which include warehouse sales, were $41.2 million and $36.0 million for the three months ended October 28, 2017 and October 29, 2016, respectively, and were $148.4 million and $99.1 million for the nine months ended October 28, 2017 and October 29, 2016, respectively.

(2)

(1)

Direct revenues include sales through our Source Books, websites, and phone orders, including our Contract business and a portion of our Trade business.

30


(3)

Comparable brand revenue growth includes direct net revenues and retail comparable store sales, including RH Baby & Child and RH Modern Galleries. Comparable brand revenue growth excludes retail non-comparable store sales, closed store sales and outlet net revenues. Comparable store sales have been calculated based upon retail stores, excluding outlet stores, that were open at least fourteen full months as of the end of the reporting period and did not change square footage by more than 20% between periods. If a store is closed for seven days during a month, that month will be excluded from comparable store sales. Membership revenue was included in comparable brand revenue growth beginning April 2017, which is the first full month following the one-year anniversary of the program launch. Waterworks revenue was included in comparable brand revenue growth beginning June 2017, which is the first full month following the one-year anniversary of the acquisition.

(4)

Adjusted net income is a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP.generally accepted accounting principles (“GAAP”). We define adjusted net income as net income, (loss), adjusted for the impact of certain non-recurring and other items that we do not consider representative of our underlying operating performance. Adjusted net income is included in this filing because management believes that adjusted net income provides meaningful supplemental information for investors regarding the performance of our business and facilitates a meaningful evaluation of actualoperating results on a comparable basis with historical results. Our management uses this non-GAAP financial measure in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter. The following table presents a reconciliation of net income, (loss), the most directly comparable GAAP financial measure, to adjusted net income for the periods indicated below.

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

(in thousands)

Net income

$

63,757

$

62,906

$

99,479

$

88,367

Adjustments pre-tax:

 

  

 

  

 

  

 

  

Amortization of debt discount (a)

 

9,918

 

9,000

 

21,607

 

16,272

Asset impairments and change in useful lives (b)

2,545

6,021

Recall accrual (c)

 

(320)

 

(1,064)

 

(1,935)

 

(1,318)

Legal settlements (d)

(1,193)

(7,204)

(1,193)

(5,289)

(Gain) loss on extinguishment of debt (e)

 

(954)

 

917

 

(954)

 

917

Reorganization related costs (f)

 

 

1,721

 

 

1,721

Impact of inventory step-up (g)

 

 

190

 

 

380

Reversal of loss on asset disposal (h)

 

 

 

 

(840)

Subtotal adjusted items

 

9,996

 

3,560

 

23,546

 

11,843

Impact of income tax items (i)

 

(2,323)

 

(11,957)

 

(3,354)

 

(13,049)

Adjusted net income

$

71,430

$

54,509

$

119,671

$

87,161

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

 

(in thousands)

 

Net income (loss)

 

$

13,151

 

 

$

2,517

 

 

$

1,919

 

 

$

(4,035

)

Adjustments pre-tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Executive non-cash compensation (a)

 

 

 

 

 

 

 

 

23,872

 

 

 

 

Amortization of debt discount (b)

 

 

6,879

 

 

 

6,629

 

 

 

20,384

 

 

 

19,550

 

Recall accrual (c)

 

 

3,552

 

 

 

 

 

 

8,285

 

 

 

 

Loss on extinguishment of debt (d)

 

 

4,880

 

 

 

 

 

 

4,880

 

 

 

 

Distribution center closure (e)

 

 

1,862

 

 

 

 

 

 

1,862

 

 

 

 

Gain on sale of building and land (f)

 

 

(819

)

 

 

 

 

 

(2,119

)

 

 

 

Legal claim (g)

 

 

 

 

 

 

 

 

 

 

 

8,701

 

Reorganization related costs (h)

 

 

 

 

 

974

 

 

 

 

 

 

5,698

 

Waterworks acquisition related:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-cash compensation (i)

 

 

 

 

 

 

 

 

 

 

 

3,672

 

Impact of inventory step-up (j)

 

 

248

 

 

 

1,786

 

 

 

2,108

 

 

 

5,187

 

Acquisition related costs (k)

 

 

 

 

 

 

 

 

 

 

 

2,847

 

Subtotal adjusted items

 

 

16,602

 

 

 

9,389

 

 

 

59,272

 

 

 

45,655

 

Impact of income tax items (l)

 

 

(5,329

)

 

 

(3,887

)

 

 

(15,272

)

 

 

(17,759

)

Adjusted net income

 

$

24,424

 

 

$

8,019

 

 

$

45,919

 

 

$

23,861

 

(a)

Represents a non-cash compensation charge related to a fully vested option grant made to Mr. Friedman in May 2017.

(b)

(a)

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 GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were issued in June 2014 (the “2019 Notes”) and, for the $300 million aggregate principal amount of convertible senior notes that were issued in June and July 2015 (the “2020 Notes”) and for the $335 million aggregate principal amount of convertible senior notes that were issued in June 2018 (the “2023 Notes”), we separated the 2019 Notes, 2020 Notes and 20202023 Notes into liability (debt) and equity (conversion option) components and we are amortizing as debt discount an amount equal to the fair value of the equity components as interest expense on the 2019 Notes, 2020 Notes and 20202023 Notes over their expected lives. The equity components represent the difference between the proceeds from the issuance of the 2019 Notes, 2020 Notes and 20202023 Notes and the fair value of the liability components of the 2019 Notes, 2020 Notes and 20202023 Notes, respectively. Amounts are presented net of interest capitalized for capital projects of $0.8$0.7 million and $0.6$0.8 million during the three months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. Amounts are presented net of interest capitalized for capital projects of $2.3$1.4 million during both the six months ended August 3, 2019 and August 4, 2018. The 2019 Notes matured on June 15, 2019 and did not impact amortization of debt discount post-maturity.

(b)Represents the acceleration of depreciation expense of $1.9 million and $1.9$4.9 million duringdue to a change in the nineestimated useful lives of certain assets in the three and six months ended October 28, 2017August 3, 2019, respectively. The six months ended August 3, 2019 includes a $0.5 million charge related to the termination of a service agreement associated with such assets. In addition, the three and October 29, 2016, respectively.

six months ended August 3, 2019 include an asset impairment of $0.6 million.

43

(c)

(c)

Represents costsan adjustment to net revenues, increase in cost of goods sold and inventory charges associated with a product recall initiated in the second quarter of fiscal 2017,recalls, as well as an adjustment in the nine months ended October 28, 2017 of the accrual related to certain product recalls initiated in the fourth quarter of fiscal 2016.adjustments and vendor claims. The recall adjustments which affected our results for the three and nine months ended October 28, 2017, had the following effect on our income before taxes:

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

(in thousands)

Reduction of net revenues

$

$

1,853

$

413

$

1,853

Impact on cost of goods sold

 

(320)

 

(3,262)

 

(2,381)

 

(3,516)

Impact on gross profit

 

(320)

 

(1,409)

 

(1,968)

 

(1,663)

Incremental selling, general and administrative expenses

 

 

345

 

33

 

345

Impact on income before income taxes

$

(320)

$

(1,064)

$

(1,935)

$

(1,318)

31


 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 28,

 

 

 

2017

 

 

2017

 

 

 

(in thousands)

 

Reduction of net revenues

 

$

 

 

$

3,813

 

Incremental cost of goods sold and inventory charges

 

 

3,552

 

 

 

4,315

 

Impact on gross profit

 

 

3,552

 

 

 

8,128

 

Incremental selling, general and administrative expenses

 

 

 

 

 

157

 

Impact on income (loss) before income taxes

 

$

3,552

 

 

$

8,285

 

(d)

(d)

Represents legal settlements, net of related legal expenses.
(e)The three and six months ended August 3, 2019 includes a gain on extinguishment of debt upon the maturity and settlement of the 2019 Notes in June 2019. The three and six months ended August 4, 2018 includes a loss on extinguishment of debt related to the second lienLILO term loan, the promissory note secured by our aircraft and the equipment security notes, all of which waswere repaid in full in October 2017.

June 2018.

(e)

Represents severance expense and certain inventory transfer costs associated with two distribution center closures, one of which was completed in November 2017 and one which is expected to occur in January 2018.

(f)

Represents the gain on the sale of building and land. As we entered into a short-term lease agreement to lease the property subsequent to the sale, the total gain associated with the sale of this property was amortized over a five month period.

(g)

Represents the estimated cumulative impact of coupons redeemed in connection with a legal claim alleging that the Company violated California’s Song-Beverly Credit Card Act of 1971 by requesting and recording ZIP codes from customers paying with credit cards.

(h)

Represents costs associated with a supply chain reorganization, including the closure of the Dallas customer call center, which include severance costs and related taxes, partially offset by a reversal of stock-based compensation expense related to unvested equity awards.

taxes.

(i)

Represents a non-cash compensation charge related to the fully vested option grants made in connection with our acquisition of Waterworks.

(j)

(g)

Represents the non-cash amortization of the inventory fair value adjustment recorded in connection with our acquisition of Waterworks.

(k)

(h)

Represents costs incurred in connection with our acquisitionthe reversal of Waterworks including professional fees.

(l)

The adjustment for the three months ended October 28, 2017 represents the tax effectan estimated loss on disposal of asset due to negotiations of the adjusted items based on our effectivesales price being finalized.

(i)Assumes a normalized tax rate of 32.1%. The nine months ended October 28, 2017 includes an adjustment to calculate income tax expense at an adjusted tax rate of 35.4%, which is calculated based on the weighted-average fiscal 2017 quarterly adjusted effective tax rates. The adjustments21% for the three and ninesix months ended October 29, 2016 representAugust 3, 2019 and August 4, 2018 in order to facilitate year over year comparison of operating results on a comparable basis with historical results at a consistent tax rate across time periods.
(2)EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income before depreciation and amortization, interest expense and income tax expense. Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the tax effectimpact of non-cash compensation, as well as certain non-recurring and other items that we do not consider representative of our underlying operating performance. EBITDA and Adjusted EBITDA are included in this filing because management believes that these metrics provide meaningful supplemental information for investors regarding the performance of our business and facilitate a meaningful evaluation of operating results on a comparable basis with historical results. Our management uses these non-GAAP financial measures in order to have comparable financial results to analyze changes in our underlying business from quarter to quarter. Our measures of EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions for other companies due to different methods of calculation.

44

The following table presents a reconciliation of net income, the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated below.

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

(in thousands)

Net income

$

63,757

$

62,906

$

99,479

$

88,367

Depreciation and amortization

 

25,321

 

21,354

 

52,510

 

41,939

Interest expense—net

 

24,513

 

15,467

 

45,631

 

30,565

Income tax expense

 

16,665

 

2,533

 

28,458

 

10,121

EBITDA

 

130,256

 

102,260

 

226,078

 

170,992

Stock-based compensation (a)

 

5,298

 

6,234

 

10,993

 

14,231

Asset impairments and change in useful lives (b)

 

629

 

 

1,112

 

Recall accrual (b)

 

(320)

 

(1,064)

 

(1,935)

 

(1,318)

Legal settlements (b)

(1,193)

(7,204)

(1,193)

(5,289)

(Gain) loss on extinguishment of debt (b)

(954)

917

(954)

917

Reorganization related costs (b)

1,721

1,721

Impact of inventory step-up (b)

 

 

190

 

 

380

Reversal of loss on asset disposal (b)

 

 

 

 

(840)

Adjusted EBITDA

$

133,716

$

103,054

$

234,101

$

180,794

(a)Represents non-cash compensation related to equity awards granted to employees.
(b)Refer to the reconciliation of net income to adjusted items based on our effective tax ratesnet income table above and the related footnotes for additional information.

(3)We define adjusted net capital expenditures as (i) capital expenditures from investing activities and (ii) cash outflows of 41.4%capital related to construction activities to design and 38.9%, respectively.

build landlord-owned leased assets, net of tenant allowances received.

(5)

45

Construction related deposits relate to payments to escrow accounts for future construction of Design Galleries.

32


The following tables present retailRH Gallery metrics, which have been calculated based upon retail stores, which includes our RH Baby & Child, RH Modern Galleries and Waterworks Showrooms,showroom metrics and excludes outlet stores.exclude outlets:

Six Months Ended

August 3,

August 4,

2019

2018

    

    

Total Leased

    

    

Total Leased

Selling Square

Selling Square

Store Count

Footage (1)

Store Count

Footage (1)

(in thousands)

(in thousands)

Beginning of period

 

86

 

1,089

 

83

 

981

Design Galleries:

 

  

 

  

 

  

 

  

Portland Design Gallery

 

 

 

1

 

26.0

Nashville Design Gallery

 

1

45.6

Modern Galleries:

Dallas RH Modern Gallery (relocation)

(4.5)

 

Dallas RH Modern Gallery

 

 

 

1

 

8.2

Baby & Child Galleries:

Dallas RH Baby & Child Gallery

(1)

(3.7)

1

 

3.7

Portland RH Baby & Child Gallery

 

1

4.7

Legacy Galleries:

Dallas legacy Gallery (relocation)

(2.6)

 

San Antonio legacy Gallery (relocation)

(3.8)

 

Portland legacy Gallery

 

 

 

(1)

 

(4.7)

Nashville legacy Gallery

 

(1)

(7.1)

Washington DC legacy Gallery

 

(1)

(5.6)

Waterworks Showrooms:

Waterworks Scottsdale Showroom (relocation)

 

 

 

 

1.1

End of period

 

85

 

1,074

 

85

 

1,053

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

Store Count

 

 

Total Leased Selling Square Footage (1)

 

 

Store Count

 

 

Total Leased Selling Square Footage (1)

 

 

 

 

 

 

 

(in thousands)

 

 

 

 

 

 

(in thousands)

 

Beginning of period

 

 

85

 

 

 

912

 

 

 

69

 

 

 

725

 

Waterworks Showrooms acquired

 

 

 

 

 

 

15

 

 

 

51.0

 

Retail Galleries opened:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Waterworks Boston Showroom

 

 

1

 

 

 

5.0

 

 

 

 

 

Yorkdale next generation Design Gallery

 

 

1

 

 

 

43.3

 

 

 

 

 

Leawood next generation Design Gallery

 

 

 

 

 

 

1

 

 

 

33.5

 

Waterworks San Francisco Showroom

 

 

 

 

 

 

1

 

 

 

5.8

 

Austin next generation Design Gallery

 

 

 

 

 

 

1

 

 

 

39.6

 

Las Vegas next generation Design Gallery

 

 

 

 

 

 

1

 

 

 

47.6

 

Retail Galleries closed:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Waterworks Boston Showroom

 

 

(1

)

 

 

(2.1

)

 

 

 

 

Toronto (Bayview) Legacy Gallery

 

 

(1

)

 

 

(6.0

)

 

 

 

 

Toronto (Yonge Street) Legacy Gallery

 

 

(1

)

 

 

(8.6

)

 

 

 

 

Kansas City Legacy Gallery

 

 

 

 

 

 

(1

)

 

 

(9.9

)

Waterworks - Kansas Street, SF

 

 

 

 

 

 

(1

)

 

 

(2.0

)

Austin Legacy Gallery

 

 

 

 

 

 

(1

)

 

 

(6.2

)

End of period

 

 

84

 

 

 

944

 

 

 

85

 

 

 

884

 

(1)

(1)

Leased selling square footage is retail space at our stores used to sell our products. Leased selling square footage excludes backrooms at retail stores used for storage, office space, food preparation, kitchen space or similar purpose, as well as exterior sales space located outside a store, such as courtyards, gardens and rooftops. Leased selling square footage for the three and ninesix months ended October 28, 2017August 3, 2019 includes approximately 11,600 square feet related to two owned store locations. Leased selling square footage for the three and six months ended August 4, 2018 includes approximately 4,800 square feet related to one owned store location. Leased sellinglocation.

Three Months Ended

Six Months Ended

August 3,

August 4,

August 3,

August 4,

    

2019

    

2018

    

2019

    

2018

(in thousands)

Total leased square footage at end of period (1)

1,451

1,414

1,451

1,414

Weighted-average leased square footage (2)

 

1,451

 

1,392

 

1,456

 

1,362

Weighted-average leased selling square footage (2)

 

1,075

 

1,035

 

1,079

 

1,013

(1)Total leased square footage for the three and nine months ended October 29, 2016as of August 3, 2019 includes approximately 13,00016,100 square feet related to two owned store locations.

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

 

 

(in thousands)

 

Total leased square footage at end of period (1)

 

 

1,276

 

 

 

1,208

 

 

 

1,276

 

 

 

1,208

 

Weighted-average leased square footage (2)

 

 

1,250

 

 

 

1,146

 

 

 

1,245

 

 

 

1,066

 

Weighted-average leased selling square footage (2)

 

 

918

 

 

 

816

 

 

 

914

 

 

 

767

 

Retail sales per leased selling square foot (in dollars) (3)

 

$

329

 

 

$

330

 

 

$

941

 

 

$

1,004

 

(1)

Total leased square footage as of October 28, 2017August 4, 2018 includes approximately 5,400 square feet related to one owned store location. Total leased square footage as of October 29, 2016 includes approximately 24,000 square feet related to two owned store locations.

location

(2)

Weighted-average leased square footage and leased selling square footage is calculated based on the number of days a Gallery location was opened during the period divided by the total number of days in the period.

(3)

46

Retail sales per leased selling square foot is calculated by dividing total net revenues for all retail stores, comparable and non-comparable, by the weighted-average leased selling square footage for the period.

33


The following table sets forth our condensed consolidated statements of operationsincome as a percentage of total net revenues.

Three Months Ended

Six Months Ended

 

August 3,

August 4,

August 3,

August 4,

 

    

2019

    

2018

    

2019

    

2018

 

Condensed Consolidated Statements of Income:

Net revenues

100.0

%  

100.0

%  

100.0

%  

100.0

%

Cost of goods sold

58.3

 

58.1

 

59.6

 

60.1

Gross profit

41.7

 

41.9

 

40.4

 

39.9

Selling, general and administrative expenses

27.0

 

29.1

 

27.2

 

29.1

Income from operations

14.7

 

12.8

 

13.2

 

10.8

Other expenses

  

 

  

 

  

 

  

Interest expense—net

3.4

 

2.5

 

3.5

 

2.5

(Gain) loss on extinguishment of debt

(0.1)

 

0.1

 

(0.1)

 

0.1

Total other expenses

3.3

 

2.6

 

3.4

 

2.6

Income before income taxes

11.4

 

10.2

 

9.8

 

8.2

Income tax expense

2.4

 

0.4

 

2.2

 

0.8

Net income

9.0

%  

9.8

%  

7.6

%  

7.4

%

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Condensed Consolidated Statements of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

 

100.0

%

 

 

100.0

%

 

 

100.0

%

 

 

100.0

%

Cost of goods sold

 

 

63.8

 

 

 

68.0

 

 

 

66.6

 

 

 

68.8

 

Gross profit

 

 

36.2

 

 

 

32.0

 

 

 

33.4

 

 

 

31.2

 

Selling, general and administrative expenses

 

 

28.9

 

 

 

29.2

 

 

 

29.9

 

 

 

29.5

 

Income from operations

 

 

7.3

 

 

 

2.8

 

 

 

3.5

 

 

 

1.7

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense—net

 

 

3.2

 

 

 

2.0

 

 

 

2.5

 

 

 

2.1

 

Loss on extinguishment of debt

 

 

0.8

 

 

 

 

 

 

0.3

 

 

 

 

Total other expenses

 

 

4.0

 

 

 

2.0

 

 

 

2.8

 

 

 

2.1

 

Income (loss) before income taxes

 

 

3.3

 

 

 

0.8

 

 

 

0.7

 

 

 

(0.4

)

Income tax expense (benefit)

 

 

1.1

 

 

 

0.3

 

 

 

0.6

 

 

 

(0.1

)

Net income (loss)

 

 

2.2

%

 

 

0.5

%

 

 

0.1

%

 

 

(0.3

%)

Three Months Ended October 28, 2017August 3, 2019 Compared to Three Months Ended October 29, 2016August 4, 2018

Three Months Ended

August 3,

August 4,

2019

2018

    

RH Segment

    

Waterworks (1)

    

Total

    

RH Segment

    

Waterworks (1)

    

Total

(in thousands)

Net revenues

$

672,328

$

34,186

$

706,514

$

607,604

$

33,194

$

640,798

Cost of goods sold

 

391,859

 

19,697

 

411,556

 

352,099

 

20,355

 

372,454

Gross profit

 

280,469

 

14,489

 

294,958

 

255,505

 

12,839

 

268,344

Selling, general and administrative expenses

 

177,408

 

13,569

 

190,977

 

173,154

 

13,367

 

186,521

Income (loss) from operations

$

103,061

$

920

$

103,981

$

82,351

$

(528)

$

81,823

 

 

Three Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

RH Segment

 

 

Waterworks (1)

 

 

Total

 

 

RH Segment

 

 

Waterworks (1)

 

 

Total

 

 

 

(in thousands)

 

Net revenues

 

$

563,174

 

 

$

29,299

 

 

$

592,473

 

 

$

521,027

 

 

$

28,301

 

 

$

549,328

 

Cost of goods sold

 

 

359,953

 

 

 

18,195

 

 

 

378,148

 

 

 

354,903

 

 

 

18,606

 

 

 

373,509

 

Gross profit

 

 

203,221

 

 

 

11,104

 

 

 

214,325

 

 

 

166,124

 

 

 

9,695

 

 

 

175,819

 

Selling, general and administrative

   expenses

 

 

159,092

 

 

 

12,071

 

 

 

171,163

 

 

 

148,438

 

 

 

11,995

 

 

 

160,433

 

Income (loss) from operations

 

$

44,129

 

 

$

(967

)

 

$

43,162

 

 

$

17,686

 

 

$

(2,300

)

 

$

15,386

 

(1)

Waterworks results include non-cash amortization of $0.2 million and $1.8 million related to the inventory fair value adjustment recorded in connection with our acquisition of Waterworks during the three months ended October 28, 2017 and October 29, 2016, respectively.

August 4, 2018. No amortization was recorded during the three months ended August 3, 2019.

Net revenues

Consolidated net revenues increased $43.1$65.7 million, or 7.9%10.3%, to $592.5$706.5 million in the three months ended October 28, 2017August 3, 2019 compared to $549.3$640.8 million in the three months ended October 29, 2016. StoresAugust 4, 2018.

Consolidated net revenues for the three months ended August 4, 2018 were negatively impacted by $1.9 million related to the reduction of revenue associated with product recalls. Excluding the product recall adjustment, consolidated net revenues increased $36.4$63.9 million, or 11.9%9.9%, to $343.2$706.5 million in the three months ended October 28, 2017August 3, 2019 compared to $306.8$642.7 million in the three months ended October 29, 2016. Direct net revenues increased $6.7 million,August 4, 2018. Product recalls and the establishment or 2.8%, to $249.3 million inadjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the three months ended October 28, 2017 compared to $242.5 million in the three months ended October 29, 2016. Comparable brand revenue was 6%period-to-period comparisons of our results. No assurance can be provided that any accruals will be for the three months ended October 28, 2017.appropriate amount, and actual losses could be higher or lower than what we accrue from time to time, which could further affect results.

47

RH Segment net revenues

RH Segment net revenues increased $42.1$64.7 million, or 8.1%10.7%, to $563.2$672.3 million in the three months ended October 28, 2017August 3, 2019 compared to $521.0$607.6 million in the three months ended October 29, 2016.

A number ofAugust 4, 2018. The below discussion highlights several significant factors contributed to the increasethat resulted in increased RH Segment net revenues, during the three months ended October 28, 2017, including,which are listed in order of magnitude, the introduction of new product categories and the expansion ofmagnitude.

RH Segment core net revenues increased primarily due to existing product categories, the performance of our new Design Galleries, and an increase in retail weighted-average leased selling square footage, as well as an increase in retail weighted-average selling square footage related to new store openings, including New York, Nashville and Yountville, and we experienced better than expected delivered sales in the last few weeks of the quarter. Net revenues also increased from our RH Hospitality operations and Contract business which representsbusiness.

RH Segment outlet sales increased $16.0 million to commercial customers.

Outlet sales, which include sales via warehouse locations, increased $5.1$53.9 million in the three months ended October 28, 2017August 3, 2019 compared to $37.9 million in the three months ended October 29, 2016. We also had an increase in Membership revenue recognized of $4.6 million.

34


The above increases were partially offset by an approximate 1% negative impact of Hurricanes Harvey and IrmaAugust 4, 2018 primarily due to storeincreased promotional activity as a result of our efforts to reduce inventory subsequent to the distribution center closures and lost sales.of as part of the distribution center network redesign, as well as an increase of four outlet locations year over year.

RH Segment net revenues for the three months ended August 4, 2018 were negatively impacted by $1.9 million related to the reduction of revenue associated with product recalls.

Waterworks net revenues

Waterworks net revenues increased $1.0 million, or 3.5%3.0%, to $29.3$34.2 million in the three months ended October 28, 2017August 3, 2019 compared to $28.3$33.2 million in the three months ended October 29, 2016. Waterworks net revenues represented 4.9% and 5.2% of our net revenues for the three months ended October 28, 2017 and October 29, 2016, respectively.August 4, 2018.

Gross profit

Consolidated gross profit increased $38.5$26.6 million, or 21.9%9.9%, to $214.3$295.0 million in the three months ended October 28, 2017August 3, 2019 from $175.8$268.3 million in the three months ended October 29, 2016.August 4, 2018. As a percentage of net revenues, consolidated gross margin increased 4.2%decreased 0.2% to 36.2%41.7% of net revenues in the three months ended October 28, 2017August 3, 2019 from 32.0%41.9% of net revenues in the three months ended October 29, 2016.August 4, 2018.

RH Segment gross profit for the three months ended October 28, 2017August 3, 2019 was negatively impacted by $3.6$1.9 million related to inventory chargesthe acceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the three months ended August 3, 2019 and August 4, 2018 was positively impacted by $0.3 million and $1.4 million, respectively, related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the reduction of revenue and $0.5 million related toincremental costs associated with anticipated distribution center closures. such product recalls.

Waterworks gross profit for the three months ended October 28, 2017 and October 29, 2016August 4, 2018 was negatively impacted by $0.2$0.2 million and $1.8 million, respectively, of amortization related to the inventory fair value adjustment recorded in connection with the acquisition.

Excluding the acceleration of depreciation, the product recall costs, costs associated with anticipated distribution center closuresadjustments and the impact of the amortization related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased 4.6%0.4% to 36.9%42.0% of net revenues in the three months ended October 28, 2017August 3, 2019 from 32.3%41.6% of net revenues in the three months ended October 29, 2016.August 4, 2018.

RH Segment gross profit

RH Segment gross profit increased $37.1$25.0 million, or 22.3%9.8%, to $203.2$280.5 million in the three months ended October 28, 2017August 3, 2019 from $166.1$255.5 million in the three months ended October 29, 2016.August 4, 2018. As a percentage of net revenues, RH Segment gross margin increased 4.2%decreased 0.4% to 36.1%41.7% of net revenues in the three months ended October 28, 2017August 3, 2019 from 31.9%42.1% of net revenues in the three months ended October 29, 2016.August 4, 2018.

Excluding the acceleration of depreciation and product recalls and costs associated with anticipated distribution center closuresrecall adjustments mentioned above, RH Segment gross margin would have increased 4.9%0.3% to 36.8%42.0% of net revenues in the three months ended October 28, 2017August 3, 2019 from 31.9%41.7% of net revenues in the three months ended October 29, 2016.August 4, 2018. The increase in order of magnitude, was dueprimarily related to improvements in our core merchandise margins as our SKU rationalization efforts had a

48

distribution center network redesign resulting in reduced impact on our margins this year compared to last year,delivery expense and leverage in occupancy costs. The overall increase was partially offset by higherlower outlet and warehouse sales driven byproduct margins due to increased promotionspromotional activity and higher discounts. Additionally, gross margin increaseddiscounts due to improvement in shipping costs as a percentage of net revenues.our efforts to reduce inventory subsequent to the distribution center closures.

Waterworks gross profit

Waterworks gross profit increased $1.4$1.7 million, or 14.5%12.9%, to $11.1$14.5 million in the three months ended October 28, 2017August 3, 2019 from $9.7$12.8 million in the three months ended October 29, 2016.August 4, 2018. As a percentage of net revenues, Waterworks gross margin increased 3.6%3.7% to 37.9%42.4% of net revenues in the three months ended October 28, 2017August 3, 2019 from 34.3%38.7% of net revenues in the three months ended October 29, 2016.August 4, 2018.

Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have decreased 1.9%increased 3.1% to 38.7%42.4% of net revenues in the three months ended October 28, 2017August 3, 2019 from 40.6%39.3% of net revenues in the three months ended October 29, 2016. The decrease in gross margin is primarily due to changes in product mix and deleverage in occupancy costs.August 4, 2018.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $10.7$4.5 million, or 6.7%2.4%, to $171.2$191.0 million in the three months ended October 28, 2017August 3, 2019 compared to $160.4$186.5 million in the three months ended October 29, 2016.

35


RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $10.7 million, or 7.2%, to $159.1 million in the three months ended October 28, 2017 compared $148.4 million in the three months ended October 29, 2016.

RH Segment selling, general and administrative expenses for the three months ended October 28, 2017 included $1.4 million related to costs associated with anticipated distribution center closures and a gain of $0.8 million related to the sale of building and land. RH Segment selling, general and administrative expenses for the three months ended October 29, 2016 included $1.0 million associated with a reorganization, including severance and related taxes.

Advertising and marketing costs increased $9.8 million during the three months ended October 28, 2017 as compared to October 29, 2016, primarily due to the timing of our Source Book mailings. In the third quarter of fiscal 2017 we amortized costs related to our 2016 Interiors Source Book which was circulated in the fall of 2016. The 2016 Interiors Source Book mailing was complete in mid-December and therefore resulted in amortized costs in the third quarter of fiscal 2017, whereas the third quarter of fiscal 2016 did not incur similarly timed expenses.

RH Segment selling, general and administrative expenses were 28.2% and 28.3% of net revenues for the three months ended October 28, 2017 and October 29, 2016, respectively, excluding the costs associated with anticipated distribution center closures, the gain related to the sale of building and land and the reorganization costs mentioned above. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by leverage in employment and employment related costs and, to a lesser extent, leverage in our corporate occupancy costs, partially offset by an increase in advertising and marketing costs.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses increased $0.1 million, or 0.6%, to $12.1 million in the three months ended October 28, 2017 compared to $12.0 million in the three months ended October 29, 2016.

Interest expensenet

Interest expense increased $7.8 million to $18.9 million for the three months ended October 28, 2017 compared to $11.1 million for the three months ended October 29, 2016. Interest expense consisted of the following:

 

 

Three Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

(in thousands)

 

Amortization of convertible senior notes debt discount

 

$

7,667

 

 

$

7,254

 

Build-to-suit lease transactions

 

 

4,133

 

 

 

3,083

 

Term loans

 

 

2,721

 

 

 

 

Asset based credit facility

 

 

2,622

 

 

 

584

 

Amortization of debt issuance costs and deferred financing fees

 

 

1,996

 

 

 

634

 

Other interest expense

 

 

772

 

 

 

833

 

Capitalized interest for capital projects

 

 

(966

)

 

 

(625

)

Interest income

 

 

(30

)

 

 

(672

)

Total interest expense—net

 

$

18,915

 

 

$

11,091

 

Loss on extinguishment of debt

We incurred a $4.9 million loss on extinguishment of debt in the three months ended October 28, 2017 due to the repayment in full of the second lien term loan on October 10, 2017, which includes a prepayment penalty of $3.0 million and acceleration of amortization of debt issuance costs of $1.9 million.

Income tax expense

Income tax expense was $6.2 million and $1.8 million in the three months ended October 28, 2017 and October 29, 2016, respectively. Our effective tax rate was 32.1% and 41.4% for the three months ended October 28, 2017 and October 29, 2016, respectively. The effective tax rate in the three months ended October 28, 2017 was impacted by net excess tax benefits from stock-based compensation of $1.9 million resulting from the Company’s adoption of ASU 2016-09 in the first quarter of fiscal 2017.

36


Nine Months Ended October 28, 2017 Compared to Nine Months Ended October 29, 2016

Prior to the Waterworks acquisition on May 27, 2016, we had one reportable segment. As we acquired the Waterworks business on May 27, 2016, reportable segment information presented below for Waterworks includes results for twenty-two weeks during the nine months ended October 29, 2016 and includes results for thirty-nine weeks during the nine months ended October 28, 2017. The RH Segment includes results for thirty-nine weeks during both the nine months ended October 28, 2017 and October 29, 2016.

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

RH Segment

 

 

Waterworks (1)

 

 

Total

 

 

RH Segment

 

 

Waterworks (1)

 

 

Total

 

 

 

(in thousands)

 

Net revenues

 

$

1,680,495

 

 

$

89,384

 

 

$

1,769,879

 

 

$

1,499,101

 

 

$

49,064

 

 

$

1,548,165

 

Cost of goods sold

 

 

1,124,651

 

 

 

54,834

 

 

 

1,179,485

 

 

 

1,031,699

 

 

 

33,333

 

 

 

1,065,032

 

Gross profit

 

 

555,844

 

 

 

34,550

 

 

 

590,394

 

 

 

467,402

 

 

 

15,731

 

 

 

483,133

 

Selling, general and administrative

   expenses

 

 

489,412

 

 

 

38,801

 

 

 

528,213

 

 

 

432,961

 

 

 

24,246

 

 

 

457,207

 

Income (loss) from operations

 

$

66,432

 

 

$

(4,251

)

 

$

62,181

 

 

$

34,441

 

 

$

(8,515

)

 

$

25,926

 

(1)

Waterworks results include non-cash amortization of $2.1 million and $5.2 million related to the inventory fair value adjustment recorded in connection with our acquisition of Waterworks during the nine months ended October 28, 2017 and October 29, 2016, respectively.

Net revenues

Consolidated net revenues increased $221.7 million, or 14.3%, to $1,769.9 million in the nine months ended October 28, 2017 compared to $1,548.2 million in the nine months ended October 29, 2016. Stores net revenues increased $137.5 million, or 15.8%, to $1,010.1 million in the nine months ended October 28, 2017 compared to $872.7 million in the nine months ended October 29, 2016. Direct net revenues increased $84.3 million, or 12.5%, to $759.8 million in the nine months ended October 28, 2017 compared to $675.5 million in the nine months ended October 29, 2016. Comparable brand revenue was 7% for the nine months ended October 28, 2017.

RH Segment net revenues

RH Segment net revenues increased $181.4 million, or 12.1%, to $1,680.5 million in the nine months ended October 28, 2017 compared to $1,499.1 million in the nine months ended October 29, 2016.

A number of factors contributed to the increase in RH Segment net revenues during the nine months ended October 28, 2017, the most significant of which was our decision to move the mailing of our 2016 Interiors Source Book to the fall of 2016. The 2016 Interiors Source Book mailing was complete in mid-December and therefore was a contributor to net revenues in the first three quarters of fiscal 2017, whereas the first three quarters of fiscal 2016 did not benefit from a similarly timed mailing.

In addition, the following factors resulted in increased RH Segment net revenues, which are listed in order of magnitude. Outlet sales, which include sales via warehouse locations, increased $49.2 million in the nine months ended October 28, 2017 compared to the nine months ended October 29, 2016, representing 3.3% of growth in RH Segment net revenues. Increased outlet sales occurred primarily as a result of our inventory optimization efforts as we increased our outlet promotional activity, including through warehouse sales, and we increased outlet selling square footage by approximately 32% compared to the prior period. Additionally, the performance of our new Design Galleries and an increase in retail weighted-average leased selling square footage contributed to the increase in RH Segment net revenues. Net revenues also increased related to deeper markdowns on discontinued merchandise based on our continued efforts to rationalize our SKU count. We also had an increase in Membership revenue recognized of $18.2 million.

RH Segment net revenues for the nine months ended October 28, 2017 were negatively impacted by $3.8 million related to the reduction of revenue associated with product recalls. During the nine months ended October 29, 2016, RH Segment net revenues were reduced by an estimated $16 million due to customer accommodation and related expenses as a result of our initiative to elevate the customer experience, including in response to production delays related to RH Modern. We did not experience similar production delays during the nine months ended October 28, 2017.

Waterworks net revenues

On May 27, 2016, we acquired a controlling interest in Waterworks. As a result of this acquisition, we acquired 15 Waterworks showrooms and included such additional retail stores in our weighted-average leased selling square footage for both the nine months

37


ended October 28, 2017 and October 29, 2016. Waterworks net revenues increased $40.3 million, or 82.2%, to $89.4 million in the nine months ended October 28, 2017 compared to $49.1 million in the nine months ended October 29, 2016. Waterworks net revenues represented 5.1% and 3.2% of our net revenues for the nine months ended October 28, 2017 and October 29, 2016, respectively. The increase in Waterworks net revenues is primarily due to the nine months ended October 28, 2017 representing thirty-nine weeks of results, whereas the nine months ended October 29, 2016 only includes twenty-two weeks of results as Waterworks was acquired on May 27, 2016.

Gross profit

Consolidated gross profit increased $107.3 million, or 22.2%, to $590.4 million in the nine months ended October 28, 2017 from $483.1 million in the nine months ended October 29, 2016. As a percentage of net revenues, consolidated gross margin increased 2.2% to 33.4% of net revenues in the nine months ended October 28, 2017 from 31.2% of net revenues in the nine months ended October 29, 2016.

RH Segment gross profit for the nine months ended October 28, 2017 was negatively impacted by $8.2 million related to the reduction of revenue, incremental costs and inventory charges associated with product recalls and $0.5 million related to costs associated with anticipated distribution center closures. RH Segment gross profit for the nine months ended October 29, 2016 was negatively impacted by $7.7 million related to the estimated cumulative impact of coupons redeemed in connection with a legal claim alleging that the Company violated California’s Song-Beverly Credit Card Act of 1971 by requesting and recording ZIP codes from customers paying with credit cards. The coupons expired in March 2016.

Waterworks gross profit for the nine months ended October 28, 2017 and October 29, 2016 was negatively impacted by $2.1 million and $5.2 million, respectively, of amortization related to the inventory fair value adjustment recorded in connection with the acquisition.

Excluding the product recall costs, costs associated with the distribution center closure, impact of the coupons redeemed in connection with the legal claim and amortization related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased 1.9% to 33.9% of net revenues in the nine months ended October 28, 2017 from 32.0% of net revenues in the nine months ended October 29, 2016.

RH Segment gross profit

RH Segment gross profit increased $88.4 million, or 18.9%, to $555.8 million in the nine months ended October 28, 2017 from $467.4 million in the nine months ended October 29, 2016. As a percentage of net revenues, RH Segment gross margin increased 1.9% to 33.1% of net revenues in the nine months ended October 28, 2017 from 31.2% of net revenues in the nine months ended October 29, 2016. Excluding the product recall costs, costs associated with anticipated distribution center closures and impact of the coupons redeemed in connection with the legal claim mentioned above, RH Segment gross margin would have increased 1.8% to 33.5% of net revenues in the nine months ended October 28, 2017 from 31.7% of net revenues in the nine months ended October 29, 2016.

The increase in gross margin was primarily due to incremental shipping charges incurred during the nine months ended October 29, 2016 related to RH Modern production delays and our investment to elevate the customer experience. In addition, our merchandise margins were impacted by our SKU rationalization efforts that had a reduced impact on our margins this year compared to last year, partially offset by higher outlet and warehouse sales driven by increased promotions and higher discounts. During the nine months ended October 28, 2017, we experienced occupancy leverage in our fixed distribution and retail occupancy costs, partially offset by increased outlet occupancy costs.

Waterworks gross profit

Waterworks gross profit increased $18.8 million, or 119.6%, to $34.6 million in the nine months ended October 28, 2017 from $15.7 million in the nine months ended October 29, 2016. The increase in Waterworks gross profit is primarily due to the nine months ended October 28, 2017 representing thirty-nine weeks of results, whereas the nine months ended October 29, 2016 only includes twenty-two weeks of results as Waterworks was acquired on May 27, 2016. As a percentage of net revenues, Waterworks gross margin increased 6.6% to 38.7% of net revenues in the nine months ended October 28, 2017 from 32.1% of net revenues in the nine months ended October 29, 2016. Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have decreased 1.6% to 41.0% of net revenues in the nine months ended October 28, 2017 from 42.6% of net revenues in the nine months ended October 29, 2016. The decrease in gross margin is primarily due to changes in product mix and deleverage in occupancy costs.

38


Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $71.0 million, or 15.5%, to $528.2 million in the nine months ended October 28, 2017 compared to $457.2 million in the nine months ended October 29, 2016.August 4, 2018.

RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $56.5$4.3 million, or 13.0%2.5%, to $489.4$177.4 million in the ninethree months ended October 28, 2017August 3, 2019 compared $433.0$173.2 million in the ninethree months ended October 29, 2016.August 4, 2018.

RH Segment selling, general and administrative expenses for the ninethree months ended October 28, 2017August 3, 2019 included $23.9a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a fully vested option grant made to Mr. Friedman in May 2017, $0.1$0.6 million incremental costs associated with product recalls, $1.4 million costs associated with anticipated distribution center closures and a gain of $2.1 million related to the sale of building and land.asset impairment.

RH Segment selling, general and administrative expenses for the ninethree months ended October 29, 2016August 4, 2018 included $5.7a favorable $7.2 million associated withlegal settlement, net of related legal expenses, partially offset by a $1.7 million charge related to the supply chain reorganization, including severancethe closure of the Dallas customer call center, and related taxes, $2.8$0.3 million related to chargesproduct recalls.

Excluding the adjustments for the legal settlements, asset impairments, reorganization and expenses incurred as a result of the Waterworks transaction, and $1.0 million related to the estimated cumulative impact of coupons redeemed in connection with a legal claim alleging that the Company violated California’s Song-Beverly Credit Card Act of 1971 by requesting and recording ZIP codes from customers paying with credit cards.

Advertising and marketing costs increased $26.9 million during the nine months ended October 28, 2017 as compared to October 29, 2016, primarily due to the timing of our Source Book mailings. In the nine months ended October 28, 2017 we amortized costs related to our 2016 Interiors Source Book which was circulated in the fall of 2016. The 2016 Interiors Source Book mailing was complete in mid-December and therefore resulted in amortized costs in the nine months ended October 28, 2017, whereas the nine months ended October 29, 2016 did not incur similarly timed expenses. In addition, we had an increase in employment and employment related costs.

product recalls mentioned above, RH Segment selling, general and administrative expenses were 27.7%26.5% and 28.2%29.3% of net revenues for the ninethree months ended October 28, 2017August 3, 2019 and October 29, 2016, respectively, excluding the fully vested option grant made to Mr. Friedman in May 2017, the product recall costs, costs associated with anticipated distribution center closures, the gain related to the sale of building and land, the reorganization costs, the charges and expenses incurred as a result of the Waterworks transaction, and the impact of coupons redeemed in connection with the legal claim mentioned above.August 4, 2018, respectively. The decrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by leverage in our employment and employment related costs as a result of our organization redesign and, to a lesser extent, leverage in our corporate occupancy costs, partially offset by an increase inexpenses and advertising and marketing costs.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses increased $14.6$0.2 million, or 60.0%1.5%, to $38.8$13.6 million in the ninethree months ended October 28, 2017August 3, 2019 compared $24.2to $13.4 million in the ninethree months ended October 29, 2016.

The increase inAugust 4, 2018. Waterworks selling, general and administrative expenses were 39.7% and 40.3% of net revenues for the three months ended August 3, 2019 and August 4, 2018, respectively.

49

Interest expense—net

Interest expense—net increased $9.0 million to $24.5 million for the three months ended August 3, 2019 compared to $15.5 million for the three months ended August 4, 2018. Interest expense—net consisted of the following:

Three Months Ended

August 3,

August 4,

    

2019

    

2018

(in thousands)

Amortization of convertible senior notes debt discount

$

10,585

$

9,764

Term loans

 

6,086

 

645

Finance lease interest expense

 

5,672

 

3,319

Amortization of debt issuance costs and deferred financing fees

 

1,171

 

881

Asset based credit facility

 

1,087

 

1,104

Promissory notes

988

471

Other interest expense

 

388

 

393

Capitalized interest for capital projects

 

(1,184)

 

(911)

Interest income

 

(280)

 

(199)

Total interest expense—net

$

24,513

$

15,467

(Gain) loss on extinguishment of debt

We recognized a $1.0 million gain on extinguishment of debt in the three months ended August 3, 2019 due to the maturity and settlement of the 2019 Notes in June 2019. We incurred a $0.9 million loss on extinguishment of debt in the three months ended August 4, 2018 due to the repayment in full of the LILO term loan, the promissory note secured by our aircraft and the equipment security notes in June 2018, which includes acceleration of amortization of debt issuance costs of $0.6 million and a prepayment penalty of $0.3 million.

Income tax expense

Income tax expense was $16.7 million and $2.5 million in the three months ended August 3, 2019 and August 4, 2018, respectively. Our effective tax rate was 20.7% and 3.9% for the three months ended August 3, 2019 and August 4, 2018, respectively. The increase in our effective tax rate is primarily due to lower discrete tax benefits related to net excess tax windfalls from stock-based compensation in the ninethree months ended October 28, 2017 representing thirty-nine weeks of results, whereasAugust 3, 2019 as compared to the ninethree months ended October 29, 2016 only includes twenty-two weeksAugust 4, 2018, as well as a discrete tax impact related to the legal settlement in the three months ended August 4, 2018.

Six Months Ended August 3, 2019 Compared to Six Months Ended August 4, 2018

Six Months Ended

August 3,

August 4,

2019

2018

    

RH Segment

    

Waterworks (1)

    

Total

    

RH Segment

    

Waterworks (1)

    

Total

(in thousands)

Net revenues

$

1,236,034

$

68,901

$

1,304,935

$

1,133,611

$

64,593

$

1,198,204

Cost of goods sold

 

737,622

 

39,541

 

777,163

 

682,400

 

38,127

 

720,527

Gross profit

 

498,412

 

29,360

 

527,772

 

451,211

 

26,466

 

477,677

Selling, general and administrative expenses

 

327,812

 

27,346

 

355,158

 

320,633

 

27,074

 

347,707

Income (loss) from operations

$

170,600

$

2,014

$

172,614

$

130,578

$

(608)

$

129,970

(1)Waterworks results include non-cash amortization of $0.4 million related to the inventory fair value adjustment recorded in connection with our acquisition of Waterworks during the six months ended August 4, 2018. No amortization was recorded during the six months ended August 3, 2019.

50

Net revenues

Consolidated net revenues increased $106.7 million, or 8.9%, to $1,304.9 million in the six months ended August 3, 2019 compared to $1,198.2 million in the six months ended August 4, 2018.

Consolidated net revenues for the six months ended August 3, 2019 and August 4, 2018 were negatively impacted by $0.4 million and $1.9 million, respectively, related to the reduction of revenue associated with product recalls. Excluding the product recall adjustments, consolidated net revenues increased $105.3 million, or 8.8%, to $1,305.3 million in the six months ended August 3, 2019 compared to $1,200.1 million in the six months ended August 4, 2018. Product recalls and the establishment or adjustment of any related recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons of our results. No assurance can be provided that any accruals will be for the appropriate amount, and actual losses could be higher or lower than what we accrue from time to time, which could further affect results.

RH Segment net revenues

RH Segment net revenues increased $102.4 million, or 9.0%, to $1,236.0 million in the six months ended August 3, 2019 compared to $1,133.6 million in the six months ended August 4, 2018. The below discussion highlights several significant factors that resulted in increased RH Segment net revenues, which are listed in order of magnitude.

RH Segment core net revenues increased primarily due to existing Galleries, as well as an increase in retail weighted-average selling square footage related to new store openings, including New York, Nashville and Yountville. Net revenues also increased from our RH Hospitality operations and Contract business.

RH Segment outlet sales increased $28.4 million to $109.5 million in the six months ended August 3, 2019 compared to $81.1 million in the six months ended August 4, 2018 primarily due to increased promotional activity as a result of our efforts to reduce inventory subsequent to the distribution center closures of as part of the distribution center network redesign, as well as an increase of four outlet locations year over year.

RH Segment net revenues for the six months ended August 3, 2019 and August 4, 2018 were negatively impacted by $0.4 million and $1.9 million, respectively, related to the reduction of revenue associated with product recalls.

Waterworks net revenues

Waterworks net revenues increased $4.3 million, or 6.7%, to $68.9 million in the six months ended August 3, 2019 compared to $64.6 million in the six months ended August 4, 2018.

Gross profit

Consolidated gross profit increased $50.1 million, or 10.5%, to $527.8 million in the six months ended August 3, 2019 from $477.7 million in the six months ended August 4, 2018. As a percentage of net revenues, consolidated gross margin increased 0.5% to 40.4% of net revenues in the six months ended August 3, 2019 from 39.9% of net revenues in the six months ended August 4, 2018.

RH Segment gross profit for the six months ended August 3, 2019 was acquired on May 27, 2016. This increase is partially offsetnegatively impacted by stock-based compensation of $3.7$4.9 million related to the fully vested option grants madeacceleration of depreciation due to a change in the estimated useful lives of certain assets. RH Segment gross profit for the six months ended August 3, 2019 and August 4, 2018 was positively impacted by $2.0 million and $1.7 million, respectively, related to reserve adjustments associated with product recalls initiated in prior years, partially offset by the reduction of revenue and incremental costs associated with such product recalls.

Waterworks gross profit for the six months ended August 4, 2018 was negatively impacted by $0.4 million of amortization related to the inventory fair value adjustment recorded in connection with our acquisitionthe acquisition.

Excluding the acceleration of Waterworks duringdepreciation, the nineproduct recall adjustments and the impact of the amortization related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased 1.0% to

51

40.7% of net revenues in the six months ended October 29, 2016.August 3, 2019 from 39.7% of net revenues in the six months ended August 4, 2018.

ExcludingRH Segment gross profit

RH Segment gross profit increased $47.2 million, or 10.5%, to $498.4 million in the fully vested option grants madesix months ended August 3, 2019 from $451.2 million in connection withthe six months ended August 4, 2018. As a percentage of net revenues, RH Segment gross margin increased 0.5% to 40.3% of net revenues in the six months ended August 3, 2019 from 39.8% of net revenues in the six months ended August 4, 2018.

Excluding the acceleration of depreciation and product recall adjustments mentioned above, RH Segment gross margin would have increased 0.9% to 40.5% of net revenues in the six months ended August 3, 2019 from 39.6% of net revenues in the six months ended August 4, 2018. The increase was primarily related to improvements in our acquisitiondistribution center network redesign resulting in reduced delivery expense and leverage in occupancy costs, as well as improvements in our core merchandise margins. The overall increase was partially offset by lower outlet product margins due to increased promotional activity and higher discounts due to our efforts to reduce inventory subsequent to the distribution center closures.

Waterworks gross profit

Waterworks gross profit increased $2.9 million, or 10.9%, to $29.4 million in the six months ended August 3, 2019 from $26.5 million in the six months ended August 4, 2018. As a percentage of net revenues, Waterworks gross margin increased 1.6% to 42.6% of net revenues in the six months ended August 3, 2019 from 41.0% of net revenues in the six months ended August 4, 2018.

Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above, Waterworks gross margin would have increased 1.0% to 42.6% of net revenues in the six months ended August 3, 2019 from 41.6% of net revenues in the six months ended August 4, 2018.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses would have been 43.4%increased $7.5 million, or 2.1%, to $355.2 million in the six months ended August 3, 2019 compared to $347.7 million in the six months ended August 4, 2018.

RH Segment selling, general and 41.9%administrative expenses

RH Segment selling, general and administrative expenses increased $7.2 million, or 2.2%, to $327.8 million in the six months ended August 3, 2019 compared $320.6 million in the six months ended August 4, 2018.

RH Segment selling, general and administrative expenses for the six months ended August 3, 2019 included a favorable $1.2 million legal settlement related to historical freight charges, partially offset by a $0.6 million asset impairment and a $0.5 million loss on disposal of an asset.

Addtionally, RH Segment selling, general and administrative expenses for the six months ended August 3, 2019 included advertising and marketing costs which increased $6.0 million primarily due to an increase in circulation and pages of our Source Books. This was partially offset by a decrease in corporate expenses of $1.7 million, primarily due to reduced preopening expense associated with our Design Gallery openings and other corporate costs.

RH Segment selling, general and administrative expenses for the six months ended August 4, 2018 included a favorable $5.3 million legal settlement, net of related legal expenses and a $0.8 million reversal of an estimated loss on disposal of asset, partially offset by a $1.7 million charge related to the supply chain reorganization, including the closure of the Dallas customer call center, and $0.3 million related to product recalls.

Excluding the adjustments for the legal settlements, asset impairments, reversal of an estimated loss on disposal of asset, reorganization and product recalls mentioned above, RH Segment selling, general and administrative expenses

52

were 26.5% and 28.6% of net revenues infor the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The increasedecrease in selling, general and administrative expenses as a percentage of net revenues was primarily driven by increasedleverage in our employment and employment related costs.costs as a result of our organization redesign and, to a lesser extent, leverage in our corporate expenses.

39Waterworks selling, general and administrative expenses


Interest expenseWaterworks selling, general and administrative expenses increased $0.3 million, or 1.0%, to $27.3 million in the six months ended August 3, 2019 compared to $27.1 million in the six months ended August 4, 2018. Waterworks selling, general and administrative expenses were 39.7% and 41.9% of net revenues for the six months ended August 3, 2019 and August 4, 2018, respectively.

Interest expenseexpense—net

Interest expense—net increased $13.0$15.1 million to $45.5$45.6 million for the ninesix months ended October 28, 2017August 3, 2019 compared to $32.5$30.6 million for the ninesix months ended October 29, 2016.August 4, 2018. Interest expenseexpense—net consisted of the following:

Six Months Ended

August 3,

August 4,

    

2019

    

2018

(in thousands)

Amortization of convertible senior notes debt discount

$

22,962

$

17,645

Finance lease interest expense

 

11,186

 

6,411

Term loans

 

7,810

 

1,649

Amortization of debt issuance costs and deferred financing fees

 

2,261

 

1,668

Asset based credit facility

 

1,774

 

3,584

Promissory notes

1,420

1,047

Other interest expense

 

783

 

733

Capitalized interest for capital projects

 

(2,003)

 

(1,811)

Interest income

 

(562)

 

(361)

Total interest expense—net

$

45,631

$

30,565

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

(in thousands)

 

Amortization of convertible senior notes debt discount

 

$

22,685

 

 

$

21,467

 

Build-to-suit lease transactions

 

 

12,360

 

 

 

9,418

 

Asset based credit facility

 

 

4,049

 

 

 

1,465

 

Amortization of debt issuance costs and deferred financing fees

 

 

3,933

 

 

 

1,884

 

Term loans

 

 

3,545

 

 

 

 

Other interest expense

 

 

1,910

 

 

 

2,515

 

Capitalized interest for capital projects

 

 

(2,547

)

 

 

(1,917

)

Interest income

 

 

(439

)

 

 

(2,304

)

Total interest expense—net

 

$

45,496

 

 

$

32,528

 

Loss(Gain) loss on extinguishment of debt

We recognized a $1.0 million gain on extinguishment of debt in the six months ended August 3, 2019 due to the maturity and settlement of the 2019 Notes in June 2019. We incurred a $4.9$0.9 million loss on extinguishment of debt in the ninesix months ended October 28, 2017August 4, 2018 due to the repayment in full of the second lienLILO term loan, on October 10, 2017,the promissory note secured by our aircraft and the equipment security notes in June 2018, which includes a prepayment penalty of $3.0 million and acceleration of amortization of debt issuance costs of $1.9$0.6 million and a prepayment penalty of $0.3 million.

Income tax expense (benefit)

Income tax expense was $9.9$28.5 million and $10.1 million in the ninesix months ended October 28, 2017 compared to an income tax benefit of $2.6 million in the nine months ended October 29, 2016.August 3, 2019 and August 4, 2018, respectively. Our effective tax rate was 83.7%22.2% and 38.9%10.3% for the ninesix months ended October 28, 2017August 3, 2019 and October 29, 2016,August 4, 2018, respectively. The increase in our effective tax rate is primarily due to lower discrete tax benefits related to net excess tax windfalls from stock-based compensation in the ninesix months ended October 28, 2017 was significantly impacted by non-deductible stock-based compensationAugust 3, 2019 as compared to the six months August 4, 2018, as well as a discrete tax impact related to the May 2017 grant to Mr. Friedman of an option to purchase 1,000,000 shares of the Company’s common stock and net excess tax benefits from stock-based compensation of $4.3 million resulting from the Company’s adoption of ASU 2016-09legal settlement in the first quarter of fiscal 2017. Refer to Note 15—Stock-Based Compensation in our condensed consolidated financial statements for a description of the option grant to Mr. Friedman.six months ended August 4, 2018.

Liquidity and Capital Resources

General

The primary cash needs of our business have historically been for merchandise inventories, payroll, Source Books, store rent, capital expenditures associated with opening new stores and updating existing stores, as well as the development of our infrastructure and information technology. We seek out and evaluate opportunities for effectively

53

managing and deploying capital in ways that improve working capital and support and enhance our business initiatives and strategies. WeIn fiscal 2017, we completed our firsttwo share repurchase programprograms in an aggregate amount of $1 billion. A $300 million share repurchase was completed during the first quarter of fiscal 2017 and completed our seconda $700 million share repurchase program in an amount of $700 millionwas completed during the second quarter of fiscal 2017 (refer2017. In October 2018, our Board of Directors approved a new $700 million share repurchase program, of which $250 million in share repurchases were completed in fiscal 2018, and the $700 million authorization amount was replenished by the Board of Directors in March 2019. During the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock for an aggregate repurchase amount of approximately $250 million, with $450 million still available under the $700 million repurchase program. Refer to “Share Repurchase Programs” below).below. We intend to evaluate our capital allocation from time to time and may engage in future share repurchases in circumstances where buying shares of our common stock represents a good value and provides a favorable return for our shareholders.

We have $650$635 million in aggregate principal amount of convertible notes outstanding, of which $350 million mature in June 2019 and $300 million mature in June 2020 and $335 million mature in June 2023. Based on anticipated strong cash flow generation in 2019 and beyond, we expect to repay the outstanding principal of the convertible notes at maturity in June 2020 and June 2023 in cash to minimize dilution. While we anticipate using excess cash, free cash flow and borrowings on our revolving line of credit to repay the convertible notes in cash to minimize dilution, we may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective maturity dates. There can be no assurance as to the availability of capital to fund such repayments, or that if capital is available through additional debt issuances or refinancing of the convertible notes, that such capital will be available on terms that are favorable to us. We believe the strength of our business and the reduction in leverage we have achieved during the past year puts us in a strong position to take advantage of the capital markets opportunistically. We believe we have multiple financing alternatives available to us on favorable terms that could provide us with additional financial flexibility with respect to capital allocation.

We extended and amended our revolving line of credit in June 2017, which has a total availability of $600.0$600 million, of which $10.0$10 million is available to Restoration Hardware Canada, Inc., and includes a $200.0$200 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600.0$600 million to up to $800.0$800 million if and to the extent the lenders revise their credit commitments to encompass a larger facility. In addition, we have an $80.0 million last out, delayed draw term loan (“LILO term loan”) facility. The revolving line of credit and LILO term loan facility havehas a maturity date of June 28, 2022.

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In July 2017, Restoration Hardware, Inc. entered into a credit agreement (the “second lien credit agreement”) with respect to an initial term loan in an aggregate principal amount equal to $100.0 million with a maturity date of January 7, 2023 (the “second lien term loan”). Refer to Second Lien Credit Agreement below. The proceeds of the second lien term loan were used to support our share repurchase program. We repaid this debt in full in October 2017.

We believe that cash expected to be generated from operations, net cash proceeds from the issuance of the convertible senior notes, borrowing availability under the revolving line ofasset based credit borrowings under our term loanfacility and other financing arrangements will be sufficient to meet working capital requirements, anticipated capital expenditures and other capital needs for the next 12 months.

Our business has relied on cash flows from operations, net cash proceeds from the issuance of the convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity. We have pursued in the past, and may pursue in the future, additional strategies to generate liquidity for our operations, including through the strategic sale of assets, utilization of our credit facilities, and entry into new debt financing arrangements that present attractive terms.

During the first quarter of fiscal 2017, we received cash of $4.9 million for the sale of an aircraft, net of $0.3 million of costs to dispose of the aircraft, which was classified as asset held for sale, and during the second quarter of fiscal 2017 we received cash of $10.2 million for the sale of a real estate parcel that we owned on which one of our retail Galleries was located, which was classified as asset held for sale. We may pursue strategies in the future, pursue additional strategies, through the use of existing assets and debt facilities, or through the pursuit of new external sources of liquidity and debt financings, to fund our strategies to enhance stockholder value. There can be no assurance that additional capital, whether raised through the sale of assets, utilization of our existing debt financing sources, or pursuit of additional debt financing sources, will be available to us on a timely manner, on favorable terms or at all. To the extent we pursue additional debt as a source of liquidity, our capitalization profile may change and may include significant leverage, and as a result we may be required to use future liquidity to repay such indebtedness and may be subject to additional terms and restrictions which affect our operations and future uses of capital.

In addition, our capital needs may change in the future due to changes in our business or new opportunities that we choose to pursue. We have invested significant capital expenditures in remodeling and opening new Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future periods as we open additional next generation Design Galleries, which may require us to undertake upgrades to historical buildings or construction of new buildings. During fiscal 2016, we spent $157.6 million for

54

Our adjusted net capital expenditures. Additionally, we made paymentsexpenditures include (i) capital expenditures from investing activities and (ii) cash outflows of $23.4 million in fiscal 2016capital related to escrow accounts for future construction activities to design and build landlord leased assets, net of next generation Design Galleries.

tenant allowances received. We anticipate our grossadjusted net capital expenditures to be approximately $120$160 million to $130$170 million forin fiscal 2017. Our2019, primarily related to our efforts to continue our growth and expansion, including construction of new Design Galleries and infrastructure investments. We anticipate that our fiscal 20172019 adjusted net capital expenditures will be partially offset by cash flowsproceeds from operating activities. Our effortssales of assets of $50 million to optimize inventory and reduce capital spending generated substantial free cash flow in$60 million. During the ninesix months ended October 28, 2017, and we expectAugust 3, 2019, adjusted net capital expenditures were $52.8 million, inclusive of cash received related to generate additional free cash flow forlandlord tenant allowances of $15.7 million.

Certain lease arrangements require the remainderlandlord to fund a portion of the year.

The majority of the currentconstruction related costs through payments directly to us. Other lease arrangements for our new Design Galleries require the landlord to fund a portion of the construction related costs directly to third parties, rather than through traditional construction allowances and accordingly, under these arrangements we do not expect to receive significant contributions directly from our landlords related to the building of our larger format and next generation Design Galleries in fiscal 2017.Galleries. As we develop new Galleries, as well as potentially other potential strategic initiatives in the future like our integrated hospitality experience;experience, we may explore other models for our real estate, which could include longer lease terms or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated with new sites and buildings. These approaches might require greater capital investment on our part than a traditional store lease with a landlord. We also believe there is an opportunity to transition our real estate strategy from a leasing model to a development model, where we potentially buy and develop our Design Galleries then recoup the investments through a sale leaseback arrangement resulting in lower capital investment and lower rent. In the event that such capital and other expenditures require us to pursue additional funding sources, we can provide no assurances that we will be successful in securing additional funding on attractive terms or at all.

There can be no assurance that we will have sufficient financial resources, or will be able to arrange financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental debt will be available to us in order to fund our cash payments in respect of the repayment of our outstanding convertible senior notes in an aggregate principal amount of $650$635 million at maturity of such senior convertible notes or our terms loan at the maturity dates of such term loan.notes. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our business in the manner we currently expect or to make required payments with respect to existing commitments including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the covenants or other requirements of existing or new debt facilities, any such event could have an impact on our other commitments and obligations including triggering cross defaults or other consequences with respect to other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur, exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively affected by credit market conditions, macroeconomic trends and other risks.

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Any weakening of, or other adverse developments in, the U.S. or global credit markets could affect our ability to manage our debt obligations and our ability to access future debt. We cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future financing requirements would not require us to raise money through an equity financing or by other means that could be dilutive to holders of our capital stock. If we fail to raise sufficient additional funds, we may be required to delay or abandon some of our planned future expenditures or aspects of our current operations.

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Cash Flow Analysis

A summary of operating, investing, and financing activities is set forth in the following table:

Six Months Ended

August 3,

August 4,

    

2019

    

2018

    

(in thousands)

Provided by operating activities

$

97,133

$

49,020

Used in investing activities

 

(25,283)

 

(42,916)

Used in financing activities

 

(66,023)

 

(6,350)

Increase (decrease) in cash and cash equivalents and restricted cash equivalents

 

5,752

 

(370)

Cash and cash equivalents and restricted cash equivalents at end of period

 

11,555

 

24,944

 

 

Nine Months Ended

 

 

 

October 28,

 

 

October 29,

 

 

 

2017

 

 

2016

 

 

 

 

 

 

 

As Revised

 

 

 

(in thousands)

 

Provided by (used in) operating activities

 

$

386,762

 

 

$

(18,985

)

Provided by (used in) investing activities

 

$

101,324

 

 

$

(263,378

)

Used in financing activities

 

$

(552,969

)

 

$

(2,311

)

Decrease in cash and cash equivalents

 

$

(64,861

)

 

$

(284,332

)

Cash and cash equivalents at end of period

 

$

22,162

 

 

$

47,135

 

Net Cash Provided By (Used In) Operating Activities

Operating activities consist primarily of net income (loss) adjusted for non-cash items including depreciation and amortization, stock-based compensation, amortization of debt discount and the effect of changes in working capital and other activities.

For the ninesix months ended October 28, 2017,August 3, 2019, net cash provided by operating activities was $386.8$97.1 million and consisted of net income of $1.9$99.5 million and an increasenon-cash items of $59.6 million, partially offset by a decrease in cash provided byused for working capital and other activities of $259.3 million and non-cash items of $125.6$61.9 million. Working capital and other activities consisted primarily of decreases in inventoryoperating lease liabilities of $190.6 million due to our SKU rationalization initiative, outlet inventory optimization efforts and revised DC network strategy. We also had decreases in prepaid expense and other current assets of $38.4$44.5 million primarily due to amortizationpayments made under the agreements, decreases in accounts payable and accrued expense of our capitalized catalog costs, reduction$40.1 million related to timing of federalpayments, increases in landlord assets under construction of $27.6 million, as well as decreases in other non-current liabilities of $13.8 million. These decreases to working capital were partially offset by decreases in merchandise inventories of $51.2 million and state tax receivables, and a reduction in prepaid rent. In addition, we had increases in deferred revenue and customer deposits of $20.6 million and increases in accounts payable and accrued liabilities of $10.5 million due to the timing of payments.$13.0 million.

For the ninesix months ended October 29, 2016,August 4, 2018, net cash used inprovided by operating activities was $19.0$49.0 million and consisted of a net lossincome of $4.0$88.4 million and an increasenon-cash items of $116.8 million, partially offset by a decrease in uses ofcash used for working capital and other activities of $109.8 million, offset by non-cash items of $94.8$156.1 million. Working capital and other activities consisted primarily of decreases in operating lease liabilities of $43.0 million primarily due to payments made under the agreements, increases in prepaid expenses and other current assets of $40.6 million, decreases in accounts payable and accrued liabilitiesexpense of $63.4$31.7 million primarily duerelated to the timing of payments, increases in landlord assets under construction of $27.6 million, as well as increases in inventory of $25.0 million. These decreases to our vendors, and prepaid expense and other current assets increased $30.4 million due to an increase in capitalized catalog costs related to our decision to move the mailing of our annual Source Books from the Spring to the Fall. In addition, other current liabilities decreased $25.4 million primarily due to federal and state tax payments, and inventory increased $23.3 million related to the increase in both existing and new products. This wasworking capital were partially offset by increases in deferred revenue and customer deposits of $22.7 million and an increase in other non-current obligations of $8.5 million primarily due to a deferred contract incentive.$20.8 million.

Net Cash Provided By (Used In)Used In Investing Activities

Investing activities consist primarily of investments in capital expenditures related to new Gallery openings, the acquisition of buildings and land, investments in supply chain and systems infrastructure, construction related deposits, acquisition of businesses, as well as activities associated with investing in available-for-sale securities.

For the nine months ended October 28, 2017, net cash provided by investing activities was $101.3 million primarily as a result of sales and maturities of investments in available-for-sale securities of $145.0 million and $46.9 million, respectively, the proceeds of which were used to fund the share repurchases made under the $300 Million Repurchase Program. In addition, we had net proceeds from the sale of building and land and the sale of an aircraft of $10.2 million and $4.9 million, respectively. These increases to cash were partially offset by investments in new Galleries, information technology and systems infrastructure, and supply chain investments, of $76.8 million, purchases of investments in available-for-sale securities of $16.1 million and payments of $12.8 million to escrow accounts for future construction of next generation Design Galleries.as well as retail stores.

For the ninesix months ended October 29, 2016,August 3, 2019 and August 4, 2018, net cash used in investing activities was $263.4$25.3 million primarily as a result of our acquisition of Waterworks, net of cash acquired, of $116.1 million. In addition, we made $104.2and $42.9 million, ofrespectively, due to investments in new

42


galleries, information technology and systems infrastructure, supply chain investments, and other corporate assets, as well as payments of $3.8 million to escrow accounts for future construction of next generation Design Galleries. In addition, we made investments in available-for-sale securities of $187.0 million, partially offset by maturities and sales of such investments of $115.9 million and $31.9 million, respectively.retail stores.

Net Cash Used In Financing Activities

Financing activities consist primarily of borrowings related to the convertible senior notes offerings, credit facilities and other financing arrangements, as well as share repurchases, principal payments under finance lease agreements and other equity related transactions.

For the ninesix months ended October 28, 2017,August 3, 2019, net cash used in financing activities was $553.0$66.0 million. The $350.0 million 2019 Notes matured in June 2019, of which $278.6 million is presented within net cash used in financing activities and $70.5 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net

56

cash provided by operating activities. Additionally, net cash used in financing activities included repurchases of approximately 2.2 million shares of our common stock for an aggregate repurchase amount of $250.0 million. Net cash provided by financing activities, which partially offset net cash used in financing activities, included borrowings under new debt arrangements of $389.0 million, which amount includes the issuance of a $200.0 million second lien term loan, a $120.0 million FILO term loan and $69.0 million of promissory notes secured by certain equipment. We incurred costs of $4.6 million related to the debt issuances. Under the asset based credit facility, we made repayments of $214.5 million in connection with the debt issuances described above pursuant to the terms of such facility, and we subsequently had borrowings of $302.0 million under such facilty to partially fund the repayment of the 2019 Notes upon maturity.

For the six months ended August 4, 2018, net cash used in financing activities was $6.4 million primarily due to $1.0 billionrepayments of share repurchases madedebt of $821.9 million under the $300 Million Repurchase Programasset based credit facility, LILO term loan, equipment loans and $700 Million Repurchase Program. Cash funding for the share repurchase programs was providedpromissory note secured by available cash balances, netour aircraft. The repayments of debt described above were partially funded by borrowings under the asset based credit facility of $341.0$510.0 million and the $335.0 million convertible senior notes issued in June 2018, which provided net proceeds of $287.8 million after taking into consideration the convertible note hedge and warrant transactions, as well as borrowings under the term loansdiscounts upon original issuance and offering costs. Equity related transactions provided $21.3 million due to $29.2 million of $180.0 million, borrowings under loans secured by certain equipment of $20.0 million and borrowings under a promissory note secured by our aircraft of $14.0 million. Additionally, proceeds from exercise of employee stock options, were $15.4 million. The cash provided by these financing activities was partially offset by repayment of the second lien term loan of $100.0 million, $8.7$7.9 million of payments on build-to-suit transactions, debt issuance costs of $8.3 million and $4.9 million cash paid for employee taxes related to net settlement of equity awards.

ForConvertible Senior Notes

0.00% Convertible Senior Notes due 2023

In June 2018, we issued in a private offering $300 million principal amount of 0.00% convertible senior notes due 2023 and issued an additional $35 million principal amount in connection with the nine months ended October 29, 2016,overallotment option granted to the initial purchasers as part of the offering (collectively, the “2023 Notes”). The 2023 Notes are governed by the terms of an indenture between us and U.S. Bank National Association, as the Trustee. The 2023 Notes will mature on June 15, 2023, unless earlier purchased by us or converted. The 2023 Notes will not bear interest, except that the 2023 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2023 Notes. The 2023 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 us or any of our subsidiaries. Certain events are also considered “events of default” under the 2023 Notes, which may result in the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes.

The initial conversion rate applicable to the 2023 Notes is 5.1640 shares of common stock per $1,000 principal amount of 2023 Notes, which is equivalent to an initial conversion price of approximately $193.65 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, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2023 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2023, the 2023 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2018, 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 calendar quarter, the last reported sale price of our 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 2023 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of August 3, 2019, none of these conditions have occurred and, as a result, the 2023 Notes were not convertible as of August 3, 2019. On and after March 15, 2023, 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 2023 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2023 Notes will be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock.

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We may not redeem the 2023 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require us to purchase all or a portion of their 2023 Notes for cash at a price equal to 100% of the principal amount of the 2023 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 2023 Notes, we separated the 2023 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 2023 Notes and the fair value of the liability component of the 2023 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 6.35% over the expected life of the 2023 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 2023 Notes, we 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 2023 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity (deficit).

Debt issuance costs related to the 2023 Notes were comprised of discounts upon original issuance of $1.7 million and third party offering costs of $4.6 million. Discounts and third party offering costs attributable to the liability component are recorded as a contra-liability and are presented net cash used in financing activities was $2.3 million primarilyagainst the convertible senior notes due to tax shortfalls from2023 balance on the condensed consolidated balance sheets.

2023 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2023 Notes and the exercise of the overallotment option in June 2018, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 1.7 million shares of our common stock optionsat a price of $2.3 million and cash paid for employee taxes related to net settlement of equity awards of $1.4 million.

Non-Cash Transactions

Non-cash transactions consist of non-cash additions of property and equipment.

Build-to-Suit Lease Transactions

approximately $193.65 per share. The non-cash additions of property and equipment due to build-to-suit lease transactions are the resulttotal cost of the accounting requirements of Accounting Standards Codification (“ASC”) 840—Leases (“ASC 840”) for those construction projects for whichconvertible note hedge transactions was $91.9 million. In addition, we aresold warrants whereby the “deemed owner”holders of the construction project givenwarrants have the extentoption to which we are involvedpurchase a total of approximately 1.7 million shares of our common stock at a price of $309.84 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 3.5 million shares of common stock (which cap may also be subject to adjustment). We received $51.0 million in constructingcash proceeds from the leased asset. If we aresale of these warrants. Taken together, the “deemed owner” for accounting purposes, upon commencementpurchase of the construction project, weconvertible note hedges and sale of the warrants are requiredintended to capitalize contributions byoffset any actual earnings dilution from the landlord toward constructionconversion of the 2023 Notes until our common stock is above approximately $309.84 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity (deficit), are not accounted for as propertyderivatives and equipmentare 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 ourthe condensed consolidated balance sheets.

We recorded a deferred tax liability of $22.3 million in connection with the debt discount associated with the 2023 Notes and recorded a deferred tax asset of $22.5 million in connection with the convertible note hedge transactions. The contributions bydeferred tax liability and deferred tax asset are recorded in deferred tax assets on the landlord toward construction, including the building, existing site improvements at construction commencement and any amounts paid by the landlord to those responsible for construction, are included as property and equipment additions due to build-to-suit lease transactions within the non-cash section of our condensed consolidated statements of cash flows.

Over the lease term, these non-cash additions to property and equipment due to build-to-suit lease transactions do not impact our cash outflows, nor do they impact net income within our condensed consolidated statements of operations.

Convertible Senior Notesbalance sheets.

0.00% Convertible Senior Notes due 2020

In June 2015, we issued in a private offering $250 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, we issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of our June 2015 offering (collectively, the “2020 Notes”). The 2020 Notes are governed by the terms of an indenture between us and U.S. Bank National Association, as the

58

Trustee. The 2020 Notes will mature on July 15, 2020, unless earlier purchased by us 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 our failure to perform certain of our 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 us or any of our 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 our 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.

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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, we 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 fiscalcalendar quarter, the last reported sale price of our 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 our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of October 28, 2017,August 3, 2019, none of these conditions have occurred and, as a result, the 2020 Notes arewere not convertible as of October 28, 2017.August 3, 2019. 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 our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock.

We 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 us 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, we 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”)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, we 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.equity (deficit).

Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $3.8 million and third party offering costs of $2.3 million. Discounts and third party offering costs attributable to the liability

59

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.

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, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 2.5 million shares of our 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, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.5 million shares of our common stock at a price of $189.00 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 5.1 million shares of common stock (which cap may also be subject to adjustment). We 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 our 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 (deficit), 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.

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

0.00% Convertible Senior Notes due 2019

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

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

Prior to March 15, 2019, the 2019 Notes will bewere 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 fiscalcalendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2019 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of October 28, 2017, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of October 28, 2017. On and after March 15, 2019, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convertcould have converted all or a portion of their 2019 Notes at any time, regardless of the foregoing circumstances. Upon conversion,

60

In June 2019, upon the maturity of the 2019 Notes, will be$350.0 million in aggregate principal amount of the 2019 Notes were settled at our election,for $349.0 million in cash and 42 shares of our common stock, orstock. As a combinationresult, we recognized a gain on extinguishment of cash and sharesdebt of our common stock.

We may not redeem$1.0 million. As of August 3, 2019, the 2019 Notes; however, uponNotes are no longer outstanding.

Upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may requirecould have required us 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, we 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 debt discount will bewas amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component iswas not remeasured as long as it continuescontinued to meet the conditions for equity classification.

In accounting for the debt issuance costs related to the issuance of the 2019 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component arewere 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 arewere netted with the equity component in stockholders’ equity.equity (deficit).

Debt issuance costs related to the 2019 Notes were comprised of discounts and commissions payable to the initial purchasers of $4.4 million and third party offering costs of $1.0 million. Discounts, commissions payable to the initial purchasers and third party offering costs attributable to the liability component arewere recorded as a contra-liability and arewere presented net against the convertible senior notes due 2019 balance on the condensed consolidated balance sheets.

45


2019 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2019 Notes, we entered into convertible note hedge transactions whereby we havehad the option to purchase a total of approximately 3.0 million shares of our common stock at a price of approximately $116.09 per share. The total cost of the convertible note hedge transactions was $73.3 million. The convertible note hedge terminated upon the maturity date of the 2019 Notes. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 3.0 million shares of our common stock at a price of $171.98 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of 6.0 million shares of common stock (which cap may also be subject to adjustment). The warrants will expire through December 2019. We 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 meetmet certain accounting criteria, the convertible note hedges were, and warrants are, recorded in stockholders’ equity and are not accounted for as derivatives. 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.

We 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 asset arewere recorded in deferred tax assets on the condensed consolidated balance sheets. There is no deferred tax asset or liability remaining as of August 3, 2019 due to the maturity of the 2019 Notes.

61

Asset Based Credit Facility

In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into a credit agreement with Bank of America, N.A., as administrative agent, and certain other lenders. On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit agreement (the “Credit Agreement”) among Restoration Hardware, Inc., Restoration Hardware Canada, Inc., various subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and Bank of America, N.A., as administrative agent and collateral agent (the “credit agreement”(“First Lien Administrative Agent”). The credit agreementCredit Agreement has a revolving line of credit with initial availability of up to $600.0 million, of which $10.0 million is available to Restoration Hardware Canada, Inc., and includes a $200.0 million accordion feature under which the revolving line of credit may be expanded by agreement of the parties from $600.0 million to up to $800.0 million if and to the extent the lenders, revisewhether existing lenders or new lenders, agree to increase their credit commitments to encompass a larger facility.commitments. In addition, the credit agreement establishesCredit Agreement established an $80.0 million last in, last out (“LILO”) term loan facility which was repaid in full in June 2018. The Credit Agreement has a maturity date of June 28, 2022.

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

On November 23, 2018, Restoration Hardware, Inc. entered into a Consent and Second Amendment to the Credit Agreement (the “Second Amendment”). The Second Amendment included certain clarifying changes to, among other things: (a) address the processing of payments from insurance proceeds in connection with casualty or other insured losses with respect to property or assets of a Loan Party, and (b) add an additional category of permitted restricted payment to allow the lead borrower to make annual restricted payments of up to $80.0$3.0 million LILOper fiscal year to cover payments of certain administrative and other obligations of RH in the ordinary course of business.

On April 4, 2019, Restoration Hardware, Inc., entered into a Third Amendment to the Credit Agreement (the “Third Amendment”). The Third Amendment, among other things, (a) established a $120.0 million first in, last out (“FILO”) term loan facility.facility, which amount was fully borrowed as of April 4, 2019 and which incurs interest at a rate that is 1.25% greater than the interest rate applicable to the revolving loans under the Credit Agreement, (b) provided for additional Permitted Indebtedness, as defined in the Credit Agreement, that the loan parties can incur, and (c) modified the borrowing availability under the Credit Agreement in certain circumstances. The FILO term loan facility has a maturity date of June 28, 2022.

The availability of credit at any given time under the credit agreementCredit Agreement is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable. As a result of the borrowing base formula, actual borrowing availability under the revolving line of credit could be less than the stated amount of the revolving line of credit (as reduced by the actual borrowings and outstanding letters of credit under the revolving line of credit). All obligations under the credit agreementCredit Agreement are secured by substantially all of the assets, including accounts receivable, inventory, intangible assets, property, equipment, goods and fixtures of Restoration Hardware, Inc., Restoration Hardware Canada, Inc., RH US, LLC, Waterworks Operating Co., LLC and Waterworks IP Co., LLC.

Borrowings under the revolving line of credit and LILO term loan facility are subject to interest, at the borrowers’ option, at either the bank’s reference rate or LIBORLondon Inter-bank Offered Rate (“LIBOR”) (or, in the case of the revolving line of credit, the Bank of America “BA” Rate or the Canadian Prime Rate, as such terms are defined in the credit agreement,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 onIn addition, under the abilityCredit Agreement, we are required to incur liens, make loansmeet specified financial ratios in order to undertake certain actions, and we may be required to maintain certain levels of excess availability 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.

The credit agreement does not contain any significant financial ormeet a specified consolidated fixed-charge coverage ratio covenants unless(“FCCR”). Subject to certain exceptions, the trigger for the FCCR occurs if the domestic

62

availability under the revolving line of credit is less than the greater of (i) $40.0 million and (ii) 10% of the sum of (a) the lesser of (x) the aggregate revolving commitments under the credit agreementCredit Agreement and (y) the aggregate revolving borrowing base, plus (b) the lesser of (x) the then outstanding amount of the LILO term loan or (y) the LILO term loan borrowing base .base. If the availability under the credit agreementCredit Agreement is less than the foregoing amount, then Restoration Hardware, Inc. is required subject to certain exceptions to maintain a consolidated fixed-charge coverage ratio (“FCCR”)an FCCR of at least one to one.

The consolidated FCCR is based upon the ratio on the last day of each month on a trailing twelve-month basis of (a) (i) consolidated EBITDA (as defined in the agreement) minus (ii) capital expenditures, minus (iii) the income taxes paid in cash to (b) the sum of (i) debt service charges plus (ii) certain dividends and distributions paid. As of October 28, 2017, Restoration Hardware, Inc. was in compliance with all applicable covenants of the credit agreement.

46


The credit agreementCredit Agreement requires a daily sweep of all cash receipts and collections to prepay the loans under the agreement while (i) an event of default exists or (ii) the availability under the revolving line of credit for extensions of credit is less than the greater of (A) $40.0 million and (B) 10% of the sum of (a) the lesser of (x) the aggregate revolving commitments under the credit agreement and (y) the aggregate revolving borrowing base, plus (b) the lesser of (x) the then outstanding amount of the LILO term loan or (y) the LILO term loan borrowing base.

On May 31, 2019, Restoration Hardware, Inc. entered into a fourth amendment to the Credit Agreement (the “Fourth Amendment”). The Fourth Amendment, among other things, amends the Credit Agreement to (a) extend the time to deliver monthly financial statements to the lenders for the fiscal months ending February 2019 and March 2019 until June 19, 2019; (b) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter; and (c) waive any default or event of default under the Credit Agreement relating to the delivery of monthly financial statements or other information to lenders for the fiscal months ending February 2019 and March 2019.

As of October 28, 2017,August 3, 2019, Restoration Hardware, Inc. had $341.0$145.0 million in outstanding borrowings under the revolving line of credit. The Credit Agreement provides for a borrowing amount based on the value of eligible collateral and $189.0 milliona formula linked to certain borrowing percentages based on certain categories of availabilitycollateral. Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of August 3, 2019 was $254.6 million, net of $27.7$12.8 million in outstanding letters of credit.

The Credit Agreement contains various restrictive and affirmative covenants, including, among others, required financial reporting, 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 28, 2017, the Company had $80.0 million outstanding borrowings under the LILO term loan facility. As a resultAugust 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the consolidated FCCR restriction that limits the last 10% of borrowing availability, actual incremental borrowing available to the Company and the other affiliated parties under the revolving line of credit would be approximately $125.2 million.Credit Agreement.

Second Lien Credit Agreement

On July 7, 2017,April 10, 2019, Restoration Hardware, Inc., a wholly-owned subsidiary of RH, entered into the second liena credit agreement, dated as of July 7, 2017,April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom are funds and accounts managed or advised by Apollo Capital Management, L.P.,either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and Wilmington Trust, National Associationits affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to thea second lien term loan in an aggregate principal amount equal to $100.0$200.0 million with a maturity date of January 7, 2023.April 9, 2024 (the “Second Lien Term Loan”).

The Second Lien Term Loan bears interest at an annual rate generally based on LIBOR plus 6.50%. This rate is a floating rate that resets periodically based upon changes in LIBOR rates during the life of the Second Lien Term Loan. At the date of the initial borrowing, the rate was set at one month LIBOR plus 6.50%.

All obligations under the Second Lien Term Loan are secured by a second lien security interest in substantially all of the assets of the loan parties, including inventory, receivables and certain types of intellectual property. The second lien term loan of $100.0 million was repaidsecurity interest encumbers substantially the same collateral that secures the credit. The second lien ranks junior in full on October 10, 2017. As a resultpriority and is subordinated to the first lien in favor of the repayment, we incurred a $4.9 million loss on extinguishment of debt, which includeslenders with respect to the Credit Agreement.

The borrowings under the Second Lien Credit Agreement may be prepaid in whole or in part at any time, subject to certain minimum payment requirements, and including (i) a prepayment penaltypremium in the amount of $3.0 million2.0% of the

63

principal amount of the Second Lien Term Loan being prepaid during the first year after the effective date of the Second Lien Credit Agreement, (ii) 1.0% of the principal amount of the Second Lien Term Loan being prepaid during the second year after the effective date of the Second Lien Credit Agreement, and acceleration(iii) no prepayment premium after the second anniversary of amortizationthe effective date of the Second Lien Credit Agreement.

The Second Lien Credit Agreement contains a financial ratio covenant not found in the Credit Agreement based upon a net senior secured leverage ratio of consolidated secured debt issuanceto consolidated EBITDA, as defined in the Credit Agreement, as follows:

The net senior secured leverage ratio test is based on the ratio of (i) the sum of (a) all obligations outstanding under the Second Lien Term Loan and the Credit Agreement plus (b) all other secured indebtedness of RH and certain of its subsidiaries that is (x) senior or pari passu to the lien on the Second Lien Term Loan collateral or (y) secured by property that does not constitute Second Lien Term Loan collateral under the Second Lien Term Loan, less (c) all unrestricted cash and cash equivalents of RH and certain of its subsidiaries subject to a blocked account control agreement, to (ii) consolidated EBITDA of RH and certain of its subsidiaries (the “Net Senior Secured Leverage Ratio”).
The Net Senior Secured Leverage Ratio may not exceed 3.50 to 1.00 as of the last day of any fiscal quarter. The Second Lien Credit Agreement also contains a consolidated fixed charge coverage ratio generally based on the same formulation set forth in the Credit Agreement such that the borrower may not make certain “restricted payments” in the event that the ratio of (i) consolidated EBITDA minus certain costs to the amount of (ii) debt service costs plus certain other costs is not less than 1.00 to 1.00 and the level of unused availability under the Credit Agreement meets certain levels.

The Second Lien Credit Agreement also contains certain events of $1.9 million.

Intercreditor Agreementdefault and other customary terms and conditions typical to a second lien credit agreement.

On July 7, 2017,May 31, 2019, Restoration Hardware, Inc. entered into a first amendment to the Second Lien Credit Agreement (the “First Amendment”). The First Amendment, among other things, amends the Second Lien Credit Agreement to (a) remove the requirement to deliver monthly financial statements to the lenders for the last fiscal month of any fiscal quarter and (b) waive any default or event of default under the Second Lien Credit Agreement relating to the delivery of monthly financial statements or other information to lenders for the fiscal months ending February 2019 and March 2019.

As of August 3, 2019, the Company had $200.0 million in outstanding borrowings and no availability under the Second Lien Credit Agreement.

The Second Lien Credit Agreement contains various restrictive and affirmative covenants generally in line with the covenants and restrictions contained in the Credit Agreement, including required financial reporting, 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 a similar type and size. As of August 3, 2019, Restoration Hardware, Inc. was in compliance with all applicable covenants of the Second Lien Credit Agreement.

Intercreditor Agreement

On April 10, 2019, in connection with the second lien credit agreement,Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an intercreditor agreementIntercreditor Agreement (the “intercreditor agreement”“Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the administrative agent and collateral agent under the credit agreementFirst Lien Administrative Agent and the administrative agent and collateral agent under the second lien credit agreement.Second Lien Administrative Agent. The intercreditor agreement establishedIntercreditor Agreement establishes various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the credit agreementCredit Agreement and the second lien credit agreementSecond Lien Credit Agreement without the consent of the other party.

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Equipment Loan Facility

On September 5, 2017, Restoration Hardware, Inc. entered into a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC (“BAL”) pursuant to which BAL and we agreed that BAL would finance certain equipment of ours from time to time, with each such equipment financing to be evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each equipment loan is secured by a purchase money security interest in the financed equipment. As of August 3, 2019, we had $64.0 million in aggregate amounts outstanding under the equipment security notes, of which $21.5 million was included in other current liabilities and $42.5 million was included in other non-current obligations on the condensed consolidated balance sheets. The intercreditor agreement was terminated upon repaymentmaturity dates of the second lien term loan on October 10, 2017.equipment security notes vary, but generally have a maturity of three or four years. We are required to make monthly installment payments under the equipment security notes.

Share Repurchase Programs

We regularly review share repurchase activity and consider various factors in determining whether and when to execute share repurchases, including, among others, current cash needs, capacity for leverage, cost of borrowings, results of operations and the market price of the our common stock. We believe that these share repurchase programs will continue to be an excellent allocation of capital for the long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to our securities.

$300 Million Repurchase Program (Completed)

On February 21, 2017, our boardBoard of directorsDirectors authorized a stockshare repurchase program of up to $300 million (the “$300 Million Repurchase Program”) through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated share repurchases. During the three months ended April 29, 2017, we repurchased approximately 7.8 million shares of our common stock under the $300 Million Repurchase Program at an average price of $38.24 per share, for an aggregate repurchase amount of approximately $300 million. No additional shares will be repurchased in future periods under the $300 Million Repurchase Program.

$700 Million Repurchase Program (Completed)

Following completion of the $300 Million Repurchase Program, our boardBoard of directorsDirectors authorized on May 2, 2017 an additional stockshare repurchase program of up to $700 million (the “$700 Million Repurchase Program”) through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives. During the three months ended July 29, 2017, we repurchased approximately 12.4 million shares of our common stock under the $700 Million Repurchase Program at an average price of $56.60 per share, for an aggregate repurchase amount of approximately $700 million. No additional shares will be repurchased in future periods under the $700 Million Repurchase Program.

47$950 Million Repurchase Program (Existing)


On October 10, 2018, our Board of Directors authorized a share repurchase program of up to $700 million through open market purchases, privately negotiated transactions or other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase program is committed in advance through a financial intermediary and/or in transactions involving hedging or derivatives, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700 million authorization amount was replenished by the Board of Directors on March 25, 2019 (as replenished, the “$950 Million Repurchase Program”). In the first quarter of fiscal 2019, we repurchased approximately 2.2 million shares of our common stock under the $950 Million Repurchase Program at an average price of $115.36 per share, for an aggregate repurchase amount of approximately

65

$250.0 million. We did not make any repurchases under this program during the three months ended August 3, 2019. As of August 3, 2019, there was $450.0 million remaining for future share repurchases under this program.

Contractual Obligations

We enter into long-termAs of August 3, 2019, there were no material changes to our contractual obligations and commitments, primarily debt obligations and non-cancelable operating leases,described in the normal courseManagement’s Discussion and Analysis of business. AsFinancial Condition and Results of October 28, 2017, our contractual cash obligations were as follows (Operations—Contractual Obligationsin thousands):the 2018 Form 10-K.

 

 

Payments Due by Period

 

 

 

Total

 

 

Remainder of

2017

 

 

2018-2019

 

 

2020–2021

 

 

Thereafter

 

 

 

(in thousands)

 

Convertible senior notes due 2019

 

$

350,000

 

 

$

 

 

$

350,000

 

 

$

 

 

$

 

Convertible senior notes due 2020

 

 

300,000

 

 

 

 

 

 

 

 

 

300,000

 

 

 

 

Asset based credit facility (1)

 

 

341,000

 

 

 

 

 

 

 

 

 

 

 

 

341,000

 

Term loan (2)

 

 

80,000

 

 

 

 

 

 

 

 

 

 

 

 

80,000

 

Operating leases (3)

 

 

683,685

 

 

 

23,058

 

 

 

163,223

 

 

 

122,998

 

 

 

374,406

 

Other non-current obligations (4)

 

 

792,723

 

 

 

9,335

 

 

 

78,971

 

 

 

86,513

 

 

 

617,904

 

Capital lease obligations

 

 

14,913

 

 

 

357

 

 

 

2,832

 

 

 

2,569

 

 

 

9,155

 

Equipment security notes

 

 

19,626

 

 

 

1,129

 

 

 

10,281

 

 

 

8,216

 

 

 

 

Notes payable for share repurchases

 

 

19,390

 

 

 

 

 

 

893

 

 

 

 

 

 

18,497

 

Promissory note

 

 

13,533

 

 

 

350

 

 

 

2,800

 

 

 

2,800

 

 

 

7,583

 

Letters of credit

 

 

27,718

 

 

 

27,718

 

 

 

 

 

 

 

 

 

 

Total

 

$

2,642,588

 

 

$

61,947

 

 

$

609,000

 

 

$

523,096

 

 

$

1,448,545

 

(1)

Under the credit agreement, the asset based credit facility has a maturity date of June 28, 2022.

(2)

Under the credit agreement, the $80.0 million LILO term loan facility has a maturity date of June 28, 2022.

(3)

We enter into operating leases in the normal course of business. Most lease arrangements provide us with the option to renew the leases at defined terms. The table above does not include future obligations for renewal options that have not yet been exercised. The future operating lease obligations would change if we were to exercise these options. Amounts above do not include estimated contingent rent due under operating leases. Our obligation for contingent rent as of October 28, 2017 was $3.6 million.

(4)

Other non-current obligations include estimated payments for rent associated with build-to-suit lease transactions. These amounts may be reduced in the event we are able to effect a sale-leaseback on any of these locations.

Off Balance Sheet Arrangements

We have no material off balance sheet arrangements as of October 28, 2017.August 3, 2019.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with GAAPaccounting principles generally accepted in the United States requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management evaluates its accounting policies, estimates, and judgments on an on-going basis. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions and such differences could be material to the consolidated financial statements.

Management evaluated the development and selection of its critical accounting policies and estimates and believes that the following involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results of operations and financial position, and are therefore discussed as critical:

Revenue Recognition
Merchandise Inventories
Impairment
Lease Accounting
Stock-Based Compensation
Income Taxes

Revenue Recognition

Merchandise Inventories

Advertising Expenses

ImpairmentIn the first quarter of Goodwillfiscal 2019, we adopted Accounting Standards Update 2016-02—Leases. The adoption of this standard resulted in a material change to the “Lease Accounting” critical accounting policy in fiscal 2019. Please refer below for our updated “Lease Accounting” critical accounting policy. There have been no material changes to the other critical accounting policies and Long-Lived Assetsestimates listed above from the disclosures included in the 2018 Form 10-K. For further discussion regarding these policies, refer to Management’s Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Estimates in the 2018 Form 10-K.

Lease Accounting

We lease nearly all of our retail and outlet store locations, corporate headquarters, distribution and home delivery facilities, as well as other storage and office space. The initial lease terms of our real estate leases generally range from ten to fifteen years, and certain leases contain renewal options for up to an additional 25 years, the exercise of which is at our sole discretion. In recognizing the lease right-of-use assets and lease liabilities, we utilize the lease term for which we are reasonably certain to use the underlying asset, including consideration of options to extend or terminate the lease. We also lease certain equipment with lease terms generally ranging from three to seven years. Our lease agreements generally do not contain any material residual value guarantees or material restrictions or covenants.

Leases, or lease extensions, with a term of twelve months or less are not recorded on the condensed consolidated balance sheets, and we recognize lease expense for these leases on a straight-line basis over the lease term.

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Income TaxesTable of Contents

48We account for lease and non-lease components as a single lease component for real estate leases, and for all other asset classes we account for the components separately. We determine the lease classification and begin to recognize lease and any related financing expenses upon the lease’s commencement, which for real estate leases is generally upon store opening or, to a lesser extent, when we take possession or control of the asset.


For further discussion regardingAs most of our leases do not include an implicit interest rate, we determine the discount rate for each lease based upon the incremental borrowing rate (“IBR”) in order to calculate the present value of lease payments at the commencement date. The IBR is computed as the rate of interest that we would have to pay to (i) borrow on a collateralized basis (ii) over a similar term (iii) an amount equal to the total lease payments and (iv) in a similar economic environment. We utilize our asset based credit facility as the basis for determining the applicable IBR for each lease.

Certain of our lease agreements include rental payments based on a percentage of retail sales over contractual levels. Due to the variable and unpredictable nature of such payments, we do not recognize a lease right-of-use asset and lease liability related to such payments. Estimated variable rental payments are included in accounts payable and accrued expenses on the condensed consolidated balance sheets.

We have a small group of leases that include rental payments periodically adjusted for inflation (e.g., based on the consumer price index). We include these policies, refer to Management’s Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Estimates variable payments in the 2016 Form 10-K. Thereinitial measurement of the lease right-of-use asset and lease liability if such increases have been no material changes toa minimum rent escalation (e.g., floor). However, we exclude these variable payments from the critical accounting policiesinitial measurement of the lease right-of-use asset and estimates listedlease liability in the 2016 Form 10-K.case of lease arrangements that do not specify a minimum rent escalation.

We rent or sublease certain real estate to third parties under operating leases and recognize rental income received on a straight-line basis over the lease term, which is included in selling, general and administrative expenses on the condensed consolidated statements of income.

Lease arrangements may require the landlord to provide tenant allowances directly to us. Standard tenant allowances received from landlords, typically those received under operating lease agreements, are recorded as cash and cash equivalents with an offset recorded in lease right-of-use assets on the condensed consolidated balance sheets. In certain instances tenant allowances are provided for us to design and build the leased asset. Tenant allowances received from landlords during the construction phase of a leased asset and prior to lease commencement are recorded as cash and cash equivalents with an offset recorded in other non-current assets (to the extent we have incurred related capital expenditure for construction costs) or in other current liabilities (to the extent that payments are received prior to capital construction expenditures by us) on the condensed consolidated balance sheets. After the leased asset is constructed and the lease commences, we reclassify the tenant allowance from other non-current assets or other current liabilities to lease right-of-use assets on the condensed consolidated balance sheets.

Lease Classification

Certain of our real estate and property and equipment are held under finance leases. Lease related assets are included in finance lease right-of-use assets within property and equipment—net on the condensed consolidated balance sheets.

Leases that do not meet the definition of a finance lease are considered operating leases. Lease related assets are included in operating lease right-of-use assets on the condensed consolidated balance sheets.

Construction Related Activities

We are sometimes involved in the construction of leased stores for certain of our newer Design Galleries. Prior to construction commencement, we evaluate whether or not we, as lessee, control the asset being constructed and, depending on the extent to which we are involved, may be the “deemed owner” of the leased asset for accounting purposes during the construction period.

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If we are not the “deemed owner” for accounting purposes during the construction period, such lease is classified as either an operating or finance lease upon lease commencement. During the construction period and prior to lease commencement, any capital amounts contributed by us toward the construction of the leased asset (excluding normal leasehold improvements, which are recorded within property and equipment—net) are recorded as “Landlord assets under construction” within other non-current assets on the condensed consolidated balance sheets (refer to Note 3—Prepaid Expense and Other Assets). Upon completion of the construction project, and upon lease commencement, we reclassify amounts of the construction project determined to be the landlord asset to lease right-of-use assets on the condensed consolidated balance sheets. The construction costs determined not to be part of the leased asset are classified as property and equipment—net on the condensed consolidated balance sheets.

If we are the “deemed owner” for accounting purposes, upon commencement of the construction project, we are required to capitalize (i) costs incurred by us and (ii) the cash and non-cash assets contributed by the landlord for construction as property and equipment on its condensed consolidated balance sheets as build-to-suit assets, with an offsetting financing obligation for the amount funded by the landlord. The contributions by the landlord toward construction, including the building, existing site improvements at construction commencement and any amounts paid by the landlord to those responsible for construction, are included as property and equipment additions due to build-to-suit lease transactions within the non-cash section of the consolidated statements of cash flows. Over the lease term, these non-cash additions to property and equipment do not impact our cash outflows, nor do they impact net income within the consolidated statements of income.

Upon completion of the construction project, we perform a sale-leaseback analysis to determine if we can derecognize the build-to-suit asset and corresponding financing obligation. If the asset and liability cannot be derecognized, we account for the agreement as a debt-like arrangement.

Recent Accounting Pronouncements

Refer to Note 2—Recently Issued Accounting Standards in our condensed consolidated financial statements for a description of recently proposed accounting standards which may impact our consolidated financial statements in future reporting periods.

Item 3. Quantitative and Qualitative Disclosure of Market Risks

Interest Rate Risk

We currently do not engage in any interest rate hedging activity and we have no intention to do so in the foreseeable future.

We are subject to interest rate risk in connection with borrowings under our revolving line of credit which bears interest at variable rates and we may incur additional indebtedness that bears interest at variable rates. At October 28, 2017, $341.0As of August 3, 2019, $145.0 million was outstanding under the revolving line of credit. AsThe Credit Agreement provides for a borrowing amount based on the value of October 28, 2017,eligible collateral and a formula linked to certain borrowing percentages based on certain categories of collateral. Under the undrawn borrowing availabilityterms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of August 3, 2019 was $189.0$254.6 million, net of $27.7$12.8 million in outstanding letters of credit. As a result of the FCCR restriction that limits the last 10% of borrowing availability, actual incremental borrowing available under the revolving line of credit would be approximately $125.2 million. Based on the average interest rate on the revolving line of credit during the three months ended October 28, 2017,August 3, 2019, and to the extent that borrowings were outstanding on such line of credit, we do not believe that a 10% change in the interest rate would have a material effect on our consolidated results of operations or financial condition. To the extent that we incur additional indebtedness, we may increase our exposure to risk from interest rate fluctuations.

We are subject to interest rate risk in connection with borrowings under our LILO term loan, which bears interest at variable rates. At October 28, 2017, $80.0 million was outstanding under the LILO term loan. Based on the average interest rates on the LILO term loan during the three months ended October 28, 2017, we do not believe that a 10% change in the interest rate would have a material effect on our consolidated results of operations or financial condition.

As of October 28, 2017, we had $350 million principal amount of 0.00% convertible senior notes dueAugust 3, 2019, outstanding (the “2019 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.

As of October 28, 2017, we had $300 million principal amount of 0.00% convertible senior notes due 2020 outstanding (the “2020 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.

As of August 3, 2019, we had $335 million principal amount of 0.00% convertible senior notes due 2023 outstanding (the “2023 Notes”). As this instrument does not bear interest, we do not have interest rate risk exposure related to this debt.

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Market Price Sensitive Instruments

0.00% Convertible Senior Notes due 2019

In connection with the issuance of the 0.00% convertible senior notes due 2019 Notes,(the “2019 Notes”), we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The 2019 Notes matured on June 15, 2019, and the convertible note hedge transactions relate to, collectively, 3.0 million shares of our common stock, which representsterminated upon the number of shares of our common stock underlying the 2019 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2019 Notes. These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to our common stock upon conversion of the 2019 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversionmaturity date of the 2019 Notes.

We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrants will expire through December 2019. To the extent they are exercised prior to expiration, the warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants unless we elect, subject to certain conditions, to settle the warrants in cash.warrants. The strike price of the warrant transactions is initially $171.98 per share. Refer to Note 9—8—Convertible Senior Notes in our condensed consolidated financial statements.

0.00% Convertible Senior Notes due 2020

In connection with the issuance of the 2020 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively, 2.5 million shares of our common stock, which represents the number of shares of our common stock underlying the 2020 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2020 Notes. These convertible note hedge transactions are expected to reduce the potential earnings

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dilution with respect to our common stock upon conversion of the 2020 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion of the 2020 Notes.

We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant transactions is initially $189.00 per share. Refer to Note 9—8—Convertible Senior Notes in our condensed consolidated financial statements.

0.00% Convertible Senior Notes due 2023

In connection with the issuance of the 2023 Notes, we entered into privately-negotiated convertible note hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively, 1.7 million shares of our common stock, which represents the number of shares of our common stock underlying the 2023 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2023 Notes. These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to our common stock upon conversion of the 2023 Notes and/or reduce our exposure to potential cash or stock payments that may be required upon conversion of the 2023 Notes.

We also entered into separate warrant transactions with the same group of counterparties initially relating to the number of shares of our common stock underlying the convertible note hedge transactions, subject to customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant transactions is initially $309.84 per share. Refer to Note 8—Convertible Senior Notes in our condensed consolidated financial statements.

Impact of Inflation

Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our consolidated results of operations and financial condition have been immaterial.

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this quarterly report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that the information required to be disclosed by us in such reports is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

PART
II

Item 1. Legal Proceedings

From time to time, we and/or our management are involved in litigation, claims and other proceedings relating to the conduct of our business, including purported class action litigation, as well as securities class action litigation. Such legal proceedings may include claims related to our employment practices, wage and hour claims, claims of intellectual property infringement, including with respect to trademarks and trade dress, claims asserting unfair competition and unfair business practices, claims with respect to our collection and sale of reproduction products, and consumer class action claims relating to our consumer practices including the collection of zip code or other information from customers. In addition, from time to time, we are subject to product liability and personal injury claims for the products that we sell and the stores we operate. Subject to certain exceptions, our purchase orders generally require the vendor to indemnify us against any product liability claims; however, if the vendor does not have insurance or becomes insolvent, we may not be indemnified. In addition, we could face a wide variety of employee claims against us, including general discrimination, privacy, labor and employment, ERISA and disability claims. Any claims could result in litigation against us and could also result in regulatory proceedings being brought against us by various federal and state agencies that regulate our business, including the U.S. Equal Employment Opportunity Commission. Often these cases raise complex factual and legal issues, which are subject to risks and uncertainties and which could require significant management time. Litigation and other claims and regulatory proceedings against us could result in unexpected expenses and liability and could also materially adversely affect our operations and our reputation.

For additional information regarding certain pending securities litigation, refer to Note 17—15—Commitments and Contingencies in our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q.

Item 1A. Risk Factors

We operate in a rapidly changing environment that involves a number of risks that could materially and adversely affect our business, financial condition, prospects, operating results or cash flows. For a detailed discussion of certain risks that affect our business, refer to the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 28, 2017February 2, 2019 (“20162018 Form 10-K”). There have been no material changes to the risk factors disclosed in our 2016 Form 10-K.

The risks described herein and those described in our 20162018 Form 10-K are not the only risks we face. We describe in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I of this quarterly report certain known trends and uncertainties that affect our business. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business, operating results and financial condition. We have identified additional material changes to our risk factors set forth below.

We are undertaking a large number of business initiatives at the same time, including exploring opportunities to expand into new categories and complementary businesses. If these initiatives are not successful, they may have a negative impact on our results of operations.

We are undertaking a large number of new business initiatives at the same time in order to support our future growth. For example, we have developed and continue to refine and enhance our Gallery format, which involves larger store square footage. We also continue to add new product categories and to expand product assortments. For example, in fiscal 2015 we launched our new RH Modern and RH Teen categories and in fiscal 2019 we are launching RH Beach House and RH Ski House. We are currently contemplating other new product lines and extensions. We introduced RH Hospitality in fiscal 2015 at RH Chicago, The Gallery at the Three Arts Club. As of August 3, 2019, six of our RH Design Galleries include an integrated RH Hospitality experience and, based on the success of our hospitality offering to date, we plan to incorporate an integrated RH Hospitality offering, including cafés, wine vaults, and barista bars, in many of the new Galleries that we open in the future. We continue to refine and develop the RH Hospitality model as we seek to optimize this part of our business and its integration with the operation of our Gallery locations. RH Hospitality is different from our traditional home furnishings business and involves evolving strategies that are untested and unproven and may expose us to a number of risks including risks related to the management and execution of food and hospitality operations in various locations where we operate retail Galleries. Although we have experienced a number of

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positive business outcomes from the RH Hospitality operations including the incremental revenue that we believe is driven in Gallery with a hospitality offering, there can be no assurance that these benefits will be sustained or that we will avoid operational or other complications from the hospitality business. There can be no assurance that we will successfully scale RH Hospitality, that we will optimally balance the resources and square footage allocated to our hospitality offerings versus our product offerings at our Galleries, or that our hospitality offerings will be attractive to consumers in our market over a sustained period of time. 

We have also embarked on an initiative to expand our product sales to international markets and are currently exploring opportunities for Design Galleries in several locations outside the United States, including the United Kingdom and Europe. International expansion would expose us to new risks, including, but not limited to, risks related to currency fluctuation, supply chain and product sourcing, international economic or political events including but not limited to the U.K.’s impending withdrawal from the European Union, commonly referred to as “Brexit,” that may negatively impact the luxury market, and new regulatory regimes applicable to our products, Galleries and employees. We may be unsuccessful in adapting our operations to address such risks. We also may be unsuccessful in accurately selecting which international markets would support demand for our products or sizing our Gallery openings to such markets. If we are not successful in managing the large number of new initiatives that are underway, we might experience an adverse impact on our financial condition and results of operations.

Furthermore, we can provide no assurances that customers will respond favorably to our new product offerings, Galleries or complementary businesses or that we will successfully execute on such business initiatives. Such new business opportunities may not achieve market acceptance or may only achieve market acceptance in limited geographic areas or at certain Design Galleries. In addition, developing and testing new and multiple business opportunities and strategies often requires knowledge in areas of expertise that may be new to our organization and may require significant time of our management and resources. For example, RH Hospitality extended our business into an area where we have had limited historical operating and management experience and where low margins and high customer expectations can put pressure on results and performance. Expanding our business internationally will also require that we develop management expertise in new markets and regulatory regimes, and an inability to adapt our business quickly and efficiently to support our international expansion could materially adversely affect our financial condition and results of operations. We can provide no assurances that we will be successful in expanding our operations into any new businesses and product lines.

Any new businesses we enter may also expose us to additional laws, regulations and risks, including the risk that we may incur ongoing operating expenses in such businesses in excess of revenues, which could harm our financial condition and results of operations. The financial profile of any such new businesses may be different than our current financial profile, which could affect our financial performance and the market price for our common stock. For example, RH Hospitality may expose us to new risks related to consumer litigation and longer lease terms. 

We often have in the past, and may in the future, incur significant costs for any new initiative before we realize any corresponding revenue with respect to such initiative. In addition, we may incur costs as we revise, restructure or discontinue existing product categories or business offerings in favor of pursuing new initiatives or retail concepts. For example, as we continue to open larger format Design Galleries in select major metropolitan markets, we expect to close a number of legacy Galleries and replace them with our Design Gallery format. The introduction of an integrated hospitality experience, including roll out of an integrated food and beverage experience at a new Gallery location often requires significant investments by us before the location is open to customers and able to generate revenues, and we anticipate that a number of Galleries to be opened during the next several years will continue to require this form of upfront investment before they generate revenue from the food and beverage offerings. In addition, during the fourth quarter of fiscal 2016, we initiated and executed a plan to integrate the RH Contemporary Art (“RHCA”) product line into the broader RH platform and we no longer operate RHCA as a separate division, and as a result we incurred restructuring related costs. To the extent that these new business opportunities do not generate sufficient revenue to recoup the cost of developing and operating such new concepts, our results of operations could be materially adversely affected.

In addition, we are continuing a number of new initiatives to improve the operations of our business, including ongoing refinements to our management structure and organizational design. Some of the improvements we are pursuing include changing the ways we source and deliver our products to our customers, as well as streamlining and realigning the management structure in our home office operations. We have also focused on elevating the customer experience,

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which includes improving our distribution and delivery of products to our customers and architecting a new fully integrated back-end operating platform, inclusive of the supply chain network, the home delivery experience as well as a new metric-driven quality system and company-wide decision data. We have focused on rationalizing our SKU count and optimizing inventory, which includes selling slower moving, discontinued and other inventory through markdowns and our outlet channel, as well as enhancing and optimizing our product sourcing capabilities and adding new management information systems. We also transitioned from a promotional to a membership model, in the early part of fiscal 2016, by introducing the RH Members Program, which provides a range of benefits to our customers in return for payment of an annual membership fee. We introduced the RH Members Program as an alternative to prior practices involving numerous event-driven promotional programs. Although we are extremely satisfied with the results of the RH Members Program to date, this program is still new to our business, and there can be no certainty as to exactly how our customers may react to this program over time or how the RH Members Program will affect our financial results from quarter to quarter.

Given the large number of organizational initiatives we are pursuing, as well as the complexity and untested nature of many of these efforts, there can be no certainty that we will be successful in executing on these initiatives including changes to our organizational design and management structure. We may not experience the operational or financial benefits we expect these improvements to generate and we may face unanticipated costs related to pursuing these initiatives such as personnel turnover, management distraction, or compliance and quality control risks, any of which could have a material adverse effect on our financial condition or results of operations.

All of the foregoing risks may be compounded due to various factors including any economic downturn. If we fail to achieve the intended results of our current business initiatives, or if the implementation of these initiatives is delayed or abandoned, diverts management’s attention or resources from other aspects of our business or costs more than anticipated (including, as a result of personnel turnover or compliance and control risks), we may experience inadequate return on investment for some or all such business initiatives, which could have a material adverse effect on our financial condition or results of operations.

We are subject to risks associated with our dependence on foreign manufacturing and imports for our merchandise.

Based on total dollar volume of purchases, in fiscal 2018 we sourced approximately 85% of our merchandise from outside the United States, including 73% from Asia, with approximately 39% of our products sourced from China and approximately 3% of our products sourced from Mexico, and in fiscal 2017 we sourced approximately 85% of our merchandise from outside the United States, including 76% from Asia, with approximately 42% of our products sourced from China and approximately 3% of our products sourced from Mexico. We expect the amount of products that we source from China will be lower in fiscal 2019 compared to fiscal 2018, but the exact product mix in terms of vendor factory locations is subject to a range of different factors and is inherently difficult to predict with accuracy. In addition, some of the merchandise we purchase from vendors in the United States also depends, in whole or in part, on vendors located outside the United States. As a result, our business highly depends on global trade, as well as any trade and or other factors that impact the specific countries where our vendors’ production facilities are located. Our future success will depend in large part upon our ability to maintain our existing foreign vendor relationships and to develop new ones based on the requirements of our business and any changes in trade dynamics that might dictate changes in the locations for sourcing of products. In addition, we face risks related to the ability of our vendors to scale their operations whether in connection with new products we introduce or new production manufacturing locations that may be added to our supply chain, which in some cases would require substantial ongoing investments to support additional capacity. In addition, we have previously encountered difficulties in the ability of our vendors to scale production commensurate with demand from our customers. While we rely on long-term relationships with many of our vendors, we do not rely on long-term contracts with our vendors and generally transact business with them on an order-by-order basis.

Many of our imported products are subject to existing duties, tariffs, anti-dumping duties and other similar trade restrictions that may limit the quantity or affect the price of some types of goods that we import into the United States. In addition, substantial regulatory uncertainty exists regarding international trade relations and trade policy, both in the United States and abroad. An introduction of new duties, tariffs, quotas or other similar trade restrictions, or increases in existing duties or tariff rates, on products imported into the United States, whether actual, pending or threatened, may have a negative impact on our results of operations. Significant uncertainty exists as to whether and when tariffs may be

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imposed, and what countries may be implicated. For example, proposed tariffs on goods imported from Mexico have been introduced and subsequently withdrawn by the U.S. government. Additionally, such uncertainties, even if not directly applicable to our imported products, may have a negative influence on the domestic and international economy generally and indirectly reduce market demand for our products.

A significant subset of our products sourced from China has been affected by increased levels of tariffs that were imposed in 2018 and 2019. The initial round of these increased tariffs became effective on certain products that we source from China including furniture and lighting initially as a 10 percent ad valorem duty on September 24, 2018, which amount increased to 25 percent on May 10, 2019, and is expected to increase further to 30 percent on October 1, 2019. On August 1, 2019, President Trump announced a new 10 percent ad valorem duty on additional categories of goods imported from China, which amount was then increased to 15 percent on August 23, 2019. The new tariff at the rate of 15 percent became effective September 1, 2019 with respect to certain categories of goods and is expected to become effective for additional categories of goods on December 15, 2019.

While we have been working with our vendor partners on mitigation strategies to seek to address the impact of the tariffs on goods imported from China, such efforts may not be fully sufficient to remediate the impact of the existing ad valorem duty on certain products imported from China or the future ad valorem duties to be imposed on products from China. In addition, such mitigation efforts may not be successful with respect to other pending or future increases in tariffs. There is substantial uncertainty regarding the possible application of additional tariffs with respect to China, or the possible imposition of tariffs on trade with additional countries other than China. We may not be able to anticipate the exact contours of tariffs and other burdens on global trade that may become applicable and our efforts to respond to these circumstances may be inadequate. In particular, we may not be able to receive or sustain adequate pricing concessions from our vendors with respect to applicable tariffs and any applicable pricing increases that we seek to pass through to our customers may not be successful in achieving our objectives. Our sales may fall in response to any price increases and our vendors may not be able to support the level of pricing concessions that we seek.

In addition, we are undertaking ongoing efforts to examine our sourcing strategy in a comprehensive way in order to achieve the best possible outcomes for our business. Such efforts include addressing among other factors the country of origin and the current and potential future imposition of tariffs with respect to particular countries of origin. These efforts to optimize our supply chain may not be successful and we may encounter various obstacles to these and other related initiatives. Although we have moved some of our merchandise sourcing away from China to other countries, these efforts may not achieve the desired outcomes. For example, we may not be able to move sufficient quantities of our product manufacturing to new locations outside of China and the quality of products manufactured in new factories may not meet the requirements of our business. In addition, we may encounter logistics and other challenges in moving manufacturing to new jurisdictions including the potential imposition of new tariffs on products sourced from such other jurisdictions.

In addition, there can be no assurance that tariffs that are imposed or proposed will not become effective on a longer term basis. In the event that any tariffs applicable to our business become applicable on a longer term basis, there can be no assurance that our efforts to mitigate the impact of such longer term tariffs will be successful.

There can be no assurance that we will not experience disruption in our business related to tariffs or other changes in trade practices and applicable rules or as a result of our efforts to respond to these matters. Tariffs and other similar trade actions are inherently unpredictable and can change quickly based on political or economic pressures or policy changes. Any changes to tariffs or other rules and practices related to cross border trade, including the possible implementation of additional tariffs, could materially increase our cost of goods sold with respect to merchandise that we purchase from vendors who manufacture products in China or other countries outside the United States, which could in turn require us to increase our prices and, in the event consumer demand declines as a result, negatively impact our financial performance. While we may seek to adopt mitigation measures and changes to our business practices to seek to counteract the effect of such tariffs on our business and results of operations, due to multiple factors that can occur in the context of trade disputes and the inherent unpredictability of how customers and market participants may respond, any mitigation measures we adopt may be not achieve their intended purpose. Certain of our competitors may be better positioned than us to withstand or react to these kinds of changes including border taxes, tariffs or other restrictions on global trade and as a result we may lose market share to such competitors. In addition, to the extent that our competitors, our vendors or companies in other industries that manufacture products in China respond to the tariffs imposed to date or the possibility of future tariffs by shifting production to other countries in Asia or to other regions, the costs of

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production in such countries may increase, which may increase our costs or otherwise have an adverse impact on our product supply chain. Similarly, to the extent that we or our vendors respond to the tariffs imposed to date or the possibility of future tariffs by shifting merchandise purchases or production to other countries in Asia or to other regions, we may face delays or costs associated with developing new vendor relationships and our vendors may face delays or costs associated with bringing online new manufacturing facilities, which may increase the cost of our products or cause delays in the shipment of our merchandise that result in the cancellation of orders by our customers. An interruption or delay in supply from our foreign sources, or the imposition of additional duties, taxes or other charges on these imports, could have a material adverse effect on our business, financial condition and results of operations unless and until alternative supply arrangements are secured. Due to broad uncertainty regarding the timing, content and extent of any regulatory changes in the U.S. or abroad, we cannot predict the impact, if any, that these changes could have to our business, financial condition and results of operations.

Our dependence on foreign imports also makes us vulnerable to risks associated with products manufactured abroad, including, among other things, risks of damage, destruction or confiscation of products while in transit to our distribution centers located in the United States, product quality control charges on or assessment of additional import duties, tariffs, anti-dumping duties and quotas, loss of “most favored nation” trading status by our foreign trading partners with the United States, work stoppages, including without limitation as a result of events such as longshoremen strikes, transportation and other delays in shipments, including without limitation as a result of heightened security screening and inspection processes or other port-of-entry limitations or restrictions in the United States, freight cost increases, political unrest, economic uncertainties, including inflation, foreign government regulations, trade restrictions, increased labor costs and other similar factors that might affect the operations of our vendors in specific countries such as China.

In addition, there is a risk of compliance violations by our vendors, which could lead to adverse consequences related to the failure of our vendors to adhere to applicable manufacturing requirements or other applicable rules or government regulations. Any such noncompliance could have an adverse impact on our business and may result in product recalls, regulatory action, product liabilities, investigation by governmental agencies and other similar adverse consequences. Any failure by our vendors outside the United States to adhere to applicable legal requirements or our global compliance standards such as fair labor standards, prohibitions on child labor and other product safety or manufacturing safety standards could give rise to a range of adverse consequences including the disruption of our supply chain as well as potential liability to us and harm our reputation and brand and could subject us to other adverse consequences including boycotts by our consumer or special interest groups including activists, any of which actions could negatively affect our business and results of operations.

Changes to accounting rules or regulations may adversely affect our results of operations.

New accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. It is difficult to predict the impact of future changes to accounting principles or current accounting practice and the exact impact of such changes may not be what we anticipate. A change in accounting rules or regulations may even affect our reporting of transactions completed before the change is effective and future changes to accounting rules or regulations or the questioning of current accounting practices may adversely affect our results of operations. For example, we adopted Accounting Standards Update 2014-09—Revenue from Contracts with Customers (Topic 606) in the first quarter of fiscal 2018, the adoption of which materially impacted the timing of recognizing advertising expense related to direct response advertising, including costs associated with our Source Books. In addition, we adopted Accounting Standards Update 2016-02—Leases (Topic 842) in the first quarter of fiscal 2019, the adoption of which materially impacted our financial statements including (i) our consolidated balance sheets due to the initial recognition of right of use assets and lease liabilities for our operating and finance lease arrangements, (ii) our consolidated statements of income, specifically cost of goods sold and interest expense—net, primarily due to the change from the build-to-suit lease transactions under the previous accounting guidance to the new finance lease classification treatment, and (iii) our cash flows due to amortization and interest expense for our operating and finance lease arrangements and classification of landlord assets under construction. For information regarding recently issued accounting pronouncements, refer to Note 2—Recently Issued Accounting Standards in our condensed consolidated financial statements within Part I of this Quarterly Report on Form 10-Q.

75

The adoption and application of new accounting standards can expose us to certain risks similar to the risks we face with respect to our ability to maintain effective internal controls over financial reporting and any failure in our adoption or application of new accounting rules or the maintenance of effective internal controls over financial reporting or disclosure controls could expose us to material risks including the inability to accurately report our financial information and results of operation in a timely manner. Our results of operations could be materially adversely affected by these and similiar risks including, to the extent we experience any increases in costs or diversions in managerial or personnel resources in order to adopt new accounting rules or regulations or to adopt and maintain effective internal controls over financial reporting or disclosure controls.

76

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Repurchases of Common Stock during the Three Months Ended October 28, 2017August 3, 2019

During the three months ended October 28, 2017,August 3, 2019, we repurchased the following shares of our common stock:

    

    

    

Total Number of 

    

Approximate Dollar

Average

Shares Repurchased

Value of Shares That

Purchase

as Part of Publicly

May Yet Be

Number of

Price Per

Announced Plans or

Purchased Under the

Shares (1)

Share

Programs (2)

Plans or Programs

(in millions)

May 5, 2019 to June 1, 2019

 

1,355

$

102.87

 

$

450

June 2, 2019 to July 6, 2019

 

50,853

$

111.45

 

$

450

July 7, 2019 to August 3, 2019

 

132

$

122.25

 

$

450

Total

 

52,340

 

 

  

 

 

Number of

Shares (1)

 

 

Average

Purchase

Price Per

Share

 

 

Total Number of shares Repurchased as Part of Publicly Announced Plans or Programs

 

 

Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

July 30, 2017 to August 26, 2017

 

 

 

 

$

 

 

 

 

 

$

 

August 27, 2017 to September 30, 2017

 

 

40,414

 

 

$

72.18

 

 

 

 

 

$

 

October 1, 2017 to October 28, 2017

 

 

752

 

 

$

77.20

 

 

 

 

 

$

 

Total

 

 

41,166

 

 

$

72.28

 

 

 

 

 

 

 

 

(1)

RepresentsIncludes shares withheld from delivery to satisfy exercise price and tax withholding obligations of employee recipients that occur upon the exercise of stock options and vesting of restricted stock units granted under the Company’s 2012 Stock Incentive Plan.

There were 52,340 shares surrendered for this purpose during the three months ended August 3, 2019.
(2)Reflects shares repurchased as part of the $950 Million Repurchase Program authorized by the Board of Directors on October 10, 2018 and replenished on March 25, 2019.

Item 3. Defaults Upon Senior Securities

Not applicable.

51


Item 4. Mine SafetySafety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

52


77

Item 6. Exhibits

 

 

Incorporated by Reference

Exhibit
Number

Exhibit Description

Form

File
Number

Date of
First Filing

Exhibit
Number

Filed
Herewith

Exhibit
Number

Exhibit Description

Form

File

Number

Date of

First Filing

Exhibit

Number

Filed

Herewith

31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14(a)13a14(a) of the Securities Exchange Act of 1934, as amended.amended.

X

31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14(a)13a14(a) of the Securities Exchange Act of 1934, as amendedamended..

X

32.1

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 20022002..

X

32.2

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 20022002..

X

101.INS

XBRL Instance DocumentDocument—the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

X

101.SCH

Inline XBRL Taxonomy Extension Schema Document

X

101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase Document

X

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document

X

101.LAB

Inline XBRL Taxonomy Extension Label Linkbase Document

X

���

101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase Document

X

104

Cover Page Interactive Data File––the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

X

53


78

SIGNATURES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

    

RHGraphic

Date: December 6, 2017September 10, 2019

By:

/s/ Gary Friedman

Gary Friedman

Chairman and Chief Executive Officer

(Principal Executive Officer)

Date: December 6, 2017September 10, 2019

By:

/s/ Jack Preston

Jack Preston

Chief Financial Officer

(Principal Financial Officer)

Date: September 10, 2019

By:

/s/ Karen BooneGlenda Citragno

Karen BooneGlenda Citragno

President,SVP, Chief Financial and AdministrativeAccounting Officer

(Principal Financial Officer and Principal Accounting Officer)

54

79