rh-10q_20180804.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended August 4, 2018

or

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

For the transition period from             to            

Commission file number: 001-35720

 

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

45-3052669

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

 

15 Koch Road, Suite K

Corte Madera, CA

 

94925

(Address of principal executive offices)

 

(Zip Code)

 

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

 

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

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

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

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

 

Emerging growth company

 

 

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

 

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

As of August 31, 2018, 22,233,789 shares of registrant’s common stock were outstanding.

 

 


 

RH

INDEX TO FORM 10-Q

 

 

 

 

 

Page

 

 

 

 

 

PART I. FINANCIAL INFORMATION

Item 1.

  

Financial Statements

 

3

 

  

Condensed Consolidated Balance Sheets (Unaudited) as of August 4, 2018, and February 3, 2018

 

3

 

  

Condensed Consolidated Statements of Operations (Unaudited) for the three and six months ended August 4, 2018, and July 29, 2017

 

4

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the three and six months ended August 4, 2018, and July 29, 2017

 

5

 

  

Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended August 4, 2018, and July 29, 2017

 

6

 

  

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

7

Item 2.

  

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

 

27

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

 

53

Item 4.

  

Controls and Procedures

 

55

 

 

 

 

 

PART II. OTHER INFORMATION

Item 1.

  

Legal Proceedings

 

56

Item 1A.

  

Risk Factors

 

56

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

61

Item 3.

 

Defaults Upon Senior Securities

 

61

Item 4.

 

Mine Safety Disclosures

 

61

Item 5.

 

Other Information

 

61

Item 6.

  

Exhibits

 

62

Signatures

 

63

 

 

2


 

PART I

 

Item 1. Financial Statements

RH

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

22,199

 

 

$

17,907

 

Accounts receivable—net

 

 

40,706

 

 

 

31,412

 

Merchandise inventories

 

 

551,343

 

 

 

527,026

 

Prepaid expense and other current assets

 

 

78,254

 

 

 

68,585

 

Total current assets

 

 

692,502

 

 

 

644,930

 

Property and equipment—net

 

 

833,232

 

 

 

800,698

 

Goodwill

 

 

141,835

 

 

 

141,893

 

Trademarks and other intangible assets

 

 

100,663

 

 

 

100,702

 

Deferred tax assets

 

 

29,437

 

 

 

23,311

 

Other non-current assets

 

 

16,438

 

 

 

21,332

 

Total assets

 

$

1,814,107

 

 

$

1,732,866

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

284,942

 

 

$

318,765

 

Deferred revenue and customer deposits

 

 

164,979

 

 

 

149,404

 

Convertible senior notes due 2019—net

 

 

335,670

 

 

 

 

Other current liabilities

 

 

51,354

 

 

 

51,166

 

Total current liabilities

 

 

836,945

 

 

 

519,335

 

Asset based credit facility

 

 

 

 

 

199,970

 

Term loan—net

 

 

 

 

 

79,499

 

Convertible senior notes due 2019—net

 

 

 

 

 

327,731

 

Convertible senior notes due 2020—net

 

 

261,929

 

 

 

252,994

 

Convertible senior notes due 2023—net

 

 

240,804

 

 

 

 

Financing obligations under build-to-suit lease transactions

 

 

225,700

 

 

 

229,323

 

Deferred rent and lease incentives

 

 

54,821

 

 

 

54,983

 

Other non-current obligations

 

 

47,847

 

 

 

76,367

 

Total liabilities

 

 

1,668,046

 

 

 

1,740,202

 

Commitments and contingencies (Note 14)

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

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

   issued or outstanding as of August 4, 2018 and February 3, 2018

 

 

 

 

 

 

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

   42,452,371 shares issued and 22,229,439 shares outstanding as of August 4, 2018;

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

 

 

2

 

 

 

2

 

Additional paid-in capital

 

 

944,610

 

 

 

860,288

 

Accumulated other comprehensive loss

 

 

(1,918

)

 

 

(171

)

Retained earnings

 

 

223,459

 

 

 

152,394

 

Treasury stock—at cost, 20,222,932 shares as of August 4, 2018 and 20,220,132 shares

   as of February 3, 2018

 

 

(1,020,092

)

 

 

(1,019,849

)

Total stockholders’ equity (deficit)

 

 

146,061

 

 

 

(7,336

)

Total liabilities and stockholders’ equity (deficit)

 

$

1,814,107

 

 

$

1,732,866

 

 

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

3


 

RH

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

August 4,

 

 

July 29,

 

 

August 4,

 

 

July 29,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net revenues

 

$

640,798

 

 

$

615,326

 

 

$

1,198,204

 

 

$

1,177,406

 

Cost of goods sold

 

 

369,198

 

 

 

409,513

 

 

 

714,569

 

 

 

801,337

 

Gross profit

 

 

271,600

 

 

 

205,813

 

 

 

483,635

 

 

 

376,069

 

Selling, general and administrative expenses

 

 

186,225

 

 

 

193,690

 

 

 

344,659

 

 

 

357,050

 

Income from operations

 

 

85,375

 

 

 

12,123

 

 

 

138,976

 

 

 

19,019

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense—net

 

 

17,480

 

 

 

14,402

 

 

 

34,515

 

 

 

26,581

 

Loss on extinguishment of debt

 

 

917

 

 

 

 

 

 

917

 

 

 

 

Total other expenses

 

 

18,397

 

 

 

14,402

 

 

 

35,432

 

 

 

26,581

 

Income (loss) before income taxes

 

 

66,978

 

 

 

(2,279

)

 

 

103,544

 

 

 

(7,562

)

Income tax expense

 

 

2,936

 

 

 

5,583

 

 

 

11,443

 

 

 

3,670

 

Net income (loss)

 

$

64,042

 

 

$

(7,862

)

 

$

92,101

 

 

$

(11,232

)

Weighted-average shares used in computing basic net income

   (loss) per share

 

 

21,925,702

 

 

 

28,398,307

 

 

 

21,735,364

 

 

 

35,667,217

 

Basic net income (loss) per share

 

$

2.92

 

 

$

(0.28

)

 

$

4.24

 

 

$

(0.31

)

Weighted-average shares used in computing diluted net income

   (loss) per share

 

 

27,496,561

 

 

 

28,398,307

 

 

 

26,363,395

 

 

 

35,667,217

 

Diluted net income (loss) per share

 

$

2.33

 

 

$

(0.28

)

 

$

3.49

 

 

$

(0.31

)

 

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

 

 

4


 

RH

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

August 4,

 

 

July 29,

 

 

August 4,

 

 

July 29,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net income (loss)

 

$

64,042

 

 

$

(7,862

)

 

$

92,101

 

 

$

(11,232

)

Net gains (losses) from foreign currency translation

 

 

(482

)

 

 

2,069

 

 

 

(1,747

)

 

 

877

 

Net unrealized holding gains on available-for-sale investments

 

 

 

 

 

 

 

 

 

 

 

11

 

Total comprehensive income (loss)

 

$

63,560

 

 

$

(5,793

)

 

$

90,354

 

 

$

(10,344

)

 

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

 

 

5


 

RH

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Six Months Ended

 

 

 

August 4,

 

 

July 29,

 

 

 

2018

 

 

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net income (loss)

 

$

92,101

 

 

$

(11,232

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

34,803

 

 

 

32,546

 

Lease impairment adjustment

 

 

(1,157

)

 

 

 

Non-cash charges resulting from inventory step-up

 

 

380

 

 

 

1,860

 

Amortization of debt discount

 

 

17,645

 

 

 

15,018

 

Stock-based compensation expense

 

 

14,092

 

 

 

36,166

 

Loss on extinguishment of debt

 

 

917

 

 

 

 

Other non-cash interest expense

 

 

2,902

 

 

 

2,314

 

Change in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(9,350

)

 

 

(617

)

Merchandise inventories

 

 

(24,995

)

 

 

140,331

 

Prepaid expense and other assets

 

 

(43,174

)

 

 

35,287

 

Accounts payable and accrued expenses

 

 

(42,717

)

 

 

29,874

 

Deferred revenue and customer deposits

 

 

20,800

 

 

 

30,349

 

Other current liabilities

 

 

9,895

 

 

 

2,269

 

Deferred rent and lease incentives

 

 

(81

)

 

 

1,166

 

Other non-current obligations

 

 

(1,832

)

 

 

(975

)

Net cash provided by operating activities

 

 

70,229

 

 

 

314,356

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(61,212

)

 

 

(56,697

)

Proceeds from sale of assets held for sale—net

 

 

 

 

 

15,123

 

Purchase of investments

 

 

 

 

 

(16,109

)

Maturities of investments

 

 

 

 

 

46,890

 

Sales of investments

 

 

 

 

 

145,020

 

Net cash provided by (used in) investing activities

 

 

(61,212

)

 

 

134,227

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Borrowing under asset based credit facility

 

 

510,000

 

 

 

323,000

 

Repayments under asset based credit facility

 

 

(709,970

)

 

 

(40,000

)

Borrowing under term loans

 

 

 

 

 

180,000

 

Repayments under term loans

 

 

(80,000

)

 

 

 

Borrowing under promissory and equipment security notes

 

 

 

 

 

14,000

 

Repayments under promissory and equipment security notes

 

 

(31,974

)

 

 

(117

)

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

)

 

 

 

Debt issuance costs

 

 

 

 

 

(7,939

)

Repurchases of common stock—including commissions

 

 

 

 

 

(1,000,326

)

Proceeds from exercise of stock options

 

 

29,209

 

 

 

11,170

 

Tax withholdings related to issuance of stock-based awards

 

 

(7,863

)

 

 

(3,106

)

Payments on build-to-suit lease transactions

 

 

(6,190

)

 

 

(4,601

)

Payments on capital leases

 

 

(290

)

 

 

(158

)

Net cash used in financing activities

 

 

(9,263

)

 

 

(528,077

)

Effects of foreign currency exchange rate translation

 

 

(124

)

 

 

55

 

Net decrease in cash and cash equivalents and restricted cash equivalents

 

 

(370

)

 

 

(79,439

)

Cash and cash equivalents

 

 

 

 

 

 

 

 

Beginning of period—cash and cash equivalents

 

 

17,907

 

 

 

87,023

 

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

 

 

7,407

 

 

 

28,044

 

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

 

 

25,314

 

 

 

115,067

 

 

 

 

 

 

 

 

 

 

End of period—cash and cash equivalents

 

 

22,199

 

 

 

21,637

 

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

 

 

2,745

 

 

 

13,991

 

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

 

$

24,944

 

 

$

35,628

 

 

 

 

 

 

 

 

 

 

Non-cash transactions:

 

 

 

 

 

 

 

 

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

 

$

24,896

 

 

$

23,860

 

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

 

 

2,478

 

 

 

27,340

 

Property and equipment acquired under capital lease

 

 

1,191

 

 

 

753

 

Property and equipment additions from unpaid construction related deposits

 

 

517

 

 

 

5,848

 

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

 

 

243

 

 

 

 

 

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

6


 

RH

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

NOTE 1—THE COMPANY

Nature of Business

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

As of August 4, 2018, the Company operated a total of 85 retail Galleries and 36 outlet stores in 32 states, the District of Columbia and Canada, and includes 15 Waterworks showrooms in the United States and in the U.K., and had sourcing operations in Shanghai and Hong Kong.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared from the Company’s records and, in management’s opinion, include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the Company’s financial position as of August 4, 2018, and the results of operations for the three and six months ended August 4, 2018 and July 29, 2017. The Company’s current fiscal year, which consists of 52 weeks, ends on February 2, 2019 (“fiscal 2018”).

Certain information and disclosures normally included in the notes to annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted for purposes of these interim condensed consolidated financial statements.

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

The results of operations for the three and six months ended August 4, 2018 presented herein are not necessarily indicative of the results to be expected for the full fiscal year.

Convertible Senior Notes

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 (collectively, the “2023 Notes”). In connection with the issuance of these notes, the Company entered into convertible note hedge transactions for which it paid an aggregate amount of $91.9 million. In addition, the Company sold warrants for which it received aggregate proceeds of $51.0 million. Taken together, the Company received total cash proceeds of $287.8 million, net of discounts upon original issuance and offering costs of $6.3 million. Refer to Note 7—Convertible Senior Notes.

 

NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS

Revenue from Contracts with Customers

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

7


 

Adoption and Accounting Policy

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

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

 

Description

Policy under Topic 605

Policy under Topic 606

Advertising expenses

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

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

Gift card breakage

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

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

Membership revenue

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

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

 

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

Revenue recognition

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

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

Allowance for sales returns

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

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

 

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

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

8


 

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

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

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

Allowance for sales returnsIn connection with adoption of Topic 606, the Company is required to recognize its allowance for sales returns on a gross basis rather than as a net liability. Upon adoption, this resulted in an increase to prepaid and other current assets (“right of return asset for merchandise”), with a corresponding increase to other current liabilities on the consolidated balance sheets, and did not impact the consolidated statements of operations. As of August 4, 2018, the right of return asset for merchandise was $6.9 million.

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

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

Contract Liabilities

The Company defers revenue associated with merchandise delivered via the home-delivery channel. As the Company recognizes revenue when the merchandise is delivered to our customers, it is included as deferred revenue on the consolidated balance sheets while in-transit. Customer deposits represent payments made by customers on custom orders. At the time of order placement the Company collects deposits for all custom orders equivalent to 50% of the purchase price. Custom order deposits are recognized as revenue when a customer obtains control of the merchandise. In addition, the Company collects annual membership fees related to the RH Members Program. New membership fees are recorded as deferred revenue when collected from customers and recognized as revenue based on expected product revenues over the annual membership period, using historical trends of sales to members. Membership renewal fees are recorded as deferred revenue when collected from customers and are recognized as revenue on a straight-line basis over the membership period, or one year. The Company expects that substantially all of the deferred revenue, customer deposits and deferred membership fees as of August 4, 2018 will be recognized within the next six months as the performance obligations are satisfied.

In addition, the Company defers revenue when cash payments are received in advance of performance for unsatisfied obligations related to its gift cards and merchandise credits. Customer liabilities related to gift cards and merchandise credits was $19.1 million and $24.1 million as of August 4, 2018 and February 3, 2018, respectively. As discussed above, $6.0 million of the decrease was due to the reclassification of gift card liabilities to retained earnings upon adoption of Topic 606. During the three and six months ended August 4, 2018, the Company recognized $4.8 million and $9.7 million of revenue related to previous deferrals related to its gift cards and merchandise credits, respectively, and recorded gift card breakage of $0.4 million and $0.8 million, respectively. The Company expects that approximately 70% of the remaining gift card and merchandise credit liabilities will be recognized when the gift cards are redeemed by customers.

9


 

Disaggregated Revenue

The Company recognizes revenue from its stores and direct sales channels. Stores net revenues represent sales originating in retail stores, including Waterworks showrooms, and outlet stores. Direct net revenues include sales through the Company’s Source Books, websites, and phone orders, including its Contract business and a portion of its Trade business. During the three months ended August 4, 2018, net revenues recognized from the stores and direct sales channels were $361.9 million and $278.9 million, respectively. During the six months ended August 4, 2018, net revenues recognized from the stores and direct sales channels were $676.4 million and $521.8 million, respectively.

Adoption Impact on Fiscal 2018 Results

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

 

 

 

Three Months Ended August 4, 2018

 

 

 

As Reported

 

 

Adjustments

 

 

Balances without Adoption of Topic 606

 

Net revenues

 

$

640,798

 

 

$

(1,685

)

 

$

639,113

 

Cost of goods sold

 

 

369,198

 

 

 

(662

)

 

 

368,536

 

Gross profit

 

 

271,600

 

 

 

(1,023

)

 

 

270,577

 

Selling, general and administrative expenses

 

 

186,225

 

 

 

(11,105

)

 

 

175,120

 

Income from operations

 

 

85,375

 

 

 

10,082

 

 

 

95,457

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense—net

 

 

17,480

 

 

 

 

 

 

17,480

 

Loss on extinguishment of debt

 

 

917

 

 

 

 

 

 

917

 

Total other expenses

 

 

18,397

 

 

 

 

 

 

18,397

 

Income before income taxes

 

 

66,978

 

 

 

10,082

 

 

 

77,060

 

Income tax expense

 

 

2,936

 

 

 

455

 

 

 

3,391

 

Net income

 

$

64,042

 

 

$

9,627

 

 

$

73,669

 

 

 

 

Six Months Ended August 4, 2018

 

 

 

As Reported

 

 

Adjustments

 

 

Balances without Adoption of Topic 606

 

Net revenues

 

$

1,198,204

 

 

$

(9,295

)

 

$

1,188,909

 

Cost of goods sold

 

 

714,569

 

 

 

(3,650

)

 

 

710,919

 

Gross profit

 

 

483,635

 

 

 

(5,645

)

 

 

477,990

 

Selling, general and administrative expenses

 

 

344,659

 

 

 

(7,302

)

 

 

337,357

 

Income from operations

 

 

138,976

 

 

 

1,657

 

 

 

140,633

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense—net

 

 

34,515

 

 

 

 

 

 

34,515

 

Loss on extinguishment of debt

 

 

917

 

 

 

 

 

 

917

 

Total other expenses

 

 

35,432

 

 

 

 

 

 

35,432

 

Income before income taxes

 

 

103,544

 

 

 

1,657

 

 

 

105,201

 

Income tax expense

 

 

11,443

 

 

 

(1,495

)

 

 

9,948

 

Net income

 

$

92,101

 

 

$

3,152

 

 

$

95,253

 

 

10


 

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

 

 

 

As of August 4, 2018

 

 

 

As Reported

 

 

Adjustments

 

 

Balances without Adoption of Topic 606

 

Prepaid expense and other current assets

 

$

78,254

 

 

$

36,012

 

 

$

114,266

 

Deferred tax assets

 

 

29,437

 

 

 

(6,561

)

 

 

22,876

 

Accounts payable and accrued expenses

 

 

284,942

 

 

 

(732

)

 

 

284,210

 

Deferred revenue and customer deposits

 

 

164,979

 

 

 

9,860

 

 

 

174,839

 

Other current liabilities

 

 

51,354

 

 

 

(3,865

)

 

 

47,489

 

Retained earnings

 

 

223,459

 

 

 

24,188

 

 

 

247,647

 

Financial Instruments

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

Cash Flow Classification

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

In November 2016, the FASB issued Accounting Standards Update No. 2016-18—Statement of Cash Flows (Topic 230): Restricted Cash. The new guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts on the statement of cash flows. The new guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. Adoption of the standard will be applied using a retrospective transition method to each period presented. The Company adopted this new accounting standard in the first quarter of fiscal 2018 which resulted in a change to the presentation of the construction related deposits within the statement of cash flows. The Company considers the construction related deposits to be “restricted cash equivalents” and therefore, under the new accounting guidance, is required to include such deposits in beginning and ending “cash and cash equivalents and restricted cash equivalents” on the statement of cash flows. Previously, funding of the construction related deposit accounts was included within the “investing” section of the statement of cash flows and usage of the deposits was presented as a non-cash transaction. Under the new accounting guidance, funding of the construction related deposit accounts will not be presented within the statement of cash flows and the usage of the deposits will be presented within the “capital expenditures” line item under the “investing” section. Adoption of this new accounting standard resulted in an increase of the beginning and ending “cash and cash equivalents and restricted cash equivalents” amounts for the six months ended July 29, 2017 of $28.0 million and $14.0 million, respectively, as well as resulted in an increase in capital expenditures for the six months ended July 29, 2017 of $17.3 million and a decrease in construction related deposits of $5.3 million for the six months ended July 29, 2017.

11


 

Income Taxes: Intra-Entity Asset Transfers

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

Stock-Based Compensation

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

Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update 2016-02—Leases, which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. In July 2018, the FASB issued Accounting Standards Update 2018-10Codification Improvements to Topic 842 (Leases), and Accounting Standards Update 2018-11Leases (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 (ii) provides lessors with a practical expedient for separating components of a contract. The ASUs are effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of this guidance will have on its consolidated financial statements and anticipates the new guidance will significantly impact its consolidated financial statements given that the Company has a significant number of leases.

 

NOTE 3—PREPAID EXPENSE AND OTHER ASSETS

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

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Vendor deposits

 

$

20,767

 

 

$

9,701

 

Capitalized catalog costs

 

 

14,285

 

 

 

44,122

 

Federal and state tax receivable

 

 

9,682

 

 

 

 

Right of return asset for merchandise

 

 

6,888

 

 

 

 

Prepaid expense and other current assets

 

 

26,632

 

 

 

14,762

 

Total prepaid expense and other current assets

 

$

78,254

 

 

$

68,585

 

 

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

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Deferred financing fees

 

$

3,915

 

 

$

4,446

 

Construction related deposits

 

 

2,745

 

 

 

7,407

 

Other deposits

 

 

5,139

 

 

 

4,997

 

Other non-current assets

 

 

4,639

 

 

 

4,482

 

Total other non-current assets

 

$

16,438

 

 

$

21,332

 

 

12


 

NOTE 4—GOODWILL AND TRADEMARKS AND DOMAIN NAMES

The following sets forth the goodwill and trademarks and domain names activity for the RH Segment and Waterworks for the six months ended August 4, 2018 (in thousands):

 

 

 

 

 

 

 

Foreign

 

 

 

 

 

 

 

February 3,

 

 

Currency

 

 

August 4,

 

 

 

2018

 

 

Translation

 

 

2018

 

RH Segment

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

124,448

 

 

$

(58

)

 

$

124,390

 

Trademarks and domain names

 

 

48,563

 

 

 

 

 

 

48,563

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Waterworks

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill (1)

 

 

17,445

 

 

 

 

 

 

17,445

 

Trademarks

 

 

52,100

 

 

 

 

 

 

52,100

 

 

(1)

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

 

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

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

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Accounts payable

 

$

164,706

 

 

$

195,313

 

Accrued compensation

 

 

47,562

 

 

 

47,534

 

Accrued freight and duty

 

 

20,412

 

 

 

23,757

 

Accrued sales taxes

 

 

17,346

 

 

 

19,525

 

Accrued occupancy

 

 

12,460

 

 

 

8,612

 

Accrued catalog costs

 

 

10,427

 

 

 

9,000

 

Accrued professional fees

 

 

2,971

 

 

 

3,555

 

Other accrued expenses

 

 

9,058

 

 

 

11,469

 

Total accounts payable and accrued expenses

 

$

284,942

 

 

$

318,765

 

 

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

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Allowance for sales returns

 

$

23,069

 

 

$

10,565

 

Unredeemed gift card and merchandise credit liability

 

 

19,110

 

 

 

24,138

 

Product recall reserves

 

 

3,501

 

 

 

1,201

 

Current portion of non-current debt

 

 

892

 

 

 

6,033

 

Federal and state tax payable

 

 

 

 

 

5,391

 

Other current liabilities

 

 

4,782

 

 

 

3,838

 

Total other current liabilities

 

$

51,354

 

 

$

51,166

 

 

13


 

NOTE 6—OTHER NON-CURRENT OBLIGATIONS

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

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Notes payable for share repurchases

 

$

18,741

 

 

$

19,390

 

Capital lease obligations—non-current

 

 

8,012

 

 

 

7,509

 

Lease loss liabilities

 

 

7,393

 

 

 

9,684

 

Deferred contract incentive (1)

 

 

4,167

 

 

 

5,358

 

Unrecognized tax benefits

 

 

3,955

 

 

 

3,728

 

Rollover units and profit interests (2)

 

 

2,424

 

 

 

2,211

 

Other non-current obligations

 

 

3,155

 

 

 

2,996

 

Equipment security notes (3)

 

 

 

 

 

13,864

 

Promissory note (4)

 

 

 

 

 

11,627

 

Total other non-current obligations

 

$

47,847

 

 

$

76,367

 

 

(1)

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

(2)

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

(3)

Represents the non-current portion of equipment security notes secured by certain of the Company’s distribution center property and equipment. The equipment security notes were repaid in full in June 2018. As a result of the repayment, the Company incurred a $0.2 million loss on extinguishment of debt.

(4)

Represents the non-current portion of a promissory note secured by the Company’s aircraft. The promissory note was repaid in full in June 2018. As a result of the repayment, the Company incurred a $0.2 million loss on extinguishment of debt.

 

NOTE 7—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.