Edgar Filing: RH - Form 10-Q

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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

☐	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):

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.

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

PART I

Item 1. Financial Statements

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.

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.

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.

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.

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

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.

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 expenses—The 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 breakage—Under 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.

Membership revenue—Under 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 recognition—Under 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 returns—In 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 customers—Under 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.

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

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.

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 2018-10—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 (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

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

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 13—Stock-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.

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 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 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 4, 2018, none of these conditions have occurred and, as a result, the 2023 Notes are not convertible as of August 4, 2018. 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.

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.

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 both the three and six months ended August 4, 2018, the Company recorded $0.1 million related to the amortization of debt issuance costs.

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