Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

June 2, 2017

 

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 April 29, 2017

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 May 31, 2017, 33,147,755 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 April 29, 2017, and January 28, 2017

 

3

 

  

Condensed Consolidated Statements of Operations (Unaudited) for the three months ended April 29, 2017, and April 30, 2016

 

4

 

 

Condensed Consolidated Statements of Comprehensive Loss (Unaudited) for the three months ended April 29, 2017, and April 30, 2016

 

5

 

  

Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended April 29, 2017 and April 30, 2016

 

6

 

  

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

7

Item 2.

  

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

 

24

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

 

39

Item 4.

  

Controls and Procedures

 

41

 

 

 

 

 

PART II. OTHER INFORMATION

Item 1.

  

Legal Proceedings

 

42

Item 1A.

  

Risk Factors

 

42

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

42

Item 3.

 

Defaults Upon Senior Securities

 

43

Item 4.

 

Mine Safety Disclosures

 

43

Item 5.

 

Other Information

 

43

Item 6.

  

Exhibits

 

44

Signatures

 

45

 

 

2


PART I

 

 

Item 1. Financial Statements

RH

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

80,150

 

 

$

87,023

 

Short-term investments

 

 

 

 

 

142,677

 

Accounts receivable—net

 

 

34,116

 

 

 

34,191

 

Merchandise inventories

 

 

683,984

 

 

 

752,304

 

Asset held for sale

 

 

8,179

 

 

 

4,900

 

Prepaid expense and other current assets

 

 

108,241

 

 

 

117,162

 

Total current assets

 

 

914,670

 

 

 

1,138,257

 

Long-term investments

 

 

 

 

 

33,212

 

Property and equipment—net

 

 

702,741

 

 

 

682,056

 

Goodwill

 

 

174,158

 

 

 

173,603

 

Trademarks and other intangible assets

 

 

100,734

 

 

 

100,757

 

Non-current deferred tax assets

 

 

28,815

 

 

 

28,466

 

Other non-current assets

 

 

27,268

 

 

 

36,169

 

Total assets

 

$

1,948,386

 

 

$

2,192,520

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

233,395

 

 

$

226,980

 

Deferred revenue and customer deposits

 

 

168,177

 

 

 

145,918

 

Other current liabilities

 

 

42,349

 

 

 

43,271

 

Total current liabilities

 

 

443,921

 

 

 

416,169

 

Convertible senior notes due 2019—net

 

 

316,153

 

 

 

312,379

 

Convertible senior notes due 2020—net

 

 

240,120

 

 

 

235,965

 

Financing obligations under build-to-suit lease transactions

 

 

220,019

 

 

 

203,015

 

Deferred rent and lease incentives

 

 

61,094

 

 

 

60,439

 

Other non-current obligations

 

 

44,301

 

 

 

44,684

 

Total liabilities

 

 

1,325,608

 

 

 

1,272,651

 

Commitments and contingencies (Note 17)

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

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

   issued or outstanding as of April 29, 2017 and January 28, 2017

 

 

 

 

 

 

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

   40,924,929 shares issued and 33,075,569 shares outstanding as of April 29, 2017;

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

 

 

3

 

 

 

4

 

Additional paid-in capital

 

 

798,467

 

 

 

790,866

 

Accumulated other comprehensive loss

 

 

(2,873

)

 

 

(1,692

)

Retained earnings

 

 

146,844

 

 

 

150,214

 

Treasury stock—at cost, 7,849,360 shares as of April 29, 2017 and 294,888 shares as

   of January 28, 2017

 

 

(319,663

)

 

 

(19,523

)

Total stockholders’ equity

 

 

622,778

 

 

 

919,869

 

Total liabilities and stockholders’ equity

 

$

1,948,386

 

 

$

2,192,520

 

 

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

 

 

 

April 29,

 

 

April 30,

 

 

 

2017

 

 

2016

 

Net revenues

 

$

562,080

 

 

$

455,456

 

Cost of goods sold

 

 

391,824

 

 

 

327,981

 

Gross profit

 

 

170,256

 

 

 

127,475

 

Selling, general and administrative expenses

 

 

163,360

 

 

 

138,950

 

Income (loss) from operations

 

 

6,896

 

 

 

(11,475

)

Interest expense—net

 

 

12,179

 

 

 

10,528

 

Loss before income taxes

 

 

(5,283

)

 

 

(22,003

)

Income tax benefit

 

 

(1,913

)

 

 

(8,533

)

Net loss

 

$

(3,370

)

 

$

(13,470

)

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

 

 

37,609,516

 

 

 

40,588,081

 

Basic net loss per share

 

$

(0.09

)

 

$

(0.33

)

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

 

 

37,609,516

 

 

 

40,588,081

 

Diluted net loss per share

 

$

(0.09

)

 

$

(0.33

)

 

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

 

 

4


RH

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

April 29,

 

 

April 30,

 

 

 

2017

 

 

2016

 

Net loss

 

$

(3,370

)

 

$

(13,470

)

Net gains (losses) from foreign currency translation

 

 

(1,192

)

 

 

2,669

 

Net unrealized holding gains on available-for-sale investments

 

 

11

 

 

 

92

 

Total comprehensive loss

 

$

(4,551

)

 

$

(10,709

)

 

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)

 

 

 

Three Months Ended

 

 

 

April 29,

 

 

April 30,

 

 

 

2017

 

 

2016

 

 

 

 

 

 

 

As Revised

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net loss

 

$

(3,370

)

 

$

(13,470

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

16,020

 

 

 

12,554

 

Net non-cash charges resulting from inventory step-up

 

 

1,380

 

 

 

 

Amortization of debt discount

 

 

7,458

 

 

 

7,057

 

Excess tax shortfall from exercise of stock options

 

 

 

 

 

76

 

Stock-based compensation expense

 

 

5,289

 

 

 

3,998

 

Other non-cash interest expense

 

 

884

 

 

 

1,126

 

Change in assets and liabilities—net of acquisition:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

8

 

 

 

(3,504

)

Merchandise inventories

 

 

66,067

 

 

 

(37,228

)

Prepaid expense and other assets

 

 

8,654

 

 

 

(33,098

)

Accounts payable and accrued expenses

 

 

1,219

 

 

 

(14,604

)

Deferred revenue and customer deposits

 

 

22,232

 

 

 

10,972

 

Other current liabilities

 

 

(1,086

)

 

 

(25,143

)

Deferred rent and lease incentives

 

 

726

 

 

 

894

 

Other non-current obligations

 

 

(426

)

 

 

20

 

Net cash provided by (used in) operating activities

 

 

125,055

 

 

 

(90,350

)

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(13,456

)

 

 

(45,276

)

Construction related deposits

 

 

 

 

 

(3,551

)

Purchase of trademarks and domain names

 

 

 

 

 

(164

)

Proceeds from sale of asset held for sale—net

 

 

4,900

 

 

 

 

Purchase of investments

 

 

(16,109

)

 

 

(44,604

)

Maturities of investments

 

 

46,890

 

 

 

54,368

 

Sales of investments

 

 

145,020

 

 

 

31,896

 

Net cash provided by (used in) investing activities

 

 

167,245

 

 

 

(7,331

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Repurchases of common stock

 

 

(300,140

)

 

 

 

Payments on build-to-suit lease transactions

 

 

(1,289

)

 

 

 

Proceeds from exercise of stock options

 

 

2,567

 

 

 

296

 

Excess tax shortfall from exercise of stock options

 

 

 

 

 

(76

)

Tax withholdings related to issuance of stock-based awards

 

 

(149

)

 

 

(141

)

Payments on capital leases

 

 

(76

)

 

 

(85

)

Net cash used in financing activities

 

 

(299,087

)

 

 

(6

)

Effects of foreign currency exchange rate translation

 

 

(86

)

 

 

888

 

Net decrease in cash and cash equivalents

 

 

(6,873

)

 

 

(96,799

)

Cash and cash equivalents

 

 

 

 

 

 

 

 

Beginning of period

 

 

87,023

 

 

 

331,467

 

End of period

 

$

80,150

 

 

$

234,668

 

Non-cash transactions:

 

 

 

 

 

 

 

 

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

 

$

18,283

 

 

$

7,775

 

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

 

$

14,498

 

 

$

10,721

 

Property and equipment additions from use of construction related deposits

 

$

8,824

 

 

$

1,740

 

 

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.

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 April 29, 2017, the Company operated a total of 85 retail Galleries and 28 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 April 29, 2017, and the results of operations for the three months ended April 29, 2017 and April 30, 2016. The Company’s current fiscal year ends on February 3, 2018 (“fiscal 2017”).

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, 2017 (the “2016 Form 10-K”). Certain prior year amounts have been reclassified for consistency with the current period presentation. Refer to “Revision” below.

The results of operations for the three months ended April 29, 2017 presented herein are not necessarily indicative of the results to be expected for the full fiscal year.

Revision

During the fourth quarter of fiscal 2016, 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 in its condensed consolidated balance sheets without properly applying the limited right of offset against cash and cash equivalents in accordance with ASC 210Balance Sheet. This resulted in an overstatement of cash and cash equivalents and an overstatement of accounts payable and accrued expenses on its condensed consolidated balance sheets, as well as a misstatement of the cash provided by operating activities on the condensed consolidated statements of cash flows. There was no impact on the condensed consolidated statements of income or stockholders’ equity 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 were not material to any prior annual or interim periods. Accordingly, in accordance with ASC 250 (SAB No. 108Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements), the amounts have been revised in the condensed consolidated statements of cash flows.

7


The following are selected line items from the Company’s unaudited condensed consolidated statements of cash flows illustrating the effect of the corrections (in thousands):

 

 

 

Three Months Ended

 

 

 

April 30,

 

 

 

2016

 

 

 

As Reported

 

 

Adjustment

 

 

As Revised

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

Change in accounts payable and accrued expenses

 

$

(30,546

)

 

$

15,942

 

 

$

(14,604

)

Net cash used in operating activities

 

$

(106,292

)

 

$

15,942

 

 

$

(90,350

)

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

Beginning of period

 

$

349,897

 

 

$

(18,430

)

 

$

331,467

 

End of period

 

$

237,156

 

 

$

(2,488

)

 

$

234,668

 

 

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. 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 shortfall of $0.1 million in the provision for income taxes as a discrete item during the three months ended April 29, 2017. This amount 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.

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 2014-09Revenue from Contracts with Customers (Topic 606). This guidance outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Under the new guidance, transfer of control is no longer the same as transfer of risks and rewards as indicated in the prior guidance. The 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, and currently believes one of the most significant impacts relates to accounting for gift card breakage. Under the new standard the Company expects to recognize breakage, which is currently recorded as a reduction to selling, general and administrative expenses, as revenue and 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 standard is required to be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially adopting it recognized at the date of initial application. The Company has not yet selected the transition method.

Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update 2016-02Leases, which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effects

8


that the adoption of ASU 2016-02 will have on its consolidated financial statements and anticipates the new guidance will significantly impact its consolidated financial statements given the Company has a significant number of leases.

Financial Instruments

In January 2016, the FASB issued Accounting Standards Update 2016-01Financial InstrumentsOverall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amends various aspects of the recognition, measurement, presentation and disclosure for financial instruments. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted only for certain provisions. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

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 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.

During the three months ended April 30, 2016, the Company incurred $2.1 million of acquisition-related costs associated with the transaction. 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.

9


During the three months ended April 29, 2017, the Company recorded purchase price allocation adjustments of $0.6 million due to changes in certain working capital and other items. 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 recorded during the three months ended April 29, 2017 (in thousands):

 

 

 

 

 

 

 

Purchase Price

 

 

 

 

 

 

 

January 28,

 

 

Allocation

 

 

April 29,

 

 

 

2017

 

 

Adjustments

 

 

2017

 

Tangible assets acquired and liabilities assumed

 

$

18,615

 

 

$

(601

)

 

$

18,014

 

Trademarks

 

 

52,100

 

 

 

 

 

 

52,100

 

Goodwill

 

 

49,229

 

 

 

601

 

 

 

49,830

 

Total

 

$

119,944

 

 

$

 

 

$

119,944

 

 

Under purchase accounting rules, the Company valued the acquired finished goods inventory to fair value, which is defined as the estimated selling price less the sum of (a) costs of disposal and (b) a reasonable profit allowance for the Company’s selling effort. This valuation resulted in an increase in inventory carrying value of approximately $10.5 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. Net revenues attributable to Waterworks represented $28.6 million of the Company’s net revenues in the three months ended April 29, 2017. 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

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.

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 from property and equipment to asset held for sale on the condensed consolidated balance sheets as of April 29, 2017. The Company performed an assessment and determined that based on management’s best estimate, the selling price of the building and land will be greater than the current net book value of the asset, which was $8.2 million as of April 29, 2017. As a result, no impairment charge was recorded during the three months ended April 29, 2017 due to this reclassification. In May 2017, the Company completed the sale of the building and land for approximately $10.2 million.

 

NOTE 5—PREPAID EXPENSE AND OTHER ASSETS

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

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Capitalized catalog costs

 

$

56,044

 

 

$

61,258

 

Federal tax receivable

 

 

14,714

 

 

 

13,124

 

Vendor deposits

 

 

11,660

 

 

 

13,276

 

Prepaid expense and other current assets

 

 

25,823

 

 

 

29,504

 

Total prepaid expense and other current assets

 

$

108,241

 

 

$

117,162

 

 

10


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

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Construction related deposits

 

$

19,220

 

 

$

28,044

 

Other deposits

 

 

4,927

 

 

 

4,706

 

Deferred financing fees

 

 

1,353

 

 

 

1,530

 

Other non-current assets

 

 

1,768

 

 

 

1,889

 

Total other non-current assets

 

$

27,268

 

 

$

36,169

 

 

 

NOTE 6—GOODWILL AND INTANGIBLE ASSETS

The following sets forth the goodwill and intangible assets as of April 29, 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

 

 

$

(1,815

)

 

$

 

 

$

110

 

Fair market write-down (2)

 

 

(1,467

)

 

 

1,365

 

 

 

 

 

 

(102

)

Total intangible assets subject to amortization

 

$

458

 

 

$

(450

)

 

$

 

 

$

8

 

Intangible assets not subject to amortization

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill (3)(4)

 

$

174,291

 

 

$

 

 

$

(133

)

 

$

174,158

 

Trademarks and domain names (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)

Waterworks goodwill increased $0.6 million during the three months ended April 29, 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.

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, in fiscal 2016 related to its acquisition of Waterworks. Refer to Note 3—Business Combination.

(4)

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

 

 

11


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

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

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Accounts payable

 

$

124,646

 

 

$

134,720

 

Accrued compensation

 

 

32,285

 

 

 

26,886

 

Accrued freight and duty

 

 

28,770

 

 

 

27,955

 

Accrued sales taxes

 

 

16,711

 

 

 

14,908

 

Accrued occupancy

 

 

8,843

 

 

 

8,137

 

Accrued catalog costs

 

 

7,183

 

 

 

3,874

 

Accrued professional fees

 

 

4,394

 

 

 

2,082

 

Other accrued expenses

 

 

10,563

 

 

 

8,418

 

Total accounts payable and accrued expenses

 

$

233,395

 

 

$

226,980

 

 

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

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Unredeemed gift card and merchandise credit liability

 

$

24,991

 

 

$

24,524

 

Allowance for sales returns

 

 

10,698

 

 

 

10,077

 

Product recall reserves

 

 

2,625

 

 

 

4,324

 

Other current liabilities

 

 

4,035

 

 

 

4,346

 

Total other current liabilities

 

$

42,349

 

 

$

43,271

 

 

NOTE 8—OTHER NON-CURRENT OBLIGATIONS

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

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Notes payable for share repurchases

 

$

19,390

 

 

$

19,390

 

Capital lease obligations—non-current

 

 

7,192

 

 

 

7,242

 

Deferred contract incentive (1)

 

 

7,144

 

 

 

7,739

 

Unrecognized tax benefits

 

 

2,538

 

 

 

2,508

 

Rollover units and profit interests (2)

 

 

1,891

 

 

 

1,784

 

Other non-current obligations

 

 

6,146

 

 

 

6,021

 

Total other non-current obligations

 

$

44,301

 

 

$

44,684

 

 

(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 15Stock-Based Compensation.

 

 

NOTE 9—CONVERTIBLE SENIOR NOTES

0.00% Convertible Senior Notes due 2020

In June 2015, the Company issued in a private offering $250 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, the Company issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of its June 2015 offering (collectively, the “2020 Notes”). The 2020 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2020 Notes will mature on July 15, 2020, unless earlier purchased by the Company or converted. The 2020 Notes will not bear interest, except that the 2020 Notes will be subject to “special interest” in certain limited circumstances in the event of the failure of the Company to perform 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

12


2020 Notes are guaranteed by the Company’s primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The guarantee is the unsecured obligation of the Guarantor and is subordinated to the Guarantor’s obligations from time to time with respect to its credit agreement and ranks equal in right of payment with respect to Guarantor’s other obligations.

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

Prior to March 15, 2020, the 2020 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2015, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sale price of the Company’s common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2020 Notes for such trading day was less than 98% of the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of April 29, 2017, none of these conditions have occurred and, as a result, the 2020 Notes are not convertible as of April 29, 2017. On and after March 15, 2020, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2020 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2020 Notes will be settled, at the Company’s election, in cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock. If the Company has not delivered a notice of its election of settlement method prior to the final conversion period it will be deemed to have elected combination settlement with a dollar amount per note to be received upon conversion of $1,000.

The Company may not redeem the 2020 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require the Company to purchase all or a portion of their 2020 Notes for cash at a price equal to 100% of the principal amount of the 2020 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2020 Notes, the Company separated the 2020 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the liability component of the 2020 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 6.47% over the expected life of the 2020 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the debt issuance costs related to the issuance of the 2020 Notes, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2020 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.

Debt issuance costs related to the 2020 Notes were 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 the three months ended April 29, 2017 and April 30, 2016, the Company recorded $0.3 million and $0.2 million, related to the amortization of debt issuance costs, respectively.

13


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

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

300,000

 

 

$

300,000

 

Less: Debt discount

 

 

(56,223

)

 

 

(60,124

)

Net carrying amount

 

$

243,777

 

 

$

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 $3.9 million and $3.7 million for the amortization of the debt discount related to the 2020 Notes during the three months ended April 29, 2017 and April 30, 2016, respectively.

2020 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment option in July 2015, the Company entered into convertible note hedge transactions whereby the Company has the option to purchase a total of approximately 5.1 million shares of its common stock at a price of approximately $118.13 per share. The total cost of the convertible note hedge transactions was $68.3 million. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 5.1 million shares of the Company’s common stock at a price of $189.00 per share. The Company received $30.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2020 Notes until the Company’s common stock is above approximately $189.00 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

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

0.00% Convertible Senior Notes due 2019

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

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

Prior to March 15, 2019, the 2019 Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2014, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding fiscal quarter, the last reported sale price of the Company’s common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading 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

14


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 April 29, 2017, none of these conditions have occurred and, as a result, the 2019 Notes are not convertible as of April 29, 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 convert all or a portion of their 2019 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2019 Notes will be settled, at the Company’s election, in cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock. If the Company has not delivered a notice of its election of settlement method prior to the final conversion period it will be deemed to have elected combination settlement with a dollar amount of $1,000.

The Company may not redeem the 2019 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require the Company to purchase all or a portion of their 2019 Notes for cash at a price equal to 100% of the principal amount of the 2019 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2019 Notes, the Company separated the 2019 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2019 Notes and the fair value of the liability component of the 2019 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 4.51% over the expected life of the 2019 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the debt issuance costs related to the issuance of the 2019 Notes, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2019 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.

Debt issuance costs related to the 2019 Notes were 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 are recorded as a contra-liability and are presented net against the convertible senior notes due 2019 balance on the condensed consolidated balance sheets. During both the three months ended April 29, 2017 and April 30, 2016, the Company recorded $0.2 million related to the amortization of debt issuance costs.

The carrying values of the 2019 Notes, excluding the discounts and commissions payable to the initial purchasers and third party offering costs, are as follows (in thousands):

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

Liability component

 

 

 

 

 

 

 

 

Principal

 

$

350,000

 

 

$

350,000

 

Less: Debt discount

 

 

(31,900

)

 

 

(35,457

)

Net carrying amount

 

$

318,100

 

 

$

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 million and $3.4 million for the amortization of the debt discount related to the 2019 Notes during the three months ended April 29, 2017 and April 30, 2016, 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 has the option to purchase a total of approximately 3.0 million shares of its common stock at a price of approximately $116.09 per share. The total cost of the convertible note hedge transactions was $73.3 million. In addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 3.0 million shares of the Company’s common stock at a price of $171.98 per share. The Company received $40.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual dilution from the

15


conversion of the 2019 Notes and to effectively increase the overall conversion price from $116.09 per share to $171.98 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as a reduction to additional paid-in capital on the condensed consolidated balance sheets.

The Company recorded a deferred tax liability of $27.5 million in connection with the debt discount associated with the 2019 Notes and recorded a deferred tax asset of $28.6 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax assets are included in non-current deferred tax assets on the condensed consolidated balance sheets.

 

 

NOTE 10—LINE OF CREDIT

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 November 24, 2014, the Company amended its existing revolving line of credit by entering into an amended and restated credit agreement with the lenders party thereto and Bank of America, N.A. as administrative agent and collateral agent. The amended and restated credit agreement increased the existing revolving line of credit by $182.5 million, while eliminating the $15.0 million term loan facility under the existing revolving line of credit. Under the amended and restated credit agreement, which has a maturity date of November 24, 2019, the Company has the option to increase the amount of the revolving line of credit by up to an additional $200.0 million, subject to satisfaction of certain customary conditions at the time of such increase.

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

As of April 29, 2017, the Company had no outstanding borrowings and $478.0 million of availability under the revolving line of credit, net of $14.4 million in outstanding letters of credit. 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 would be approximately $430 million.

Borrowings under the revolving line of credit are subject to interest, at the borrowers’ option, at either the bank’s reference rate or LIBOR (or the Bank of America “BA” Rate or the Canadian Prime Rate, as such terms are defined in the amended and restated 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 amended and restated credit agreement contains various restrictive covenants, including, among others, limitations on the ability to incur liens, make loans or other investments, incur additional debt, issue additional equity, merge or consolidate with or into another person, sell assets, pay dividends or make other distributions, or enter into transactions with affiliates, along with other restrictions and limitations typical to credit agreements of this type and size. As of April 29, 2017, the Company was in compliance with all covenants of the amended and restated credit agreement. As of April 29, 2017, the Company would not be in compliance with the consolidated FCCR in the event that availability under the amended and restated credit agreement was less than 10% of the domestic borrowing base.

 

NOTE 11—FAIR VALUE OF FINANCIAL INSTRUMENTS

Financial Assets and Liabilities

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

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

16


pricing observability and a lesser degree of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.

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

 

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

 

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

 

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

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

Fair Value Measurements

All of the Company’s investments are classified as available-for-sale and are carried at fair value. The Company did not hold any short-term or long-term investments as of April 29, 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 months ended April 29, 2017 or April 30, 2016. There were no transfers into or out of level 1 and level 2 during the three months ended April 29, 2017 or April 30, 2016.

17


Fair Value of Financial Instruments

Amounts reported as cash and equivalents, receivables, and accounts payable and accrued expenses approximate fair value. The estimated fair value and carrying value of the 2019 Notes and 2020 Notes (carrying value excludes the equity component of the 2019 Notes and 2020 Notes classified in stockholders’ equity) were as follows (in thousands):

 

 

 

April 29,

 

 

January 28,

 

 

 

2017

 

 

2017

 

 

 

Fair

Value

 

 

Carrying

Value

 

 

Fair

Value

 

 

Carrying

Value

 

Convertible senior notes due 2019

 

$

302,145

 

 

$

318,100

 

 

$

295,381

 

 

$

314,543

 

Convertible senior notes due 2020

 

$

239,140

 

 

$

243,777

 

 

$

232,463

 

 

$

239,876

 

 

The fair value of each of the 2019 Notes and 2020 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 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 2).

 

 

NOTE 12—INCOME TAXES

The Company recorded an income tax benefit of $1.9 million and $8.5 million in the three months ended April 29, 2017 and April 30, 2016, respectively. The effective tax rate was 36.2% and 38.8% for the three months ended April 29, 2017 and April 30, 2016, respectively. The decrease in the effective tax rate is primarily due to discrete tax expense of $0.1 million in the three months ended April 29, 2017 related to net excess tax shortfalls from stock-based payments resulting from the Company’s adoption of ASU 2016-09 in the first quarter of fiscal 2017.

As of both April 29, 2017 and January 28, 2017, $1.4 million of the exposures related to unrecognized tax benefits would affect the effective tax rate if realized and are included in other non-current obligations on the condensed consolidated balance sheets. As of April 29, 2017, the Company does not have any exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.

 

 

NOTE 13—NET LOSS PER SHARE

The weighted-average shares used for net loss per share is presented in the table below. As the Company was in a net loss position for both the three months ended April 29, 2017 and April 30, 2016, the weighted-average shares outstanding for basic and diluted are the same.

 

 

 

Three Months Ended

 

 

 

April 29,

 

 

April 30,

 

 

 

2017

 

 

2016

 

Weighted-average shares—basic

 

 

37,609,516

 

 

 

40,588,081

 

Effect of dilutive stock-based awards