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Document and Entity Information - shares	3 Months Ended
Document and Entity Information - shares	May 02, 2020	May 29, 2020
Document And Entity Information [Abstract]
Document Type	10-Q
Document Quarterly Report	true
Document Transition Report	false
Document Period End Date	May 02, 2020
Entity File Number	001-35720
Entity Registrant Name	RH
Entity Tax Identification Number	45-3052669
Entity Incorporation, State or Country Code	DE
Entity Address, Address Line One	15 Koch Road
Entity Address, City or Town	Corte Madera
Entity Address, State or Province	CA
Entity Address, Postal Zip Code	94925
City Area Code	415
Local Phone Number	924-1005
Title of 12(b) Security	Common Stock
Trading Symbol	RH
Security Exchange Name	NYSE
Entity Current Reporting Status	Yes
Entity Interactive Data Current	Yes
Entity Filer Category	Large Accelerated Filer
Entity Small Business	false
Entity Emerging Growth Company	false
Entity Shell Company	false
Entity Common Stock, Shares Outstanding		19,290,966
Entity Central Index Key	0001528849
Current Fiscal Year End Date	--02-01
Document Fiscal Year Focus	2020
Document Fiscal Period Focus	Q1
Amendment Flag	false

Condensed Consolidated Balance Sheets - USD ($) $ in Thousands	May 02, 2020	Feb. 01, 2020
Current assets:
Cash and cash equivalents	$ 17,208	$ 47,658
Accounts receivable-net	49,099	48,979
Merchandise inventories	494,260	438,696
Prepaid expense and other current assets	65,154	61,619
Total current assets	625,721	596,952
Property and equipment-net	953,738	967,599
Operating lease right-of-use assets	392,934	410,904
Goodwill	124,290	124,367
Tradenames, trademarks and domain names	65,563	86,022
Deferred tax assets	38,875	45,005
Other non-current assets	228,772	214,845
Total assets	2,429,893	2,445,694
Current liabilities:
Accounts payable and accrued expenses	284,980	330,309
Deferred revenue and customer deposits	189,048	162,433
Operating lease liabilities	61,997	58,924
Other current liabilities	137,336	140,714
Total current liabilities	968,935	982,912
Asset based credit facility	58,062	53,062
Non-current operating lease liabilities	395,641	409,930
Non-current finance lease liabilities	439,470	442,988
Other non-current obligations	28,017	28,520
Total liabilities	2,410,761	2,427,043
Stockholders' equity:
Preferred stock-$0.0001 par value per share, 10,000,000 shares authorized, no shares issued or outstanding as of May 2, 2020 and February 1, 2020
Common stock-$0.0001 par value per share, 180,000,000 shares authorized, 19,264,727 shares issued and 19,264,127 shares outstanding as of May 2, 2020; 19,236,681 shares issued and outstanding as of February 1, 2020	2	2
Additional paid-in capital	436,799	430,662
Accumulated other comprehensive loss	(5,132)	(2,760)
Accumulated deficit	(412,465)	(409,253)
Treasury stock-at cost, 600 shares as of May 2, 2020 and no shares as of February 1, 2020	(72)
Total stockholders' (deficit)	19,132	18,651
Total liabilities and stockholders' (deficit)	2,429,893	2,445,694
Asset based credit facility
Current liabilities:
Asset based credit facility	10,000
Equipment promissory notes
Current liabilities:
Term loan-net	28,475	31,053
Convertible senior notes due 2020
Current liabilities:
Convertible senior notes due-net	295,574	290,532
Operating lease liabilities	61,997	58,924
Non-current operating lease liabilities	395,641	409,930
Convertible senior notes due 2023
Current liabilities:
Convertible senior notes due-net	271,211	266,658
Non-current finance lease liabilities	439,470	442,988
Convertible senior notes due 2024
Current liabilities:
Convertible senior notes due-net	269,012	264,982
Other non-current obligations	$ 28,017	$ 28,520

Condensed Consolidated Balance Sheets (Parenthetical) - $ / shares	May 02, 2020	Feb. 01, 2020
Condensed Consolidated Balance Sheets
Preferred stock, par value	$ 0.0001	$ 0.0001
Preferred stock, shares authorized	10,000,000	10,000,000
Preferred stock, shares issued	0	0
Preferred stock, shares outstanding	0	0
Common stock, par value	$ 0.0001	$ 0.0001
Common stock, shares authorized	180,000,000	180,000,000
Common stock, shares issued	19,264,727	19,236,681
Common stock, shares outstanding	19,264,127	19,236,681
Treasury stock, shares	600	0

Condensed Consolidated Statements of Operations - USD ($) $ in Thousands	3 Months Ended
	May 02, 2020	May 04, 2019
Condensed Consolidated Statements of Operations
Net revenues	$ 482,895	$ 598,421
Cost of goods sold	283,241	365,607
Gross profit	199,654	232,814
Selling, general and administrative expenses	164,201	164,181
Income from operations	35,453	68,633
Other expenses
Interest expense-net	19,629	21,118
Tradename impairment	20,459
Goodwill And Tradename Impairment	20,459
Total other expenses	40,088	21,118
Income (loss) before income taxes	(4,635)	47,515
Income tax expense (benefit)	(1,423)	11,793
Net income (loss)	$ (3,212)	$ 35,722
Weighted-average shares used in computing basic net income (loss) per share	19,242,641	19,976,858
Basic net income (loss) per share	$ (0.17)	$ 1.79
Weighted-average shares used in computing diluted net income (loss) per share	19,242,641	24,933,987
Diluted net income (loss) per share	$ (0.17)	$ 1.43

Condensed Consolidated Statements of Comprehensive Income (Loss) - USD ($) $ in Thousands	3 Months Ended
	May 02, 2020	May 04, 2019
Condensed Consolidated Statements of Comprehensive Income (Loss)
Net income (loss)	$ (3,212)	$ 35,722
Net losses from foreign currency translation	(2,372)	(937)
Total comprehensive income (loss)	$ (5,584)	$ 34,785

- Definition

The portion of profit or loss for the period, net of income taxes, which is attributable to the parent.

+ References + Details

Condensed Consolidated Statements of Stockholders' Equity (Deficit) - USD ($) $ in Thousands	Common Stock	Additional Paid-In Capital	Accumulated Other Comprehensive Income (Loss)	Retained Earnings (Accumulated Deficit)	Treasury Stock	Total
Balances at Feb. 02, 2019	$ 2	$ 356,422	$ (2,333)	$ (392,538)	$ (243)	$ (38,690)
Balances, shares at Feb. 02, 2019	20,477,813				2,800
Stock-based compensation		5,588				5,588
Vested and delivered restricted stock units		(250)				(250)
Vested and delivered restricted stock units, Shares	21,241
Exercise of stock options		1,226				1,226
Exercise of stock options, Shares	26,158
Repurchases of common stock					$ (250,032)	(250,032)
Repurchases of common stock, Shares	(2,167,396)				2,167,396
Net income (loss)				35,722		35,722
Net losses from foreign currency translation			(937)			(937)
Balances at May. 04, 2019	$ 2	362,986	(3,270)	(356,816)	$ (250,275)	(247,373)
Balances, shares at May. 04, 2019	18,357,816				2,170,196
Balances at Feb. 01, 2020	$ 2	430,662	(2,760)	(409,253)		$ 18,651
Balances, shares at Feb. 01, 2020	19,236,681
Balances, shares at Feb. 01, 2020						19,236,681
Stock-based compensation		5,721				$ 5,721
Vested and delivered restricted stock units		(381)				(381)
Vested and delivered restricted stock units, Shares	10,286
Exercise of stock options		797				797
Exercise of stock options, Shares	17,760
Repurchases of common stock					$ (72)	(72)
Repurchases of common stock, Shares	(600)				600
Net income (loss)				(3,212)		(3,212)
Net losses from foreign currency translation			(2,372)			(2,372)
Balances at May. 02, 2020	$ 2	$ 436,799	$ (5,132)	$ (412,465)	$ (72)	$ 19,132
Balances, shares at May. 02, 2020	19,264,127				600
Balances, shares at May. 02, 2020						19,264,127

Condensed Consolidated Statements of Cash Flows - USD ($) $ in Thousands	3 Months Ended
	May 02, 2020	May 04, 2019
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$ (3,212)	$ 35,722
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	24,870	27,189
Non-cash operating lease cost	15,907	16,279
Tradename impairment	20,459
Asset impairments	4,783
Goodwill And Tradename Impairment	20,459
Amortization of debt discount	12,916	12,377
Stock-based compensation expense	5,828	5,695
Non-cash finance lease interest expense	5,781	5,514
Product recalls		(1,786)
Other non-cash interest expense	1,145	1,089
Change in assets and liabilities:
Accounts receivable	1,554	(7,218)
Merchandise inventories	(55,837)	1,653
Prepaid expense and other assets	(8,324)	(17,846)
Landlord assets under construction-net of tenant allowances	(7,600)	(4,542)
Accounts payable and accrued expenses	(52,989)	(38,595)
Deferred revenue and customer deposits	26,679	21,641
Other current liabilities	4,696	15,231
Current and non-current operating lease liabilities	(7,065)	(27,131)
Other non-current obligations	(6,459)	(6,448)
Net cash provided by (used in) operating activities	(16,868)	38,824
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures	(16,632)	(7,916)
Net cash used in investing activities	(16,632)	(7,916)
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under promissory and equipment security notes		60,000
Repayments under promissory and equipment security notes	(5,166)	(983)
Debt issuance costs		(4,499)
Principal payments under finance leases	(2,068)	(2,129)
Repurchases of common stock-including commissions		(250,032)
Proceeds from exercise of stock options	797	1,226
Tax withholdings related to issuance of stock-based awards	(381)	(250)
Net cash provided by financing activities	3,182	65,833
Effects of foreign currency exchange rate translation	(132)	6
Net increase (decrease) in cash and cash equivalents and restricted cash	(30,450)	96,747
Cash, cash equivalents and restricted cash
Beginning of period-cash and cash equivalents	47,658	5,803
End of period-cash and cash equivalents	17,208	37,550
End of period-restricted cash		65,000
End of period-cash, cash equivalents and restricted cash	17,208	102,550
Non-cash transactions:
Property and equipment additions in accounts payable and accrued expenses at period-end	2,935	8,529
Landlord asset additions in accounts payable and accrued expenses at period-end	23,489	19,481
Landlord asset additions from unpaid construction related deposits	195	2,056
Issuance of non-current notes payable related to share repurchases from former employees	72
Asset based credit facility
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings	71,100	94,000
Repayments	$ (61,100)	(151,500)
Term Loan
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings		$ 320,000

The Company

3 Months Ended

May 02, 2020

The Company

The Company

NOTE 1—THE COMPANY

Nature of Business

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

As of May 2, 2020, we operated a total of 69 RH Galleries and 38 RH outlet stores in 31 states, the District of Columbia and Canada, as well as 15 Waterworks showrooms throughout 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 our financial position as of May 2, 2020, and the results of operations for the three months ended May 2, 2020 and May 4, 2019. Our current fiscal year, which consists of 52 weeks, ends on January 30, 2021 (“fiscal 2020”).

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.

The preparation of our condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and such differences could be material to the condensed consolidated financial statements.

We have assessed various accounting estimates and other matters, including those that require consideration of forecasted financial information, in context of the unknown future impacts of COVID-19 using information that is reasonably available to us at this time. The accounting estimates and other matters we have assessed include, but were not limited to, sales return reserve, inventory reserve, allowance for doubtful accounts, goodwill, intangible and other long-lived assets. Our current assessment of these estimates are included in our condensed consolidated financial statements as of and for the three months ended May 2, 2020. As additional information becomes available to us, our future assessment of these estimates, including our expectations at the time regarding the duration, scope and severity of the pandemic, as well as other factors, could materially and adversely impact our condensed consolidated financial statements in future reporting periods.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020 (the “2019 Form 10-K”).

The results of operations for the three months ended May 2, 2020 presented herein are not necessarily indicative of the results to be expected for the full fiscal year. Our business, like the businesses of retailers generally, is subject to uncertainty surrounding the financial impact of the novel coronavirus disease as discussed in Recent Developments—COVID-19 below.

Recent Developments—COVID-19

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus disease (“COVID-19”) as a pandemic. The initial wave of the COVID-19 outbreak caused disruption to our business operations, as we temporarily closed all of our retail locations on March 17, 2020 in response to the public health crisis. While our retail locations were substantially closed at the end of the first fiscal quarter on May 2, 2020, since that date we have been able to reopen a large number of our stores based on local market circumstances including the gradual lifting of restrictions on business operations, including shelter-in-place rules. During the time that our Gallery locations were closed, we continued to serve our customers in those market areas virtually through our Gallery representatives and designers, as well as our online capabilities.

As of June 3, 2020, we had reopened 74% of our Gallery locations, 68% of our Outlets and 50% of our Restaurants, and are moving toward the expected complete reopening of our retail locations in the U.S. and Canada based on local conditions and requirements. While we have continued to serve our customers and operate our business through the initial phase of the COVID-19 health crisis and retail closures in the U.S. and Canada, there can be no assurance that future events including additional waves of COVID-19 outbreaks, evolving federal, state and local restrictions and safety regulations in response to COVID-19 risks, changes in consumer behavior and health concerns, or other similar issues will not adversely affect our business, results of operations or financial condition in the future, or that the pace of economic activity in the wake of the first wave of COVID-19 outbreaks will not have a negative impact on our business, results of operations or financial condition. The extent and duration of the crisis remains uncertain, and the results of the fiscal year ending January 30, 2021 could be further impacted in future periods, through reduced revenues, increased receivable and merchandise inventory reserves, asset impairments, valuation allowances and potential declines in liquidity.

We have historically relied on cash flows from operations, net cash proceeds from the issuance of convertible senior notes, as well as borrowings under credit facilities as primary sources of liquidity. When our retail locations were closed as a result of the COVID-19 outbreak, we took immediate action to assure that our liquidity needs would not be materially affected, including our ability to fund our business operations, as well as to make debt repayments when due, such as the $300 million convertible senior notes maturing in July 2020 (the “2020 Notes”) and payments under equipment promissory notes. In response to the initial impact of COVID-19, we implemented a number of measures to minimize cash outlays, including managing workforce costs, delaying planned capital expenditures, deferring new business introductions, adjusting the timing and circulation of Source Books and minimizing discretionary expenses. Given the pace at which business conditions are evolving in response to the COVID-19 health crisis, we may further adjust our investments in various business initiatives including our capital expenditures over the course of fiscal 2020. We will continue to closely manage our expenses and investments while considering both the overall economic environment as well as the needs of our business operations. In addition, our near term decisions regarding the sources and uses of capital in our business will continue to reflect and adapt to changes in market conditions and our business related to COVID-19.

We have utilized, and expect to continue to utilize, our asset based credit facility, and we may pursue other sources of capital that may include other forms of external financing, in order to increase our cash position and preserve financial flexibility in response to the uncertainty in the United States and global markets resulting from COVID-19. Refer to Note 8—Convertible Senior Notes and Note 9—Credit Facilities for further information on the terms and conditions of our outstanding debt agreements. We had no outstanding borrowings under our asset based credit facility as of May 29, 2020 and the amount under the revolving line of credit borrowing base that could be available pursuant to the asset based credit facility was $170.4 million, net of reserves for the repayment of the 2020 Notes and outstanding letters of credit. We believe our operating cash flows, in conjunction with available financing arrangements, will be sufficient to repay our debt obligations as they become due, meet working capital requirements and fulfill other capital needs for more than the next 12 months.

Recently Issued Accounting Standards

3 Months Ended

May 02, 2020

Recently Issued Accounting Standards

Recently Issued Accounting Standards

NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS

Cloud Computing

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-15—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which amends Accounting Standards Update 2015-05—Customers Accounting for Fees in a Cloud Computing Agreement. The amendments in this ASU more closely align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license).

We adopted the ASU as of February 2, 2020 using a prospective method. We capitalize implementation costs related to hosted arrangements, which typically include three-year service terms with additional renewal periods generally ranging from one to three years. The related assets are recorded within other non-current assets on our condensed consolidated balance sheets, net of accumulated amortization for assets placed in service. The amortization of assets placed in service is recorded in either cost of goods sold or selling, general and administrative expenses, consistent with the costs of the hosting arrangement, on the condensed consolidated statements of operations on a straight-line basis over the term of the hosting arrangement, which includes reasonably certain renewal periods. The adoption of the ASU did not have a material effect on our condensed consolidated financial statements. Refer to Note 3—Prepaid Expense and Other Assets.

Current Expected Credit Losses

In June 2016, the FASB issued Accounting Standards Update 2016-13—Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments and also issued subsequent amendments to the initial guidance through ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, ASU 2020-02 and ASU 2020-03 (collectively, the “ASUs”). The ASUs amend the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology to result in more timely recognition of losses. The guidance in the ASUs applies to financial assets measured at amortized cost basis, such as receivables that result from revenue transactions.

Accounts receivable consist primarily of receivables from our credit card processors for sales transactions, receivables related to our contract business and other miscellaneous receivables. Accounts receivable is presented net of allowance for doubtful accounts as a result of the assessment of the collectability of customer accounts, which is recorded by considering factors such as historical experience, credit quality, the age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts was $3.2 million and $2.2 million as of May 2, 2020 and February 1, 2020, respectively.

We adopted the ASUs as of February 2, 2020 using a modified retrospective transition method, which requires a cumulative-effect adjustment, if any, to the opening balance of retained earnings. We did not recognize a cumulative-effect adjustment upon adoption as the adoption of the ASUs did not have a material effect on our condensed consolidated financial statements.

Income Taxes

In December 2019, the FASB issued Accounting Standards Update 2019-12—Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The ASU impacts various topic areas within ASC 740, including accounting for taxes under hybrid tax regimes, accounting for increases in goodwill, allocation of tax amounts to separate company financial statements within a group that files a consolidated tax return, intra period tax allocation, interim period accounting, and accounting for ownership changes in investments, among other minor codification improvements. The guidance in this ASU becomes effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We will adopt this standard in the first fiscal quarter of 2021 and are currently evaluating the effects that the adoption of this ASU will have on our consolidated financial statements.

Prepaid Expense and Other Assets

3 Months Ended

May 02, 2020

Prepaid Expense and Other Assets

Prepaid Expense and Other Assets

NOTE 3—PREPAID EXPENSE AND OTHER ASSETS

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


	May 2,		February 1,
	2020		2020
Prepaid expense and other current assets	$	34,118	$	30,875
Capitalized catalog costs		14,616		13,740
Vendor deposits		11,187		11,258
Right of return asset for merchandise		5,233		5,746
Total prepaid expense and other current assets	$	65,154	$	61,619

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


	May 2,		February 1,
	2020		2020
Landlord assets under construction	$	148,487	$	138,315
Deposits on asset under construction		60,000		60,000
Promissory note receivable, including interest		5,417		5,354
Other deposits		5,258		5,157
Deferred financing fees		2,332		2,602
Other non-current assets		7,278		3,417
Total other non-current assets	$	228,772	$	214,845

Goodwill, Tradenames, Trademarks and Domain Names

3 Months Ended

May 02, 2020

Goodwill, Tradenames, Trademarks and Domain Names

Goodwill, Tradenames, Trademarks and Domain Names

NOTE 4—GOODWILL, TRADENAMES, TRADEMARKS AND DOMAIN NAMES

The following sets forth the goodwill, tradenames, trademarks and domain names activity for the RH Segment and Waterworks (See Note 16—Segment Reporting), for the three months ended May 2, 2020 (in thousands):


					Foreign
	February 1,				Currency		May 2,
	2020		Impairment ⁽¹⁾		Translation		2020
RH Segment
Goodwill	$	124,367	$	—	$	(77)	$	124,290
Tradenames, trademarks and domain names		48,563		—		—		48,563

Waterworks ⁽¹⁾
Tradename ⁽²⁾		37,459		(20,459)		—		17,000

(1)	Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $17.4 million and $33.7 million of impairment recorded in fiscal 2018 and fiscal 2017, respectively.

(2)	Presented net of an impairment charge of $35.1 million, with $20.5 million recorded in the three months ended May 2, 2020 and $14.6 million recorded in fiscal 2018. Refer to “Waterworks Tradename Impairment” below for further discussion regarding the fiscal 2020 impairment.

Waterworks Tradename Impairment

During the first fiscal quarter of 2020, as a result of the COVID-19 health crisis and related Showroom closures and slowdown in construction activity, management updated the long-term financial projections for the Waterworks reporting unit which resulted in a significant decrease in forecasted revenues and profitability. We performed an interim impairment test on the Waterworks tradename and the estimated future cash flows of the Waterworks reporting unit indicated the fair value of the tradename asset was below its carrying amount. We determined fair value utilizing a discounted cash flow methodology under the relief-from-royalty method. Significant assumptions under this method include forecasted net revenues and the estimated royalty rate, expressed as a percentage of revenues, in addition to the

discount rate based on the weighted-average cost of capital. Based on the impairment test performed, we concluded that the Waterworks reporting unit tradename was impaired as of May 2, 2020.

As a result, we recognized a $20.5 million non-cash impairment charge for the Waterworks reporting unit tradename during the three months ended May 2, 2020, and the carrying value of the Waterworks indefinite-lived tradename asset after the impairment charge was $17.0 million.

Accounts Payable, Accrued Expenses and Other Current Liabilities

3 Months Ended

May 02, 2020

Accounts Payable, Accrued Expenses and Other Current Liabilities

Accounts Payable, Accrued Expenses and Other Current Liabilities

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

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


	May 2,		February 1,
	2020		2020
Accounts payable	$	151,890	$	180,714
Accrued compensation		61,950		64,659
Accrued freight and duty		18,260		25,170
Accrued sales taxes		16,792		19,618
Accrued occupancy		9,266		12,067
Accrued catalog costs		6,250		8,267
Accrued professional fees		5,187		4,381
Other accrued expenses		15,385		15,433
Total accounts payable and accrued expenses	$	284,980	$	330,309

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


	May 2,		February 1,
	2020		2020
Promissory notes on asset under construction	$	53,000	$	53,000
Unredeemed gift card and merchandise credit liability		21,877		16,625
Current portion of equipment promissory notes		19,587		22,009
Allowance for sales returns		17,962		19,206
Finance lease liabilities		11,752		9,188
Federal and state taxes payable		6,048		13,591
Product recall reserve		1,819		2,055
Other current liabilities		5,291		5,040
Total other current liabilities	$	137,336	$	140,714

Contract Liabilities

We defer revenue associated with merchandise delivered via the home-delivery channel. We expect that substantially all of the deferred revenue, customer deposits and deferred membership fees as of May 2, 2020 will be recognized within the next six months as the performance obligations are satisfied.

In addition, we defer revenue when cash payments are received in advance of performance for unsatisfied obligations related to our gift cards and merchandise credits. During the three months ended May 2, 2020 and May 4, 2019, we recorded $4.1 million and $4.7 million, respectively, of revenue for previous deferrals related to our gift cards and merchandise credits. During the three months ended May 2, 2020 and May 4, 2019, we recorded gift card breakage of $0.6 million and $0.4 million, respectively. We expect that approximately 70% of the remaining gift card and merchandise credit liabilities as of May 2, 2020 will be recognized within the next twelve months as the gift cards are redeemed by customers.

Other Non-Current Obligations

3 Months Ended

May 02, 2020

Other Non-Current Obligations.

Other Non-Current Obligations

NOTE 6—OTHER NON-CURRENT OBLIGATIONS

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


	May 2,		February 1,
	2020		2020
Notes payable for share repurchases	$	18,813	$	18,741
Rollover units and profit interests ⁽¹⁾		3,170		3,064
Unrecognized tax benefits		3,063		3,020
Other non-current obligations		2,971		3,695
Total other non-current obligations	$	28,017	$	28,520

(1)	Represents rollover units and profit interests associated with the acquisition of Waterworks. Refer to Note 14—Stock-Based Compensation.

Leases

3 Months Ended

May 02, 2020

Leases

Leases

NOTE 7—LEASES

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


	Three Months Ended
	May 2,		May 4,
	2020		2019
Operating lease cost⁽¹⁾	$	20,726	$	19,117

Finance lease costs
Amortization of leased assets⁽¹⁾		9,588		8,852
Interest on lease liabilities⁽²⁾		5,781		5,514

Variable lease costs ⁽³⁾		3,560		5,607
Sublease income⁽⁴⁾		(2,575)		(3,282)
Total lease costs—net	$	37,080	$	35,808

(1)

Operating lease costs and amortization of finance lease right-of-use assets are included in cost of goods sold or selling, general and administrative expenses on the condensed consolidated statements of operations based on our accounting policy. Refer to Note 3—Significant Accounting Policies in the 2019 Form 10-K.

(2)	Included in interest expense—net on the condensed consolidated statements of operations.

(3)

Represents variable lease payments under operating and finance lease agreements, primarily associated with contingent rent based on a percentage of retail sales over contractual levels of $2.0 million and $3.3 million for the three months ended May 2, 2020 and May 4, 2019, respectively. Other variable costs, such as single lease cost related to variable lease payments based on an index or rate that were not included in the measurement of the initial lease liability and right-of-use asset, were not material for the three months ended May 2, 2020 and May 4, 2019.

(4)	Included in selling, general and administrative expenses on the condensed consolidated statements of operations.

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


		May 2,		February 1,
		2020		2020
	Balance Sheet Classification
Assets
Operating leases	Operating lease right-of-use assets	$	392,934	$	410,904
Finance leases ⁽¹⁾⁽²⁾	Property and equipment—net		630,781		642,117
Total lease right-of-use assets		$	1,023,715	$	1,053,021

Liabilities
Current⁽³⁾
Operating leases	Operating lease liabilities	$	61,997	$	58,924
Finance leases	Other current liabilities		11,752		9,188
Total lease liabilities—current			73,749		68,112

Non-current
Operating leases	Non-current operating lease liabilities		395,641		409,930
Finance leases	Non-current finance lease liabilities		439,470		442,988
Total lease liabilities—non-current			835,111		852,918
Total lease liabilities		$	908,860	$	921,030

(1)	Finance lease right-of-use assets include capitalized amounts related to our completed construction activities to design and build leased assets, which are reclassified from other non-current assets upon lease commencement.

(2)	Finance lease right-of-use assets are recorded net of accumulated amortization of $101.7 million and $92.3 million as of May 2, 2020 and February 1, 2020, respectively.

(3)	Current portion of lease liabilities represents the reduction of the related lease liability over the next 12 months.

The maturities of lease liabilities are as follows as of May 2, 2020 (in thousands):


Fiscal year	Operating Leases		Finance Leases		Total
Remainder of fiscal 2020	$	59,698	$	25,738	$	85,436
2021		69,968		35,311		105,279
2022		60,642		35,729		96,371
2023		56,210		36,143		92,353
2024		52,407		36,630		89,037
2025		52,396		37,791		90,187
Thereafter		193,769		530,520		724,289
Total lease payments⁽¹⁾⁽²⁾		545,090		737,862		1,282,952
Less—imputed interest ⁽³⁾		(87,452)		(286,640)		(374,092)
Present value of lease liabilities	$	457,638	$	451,222	$	908,860

(1)

Total lease payments include future obligations for renewal options that are reasonably certain to be exercised and are included in the measurement of the lease liability. Total lease payments exclude $381.9 million of legally binding payments under the noncancellable term for leases signed but not yet commenced as of May 2, 2020.

(2)	Excludes future commitments under short-term lease agreements of $0.5 million as of May 2, 2020.

(3)	Calculated using the incremental borrowing rate for each lease at lease commencement.

Supplemental information related to leases consists of the following:


	Three Months Ended
	May 2,		May 4,
	2020		2019
Weighted-average remaining lease term (years)
Operating leases		8.7		9.1
Finance leases		18.4		19.1

Weighted-average discount rate
Operating leases		3.82%		3.80%
Finance leases		5.25%		5.26%

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


	Three Months Ended
	May 2,		May 4,
	2020		2019
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	(10,786)	$	(31,780)
Operating cash flows from finance leases		(2,437)		(5,514)
Financing cash flows from finance leases		(2,068)		(2,129)
Total cash outflows from leases	$	(15,291)	$	(39,423)

Lease right-of-use assets obtained in exchange for lease obligations—net of lease terminations (non-cash)
Operating leases	$	1,198	$	8,173
Finance leases		58		17,984

Long-lived Asset Impairment

During the three months ended May 2, 2020, we recognized long-lived asset impairment charges of $3.5 million related to one RH Baby & Child Gallery and one Waterworks showroom, comprised of lease right-of-use asset impairment of $2.0 million and property and equipment impairment of $1.5 million.

Convertible Senior Notes

3 Months Ended

May 02, 2020

Debt Disclosure

Convertible Senior Notes

NOTE 8—CONVERTIBLE SENIOR NOTES

$350 million 0.00% Convertible Senior Notes due 2024

In September 2019, we issued in a private offering $350 million principal amount of 0.00% convertible senior notes due 2024 (the “2024 Notes”). The 2024 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2024 Notes will mature on September 15, 2024, unless earlier purchased by us or converted. The 2024 Notes will not bear interest, except that the 2024 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2024 Notes. The 2024 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events are also considered “events of default” under the 2024 Notes, which may result in the acceleration of the maturity of the 2024 Notes, as described in the indenture governing the 2024 Notes. Events of default under the indenture for the 2024 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal

amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2024 Notes then outstanding.

The initial conversion rate applicable to the 2024 Notes is 4.7304 shares of common stock per $1,000 principal amount of 2024 Notes, or a total of approximately 1.656 million shares for the total $350 million principal amount. This initial conversion rate is equivalent to an initial conversion price of approximately $211.40 per share, which represents a 25% premium to the $169.12 closing share price on the day the 2024 Notes were priced. 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 governing the 2024 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2024 Notes in connection with such make-whole fundamental change.

Prior to June 15, 2024, the 2024 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after December 31, 2019, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2024 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of May 2, 2020, none of these conditions have occurred and, as a result, the 2024 Notes were not convertible as of May 2, 2020. On and after June 15, 2024, 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 2024 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2024 Notes will be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. 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.

We may not redeem the 2024 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require us to purchase all or a portion of their 2024 Notes for cash at a price equal to 100% of the principal amount of the 2024 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 2024 Notes, we separated the 2024 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 2024 Notes and the fair value of the liability component of the 2024 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 5.74% over the expected life of the 2024 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

Debt issuance costs related to the 2024 Notes were comprised of discounts upon original issuance of $3.5 million and third party offering costs of $1.3 million. In accounting for the debt issuance costs related to the issuance of the 2024 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2024 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.

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 2024 balance on the condensed consolidated balance

sheets. During the three months ended May 2, 2020 we recorded $0.2 million related to the amortization of debt issuance costs related to the 2024 Notes.

The carrying value of the 2024 Notes, excluding the discounts upon original issuance and third party offering costs, is as follows (in thousands):


	May 2,		February 1,
	2020		2020
Liability component
Principal	$	350,000	$	350,000
Less: Debt discount		(77,764)		(81,634)
Net carrying amount	$	272,236	$	268,366
Equity component ⁽¹⁾	$	87,252	$	87,252

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

We recorded interest expense of $3.9 million for the amortization of the debt discount related to the 2024 Notes during the three months ended May 2, 2020.

2024 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2024 Notes and exercise of the overallotment option in September 2019, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 1.656 million shares of our common stock at a price of approximately $211.40 per share. The total cost of the convertible note hedge transactions was approximately $91.4 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.656 million shares of our common stock at a price of $338.24 per share, which represents a 100% premium to the $169.12 closing share price on the day the 2024 Notes were priced. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 3.3 million shares of common stock (which cap may also be subject to adjustment). We received approximately $50.2 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 2024 Notes until our common stock is above approximately $338.24 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.

We recorded a deferred tax liability of $21.7 million in connection with the debt discount associated with the 2024 Notes and recorded a deferred tax asset of $22.7 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.

$335 million 0.00% Convertible Senior Notes due 2023

In June 2018, we issued in a private offering $300 million principal amount of 0.00% convertible senior notes due 2023 and issued an additional $35 million principal amount in connection with the 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 us or converted. The 2023 Notes will not bear interest, except that the 2023 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2023 Notes. The 2023 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events are also considered “events of default” under the 2023 Notes, which may result in the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes. Events of default under the indenture for the 2023 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which

there may be issued, or by which there may be secured or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2023 Notes then outstanding.

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 governing the 2023 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2023 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2023, the 2023 Notes are convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2018, if, for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2023 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. As of May 2, 2020, none of these conditions have occurred and, as a result, the 2023 Notes were not convertible as of May 2, 2020. On and after March 15, 2023, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or a portion of their 2023 Notes at any time, regardless of the foregoing circumstances. Upon conversion, the 2023 Notes will be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. 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.

We may not redeem the 2023 Notes; however, upon the occurrence of a fundamental change (as defined in the indenture governing the notes), holders may require us to purchase all or a portion of their 2023 Notes for cash at a price equal to 100% of the principal amount of the 2023 Notes to be purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2023 Notes, we separated the 2023 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2023 Notes and the fair value of the liability component of the 2023 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) will be amortized to interest expense using an effective interest rate of 6.35% over the expected life of the 2023 Notes. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

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. In accounting for the debt issuance costs related to the issuance of the 2023 Notes, we allocated the total amount incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the expected life of the 2023 Notes, and debt issuance costs attributable to the equity component are netted with the equity component in stockholders’ equity.

sheets. During both the three months ended May 2, 2020 and May 4, 2019, we recorded $0.2 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):


	May 2,		February 1,
	2020		2020
Liability component
Principal	$	335,000	$	335,000
Less: Debt discount		(60,417)		(64,729)
Net carrying amount	$	274,583	$	270,271
Equity component ⁽¹⁾	$	90,990	$	90,990

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

We recorded interest expense of $4.3 million and $4.1 million for the amortization of the debt discount related to the 2023 Notes during the three months ended May 2, 2020 and May 4, 2019, respectively.

2023 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2023 Notes and exercise of the overallotment option in June 2018, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 1.730 million shares of our common stock at a price of approximately $193.65 per share. The total cost of the convertible note hedge transactions was approximately $91.9 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 1.730 million shares of our common stock at a price of $309.84 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 3.5 million shares of common stock (which cap may also be subject to adjustment). We received approximately $51.0 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2023 Notes until our common stock is above approximately $309.84 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, 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.

We recorded a deferred tax liability of $22.3 million in connection with the debt discount associated with the 2023 Notes and recorded a deferred tax asset of $22.5 million in connection with the convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the condensed consolidated balance sheets.

$300 million 0.00% Convertible Senior Notes due 2020

In June 2015, we issued in a private offering $250 million principal amount of 0.00% convertible senior notes due 2020 and, in July 2015, we issued an additional $50 million principal amount pursuant to the exercise of the overallotment option granted to the initial purchasers as part of our June 2015 offering (collectively, the “2020 Notes”). The 2020 Notes are governed by the terms of an indenture between the Company and U.S. Bank National Association, as the Trustee. The 2020 Notes will mature on July 15, 2020, unless earlier purchased by us or converted. The 2020 Notes will not bear interest, except that the 2020 Notes will be subject to “special interest” in certain limited circumstances in the event of our failure to perform certain of our obligations under the indenture governing the 2020 Notes. The 2020 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of our subsidiaries. Certain events are also considered “events of default” under the 2020 Notes, which may result in the acceleration of the maturity of the 2020 Notes, as described in the indenture governing the 2020 Notes. Events of default under the indenture for the 2020 Notes include, among other things, the occurrence of an event of default by us as defined under any mortgage, indenture or instrument under which there may be issued, or by which there may be secured

or evidenced, any indebtedness of the Company or any of its significant subsidiaries for money borrowed, if that event of default (i) constitutes the failure to pay when due indebtedness in the aggregate principal amount in excess of $20 million and (ii) such event of default continues for a period of 30 days after written notice is delivered to the Company by the Trustee or to the Company and the Trustee by the holders of at least 25% of the aggregate principal amount of the 2020 Notes then outstanding. The 2020 Notes are guaranteed by our primary operating subsidiary, Restoration Hardware, Inc., as Guarantor. The guarantee is the unsecured obligation of the Guarantor and is subordinated to the Guarantor’s obligations from time to time with respect to its Credit Agreement and ranks equal in right of payment with respect to Guarantor’s other obligations.

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. To the extent the stock price is less than $118.13 per share, we are required to settle the par value in cash, subject to the cash settlement averaging period under the indenture. To the extent the stock price is greater than $118.13 per share, we may settle the par value at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock. 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 governing the 2020 Notes, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its 2020 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2020, the 2020 Notes were 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 calendar quarter, the last reported sale price of our common stock on such trading day is greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five consecutive business day period after any ten consecutive trading day period in which, for each day of that period, the trading price per $1,000 principal amount of 2020 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on such trading day; or (3) upon the occurrence of specified corporate transactions. The first condition was satisfied during the calendar quarter ended December 31, 2019 and, accordingly, holders were eligible to convert their 2020 Notes during the calendar quarter ending March 31, 2020. In addition, 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. Upon conversion, the 2020 Notes will be settled, at our election, in cash, shares of our common stock, or a combination of cash and shares of our common stock to the extent our stock price is greater than $118.13 per share. 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. We expect to repay the $300 million outstanding principal amount of the convertible notes in cash, whether in connection with a conversion of such notes or repayment at maturity in July 2020.

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

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2020 Notes, we separated the 2020 Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the liability component of the 2020 Notes. The 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.

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. In accounting for the debt issuance costs related to the issuance of the 2020

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

Discounts and third party offering costs attributable to the liability component were recorded as a contra-liability and are presented net against the convertible senior notes due 2020 balance on the condensed consolidated balance sheets. During both the three months ended May 2, 2020 and May 4, 2019, we recorded $0.3 million related to the amortization of debt issuance costs.

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


	May 2,		February 1,
	2020		2020
Liability component
Principal	$	300,000	$	300,000
Less: Debt discount		(4,156)		(8,890)
Net carrying amount	$	295,844	$	291,110
Equity component ⁽¹⁾	$	84,003	$	84,003

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

We recorded interest expense of $4.7 million and $4.4 million for the amortization of the debt discount related to the 2020 Notes during the three months ended May 2, 2020 and May 4, 2019, respectively.

In May 2020, we paid $9.2 million in cash to settle $9.4 million in aggregate principal amount of 2020 Notes converted at the option of the noteholders. In settlement, such noteholders also received approximately 15,000 shares of common stock. We did not issue any shares of our common stock on a net basis in respect of such settlement of the 2020 Notes as a result of our exercise of the convertible bond hedge we purchased concurrently with the issuance of the 2020 Notes, as described below.

2020 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment option in July 2015, we entered into convertible note hedge transactions whereby we have the option to purchase a total of approximately 2.540 million shares of our common stock at a price of approximately $118.13 per share. The total cost of the convertible note hedge transactions was approximately $68.3 million. In addition, we sold warrants whereby the holders of the warrants have the option to purchase a total of approximately 2.540 million shares of our common stock at a price of $189.00 per share. The warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such warrants may be increased up to a cap of approximately 5.1 million shares of common stock (which cap may also be subject to adjustment). We received approximately $30.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2020 Notes until our common stock is above approximately $189.00 per share. As these transactions meet certain accounting criteria, the convertible note hedges and warrants are recorded in stockholders’ equity, 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.

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

Credit Facilities

3 Months Ended

May 02, 2020

Debt Disclosure

Credit Facilities

NOTE 9—CREDIT FACILITIES

The outstanding balances under our credit facilities were as follows (in thousands):


	May 2,						February 1,
	2020						2020
	Outstanding		Unamortized Debt		Net Carrying		Outstanding		Unamortized Debt		Net Carrying
	Amount		Issuance Costs		Amount		Amount		Issuance Costs		Amount
Asset based credit facility⁽¹⁾	$	10,000	$	—	$	10,000	$	—	$	—	$	—
Equipment promissory notes⁽²⁾		48,337		(275)		48,062		53,372		(310)		53,062
Total credit facilities	$	58,337	$	(275)	$	58,062	$	53,372	$	(310)	$	53,062

(1)

Deferred financing fees associated with the asset based credit facility as of May 2, 2020 and February 1, 2020 were $2.3 million and $2.6 million, respectively, and are included in other non-current assets on the condensed consolidated balance sheets. The deferred financing fees are amortized on a straight-line basis over the life of the revolving line of credit, which has a maturity date of June 28, 2022.

(2)

Represents total equipment security notes secured by certain of our property and equipment, of which $19.6 million outstanding was included in other current liabilities on the condensed consolidated balance sheets. The remaining $28.7 million outstanding, included in other non-current obligations on the condensed consolidated balance sheets, has principal payments due of $16.2 million, $11.4 million and $1.1 million in fiscal 2021, fiscal 2022 and fiscal 2023, respectively.

Asset Based Credit Facility

In August 2011, Restoration Hardware, Inc., along with its Canadian subsidiary, Restoration Hardware Canada, Inc., entered into a credit agreement with Bank of America, N.A., as administrative agent, and certain other lenders (the “Original Credit Agreement”).

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

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

We repaid the full amount of the FILO term loan as of February 1, 2020. As a result of the repayment, we incurred a $0.8 million loss on extinguishment of debt in fiscal 2019, which represents the acceleration of amortization of debt issuance costs. We did not incur any prepayment penalties upon the early extinguishment of the FILO term loan.

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

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

Borrowings under the revolving line of credit are subject to interest, at the borrowers’ option, at either the bank’s reference rate or London Inter-bank Offered Rate (“LIBOR”) (or, in the case of the revolving line of credit, the Bank of America “BA” Rate or the Canadian Prime Rate, as such terms are defined in the Credit Agreement, for Canadian borrowings denominated in Canadian dollars or the United States Index Rate or LIBOR for Canadian borrowings denominated in United States dollars) plus an applicable margin rate, in each case.

The Credit Agreement contains various restrictive covenants, including, among others, limitations 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. The Credit Agreement also contains various affirmative covenants, including the obligation to deliver notice to the First Lien Administrative Agent following the Company’s obtaining knowledge of any matter that has resulted or could reasonably be expected to result in a “Material Adverse Effect” (as defined in the Credit Agreement).

In addition, under the Credit Agreement, we are required to meet specified financial ratios in order to undertake certain actions, and we may be required to maintain certain levels of excess availability or meet a specified consolidated fixed-charge coverage ratio (“FCCR”). Subject to certain exceptions, the trigger for the FCCR occurs if the domestic availability under the revolving line of credit is less than the greater of (i) $40.0 million and (ii) 10% of the lesser of (x) the domestic revolving commitments under the Credit Agreement and (y) the domestic revolving borrowing base. If the availability under the Credit Agreement is less than the foregoing amount, then Restoration Hardware, Inc. is required subject to certain exceptions to maintain an FCCR of at least one to one. As of May 2, 2020, Restoration Hardware, Inc. was in compliance with all applicable financial covenants of the Credit Agreement.

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

The Credit Agreement includes customary events of default, in certain cases subject to customary periods to cure. The occurrence of an event of default, following the applicable cure period, would permit the lenders to, among other things, terminate any existing commitments under the Credit Agreement and declare the unpaid principal, accrued and unpaid interest and all other amounts payable under the Credit Agreement to be immediately due and payable.

As of May 2, 2020, we had $10.0 million outstanding borrowings under the revolving credit facility portion of the Credit Agreement. The availability of credit at any given time under the Credit Agreement is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable. As a result of the borrowing base formula, actual borrowing availability under the revolving line of credit could be less than the stated amount of the revolving line of credit (as reduced by the actual borrowings and outstanding

letters of credit under the revolving line of credit). Under the terms of such provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the Credit Agreement as of May 2, 2020 was $356.5 million, net of $13.2 million in outstanding letters of credit.

Second Lien Credit Agreement

On April 10, 2019, Restoration Hardware, Inc., entered into a credit agreement, dated as of April 9, 2019 and effective as of April 10, 2019 (the “Second Lien Credit Agreement”), among (i) Restoration Hardware, Inc., as lead borrower, (ii) the guarantors party thereto, (iii) the lenders party thereto, each of whom were managed or advised by either Benefit Street Partners L.L.C. and its affiliated investment managers or Apollo Capital Management, L.P. and its affiliated investment managers, as applicable, and (iv) BSP Agency, LLC, as administrative agent and collateral agent (the “Second Lien Administrative Agent”) with respect to a second lien term loan in an aggregate principal amount equal to $200.0 million with a maturity date of April 9, 2024 (the “Second Lien Term Loan”). The Second Lien Term Loan of $200.0 million in principal was repaid in full on September 20, 2019.

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

Intercreditor Agreement

On April 10, 2019, in connection with the Second Lien Credit Agreement, Restoration Hardware, Inc. entered into an Intercreditor Agreement (the “Intercreditor Agreement”), dated as of April 9, 2019 and effective as of April 10, 2019, with the First Lien Administrative Agent and the Second Lien Administrative Agent. The Intercreditor Agreement established various customary inter-lender terms, including, without limitation, with respect to priority of liens, permitted actions by each party, application of proceeds, exercise of remedies in case of default, releases of liens and certain limitations on the amendment of the Credit Agreement and the Second Lien Credit Agreement without the consent of the other party. The Intercreditor Agreement was terminated upon repayment of the Second Lien Term Loan on September 20, 2019.

Equipment Loan Facility

On September 5, 2017, Restoration Hardware, Inc. entered into a Master Loan and Security Agreement with Banc of America Leasing & Capital, LLC (“BAL”) pursuant to which BAL and we agreed that BAL would finance certain equipment of ours from time to time, with each such equipment financing to be evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each equipment loan is secured by a purchase money security interest in the financed equipment. The maturity dates of the equipment security notes vary, but generally have a maturity of three or four years. We are required to make monthly installment payments under the equipment security notes.

Fair Value Measurements

3 Months Ended

May 02, 2020

Fair Value Measurements

Fair Value Measurements

NOTE 10—FAIR VALUE MEASUREMENTS

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, we utilize market data or assumptions that we believes market participants would use in pricing the asset or liability, which would maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, including assumptions about risk and the risks inherent in the inputs of the valuation technique.

The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Financial instruments with readily available active quoted prices for which fair value can be measured generally will have a higher degree of pricing observability and a lesser degree of judgment used in measuring fair value.

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

Our 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—Recurring

Amounts reported as cash and equivalents, receivables, and accounts payable and accrued expenses approximate fair value due to the short-term nature of activity within these accounts. The estimated fair value of the asset based credit facility approximates cost as the interest rate associated with the facility is variable and resets frequently. The estimated fair value and carrying value of the 2020 Notes, 2023 Notes and 2024 Notes were as follows (in thousands):


	May 2,					February 1,
	2020					2020
	Fair			Carrying		Fair		Carrying
	Value			Value ⁽¹⁾		Value		Value ⁽¹⁾
Convertible senior notes due 2020	$	287,841	$		295,844	$	295,573	$	291,110
Convertible senior notes due 2023		232,109			274,583		272,623		270,271
Convertible senior notes due 2024		214,761			272,236		255,849		268,366

(1)

Carrying value represents the principal amount less the equity component of the 2020 Notes, 2023 Notes and 2024 Notes classified in stockholders’ equity, and does not exclude the discounts upon original issuance, discounts and commissions payable to the initial purchasers and third party offering costs, as applicable.

The fair value of each of the 2020 Notes, 2023 Notes and 2024 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 our convertible notes, when available, our common stock price and interest rates based on similar debt issued by parties with credit ratings similar to ours (Level 2).

Fair Value Measurements—Non-Recurring

The fair value of the Waterworks reporting unit tradename as of May 2, 2020 and February 1, 2020 was determined based on unobservable (Level 3) inputs and valuation techniques, as discussed in Note 4—Goodwill, Trademarks, Trademarks and Domain Names and in “Impairment” within Note 3—Significant Accounting Policies in the 2019 Form 10-K.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References + Details

Income Taxes

3 Months Ended

May 02, 2020

Income Taxes

Income Taxes

NOTE 11—INCOME TAXES

We recorded income tax benefit of $1.4 million and income tax expense of $11.8 million in the three months ended May 2, 2020 and May 4, 2019, respectively. The effective tax rate was 30.7% and 24.8% for the three months ended May 2, 2020 and May 4, 2019, respectively. The increase in the effective tax rate for the three months ended

May 2, 2020, as compared to the three months May 4, 2019, is primarily attributable to the Company reporting a loss before income taxes, and, to a lesser extent, discrete tax benefits related to net excess tax benefits from stock-based compensation.

As of May 2, 2020, we had $8.5 million of unrecognized tax benefits, of which $7.8 million would reduce income tax expense and the effective tax rate, if recognized. The remaining unrecognized tax benefits would offset other deferred tax assets, if recognized. As of May 2, 2020, we had $6.3 million of exposures related to unrecognized tax benefits that are expected to decrease in the next 12 months.

Net Income (Loss) Per Share

3 Months Ended

May 02, 2020

Net Income (Loss) Per Share

Net Income (Loss) Per Share

NOTE 12—NET INCOME (LOSS) PER SHARE

The weighted-average shares used for net income (loss) per share are presented in the table below. As we reported a net loss for the three months ended May 2, 2020, the weighted-average shares outstanding for basic and diluted are the same.


	Three Months Ended
	May 2,	May 4,
	2020	2019
Weighted-average shares—basic	19,242,641	19,976,858
Effect of dilutive stock-based awards	—	4,472,545
Effect of dilutive convertible senior notes⁽¹⁾	—	484,584
Weighted-average shares—diluted	19,242,641	24,933,987

(1)	The 2020 Notes, 2023 Notes and 2024 Notes have an impact on our dilutive share count beginning at stock prices of $118.13 per share, $193.65 per share and $211.40 per share, respectively.

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


	Three Months Ended
	May 2,	May 4,
	2020	2019
Options	4,436,083	463,506
Restricted stock units	177,312	—
Convertible senior notes	589,095	—
Total anti-dilutive stock-based awards	5,202,490	463,506

Share Repurchases

3 Months Ended

May 02, 2020

Share Repurchases

Share Repurchases

NOTE 13—SHARE REPURCHASES

Share Repurchase Program

On October 10, 2018, our Board of Directors authorized a share repurchase program of up to $700.0 million, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700.0 million authorization amount was replenished by the Board of Directors on March 25, 2019. We did not make any repurchases under this program during the three months ended May 2, 2020. During the three months ended May 4, 2019, we repurchased approximately 2.2 million shares of our common stock at an average price of $115.36 per share, for an aggregate repurchase amount of approximately $250.0 million under this share repurchase program. As of May 2, 2020, there was $450.0 million remaining for future share repurchases under this program.

Share Repurchases Under Equity Plans

As of May 2, 2020 and February 1, 2020, the aggregate unpaid principal amount of the notes payable for share repurchases was $18.8 million and $18.7 million, respectively, which were included in other non-current obligations on

the condensed consolidated balance sheets. During both the three months ended May 2, 2020 and May 4, 2019, we recorded interest expense on the outstanding notes of $0.2 million.

Of the $18.8 million and $18.7 million notes payable for share repurchases outstanding as of May 2, 2020 and February 1, 2020, $15.5 million was due to a current board member of the Company.

Stock-Based Compensation

3 Months Ended

May 02, 2020

Stock-Based Compensation.

Stock-Based Compensation

NOTE 14—STOCK-BASED COMPENSATION

We recorded stock-based compensation expense of $5.8 million and $5.7 million during the three months ended May 2, 2020 and May 4, 2019, respectively, which is included in selling, general and administrative expenses on the condensed consolidated statements of operations. No stock-based compensation cost has been capitalized in the accompanying condensed consolidated financial statements.

2012 Stock Incentive Plan and 2012 Stock Option Plan

As of May 2, 2020, 7,766,765 options were outstanding with a weighted-average exercise price of $66.74 per share and 5,906,720 options were vested with a weighted-average exercise price of $53.62 per share. The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options exercisable as of May 2, 2020 was $563.5 million, $550.3 million, and $495.2 million, respectively. Stock options exercisable as of May 2, 2020 had a weighted-average remaining contractual life of 4.13 years. As of May 2, 2020, the total unrecognized compensation expense related to unvested options was $65.2 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 4.47 years.

As of May 2, 2020, we had 201,920 restricted stock units outstanding with a weighted-average grant date fair value of $47.78 per share. During the three months ended May 2, 2020, 13,685 restricted stock units vested with a weighted-average grant date and vest date fair value of $68.82 per share. As of May 2, 2020, there was $4.0 million of total unrecognized compensation expense related to unvested restricted stock and restricted stock units which is expected to be recognized over a weighted-average period of 1.26 years.

Rollover Units

In connection with the acquisition of Waterworks in May 2016, $1.5 million rollover units in the Waterworks subsidiary (the “Rollover Units”) were recorded as part of the transaction. The Rollover Units are subject to the terms of the Waterworks LLC agreement, including redemption rights at an amount equal to the greater of (i) the $1.5 million remitted as consideration in the business combination or (ii) an amount based on the percentage interest represented in the overall valuation of the Waterworks subsidiary (the “Appreciation Rights”). The Appreciation Rights are measured at fair value and are subject to fair value measurements during the expected life of the Rollover Units, with changes to fair value recorded in the condensed consolidated statements of operations. The fair value of the Appreciation Rights is determined based on an option-pricing model (“OPM”). We did not record any expense related to the Appreciation Rights during both the three months ended May 2, 2020 and May 4, 2019. As of both May 2, 2020 and February 1, 2020, the liability associated with the Rollover Units and related Appreciation Rights was $1.5 million, which is included in other non-current obligations on the condensed consolidated balance sheets.

Profit Interests

In connection with the acquisition of Waterworks in May 2016, profit interests units in the Waterworks subsidiary (the “Profit Interests”) were issued to certain Waterworks associates. The Profit Interests are measured at their grant date fair value and expensed on a straight-line basis over their expected life, or five years. The Profit Interests are subject to fair value measurements during their expected life, with changes to fair value recorded in the condensed consolidated statements of operations. The fair value of the Profit Interests is determined based on an OPM. For both the three months ended May 2, 2020 and May 4, 2019, we recorded $0.1 million related to the Profit Interests, which is included in selling, general and administrative expenses on the condensed consolidated statements of operations. As of May 2, 2020 and February 1, 2020, the liability associated with the Profit Interests was $1.7 million and $1.6 million, respectively, which is included in other non-current obligations on the condensed consolidated balance sheets.

Commitments and Contingencies

3 Months Ended

May 02, 2020

Commitments and Contingencies.

Commitments and Contingencies

NOTE 15—COMMITMENTS AND CONTINGENCIES

Commitments

We had no material off balance sheet commitments as of May 2, 2020.

Contingencies

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

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

Securities Class Action

On February 2, 2017, City of Miami General Employees’ & Sanitation Employees’ Retirement Trust filed a class action complaint in the United States District Court, Northern District of California, against the Company, Gary Friedman, and Karen Boone. On March 16, 2017, Peter J. Errichiello, Jr. filed a similar class action complaint in the same forum and against the same parties. On April 26, 2017, the court consolidated the two actions. The consolidated action is captioned In re RH, Inc. Securities Litigation. An amended consolidated complaint was filed in June 2017 asserting claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The complaint asserts claims purportedly on behalf of a class of purchasers of our common stock from March 26, 2015 to June 8, 2016. The alleged misstatements relate to statements regarding the roll out of the RH Modern product line and our inventory levels. The complaint seeks class certification, monetary damages, and other appropriate relief, including an award of costs and attorneys’ fees. On March 21, 2019, we and the individual defendants in the case entered into a binding memorandum of understanding to settle the case. The settlement amount is $50 million, which was funded entirely by our insurance carriers. On May 6, 2019, the plaintiffs filed a motion for preliminary approval of the proposed settlement together with a settlement agreement executed by both parties. The settlement agreement was subject to customary conditions including court approval following notice to our shareholders, and a hearing at which time the court will consider the fairness, reasonableness and adequacy of the settlement. On June 21, 2019, the court issued an order preliminarily approving the settlement. The court granted final approval of the settlement on October 25, 2019.

As a result of the court approval and adjudication of the claims in 2019, as well as our insurance carriers funding the settlement amount, we have derecognized the provision for legal settlement and unpaid legal fees within other current liabilities and the associated litigation insurance recovery receivable on the condensed consolidated balance sheets as of May 2, 2020, which settlement resolved all of the claims that were or could have been brought in the action.

Shareholder Derivative Lawsuit

On April 24, 2018, purported Company shareholder David Magnani filed a purported shareholder derivative suit in the United States District Court, Northern District of California, captioned Magnani v. Friedman et al. (No. 18-cv-02452). On June 29, 2018, Hosrof Izmirliyan filed a similar purported shareholder derivative complaint in the same forum, captioned Izmirliyan v. Friedman et al. (No. 18-cv-03930). On July 29, 2018, the court consolidated both

derivative actions, and the consolidated action is captioned In re RH Shareholder Derivative Litigation. On August 24, 2018, plaintiffs filed an amended complaint that names the Company as a nominal defendant and Gary Friedman, Karen Boone, Carlos Alberini, Keith Belling, Eri Chaya, Mark Demilio, Katie Mitic, Ali Rowghani and Leonard Schlesinger as defendants. The allegations substantially track those in the securities class action described above. Plaintiffs bring claims against all individual defendants under Section 14(a) of the Exchange Act, as well as claims for breach of fiduciary duty, unjust enrichment, and waste of corporate assets. The plaintiffs also allege insider trading and misappropriation of information claims against two of the individual defendants. The amended complaint seeks monetary damages, corporate governance changes, restitution, and an award of costs and attorneys’ fees. We believe that plaintiffs lack standing to bring this derivative action. On September 28, 2018, we filed a motion to stay proceedings and a motion to dismiss the consolidated complaint. On January 23, 2019, the court granted the motion to stay the case pending resolution of the securities class action discussed above. On March 19, 2020, the parties reached an agreement in principle to settle the litigation, which agreement is subject to the finalization of a stipulation of settlement, and certain conditions, including approval by our Board of Directors, and approval by the Court. The settlement involves certain non-monetary terms as well as payment of the plaintiffs’ attorneys’ legal fees, which payment is expected to be funded by our insurance carriers.

Segment Reporting

3 Months Ended

May 02, 2020

Segment Reporting

Segment Reporting

NOTE 16—SEGMENT REPORTING

We define reportable and operating segments on the same basis that we use to evaluate performance internally by the Chief Operating Decision Maker (the “CODM”), which we have determined is our Chief Executive Officer. We have two operating segments: RH Segment and Waterworks. The two operating segments include all sales channels accessed by our customers, including sales through catalogs, websites, stores, and the commercial channel.

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

We use operating income (loss) to evaluate segment profitability. Operating income (loss) is defined as net income (loss) before interest expense—net, tradename impairment and income tax expense (benefit).

Segment Information

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


	Three Months Ended
	May 2,						May 4,
	2020						2019
	RH Segment		Waterworks		Total		RH Segment		Waterworks		Total
Net revenues	$	454,957	$	27,938	$	482,895	$	563,706	$	34,715	$	598,421
Gross profit		187,762		11,892		199,654		217,943		14,871		232,814
Depreciation and amortization		23,717		1,153		24,870		26,004		1,185		27,189

The following table presents the balance sheet metrics as required under ASC 280—Segment Reporting (in thousands):


	May 2,						February 1,
	2020						2020
	RH Segment		Waterworks		Total		RH Segment		Waterworks		Total
Goodwill ⁽¹⁾	$	124,290	$	—	$	124,290	$	124,367	$	—	$	124,367
Tradenames, trademarks and domain names ⁽²⁾		48,563		17,000		65,563		48,563		37,459		86,022
Total assets		2,310,111		119,782		2,429,893		2,301,823		143,871		2,445,694

(1)	The Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully impaired as of fiscal 2018, with $17.4 million and $33.7 million impairment recorded in fiscal 2018 and fiscal 2017, respectively.

(2)

The Waterworks reporting unit tradename is presented net of an impairment charge of $35.1 million, with $20.5 million recorded in the three months ended May 2, 2020 and $14.6 million recorded in fiscal 2018. Refer to “Waterworks Tradename Impairment” within Note 4—Goodwill, Trademarks, Trademarks and Domain Names.

We use segment operating income to evaluate segment performance and allocate resources. Segment operating income excludes (i) asset impairments and change in useful lives, (ii) severance costs associated with reorganizations and (iii) product recall accruals and adjustments. These items are excluded from segment operating income in order to provide better transparency of segment operating results. Accordingly, these items are not presented by segment because they are excluded from the segment profitability measure that the CODM and management review.

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


	Three Months Ended
	May 2,		May 4,
	2020		2019
Operating income (loss):
RH Segment	$	49,517	$	69,400
Waterworks		(1,450)		1,094
Asset impairments and change in useful lives		(8,471)		(3,476)
Reorganization related costs		(4,143)		—
Recall accrual		—		1,615