RH

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
È ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

‘ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the fiscal year ended February 1, 2020
or

For the transition period from

to

Commission file number: 001-35720

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
15 Koch Road
Corte Madera, CA
(Address of principal executive offices)

45-3052669
(I.R.S. Employer
Identification Number)

94925
(Zip Code)
Registrant’s telephone number, including area code: (415) 924-1005
Securities registered pursuant to Section 12(b) of the Act:
RH
(Trading Symbol)

Common Stock, $0.0001 par value
(Title of class)

New York Stock Exchange, Inc.
(Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities

Act. Yes È No ‘

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the

Act. Yes ‘ No È

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be
submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit such files). Yes È No ‘

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a

smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated
filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
È
Large accelerated filer
‘
Non-accelerated filer
Emerging growth company ‘

‘
Accelerated filer
Smaller reporting company ‘

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition

period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the
Exchange Act. ‘

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange

Act). Yes ‘ No È

As of August 2, 2019, the last business day of the registrant’s most recently completed second quarter, the approximate

market value of the registrant’s common stock held by non-affiliates was $2,188,285,246. Solely for purposes of this
disclosure, shares of common stock held by executive officers and directors of the registrant as of such date have been
excluded because such persons may be deemed to be affiliates.

As of March 27, 2020, 19,238,681 shares of registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for its 2020 Annual Meeting of Stockholders are incorporated by reference

in Part III of this Annual Report on Form 10-K where indicated. Such proxy statement will be filed with the Securities and
Exchange Commission within 120 days of the registrant’s fiscal year ended February 1, 2020.

RH
INDEX TO FORM 10-K

PART I.
Item 1.
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 2.
Item 3.
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 4. Mine Safety Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART II.

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 6.
Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 7. Management’s Discussion And Analysis of Financial Condition and Results of Operations . . . .
Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 8.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . .
Item 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART III.

Item 10. Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder

Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 13. Certain Relationships and Related Transactions and Director Independence . . . . . . . . . . . . . . . .
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 14.

Page

1
10
44
44
44
45

46
47
54
98
101
165
165
165

166
166

166
166
166

Item 15. Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Form 10-K Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 16.

167
167

PART IV.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND MARKET DATA

This annual report contains forward-looking statements that are subject to risks and uncertainties. Forward-

looking statements give our current expectations and projections relating to our financial condition, results of
operations, plans, objectives, future performance and business. You can identify forward-looking statements by
the fact that they do not relate strictly to historical or current facts. These statements may include words such as
“anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “short-term,”
“non-recurring,” “one-time,” “unusual,” “should,” “likely” and other words and terms of similar meaning in
connection with any discussion of the timing or nature of future operating or financial performance or other
events.

Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ
materially from those that we expected. We derive many of our forward-looking statements from our operating
budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions
are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for
us to anticipate all factors that could affect our actual results and matters that we identify as “short term,”
“non-recurring,” “unusual,” “one-time,” or other words and terms of similar meaning may in fact recur in one or
more future financial reporting periods. Important factors that could cause actual results to differ materially from
our expectations, or cautionary statements, are disclosed in Item 1A—Risk Factors, Item 7—Management’s
Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere in this annual report.
All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their
entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-
looking statements made in this annual report in the context of these risks and uncertainties.

We cannot assure you that we will realize the results or developments we expect or anticipate or, even if

substantially realized, that they will result in the consequences or affect us or our operations in the way we
expect. The forward-looking statements included in this annual report are made only as of the date hereof. We
undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new
information, future events or otherwise, except as required by law.

ii

Item 1.

Business

Overview

PART I

RH (“we,” “us,” or the “Company”) is a leading luxury retailer in the home furnishings marketplace. Our
curated and fully-integrated assortments are presented consistently across our sales channels in sophisticated and
unique lifestyle settings that we believe are on par with world-class interior designers. We offer dominant
merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware,
décor, outdoor and garden, and child and teen furnishings. We position our Galleries as showrooms for our
brand, while our Source Books and websites act as virtual extensions of our stores. Our retail business is fully
integrated across our multiple channels of distribution, consisting of our stores, Source Books, and websites. We
have an integrated RH Hospitality experience in eight of our new Design Gallery locations, which include
restaurants, wine vaults and barista bars.

As of February 1, 2020, we operated a total of 68 RH Galleries consisting of 22 Design Galleries, 40 legacy

Galleries, 2 RH Modern Galleries and 4 RH Baby & Child Galleries throughout the United States and Canada,
and 15 Waterworks showrooms throughout the United States and in the U.K. As of February 1, 2020, we
operated 38 outlet stores throughout the United States and Canada.

In response to the public health crisis posed by COVID-19, effective from March 17, 2020, the Company

temporarily closed its retail locations for an indeterminate period of time. Although we continue to serve our
customers virtually through our Gallery representatives and designers, as well as our online websites, our
business operations are being substantially affected by applicable regulatory restrictions including stay-at-home
requirements applicable in California where our corporate headquarters is located. Our decision to reopen retail
locations will be affected by a number of factors including applicable regulatory restrictions and there is
substantial uncertainty regarding the manner and timing in which we can return some or all of our business to
more normal business operations. We may face longer term closure requirements and other operational
restrictions with respect to some or all of our physical locations for prolonged periods of time due to, among
other factors, evolving and increasingly stringent federal, state and local restrictions including shelter-in-place
orders. Even once we are able to reopen closed physical locations, changes in consumer behavior and health
concerns may continue to impact consumer demand for our products and customer traffic at our Galleries,
restaurants and outlets and may make it more difficult to staff our business operations. For more information,
refer to Item 1A—Risk Factors— The global outbreak of the COVID-19 virus is likely to have an adverse impact
on our business and Item 7—Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Overview.

Products and Product Development

We have positioned RH as a lifestyle brand and design authority by offering dominant merchandise

assortments. We are merchants of luxury home furnishings and our luxury products embody our design aesthetic
and reflect inspiration from across the centuries and around the globe.

We have developed a proprietary product development platform that is fully integrated from ideation to

presentation. Key aspects of our product development platform are:

• Organization—We have established a collaborative, cross-functional organization centered on product
leadership and coordinated across our product development, sourcing, merchandising, inventory and
creative teams. Our product teams are focused on maximizing the sales potential of each product
category across all channels, which eliminates channel conflicts and functional redundancies.

• Process—For many of our products, we work closely with our network of artisan partners who possess
specialized product development and manufacturing capabilities and who we consider an extension of

1

our product development team. We collaborate with our global network of specialty vendors and
manufacturers to produce artisanal pieces of high quality and value on a large scale, including both
distinctive original designs and reinterpretations of antiques.

• Facility—We have built the RH Center of Innovation & Product Leadership, a facility which supports

the entire product development process from product ideation to presentation for all channels.

As a result of our proprietary organization, process and facility, our typical product lead times are 3 –
9 months, which enhances our ability to introduce more new products with each collection. In addition, our
product development platform, sourcing capabilities and significant scale enable us to reduce our product costs.

Sales Channels

We distribute our products through a fully integrated sales platform comprised of our Stores, E-Commerce,

Source Books and Trade and Contract. We believe the level of integration among all of our channels and our
approach to the market distinguishes us from other retailers. We believe our channels complement each other and
our customers’ buying decisions are influenced by their experiences across more than one of our sales channels.
We encourage our customers to shop across our channels and have aligned our business and internal organization
to be channel agnostic. Our integrated distribution and product delivery network serves all of our channels. We
believe the key advantage of our multiple sales channels is our ability to leverage the unique attributes of each
channel in our approach to the market.

Stores

Retail Locations

As of February 1, 2020, our retail locations are comprised of RH Galleries and Waterworks Showrooms:

February 1, 2020

Count

Average Leased Selling
Square Footage (1)

RH

Design Galleries . . . . . . . . . . . . . . . . . . . . . . .
Legacy Galleries . . . . . . . . . . . . . . . . . . . . . . .
Modern Galleries . . . . . . . . . . . . . . . . . . . . . .
Baby & Child and Teen Galleries . . . . . . . . . .

Total Galleries . . . . . . . . . . . . . . . . . . . . .
Waterworks Showrooms . . . . . . . . . . . . . . . . . . . . .

Total retail locations . . . . . . . . . . . . . . . . . . . . . . . .

22
40
2
4

68
15

83

33,100
7,300
8,300
3,900

4,000

(1) Average leased selling square footage is calculated based on total leased selling square footage divided by
total locations. Leased selling square footage is retail space at our retail locations used to sell our products.
Leased selling square footage excludes backrooms at retail locations used for storage, office space, food
preparation, kitchen space or similar purpose, as well as exterior sales space located outside a retail location,
such as courtyards, gardens and rooftops.

Our Galleries are located in upscale malls and street locations, as well as in iconic locations. We believe
situating our Galleries in desirable locations is critical to the success of our business. New sites are identified
based on a variety of factors, such as (i) the availability of suitable new site locations based on several store
specific factors including geographic location, demographics, and proximity to affluent consumers, (ii) the ability
to negotiate favorable economic terms, as well as (iii) the satisfactory and timely completion of real estate
development including procurement of permits and completion of construction. We pursue a market-based sales

2

strategy, whereby we assess each market’s overall sales potential and how best to approach the market across all
of our channels. We customize square footage, as well as catalog circulation, to maximize each market’s sales
potential and increase our return on invested capital.

Our Galleries reinforce our luxury brand aesthetic and are highly differentiated from other home furnishings

retailers. We have revolutionized the customer experience by showcasing products in a sophisticated lifestyle
setting that we believe is on par with world-class interior designers, consistent with the imagery and product
presentation featured on our websites and in our catalogs. Products in our Galleries are presented in fully
appointed rooms, emphasizing collections over individual pieces. This presentation encourages a higher average
order value as our customers are inspired to consider purchasing a full collection of products to replicate the
design aesthetic experienced in our Galleries. In addition, our associates use iPads and other devices to allow
customers to shop our entire merchandise assortment while in a retail location.

In 2015 we began to introduce an integrated hospitality experience, including cafés, wine vaults and barista
bars, into a number of our new Gallery locations. We believe this has created a unique new retail experience that
cannot be replicated online, and that the addition of hospitality is helping to drive incremental sales of home
furnishings in these Galleries. As of February 1, 2020, eight of our RH Design Galleries included an integrated
RH Hospitality experience and we plan to incorporate hospitality into the new Galleries that we open in the
future.

We have identified key learnings from our real estate transformation that have supported the development of

a multi-tier market approach that we believe will optimize both market share and return on invested capital over
time.

First, we have developed a RH prototype Design Gallery that is an innovative and flexible blueprint which

we believe will enable us to more quickly place our disruptive product assortment and immersive retail
experience into the market. The new model is a standard we will utilize in the future that is based on key
learnings from more recent Design Gallery openings and will have approximately 38,000 leased selling square
feet inclusive of our integrated hospitality experience. This prototype will present our assortments across our
businesses and contain interior design offices and presentation rooms where design professionals can work with
clients on their projects. This new model will be more capital efficient with less time and cost risk, but yield
similar productivity. We anticipate the new prototype Design Galleries will represent the format of most of our
upcoming Design Galleries in North America. Our most recently opened Design Galleries in Minneapolis and
Columbus are prototype Design Galleries, and upcoming prototype locations include Corte Madera, CA,
Charlotte, NC, Jacksonville, FL, Dallas, TX and Oakbrook, IL.

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

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

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

3

We believe our multi-tier market approach to transforming our real estate will enable us to ramp our

opening cadence from 3 to 5 new Galleries per year, to a pace of 5 to 7 new Galleries per year.

We plan to expand our product sales to international markets and are currently exploring opportunities for

Design Galleries in several locations outside of North America, including the United Kingdom and Europe.

The following tables present our retail location metrics:

Beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Design Galleries:

Year Ended

February 1,
2020

February 2,
2019

Total Leased
Selling Square
Footage (1)

(in thousands)
1,089

Count

83

Total Leased
Selling Square
Footage (1)

(in thousands)
981

Count

86

1
Minneapolis Design Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1
Columbus Design Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Portland Design Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
Nashville Design Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
New York Design Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
Yountville Design Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —

Modern Galleries:

Dallas RH Modern Gallery (relocation) . . . . . . . . . . . . . . . . . . . —
Dallas RH Modern Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —

Baby & Child Galleries:

Dallas RH Baby & Child Gallery . . . . . . . . . . . . . . . . . . . . . . . .
Portland RH Baby & Child Gallery . . . . . . . . . . . . . . . . . . . . . .

(1)
(1)

Legacy Galleries:

San Diego legacy Gallery (relocation) . . . . . . . . . . . . . . . . . . . . —
(1)
Minneapolis legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1)
Columbus legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Durham legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1)
Dallas legacy Gallery (relocation) . . . . . . . . . . . . . . . . . . . . . . . —
San Antonio legacy Gallery (relocation) . . . . . . . . . . . . . . . . . . —
Portland legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
Nashville legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
Washington DC legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . —
New York legacy Gallery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —

Waterworks Showrooms:

Waterworks Scottsdale Showroom (relocation) . . . . . . . . . . . . . —

End of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

83

Total leased square footage at end of period (2)
Weighted-average leased square footage (3)
Weighted-average leased selling square footage (3)

. . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . .

32.9 —
33.0 —
1
—
1
—
1
—
1
—

(4.5) —
1
—

(3.7)
(4.7)

1
1

0.5 —
(13.3) —
(6.2) —
(5.7) —
(2.6) —
(3.8) —
(1)
—
(1)
—
(1)
—
(1)
—

—

86

—

1,111

1,497
1,468
1,088

—
—
26.0
45.6
50.5
6.7

—
8.2

3.7
4.7

—
—
—
—
—
—
(4.7)
(7.1)
(5.6)
(21.4)

1.1

1,089

1,467
1,409
1,047

(1) Leased selling square footage is retail space at our retail locations used to sell our products. Leased selling
square footage excludes backrooms at retail locations used for storage, office space, food preparation,
kitchen space or similar purpose, as well as exterior sales space located outside a retail location, such as
courtyards, gardens and rooftops. Leased selling square footage includes approximately 37,700 and 11,600
square feet as of fiscal 2019 and fiscal 2018, respectively, related to two owned retail locations.

4

(2) Total leased square footage includes approximately 48,700 and 16,100 square feet as of fiscal 2019 and

fiscal 2018, respectively, related to two owned retail locations.

(3) Weighted-average leased square footage and leased selling square footage are calculated based on the

number of days a Gallery location was opened during the period divided by the total number of days in the
period.

The following list shows the number of retail locations in each U.S. state, each Canadian province and in the

U.K. where we operate as of February 1, 2020:

Location

Alabama
Arizona
California
Colorado
Connecticut
Florida
Georgia
Illinois
Indiana
Kansas
Louisiana

Maryland

Count Location

Count Location

Count

1 Massachusetts
2 Michigan
20 Minnesota
2 Missouri
4
5
2
3
1
1
1

Nevada
New Jersey
New York
North Carolina
Ohio
Oklahoma
Oregon

1

Pennsylvania

2
Tennessee
1
Texas
1
Utah
Virginia
1
1 Washington
2
5
1
3
1
1

District of Columbia
Alberta
British Columbia
Ontario
London (1)

2

Total

1
8
1
2
1
1
2
1
1
1

83

(1) The London retail location is a Waterworks showroom.

We continually analyze opportunities to selectively consolidate retail locations in connection with openings
of our Design Galleries or close retail locations that have been under-performing or are no longer consistent with
our brand positioning. In many cases, we continue to operate a retail location until its lease has expired in order
to effect the closure in a cost-efficient manner.

Outlet Stores

Our outlet stores are branded as RH Outlet or Restoration Hardware Outlet and are typically located in
outlet malls. Our outlet stores serve as a key part of our reverse logistics platform and provide an efficient means
to sell primarily returned merchandise and, to a lesser extent, discontinued and overstock merchandise outside of
our core sales channels. As of February 1, 2020, we operated 38 outlet stores.

E-Commerce

Our primary RH websites, www.rh.com, www.restorationhardware.com, www.rhmodern.com,
www.rhbabyandchild.com and www.rhteen.com, provide our customers with the ability to purchase our
merchandise online. We sell Waterworks products online through www.waterworks.com.

Our e-commerce platform allows our customers to experience the unique lifestyle settings reflected in our

catalogs and throughout our stores, and to shop all of our current product assortment. We update our websites
regularly to reflect new products, product availability and occasionally special offers.

The RH websites also offer room-based navigation, which allows the customer to envision and shop items
by room or by product, expanding on the richness of the online experience. Customers can search our websites
for products by size or color, browse through our extensive product categories and see detailed information about
each item and collection, such as dimensions, materials and care instructions. Additionally, customers can select
color swatches and view merchandise displayed with different color and fabric options.

5

Source Books

We produce a series of catalogs, which we refer to as Source Books, to showcase our merchandise
assortment. In fiscal 2019, our mailed Source Books included RH Interiors, RH Modern, RH Outdoor, RH
Baby & Child, RH Teen, RH Beach House, RH Ski House and RH Rugs. Our Source Books are one of our
primary branding and advertising vehicles. We have found that merchandise assortments displayed in our Source
Books contribute to increased sales of those products across all of our channels. As in our Galleries, our Source
Books present our merchandise in lifestyle settings that reflect our unique design aesthetic. Our Source Books
also feature profiles of select artisan vendors and other compelling editorial content regarding home décor. All
creative work on our Source Books is coordinated in-house in our RH Center of Innovation & Product
Leadership, providing us greater control over the brand image presented to our customers, while also reducing
our Source Book production costs.

Our Source Book mailings serve as a key driver of sales through both our stores and websites. Our
customers respond to the Source Books across all of our channels, with sales trends closely correlating to the
assortments that we emphasize and feature prominently in our Source Books, websites and Galleries. We
continue to evaluate and optimize our Source Book strategy based on our experience.

We maintain a database of customer information, including customer information from our RH Members
Program, which includes sales patterns, detailed purchasing information and certain demographic information, as
well as mailing and email addresses. We mail our Source Books to addresses within this database and to
addresses provided to us by third parties. The database supports our ability to analyze our customers’ buying
behaviors across sales channels and facilitates the development of targeted marketing strategies, and is
maintained in accordance with our privacy policy disclosed on our website. We segment our customer files based
on multiple variables, and we tailor our Source Book mailings and emails in response to the purchasing patterns
and product needs of our customers. We focus on continually improving the segmentation of customer files and
the expansion of our customer database.

Our Source Books, in concert with our e-commerce channel, are a cost-effective means to test new products,

and allow us to launch categories in a disciplined, expeditious and cost-effective manner.

Trade and Contract

In addition to our core channels, we continue to expand into B2B channels, including Trade and Contract. In

the Trade channel, we work directly with independent interior designers and decorators purchasing products for
their clients’ residential projects. We also sell directly to customers who make purchases with the assistance of
their interior designers or decorators, which we refer to as “designer-assisted sales.” Our Contract business
supplies products to large-scale hospitality, commercial and residential development projects, by working with
architecture and design firms, developers and their ecosystem of business partners. These channels offer
additional avenues for reaching new customers, including both businesses and individuals.

Marketing and Advertising

Our Galleries and our Source Books are the primary branding and advertising vehicles for the RH brands. In

addition, we employ a variety of marketing and advertising vehicles to drive customer traffic across all our
channels, strengthen and reinforce our brand image and acquire new customers. These include targeted Source
Book circulation, promotional mailings, email communications, online and print advertisements, and public
relations activities and events. We use our customer database to tailor our programs and increase productivity of
our marketing and promotion initiatives. We leverage our marketing and advertising expenses across all our
channels as we seek to optimize the efficiency of our investment.

6

The highly-differentiated design aesthetic and shopping environment of our stores drive customer traffic not

only to our stores but also to our direct channel. Our Source Books and targeted emails further reinforce the RH
brand image and drive sales across all of our sales channels. We also engage in a wide range of other marketing,
promotional and public relations activities to promote our brands. These campaigns include media coverage in
design, lifestyle, culture/society and specialty publications, as well as in-store events related to new Design
Gallery openings and product launches. We also engage in print advertising in brand-relevant publications such
as Architectural Digest, Elle Décor, Veranda, Town and Country, T: The New York Times Style Magazine, WSJ.
Magazine and others, and deliver marketing messages to customers via online advertising. We believe that these
efforts will drive increased brand awareness, leading to higher sales over time.

RH Members Program

The RH Members Program is an exclusive program that reimagines and simplifies the shopping experience.

For an annual fee, the RH Members Program provides a set discount every day across all RH brands, excluding
RH Hospitality and Waterworks, in addition to other benefits including complimentary interior design services
through the RH Interior Design program and eligibility for preferred financing plans on the RH Credit Card,
among other benefits. The RH Members Program allows our customers to shop for what they want, when they
want, and receive the greatest value, which has resulted in orders and sales being more evenly distributed
throughout the year as opposed to the peaks and valleys of orders and sales we experienced under the prior
promotional model. We believe the shift to a membership model has enhanced the customer experience, rendered
our brand more valuable, improved operational execution and reduced costs.

Sourcing

We primarily contract with third-party vendors to manufacture our merchandise. Our sourcing strategy
focuses on identifying and using vendors that can provide quality materials and fine craftsmanship that our
customers expect of our brand. To ensure that our high standards of quality and timely delivery of merchandise
are met, we work closely with vendors and manufacturers. Our products are generally made from readily
available raw materials. We seek to ensure the consistent quality of our manufacturers’ products by selectively
inspecting pre-production samples, conducting periodic site visits to certain of our vendors’ production facilities
and selectively inspecting inbound shipments at our distribution facilities. In fiscal 2019, we sourced
approximately 75% of our purchase dollar volume from approximately 31 vendors. In fiscal 2019, one vendor
accounted for approximately 10% of our purchase dollar volume. Based on total dollar volume of purchases for
fiscal 2019, approximately 70% of our products were sourced in from Asia, 16% from the United States and the
remainder from other countries and regions. For fiscal 2019, approximately 38% of our products were sourced
from China.

RH is committed to offering safe, legal, high quality products, made consistently with our values. RH has a
Compliance and Social Responsibility team dedicated to ensuring we keep these commitments through product
testing, audits and other verification methods. Product testing is a core process for our organization. For example,
RH Baby & Child offers an extensive selection of GREENGUARD Gold Certificated children’s furniture.
GREENGUARD Gold Certified products aid in the creation of healthier indoor environments by emitting fewer
airborne chemical compounds that can contribute to health issues, including asthma, allergies and other
respiratory conditions. We are in the process of expanding our offering of GREENGUARD certified collections
to include products in our core brands beyond RH Baby & Child.

While we currently do not have any long-term merchandise supply contracts, we believe that we generally

have strong relationships with our product vendors. Although we transact business primarily on an
order-by-order basis, we typically work with many of our vendors over extended periods of time, and many
vendors are making long-term capacity investments to serve our increasing demands.

7

Distribution and Delivery

We manage the distribution and delivery of our products through our distribution centers. We currently
operate two furniture fulfillment centers and one small parcel fulfillment center servicing RH products, which are
located strategically in three markets throughout the United States. We have one fulfillment center in the United
States servicing Waterworks products.

We operate portions of our home delivery services in 13 key markets to leverage operating costs and
improve our customers’ delivery experience, while reducing returns and damage to our products. We offer a
white glove home delivery service for our larger merchandise and furniture categories, where third-party
personnel deliver fully assembled items to the location of our customers’ choice. We believe there is an
opportunity to improve the customer experience by taking greater control of the home delivery experience over
time. We believe that many third-party furniture delivery providers are designed to support mass and mid-market
companies and that significant opportunity exists for developing improved solutions for the luxury market. We
believe we have dramatically enhanced the customer experience while reducing return rates, damages and
deliveries per order by enhancing the quality of our delivery providers through metric-based accountability
standards.

Through our distribution center network redesign, reverse logistics and outlet redesign, and the

reconceptualization of home delivery, we have improved our supply chain and fulfillment capabilities, and have
built a scalable infrastructure to support our future growth. We believe our enhanced supply chain and fulfillment
operations allow us to manage customer orders and distribute merchandise to our customers in an efficient and
cost-effective manner. We also believe that these upgrades have improved customer satisfaction by reducing
delivery times, reducing damage to merchandise, and improving our customer’s overall buying experience.

Competition

The home furnishings industry is highly competitive. We primarily compete against a large number of
independent retailers that provide unique items and custom-designed product offerings at high price points,
including antique dealers and home furnishings retailers who market to the interior design community. We also
compete with national and regional home furnishings retailers and department stores, as well as with mail order
catalogs and online retailers focused on home furnishings.

We believe that we compete primarily on the basis of design, quality and value, and that our distinct
combination of these elements, along with the strength of our brand and our fully integrated multi-channel
business model, allows us to compete effectively and differentiate ourselves from competitors. We compete with
the interior design trade and specialty merchants by providing a high quality, broad product assortment at an
exceptional value. We compete against certain other home furnishings retailers primarily by offering what we
believe are superior quality, highly distinctive design styles and a sophisticated lifestyle presentation in our
product offering.

We also believe that our success depends in substantial part on our ability to originate and define product
trends, as well as to timely anticipate, gauge and react to changing consumer demands. Certain competitors are
larger and have greater financial, marketing and other resources than us. However, many smaller specialty
retailers may lack the financial resources, infrastructure, scale and national brand identity necessary to compete
effectively with us. We believe we are effectively positioned to gain market share from both of these segments
and drive growth.

Employees

As of February 1, 2020, we had approximately 5,100 employees, of which approximately 700 were part-
time employees. As of that date, approximately 3,000 of our employees were based in our stores. None of our
employees are represented by a union, and we have had no labor-related work stoppages. We believe our
relations with our employees are good.

8

Intellectual Property

The “RH,” “Restoration Hardware,” “RH Interiors,” “RH Modern,” “RH Outdoor,” “RH Baby & Child,”
“RH Teen,” “RH Beach House,” “RH Ski House,” “RH Rugs” and “Waterworks,” and “Waterworks Studio”
trademarks, among others, are registered or are the subject of pending trademark applications with the United
States Patent and Trademark Office and with the trademark registries of several foreign countries. Each of our
trademark registrations is perpetually renewable provided that we use or continue to use the trademarks in
commerce in the particular geographic market and for the goods or services covered by the registration. In
addition, we own many domain names, including “rh.com,” “restorationhardware.com,” “rhmodern.com,”
“rhbabyandchild.com,” “rhteen.com,” “rhbeachouse.com,” “rhskihouse.com,” “waterworks.com” and others that
include our trademarks. These domain names are perpetually renewable. We own design patents or pending
design patent applications to protect the ornamental appearance of several of our products. These design patents
are valid for 15 years from their date of issuance. We own copyrights, including copyright registrations or
pending applications, for our website and for several of our Source Books. We believe that our trademarks,
design patents, and copyrights have significant value and we vigorously protect them against infringement.

Fluctuation in Quarterly Results

Our quarterly results vary depending upon a variety of factors, including our product offerings, store
openings, shifts in the timing of holidays and the timing of Source Book releases, promotional events and the
timing and extent of our realization of the costs and benefits of our numerous strategic initiatives, among other
things. As a result of these factors, our working capital requirements and demands on our product distribution
and delivery network may fluctuate during the year. Unique factors in any given quarter may affect
period-to-period comparisons between the quarters being compared, and the results for any quarter are not
necessarily indicative of the results that we may achieve for a full fiscal year.

Corporate Information

The Company was formed as a Delaware corporation on August 18, 2011. On November 7, 2012, the
Company completed an initial public offering. On December 15, 2016, Restoration Hardware Holdings, Inc. filed
a Certificate of Amendment to its Amended and Restated Certificate of Incorporation with the Secretary of State
of the State of Delaware to change its name to “RH,” effective January 1, 2017.

Regulation and Legislation

We are subject to numerous regulations, including labor and employment laws, customs, laws governing

truth-in-advertising, consumer protection, privacy, safety, real estate, environmental and zoning and occupancy
laws, and other laws and regulations that regulate retailers and govern the promotion and sale of merchandise and
the operation of our retail locations, outlets and warehouse facilities, in the United States, Canada and the U.K.,
as well as in jurisdictions from which we source our products. We believe we are in material compliance with
laws applicable to our business.

Where You Can Find More Information

We are required to file annual, quarterly and current reports, proxy statements and other information
required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the SEC. The SEC
maintains a website that contains reports, proxy statements and other information about issuers, like us, who file
electronically with the SEC. The address of that website is http://www.sec.gov.

We maintain public internet sites at www.restorationhardware.com and www.rh.com and make available,

free of charge, through these sites our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5 filed on behalf of directors and executive officers,

9

as well as any amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably
practicable after we electronically file such material with, or furnish it to, the SEC. We also put on our websites
the charters for our Board of Directors’ Audit Committee, Compensation Committee, and Nominating and
Corporate Governance Committee, as well as our Code of Business Conduct, our Corporate Governance
Guidelines and Code of Ethics governing our chief executive and senior financial officers and other related
materials. The information on our websites is not part of this annual report.

Our Investor Relations Department can be contacted at RH, 15 Koch Road, Corte Madera, CA 94925,

Attention: Investor Relations; telephone: 415-945-3500; e-mail: investorrelations@rh.com.

Item 1A. Risk Factors

Certain factors may have a material adverse effect on our business, financial condition, and results of
operations. You should consider carefully the risks and uncertainties described below, in addition to other
information contained in this Annual Report on Form 10-K, including our consolidated financial statements and
related notes. If any of the following risks actually occurs, our business, financial condition, results of
operations, and future prospects could be materially and adversely affected. In that event, the trading price of
our common stock could decline, and you could lose part or all of your investment. The risks and uncertainties
described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that
we currently believe are not material, may also become important factors that adversely affect our business.

Risks Related to Our Business

The global outbreak of the COVID-19 virus is likely to have an adverse impact on our business.

The global outbreak of the coronavirus (COVID-19) poses significant and widespread risks to our business

as well as to the business environment and the markets in which we operate our business. We have already
experienced significant disruption to our business as a result of the rapid development of the COVID-19
pandemic. The immediate impact from this global health crisis has been both in terms of disruption in numerous
aspects of our business operations, as well as indirect in terms of the adverse effect on overall economic
conditions. For example, the Company has temporarily closed its retail locations for an indeterminate period of
time, and we believe changes in consumer behavior and health concerns have impacted customer demand. The
magnitude and duration of the negative impact to our business from the COVID-19 pandemic cannot be
predicted with certainty. Accordingly, we withdrew all prior guidance and outlook statements that relate to the
performance of our business with respect to fiscal 2020.

Public health officials and other governmental authorities have adopted numerous mitigation measures to
address the spread of the virus, and in particular to discourage people from congregating in public, commercial or
private spaces. Federal, state and local authorities in the U.S. and Canada have implemented a number of
different directives that encourage or require changes in our business practices including requirements to close
our retail stores and to curtail various aspects of our business operations. The scope and duration of these
directives is evolving and not entirely clear. A large number of states and municipalities in the U.S. where we
operate have implemented temporary closure requirements with respect to non-essential business operations and
the duration of these requirements are unknown. Governmental restrictions applicable to our restaurants have
different terms and conditions than those that apply to our Galleries. Many of our Galleries are located in malls
or otherwise located in proximity to a number of other retail stores. A number of mall operators as well as other
retailers have elected to temporarily cease operations and our decision to close Galleries has been influenced by
these closures of other retail locations.

In response to the public health crisis posed by COVID-19, effective from March 17, 2020, the Company

temporarily closed its retail locations for an indeterminate period of time. Although we continue to serve our
customers virtually through our Gallery representatives and designers, as well as our online websites, our
business operations are being substantially affected by applicable regulatory restrictions including stay-at-home

10

requirements applicable in California where our corporate headquarters is located. Our decision to reopen retail
locations will be affected by a number of factors including applicable regulatory restrictions and there is
substantial uncertainty regarding the manner and timing in which we can return some or all of our business to
more normal business operations. We may face longer term closure requirements and other operational
restrictions with respect to some or all of our physical locations for prolonged periods of time due to, among
other factors, evolving and increasingly stringent federal, state and local restrictions including shelter-in-place
orders. Even once we are able to reopen closed physical locations, changes in consumer behavior and health
concerns may continue to impact consumer demand for our products and customer traffic at our Galleries,
restaurants and outlets and may make it more difficult to staff our business operations. The COVID-19 outbreak
may have a material adverse impact on our supply chain including the manufacture, supply, distribution,
transportation and delivery of our products. There have been substantial disruptions that have already occurred
with respect to the global supply chain as a result of the COVID-19 health crisis. Our business depends on the
successful operation of a global supply chain. Based on total dollar volume of purchases for fiscal 2019,
approximately 70% of our products were sourced in from Asia (including a substantial portion from China), 16%
from the United States and the remainder from other countries and regions. Although China was at the center of
the initial outbreak of the COVID-19, the health crisis has spread to numerous other countries throughout the
world. The presence of the virus and the response to the health crisis in various countries is likely to have a
continuing impact on our supply chain and the extent that the health crisis may abate in particular countries such
as China is uncertain.

If we are not able to access capital at the time and on terms that our business requires, we may encounter
difficulty funding our business requirements including debt repayments when due. We may not be able to access
liquidity or the terms and conditions of available credit may be substantially more expensive than previously
expected due to changes in financial conditions and credit markets. We may require waivers or amendments to
our existing credit facilities and these requirements may trigger pricing increases from lenders for available
credit. If we are not able to access credit to fund our business requirements for liquidity, or the cost of available
credit increases, we may need to curtail our business operations including various business initiatives that require
capital investment. We have recently commenced an effort to expand our business internationally by establishing
a new retail presence in global markets including Europe and the United Kingdom. In addition, we are in the
process of developing a number of new Gallery locations in the U.S. In addition, our RH Guesthouse initiative
may be negatively impacted by the disease outbreak as federal, state and local governments have restricted travel,
conferences, events and gatherings. Reductions in our liquidity position and the need to use capital for other day
to day requirements of our business may affect a number of our business initiatives and long-term investments
and as a result we may be required to curtail and/or postpone business investments including those related to
international expansion, the pace of opening new Galleries in the U.S. as well as other initiatives that require
capital investment.

Our business also depends on a number of third parties including vendors, landlords, lenders and other
suppliers. One or more of these third parties may experience financial distress, staffing shortages or liquidity
challenges, file for bankruptcy protection, go out of business, or suffer disruptions in their business due to the
COVID-19 outbreak. The health crisis, resulting deterioration in financial markets and overall economic
conditions could have a material adverse effect on the financial condition of third parties that are essential to our
business operations and we may incur losses and other negative impact for difficulties experienced by our
vendors and other third parties.

As a result of the COVID-19 outbreak, and the corresponding reduction in our sales, we have had to
institute a number of measures to mitigate expenses and reduce costs. These efforts may not be enough to offset
anticipated declines in revenue including the loss of sales related to store closures, and may negatively affect our
ability to quickly resume operations when we are able to re-open our Galleries, restaurants and outlets. In
addition, new regulation or requirements with respect to the compensation of our employees that governmental
authorities may impose could also have an adverse effect on our business. Substantially all of our management
personnel, including those in our corporate office in Corte Madera, CA, are subject to shelter-in-place

11

requirements which have resulted in most of our management team being required to work remotely. These
working arrangements as well as other related restrictions including severe limitations on travel may have an
impact on our operations and management effectiveness. Although we have technology and other resources to
support these new work requirements, there can be no assurance that we will not suffer material risks to our
business, operations, productivity and results of operations as a result of these restrictions. If a significant
percentage of our workforce is unable to work, including because of illness or travel or government restrictions
in connection with COVID-19, our operations may be negatively impacted, potentially materially adversely
affecting our business, liquidity, financial condition or results of operations.

The COVID-19 pandemic and mitigation measures have also had an adverse impact on global economic
conditions as well as the business climate in our primary consumer markets in the U.S. and Canada, which could
have an adverse effect on our business and financial condition and our ability to regain previous sales levels as
we reopen our retail locations. Our business also depends to some extent on conditions in financial markets. We
have determined that our customer purchasing patterns are influenced by economic factors including the health
of the stock market. We have seen that previous downturns in the stock market have been correlated with a
reduction in consumer demands for our products. The precise impact on our business from the disruption of
financial markets and the weakening of overall economic conditions cannot be predicted with certainty.
Uncertainties regarding the economic impact of COVID-19 have resulted in, and are likely to continue to result
in, sustained impact on the economy. The Company’s business is particularly sensitive to reductions in
discretionary consumer spending, which may be adversely impacted by a recession or fears of a recession,
volatility and declines in the stock market and increasingly pessimistic consumer sentiment due to perceived or
actual economic and/or health risks.

The global scale and scope of COVID-19 is unknown and the duration of the business disruption and related

financial impact cannot be reasonably estimated at this time. The extent to which the COVID-19 pandemic
impacts our results will depend on future developments that are highly uncertain and cannot be predicted,
including the duration of our RH Galleries, restaurant and outlet closures, emerging information concerning the
severity of COVID-19 and the actions taken by governments and private businesses to attempt to contain
COVID-19. However, the Company believes COVID-19 is likely to result in an adverse impact on our business,
results of operations and financial condition, particularly if ongoing mitigation actions occur for a significant
amount of time.

We have experienced significant fluctuations in the growth rate of our business during the last several years,
and high levels of growth may not be achieved in future periods and may not generate a corresponding
improvement in our results of operations.

We have experienced significant fluctuations in the growth rate of our business during the last several years.
We may continue to experience wide fluctuations in quarter-to-quarter performance, not only because the rate of
sales growth in some quarters may be slower than in prior periods but also because we may experience some
quarters that have growth rates that are higher than prior periods. We are currently engaged in a number of
initiatives to support the growth and transformation of our business, including investments to elevate the
customer experience, which includes architecting a new fully integrated back-end operating platform, inclusive
of the supply chain network, the home delivery experience as well as a new metric-driven quality system and
company-wide decision data, the transition from a promotional to a membership model, and a more aggressive
approach to rationalizing our SKU count and optimizing inventory including through selling slower moving,
discontinued and other inventory through markdowns and our outlet channel. While we anticipate that these
initiatives will support the growth of our business, costs and timing issues associated with pursuing these
initiatives can negatively affect our gross margins in the short term and may amplify fluctuations in our growth
rate from quarter to quarter depending on the timing and extent of our realization of the costs and benefits of such
initiatives.

There can be no assurance that these efforts will be successful or that we will not encounter other

operational difficulties that may have a material negative impact on growth and profitability. In addition, these

12

initiatives may have near-term material negative impacts on growth and profitability as we incur costs or pursue
strategies that may not contribute to our profits and margins until future periods, if at all. For example, in fiscal
2017, net revenues increased 14%, of which 2.9 points of growth was related to higher outlet and warehouse
sales stemming from our accelerated inventory optimization efforts. While our higher outlet revenues and
inventory optimization efforts had a positive impact on revenues and working capital, they had a negative impact
on margins and earnings.

Some factors affecting our business, including macroeconomic conditions and policies and changes in
legislation, are not within our control. In prior periods, our results of operations have been adversely affected by
weakness in the overall economic environment such as periods of economic recession as well as slowdowns in
the housing market. Our business depends on consumer demand for our products and, consequently, is sensitive
to a number of factors that influence consumer spending, including, among other things, the general state of the
economy, capital and credit markets, consumer confidence, general business conditions, the availability and cost
of consumer credit, the level of consumer debt, interest rates, level of taxes affecting consumers, housing prices,
new construction and other activity in the housing sector and the state of the mortgage industry and other aspects
of consumer credit tied to housing, including the availability and pricing of mortgage refinancing and home
equity lines of credit.

In particular, our business performance is linked to the overall strength of luxury consumer spending in
markets in which we operate. Economic conditions affecting selected markets in which we operate are expected
to have an impact on the strength of our business in those local markets. As an example, during periods in which
the price for oil declined rapidly, we experienced a slowing in our business in some regions where the economy
is linked to energy exploration and production, including Texas and Canada. The global economic environment is
currently in a period of heightened uncertainty, and in the event that equity and credit markets continue to
experience volatility and disruption, our results of operations may be adversely affected.

In addition, our rates of revenue growth have sharply fluctuated from quarter to quarter over the last
three years and we expect volatility in the rates of our growth to continue in future quarterly periods. Unique
factors in any given quarter may affect period-to-period comparisons in our revenue growth, including;

•

•

•

•

•

•

•

•

•

•

the overall economic and general retail sales environment, including the effects of uncertainty or stock
market volatility on consumer spending;

consumer preferences and demand;

the number, size and location of stores we open, close, remodel or expand in any period;

changes in Source Book circulation, and the number of pages in our Source Books and timing of
mailing;

our ability to efficiently source and distribute products;

changes in our product offerings and the introduction, and timing thereof, of introduction of new
products and new product categories;

promotional events;

our competitors introducing similar products or merchandise formats;

the timing of various holidays, including holidays with potentially heavy retail impact; and

the success of our marketing programs.

Due to these factors, our results for any quarter are not necessarily indicative of the results that we may

achieve for a full fiscal year. Our results of operations may also vary relative to corresponding periods in
prior years. We may take certain pricing, merchandising or marketing actions that could have a disproportionate
effect on our business, financial condition and results of operations in a particular quarter or selling season, and
as a result we believe that period-to-period comparisons of our results of operations are not necessarily
meaningful and cannot be relied upon as indicators of future performance.

13

Other future developments in our business could also result in material changes in our operating costs,
including increased merchandise inventory costs and costs for paper and postage associated with the mailing and
shipping of Source Books and products. We cannot assure you that we will succeed in offsetting any such
expenses with increased efficiency or that cost increases associated with our business will not have an adverse
effect on our financial results.

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

We are undertaking a large number of new business initiatives at the same time in order to support our
future growth. For example, we have developed and continue to refine and enhance our Gallery format, which
involves larger store square footage. We also continue to add new product categories and to expand product
assortments. For example, in fiscal 2015 we launched our new RH Modern and RH Teen categories and in fiscal
2019 we launched RH Beach House and RH Ski House. We are currently contemplating other new product lines
and extensions. We introduced RH Hospitality in fiscal 2015 at RH Chicago, The Gallery at the Three Arts Club.
As of February 1, 2020, eight of our RH Design Galleries included an integrated RH Hospitality experience and,
based on the success of our hospitality offering to date, we plan to incorporate an integrated RH Hospitality
offering, including cafés, wine vaults, and barista bars, in many of the new Galleries that we open in the future.
We continue to refine and develop the RH Hospitality model as we seek to optimize this part of our business and
its integration with the operation of our Gallery locations. RH Hospitality is different from our traditional home
furnishings business and involves evolving strategies that are untested and unproven and may expose us to a
number of risks including risks related to the management and execution of food and hospitality operations in
various locations where we operate retail locations. Although we have experienced a number of positive business
outcomes from the RH Hospitality operations including the incremental revenue that we believe is driven in
Gallery with a hospitality offering, there can be no assurance that these benefits will be sustained or that we will
avoid operational or other complications from the hospitality business. There can be no assurance that we will
successfully scale RH Hospitality, that we will optimally balance the resources and square footage allocated to
our hospitality offerings versus our product offerings at our Galleries, or that our hospitality offerings will be
attractive to consumers in our market over a sustained period of time.

We have also embarked on an initiative to expand our product sales to international markets and are
currently exploring opportunities for Design Galleries in several locations outside the United States, including
the U.K. and Europe. International expansion will expose us to new risks, including, but not limited to, risks
related to currency fluctuation, supply chain and product sourcing, new regulatory regimes applicable to our
products, Galleries and employees, global health emergencies such as that related to the outbreak of COVID-19,
and international economic or political events including but not limited to the U.K.’s withdrawal from the
European Union, commonly referred to as “Brexit,” from which there is expected to be considerable change in
the regulatory framework governing business in the U.K. and which may negatively impact the luxury market.
We may be unsuccessful in adapting our operations to address such risks. We also may be unsuccessful in
accurately selecting which international markets would support demand for our products or sizing our Gallery
openings to such markets. If we are not successful in managing the large number of new initiatives that are
underway, we might experience an adverse impact on our financial condition and results of operations. We may
determine to curtail and/or slow our international expansion initiative as part of our efforts to manage liquidity in
response to overall market conditions and to address priorities in the different capital requirements of our
business.

Furthermore, we can provide no assurances that customers will respond favorably to our new product

offerings, Galleries or complementary businesses or that we will successfully execute on such business
initiatives. Such new business opportunities may not achieve market acceptance or may only achieve market
acceptance in limited geographic areas or at certain Design Galleries. In addition, developing and testing new and
multiple business opportunities and strategies often requires knowledge in areas of expertise that may be new to

14

our organization and may require significant time of our management and resources. For example, RH
Hospitality extended our business into an area where we have had limited historical operating and management
experience and where low margins and high customer expectations can put pressure on results and performance.
Expanding our business internationally will also require that we develop management expertise in new markets
and regulatory regimes, and an inability to adapt our business quickly and efficiently to support our international
expansion could materially adversely affect our financial condition and results of operations. We can provide no
assurances that we will be successful in expanding our operations into any new businesses and product lines.

Any new businesses we enter may also expose us to additional laws, regulations and risks, including the risk

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

We often have in the past, and may in the future, incur significant costs for any new initiative before we

realize any corresponding revenue with respect to such initiative. In addition, we may incur costs as we revise,
restructure or discontinue existing product categories or business offerings in favor of pursuing new initiatives or
retail concepts. For example, as we continue to open larger format Design Galleries in select major metropolitan
markets, we expect to close a number of legacy Galleries and replace them with our Design Gallery format. The
introduction of an integrated hospitality experience, including roll out of an integrated food and beverage
experience at a new Gallery location often requires significant investments by us before the location is open to
customers and able to generate revenues, and we anticipate that a number of Galleries to be opened during the
next several years will continue to require this form of upfront investment before they generate revenue from the
food and beverage offerings. To the extent that these new business opportunities do not generate sufficient
revenue to recoup the cost of developing and operating such new concepts, our results of operations could be
materially adversely affected.

In addition, we are continuing a number of new initiatives to improve the operations of our business,

including ongoing refinements to our management structure and organizational design. Some of the
improvements we are pursuing include changing the ways we source and deliver our products to our customers,
as well as streamlining and realigning the management structure in our home office operations. We have also
focused on elevating the customer experience, which includes improving our distribution and delivery of
products to our customers and architecting a new fully integrated back-end operating platform, inclusive of the
supply chain network, the home delivery experience as well as a new metric-driven quality system and company-
wide decision data. We have focused on rationalizing our SKU count and optimizing inventory, which includes
selling slower moving, discontinued and other inventory through markdowns and our outlet channel, as well as
enhancing and optimizing our product sourcing capabilities and adding new management information systems.

Given the large number of organizational initiatives we are pursuing, as well as the complexity and untested

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

All of the foregoing risks may be compounded due to various factors including any economic downturn. If

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

15

Changes in consumer spending and factors that influence spending of the specific categories of consumers
that purchase from us, including the health of the high-end housing market, may significantly impact our
revenue and results of operations.

We target consumers of high-end home furnishings as customers for our products. As a result, we believe
that our sales are sensitive to a number of factors that influence consumer spending generally, but are particularly
affected by the financial health of the higher end customer and demand levels from that customer demographic.
In addition, not all macroeconomic factors are highly correlated in their impact on lower end housing versus the
higher end customer. Demand for lower priced homes and first time home buying may be influenced by factors
such as employment levels, interest rates, demographics of new household formation and the affordability of
homes for the first time home buyer. The higher end of the housing market may be disproportionately influenced
by other factors including the number of foreign buyers in higher end real estate markets in the U.S., the number
of second and third homes being sold, stock market volatility and illiquid market conditions, global economic
uncertainty, decreased availability of income tax deductions for mortgage interest and state income and property
taxes, and the perceived prospect for capital appreciation in higher end real estate. In recent periods the stock
market has experienced significant volatility as well as periods of significant decline, and rising house prices
have dampened and increases in interest rates may dampen growth in the U.S. housing market and may depress
consumer optimism about the U.S. housing market and home buying in the higher end of the housing market.
There can be no assurance that some of the other macroeconomic factors described above will not adversely
affect the higher end consumer that we believe makes up the bulk of our customer demand.

We believe that a number of these factors have in the past had, and may in the future have, an adverse
impact on the high-end retail home furnishings sector and affect our business and results. These factors may
make it difficult for us to accurately predict our operating and financial results for future periods and some of
these factors could contribute to a material adverse effect on our business and results of operations.

If we are unable to maintain and enhance our brand or market our product offerings, we may be unable to
attract a sufficient number of customers or sell sufficient quantities of our products.

Our business depends in part on a strong brand image, and we continue to invest in the development of our
brand and the marketing of our business. We believe that the brand image we have developed, and the lifestyle
image associated with our brand, have contributed significantly to the success of our business to date. We also
believe that maintaining and enhancing our brand is integral to the future of our business and to the
implementation of our strategies for expanding our business. This will require us to continue to make
investments in areas such as marketing and advertising, as well as the day-to-day investments required for store
operations, Source Book mailings, website operations and employee training. Our brand image may be
diminished if new products, services or other businesses fail to maintain or enhance our distinctive brand image.

Additionally, our reputation could be jeopardized if we fail to maintain high standards for merchandise and

service quality. With the growth in importance and the impact of social media, any negative publicity from
product defects, recalls or failures in service may be magnified and reach a large portion of our customer base in
a very short period of time, which could harm the value of our brand and, consequently, our financial
performance could suffer. We may also suffer reputational harm if we fail to maintain high ethical, social and
environmental standards for all of our operations and activities, if we fail to comply with local laws and
regulations or if we experience other negative events that affect our image or reputation. Any failure to maintain
a strong brand image could have an adverse effect on our sales and results of operations.

Our failure to successfully manage the strategy and costs of our Source Book mailings or other promotional
programs and costs could have a negative impact on our business.

Source Book mailings are an important component of our business. We continue to adjust and refine our
Source Book mailing strategy based on a variety of factors, including the success of the various changes that we

16

adopt. We can provide no assurances as to the success of any Source Book strategy we pursue. Increased
expenditures on our catalog strategy may result in the production of too many Source Books, which could
negatively affect our operating margins. Reducing expenditures on our catalog strategy, however, could overly
restrict catalog circulation and have a negative effect on our revenues. Our efforts to optimize our Source Books
and strategies for use of the Source Books to market our business may encounter difficulties. There can be no
assurance that we will be successful as we make changes to our Source Book strategy including with respect to
the cadence and timing of mailings, the format of the Source Books, the team we staff for optimizing our Source
Book format and mailings, and the use of the Source Books as a marketing and promotional tool including with
respect to prospecting for new customers. Additionally, due to the size of our Source Books we have in the past
received negative publicity from environmental groups. If we fail to adequately adjust our catalog strategy to
meet our goals, or if our catalog strategy is unsuccessful, our results of operations could be negatively impacted.

We also rely on customary discounts from the basic shipping rate structure that are available for our catalog

mailings, which could be changed or discontinued at any time, and we are subject to fluctuations in the market
price for paper, which has historically fluctuated significantly and may continue to fluctuate in the future. Future
increases in shipping rates, paper costs or printing costs would have a negative impact on our results of
operations to the extent that we are unable to offset such increases through increased sales or by raising prices, by
implementing more efficient printing, mailing, delivery and order fulfillment systems, or by using alternative
direct-mail formats.

We have historically experienced fluctuations in customer response to our Source Books. Customer
response depends substantially on product assortment, product availability and creative presentation, the
selection of customers to whom the catalogs are mailed, changes in mailing strategies, page size, page count,
frequency and timing of delivery of catalogs, as well as the general retail sales environment and current domestic
and global economic conditions. The failure to effectively produce or distribute our catalogs could affect the
timing of catalog delivery. The timing of catalog delivery has in the past been, and in the future can be, affected
by shipping service delays. Any delays in the timing of catalog delivery could cause customers to forgo or defer
purchases. If the performance of our catalogs declines, if we misjudge the correlation between our catalog
circulation and net revenues, or if our catalog circulation optimization strategy is not successful, our results of
operations could be negatively impacted.

Competition in the home furnishings sector of the retail market may adversely affect our future financial
performance.

The home furnishings sector within the retail market is highly competitive. We compete with the interior
design trade and specialty stores, as well as antique dealers and other merchants that provide unique items and
custom-designed product offerings at higher price points. We also compete with national and regional home
furnishing retailers and department stores. In addition, we compete with mail order catalogs and online retailers
focused on home furnishings.

We compete generally with these other retailers for customers, suitable retail locations, vendors, qualified
employees and management personnel. As we have traditionally been a leader in the home furnishings sector,
some of our competitors have also attempted to imitate our product offerings and business initiatives from time
to time in the past. In addition, many of our competitors have significantly greater financial, marketing and other
resources than we do and therefore may be able to devote greater resources to the marketing and sale of their
products, generate greater national brand recognition or adopt more aggressive pricing policies than we can. Such
competitors may also be able to adapt to changes in customer preferences more quickly than we can due to their
greater financial or marketing resources, through new product launches or by adapting their business models and
operations to new customer trends, which may in turn change how our customers acquire products or view our
business and brand. Further, increased catalog mailings by our competitors may adversely affect response rates to
our own Source Book mailings. There can be no assurance that such competitors will not be more successful than
us, based on imitation or otherwise, or that we will be able to continue to maintain a leadership position in style
and innovation in the future.

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Increased competition also has resulted, and may in the future result, in potential or actual litigation between

us and our competitors related to a variety of activities, including hiring practices. If we are not successful in
such litigation, our business could be harmed.

If we fail to successfully anticipate consumer preferences and demand our results of operations may be
adversely affected.

We are vulnerable to customer preferences and demand. Our success depends in large part on our ability to

originate and define home product trends, as well as to anticipate, gauge and react to changing consumer
demands in a timely manner. Our products must appeal to a range of consumers whose preferences cannot
always be predicted with certainty. We cannot assure you that we will be able to continue to develop products
that customers positively respond to or that we will successfully meet consumer demands in the future. Any
failure on our part to anticipate, identify or respond effectively to consumer preferences and demand could
adversely affect sales of our products, which could have a material adverse effect on our financial condition and
results of operations.

If we fail to successfully and timely deliver merchandise to our customers and manage our supply chain
commensurate with demand, our results of operations may be adversely affected.

We must successfully manage our supply chain and vendors in order to produce sufficient quantities of

products that our customers wish to purchase in a timely manner. We must manage our supply chain and
inventory levels, including predicting the appropriate levels and type of inventory to stock within each of our
distribution centers, such that our “in stock” position in merchandise correlate well to consumer demand and
expected delivery times. Because much of our merchandise requires that we provide vendors with significant
ordering lead times, frequently before market factors are known, we may not be able to source sufficient
inventory to meet demand if our products prove more popular than anticipated. In addition, our current initiatives
to streamline and optimize our inventory levels may not be successful and implementing such initiatives may
complicate our efforts to manage our supply chain. To the extent our business initiatives result in new product
lines, new product or service offerings or expansion into new markets in the U.S. or abroad, we may need to
establish new vendor relationships or new supply chain operations, which may expose us to new counterparty,
regulatory, market or other risks and which may not be successful. From time to time, we have experienced
periods in which some of our vendors were not able to meet customer demand levels for certain products
resulting in significant back orders for goods, higher rates of cancellation on orders in process and, in some
instances, the loss of customer sales when orders could not be completed in a timely manner. In addition,
vulnerabilities in the information systems of our vendors could make our vendors the targets of cybersecurity
breaches or cyber fraud, which could result in disruptions in our supply chain and product sourcing. Further, the
seasonal nature of some of our products requires us to carry a significant amount of inventory prior to certain
selling seasons. If we are unable to accurately predict and track demand, we may be required to mark down the
price of certain products in order to sell excess inventory or we may be required to sell such inventory through
our outlet stores or warehouse sales. For these reasons, our results of operations in any given quarterly period
may be adversely affected. We expect these factors to continue from time to time as we add new product
assortments and new merchandise categories into our business.

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

Based on total dollar volume of purchases for fiscal 2019, approximately 70% of our products were sourced

from Asia, 16% from the United States and the remainder from other countries and regions. For fiscal 2019,
approximately 38% of our products were sourced from China. We expect the amount of products that we source
from China will be lower in fiscal 2020 compared to fiscal 2019, but the exact product mix in terms of vendor
factory locations is subject to a range of different factors and is inherently difficult to predict with accuracy. In
addition, some of the merchandise we purchase from vendors in the United States also depends, in whole or in

18

part, on vendors located outside the United States. As a result, our business highly depends on global trade, as
well as any trade and or other factors that impact the specific countries where our vendors’ production facilities
are located. Our future success will depend in large part upon our ability to maintain our existing foreign vendor
relationships and to develop new ones based on the requirements of our business and any changes in trade
dynamics that might dictate changes in the locations for sourcing of products. In addition, we face risks related to
the ability of our vendors to scale their operations whether in connection with new products we introduce or new
production manufacturing locations that may be added to our supply chain, which in some cases would require
substantial ongoing investments to support additional capacity. In addition, we have previously encountered
difficulties in the ability of our vendors to scale production commensurate with demand from our customers.
While we rely on long-term relationships with many of our vendors, we do not rely on long-term contracts with
our vendors and generally transact business with them on an order-by-order basis.

Many of our imported products are subject to existing duties, tariffs, anti-dumping duties and other similar

trade restrictions that may limit the quantity or affect the price of some types of goods that we import into the
United States. In addition, substantial regulatory uncertainty exists regarding international trade relations and
trade policy, both in the United States and abroad. An introduction of new duties, tariffs, quotas or other similar
trade restrictions, or increases in existing duties or tariff rates, on products imported into the United States,
whether actual, pending or threatened, may have a negative impact on our results of operations. Significant
uncertainty exists as to whether and when tariffs may be imposed, and what countries may be implicated. For
example, proposed tariffs on goods imported from Mexico have been introduced and subsequently withdrawn by
the U.S. government. Additionally, such uncertainties, even if not directly applicable to our imported products,
may have a negative influence on the domestic and international economy generally and indirectly reduce market
demand for our products.

A significant subset of our products sourced from China has been affected by increased levels of tariffs that
were imposed in 2018 and 2019. The initial round of these increased tariffs became effective on certain products
that we source from China including furniture and lighting initially as a 10 percent ad valorem duty on
September 24, 2018, which amount increased to 25 percent on May 10, 2019, and is expected to increase further
to 30 percent on October 1, 2019. On August 1, 2019, President Trump announced a new 10 percent ad valorem
duty on additional categories of goods imported from China, which amount was then increased to 15 percent on
August 23, 2019. The new tariff at the rate of 15 percent became effective September 1, 2019 with respect to
certain categories of goods and was expected to become effective for additional categories of goods on
December 15, 2019. In January 2020, the U.S. and China signed a “Phase One” trade agreement pursuant to
which, among other things, the U.S. will modify its Section 301 tariff actions and which suspended the tariff on
this additional set of goods. Further, as of February 14, 2020, the 15 percent tariff which was implemented on
September 1, 2019 was reduced to 7.5 percent.

While we have been working with our vendor partners on mitigation strategies to seek to address the impact

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

In addition, we are undertaking ongoing efforts to examine our sourcing strategy in a comprehensive way in
order to achieve the best possible outcomes for our business. Such efforts include addressing among other factors

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

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

There can be no assurance that we will not experience disruption in our business related to tariffs or other
changes in trade practices and applicable rules or as a result of our efforts to respond to these matters. Tariffs and
other similar trade actions are inherently unpredictable and can change quickly based on political or economic
pressures or policy changes. Any changes to tariffs or other rules and practices related to cross border trade,
including the possible implementation of additional tariffs, could materially increase our cost of goods sold with
respect to merchandise that we purchase from vendors who manufacture products in China or other countries
outside the United States, which could in turn require us to increase our prices and, in the event consumer
demand declines as a result, negatively impact our financial performance. While we may seek to adopt mitigation
measures and changes to our business practices to seek to counteract the effect of such tariffs on our business and
results of operations, due to multiple factors that can occur in the context of trade disputes and the inherent
unpredictability of how customers and market participants may respond, any mitigation measures we adopt may
be not achieve their intended purpose. Certain of our competitors may be better positioned than us to withstand
or react to these kinds of changes including border taxes, tariffs or other restrictions on global trade and as a
result we may lose market share to such competitors. In addition, to the extent that our competitors, our vendors
or companies in other industries that manufacture products in China respond to the tariffs imposed to date or the
possibility of future tariffs by shifting production to other countries in Asia or to other regions, the costs of
production in such countries may increase, which may increase our costs or otherwise have an adverse impact on
our product supply chain. Similarly, to the extent that we or our vendors respond to the tariffs imposed to date or
the possibility of future tariffs by shifting merchandise purchases or production to other countries in Asia or to
other regions, we may face delays or costs associated with developing new vendor relationships and our vendors
may face delays or costs associated with bringing online new manufacturing facilities, which may increase the
cost of our products or cause delays in the shipment of our merchandise that result in the cancellation of orders
by our customers. An interruption or delay in supply from our foreign sources, or the imposition of additional
duties, taxes or other charges on these imports, could have a material adverse effect on our business, financial
condition and results of operations unless and until alternative supply arrangements are secured. Due to broad
uncertainty regarding the timing, content and extent of any regulatory changes in the U.S. or abroad, we cannot
predict the impact, if any, that these changes could have to our business, financial condition and results of
operations.

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

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In addition, there is a risk of compliance violations by our vendors, which could lead to adverse

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

Our growth strategy and performance depend on our ability to purchase quality merchandise in sufficient
quantities at competitive prices, including products that are produced by artisans and specialty vendors. Any
disruptions we experience in our ability to obtain quality products in a timely fashion or in the quantities
required could have a material adverse effect on our business.

We purchase substantially all of our merchandise from a number of third party vendors. Many such vendors

are the sole sources for particular products, and we generally transact business with such vendors on an
order-by-order basis without any long-term or other contractual assurances of continued supply, pricing or access
to new products with our vendors. Therefore, we may be dependent on particular vendors that produce popular
items, and any vendor could discontinue selling to us at any time. In addition, the expansion of our business into
new U.S. or international markets or new product categories could put pressure on our ability to source sufficient
quantities of our products from such vendors. In the event that one or more of our vendors is unable or unwilling
to meet the quantity or quality of our product requirements, we may not be able to develop relationships with
new vendors in a manner that is sufficient to supply the shortfall. We also may be required to develop such new
vendor relationships in response to changes in our supply chain, for example in response to new tariffs or
competitive pressures. Even if we do identify such new vendors, we may experience product shortages and
customer backorders as we transition our product requirements to incorporate alternative suppliers. Our
relationship with any new vendor would be subject to the same or similar risks as those of our existing suppliers.

Furthermore, our growth strategy includes expanding our product assortment, and our performance depends

on our ability to purchase our merchandise in sufficient quantities at competitive prices. However, many of our
key products are produced by artisans, specialty vendors and other vendors that are small, undercapitalized or
that may have limited production capacity, and we have from time to time in prior periods experienced supply
constraints that have affected our ability to supply high demand items or new products due to such capacity and
other limits in our vendor base.

A number of our vendors, particularly our artisan vendors, may have limited financial or other resources and

operating histories and may receive various forms of credit from us, including with respect to payment terms or
other arrangements. In some cases, we have advanced payments to vendors in order to assist a vendor in funding
additional merchandise production to meet our orders. We may advance a portion of the payments to be made to
some vendors under our purchase orders prior to the delivery of the ordered products. These advance payments
are normally unsecured. Vendors may become insolvent and their failure to repay our advances, and any failure
to deliver products to us, could have a material adverse impact on our results of operations. There can be no
assurance that the capacity of any particular vendor will continue to be able to meet our supply requirements in
the future, as our vendors may be susceptible to production difficulties or other factors that negatively affect the
quantity or quality of their production during future periods. A disruption in the ability of our significant vendors
to access liquidity could also cause serious disruptions or an overall deterioration of their businesses, which
could lead to a significant reduction in their ability to manufacture or ship products to us. Any difficulties that we
experience in our ability to obtain products in sufficient quality and quantity from our vendors could have a
material adverse effect on our business.

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Our vendors may sell similar or identical products to our competitors or on their own, which could harm our
business.

Because the arrangements with our vendors are generally not exclusive, many of our vendors might be able

to sell similar or identical products to our competitors. Our competitors may enter into arrangements with
suppliers that could impair our ability to sell those suppliers’ products, including by requiring suppliers to enter
into exclusive arrangements, which could limit our ability to enter into arrangements with such suppliers or
otherwise access their products. Such competitors may also purchase products in significantly greater volume
that we do, which may enable them to sell the products at reduced cost or flood the market with similar products.

Our vendors could also initiate or expand sales of their products through vendor-owned stores or through the
Internet to the retail market and therefore directly compete with us or sell their products through outlet centers or
discount stores, increasing the competitive pricing pressure we face.

Any of the above factors could negatively affect our business and results of operations.

Defective merchandise purchased from our vendors could damage our reputation and brand image and harm
our business, and we may not have adequate remedies against our vendors for defective merchandise.

We have in recent periods, and may in the future, recall products from the market due to quality or other

issues. Despite our ongoing efforts to improve customers’ satisfaction with their experience at RH, we may fail
to maintain the necessary level of quality for some of our products in order to satisfy our customers. For
example, our vendors may not be able to continuously adhere to our quality control standards, and we might not
identify a quality deficiency before merchandise ships to our stores or customers. Our failure to supply high
quality merchandise in a timely and effective manner to our customers, our announcement of additional product
recalls, or any perception that we are not adequately maintaining our sourcing and quality control processes in
order to anticipate product quality issues could damage our reputation and brand image, and could lead to an
increase in product returns or exchanges or customer litigation against us and a corresponding increase in our
routine and non-routine litigation costs. Further, any merchandise that does not meet our quality standards or
applicable government requirements could trigger high rates of customer complaints or returns, become subject
to a product recall and/or attract negative publicity, which could in turn damage our reputation and brand image,
result in consumer litigation (including class-action lawsuits), and harm our business. With the growth in
importance and the impact of social media, the magnitude of such harm to our business, reputation and brand
image may be significantly amplified. The number of business initiatives we are undertaking to enhance the
quality of our customers’ experience and to improve our organizational design, which are expected to include
increasingly significant operational and other changes in the near term, may complicate our supply chain and
quality control management process, and any inability to invest sufficient resources in quality control and
compliance processes or significant turnover in the personnel dedicated to such function may result in quality
control issues or product recalls.

Even if we detect that merchandise is defective before such merchandise is shipped to our customers, we
may not be able to return such products to the vendor, obtain a refund of our purchase price from the vendor or
obtain other indemnification from the vendor. The limited capacities of certain of our vendors may constrain the
ability of such vendors to replace any defective merchandise in a timely manner. Similarly, the limited
capitalization and liquidity of certain of our vendors and their lack of insurance coverage for product recall
claims may result in such vendors being unable to refund our purchase price or pay applicable penalties or
damages associated with any such defects or resulting product recalls.

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Our results may be adversely affected by fluctuations in raw materials, energy costs and currency exchange
rates.

Increases in the prices of the components and raw materials used in our products could negatively affect the

sales of our merchandise and our product margins. Alternatively, the strength of the U.S. dollar may negatively
impact the ability of some of our customers to purchase our goods. We believe some portion of our business
depends on non-U.S. consumers, including sales in our stores in Canada and Waterworks showrooms in the U.K.,
as well as sales in some of our U.S.-based stores which have a high number of visitors from other countries who
purchase goods from us while visiting the United States. Declines in the purchasing power of the British pound
sterling and volatility in the British pound sterling exchange rate as a result of Brexit, for example, may dampen
demand for our products in the U.K. and may delay or negatively affect the success of our business initiative to
expand internationally.

Changes in prices for raw materials and fluctuations in exchange rates are dependent on a number of factors
beyond our control, including macroeconomic factors that may affect commodity prices (including prices for oil,
lumber and cotton); changes in supply and demand; general economic conditions; significant political events;
labor costs; competition; import duties, tariffs, anti-dumping duties and other similar costs; currency exchange
rates and government regulation; and events such as natural disasters and widespread outbreaks of infectious
diseases (such as the recent outbreak of COVID-19). In addition, energy costs have fluctuated dramatically in the
past and, in recent periods, energy prices have been declining and could experience significant volatility in the
near term. Depending on the nature of changes in these different factors that affect our business, we may
experience an adverse impact on our business for different reasons including increased costs of operation or
lower demand for our products. We may experience slower demand from customers in markets that depend upon
energy prices for a portion of their economic activity.

Changes in the value of the U.S. dollar relative to foreign currencies, including the Chinese Yuan, may

increase our vendors’ cost of business and ultimately our cost of goods sold and our selling, general and
administrative costs. If we are unable to pass such cost increases on to our customers or the higher cost of the
products results in decreased demand for our products, our results of operations could be harmed.

We are subject to risks associated with occupying substantial amounts of space, including future increases in
occupancy costs. We are pursuing various alternatives to traditional leasing of our Gallery locations that may
subject us to a range of risks related to real estate development including risks related to construction and
development of locations, risks related to the financing of commercial real estate and the market for
commercial real estate.

We lease nearly all of our retail store locations and we also lease our outlet stores, our corporate
headquarters and other storage and office space, and our distribution and home delivery facilities. The initial
lease term of our retail locations generally ranges from ten to fifteen years, and certain leases contain renewal
options for anywhere from ten to twenty-five years. The initial lease term for one of our future Design Galleries
is forty-one years, and contains a renewal option for five years. Most leases for our retail locations provide for a
minimum rent, typically including escalating rent amounts, plus a percentage rent based upon sales after certain
minimum thresholds are achieved, as well as common area maintenance charges, real property insurance and real
estate taxes.

We are currently pursuing several other models for the transformation of our real estate beyond a traditional

leasing approach including a real estate development model, a joint venture model and a capital light model.
While these alternative models are designed to achieve superior financial returns to traditional real estate lease
structures for a retail business, some of these new ways of operation will expose us to a range of different risks.
Various aspects of our recently developed multi-tier real estate strategy may expose us to new forms of risk
versus our traditional leasing model. Our new strategies include (1) our “capital light” leasing deals, where as
much as 65% to 100% of the capital requirement would be funded by the landlord, versus 35% to 50%

23

previously; (2) our real estate development model where we expect either to do a sale-leaseback transaction or to
pre-sell the property and structure the transaction such that the capital to build the project is advanced by the
buyer during construction; and (3) our hybrid or joint venture structure where we are working on joint venture
projects in which we share the upside of development with the developer/landlord.

These new approaches might cause us to pursue complicated real estate transactions and may require
additional capital investment and could present different risks related to the ownership and developments of real
estate compared to those risks associated with a traditional store lease with a landlord, including greater financial
exposure if our plans for the relevant real estate are not as successful as we originally anticipate or if the value of
the real estate we acquire subsequently decreases. Pursuing multiple different paths for addressing our real estate
needs may create various risks including increased complexity and risks related to the time and costs of real
estate development as well as the need for additional capital and risks related to resale of real estate projects.
These risks could distract management focus, strain our operational resources and personnel, or expose us to new
regulatory or tax regimes in which we must develop expertise.

Several of our new real estate development strategies expose us to additional risks related to operating in

commercial real estate from a development perspective. Such risks include the cost and financing of the
acquisition of real estate interests, market risks related to real estate prices, the time and costs related to
developing real estate projects including construction and development risks and other factors that affect the
commercial real estate industry more generally. We have not historically operated directly in all phases of real
estate development including managing all aspects of construction of large scale real estate projects. Although
our strategy in assuming greater risk and responsibility for real estate development in certain projects is to
achieve greater financial returns and a higher overall return on investment if our efforts our successful, we could
face increased downside risks if we encounter difficulties in implementing these strategies such as cost overruns
or delays in construction.

If we decide to close an existing or future store, we may nonetheless have continuing obligations with
respect to that property pursuant to the applicable lease or ownership arrangements, including, among other
things, paying the base rent for the balance of the lease term. Our ability to re-negotiate favorable terms on an
expiring lease, to arrange for the sale of an owned property or to negotiate favorable terms for a suitable alternate
location could depend on conditions in the real estate market, competition for desirable properties, our
relationships with current and prospective landlords and other factors that are not within our control. Our
inability to enter into new leases or renew existing leases on terms acceptable to us or be released from our
obligations under leases or other obligations for stores that we close could materially adversely affect our
business and results of operations.

A number of factors that affect our ability to successfully open new stores within the time frames we initially
target or optimize our store footprint are beyond our control, and these factors may harm our ability to execute
our strategy to transform our real estate, which may negatively affect our results of operations.

We are focused on sizing our assortments and our stores to the potential of the market by adjusting the
square footage and number of stores on a geographic market-by-market basis. We plan to optimize our real estate
by continuing to open larger square footage Galleries in key markets and relocating or closing selected stores in
these or adjacent markets. In addition, we have developed a new RH prototype Design Gallery, we intend to
continue to open indigenous Bespoke Galleries in the second home markets and we are developing a new Gallery
model tailored to secondary markets. When we address the introduction of new stores in a particular market or
changes to, or closure of, existing stores, we must make a series of decisions regarding the size and location of
new stores (or the existing stores slated to undergo changes or closure) and the impact on our other existing
stores in the area or being without presence or “out of the market.”

Our ability to maximize the productivity of our retail store base, depends on many factors, including, among

others, our ability to:

•

identify suitable locations, the availability of which is largely outside of our control;

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•

•

•

•

•

•

•

•

size the store locations to the market opportunity;

retain customers in a certain geographic market when we close stores in such market or an adjacent
market;

negotiate acceptable new lease terms or lease renewals, modifications or terminations;

efficiently build and equip new stores or remodel existing locations;

source sufficient levels of inventory to meet the needs of changes in our store footprint in a timely
manner;

successfully integrate changes in our store base into our existing operations and information
technology systems;

obtain or maintain adequate capital resources on acceptable terms;

avoid construction or local permit delays, construction accidents and injuries and cost overruns in
connection with the opening of new stores or the expansion or remodeling of existing stores;

• maintain adequate distribution facilities, information systems and other operational systems to serve

our new stores and remodeled stores; and

•

address competitive, merchandising, marketing, distribution and other challenges encountered in
connection with expansion into new geographic areas and markets.

We have experienced delays in opening some new stores within the time frames we initially targeted, and

may experience such delays again in the future. We have also incurred higher levels of capital and other
expenditures associated with the opening of some of our new Gallery locations. While we are investing in
strategies to address these challenges in the future, we may not be successful in deploying such strategies or they
may not have the effect that we anticipate. Any of the above challenges or other similar challenges could delay or
prevent us from completing store openings or the additional remodeling of existing stores or hinder the
operations of stores we open or remodel. If any of these challenges delays the opening of a store, our results of
operations will be negatively affected as we will incur various costs during the delay without associated store
revenue at such location and our overall return on investment and profit goals for some locations could be
adversely affected. Unfavorable economic and business conditions and other events could also interfere with our
plans to expand or modify store footprints. Changes in regulation or increases in building or construction costs
including with respect to the cost of building materials could result in unanticipated increases in real estate
development costs or delays in the completion of our real estate projects. Our failure to effectively address
challenges such as those listed above could adversely affect our ability to successfully open new stores or change
our store footprint in a timely and cost-effective manner and could have a material adverse effect on our
business, results of operations and financial condition.

Reductions in the volume of mall and other in-store traffic or the closing of shopping malls as a result of
changing demographic patterns could significantly reduce our sales.

Although many of the new Design Galleries that we have opened are being developed outside of the
shopping mall setting, a significant portion of our existing footprint of legacy Galleries is currently located in
shopping malls. Sales at stores located in malls are derived, in part, from the volume of traffic in those malls.
These stores benefit from the ability of the malls to generate consumer traffic in the vicinity of our stores and the
continuing popularity of the malls as shopping destinations and positive experiences.

However, in recent years there has been a shift in consumer preferences to purchasing certain products
online rather than in stores. This shift, particularly when coupled with past unfavorable economic conditions in
certain regions, has adversely affected mall traffic in some regions and has threatened the viability of certain
commercial real estate firms that operate major shopping malls. A continuation of such trend could adversely
impact the sales generated by our stores currently located in shopping malls.

25

If we are unable to successfully optimize and operate our distribution centers, furniture home delivery centers
and other aspects of our supply chain and customer delivery network, or if we are not able to fulfill orders and
deliver our merchandise to our customers in an effective manner, our business and results of operations will
be harmed.

Our business depends upon the successful operation of our distribution centers, furniture home delivery

centers and other aspects of our supply chain and customer delivery network, as well as upon our order
management and fulfillment services and the re-stocking of certain inventories within our stores. The efficient
flow of our merchandise requires that our facilities have adequate capacity to support our current level of
operations and any anticipated increased levels that may follow from any growth of our business.

We are currently engaged in efforts to improve the quality of our customer experience, which includes

making changes to the way in which we operate our distributions centers, furniture home delivery centers and
other aspects of our supply chain and customer delivery network. Additionally, we plan to invest significant time
architecting a new fully integrated back-end operating platform, inclusive of the supply chain network, the home
delivery experience as well as a new metric driven quality system and company-wide decision data. Some of
these efforts may require us to make significant expenditures in periods in the near term, which may also have a
negative effect on our results of operations if there is no associated increase in revenues or decrease in returns or
if any such effect is less than anticipated. There can be no assurance however that any of these efforts will be
successful or that we will not encounter additional difficulties in achieving higher levels of customer satisfaction.

We are also engaged in initiatives to rationalize our SKU count, and in order to realize the anticipated
benefits of such initiatives, including through lower inventories and reduced working capital, we have focused on
optimizing the use of our distribution centers, furniture home delivery centers and outlets. For example, we have
consolidated our distribution center network and we are in the process of opening new outlet and home delivery
center locations and reconfiguring our furniture home delivery centers and outlets in order to streamline our
operations. While we believe that optimizing and consolidating our distribution centers and other aspects of our
supply chain and customer delivery network will allow us to more efficiently manage our inventory and optimize
our uses of capital, in the short term such strategy may result in additional costs, including increased freight costs
and lease early termination fees. Furthermore, in the past, during periods of significant customer growth and
demand, we have found that our distribution centers often run at capacity. If we fail to accurately anticipate the
future capacity requirements of our distribution centers, we may experience delays and difficulties in fulfilling
orders and delivering merchandise to customers in a timely manner. Furthermore, we may be unable to remedy
such issues quickly as opening additional distribution and home delivery facilities can face operational
difficulties, such as disruptions in transitioning fulfillment orders to the new distribution facilities, competition
for distribution facility space and problems associated with operating new facilities or reducing the size and
changing functions of existing facilities. These difficulties can result in a negative experience for our customers.
Any delays in fulfilling orders and delivering merchandise to customers, or related negative experience of our
customers, could harm our results of operations.

We currently rely upon independent third-party transportation providers for the majority of our product
shipments, which subjects us to certain risks.

We currently rely upon independent third-party transportation providers for product shipments from our
vendors to our stores and to our customers outside of certain areas. Our utilization of third-party delivery services
for shipments is subject to risks, including increases in fuel prices, which would increase our shipping costs, as
well as strikes, work stoppages and inclement weather, which may impact shipping companies’ abilities to
provide delivery services that adequately meet our shipping needs. For example, strikes or even threat of strikes
involving longshoreman and clerical workers at ports in the past have completely shut down such ports for
periods of time, impacting retail and other industries. If we change shipping companies, we could face logistical
difficulties that could adversely affect deliveries and we would incur costs and expend resources in connection
with such change. Moreover, we may not be able to obtain terms as favorable as those received from the third-
party transportation providers we currently use, which in turn would increase our costs.

26

Our operations have significant liquidity and capital requirements and depend on the availability of adequate
financing and sources of capital on reasonable terms. If we fail to use our financial resources effectively, or if
we are unable to obtain sufficient capital when needed, it could have a significant negative effect on our
ability to grow our business.

We have historically relied on the availability of some amount of debt financing to fund our operations,
including borrowings under our revolving line of credit. We have also incurred indebtedness to finance other
strategic initiatives, including our share repurchase programs, such as (i) the aggregate $1 billion in share
repurchase programs authorized by our Board of Directors, which program was fully completed during fiscal
2017, and (ii) the share repurchase program authorized by our Board of Directors in October 2018 in an
aggregate amount of $700 million of which (x) $250.0 million in share repurchases were completed in fiscal
2018, (y) the $700 million authorization amount was replenished by the Board of Directors in March 2019 and
(z) of which $250.0 million in share repurchases were completed in fiscal 2019. We completed debt financing in
fiscal 2014, fiscal 2015, fiscal 2018 and fiscal 2019 through the issuance of four series of convertible senior
notes, the aggregate principal amount of which was $985 million as of February 1, 2020. As of February 1, 2020,
we had no outstanding borrowings and $321.7 million of availability under our revolving line of credit facility,
net of $13.2 million in outstanding letters of credit. Our revolving line of credit 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. These restrictive covenants may
limit the amount of borrowings available to us under our line of credit and our operational and financial
flexibility. We may face financial and contractual consequences to the extent we are not able to maintain our
compliance with such covenants, which could have a materially adverse effect on our business, financial
condition and results of operations.

We will have significant capital requirements for the operation of our business in the near term if we are to

continue to pursue all of our current business initiatives. In addition, the $300 million principal amount of
convertible senior notes that we issued in fiscal 2015 matures on July 15, 2020, at which time we expect to repay
the remaining principal balance of such notes in cash. We have substantial capital requirements related to
investments in our business, our real estate strategy, our international expansion, the development of new
businesses and our significant number of concurrent initiatives. We have invested significant capital expenditures
in remodeling and opening new Galleries, and these capital expenditures have increased in the past and may
continue to increase in future periods as we open additional Design Galleries, which may require us to undertake
upgrades to historical buildings or construction of new buildings. During fiscal 2019, our adjusted net capital
expenditures were $157.9 million, inclusive of cash received related to landlord tenant allowances of
$28.3 million.

We are implementing a number of changes to our business operations as a result of the COVID-19 health
crisis and the related impact to our business resulting from the closure of stores and other operational restrictions
on our business that have resulted from the health crisis. One focal point of these operational changes is to
preserve cash and maintain liquidity in response to the reduction in our sales. As a result of these efforts to
manage our liquidity, we anticipate substantial reductions to the level of our fiscal 2020 capital expenditures. The
exact scope of our capital plans for 2020 will depend on a variety of factors including the availability of other
sources of capital and the way that our business performs during the duration of the health crisis.

Our current real estate strategy involves opening Design Galleries in select major metropolitan markets,
developing new RH model Design Galleries and Galleries tailored to secondary markets, and opening indigenous
Bespoke Galleries in the second home markets, as well as pursuing category extensions of our brand and
exploring new business areas. We have principally relied upon leases with landlords for most of our Gallery
locations to date. We have begun to pursue a real estate development model strategy for some of our new Gallery
developments in which we invest in ownership of real estate such as we did in the case of our current Gallery
location in San Francisco where we own both the building and the land. The real estate development model may

27

require us to pursue additional capital expenditures than a traditional leasing model, but we may be able to
recoup substantial amounts of capital and may also achieve gains on our capital investments if we are successful
with this model and are able to sell the real estate interests to a real estate investor in a sale-leaseback transaction.
As we develop new Galleries, as well as potentially other strategic initiatives in the future like our integrated
hospitality experience, we may explore other models for our real estate, which could include longer lease terms
or further purchases of, or joint ventures or other forms of equity ownership in, real estate interests associated
with new sites and buildings. These approaches might require greater capital investment than a traditional store
lease with a landlord. In the event that such capital and other expenditures require us to pursue additional funding
sources, we can provide no assurances that we will be successful in securing additional funding on attractive
terms or at all. In addition, the effects of COVID-19 on our business, including due to actions taken by federal,
state and local government authorities in response to the outbreak, may require changes to our real estate strategy
and related capital expenditure and financing plans. For example, we expect that there will be a need to delay
planned construction projects and Gallery openings and defer expansions into new markets including our
anticipated international expansion. In addition, we may continue to be required to make lease payments for our
Galleries, restaurants and outlets that have been closed. Our efforts to mitigate the costs of construction delays
and deferrals, store closures and other operational difficulties resulting from COVID-19, including negotiating
with landlords and other third parties regarding the timing and amount of payments under existing contractual
arrangements, may not be successful, and as a result, our real estate strategy may have ongoing significant
liquidity needs even as we scale back our operations and expansion cadence.

While our general approach has been to target capital toward investments that we believe will achieve
favorable returns for our shareholders, these decisions involve a significant amount of judgment regarding the
availability of capital and the anticipated growth of the business in both revenue and earnings in future periods.
In addition, our near term decisions regarding the sources and uses of capital in our business will reflect and
adapt to changes in market conditions and disruption in our business related to COVID-19.

During the time period from fiscal 2017 through fiscal 2019, we have invested substantial amounts of
capital to repurchase shares which has materially reduced the number of our outstanding shares which could in
turn yield financial benefits to our investors including the potential for increased earnings per share. At the same
time, such share repurchases have increased our aggregate levels of indebtedness, increased our costs for cash
and/or non-cash interest expense and diverted capital from other purposes including other investments that we
might have undertaken with respect to the business. We can provide no assurances of the exact financial and
operational impact of previous or future share repurchases on our business and results of operation and the
resulting incurrence of debt may have an impact on our future liquidity position and capital available for other
aspects of our business. Although our share repurchase programs are intended to enhance long-term shareholder
value, depending on the exact financial and operational impact of these programs on our business, there can be
no assurance that share repurchases will have the benefits that we expect.

When we purchase shares in the market as part of one of our share repurchase programs, we generally
undertake such transactions out of a belief that the shares represent a good investment and that the market price
for the shares may be undervalued. There can be no assurance that these decisions will prove to be correct as
valuation of common stock is subject to a range of factors and is subject to inherent degrees of uncertainty. Over
time it may turn out that the value of our common stock will be substantially higher or lower than some of the
prices that we pay to undertake repurchase transactions. For example, the market price of our common stock may
subsequently decline below the levels at which repurchases were made or it may appreciate to prices
substantially above the amounts we pay for the buyback. If we access capital through sales of our common stock
or other securities linked to the price of our common stock, our investors may experience dilution from such
capital transactions and there can be no assurance that such financing will be incurred at prices that are higher for
shares of our common stock than the prices at which we engaged in share repurchases.

Pursuit of share repurchases may expose us to other risks in connection with our business including legal

and financial constraints, risks related to capital allocation, the level of indebtedness that we carry, increases

28

costs for borrowing, risks related to legal claims and litigation and increased dependency on capital markets and
sources of financing to fund the requirements of our business including the costs of any share repurchases. To the
extent that we incur indebtedness in connection with our business in connection with or as a result of our share
repurchases, the requirements of such debt may include terms and conditions that could have an adverse effect
upon our business including as a result of restrictive financial or operational covenants, burdensome rates of
interest, cross defaults and other terms that may reduce our operational or financial flexibility or cause us to incur
substantial costs including restructuring or refinancing such indebtedness.

In addition, while we anticipate that we should be able to repay our debt maturities as they come due, there
can be no assurance that we will have sufficient financial resources at the maturity of any specific indebtedness,
whether upon its state maturity or otherwise. In particular, we may need to incur additional debt or refinance
existing debt in order to achieve repayment of existing debt. Given the fast moving nature of the COVID-19
health crisis, and the corresponding impact on financial markets and the economy as a whole, there is an
enhanced degree of uncertainty regarding the Company’s capital position and availability of capital to fund the
Company’s liquidity requirements.

In recognition of the significant threat to the liquidity of financial markets posed by COVID-19, the Federal

Reserve and Congress have taken dramatic actions to provide liquidity to businesses and the banking system in
the U.S. For example, on March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and
Economic Security Act (the “CARES Act”), a sweeping stimulus bill intended to bolster the U.S. economy,
among other things, and provide emergency assistance to qualifying businesses and individuals. There can be no
assurance that these interventions by the government will be successful, and the financial markets may
experience significant contractions in available liquidity. While the Company may receive financial, tax or other
relief and other benefits under and as a result of the CARES Act, it is not possible to estimate at this time the
availability, extent or impact of any such relief. In addition, store closures and other operational difficulties faced
by the Company may negatively affect the Company’s financial condition and restrict the availability of liquidity
for its operational needs, including due to, among other reasons, increased and unforeseeable liquidity needs and
limited flexibility to control expenses in line with potential decreases in revenue. If the Company is not able to
arrange financing to repay its debt obligations, or to extend the maturities of existing debt or otherwise refinance
the Company’s obligations as needed, we may experience a material adverse effect on our business and
operations. For example, in certain circumstances, we may be required to repay the three series of convertible
senior notes that we issued in fiscal 2015, fiscal 2018 and fiscal 2019 with cash payments. See Item 2—
Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and
Capital Resources—Convertible Senior Notes. The $300 million principal amount of convertible senior notes that
we issued in fiscal 2015 matures on July 15, 2020 and is convertible as of February 1, 2020 through the close of
business on the second schedule trading day immediately preceding July 15, 2020. At the time the notes become
due, and prior to maturity to the extent holders exercise their conversion right, the trading price of our common
stock may be such that we may find it necessary to settle the notes in cash. There can be no assurance that we
will be able to pay the amount of cash due if holders surrender their notes for conversion. In addition, agreements
governing any debt may restrict our ability to make each of the required cash payments even if we have sufficient
funds to make them. Furthermore, our ability to purchase the notes or to pay cash upon the conversion of the
notes may be limited by law or regulatory authority. In addition, if we fail to purchase the notes, to pay special
interest, if any, due on the notes, or to pay the amount of cash due upon conversion, we will be in default under
the respective indentures governing the notes, which in turn may result in the acceleration of other indebtedness
we may then have. If the repayment of the other indebtedness were to be accelerated, we may not have sufficient
funds to repay that indebtedness and to purchase the notes or to pay the amount of cash due upon conversion.

The need to repay our convertible senior notes or other debt obligations could cause us to incur additional
borrowings or issue additional debt to investors and lenders. We may also experience cash flow shortfalls in the
future, and we may otherwise require additional external funding, or we may need to raise funds to take
advantage of unanticipated opportunities, to make acquisitions of other businesses or companies or to respond to
changing business conditions or unanticipated competitive pressures. Disruptions in the global financial markets

29

and banking systems have made credit and capital markets more difficult for companies to access, even for some
companies with established revolving or other credit facilities. The continued volatility of, or other adverse
developments in, U.S. or global market conditions, including as a result of fluctuations in the stock market, the
global outbreak of COVID-19, risks related to Brexit, declines in energy prices or the housing market or other
U.S. or global political or economic trends, could affect our ability to access future debt and to manage our debt
obligations. We cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or
that future financing requirements would not be dilutive to holders of our capital stock. If we fail to raise
sufficient additional funds, we may be required to delay or abandon some of our planned future expenditures or
aspects of our current operations.

Our business is dependent on certain key personnel; if we lose key personnel or are unable to hire additional
qualified personnel, our business may be harmed.

The success of our business depends upon our ability to retain continued service of certain key personnel,

particularly our Chairman and Chief Executive Officer, Gary Friedman, and to attract and retain additional
qualified key personnel in the future. We face risks related to loss of any key personnel and we also face risks
related to any changes that may occur in key senior leadership executive positions. Any disruption in the services
of our key personnel could make it more difficult to successfully operate our business and achieve our business
goals and could adversely affect our results of operation and financial condition. These changes could also
increase the volatility of our stock price.

Many of our key personnel periodically travel together while on company business. We do not have a policy

that prohibits key officers and directors from flying together, whether flying commercially or in our corporate
aircraft. We face risks related to any loss of key personnel that might arise as a result of such travel
arrangements. In addition, we do not maintain key man life insurance policies on any of our key personnel. As a
result, we may not be able to cover the financial loss we may incur in losing the services of any of our key
personnel.

In March 2019, we appointed a new Chief Financial Officer as a result of the prior President, Chief
Financial and Administrative Officer’s decision to step down due to health considerations. We may face risks
related to this and other transitions in our leadership team.

Competition for qualified employees and personnel in the retail industry is intense, particularly in the San

Francisco Bay Area where our headquarters are located, and we may be unable to retain personnel that are
important to our business or hire additional qualified personnel. The process of identifying personnel with the
combination of skills and attributes required to carry out our goals is often lengthy. Our success depends to a
significant degree upon our ability to attract, retain and motivate qualified management, marketing and sales
personnel, and store managers, and upon the continued contributions of these people. In addition, our complex
operations require the services of qualified and experience management personnel, with expertise in the areas
including information technology and supply chain management. We cannot assure you that we will be
successful in attracting and retaining qualified executives and personnel. In addition, we are pursuing a dynamic
business model which is subject to a number of new business initiatives as we seek to optimize our business and
financial performance. As a result of the ongoing evolution of our business, we frequently implement changes to
our organizational design in order to more closely align our management structure with the needs of the business.
In connection with such changes to our management structure, we also implement changes in personnel and
reductions in force as a result of which we may incur severance costs and other reorganization charges and
expenses. Changes in our organizational structure may also have an impact on retention of personnel.

Inasmuch as our success depends in part upon our ability to attract, motivate and retain a sufficient number

of store and other employees who understand and appreciate our corporate culture and customers. Turnover in
the retail industry and food and beverage industry is generally high. Excessive employee turnover will result in
higher employee costs associated with finding, hiring and training new store employees. If we are unable to hire

30

and retain store and other personnel capable of consistently providing a high level of customer service, our ability
to open new stores, service the needs of our customers and expand our food and beverage business may be
impaired, the performance of our existing and new stores and operations could be materially adversely affected
and our brand image may be negatively impacted.

Material damage to, or interruptions in, our information systems as a result of external factors, staffing
shortages, cybersecurity breaches or cyber fraud, or difficulties in updating our existing software or
developing or implementing new software could have a material adverse effect on our business or results of
operations, and we may be exposed to risks and costs associated with protecting the integrity and security of
our customers’ information.

We depend largely upon our information technology systems in the conduct of all aspects of our operations,

many of which we have only adopted and implemented within the past several years or are in the midst of
implementing in connection with rebuilding our supply chain and infrastructure. These systems can be complex
to develop, maintain, upgrade and protect against emerging threats, and we may fail to adequately hire or retain
adequate personnel to manage our information systems, we may fail to accurately gauge the level of financial and
managerial resources to invest in our information systems, or we may fail to realize the anticipated benefits of
resources invested in our information systems particularly as our business changes as a result of the many
initiatives that we are pursuing. Such systems are subject to damage or interruption from power outages,
computer and telecommunications failures, computer viruses, security breaches and natural disasters. In addition,
damage or interruption can also occur as a result of non-technical issues, including vandalism, catastrophic
events, and human error. Damage or interruption to our information systems may require a significant investment
to fix or replace the affected system, and we may suffer interruptions in our operations in the interim. Any
material interruptions or failures in our systems or the systems of our third party vendors may have a material
adverse effect on our business or results of operations.

We routinely experience cybersecurity attacks and expect to continue to be the target of cyber fraud,
hacking or theft. While to date none of these incidents have been material, despite our efforts to ensure the
integrity of our information technology systems, we may not be able to anticipate, detect or implement adequate
preventive measures against all cyber threats because techniques used to obtain unauthorized access or to
sabotage systems change frequently and often are not recognized until launched against a target. Our operations
are also dependent on the information technology systems and cybersecurity measures of our third party vendors.
Attempted cyber intrusions into our information systems through compromised vendor networks, if successful,
could compromise our information systems. In addition, our information systems can face risks to the extent we
acquire new businesses but are not able to quickly or comprehensively integrate such acquired businesses into
our policies and procedures for addressing cybersecurity risks or identify and address weaknesses in such
acquired entity’s information systems, which risks may be compounded to the extent the information systems of
an acquired entity are integrated with ours, thus providing access to a broader set of sensitive customer
information through a compromised network at the acquired entity level. If a computer hacker or other third party
is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our
operations. Any successful breaches or attempted intrusions could result in increased information systems costs
and potential reputational damage, which could materially adversely affect our business and results of operations.

Additionally, in order for our business to function successfully, we and other market participants must be

able to handle and transmit confidential and personal information securely, including in customer orders placed
through our website. That information includes data about our customers, including personally identifiable
information and credit card information, as well as sensitive information about our vendors and workforce,
including social security numbers and bank account information. If our systems are damaged, interrupted or
subject to unauthorized access, information about our customers, vendors or workforce could be stolen or
misused. Any security breach could expose us to risks of data loss, fines, litigation and liability and could
seriously disrupt our operations and harm our reputation, any of which could adversely affect our business. We
may be subject to one or more claims or lawsuits related to the intentional or unintentional release of confidential

31

or personal information, including personally identifiable information about our customers, vendors or
workforce. In addition to the possibility of fines, lawsuits and other claims, we could be required to expend
significant resources to change our business practices or modify our service offerings in connection with the
protection of personally identifiable information, which could have a material adverse effect on our business.
Any breach could also cause consumers to lose confidence in the security of our website and choose not to
purchase from us.

We are also subject to payment card association rules and network operating rules, including data security
rules, certification requirements and rules governing electronic funds transfers, which could change over time.
For example, we are subject to Payment Card Industry Data Security Standards (“PCI DSS”), which contain
compliance guidelines and standards with regard to our security surrounding the physical and electronic storage,
processing and transmission of individual cardholder data. As of October 1, 2015, the payment card industry
shifted the liability of certain credit card transactions to retailers who are not able to process Europay,
MasterCard, Visa (“EMV”) chip enabled card transactions. As a result, before our implementation of the EVM
technology is complete, we may be liable for costs incurred by payment card issuing banks or other third parties
for fraudulent transactions initiated through EMV chip enabled cards before our implementation of EMV chip
technology. In addition, if our internal systems are breached or compromised, we may be liable for card
re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit
card payments from our members, and our business and operating results could be adversely affected.

States and the federal government have enacted additional laws and regulations to protect consumers against

identity theft, including laws governing treatment of personally identifiable information. For example, the EU
General Data Protection Regulation (“GDPR”), which took effect in May 2018, and the California Consumer
Privacy Act, which took effect in January 2020, impose stringent requirements on how we and third parties with
whom we contract collect and process personal information, and provide for significant penalties for
noncompliance. These laws have increased the costs of doing business and, if we fail to implement appropriate
safeguards or we fail to detect and provide prompt notice of unauthorized access as required by some of these
laws, we could be subject to potential claims for damages and other remedies. If we were required to pay any
significant amount in satisfaction of claims under these laws, or if we were forced to cease our business
operations for any length of time as a result of our inability to comply fully with any such law, our business,
results of operations and financial condition could be adversely affected. We may also incur legal costs if we are
required to defend our methods of collection, processing and storage of personal data. Investigations, lawsuits, or
adverse publicity relating to our methods of handling personal data could result in increased costs and negative
market reaction.

Furthermore, data security breaches suffered by well-known companies and institutions have attracted a

substantial amount of media attention, prompting additional state and federal proposals addressing data privacy
and security. As the data privacy and security laws and regulations evolve, we may be subject to more extensive
requirements to protect the customer information that we process in connection with the purchases of our
products. Our failure to successfully respond to these risks and uncertainties could reduce website sales and have
a material adverse effect on our business or results of operations.

We currently maintain insurance to protect against cybersecurity risks and incidents. However, there can be
no assurance that such insurance coverage will be available in the future on commercially reasonable terms or at
commercially reasonable rates. In addition, insurance coverage may be insufficient or may not cover certain
cybersecurity losses and liability.

We face product liability risks and certain of our products may be subject to recalls or other actions by
regulatory authorities, and any such recalls or similar actions could have a material adverse effect on our
business.

We face product liability, product safety and product compliance risks relating to the design, manufacturing,

raw material sourcing, testing, contents, importation, sale, use and performance of some of our products. The

32

products we sell must be designed and manufactured to be safe for their intended purposes. Some of our products
must comply with certain federal and state laws and regulations. For example, some of our products are subject
to the Consumer Product Safety Act, the Federal Hazardous Substances Act and the Consumer Product Safety
Improvement Act (the “CPSIA”), which empower the Consumer Product Safety Commission (the “CPSC”) to
establish product bans, substance bans, substance limits, performance requirements, test methods and other
compliance verification processes. The CPSC is empowered to take action against hazards presented by
consumer products, up to and including product recalls. We are required to report certain incidents related to the
safety and compliance of our products to the CPSC, and failure to do so could result in a civil penalty. The CPSC
is particularly active in regulation and enforcement activities related to the kinds of children’s products sold in
our RH Baby & Child division. Certain of the products we sell are subject to the Lacey Act, prohibiting the
importation and sale of products containing illegally harvested wood, among other things. Likewise, many of our
products are subject to the regulations of the California Air Resources Board (the “CARB”) and the
Environmental Protection Agency regarding formaldehyde emissions from composite wood products (e.g.,
plywood and medium density fiberboard).

If we experience negative publicity, regardless of any factual basis, customer complaints or litigation
alleging illness or injury, related to our products, or if there are allegations of failure to comply with applicable
regulations, our brand reputation would be harmed.

We maintain a product safety and compliance program to help ensure our products are safe, legal and made

consistently in compliance with our values. Nevertheless, our products have in the past (including during fiscal
2019) been, and may in the future be, subject to recall for product safety and compliance reasons. Our efforts to
address the sources of these product recalls, including those due to products sourced from our vendors, may not
be successful and we may continue to face additional product recalls. Concerns of product safety and compliance
could result in future voluntary or involuntary removal of products, product recalls, other actions by applicable
government authorities or product liability, personal injury or property damage claims. To the extent future
product recalls create a negative public perception of our business, we could face reputational harm or could be
subject to elevated levels of legal claims. There can be no assurance that we will have the benefit of adequate
insurance or payments from third parties including our product vendors in order to address losses and expenses
that we may incur in connection with product recalls. Not all of the costs and expenses that we have previously
incurred in connection with product recalls have been covered by insurance or reimbursement from third parties
including our product vendors. We and our product vendors may be unable to obtain such insurance or the
insurance may be prohibitively expensive and any coverage that is available may be inadequate to cover costs we
incur in connection with product recalls.

Federal, state, provincial and local legislators and regulators in the United States, Canada and the U.K.,
where our products are sold, continue to adopt new product laws and regulations. These new laws and regulations
have increased or likely will significantly increase the regulatory requirements governing the manufacture and
sale of certain of our products as well as the potential penalties for noncompliance with applicable regulations. In
addition, product recalls, removal of products, product compliance enforcement actions and defending product
liability claims can result in, among other things, lost sales, diverted resources, potential harm to our reputation
and increased customer service costs, any of which could have a material adverse effect on our business and
results of operations.

We are involved in legal and regulatory proceedings from time to time that may affect our Company and/or
our management including litigation, claims, investigations and regulatory and other proceedings, which
could distract management from our business activities and result in significant liability.

From time to time, we and/or our management are involved in legal and regulatory proceedings including

litigation, claims, investigations and regulatory and other proceedings related to a range of matters in connection
with the conduct of our business, including (i) privacy and data security, (ii) our labor and employment practices
including laws related to discrimination, wages and benefits, ERISA and disability claims, (iii) intellectual

33

property issues with respect to copyright, trademarks, patents and trade dress, (iv) trade and business practices
including unfair competition and unfair business practices, (v) consumer class action claims relating to our
consumer practices including the collection of zip code or other information from customers, (vi) product safety
and compliance including products liability, product recalls personal injury, (vii) advertising and promotion of
products and services, (viii) compliance with securities laws including class actions related to allegations of
securities fraud, (ix) taxation, (x) contractual disputes, and (xi) health and safety regulations.

Claims and legal proceedings may involve arbitration, mediation, private litigation, class action matters,

derivative claims, investigations and enforcement matters. We are subject to regulatory oversight and legal
enforcement by a range of government and self-regulatory organizations including federal, state and local
governmental bodies both within the U.S. and in other jurisdictions where we operate such as, among others, the
United States Equal Employment Opportunity Commission, the Consumer Product Safety Commission, the
Federal Trade Commission, the Department of Labor, the SEC, FINRA, the New York Stock Exchange (the
“NYSE”), the Department of Justice and numerous state and local governmental authorities including state
attorney generals and state agencies. Litigation against us, depending on the outcome of such claims, could lead
to further claims and proceedings including on new and otherwise unrelated matters, for example by attracting
the attention of plaintiff’s firms or of regulators.

We have recently faced certain securities litigations, including securities class action cases that were
consolidated by the court (the “Class Action Case”) and certain related legal proceedings (collectively, the
“Derivative Case”). We are also currently responding to several governmental investigations regarding trading in
our securities. We have settled the Class Action Case, and the court granted final approval of the Class Action
Case settlement on October 25, 2019 and such settlement has been funded entirely by our insurance carriers. On
March 19, 2020, we reached an agreement in principle to settle the Derivative Case, and we expect that the
Derivative Case settlement will be funded by our insurance carriers. We maintain insurance for legal proceedings
but there can be no assurance that such insurance will be available for the payment of all or any portion of the
costs associated with any particular investigation, legal proceedings or other claims against us, or that coverage
under any such insurance will be adequate to fund the full cost of any such legal proceedings including the costs
of investigation, defense and resolution of any such legal proceedings.

Legal proceedings often involve complex factual and legal issues, which are subject to risks and
uncertainties and which could require significant management time that could otherwise be focused on our
operations. Furthermore, legal proceedings where the related claims involve members of our management team
could distract management from the operation of our business, damage the reputation of our management team
and otherwise materially adversely affect our operations and management morale. Litigation and other claims
and regulatory proceedings against our management or us could result in unexpected expenses and liability and
could also materially adversely affect our operations and our reputation.

Intellectual property claims by third parties or our failure or inability to protect our intellectual property rights
could diminish the value of our brand and weaken our competitive position.

Third parties have in the past asserted, and may in the future assert, intellectual property claims against us,

particularly as we expand our business to include new products and product categories and move into other
geographic markets. Our defense of any claim, regardless of its merit, could be expensive and time consuming
and could divert management resources. Successful infringement claims against us could result in significant
monetary liability and prevent us from selling some of our products. In addition, resolution of claims may require
us to redesign our products, license rights from third parties or cease using those rights altogether, which could
have a material adverse impact on our business, financial condition or results of operations.

We currently rely on a combination of copyright, trademark, patent, trade dress and unfair competition laws,
as well as confidentiality procedures and licensing arrangements, to establish and protect our intellectual property
rights. We believe that our photographs, trademarks and other proprietary rights have significant value and are

34

important to identifying and differentiating certain of our products and brand from those of our competitors and
creating and sustaining demand for certain of our products. We have from time to time encountered other
retailers selling products substantially similar to our products or misrepresenting that the products such retailers
were selling were our products. We cannot assure you that the steps taken by us to protect our intellectual
property rights will be adequate to prevent infringement of our rights by others (especially with respect to
infringement by non-U.S. entities with no physical U.S. presence), including imitation of our products and
misappropriation of our images and brand. The costs of defending and enforcing our intellectual property assets
may incur significant time and legal expense, and we may not be entirely successful in protecting our assets,
enforcing our rights or collecting on judgments as a prevailing party. If we are unable to protect and maintain our
intellectual property rights, the value of our brand could be diminished and our competitive position could suffer.

Compliance with laws, including laws relating to our business activities outside of the United States, may be
costly, and changes in laws could make conducting our business more expensive or otherwise change the way
we do business.

We are subject to numerous regulations, including labor and employment, customs, truth-in-advertising,

consumer protection, e-commerce, privacy, health and safety, real estate, environmental and zoning and
occupancy laws, and other laws and regulations that regulate retailers, food and beverage providers or otherwise
govern our business. In addition, to the extent we expand our operations as a result of engaging in new business
initiatives or product lines, pursuing our multi-tier real estate strategy or expanding into new international
markets, we may become subject to new regulations and regulatory regimes. We may need to continually
reassess our compliance procedures, personnel levels and regulatory framework in order to keep pace with the
numerous business initiatives that we are pursuing, and there can be no assurance that we will be successful in
doing so. If the regulations applicable to our business operations were to change or were violated by us or our
vendors or buying agents, the costs of certain goods could increase, or we could experience delays in shipments
of our goods, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our
products and harm our business and results of operations.

In addition to increased regulatory compliance requirements, changes in laws could make ordinary conduct

of our business more expensive or require us to change the way we do business. For example, public health
officials and other governmental authorities have adopted numerous mitigation measures to address the spread of
COVID-19, and in particular to discourage people from congregating in public, commercial or private spaces.
Federal, state and local authorities, and in some instances mall and shopping center owners, in the U.S. and
Canada have implemented a number of different directives that encourage or require changes in our business
practices including requirements to close our retail stores and to curtail various aspects of our business
operations. The scope and duration of these directives is evolving and not entirely clear. A large number of states
and municipalities in the U.S. where we operate have implemented temporary closure requirements with respect
to non-essential business operations and the duration of these requirements are unknown. In response to the
public health crisis posed by COVID-19, effective from March 17, 2020, the Company temporarily closed its
retail locations for an indeterminate period of time. Although we continue to serve our customers virtually
through our Gallery representatives and designers, as well as our online websites, our business operations are
being substantially affected by applicable regulatory restrictions including stay-at-home requirements applicable
in California where our corporate headquarters is located. Our decision to reopen retail locations will be affected
by a number of factors including applicable regulatory restrictions and there is substantial uncertainty regarding
the manner and timing in which we can return some or all of our business to more normal business operations.
We may face longer term closure requirements and other operational restrictions with respect to some or all of
our physical locations for prolonged periods of time due to, among other factors, evolving and increasingly
stringent federal, state and local restrictions including shelter-in-place orders. Even once we are able to reopen
closed physical locations, changes in consumer behavior and health concerns may continue to impact consumer
demand for our products and customer traffic at our Galleries, restaurants and outlets and may make it more
difficult to staff our business operations. In addition, as a retail business, changes in laws related to employee
benefits and treatment of employees, including laws related to limitations on employee hours, supervisory status,

35

leaves of absence, mandated health benefits or overtime pay, could negatively impact us by increasing
compensation and benefits costs for overtime and medical expenses. Changes to United States health care laws,
or potential global and domestic greenhouse gas emission requirements and other environmental legislation and
regulations, could result in increased direct compliance costs for us (or may cause our vendors to raise the prices
they charge us in order to maintain profitable operations because of increased compliance costs), increased
transportation costs or reduced availability of raw materials.

In fiscal 2019, we sourced 84% of our products from outside the United States, and we are increasing the
level of our international sourcing activities in an effort to obtain more of our products directly from vendors
located outside the United States. Additionally, we have expanded our business-to-business sales. The foreign
and U.S. laws and regulations that are applicable to our operations are complex and may increase the costs of
regulatory compliance, or limit or restrict the products or services we sell or subject our business to the
possibility of regulatory actions or proceedings. The United States Foreign Corrupt Practices Act, and other
similar laws and regulations, generally prohibit companies and their intermediaries from making improper
payments to foreign governmental officials for the purpose of obtaining or retaining business. While our policies
mandate compliance with applicable laws and regulations, including anti-bribery laws and other anti-corruption
laws, we cannot assure you that we will be successful in preventing our employees or other agents from taking
actions in violation of these laws or regulations. Such violations, or allegations of such violations, could disrupt
our business and result in a material adverse effect on our financial condition, results of operations and cash
flows.

Labor organizing and other activities could negatively impact us.

Currently, none of our employees are represented by a union. However, our employees have the right at any

time to form or affiliate with a union, and union organizational activities have occurred from time to time. We
cannot predict the negative effects that any future organizing activities will have on our business and operations.
If we were to become subject to work stoppages, we could experience disruption in our operations and increases
in our labor costs, either of which could materially adversely affect our business, financial condition or results of
operations.

In addition, one of our key value driving strategies involves the development and introduction of new
Gallery locations. We pursue a range of different real estate development models for these projects. In a number
of these projects, we perform a significant role in various aspects of the design and construction of the Gallery
location. Both we and third party contractors that we use in these construction projects may be subject to efforts
and activities by organized labor to drive the hiring of union labor on these projects. To the extent that union
workers are not involved in these projects, we and our third party contractors may be subject to picketing and
other labor actions that could affect our business including protests in front of our Gallery locations in order to
discourage our customers from entering our stores, which could adversely affect our business at those locations
and our results of operations, including our same-store sales metrics. In addition, to the extent that we become
more directly involved in additional aspects of the construction work at our Gallery locations, we could be
subject to additional pressure from organized labor including union organizing efforts.

Fluctuations in our tax obligations and effective tax rate and realization of our deferred tax assets, including
net operating loss carryforwards, may result in volatility of our results of operations.

We are subject to income taxes in the United States and certain foreign jurisdictions. We record income tax
expense based on our estimates of future payments, which include reserves for uncertain tax positions in multiple
tax jurisdictions, and valuation allowances related to certain net deferred tax assets, including net operating loss
carryforwards. At any one time, many tax years are subject to audit by various taxing jurisdictions. The results of
these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. We expect
that throughout the year there could be ongoing variability in our quarterly tax rates as events occur and
exposures are evaluated.

36

In addition, our effective tax rate in a given financial statement period may be materially impacted by
changes in the mix and level of earnings, timing of the utilization of net operating loss carryforwards, changes in
the valuation allowance for deferred taxes or by changes to existing accounting rules or regulations.

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

New accounting rules or regulations and varying interpretations of existing accounting rules or regulations

have occurred and may occur in the future. It is difficult to predict the impact of future changes to accounting
principles or current accounting practice and the exact impact of such changes may not be what we anticipate. A
change in accounting rules or regulations may even affect our reporting of transactions completed before the
change is effective and future changes to accounting rules or regulations or the questioning of current accounting
practices may adversely affect our results of operations. For example, we adopted Accounting Standards Update
2014-09—Revenue from Contracts with Customers (Topic 606) in the first quarter of fiscal 2018, the adoption of
which materially impacted the timing of recognizing advertising expense related to direct response advertising,
including costs associated with our Source Books. In addition, we adopted Accounting Standards Update
2016-02—Leases (Topic 842) in the first quarter of fiscal 2019, the adoption of which materially impacted our
financial statements including (i) our consolidated balance sheets due to the initial recognition of right of use
assets and lease liabilities for our operating and finance lease arrangements, (ii) our consolidated statements of
operations, specifically cost of goods sold and interest expense—net, primarily due to the change from the
build-to-suit lease transactions under the previous accounting guidance to the new finance lease classification
treatment, and (iii) our cash flows due to amortization and interest expense for our operating and finance lease
arrangements and classification of landlord assets under construction. For information regarding recently issued
accounting pronouncements, refer to Note 3—Significant Accounting Policies in our consolidated financial
statements within Part II of this Annual Report on Form 10-K.

We may be unsuccessful in identifying attractive acquisition opportunities or, to the extent that we pursue
attractive acquisition opportunities, we may be unsuccessful in completing or realizing the expected benefits of
such acquisitions.

As part of exploring growth opportunities, we may from time to time seek to acquire value-creating, add-on

businesses that we believe will broaden our existing position and market reach. For example, in fiscal 2016, we
acquired a controlling interest in Waterworks. In the fourth quarters of fiscal 2018 and fiscal 2017, we recorded
goodwill impairment charges of $17.4 million and $33.7 million, respectively, with respect to Waterworks due to
indicators identified in the fourth quarters of fiscal 2018 and fiscal 2017 that there could be an impairment of the
Waterworks reporting unit. In addition, in the fourth quarter of fiscal 2018, we recorded a tradename impairment
charge of $14.6 million with respect to Waterworks due to indicators identified in the fourth quarter of fiscal
2018 that there could be an impairment of the Waterworks reporting unit. Refer to Note 3—Significant
Accounting Policies in our consolidated financial statements within Part II of this Annual Report on Form 10-K.
There can be no assurance that the Waterworks business will meet its future operating or financial objectives and
if its results do not improve we may recognize additional charges related to this business and our financial results
of operation may be adversely affected.

Furthermore, there can be no assurance that in the future we will be able to find suitable businesses to

purchase if we choose to acquire additional businesses, that we will be able to acquire such businesses on
acceptable terms, or that we will be successful in realizing the benefits of any acquisition we pursue. If we are
unsuccessful in any such acquisition efforts, then our ability to continue to grow at rates we anticipate could be
adversely affected.

In addition, we face the risk that an acquired business may not be successful on the RH platform and may

underperform relative to expectations. We may be unable to achieve synergies originally anticipated, we may be
exposed to unexpected liabilities or we may be unable to sufficiently integrate completed acquisitions into our
current business model and platform. The success of any completed acquisition will depend on our ability to

37

effectively manage the business after the acquisition. The process of maintaining the right incentives for
management of acquired businesses and integrating the acquired businesses may involve unforeseen difficulties
and may require a disproportionate amount of our managerial and financial resources. Our failure to incorporate
acquired businesses into our existing operations successfully or to minimize any unforeseen operational
difficulties could have a material adverse effect on our financial condition and results of operations. Further, if
we fail to allocate our capital appropriately, in respect of either our acquisitions or organic growth in our
operations, we could be overexposed in certain markets and geographies and unable to expand into adjacent
products or markets.

Any efforts that we undertake to improve the operations of an acquired business or to improve the

integration of such business with our larger business operations may not be successful and may create additional
operational challenges, in particular at a time when we are also engaged in numerous initiatives to
re-conceptualize our own organizational design and elevate the customer experience. To the extent we are
unsuccessful in such efforts, and our acquired business does not perform in line with our expectations or does not
contribute to the overall performance of our business, our gross margins, results of operations and business could
be materially adversely affected.

Our total assets include intangible assets with an indefinite life, goodwill, tradename and trademarks, and
substantial amounts of long-lived assets, principally property and equipment and lease right-of-use assets.
Changes to estimates or projections used to assess the fair value of these assets, or results of operations that
are lower than our current estimates at certain store locations, may cause us to incur impairment charges that
could adversely affect our results of operations.

Our total assets include intangible assets with an indefinite life, goodwill, tradename, trademarks and
domain names, and substantial amounts of property and equipment and lease right-of-use assets. We evaluate
these long-lived assets for possible impairment annually or earlier if impairment indicators exist and make
certain estimates and projections in connection with the impairment analyses for these long-lived assets. We also
review the carrying value of these assets for impairment whenever events or changes in circumstances indicate
that the carrying value of the asset may not be recoverable. We will record an impairment loss when the carrying
value of the underlying asset, asset group or reporting unit exceeds its fair value. These calculations require us to
make a number of estimates and projections of future results. If these estimates or projections change, we may be
required to record additional impairment charges on certain of these assets. If these impairment charges were
significant, our results of operations would be adversely affected. Refer to “Impairment” within Note 3—
Significant Accounting Policies in our consolidated financial statements within Part II of this Annual Report on
Form 10 K.

If we are unable to implement and maintain effective internal control over financial reporting in the future,
the accuracy and timeliness of our financial reporting may be adversely affected.

We are subject to Section 404 of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”),

which requires us to maintain internal control over financial reporting and to report any material weaknesses in
such internal control. We have in the past periodically experienced deficiencies in our internal controls that have
been identified during the audit process or at other times. If we identify in the future one or more material
weaknesses in our internal control over financial reporting, we will be unable to assert that our internal control
over financial reporting is effective. In addition, our independent registered public accounting firm is required to
attest to the effectiveness of our internal control over financial reporting. Therefore, even if our management
concludes that our internal control over financial reporting is effective, our independent registered public
accounting firm may issue a report that is qualified if they are not satisfied with our controls or the level at which
our controls are documented, designed, operated, or reviewed. Material weaknesses and significant deficiencies
may be identified during the audit process or at other times.

Our reporting obligations as a public company place a significant strain on our management and our

operational and financial resources and systems and will continue to do so for the foreseeable future. In addition,

38

we have experienced changes in personnel who are involved in our financial reporting. Although we believe that
we have invested adequate resources in developing and maintaining the procedures, personnel and systems
necessary to support our reporting obligations, there can be no assurance that these efforts have been or will be
successful. Changes in personnel, systems or procedures, as well as other events might have an adverse impact
on our internal controls. Deficiencies in our internal controls or other challenges in the financial reporting aspects
of our business may have an adverse impact on our ability to provide financial statements in accordance with
generally accepted accounting procedures and may give rise to errors in our financial statement. There can be no
assurance that our internal controls and financial reporting infrastructure and personnel have in the past
complied, or will continue in the future to comply, with our financial reporting obligations. If we fail to timely
achieve and maintain the adequacy of our internal control over financial reporting, we may not be able to produce
reliable financial reports. Our failure to achieve and maintain effective internal control over financial reporting
could prevent us from filing our periodic reports on a timely basis, which could result in the loss of investor
confidence in the reliability of our financial statements, harm our business, and negatively impact the trading
price of our common stock.

Our operations are subject to risks of natural or man-made disasters, acts of war, terrorism or widespread
illness, any one of which could result in a business stoppage and negatively affect our results of operations.

Our business operations depend on our ability to maintain and protect our facilities, computer systems and

personnel. Our operations and consumer spending may be affected by natural or man-made disasters or other
similar events, including floods, hurricanes, earthquakes, widespread illness, fires, loss of power, interruption of
other utilities, industrial accidents, social unrest and riots. In particular, our corporate headquarters is located in
Northern California and other parts of our operations are located in Northern and Southern California, each of
which is vulnerable to the effects of disasters, including fires and earthquakes that could disrupt our operations
and affect our results of operations, and there is evidence that extreme weather, extended drought and shifting
climate patterns have intensified the frequency and severity of wildfires in California. Many of our vendors are
also located in areas that may be affected by such events. Moreover, geopolitical or public safety conditions
which affect consumer behavior and spending may impact our business. Terrorist attacks or other hostilities, or
threats thereof, in the United States or in other countries around the world, as well as future events occurring in
response to or in connection with them, could again result in reduced levels of consumer spending. Any of these
occurrences could have a significant impact on our results of operations, revenue and costs.

If we encounter difficulties associated with any of our facilities or if any of our facilities were to shut down

for any reason, including as a result of a natural disaster, we could face shortages of inventory resulting in
backorders, significantly higher costs and longer lead times associated with distributing our products to both our
stores and online customers and the inability to process orders in a timely manner or ship goods to our customers.
Further, any significant interruption in the operation of our customer service centers could also reduce our ability
to receive and process orders and provide products and services to our stores and customers, which could result
in lost sales, cancelled sales and a loss of loyalty to our brand and have a material adverse effect on our business,
financial condition and results of operations.

Risks Related to Ownership of Our Common Stock

Our common stock price may be volatile or may decline regardless of our operating performance.

The market price for our common stock has recently experienced extreme volatility. As a retailer, our results

are significantly affected by factors outside our control, particularly consumer spending and consumer
confidence, which can significantly affect our stock price. In addition, the market price of our common stock
may fluctuate significantly in response to a number of other factors, including those described elsewhere in this
“Risk Factors” section, as well as the following:

•

•

quarterly variations in our results of operations compared to market expectations;

changes in preferences of our customers;

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•

•

•

•

•

•

•

•

•

•

•

•

•

•

announcements of new products or significant price reductions by us or our competitors;

size of our public float;

stock price performance of our competitors;

fluctuations in stock market prices and volumes;

default on our indebtedness;

actions by competitors or other shopping center tenants;

changes in senior management or key personnel;

changes in financial estimates by securities analysts or failure to meet their expectations;

actual or anticipated negative earnings or other announcements by us or other retail companies;

downgrades in our credit ratings or the credit ratings of our competitors;

natural or man-made disasters or other similar events;

issuances or expected issuances of capital stock;

impacts of the COVID-19 global outbreak; and

global economic, legal and regulatory changes unrelated to our performance.

In addition, stock markets have experienced extreme price and volume fluctuations that have affected and

continue to affect the market prices of equity securities of many retail companies. Stockholders can institute
securities class action litigation following periods of market volatility. We have been subject to such class action
securities litigation and may experience further claims of this kind. Any such securities litigation can result in
substantial costs and expenses and the attention of management could be diverted from our business.

Substantial future sales of our common stock, or the perception in the public markets that these sales may
occur, may depress our stock price.

In the future, we may issue our securities in connection with a capital raise or acquisitions. The amount of
shares of our common stock issued in connection with a capital raise or acquisition could constitute a material
portion of our then-outstanding shares of our common stock, which would result in dilution.

In addition, sales of substantial amounts of our common stock in the public market, or the perception that

these sales could occur, could adversely affect the price of our common stock and could impair our ability to
raise capital through the sale of additional shares.

Anti-takeover provisions in our charter documents and Delaware law might discourage or delay acquisition
attempts for us that you might consider favorable.

Our certificate of incorporation and bylaws contain provisions that may make the acquisition of our

Company more difficult without the approval of our board of directors. These provisions:

•

•

•

establish a classified board of directors so that not all members of our board of directors are elected at
one time;

authorize the issuance of undesignated preferred stock, the terms of which may be established and the
shares of which may be issued without stockholder approval, and which may include super voting,
special approval, dividend or other rights or preferences superior to the rights of the holders of
common stock;

prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a
meeting of our stockholders;

40

•

•

provide that our board of directors is expressly authorized to make, alter or repeal our bylaws; and

establish advance notice requirements for nominations for elections to our board of directors or for
proposing matters that can be acted upon by stockholders at stockholder meetings.

Our certificate of incorporation also contains a provision that provides us with protections similar to
Section 203 of the Delaware General Corporation Law (“DGCL”), and prevents us from engaging in a business
combination with a person who acquires at least 15% of our common stock for a period of three years from the
date such person acquired such common stock unless board or stockholder approval is obtained prior to the
acquisition, subject to certain exceptions. These anti-takeover provisions and other provisions under Delaware
law could discourage, delay or prevent a transaction involving a change in control of our Company, even if doing
so would benefit our stockholders. These provisions could also discourage proxy contests and make it more
difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate
actions you desire.

We do not expect to pay any cash dividends for the foreseeable future.

We do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable

future. Any determination to pay dividends in the future will be at the discretion of our board of directors and
will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by
applicable law and other factors our board of directors deems relevant. Accordingly, realization of a gain on your
investment will depend on the appreciation of the price of our common stock, which may never occur. Investors
seeking cash dividends in the foreseeable future should not purchase our common stock.

Expectations of our company relating to environmental, social and governance factors may impose additional
costs and expose us to new risks.

There is an increasing focus from certain investors, customers and other key stakeholders concerning
corporate responsibility, specifically related to environmental, social and governance (“ESG”) factors. Some
investors may use ESG criteria to guide their investment strategies and, in some cases, may choose not to invest
in us if they believe our policies relating to corporate responsibility are inadequate. Third-party providers of
corporate responsibility ratings and reports on companies have increased to meet growing investor demand for
measurement of corporate responsibility performance. In addition, the ESG factors by which companies’
corporate responsibility practices are assessed may change, which could result in greater expectations of us and
cause us to undertake costly initiatives to satisfy such new criteria. Alternatively, if we are unable to satisfy such
new criteria, investors may conclude that our policies with respect to corporate responsibility are inadequate. We
risk damage to our brand and reputation in the event that our corporate responsibility procedures or standards do
not meet the standards set by various constituencies. Furthermore, if our competitors’ corporate responsibility
performance is perceived to be greater than ours, potential or current investors may elect to invest with our
competitors instead. In addition, in the event that we communicate certain initiatives and goals regarding ESG
matters, we could fail, or be perceived to fail, in our achievement of such initiatives or goals, or we could be
criticized for the scope of such initiatives or goals. If we fail to satisfy the expectations of investors and other key
stakeholders or our initiatives are not executed as planned, our reputation and financial results could be
materially and adversely affected.

We expect that our common stock may experience increased trading volatility in connection with our
Convertible Notes Financing.

In September 2019, we issued $350 million of 0.00% convertible senior notes due 2024 (the “2024 Notes”).

In June 2018, we issued $300 million of 0.00% convertible senior notes due 2023 and, on June 26, 2018, we
issued an additional $35 million pursuant to the exercise of an overallotment option granted to the initial
purchasers as part of the June 2018 offering (the “2023 Notes”). In June 2015, we issued $250 million of 0.00%

41

convertible senior notes due 2020 and, on July 2, 2015, we issued an additional $50 million pursuant to the
exercise of the overallotment option granted to the initial purchasers as part of the June 2015 offering
(collectively, the “2020 Notes”). In June 2014, we issued $300 million of 0.00% convertible senior notes due
2019 and, on June 24, 2014, we issued an additional $50 million pursuant to the exercise of an overallotment
option granted to the initial purchasers as part of the June 2014 offering (the “2019 Notes” and, together with the
2024 Notes, 2023 Notes and the 2020 Notes, the “Notes”). In connection with each offering of the Notes, we
entered into convertible note hedge transactions with certain counterparties (the “Bond Hedge”) and warrant
transactions (the “Warrants” and together with the Notes and the Bond Hedge, the “Convertible
Notes Financing”) with the same counterparties (the “hedge counterparties”).

We have been advised that, in connection with establishing their initial hedge positions with respect to the
Bond Hedge and Warrants, the hedge counterparties and/or their affiliates would likely purchase shares of our
common stock or enter into various derivative transactions with respect to our common stock concurrently with,
or shortly after, the pricing of the Notes, including with certain investors in the Notes. These hedging activities
could increase (or reduce the size of any decrease in) the market price of our common stock or the Notes.

In addition, we expect that many investors in, including future purchasers of, the Notes may employ, or seek
to employ, a convertible arbitrage strategy with respect to the Notes. Investors would typically implement such a
strategy by selling short the common stock underlying the Notes and dynamically adjusting their short position
while continuing to hold the Notes. Investors may also implement this type of strategy by entering into swaps on
our common stock in lieu of or in addition to short selling the common stock.

Further, investors in the Notes may periodically modify their arbitrage strategies with respect to the Notes or

modify their hedge positions with respect to the Notes from time to time. The hedge counterparties and/or their
respective affiliates also may periodically modify their hedge positions from time to time (and are likely to do so
during the conversion period relating to any conversion of the Notes or following any repurchase of Notes by us
on any fundamental repurchase date or otherwise). Such modifications may be implemented by entering into or
unwinding various derivatives with respect to our common stock, and/or by purchasing or selling shares of our
common stock or other securities of the Company in secondary market transactions and/or open market
transactions. The effect, if any, of these transactions and activities on the market price of our common stock or
the trading prices of the Notes (which could affect a noteholder’s ability to convert the Notes or the amount and
value of the consideration received upon conversion of the Notes) will depend in part on market conditions and
cannot be ascertained at this time. Any of these activities, however, could adversely affect the market price of our
common stock.

It is not possible to predict the effect that these hedging or arbitrage strategies adopted by holders of the
Notes or counterparties to the Bond Hedge and Warrants will have on the market price of our common stock. For
example, the SEC and other regulatory and self-regulatory authorities have implemented various rules and taken
certain actions, and may in the future adopt additional rules and take other actions, that may impact those
engaging in short selling activity involving equity securities (including our common stock). Such rules and
actions include Rule 201 of SEC Regulation SHO, the adoption by the Financial Industry Regulatory
Authority, Inc. of a “Limit Up-Limit Down” program, the imposition of market-wide circuit breakers that halt
trading of securities for certain periods following specific market declines, and the implementation of certain
regulatory reforms required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Any
changes in government regulations or other factors that affect the manner in which third parties can engage in
hedging strategies, including entering into short sales or swaps on our common stock, could adversely affect the
trading prices and the liquidity of the Notes and/or our common stock.

Taken together, the Bond Hedge and Warrants are intended, but not guaranteed, to offset any actual earnings

dilution that could occur upon delivery of shares of common stock to satisfy to our conversion obligation under
the Notes. For the 2024 Notes, the corresponding Bond Hedge and Warrants are intended to limit the earnings
dilution that our stockholders would experience until the Company’s common stock is above approximately

42

$338.24 per share, the strike price of the 2024 Notes warrant transactions, which represented a 100% premium
over the closing price of our common stock at the time we entered into the Bond Hedge and Warrants related to
the 2024 Notes. For the 2023 Notes, the corresponding Bond Hedge and Warrants are intended to limit the
earnings dilution that our stockholders would experience until the Company’s common stock is above
approximately $309.84 per share, the strike price of the 2023 Notes warrant transactions, which represented a
100% premium over the closing price of our common stock at the time we entered into the Bond Hedge and
Warrants related to the 2023 Notes. For the 2020 Notes, the corresponding Bond Hedge and Warrants are
intended to limit the earnings dilution that our stockholders would experience until the Company’s common
stock is above approximately $189.00 per share, the strike price of the 2020 Notes warrant transactions, which
represented a 100% premium over the closing price of our common stock at the time we entered into the Bond
Hedge and Warrants related to the 2020 Notes. However, these transactions are complex, and there can be no
assurance that they will operate as planned.

We do not make any representation or prediction as to the direction or magnitude of any potential effect that

the transactions described above may have on the price of our common stock. In addition, we do not make any
representation that the counterparties to those transactions will engage in these transactions or activities or that
these transactions and activities, once commenced, will not be discontinued without notice; the counterparties or
their affiliates may choose to engage in, or discontinue engaging in, any of these transactions or activities with or
without notice at any time, and their decisions will be in their sole discretion and not within our control.

We may issue additional shares of our common stock or instruments convertible into shares of our common
stock, including in connection with the conversion of the Notes, and thereby materially and adversely affect
the market price of our common stock and the trading prices of the Notes.

We are not restricted from issuing additional shares of our common stock or other instruments convertible
into, or exchangeable or exercisable for, shares of our common stock during the life of each of the Notes. If we
issue additional shares of our common stock or instruments convertible into shares of our common stock, it may
materially and adversely affect the market price of our common stock and, in turn, the trading prices of the
Notes. In addition, the conversion of some or all of the Notes may dilute the ownership interests of existing
holders of our common stock, and any sales in the public market of any shares of our common stock issuable
upon such conversion of the Notes could adversely affect prevailing market prices of our common stock. In
addition, the anticipated conversion of the Notes could depress the market price of our common stock.

The fundamental change provisions of the Notes and the terms of the Bond Hedge and Warrants may delay or
hinder an otherwise beneficial takeover attempt of us.

The fundamental change purchase rights allow holders of Notes to require us to purchase all or a portion of

their Notes upon the occurrence of a fundamental change. The provisions of the indenture governing the
Notes requiring an increase to the conversion rate for conversions in connection with a make-whole fundamental
change, including certain corporate transactions such as a change in control, may result in a change in the value
of the Notes. Additionally, upon certain change of control transactions, the offsetting Bond Hedge and Warrants
that we entered into at the time we issued the Notes may be exercised and/or terminated early. As a result of
these provisions, we may be required to make payments to, or renegotiate terms with, holders of the Notes and/or
the hedge counterparties.

These features of the Notes and the Bond Hedge and Warrants, including the financial implications of any

renegotiation of the above-mentioned provisions, could have the effect of delaying or preventing a change of
control, whether or not it is desired by, or beneficial to, our stockholders, and may result in the acquisition of us
being on terms less favorable to our stockholders than it would otherwise be, or could require us to pay a portion
of the consideration available in such a transaction to holders of the Notes or Warrants or the counterparties to
the Bond Hedge.

43

Item 1B. Unresolved Staff Comments

None.

Item 2.

Properties

Leased Properties

As of February 1, 2020, we have approximately 1,735,000 leased gross square feet for 22 Design Galleries,
40 legacy Galleries, 2 RH Modern Galleries, 4 RH Baby & Child Galleries and 15 Waterworks showrooms. We
have approximately 1,208,000 leased gross square feet for 38 outlet stores as of February 1, 2020.

The following table summarizes the location and size of our leased fulfillment centers, home delivery center

locations and corporate facilities occupied as of February 1, 2020:

Location

RH Furniture Fulfillment Centers

Leased Square Footage
(Approximate)

Patterson, California . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Baltimore (North East), Maryland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

RH Small Parcel Fulfillment Center

West Jefferson, Ohio (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Home Delivery Center Locations (2)
Waterworks Fulfillment Center

1,501,000
1,195,000

1,224,000
1,384,000

Brookfield, Connecticut

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

160,000

Corporate Facilities

Corte Madera, California (1) (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pinole, California (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Danbury, Connecticut (5)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

257,000
200,000
41,000
101,000

(1) Customer service center and home delivery operations are also performed at this location.
(2)

Includes total approximate leased square footage for 13 separate home delivery center locations, 1 of which
was not yet operational as of February 1, 2020.

(3) Location of RH Headquarters. Includes approximately 8,000 square feet of warehouse space.
(4) Represents warehouse space.
(5) Location of Waterworks Headquarters.

For additional information regarding leases, refer to “Lease Accounting” within Note 3—Significant
Accounting Policies and Note 9—Leases in our consolidated financial statements within Part II of this Annual
Report on Form 10-K.

Owned Properties

We currently own two properties, a 9,000 total square foot property that is the location of our Gallery in San

Francisco’s Design District, and a 57,000 total square foot property that is the location of our Minneapolis
Design Gallery. Both owned properties are part of our RH Segment.

We believe that our current offices and facilities are in good condition, are being used productively and are

adequate to meet our requirements for the foreseeable future.

Item 3.

Legal Proceedings

From time to time, we and/or our management are involved in litigation, claims and other proceedings
relating to the conduct of our business, including purported class action litigation, as well as securities class
action litigation. Such legal proceedings may include claims related to our employment practices, wage and hour

44

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

For additional information regarding certain securities litigation, refer to Note 18—Commitments and
Contingencies in our consolidated financial statements within Part II of this Annual Report on Form 10-K.

Item 4. Mine Safety Disclosures

Not applicable.

45

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of

Equity Securities

Market Information and Dividend Policy

Our common stock trades under the symbol “RH” on the NYSE.

The number of stockholders of record of our common stock as of February 1, 2020 was 19. This number

excludes stockholders whose stock is held in nominee or street name by brokers.

No dividends have been declared or paid on our common stock. We do not currently anticipate that we will

pay any cash dividends on our common stock in the foreseeable future.

Stock Performance Graph

This performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for
purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall
not be deemed to be incorporated by reference into any filing of RH under the Securities Act of 1933, as
amended, or the Exchange Act.

The following graph and table compare the cumulative total stockholder return for our common stock during
the five-year period ended February 1, 2020 in comparison to the NYSE Composite Index and the S&P Retailing
Select Index, our peer group index. The graph and the table below assume that $100 was invested at the market
close on January 30, 2015 in the common stock of RH, the NYSE Composite Index and the S&P Retailing Select
Index. Data for the NYSE Composite Index and the S&P Retailing Select Index assumes reinvestments of
dividends. The comparisons in the graph and table are required by the SEC and are not intended to be indicative
of possible future performance of our common stock.

$250.00

$200.00

$150.00

$100.00

$50.00

$0.00

January 30, 2015

January 29, 2016

January 27, 2017

February 2, 2018

February 1, 2019

January 31, 2020

RH

NYSE Composite Index

S&P Retailing Select Index

RH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NYSE Composite Index . . . . . . . . . . . . . . . . .
S&P Retailing Select Index . . . . . . . . . . . . . . .

100.00
100.00
100.00

70.40
91.42
88.63

29.81
107.08
92.27

105.15
124.18
98.29

152.68
117.01
94.69

238.49
129.20
92.79

1/30/2015

1/29/2016

01/27/2017

02/02/2018

02/01/2019

01/31/2020

46

Repurchases of Common Stock

During the three months ended February 1, 2020, we repurchased the following shares of our common

stock:

Average
Purchase
Price Per
Share

$ —
$217.45
$ —

Number of
Shares (1)

—
2,445
—

2,445

Total Number
of Shares
Repurchased
as Part of
Publicly
Announced
Plans or
Programs (2)

—
—
—

—

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

(in millions)
$450
$450
$450

November 3, 2019 to November 30, 2019 . . .
December 1, 2019 to January 4, 2020 . . . . . .
January 5, 2020 to February 1, 2020 . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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

(2) Reflects shares repurchased as part of $950 Million Repurchase Program authorized by the Board of

Directors on October 10, 2018 and replenished on March 25, 2019.

Item 6.

Selected Consolidated Financial Data

The following tables present RH’s consolidated financial and operating data as of the dates and for the
periods indicated. The selected consolidated financial data as of February 1, 2020 and February 2, 2019 and for
the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018 were derived from consolidated
financial statements included in Item 8—Financial Statements and Supplementary Data. The selected
consolidated financial data as of February 3, 2018 and as of and for the periods ended January 28, 2017 and
January 30, 2016 were derived from consolidated financial statements for such years not included herein.

The selected financial data as of and for the periods ended February 1, 2020, February 2, 2019 and

February 3, 2018 reflect the modified retrospective application of the new lease accounting standard (Accounting
Standards Update 2016-02—Leases). The selected consolidated financial data as of and for the periods ended
January 28, 2017 and January 30, 2016 were not modified to reflect the impact of the new lease accounting
standard. For information regarding recently issued accounting pronouncements, refer to Note 3—Significant
Accounting Policies in our consolidated financial statements within Part II of this Annual Report on Form 10-K.

The fiscal years ended February 1, 2020, February 2, 2019, January 28, 2017 and January 30, 2016 each

consisted of 52 weeks. The fiscal year ended February 3, 2018 consisted of 53 weeks.

47

The selected historical consolidated data presented below should be read in conjunction with Item 1A—Risk
Factors, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations, our
consolidated financial statements and the notes to our consolidated financial statements.

As Revised Under ASU 2016-02—Leases

February 1,
2020 (1)

Year Ended

February 2,
2019 (1)

February 3,
2018 (1)

January 28,
2017 (2)

January 30,
2016 (2)

As Reported

Year Ended

Consolidated Statements of

Operations:

(dollars in thousands, except per share amounts)

Net revenues . . . . . . . . . . . . . . . . . . . . . $ 2,647,437 $ 2,505,653 $ 2,440,174
1,600,876
Cost of goods sold . . . . . . . . . . . . . . . . .

1,520,076

1,552,426

$ 2,134,871 $ 2,109,006
1,356,314

1,455,084

Gross profit

. . . . . . . . . . . . . . . . . .

1,095,011

985,577

839,298

679,787

752,692

Selling, general and administrative

expenses . . . . . . . . . . . . . . . . . . . . . . .

Income from operations . . . . . . . . .

Other expenses

Interest expense—net
Goodwill and tradename

. . . . . . . . . .

732,180

362,831

723,841

261,736

722,183

117,115

626,751

53,036

567,131

185,561

87,177

67,769

56,002

44,482

35,677

impairment . . . . . . . . . . . . . . . . .

—

32,086

33,700

Loss on extinguishment of debt—

net

. . . . . . . . . . . . . . . . . . . . . . .

Total other expenses . . . . . . . . . . . . . . .

Income before income taxes . . . . .
Income tax expense . . . . . . . . . . . . . . . .

6,472

93,649

269,182
48,807

917

100,772

160,964
25,233

4,880

94,582

22,533
25,132

—

—

44,482

8,554
3,153

—

—

35,677

149,884
58,781

Net income (loss) . . . . . . . . . . . . . . $

220,375 $

135,731 $

(2,599) $

5,401 $

91,103

Weighted-average shares used in

computing basic net income (loss)
per share . . . . . . . . . . . . . . . . . . . . . . .
Basic net income (loss) per share . . . . . $
Weighted-average shares used in

computing diluted net income (loss)
per share . . . . . . . . . . . . . . . . . . . . . . .
Diluted net income (loss) per share . . . . $
Other Financial and Operating Data:
. . . . . . . . . . . . . $
Adjusted net income (3)
Adjusted EBITDA (4) . . . . . . . . . . . . . . . $

19,082,303

21,613,678

27,053,616

40,691,483

11.55 $

6.28 $

(0.10) $

0.13 $

40,190,448
2.27

24,299,034

26,533,225

27,053,616

40,926,840

9.07 $

5.12 $

(0.10) $

0.13 $

42,256,559
2.16

276,297 $
495,418 $

204,318 $
400,067 $

103,822
269,509

$
$

$

51,789 $
186,225 $

114,772
273,425

170,031 $

127,902

Capital expenditures . . . . . . . . . . . . . . . $
Landlord assets under construction—

93,623 $

79,992 $

68,393

net of tenant allowances . . . . . . . . . .

64,300

59,001

81,065

—

—

Adjusted net capital

expenditures . . . . . . . . . . . . . . . . $

157,923 $

138,993 $

149,458

$

170,031 $

127,902

48

As Revised Under ASU 2016-02—Leases

As Reported

February 1,
2020 (1)

February 2,
2019 (1)

February 3,
2018 (1)

January 28,
2017 (2)

January 30,
2016 (2)

(in thousands)

Balance Sheet Data:
Cash and cash equivalents . . . . . . . . . . . . . . . . . $
Short-term and long-term investments (5)
. . . . .
Working capital (deficit) (6) . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financing obligations under build-to-suit lease
transactions . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2019—net (7) . . . .
Convertible senior notes due 2020—net (7) . . . .
Convertible senior notes due 2023—net (7) . . . .
Convertible senior notes due 2024—net (7) . . . .
Asset based credit facility . . . . . . . . . . . . . . . . .
Term loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment promissory notes . . . . . . . . . . . . . . .
Promissory notes (8) . . . . . . . . . . . . . . . . . . . . . .
Notes payable for share repurchases . . . . . . . . .
Total debt (including current portion) (9) . . . . . .
Total stockholders’ equity (deficit) . . . . . . . . . .

47,658 $
—
(20,419)
2,445,694

5,803 $
—
56,062
2,423,018

17,907
—
55,867
2,234,260

$

87,023 $ 331,467
152,855
175,889
722,355
861,304
2,067,944
2,192,520

—
—
291,110
270,271
268,366
—
—
53,372
53,000
18,741
954,860
18,651

—
344,146
272,919
253,689
—
57,500
—
—
—
19,633
947,887
(38,690)

—
329,012
255,865
—
—
199,970
80,000
18,497
13,183
19,390
915,917
(8,155)

203,015
314,543
239,876
—
—
—
—
—
—
19,390
581,318
919,869

146,621
300,711
224,887
—
—
—
—
—
—
19,523
552,702
886,160

(1)

Fiscal periods reflect the modified retrospective application of the new lease accounting standard
(Accounting Standards Update 2016-02—Leases). For information regarding recently issued accounting
pronouncements, refer to Note 3—Significant Accounting Policies in our consolidated financial statements
within Part II of this Annual Report on Form 10-K.
(2)
Fiscal periods were not modified to reflect the impact of the new lease accounting standard.
(3) Adjusted net income is a supplemental measure of financial performance that is not required by, or

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

49

The following table presents a reconciliation of net income (loss), the most directly comparable GAAP
financial measure, to adjusted net income for the periods indicated below.

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments pre-tax:

. . . . . . . . . .
Amortization of debt discount (a)
Asset impairments and lease losses (b)
. . . . . .
Loss on extinguishment of debt—net (c) . . . . .
Reorganization related costs (d) . . . . . . . . . . . .
Recall accrual (e) . . . . . . . . . . . . . . . . . . . . . . .
Asset held for sale loss (gain) (f) . . . . . . . . . . .
Legal settlements (g)
. . . . . . . . . . . . . . . . . . . .
Goodwill and tradename impairment (h) . . . . .
Distribution center closures (i) . . . . . . . . . . . . .
Impact of inventory step-up (j)
. . . . . . . . . . . .
Non-cash compensation (k) . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . .
Anti-dumping exposure (l)
Gain on sale of building and land (m)
. . . . . . .
Legal claim (n) . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . .
Acquisition related costs (o)

Subtotal adjusted items . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . .

Impact of income tax items (p)

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

January 28,
2017

January 30,
2016

$220,375

$135,731

(in thousands)
$ (2,599)

$ 5,401

$ 91,103

42,545
21,899
6,472
1,075
(3,988)
(1,529)
(1,193)
—
—
—
—
—
—
—
—

65,281
(9,359)

39,216
7,218
917
9,977
1,619
8,497
(5,289)
32,086
3,046
380
—
—
—
—
—

27,926
4,417
4,880
949
7,707
—
—
33,700
7,230
2,527
23,872
(2,202)
(2,119)
—
—

26,404
12,743
—
5,698
4,615
4,767
—
—
—
6,835
3,672
—
—
8,701
2,847

19,803
—
—
—
—
—
—
—
—
—
—
—
—
19,046
—

97,667
(29,080)

108,887
(2,466)

76,282
(29,894)

38,849
(15,180)

Adjusted net income . . . . . . . . . . . . . . . . . . . . . . . .

$276,297

$204,318

$103,822

$ 51,789

$114,772

(a) Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are
required to be separately accounted for as liability and equity components of the instrument in a
manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for
GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were
issued in June 2014 (the “2019 Notes”), for the $300 million aggregate principal amount of convertible
senior notes that were issued in June and July 2015 (the “2020 Notes”), for the $335 million aggregate
principal amount of convertible senior notes that were issued in June 2018 (the “2023 Notes”) and for
the $350 million aggregate principal amount of convertible senior notes that were issued in September
2019 (the “2024 Notes”), we separated the 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes into
liability (debt) and equity (conversion option) components and we are amortizing as debt discount an
amount equal to the fair value of the equity components as interest expense on the 2019 Notes, 2020
Notes, 2023 Notes and 2024 Notes over their expected lives. The equity components represent the
difference between the proceeds from the issuance of the 2019 Notes, 2020 Notes, 2023 Notes and
2024 Notes and the fair value of the liability components of the 2019 Notes, 2020 Notes, 2023 Notes
and 2024 Notes, respectively. Amounts are presented net of interest capitalized for capital projects of
$3.7 million, $2.7 million, $2.5 million, $2.4 million and $2.3 million during fiscal 2019, fiscal 2018,
fiscal 2017, fiscal 2016 and fiscal 2015, respectively. The 2019 Notes matured on June 15, 2019 and
did not impact amortization of debt discount post-maturity.

(b) The adjustments in fiscal 2019 include (i) asset impairments of $9.1 million, (ii) acceleration of

depreciation expense of $6.2 million due to a change in the estimated useful lives of certain assets and
a $0.5 million charge related to the termination of a service agreement associated with such assets,
(iii) an RH Contemporary Art lease impairment of $4.6 million, resulting from an update to both the
timing and the amount of future estimated lease related cash inflows, and (iv) other lease impairments
of $1.5 million due to early exit of leased facilities. The adjustments in fiscal 2018 include (i) an RH

50

Contemporary Art lease impairment of $3.4 million, (ii) acceleration of depreciation expense of
$2.6 million due to a change in the estimated useful life of certain assets and (iii) a $1.2 million
inventory impairment charge related to holiday merchandise. The adjustment in fiscal 2017 represents
an RH Contemporary Art lease impairment. The adjustment in fiscal 2016 includes the initial
impairment associated with RH Contemporary Art, which was integrated into the broader RH platform
and was no longer operational as a separate division, which resulted in inventory impairment of
$1.1 million and impairment of $10.6 million related to the lease, property and equipment disposals,
and donations. Fiscal 2016 also includes a $1.0 million inventory impairment charge associated with
RH Kitchen due to the alignment with the Waterworks Kitchen product line strategy.

(c) The adjustment in fiscal 2019 represents the loss on extinguishment of debt related to a second lien

term loan which was repaid in full in September 2019 and the acceleration of debt issuance costs
related to early repayment of the FILO term loan, partially offset by the gain on extinguishment of debt
upon the maturity and settlement of the 2019 Notes in June 2019. The adjustment in fiscal 2018
represents the loss on extinguishment of debt related to the LILO term loan, the promissory note
secured by our aircraft and the equipment security notes, all of which were repaid in full in June 2018.
The adjustment in fiscal 2017 represents the loss on extinguishment of debt related to a second lien
term loan which was repaid in full in October 2017.

(d) Represents severance costs and related taxes associated with reorganizations. The fiscal 2017 and fiscal
2016 adjustments are partially offset by a reversal of stock-based compensation expense related to
unvested equity awards.

(e) Represents adjustments to net revenues, cost of goods sold and inventory charges associated with
product recalls, as well as accrual adjustments, and vendor and insurance claims. The recall
adjustments had the following effect on our income before taxes:

(Increase) decrease to net revenues . . . . . . . . . . . . . . . . . . . . . .
Increase (decrease) to cost of goods sold . . . . . . . . . . . . . . . . . .

(Increase) decrease to gross profit
Increase (decrease) to selling, general and administrative

. . . . . . . . . . . . . . . . . . . . . . .

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

January 28,
2017

$ (391)
(3,372)

(3,763)

$ 4,733
(4,139)

594

$3,207
4,315

7,522

$3,441
535

3,976

expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(225)

1,025

185

639

(Increase) decrease to income before income taxes . . . . . .

$(3,988)

$ 1,619

$7,707

$4,615

(f) The adjustment in fiscal 2019 includes gain on real estate related to asset previously classified as held

for sale and other land sales. The adjustment in fiscal 2018 represents the impairment recorded upon
reclassification of an owned Design Gallery as held for sale. The adjustment in fiscal 2016 represents
the impairment recorded upon reclassification of aircraft as asset held for sale.

(g) Represents legal settlements, net of related legal expenses.
(h) Represents goodwill and tradename impairment related to the Waterworks reporting unit. Refer to

“Impairment” within Note 3—Significant Accounting Policies in our consolidated financial statements
within Part II of this Annual Report on Form 10-K.

(i) Represents disposals of inventory and property and equipment, lease related charges, inventory transfer

costs and other costs associated with distribution center closures.

(j) Represents the non-cash amortization of the inventory fair value adjustment recorded in connection

with our acquisition of Waterworks.

(k) The adjustment in fiscal 2017 represents a non-cash compensation charge related to a fully vested

option grant made to Mr. Friedman in May 2017. The adjustment in fiscal 2016 represents a non-cash
compensation charge related to the fully vested option grants made in connection with our acquisition
of Waterworks.

51

(l) Represents the release of the remaining reserve for potential claims regarding anti-dumping duties

which we believe have lapsed. The reserve related to potential tariff obligations of one of our foreign
suppliers following the U.S. Department of Commerce’s review on the anti-dumping duty order on
wooden bedroom furniture from China for the period from January 1, 2011 through December 31,
2011.

(m) Represents the gain on the sale of building and land of one of our previously owned retail Galleries.
(n) Represents charges incurred or the estimated cumulative impact of coupons redeemed in connection
with a legal claim alleging that the Company violated California’s Song-Beverly Credit Card Act of
1971 by requesting and recording ZIP codes from customers paying with credit cards.

(o) Represents costs incurred in connection with our acquisition of Waterworks including professional

fees.

(4)

(p) The adjustment in fiscal 2019 is based on an adjusted tax rate of 17.4%, which is calculated using a
21% normalized tax rate for the first and second quarters of fiscal 2019 and the effective tax rates of
13.7% and 14.9% for the third and fourth quarters of fiscal 2019, respectively. Fiscal 2018 and fiscal
2017 assume a normalized tax rate of 21%. Fiscal 2016 assumes a normalized tax rate of 39%. The
adjustment in fiscal 2015 represents the tax effect of the adjusted items based on our effective tax rate
of 39.2%.

EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required
by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income (loss) before
depreciation and amortization, interest expense—net and income tax expense. Adjusted EBITDA reflects
further adjustments to EBITDA to eliminate the impact of non-cash compensation, as well as certain
non-recurring and other items that we do not consider representative of our underlying operating
performance. EBITDA and Adjusted EBITDA are included in this filing because management believes
that these metrics provide meaningful supplemental information for investors regarding the performance of
our business and facilitate a meaningful evaluation of operating results on a comparable basis with
historical results. Our management uses these non-GAAP financial measures in order to have comparable
financial results to analyze changes in our underlying business from quarter to quarter. Our measures of
EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions for other
companies due to different methods of calculation. The following table presents a reconciliation of net
income (loss), the most directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA
for the periods indicated below.

52

February 1,
2020

February 2,
2019

February 3,
2018

January 28,
2017

January 30,
2016

Year Ended

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation and amortization . . . . . . . . . . . . . . . .
Interest expense—net . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . .

$220,375
100,739
87,177
48,807

$135,731
91,372
67,769
25,233

$ (2,599) $
83,176
56,002
25,132

5,401
56,995
44,482
3,153

$ 91,103
44,595
35,677
58,781

EBITDA . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . .
Non-cash compensation (a)
Asset impairments and lease losses (b)
. . . . . . . . . .
Loss on extinguishment of debt—net (b) . . . . . . . . .
Reorganization related costs (b) . . . . . . . . . . . . . . . .
Recall accrual (b) . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset held for sale loss (gain) (b) . . . . . . . . . . . . . . .
Legal settlements (b)
. . . . . . . . . . . . . . . . . . . . . . . .
Goodwill and tradename impairment (b) . . . . . . . . .
. . . . . . . . . . . . . . . .
Distribution center closures (b)
. . . . . . . . . . . . . . . .
Impact of inventory step-up (b)
Anti-dumping exposure (b)
. . . . . . . . . . . . . . . . . . .
Gain on sale of building and land (b) . . . . . . . . . . . .
Legal claim (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisition related costs (b) . . . . . . . . . . . . . . . . . . .

457,098
21,832
15,651
6,472
1,075
(3,988)
(1,529)
(1,193)
—
—
—
—
—
—
—

320,105
24,122
4,607
917
9,977
1,619
8,497
(5,289)
32,086
3,046
380
—
—
—
—

161,711
50,709
4,417
4,880
949
7,707
—
—
33,700
7,230
2,527
(2,202)
(2,119)
—
—

110,031
29,988
12,743
—
5,698
4,615
4,767
—
—
—
6,835
—
—
8,701
2,847

230,156
24,223
—
—
—
—
—
—
—
—
—
—
—
19,046
—

Adjusted EBITDA . . . . . . . . . . . . . . . . . . . . .

$495,418

$400,067

$269,509

$186,225

$273,425

(a) Represents non-cash compensation related to equity awards granted to employees, including the

non-cash compensation charge related to a fully vested option grant made to Mr. Friedman in May
2017 and a non-cash compensation charge related to the fully vested option grants made in connection
with our acquisition of Waterworks in fiscal 2016.

(b) Refer to the reconciliation of net income (loss) to adjusted net income table above and the related

footnotes for additional information.

(5) As of the year ended fiscal 2016 and fiscal 2015, $142.7 million and $130.8 million, respectively, of our

investments were due within one year. As of the year ended fiscal 2016 and fiscal 2015, $33.2 million and
$22.1 million, respectively, of our investments were due within two years. We held no investments as of
fiscal 2019, fiscal 2018 or fiscal 2017.

(6) Working capital (deficit) is defined as current assets, less current liabilities, excluding the current portion

(7)

(8)

(9)

of long-term debt.
Represents our obligations, net of debt discount, related to the 2019 Notes, 2020 Notes, 2023 Notes and
2024 Notes. The aggregate principal amounts due under the 2020 Notes, 2023 Notes and 2024 Notes are
$300 million, $335 million and $350 million, respectively. The aggregate principal amount under the 2019
Notes that matured on June 15, 2019 was $350 million.
Represents promissory notes on asset under construction as of February 1, 2020 and an aircraft promissory
note as of February 3, 2018.
Total debt (including current portion) includes the 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes,
net of debt discount, asset based credit facility, term loan, equipment promissory notes, promissory notes
and notes payable for share repurchases. Total debt (including current portion) includes capital lease
obligations and excludes financing obligations under build-to-suit lease transactions in fiscal 2016 and
fiscal 2015.

53

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a leading luxury retailer in the home furnishings marketplace. Our curated and fully-integrated
assortments are presented consistently across our sales channels in sophisticated and unique lifestyle settings that
we believe are on par with world-class interior designers. We offer dominant merchandise assortments across a
growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, and
child and teen furnishings. We position our Galleries as showrooms for our brand, while our Source Books and
websites act as virtual extensions of our stores. Our retail business is fully integrated across our multiple channels
of distribution, consisting of our stores, Source Books, and websites. We have an integrated RH Hospitality
experience in eight of our new Design Gallery locations, which include restaurants, wine vaults and barista bars.

Our business is fully integrated across our multiple channels of distribution, consisting of our stores, Source

Books and websites. As of February 1, 2020, we operated the following number of Galleries, outlets and
showrooms:

RH

Design Galleries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legacy Galleries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Modern Galleries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Baby & Child and Teen Galleries . . . . . . . . . . . . . . . . . . . . .

Total Galleries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outlets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Waterworks Showrooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Count

22
40
2
4

68
38
15

We are undertaking substantial changes in our business and operations in response to the recent global

outbreak of the coronavirus (COVID-19).

The COVID-19 health crisis poses significant and widespread risks to our business as well as to the business

environment and the markets in which we operate our business. We have already experienced significant
disruption to our business as a result of the rapid development of the COVID-19 pandemic. The immediate
impact from this global health crisis has been both direct in terms of disruption in numerous aspects of our
business operations as well as indirect in terms of the adverse effect on overall economic conditions. The
magnitude and duration of the negative impact to our business from the COVID-19 pandemic cannot be
predicted with certainty. Accordingly, we withdrew all prior guidance and outlook statements that relate to the
performance of our business with respect to fiscal 2020.

In response to the public health crisis posed by COVID-19, effective from March 17, 2020, the Company

temporarily closed its retail locations for an indeterminate period of time. Although we continue to serve our
customers virtually through our Gallery representatives and designers, as well as our online websites, our
business operations are being substantially affected by applicable regulatory restrictions including stay-at-home
requirements applicable in California where our corporate headquarters is located. Our decision to reopen retail
locations will be affected by a number of factors including applicable regulatory restrictions and there is
substantial uncertainty regarding the manner and timing in which we can return some or all of our business to
more normal business operations. We may face longer term closure requirements and other operational
restrictions with respect to some or all of our physical locations for prolonged periods of time due to, among
other factors, evolving and increasingly stringent federal, state and local restrictions including shelter-in-place
orders. Even once we are able to reopen closed physical locations, changes in consumer behavior and health
concerns may continue to impact consumer demand for our products and customer traffic at our Galleries,
restaurants and outlets and may make it more difficult to staff our business operations. If we are not able to
access capital at the time and on terms that our business requires, we may encounter difficulty funding our

54

business requirements including debt repayments when due. Given the fast moving nature of the COVID-19
health crisis, and the corresponding impact on financial markets and the economy as a whole, there is an
enhanced degree of uncertainty regarding the Company’s capital position and availability of capital to fund the
Company’s liquidity requirements. We may not be able to access liquidity or the terms and conditions of
available credit may be substantially more expensive than previously expected due to changes in financial
conditions and credit markets. We may require waivers or amendments to our existing credit facilities and these
requirements may trigger pricing increases from lenders for available credit. If we are not able to access credit to
fund our business requirements for liquidity, or the cost of available credit increases, we may need to curtail our
business operations including various business initiatives that require capital investment. We have recently
commenced an effort to expand our business internationally by establishing a new retail presence in global
markets including Europe and the United Kingdom. In addition, we are in the process of developing a number of
new Gallery locations in the U.S. In addition, our RH Guesthouse initiative may be negatively impacted by the
disease outbreak as federal, state and local governments have restricted travel, conferences, events and
gatherings. Reductions in our liquidity position and the need to use capital for other day to day requirements of
our business may affect a number of our business initiatives and long-term investments and as a result we may be
required to curtail and/or postpone business investments including those related to international expansion, the
pace of opening new Galleries in the U.S. as well as other initiatives that require capital investment.

As a result of the COVID-19 outbreak, and the corresponding reduction in our sales, we have had to
institute a number of measures to mitigate expenses and reduce costs. These efforts may not be enough to offset
anticipated declines in revenue including the loss of sales related to store closures, and may negatively affect our
ability to quickly resume operations when we are able to re-open our Galleries, restaurants and outlets.
Substantially all of our management personnel, including those in our corporate office in Corte Madera, CA, are
subject to shelter-in-place requirements which have resulted in most of our management team being required to
work remotely. These working arrangements as well as other related restrictions including severe limitations on
travel may have an impact on our operations and management effectiveness. Although we have technology and
other resources to support these new work requirements, there can be no assurance that we will not suffer
material risks to our business, operations, production productivity and results of operations as a result of these
restrictions. If a significant percentage of our workforce is unable to work, including because of illness or travel
or government restrictions in connection with COVID-19, our operations may be negatively impacted, potentially
materially adversely affecting our business, liquidity, financial condition or results of operations. The global
scale and scope of COVID-19 is unknown and the duration of the business disruption and related financial
impact cannot be reasonably estimated at this time. The extent to which the COVID-19 pandemic impacts our
results will depend on future developments that are highly uncertain and cannot be predicted, including the
duration of our RH Galleries, restaurant and outlet closures, emerging information concerning the severity of
COVID-19 and the actions taken by governments and private businesses to attempt to contain COVID-19.
However, the Company believes COVID-19 is likely to result in an adverse impact on our business, results of
operations and financial condition, particularly if ongoing mitigation actions occur for a significant amount of
time. For more information, refer to Item 1A—Risk Factors— The global outbreak of the COVID-19 virus is
likely to have an adverse impact on our business.

Our net revenue for the fourth quarter of fiscal 2019 was $665.0 million, compared to $670.9 million for the

fourth quarter of 2018. Net revenue for the fourth quarter of fiscal 2019 was negatively impacted by several
factors, including higher than expected backorders due to a year-over-year decrease in inventories as well as our
decision to eliminate most seasonal holiday merchandising from our business, which decision we believe
contributed a larger than anticipated impact to sales as customers who might otherwise purchase our holiday
merchandise chose to shop at other retailers offering holiday merchandise selections and, as a result, our net
revenues were less than the prior period not only due to elimination of the sale of the holiday merchandise but
also the loss of additional sales of non-holiday merchandise that would typically been made at the same time by
customers attracted to our product offerings of holiday merchandise. In addition, prior periods including the
fourth quarter of fiscal 2018 included revenue from higher outlet and warehouse sales stemming from our
inventory optimization efforts. In fiscal 2019, we resumed introducing product expansions in our merchandise

55

assortment including a number of new merchandise collections in both RH Interiors and RH Modern, as well as
the launch of RH Beach House in the Spring and RH Ski House in the Fall. While we believe that product
expansion will provide us with a significant opportunity to increase our market share and revenues, in the fourth
quarter of fiscal 2019 we experienced some delays in the delivery of products to our customers due to back
orders and special orders, which resulted from insufficient inventory to meet customer demand and slow
ramp-ups at the factories that produce such products in response to the demand level from consumers.

Key Value Driving Strategies

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

•

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

New sites are identified based on a variety of factors, such as (i) the availability of suitable new site
locations based on several store specific factors including geographic location, demographics, and
proximity to affluent consumers, (ii) the ability to negotiate favorable economic terms, as well as
(iii) the satisfactory and timely completion of real estate development including procurement of
permits and completion of construction. Based on our analysis, we believe we have the opportunity to
operate Design Galleries in 60 to 70 locations in the United States and Canada. The number of Design
Galleries we open in any fiscal year is highly dependent upon these variables and individual new
Design Galleries may be subject to delay or postponement depending on the circumstances of specific
projects, which we have experienced with some of our recent projects.

We opened our Portland Design Gallery in March 2018, our Nashville Design Gallery in June 2018,
our New York Design Gallery and our Yountville Design Gallery in September 2018, our Minneapolis
Design Gallery in September 2019, and our Columbus Design Gallery in December 2019. Our
Galleries in Nashville, New York, Yountville, Minneapolis and Columbus include integrated
restaurants, wine vaults and barista bars.

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

First, we have developed a new RH prototype Design Gallery that is an innovative and flexible
blueprint which we believe will enable us to more quickly place our disruptive product assortment and
immersive retail experience into the market. The new model is a standard we will utilize in the future
that is based on key learnings from more recent Design Gallery openings and will have approximately
38,000 leased selling square feet inclusive of our integrated hospitality experience. This prototype will
present our assortments across our businesses and contain interior design offices and presentation
rooms where design professionals can work with clients on their projects. This new model will be more
capital efficient with less time and cost risk, but yield similar productivity. We anticipate the new
prototype Design Galleries will represent the format of most of our upcoming Design Galleries in
North America. Our most recently opened Design Galleries in Minneapolis, MN and Columbus, OH
are prototype Design Galleries, and upcoming prototype locations include Corte Madera, CA,
Charlotte, NC, Jacksonville, FL, Dallas, TX and Oakbrook, IL.

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

Third, we will continue to open indigenous Bespoke Galleries in the best second home markets where
the wealthy and affluent visit and vacation. These Galleries are tailored to reflect the local culture and

56

are sized to the potential of each market. Examples of current indigenous Bespoke Galleries include
Yountville, CA and Aspen, CO.

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

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

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

•

•

First, due to the productivity and proof of concept of our recent new Galleries, and the addition of
a powerful, traffic-generating hospitality experience, we are able to negotiate “capital light”
leasing deals, where as much as 65% to 100% of the capital requirement would be funded by the
landlord, versus 35% to 50% previously.

Second, in select projects we are migrating from a leasing to a development model. We currently
have two Galleries, Yountville and Minneapolis, using this new model, and have additional
projects in the pipeline. In the case of Yountville and Minneapolis, we have completed or expect
to complete sale-leaseback transactions that should allow us to recoup all or a large portion of our
capital.

• Third, we are working on joint venture projects, where we share the upside of a development with

the developer/landlord. An example of this new model would be our future Gallery and
Guesthouse in Aspen, where we are contributing the value of our lease to the development in
exchange for a profits interest in the project. The developer will deliver to RH a substantially
turnkey Gallery and Guesthouse, while we continue to retain a 20% and 25% profits interest in the
properties, respectively. We would expect to monetize the profits interest at the time of sale of the
properties during the first five years. The net result should be a minimal capital investment to
operationalize the business, with the expectation for a net positive capital benefit at time of
monetization of the profits interest.

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

• Pursue International Expansion. We believe that our luxury brand positioning and unique aesthetic has
strong international appeal. As such, we believe there is tremendous opportunity for the RH brand to
expand globally and launch RH International in 2021 or 2022 and we are close to completing real
estate transactions for approximately 5 initial locations across Europe.

• Expand Our Offering and Increase Our Market Share. We believe we have a significant opportunity to

increase our market share by:

•

•

•

•

transforming our real estate platform;

growing our merchandise assortment and introducing new products and categories;

expanding our service offerings, including design services;

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

57

•

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

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

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

• Grow Our Integrated Hospitality Experience. In 2015 we began to introduce an integrated

hospitality experience, including restaurants, wine vaults and barista bars, into a number of our
new Gallery locations. The success of our initial hospitality offering in Chicago led us to broaden
this initiative by adding hospitality to a number of our other new Gallery locations. We believe
this has created a unique new retail experience that cannot be replicated online, and that the
addition of hospitality is helping to drive incremental sales of home furnishings in these Galleries.
We plan to incorporate hospitality in many of the new Galleries that we open in the future.

• Architect New Operating Platform. We have spent the last four years architecting a new operating
platform, inclusive of transitioning from a promotional to membership model, our distribution
center network redesign, the redesign of our reverse logistics and outlet business, and the
reconceptualization of our home delivery and customer experience, which enables us to drive
lower costs and inventory levels, and higher earnings and inventory turns. Looking forward, we
expect this multi-year effort to result in a dramatically improved customer experience, continued
margin enhancement and significant cost savings over the next several years.

• Maximize Cash Flow and Optimize the Allocation of Capital in the Business. In fiscal 2017 and
2018, we focused on maximizing cash flow in our business and the allocation of capital. We
believe that our operations and current initiatives are providing a significant opportunity to
optimize the allocation of capital in our business, including generating free cash flow and
optimizing our balance sheet, as well as deploying capital to repay debt and repurchase shares of
our common stock, which we believe creates a long term benefit to our shareholders.

During fiscal 2017, we repurchased approximately 20.2 million shares of our common stock under two
separate repurchase programs for an aggregate repurchase amount of approximately $1 billion. During
fiscal 2018, we repurchased approximately 2.0 million shares of our common stock under a separate
repurchase program for an aggregate repurchase amount of approximately $250 million. During fiscal
2019, we repurchased approximately 2.2 million shares of our common stock under a separate
repurchase program for an aggregate repurchase amount of approximately $250 million. Total
repurchases made in fiscal 2019, fiscal 2018 and fiscal 2017 represent 59.8% of the shares outstanding
as of the end of fiscal 2016. Our focus on cash also resulted in our generating $330 million,
$163 million and $415 million in free cash flow in fiscal 2019, fiscal 2018 and fiscal 2017, respectively
(refer to “Share Repurchase Programs” within Liquidity and Capital Resources below for our free cash
flow calculation).

•

Increase Operating Margins. During the period from fiscal 2016 through fiscal 2019, we have
substantially increased the operating margins in our business. We anticipate continued improvements
in operating margins as a result of our focus on a number of our strategic initiatives including (i) the
occupancy leverage we expect to gain from our real estate transformation, (ii) product margin
expansion as we continue to drive higher full price selling in our core business, and (iii) the continued
cost savings of improvements to our operating platform and organizational structure.

58

Business Initiatives

We are undertaking a large number of new business initiatives in support of our key value driving strategies.

In particular, beginning in fiscal 2016 and continuing through fiscal 2019, we have pursued a range of strategic
efforts to improve our business and operations including the following:

•

•

Introduction of Membership Model. In March 2016, we introduced the RH Members Program, an
exclusive program that reimagines and simplifies the shopping experience. For an annual fee, the RH
Members Program provides a set discount every day across all RH brands, excluding RH Hospitality
and Waterworks, in addition to other benefits including complimentary interior design services through
the RH Interior Design program and eligibility for preferred financing plans on the RH Credit Card,
among other benefits. The RH Members Program allows our customers to shop for what they want,
when they want, and receive the greatest value, which has resulted in orders and sales being more
evenly distributed throughout the year as opposed to the peaks and valleys of orders and sales we
experienced under the prior promotional model. We believe the shift to a membership model has
enhanced the customer experience, rendered our brand more valuable, improved operational execution
and reduced costs.

For the year ended February 1, 2020, our members drove approximately 95% of sales in our core RH
business, and we had approximately 415,000 members at year end. Our core RH business reflects the
product categories that the membership discount can be applied to, and as a result sales generated via
Outlet, Contract, Hospitality or Waterworks are excluded.

We believe that the shift to a membership model has positively affected the financial results of our
business. Specifically, we believe some of the benefits include:

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

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

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

Luxury In-Home Furniture Delivery Experience. We believe there is an opportunity to improve the
customer experience by enhancing our approach to services in connection with in-home delivery. We
are in the process of implementing a number of measures that are designed to increase our level of
control and improve service levels throughout the delivery experience to the customer’s residence. We
believe that we are well positioned to develop improved solutions for in-home delivery to the customer
in the luxury market. We have already adopted a number of service improvements that are yielding
improvements in the customer experience and reductions in product return and exchange rates. We
expect to continue to optimize our service offering to customers in connection with the in-home
delivery experience and are confident that our efforts in this regard will continue to achieve substantial
results.

59

• Elevate the Customer Experience. We are focused on improving the end-to-end customer experience.

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

In fiscal 2017, fiscal 2018 and continuing into fiscal 2019, we have focused on the allocation of capital. We

believe that our operations and current initiatives are providing a significant opportunity to optimize the
allocation of capital in our business, including generating free cash flow and optimizing our balance sheet, as
well as deploying capital to repay debt and repurchase shares of our common stock, which we believe creates a
long-term benefit to our shareholders.

We continue to pursue and test numerous initiatives to improve many aspects of our business including

through efforts to optimize inventory, elevate the home delivery experience, simplify our distribution network
and improve our organizational design including by streamlining and realigning our home office operations, as
well as to expand our product offering and transform our real estate using a range of different models for specific
real estate development projects. Many of these initiatives and other initiatives such as our transition to a direct
sourcing model for our rug business have improved our operating margins, but other initiatives such as RH
Hospitality, RH Guesthouse and international expansion are expected to offset some planned margin
improvement next year due to our investments in those platforms. There can be no assurance as to the timing and
extent of the operational benefits and financial contributions of these strategic efforts. In addition, our pursuit of
multiple initiatives with respect to our business in any given period may result in period-to-period changes in,
and increased fluctuation in, our results of operations. We have also experienced delays in development timelines
for some of our recent projects, and delays in completion of our real estate development projects or costs
overruns could negatively affect our results of operations and revenues. Further, macroeconomic or political
events outside of our control could impact our ability to pursue our initiatives or the success of such initiatives.
For example, the COVID-19 outbreak and resulting global health crisis and related impact on financial markets
have contributed to a period of significant market stress and anticipated illiquidity which is expected to
negatively impact the economies and financial markets of many countries and could adversely affect our results
of operations. In addition, while we believe that the tariffs imposed to date on most of our goods sourced from
China have not had an adverse effect on our results of operations, including our revenues, margins and earnings,
there can be no assurance that the existing tariffs and the additional tariffs that will become effective, as well as
other future tariffs that may be imposed, will not adversely affect our results of operation in future time periods.
In addition, in recent periods the stock market has experienced significant volatility as well as periods of
significant decline and is currently in a period of heightened market volatility and decline, which may negatively
affect the financial health and demand levels of high-end consumers, and we can provide no assurance as to
whether such trends will occur in the future. The housing market is affected by a range of factors including home
prices and interest rates and slowdowns in the housing market can have a negative impact on demand for our
products. Factors that affect the higher end housing market in particular may have an outsized influence on our
levels of consumer demand since our business is geared toward the higher end of the home furnishings market.
The above factors and other current and future operational initiatives may create additional uncertainty with
respect to our consolidated net revenues and profit in the near term.

Factors Affecting Our Results of Operations

Various factors affected our results for the periods presented in this “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” and such discussion generally lists the factors in

60

order of magnitude based on their impact. Due to the global outbreak of the COVID-19 virus as discussed
elsewhere in this Annual Report, our operating results in the near-term are difficult to predict. Apart from the
impact of the near-term actions we are undertaking in response to the COVID-19 outbreak, below are certain
factors that affect our results of operations.

Our Strategic Initiatives. We are in the process of implementing a number of significant business initiatives

that have had and will continue to have an impact on our results of operations, including:

•

•

•

•

•

•

•

•

•

•

the introduction and expansion of new product categories and services;

the timing and progress of the opening of new Design Galleries that are under development;

the launch of RH International;

the pursuit of our multi-tier market approach to our real estate transformation;

the redesign of our distribution center network;

the introduction of RH Hospitality, an integrated hospitality experience, including the roll out of an
integrated food and beverage experience in a number of our new Design Galleries and Guesthouse;

changes in our Source Book circulation strategy including the depth, frequency and timing of mailings
as well as the scope of product offerings displayed in our Source Books;

changes in our reverse logistics model resulting in transferring customer returns direct from our home
delivery centers to Outlets;

efforts to elevate the customer experience including architecting a new fully integrated back-end
operating platform, inclusive of the supply chain network, the home delivery experience as well as a
new metric driven quality system and company-wide decision data, vendor product initiatives and
changes to the way we operate our distribution centers, home delivery centers and customer service
centers; and

leveraging the above strategic initiatives across both our RH Segment and Waterworks to drive the
performance of each business.

As a result of the number of current business initiatives we are pursuing, we have experienced in the past

and may experience in the future significant period-to-period variability in our financial performance and results
of operations. While we anticipate that these initiatives will support the growth of our business, costs and timing
issues associated with pursuing these initiatives can negatively affect our growth rates in the short term and may
amplify fluctuations in our growth rates from quarter to quarter. In addition, we anticipate that our net revenues,
adjusted net income and other performance metrics will remain variable as our business model continues to
emphasize high growth and numerous, concurrent and evolving business initiatives.

Our Ability to Source and Distribute Products Effectively. Our net revenues and gross profit are affected by
our ability to purchase our merchandise in sufficient quantities at competitive prices. Our current and anticipated
demand, and our level of net revenues have been adversely affected in prior periods by constraints in our supply
chain, including the inability of our vendors to produce sufficient quantities of some merchandise in a manner
that was able to match market demand from our customers, leading to higher levels of customer back orders and
lost sales. For example, some of our vendors experienced difficulty in producing goods in sufficient quantity to
meet initial customer demand for RH Modern when it was launched in October 2015. Further, the COVID-19
outbreak is anticipated to adversely affect our supply chain. Based on total dollar volume of purchases for fiscal
2019, approximately 70% of our products were sourced in from Asia, 16% from the United States and the
remainder from other countries and regions. For fiscal 2019, approximately 38% of our products were sourced
from China. For more information, refer to Item 1A—Risk Factors— The global outbreak of the COVID-19 virus
is likely to have an adverse impact on our business.

61

Consumer Preferences and Demand. Our ability to maintain our appeal to existing customers and attract
new customers depends on our ability to originate, develop and offer a compelling product assortment responsive
to customer preferences and design trends. We have successfully introduced a large number of new products in
past periods, which we believe has been a contributing factor in our sales growth and results of operations.
Periods in which our products have achieved strong customer acceptance generally have had more favorable
results. If we misjudge the market for our products or the product lines that we acquire, we may be faced with
excess inventories for some products and may be required to become more promotional in our selling activities,
which would impact our net revenues and gross profit.

Overall Economic Trends. The industry in which we operate is cyclical, and consequently our net revenues

are affected by general economic conditions including conditions that affect the housing market. For example,
reduced consumer confidence and lower availability and higher cost of consumer credit reduce demand for our
products and limit our ability to increase prices or sustain price increases. We expect that some of the economic
factors that are currently in place such as global economic uncertainty and market volatility may continue in
future periods. We target consumers of high-end home furnishings. As a result, we believe that our sales are
sensitive to a number of macroeconomic factors that influence consumer spending generally, but that our sales
are particularly affected by the health of the higher end customer and demand levels from that customer
demographic. While the overall home furnishings market may be influenced by factors such as employment
levels, interest rates, demographics of new household formation and the affordability of homes for the first time
home buyer, the higher end of the housing market may be disproportionately influenced by other factors,
including stock market prices, restrictions on travel due to the COVID-19 outbreak, the number of second and
third homes being bought and sold, the number of foreign buyers in higher end real estate markets in the U.S., tax
policies and interest rates, and the perceived prospect for capital appreciation in higher end real estate. We have
in the past experienced volatility in our sales trends related to many of these factors and believe our sales may be
impacted by these economic factors in future periods. These headwinds tied to macroeconomic factors may
continue in future quarters. For more information, refer to Item 1A—Risk Factors—Changes in consumer
spending and factors that influence spending of the specific categories of consumers that purchase from us,
including the health of the high-end housing market, may significantly impact our revenue and results of
operations and — The global outbreak of the COVID-19 virus is likely to have an adverse impact on our
business.

Fluctuation in Quarterly Results. Our quarterly results vary depending upon a variety of factors, including

our product offerings, store openings, shifts in the timing of holidays and the timing of Source Book releases,
promotional events and the timing and extent of our realization of the costs and benefits of our numerous
strategic initiatives, among other things. As a result of these factors, our working capital requirements and
demands on our product distribution and delivery network may fluctuate during the year. Unique factors in any
given quarter may affect period-to-period comparisons between the quarters being compared, and the results for
any quarter are not necessarily indicative of the results that we may achieve for a full fiscal year.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of financial and operating measures that

affect our results of operations, including:

Net Revenues. Net revenues reflect our sale of merchandise plus shipping and handling revenue collected

from our customers, less returns and discounts. Revenues are recognized when a customer obtains control of the
merchandise. We collect annual membership fees related to the RH Members Program, which are recorded as
deferred revenue when collected from customers and recognized as revenue based on expected product revenues
over the annual membership period.

Gross Profit. Gross profit is equal to our net revenues less cost of goods sold. Gross profit as a percentage of

our net revenues is referred to as gross margin. Cost of goods sold include the direct cost of purchased merchandise;

62

inventory shrinkage, inventory adjustments due to obsolescence, including excess and slow-moving inventory and
lower of cost or net realizable value reserves; inbound freight; all freight costs to get merchandise to our stores;
design, buying and allocation costs; occupancy costs related to store operations and our supply chain, such as rent
and common area maintenance for our leases; depreciation and amortization of leasehold improvements, equipment
and other assets in our stores and distribution centers. In addition, cost of goods sold include all logistics costs
associated with shipping product to our customers, which are partially offset by shipping income collected from
customers (recorded in net revenues). We expect gross profit to increase to the extent that we successfully grow our
net revenues and leverage the fixed portion of cost of goods sold.

Our gross profit can be favorably impacted by sales volume increases, as occupancy and certain other costs
that are largely fixed do not necessarily increase proportionally with volume increases. Changes in the mix of our
products may also impact our gross profit. We review our inventory levels on an ongoing basis in order to
identify slow-moving merchandise and use product markdowns and our outlet stores to efficiently sell these
products. The timing and level of markdowns are driven primarily by customer acceptance of our merchandise.
The primary drivers of the costs of individual goods are raw materials costs, which fluctuate based on a number
of factors beyond our control, including commodity prices, changes in supply and demand, general economic
conditions, competition, import duties, tariffs and government regulation, logistics costs (which may increase in
the event of, for example, expansions of or interruptions in the operation of our distribution centers, furniture
home delivery centers and customer service center or damage or interruption to our information systems) and
labor costs in the countries where we source our merchandise. We place orders with merchandise vendors
primarily in United States dollars and, as a result, are not exposed to significant foreign currency exchange risk.

Our gross profit may not be comparable to other specialty retailers, as some companies may not include all

or a portion of the costs related to their distribution network and store occupancy in calculating gross profit as we
and many other retailers do, but instead may include them in selling, general and administrative expenses. In
addition, certain of our store leases are accounted for as build-to-suit lease transactions which result in our
recording a portion of our rent payments under these agreements in interest expense on the consolidated
statements of operations.

Selling, General and Administrative Expenses. Selling, general and administrative expenses include all
operating costs not included in cost of goods sold. These expenses include payroll and payroll related expenses,
store expenses other than occupancy and expenses related to many of our operations at our corporate
headquarters, including utilities, depreciation and amortization, credit card fees and marketing expense, which
primarily includes Source Book production, mailing and print advertising costs. All store pre-opening costs are
included in selling, general and administrative expenses and are expensed as incurred. We expect certain of these
expenses to continue to increase as we continue to open new stores, develop new product categories and
otherwise pursue our current business initiatives. Selling, general and administrative expenses as a percentage of
net revenues are usually higher in lower-volume quarters and lower in higher-volume quarters because a
significant portion of the costs are relatively fixed.

In addition, in recent periods we have experienced increased selling, general and administrative expenses,

including certain non-cash compensation and costs associated with reorganizations and distribution center
closures, product recalls, and asset impairments and lease losses, as discussed in “Basis of Presentation and
Results of Operations” below.

Adjusted Operating Income, Adjusted EBITDA and Adjusted Net Income. We believe that adjusted operating

income, adjusted EBITDA and adjusted net income are useful measures of operating performance, as the
adjustments eliminate non-recurring and other items that are not reflective of underlying business performance,
facilitate a comparison of our operating performance on a consistent basis from period-to-period and provide for
a more complete understanding of factors and trends affecting our business. We also use adjusted operating
income, adjusted EBITDA and adjusted net income as methods for planning and forecasting overall expected
performance and for evaluating on a quarterly and annual basis actual results against such expectations.

63

We define adjusted operating income as consolidated operating income, adjusted for the impact of certain
non-recurring and other items that we do not consider representative of our underlying operating performance.

We define EBITDA as consolidated net income (loss) before depreciation and amortization, interest
expense—net and income tax expense. Adjusted EBITDA reflects further adjustments to EBITDA to eliminate
the impact of non-cash compensation, as well as certain non-recurring and other items that we do not consider
representative of our underlying operating performance. Because adjusted EBITDA omits non-cash items, we
feel that it is less susceptible to variances in actual performance resulting from depreciation, amortization and
other non-cash charges and can be more reflective of our operating performance.

We define adjusted net income as consolidated net income (loss), adjusted for the impact of certain
non-recurring and other items that we do not consider representative of our underlying operating performance.
Refer to Item 6—Selected Consolidated Financial Data for further information.

Basis of Presentation and Results of Operations

The results of operations for the fiscal years ended February 1, 2020, February 2, 2019 and February 3, 2018

reflect the modified retrospective application of the new lease accounting standard (Accounting Standards
Update 2016-02—Leases). For information regarding recently issued accounting pronouncements, refer to
Note 3—Significant Accounting Policies in our consolidated financial statements within Part II of this Annual
Report on Form 10-K.

The following table sets forth our consolidated statements of operations and other financial and operating

data.

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

Consolidated Statements of Operations:
Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . .

$2,647,437
1,552,426

$2,505,653
1,520,076

$2,440,174
1,600,876

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . .
Selling, general and administrative expenses . . .

1,095,011
732,180

Income from operations . . . . . . . . . . . . . . .

362,831

Other expenses

. . . . . . . . . . . . . . . . .
Interest expense—net
Goodwill and tradename impairment
. . . . .
Loss on extinguishment of debt—net . . . . .

Total other expenses . . . . . . . . . . . . . . . . . . . . . .

Income before income taxes . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . .

87,177
—
6,472

93,649

269,182
48,807

985,577
723,841

261,736

67,769
32,086
917

100,772

160,964
25,233

839,298
722,183

117,115

56,002
33,700
4,880

94,582

22,533
25,132

Net income (loss)

. . . . . . . . . . . . . . . . . . . .

$ 220,375

$ 135,731

$

(2,599)

64

The following table sets forth our consolidated statements of operations as a percentage of total net

revenues.

Consolidated Statements of Operations:
Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . .

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selling, general and administrative expenses . . . . . .

Income from operations . . . . . . . . . . . . . . . . . .

Other expenses

Interest expense—net . . . . . . . . . . . . . . . . . . . .
Goodwill and tradename impairment . . . . . . . .
Loss on extinguishment of debt—net . . . . . . . .

Total other expenses . . . . . . . . . . . . . . . . . . . . . . . . .

Income before income taxes . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . .

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

100.0%
58.6

100.0%
60.7

100.0%
65.6

41.4
27.7

13.7

3.3
—
0.2

3.5

10.2
1.9

39.3
28.9

10.4

2.7
1.3
—

4.0

6.4
1.0

34.4
29.6

4.8

2.3
1.4
0.2

3.9

0.9
1.0

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . .

8.3%

5.4%

(0.1)%

Fiscal 2019 Compared to Fiscal 2018

Year Ended

February 1, 2020

February 2, 2019

RH Segment Waterworks

Total

RH Segment Waterworks (1)

Total

(in thousands)

Net revenues . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . .

$2,514,296
1,475,574

$133,141
76,852

$2,647,437
1,552,426

$2,375,472
1,441,667

$130,181
78,409

$2,505,653
1,520,076

Gross profit . . . . . . . . . . .

1,038,722

56,289

1,095,011

933,805

51,772

985,577

Selling, general and

administrative expenses . . .

679,671

52,509

732,180

670,767

53,074

723,841

Income (loss) from

operations . . . . . . . . . .

$ 359,051

$

3,780

$ 362,831

$ 263,038

$ (1,302)

$ 261,736

(1) Waterworks results include non-cash amortization of $0.4 million related to the inventory fair value

adjustment recorded in connection with our acquisition of Waterworks during fiscal 2018.

Net revenues

Consolidated net revenues increased $141.8 million, or 5.7%, to $2,647.4 million in fiscal 2019 compared to

$2,505.7 million in fiscal 2018.

Consolidated net revenues for fiscal 2019 were positively impacted by $0.4 million and for fiscal 2018 were

negatively impacted by $4.7 million, in each case related to product recalls. Excluding the product recall
adjustments, consolidated net revenues increased $136.7 million, or 5.4%, to $2,647.0 million in fiscal 2019
compared to $2,510.4 million in fiscal 2018. Product recalls and the establishment or adjustment of any related
recall accruals can affect our results and cause quarterly fluctuations affecting the period-to-period comparisons
of our results. No assurance can be provided that any accruals will be for the appropriate amount, and actual
losses could be higher or lower than what we accrue from time to time, which could further affect results.

65

RH Segment net revenues

RH Segment net revenues increased $138.8 million, or 5.8%, to $2,514.3 million in fiscal 2019 compared to

$2,375.5 million in fiscal 2018. The below discussion highlights several significant factors that resulted in
increased RH Segment net revenues, which are listed in order of magnitude.

RH Segment core net revenues increased primarily due to existing Galleries, as well as an increase in retail

weighted-average selling square footage related to new store openings, including New York, Nashville,
Minneapolis, Columbus and Yountville. Net revenues also increased from our RH Hospitality operations and
Contract business. In addition, we believe that our net revenues were negatively impacted by a decline in sales in
the fourth quarter resulting from several factors, including higher than expected backorders due to a year-over-
year decrease in inventories as well as our decision to eliminate most seasonal holiday merchandising from our
business, which decision we believe contributed a larger than anticipated impact to sales as customers who might
otherwise purchase our holiday merchandise chose to shop at other retailers offering holiday merchandise
selections and, as a result, our net revenues were less than the prior period not only due to elimination of the sale
of the holiday merchandise but also the loss of additional sales of non-holiday merchandise that would typically
been made at the same time by customers attracted to our product offerings of holiday merchandise.

Outlet sales increased $42.4 million in fiscal 2019 compared to fiscal 2018 primarily due to increased
promotional activity as a result of our efforts to reduce inventory subsequent to the distribution center closures as
part of the distribution center network redesign.

RH Segment net revenues for fiscal 2019 were positively impacted by $0.4 million and for fiscal 2018 were

negatively impacted by $4.7 million, in each case related to product recalls.

Waterworks net revenues

Waterworks net revenues increased $3.0 million, or 2.3%, to $133.1 million in fiscal 2019 compared to

$130.2 million in fiscal 2018.

Gross profit

Consolidated gross profit increased $109.4 million, or 11.1%, to $1,095.0 million in fiscal 2019 compared to

$985.6 million in fiscal 2018. As a percentage of net revenues, gross margin increased 2.1% to 41.4% of net
revenues in fiscal 2019 compared to 39.3% of net revenues in fiscal 2018.

RH Segment gross profit for fiscal 2019 was negatively impacted by $4.9 million related to acceleration of

depreciation due to a change in the estimated useful life of certain assets and was positively impacted by
$3.8 million related to product recalls. RH Segment gross profit for fiscal 2018 was negatively impacted by
$2.6 million related to acceleration of depreciation due to a change in the estimated useful life of certain assets,
$1.5 million related to costs associated with distribution center closures, $1.2 million due to inventory
impairment related to Holiday merchandise and $0.6 million related to product recalls.

Waterworks gross profit for fiscal 2018 was negatively impacted by $0.4 million of amortization related to

the inventory fair value adjustment recorded in connection with the acquisition.

Excluding the accelerated asset depreciation, product recall adjustments, costs associated with the
distribution center closures, inventory impairment and impact of the amortization related to the inventory fair
value adjustment mentioned above, consolidated gross margin would have increased 1.9% to 41.4% of net
revenues in fiscal 2019 compared to 39.5% of net revenues in fiscal 2018.

66

RH Segment gross profit

RH Segment gross profit increased $104.9 million, or 11.2%, to $1,038.7 million in fiscal 2019 compared to

$933.8 million in fiscal 2018. As a percentage of net revenues, RH Segment gross margin increased 2.0% to
41.3% of net revenues in fiscal 2019 compared to 39.3% of net revenues in fiscal 2018.

Excluding the accelerated asset depreciation, product recall adjustments, costs associated with distribution

center closures and inventory impairment mentioned above, RH Segment gross margin would have increased
1.9% to 41.4% of net revenues in fiscal 2019 compared to 39.5% of net revenues in fiscal 2018. The increase was
primarily related to improvements in our distribution center network redesign resulting in reduced delivery
expense and leverage in occupancy costs, as well as improvements in our core merchandise margins. The overall
increase was partially offset by lower outlet product margins due to increased promotional activity and higher
discounts due to our efforts to reduce inventory.

Waterworks gross profit

Waterworks gross profit increased $4.5 million, or 8.7%, to $56.3 million in fiscal 2019 compared to
$51.8 million in fiscal 2018. As a percentage of net revenues, Waterworks gross margin increased 2.5% to 42.3%
of net revenues in fiscal 2019 compared to 39.8% of net revenues in fiscal 2018.

Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above,

Waterworks gross margin would have increased 2.2% to 42.3% of net revenues in fiscal 2019 compared to
40.1% of net revenues in fiscal 2018.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses increased $8.3 million, or 1.2%, to $732.2 million

in fiscal 2019 compared to $723.8 million in fiscal 2018.

RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $8.9 million, or 1.3%, to $679.7 million

in fiscal 2019 compared to $670.8 million in fiscal 2018.

RH Segment selling, general and administrative expenses for fiscal 2019 included impairments of
$15.2 million which consisted of (i) asset impairments of $9.1 million, (ii) an RH Contemporary Art lease
impairment of $4.6 million, resulting from an update to both the timing and the amount of future estimated lease
related cash inflows, and (iii) other lease impairments of $1.5 million due to early exit of leased facilities. RH
Segment selling, general and administrative expenses for fiscal 2019 also included acceleration of depreciation
due to a change the estimated useful life of certain assets of $1.3 million, reorganization related costs of
$1.1 million and a $0.5 million charge related to the termination of a service agreement, partially offset by a gain
on real estate related to asset previously classified as held for sale and other land sales of $1.5 million, a
favorable $1.2 million legal settlement related to historical freight charges and $0.2 million related to product
recalls.

Additionally, RH Segment selling, general and administrative expenses for fiscal 2019 included advertising

and marketing costs which increased $10.7 million primarily due to an increase in circulation and pages of our
Source Books. This was partially offset by a decrease in corporate expenses of $3.4 million, primarily due to
reduced preopening expense associated with our Design Gallery openings, partially offset by an increase in credit
card fees and other corporate costs.

RH Segment selling, general and administrative expenses for fiscal 2018 included a $10.0 million charge

related to reorganizations primarily due to streamlining and realigning our home office operations, $8.5 million

67

impairment recorded upon reclassification of an owned Design Gallery as asset held for sale, $3.4 million related
to impairment of the RH Contemporary Art lease, $1.6 million related to costs associated with distribution center
closures and $1.0 million related to product recalls, partially offset by a favorable $5.3 million legal settlement,
net of related legal expenses.

RH Segment selling, general and administrative expenses were 26.4% and 27.4% of net revenues for fiscal

2019 and fiscal 2018, respectively, excluding the asset impairments, accelerated asset depreciation,
reorganization related costs, product recall adjustments, costs associated with distribution center closures and
legal settlements mentioned above. The decrease in selling, general and administrative expenses as a percentage
of net revenues was primarily driven by other corporate costs.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses decreased $0.6 million, or 1.1%, to $52.5 million

in fiscal 2019 compared to $53.1 million in fiscal 2018. Waterworks selling, general and administrative expenses
were 39.4% and 40.8% of net revenues in fiscal 2019 and fiscal 2018, respectively. The decrease in selling,
general and administrative expenses as a percentage of net revenues was primarily driven by leverage in
corporate costs.

Interest expense—net

Interest expense increased $19.4 million to $87.2 million in fiscal 2019 compared to $67.8 million in fiscal

2018. Interest expense consisted of the following:

Year Ended

February 1,
2020

February 2,
2019

(in thousands)

Amortization of convertible senior notes debt discount . . . . . . . . . . .
Finance lease interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of debt issuance costs and deferred financing fees . . . .
Promissory notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset based credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Capitalized interest for capital projects . . . . . . . . . . . . . . . . . . . . . . .
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$46,245
22,608
12,135
4,341
3,854
2,604
1,652
(4,930)
(1,332)

$41,868
16,785
1,649
3,640
1,566
4,661
1,573
(3,139)
(834)

Total interest expense—net

. . . . . . . . . . . . . . . . . . . . . . . . . . . .

$87,177

$67,769

Goodwill and tradename impairment

We did not recognize goodwill or tradename impairment in fiscal 2019. We incurred a $32.1 million

goodwill and tradename impairment charge in fiscal 2018 for our Waterworks reporting unit. Refer to
“Impairment” within Note 3—Significant Accounting Policies in our consolidated financial statements within
Part II of this Annual Report on Form 10-K.

Loss on extinguishment of debt—net

We incurred $6.5 million of loss on extinguishment of debt in fiscal 2019 primarily due to a $6.7 million

loss from the repayment in full of the second lien term loan in September 2019, which resulted in a prepayment
penalty of $4.0 million and acceleration of amortization of debt issuance costs of $2.7 million. In addition, we

68

recognized a $1.0 million gain on extinguishment of debt in fiscal 2019 due to the maturity and settlement of the
2019 Notes in June 2019 and a $0.8 million loss due to accelerated debt issuance costs related to the early
repayment of the FILO term loan. We incurred a $0.9 million loss on extinguishment of debt in fiscal 2018 due
to the repayment in full of the LILO term loan, the promissory note secured by our aircraft and the equipment
security notes in June 2018, which resulted in accelerated amortization of debt issuance costs of $0.6 million and
a prepayment penalty of $0.3 million.

Income tax expense

Income tax expense was $48.8 million in fiscal 2019 compared to $25.2 million in fiscal 2018. Our effective

tax rate was 18.1% in fiscal 2019 compared to 15.7% in fiscal 2018. The effective tax rate was significantly
impacted by discrete tax benefits related to net excess tax windfalls from stock-based compensation of
$21.4 million in fiscal 2019 and $19.0 million in fiscal 2018 resulting from increased option exercise activity and
appreciation of our stock price. Additionally, the effective tax rate in fiscal 2018 was impacted by the goodwill
impairment for the Waterworks reporting unit.

Fiscal 2018 Compared to Fiscal 2017

Fiscal 2018 includes results for fifty-two weeks and fiscal 2017 includes results for fifty-three weeks.

Year Ended

February 2, 2019

February 3, 2018

RH Segment Waterworks (1)

Total

RH Segment Waterworks (1)

Total

(in thousands)

Net revenues . . . . . . . . . . . .
Cost of goods sold . . . . . . . .

$2,375,472
1,441,667

$130,181
78,409

$2,505,653
1,520,076

$2,319,332
1,527,602

$120,842
73,274

$2,440,174
1,600,876

Gross profit . . . . . . . . .

933,805

51,772

985,577

791,730

47,568

839,298

Selling, general and
administrative
expenses . . . . . . . . . . . . .

Income (loss) from

670,767

53,074

723,841

670,473

51,710

722,183

operations . . . . . . . .

$ 263,038

$ (1,302)

$ 261,736

$ 121,257

$ (4,142)

$ 117,115

(1) Waterworks results include non-cash amortization of $0.4 million and $2.5 million related to the inventory
fair value adjustment recorded in connection with our acquisition of Waterworks during fiscal 2018 and
fiscal 2017, respectively.

Net revenues

Consolidated net revenues increased $65.5 million, or 2.7%, to $2,505.7 million in fiscal 2018 compared to

$2,440.2 million in fiscal 2017.

Consolidated net revenues for fiscal 2018 and fiscal 2017 were negatively impacted by $4.7 million and

$3.2 million, respectively, related to product recalls. Excluding the product recall adjustments, consolidated net
revenues increased $67.0 million, or 2.7%, to $2,510.4 million in fiscal 2018 compared to $2,443.4 million in
fiscal 2017. Product recalls and the establishment or adjustment of any related recall accruals can affect our
results and cause quarterly fluctuations affecting the period-to-period comparisons of our results. No assurance
can be provided that any accruals will be for the appropriate amount, and actual losses could be higher or lower
than what we accrue from time to time, which could further affect results.

RH Segment net revenues

RH Segment net revenues increased $56.1 million, or 2.4%, to $2,375.5 million in fiscal 2018 compared to

$2,319.3 million in fiscal 2017. The below discussion highlights several significant factors that resulted in
increased RH Segment net revenues, which are listed in order of magnitude.

69

RH Segment core net revenues increased due to timing and an increase in total pages circulated of our

Source Book mailings, as well as the introduction of new products and new product categories, including the
strong performance of our Outdoor product line in fiscal 2018 as compared to fiscal 2017. In addition, RH
Segment core net revenues increased due to an increase in retail weighted-average leased selling square footage
related to new store openings, including New York, West Palm Beach, Toronto, Portland, Nashville and
Yountville. RH Segment core net revenues also increased during fiscal 2018 due to increased revenues from our
Contract business, RH Hospitality operations and Membership. The overall increase in RH Segment core net
revenues was partially offset by additional discounts offered on discontinued merchandise related to the
optimization of our inventory and SKU rationalization. In addition, we believe that our net revenues were
negatively impacted by a decline in sales in the fourth quarter resulting from stock market fluctuations and
negative trends in high-end housing.

Outlet sales decreased $26.7 million in fiscal 2018 compared to fiscal 2017 primarily as a result of our
inventory optimization efforts in fiscal 2017 as we increased our outlet promotional activity and offered higher
discounts. Similar promotions and discounts were not offered to the same extent in fiscal 2018. This overall
decrease was partially offset by an increase of seven outlet locations year over year, resulting in an approximate
15% increase in outlet selling square footage.

RH Segment net revenues decreased approximately $40.6 million due to fiscal 2017 representing fifty-three

weeks of results, whereas fiscal 2018 included fifty-two weeks of results.

RH Segment net revenues for fiscal 2018 and fiscal 2017 were negatively impacted by $4.7 million and

$3.2 million, respectively, related to product recalls.

Waterworks net revenues

Waterworks net revenues increased $9.3 million, or 7.7%, to $130.2 million in fiscal 2018 compared to

$120.8 million in fiscal 2017, primarily due to new product launches, particularly fittings for bath and kitchen.
The overall increase in net revenues is partially offset by a decrease in net revenues due to Waterworks fiscal
2017, which included fifty-three weeks of results, whereas fiscal 2018 included fifty-two weeks of results.

Gross profit

Consolidated gross profit increased $146.3 million, or 17.4%, to $985.6 million in fiscal 2018 compared to

$839.3 million in fiscal 2017. As a percentage of net revenues, gross margin increased 4.9% to 39.3% of net
revenues in fiscal 2018 compared to 34.4% of net revenues in fiscal 2017.

RH Segment gross profit for fiscal 2018 was negatively impacted by $2.6 million related to acceleration of
depreciation due to a change in the estimated useful life of certain assets, $1.5 million related to costs associated
with distribution center closures, $1.2 million due to inventory impairment related to Holiday merchandise and
$0.6 million related to product recalls.

RH Segment gross profit for fiscal 2017 was negatively impacted by $7.5 million related to product recalls
and $1.7 million related to costs associated with distribution center closures. RH Segment gross profit for fiscal
2017 was positively impacted by $2.2 million related to the release of the remaining reserve for potential claims
regarding anti-dumping duties which we believe have lapsed.

Waterworks gross profit for fiscal 2018 and fiscal 2017 was negatively impacted by $0.4 million and
$2.5 million, respectively, of amortization related to the inventory fair value adjustment recorded in connection
with the acquisition.

Excluding the accelerated asset depreciation, costs associated with the distribution center closures, inventory

impairment, product recall adjustments, release of the anti-dumping duty reserve and impact of the amortization

70

related to the inventory fair value adjustment mentioned above, consolidated gross margin would have increased
4.8% to 39.5% of net revenues in fiscal 2018 compared to 34.7% of net revenues in fiscal 2017.

RH Segment gross profit

RH Segment gross profit increased $142.1 million, or 17.9%, to $933.8 million in fiscal 2018 compared to

$791.7 million in fiscal 2017. As a percentage of net revenues, RH Segment gross margin increased 5.2% to
39.3% of net revenues in fiscal 2018 compared to 34.1% of net revenues in fiscal 2017.

Excluding the accelerated asset depreciation, costs associated with distribution center closures, inventory

impairment, product recall adjustments and release of the anti-dumping duty reserve mentioned above, RH
Segment gross margin would have increased 5.1% to 39.5% of net revenues in fiscal 2018 compared to 34.4% of
net revenues in fiscal 2017. The increase was related to improvements in our core merchandise margins as our
SKU rationalization efforts had a reduced impact on our margins this year compared to last year, as well as
increased outlet product margins due to higher outlet and warehouse sales during fiscal 2017 driven by increased
promotions and higher discounts versus fiscal 2018. In addition, we achieved leverage in our occupancy costs
primarily related to our distribution center network redesign, offset by deleverage in retail occupancy costs. The
overall increase in gross margin was partially offset by higher delivery costs and our investment in the ramping
of our new RH Hospitality locations.

Waterworks gross profit

Waterworks gross profit increased $4.2 million, or 8.8%, to $51.8 million in fiscal 2018 compared to
$47.6 million in fiscal 2017. As a percentage of net revenues, Waterworks gross margin increased 0.4% to 39.8%
of net revenues in fiscal 2018 compared to 39.4% of net revenues in fiscal 2017.

Excluding the impact of the amortization related to the inventory fair value adjustment mentioned above,

Waterworks gross margin would have decreased 1.4% to 40.1% of net revenues in fiscal 2018 compared to
41.5% of net revenues in fiscal 2017. The decrease in gross margin is primarily due to SKU rationalization
efforts in fiscal 2018, as well as deleverage in occupancy costs resulting from lower than expected revenue
growth.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses decreased $1.7 million, or 0.2%, to

$723.8 million in fiscal 2018 compared to $722.2 million in fiscal 2017.

RH Segment selling, general and administrative expenses

RH Segment selling, general and administrative expenses increased $0.3 million to $670.8 million in fiscal

2018 compared $670.5 million in fiscal 2017.

RH Segment selling, general and administrative expenses for fiscal 2018 included a $10.0 million charge

related to reorganizations primarily due to streamlining and realigning our home office operations, $8.5 million
impairment recorded upon reclassification of an owned Design Gallery as asset held for sale, $3.4 million related
to impairment of the RH Contemporary Art lease, $1.6 million related to costs associated with distribution center
closures and $1.0 million related to product recalls, partially offset by a favorable $5.3 million legal settlement,
net of related legal expenses.

RH Segment selling, general and administrative expenses for fiscal 2017 included $23.9 million related to a

fully vested option grant made to Mr. Friedman in May 2017, $5.5 million costs associated with distribution
center closures, $4.4 million related to impairment of the RH Contemporary Art lease, $0.9 million charge
related to a reorganization, $0.2 million related to product recalls and a gain of $2.1 million related to the sale of
building and land.

71

Employment and employee related costs, excluding the fully vested option grant to Mr. Friedman, and the
severance costs associated with the reorganizations and distribution center closures mentioned above, increased
$10.5 million during fiscal 2018 as compared to fiscal 2017, primarily related to incentive compensation.

Corporate expenses increased $9.5 million, primarily due to an increase in preopening expense associated

with our Design Gallery openings and, to a lesser extent, an increase in credit card fees due to an increase in
revenues.

Advertising and marketing costs decreased $8.9 million primarily due to the adoption of Topic 606 in the
first quarter of fiscal 2018, which resulted in the costs associated with Source Books being fully expensed upon
delivery to the carrier, as well as the timing of our Source Book mailings.

RH Segment selling, general and administrative expenses were 27.4% and 27.5% of net revenues for fiscal

2018 and fiscal 2017, respectively, excluding reorganizations, asset impairments, costs associated with
distribution center closures, product recall adjustments, legal settlement, the fully vested option grant made to
Mr. Friedman in May 2017 and the gain related to the sale of building and land mentioned above. The decrease
in selling, general and administrative expenses as a percentage of net revenues was primarily driven by
advertising and marketing, partially offset by preopening expense associated with our Design Gallery openings.

Waterworks selling, general and administrative expenses

Waterworks selling, general and administrative expenses increased $1.4 million, or 2.6%, to $53.1 million

in fiscal 2018 compared to $51.7 million in fiscal 2017. Waterworks selling, general and administrative expenses
were 40.8% and 42.8% of net revenues in fiscal 2018 and fiscal 2017, respectively. The decrease in selling,
general and administrative expenses as a percentage of net revenues was primarily driven by leverage in
corporate costs.

Interest expense—net

Interest expense increased $11.8 million to $67.8 million in fiscal 2018 compared to $56.0 million in fiscal

2017. Interest expense consisted of the following:

Year Ended

February 2,
2019

February 3,
2018

(in thousands)

Amortization of convertible senior notes debt discount . . . . . . . . . . .
Finance lease interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset based credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of debt issuance costs and deferred financing fees . . . .
Term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Promissory notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Capitalized interest for capital projects . . . . . . . . . . . . . . . . . . . . . . .
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$41,868
16,785
4,661
3,640
1,649
1,566
1,573
(3,139)
(834)

$30,457
11,154
5,726
4,705
4,526
1,691
1,561
(3,304)
(514)

Total interest expense—net

. . . . . . . . . . . . . . . . . . . . . . . . . . . .

$67,769

$56,002

Goodwill and tradename impairment

We incurred a $32.1 million goodwill and tradename impairment charge in fiscal 2018 and a $33.7 million

goodwill impairment charge in fiscal 2017 for our Waterworks reporting unit. Refer to “Impairment” within
Note 3—Significant Accounting Policies in our consolidated financial statements within Part II of this Annual
Report on Form 10-K.

72

Loss on extinguishment of debt—net

We incurred a $0.9 million loss on extinguishment of debt in fiscal 2018 due to the repayment in full of the

LILO term loan, the promissory note secured by our aircraft and the equipment security notes in June 2018,
which includes acceleration of amortization of debt issuance costs of $0.6 million and a prepayment penalty of
$0.3 million. We incurred a $4.9 million loss on extinguishment of debt in fiscal 2017 due to the repayment in
full of the second lien term loan in October 2017, which resulted in a prepayment penalty of $3.0 million and
accelerated amortization of debt issuance costs of $1.9 million.

Income tax expense

Income tax expense was $25.2 million in fiscal 2018 compared to $25.1 million in fiscal 2017. Our effective

tax rate was 15.7% in fiscal 2018 compared to 111.5% in fiscal 2017. The effective tax rate in fiscal 2018 was
significantly impacted by discrete tax benefits related to net excess tax windfalls from stock-based compensation
of $19.0 million resulting from increased option exercise activity and appreciation of the stock price, was
impacted by the goodwill impairment for the Waterworks reporting unit. The effective tax rate in fiscal 2017 was
significantly impacted by non-deductible stock-based compensation related to the May 2017 grant to
Mr. Friedman of an option to purchase 1,000,000 shares of the Company’s common stock. Refer to “Chairman
and Chief Executive Officer Option Grant” within Note 16—Stock-Based Compensation in our consolidated
financial statements within Part II of this Annual Report on Form 10-K. In addition, the effective tax rate in fiscal
2017 was impacted by tax reform and the Waterworks reporting unit goodwill impairment. The fiscal 2017
effective tax rate was favorably impacted by net excess tax benefits from stock-based compensation of
$7.0 million.

The United States enacted the Tax Cuts and Jobs Act (the “Tax Act”) on December 22, 2017. The new

legislation contains several key tax provisions that affect us and, as required, we have included reasonable
estimates of the income tax effects of the changes in tax law and tax rate in our fiscal 2017 financial results.
Since the Tax Act was passed in the fourth quarter of fiscal 2017, we considered the accounting for the transition
tax, deferred tax re-measurements, and other items to be provisional. We finalized our estimates within the
one-year measurement period allowed by the SEC and completed our accounting for the tax effects of enactment
of the Tax Act.

Our provision for income taxes in fiscal 2017 included $7.1 million of income tax expense as a result of the

Tax Act, including $6.1 million for the provisional re-measurement of our net deferred tax assets for the
reduction in the U.S. corporate income tax rate from 35% to 21% and a $1.0 million charge for our provisional
estimate of the transition tax. We completed our accounting for re-measurement of our deferred tax assets and
recorded $0.5 million of income tax expense as a result. No additional income tax expense or benefit was
recorded relating to the completion of our transition tax liability.

Quarterly Results

The following table sets forth our historical quarterly consolidated statements of operations for each of the

last eight fiscal quarters ended through February 1, 2020. This quarterly information has been prepared on the
same basis as our annual audited financial statements and includes all adjustments that we consider necessary to
fairly state the financial information for the fiscal quarters presented. The quarterly data should be read in
conjunction with our consolidated financial statements and the related notes included in Item 8—Financial
Statements and Supplementary Data.

73

Our quarterly results vary depending upon a variety of factors, including our product offerings, store
openings, shifts in the timing of holidays, the timing of Source Book releases and promotional events, among
other things. As a result of these factors, our working capital requirements and demands on our product
distribution and delivery network may fluctuate during the year and results of a period shorter than a full year
may not be indicative of results expected for the entire year.

Fiscal 2018

Fiscal 2019

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

(in thousands)

Net revenues . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . .

$557,406
348,073

$640,798
372,454

$636,558
386,537

$670,891
413,012

$598,421
365,607

$706,514
411,556

$677,526
393,360

$664,976
381,903

Gross profit
Selling, general and

. . . . . . . . . . .

209,333

268,344

250,021

257,879

232,814

294,958

284,166

283,073

administrative expenses . . . .

161,186

186,521

207,793

168,341

164,181

190,977

194,929

182,093

Income from

operations . . . . . . . . . . .

48,147

81,823

42,228

89,538

68,633

103,981

89,237

100,980

Other expenses

Interest expense—net
Goodwill and tradename

. . .

impairment . . . . . . . . . .

Loss (gain) on

extinguishment of
debt

. . . . . . . . . . . . . . .

15,098

15,467

17,695

19,509

21,118

24,513

21,564

19,982

—

—

—

—

32,086

917

—

—

—

—

—

—

—

(954)

6,857

569

Total other expenses . . . . . . . .

15,098

16,384

17,695

51,595

21,118

23,559

28,421

20,551

Income before income

taxes . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . .

33,049
7,588

65,439
2,533

24,533
4,419

37,943
10,693

47,515
11,793

80,422
16,665

60,816
8,353

80,429
11,996

Net income . . . . . . . . . . . .

$ 25,461

$ 62,906

$ 20,114

$ 27,250

$ 35,722

$ 63,757

$ 52,463

$ 68,433

. . . . . .
Adjusted net income (1)
Adjusted EBITDA (2) . . . . . . . .

$ 32,652
$ 77,740

$ 54,509
$103,054

$ 43,184
$ 87,755

$ 73,973
$131,518

$ 48,241
$100,385

$ 71,430
$133,716

$ 65,446
$116,312

$ 91,180
$145,005

(1) Adjusted net income is a supplemental measure of financial performance that is not required by, or

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

74

Fiscal 2018

Fiscal 2019

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

(in thousands)

Net income . . . . . . . . . . . . . . . . . . . . . . $25,461 $ 62,906 $20,114 $27,250 $35,722 $63,757 $52,463 $68,433
Adjustments pre-tax:

Amortization of debt

discount (a) . . . . . . . . . . . . . . . . .

7,272

9,000 11,283 11,661 11,689

9,918

9,638 11,300

Asset impairments and lease

losses (b) . . . . . . . . . . . . . . . . . . .

—

— 3,411

3,807

3,476

2,545

1,031 14,847

Loss (gain) on extinguishment of

debt (c)

. . . . . . . . . . . . . . . . . . . .
Reorganization related costs (d) . . .
. . . . . . . . . . . . . .
Recall accrual (e)
. .
Asset held for sale loss (gain) (f)
Legal settlements (g) . . . . . . . . . . . .
Goodwill and tradename

impairment (h) . . . . . . . . . . . . . . .
Distribution center closures (i) . . . .
Impact of inventory step-up (j) . . . .

—
—
(254)
—
1,915

—
(840)
190

917
1,721
(1,064)
—

—
7,564
3,986

—
692
(1,049)
— 8,497
—

—
—
(1,615)
—
— (1,193) —

569
(954)
6,857
—
— 1,075
(320)
(2,053) —
— (1,529) —
—

(7,204) —

—
— 3,886
—
190

— 32,086
—
—

—
—
—

—
—
—

—
—
—

—
—
—

Subtotal adjusted items . . . . . . . . . . . . .
Impact of income tax items (k) . . . .

8,283
(1,092) (11,957)

3,560 30,130 55,694 13,550
(1,031)

(8,971)

(7,060)

9,996 15,019 26,716
(3,969)
(2,036)
(2,323)

Adjusted net income . . . . . . . . . . . . . . . $32,652 $ 54,509 $43,184 $73,973 $48,241 $71,430 $65,446 $91,180

(a) Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are
required to be separately accounted for as liability and equity components of the instrument in a
manner that reflects the issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for
GAAP purposes for the $350 million aggregate principal amount of convertible senior notes that were
issued in June 2014 (the “2019 Notes”), for the $300 million aggregate principal amount of convertible
senior notes that were issued in June and July 2015 (the “2020 Notes”), for the $335 million aggregate
principal amount of convertible senior notes that were issued in June 2018 (the “2023 Notes”) and for
the $350 million aggregate principal amount of convertible senior notes that were issued in
September 2019 (the “2024 Notes”), we separated the 2019 Notes, 2020 Notes, 2023 Notes and 2024
Notes into liability (debt) and equity (conversion option) components and we are amortizing as debt
discount an amount equal to the fair value of the equity components as interest expense on the 2019
Notes, 2020 Notes, 2023 Notes and 2024 Notes over their expected lives. The equity components
represent the difference between the proceeds from the issuance of the 2019 Notes, 2020 Notes, 2023
Notes and 2024 Notes and the fair value of the liability components of the 2019 Notes, 2020 Notes,
2023 Notes and 2024 Notes, respectively. Amounts are presented net of interest capitalized for capital
projects of $0.6 million, $0.8 million, $0.7 million and $0.6 million during the first, second, third and
fourth quarters of fiscal 2018, respectively. Amounts are presented net of interest capitalized for capital
projects of $0.7 million, $0.7 million, $0.9 million and $1.4 million during the first, second, third and
fourth quarters of fiscal 2019, respectively. The 2019 Notes matured on June 15, 2019 and did not
impact amortization of debt discount post-maturity.

(b) The adjustment in the third quarter of fiscal 2018 represents an RH Contemporary Art lease

impairment, resulting from an update to both the timing and the amount of future estimated lease
related cash inflows. The adjustment in the fourth quarter of fiscal 2018 includes acceleration of
depreciation expense of $2.6 million due to a change in the estimated useful life of certain assets and a
$1.2 million inventory impairment charge related to holiday merchandise. The adjustment in the first
quarter of fiscal 2019 includes acceleration of depreciation expense of $3.0 million due to a change in
the estimated useful lives of certain assets and a $0.5 million charge related to the termination of a
service agreement associated with such assets. The adjustment in the second quarter of fiscal 2019
includes acceleration of depreciation expense of $1.9 million due to a change in the estimated useful

75

lives of certain assets and lease impairments of $0.7 million due to early exit of leased facilities. The
adjustment in the third quarter of fiscal 2019 includes lease impairments of $0.8 million due to early
exit of leased facilities and asset impairments of $0.2 million. The adjustment in the fourth quarter of
fiscal 2019 includes asset impairments of $8.9 million, an RH Contemporary Art lease impairment of
$4.6 million and acceleration of depreciation expense of $1.3 million due to a change in the estimated
useful lives of certain assets.

(c) The adjustment in the second quarter of fiscal 2018 represents the loss on extinguishment of debt

related to the LILO term loan, the promissory note secured by our aircraft and the equipment security
notes, all of which were repaid in full in June 2018. The adjustment in the second quarter of fiscal 2019
represents the gain on extinguishment of debt upon the maturity and settlement of the 2019 Notes in
June 2019. The adjustment in the third quarter of fiscal 2019 includes the loss on extinguishment of
debt related to a second lien term loan which was repaid in full in September 2019. The adjustments in
the third and fourth quarters of fiscal 2019 include the acceleration of debt issuance costs related to
early repayment of the FILO term loan.

(d) Represents severance costs and related taxes associated with reorganizations.
(e) Represents adjustments to net revenues, cost of goods sold and inventory charges associated with

product recalls, as well as accrual adjustments, and vendor and insurance claims.

(f) The adjustment in the fourth quarter of fiscal 2018 represents the loss recorded upon reclassification of
an owned Design Gallery as held for sale. The adjustment in the third quarter of fiscal 2019 represents
a gain on real estate related to asset previously classified as held for sale and other land sales.

(g) Represents legal settlements, net of related legal expenses.
(h) Represents goodwill and tradename impairment related to the Waterworks reporting unit. Refer to

“Impairment” within Note 3—Significant Accounting Policies in our consolidated financial statements
within Part II of this Annual Report on Form 10-K.

(i) Represents disposals of inventory and property and equipment, lease related charges, inventory transfer

costs and other costs associated with distribution center closures.

(j) Represents the non-cash amortization of the inventory fair value adjustment recorded in connection

with our acquisition of Waterworks.

(k) The adjustment in the third and fourth quarters of fiscal 2019 represents the tax effect of the adjusted
items based on our effective tax rates of 13.7% and 14.9%, respectively. The first and second quarters
of fiscal 2019 and all quarters in fiscal 2018 assume a normalized tax rate of 21%.

(2) EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required
by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income before
depreciation and amortization, interest expense—net and income tax expense. Adjusted EBITDA reflects
further adjustments to EBITDA to eliminate the impact of non-cash compensation, as well as certain
non-recurring and other items that we do not consider representative of our underlying operating
performance. EBITDA and Adjusted EBITDA are included in this filing because management believes that
these metrics provide meaningful supplemental information for investors regarding the performance of our
business and facilitate a meaningful evaluation of operating results on a comparable basis with historical
results. Our management uses these non-GAAP financial measures in order to have comparable financial
results to analyze changes in our underlying business from quarter to quarter. Our measures of EBITDA and
Adjusted EBITDA are not necessarily comparable to other similarly titled captions for other companies due
to different methods of calculation. The following table presents a reconciliation of net income, the most
directly comparable GAAP financial measure, to EBITDA and Adjusted EBITDA for the periods indicated
below.

76

569
—
—

—
—

—
—
—

Fiscal 2018

Fiscal 2019

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

(in thousands)

Net income . . . . . . . . . . . . . . . . . . . . . $25,461 $ 62,906 $20,114 $ 27,250 $ 35,722 $ 63,757 $ 52,463 $ 68,433
24,794
21,354 22,995
Depreciation and amortization . . . . . . 20,585
19,982
15,467 17,695
. . . . . . . . . 15,098
11,996
4,419
2,533
7,588

Interest expense—net
Income tax expense . . . . . . . . . . .

25,321
24,513
16,665

26,438
19,509
10,693

23,435
21,564
8,353

27,189
21,118
11,793

EBITDA . . . . . . . . . . . . . . . . . . . 68,732 102,260 65,223
Non-cash compensation (a) . . . . . .
3,685
Asset impairment and lease

7,997

6,234

83,890
6,206

95,822 130,256 105,815 125,205
5,723
5,695

5,298

5,116

—

— 3,411

1,196

483

629

1,031

13,508

debt (b)

losses (b) . . . . . . . . . . . . . . . . . .
Loss (gain) on extinguishment of
. . . . . . . . . . . . . . . . . . .
. .
. . . . . . . . . . . . .

Reorganization related costs (b)
Recall accrual (b)
Asset held for sale loss

—
—
(254)

917
1,721
(1,064)

—
7,564
3,986

—
692
(1,049)

—
—
(1,615)

(954)
—
(320)

6,857
1,075
(2,053)

(gain) (b) . . . . . . . . . . . . . . . . . .
Legal settlements (b) . . . . . . . . . . .
Goodwill and tradename

impairment (b) . . . . . . . . . . . . . .
Distribution center closures (b) . . .
Impact of inventory step-up (b)
. .

—
1,915

—

—
(7,204) —

8,497
—

—
(840)
190

—
— 3,886
—
190

— 32,086
—
—

—
—

—
—
—

—
(1,193)

(1,529)
—

—
—
—

—
—
—

Adjusted EBITDA . . . . . . . . . . . . . . . . $77,740 $103,054 $87,755 $131,518 $100,385 $133,716 $116,312 $145,005

(a) Represents non-cash compensation related to equity awards granted to employees.
(b) Refer to the reconciliation of net income to adjusted net income table above and the related footnotes

for additional information.

Liquidity and Capital Resources

General

The primary cash needs of our business have historically been for merchandise inventories, payroll, Source

Books, store rent, capital expenditures associated with opening new stores and updating existing stores, as well as
the development of our infrastructure and information technology. We seek out and evaluate opportunities for
effectively managing and deploying capital in ways that improve working capital and support and enhance our
business initiatives and strategies. In fiscal 2017, we completed two share repurchase programs in an aggregate
amount of $1 billion. A $300 million share repurchase was completed during the first quarter of fiscal 2017 and a
$700 million share repurchase was completed during the second quarter of fiscal 2017. In October 2018, our
Board of Directors approved a new $700 million share repurchase program, of which $250 million in share
repurchases were completed in fiscal 2018, and the $700 million authorization amount was replenished by the
Board of Directors in March 2019. During the first quarter of fiscal 2019, we repurchased approximately
2.2 million shares of our common stock for an aggregate repurchase amount of approximately $250 million, with
$450 million still available under the $700 million repurchase program. Refer to “Share Repurchase Programs”
below. We evaluate our capital allocation from time to time and may engage in future share repurchases in
circumstances where buying shares of our common stock represents a good value and provides a favorable return
for our shareholders.

We have $985 million in aggregate principal amount of convertible notes outstanding as of February 1,
2020, of which $300 million mature in July 2020, $335 million mature in June 2023 and $350 million mature in
September 2024. The $300 million principal amount of convertible notes that we issued in fiscal 2015 mature on
July 15, 2020 and are convertible through the close of business on the second scheduled trading day immediately

77

preceding July 15, 2020. 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
also expect to repay the outstanding principal amount of our other convertible notes at maturity in June 2023 and
September 2024 in cash, in each case to minimize dilution. While we anticipate using excess cash, free cash flow
and borrowings on our asset based credit facility to repay the convertible notes in cash to minimize dilution, we
may need to pursue additional sources of liquidity to repay such convertible notes in cash at their respective
maturity dates or upon early conversion, as applicable. There can be no assurance as to the availability of capital
to fund such repayments, or that if capital is available through additional debt issuances or refinancing of the
convertible notes, that such capital will be available on terms that are favorable to us.

Our business has relied on cash flows from operations, net cash proceeds from the issuance of the

convertible senior notes, as well as borrowings under our credit facilities as our primary sources of liquidity. Our
liquidity will be impacted by the outbreak of COVID-19. In response to the public health crisis posed by
COVID-19, effective from March 17, 2020, the Company temporarily closed its retail locations for an
indeterminate period of time. Although we continue to serve our customers virtually through our Gallery
representatives and designers, as well as our online websites, our business operations are being substantially
affected by applicable regulatory restrictions including stay-at-home requirements applicable in California where
our corporate headquarters is located. Our decision to reopen retail locations will be affected by a number of
factors including applicable regulatory restrictions and there is substantial uncertainty regarding the manner and
timing in which we can return some or all of our business to more normal business operations. We may face
longer term closure requirements and other operational restrictions with respect to some or all of our physical
locations for prolonged periods of time due to, among other factors, evolving and increasingly stringent federal,
state and local restrictions including shelter-in-place orders. Even once we are able to reopen closed physical
locations, changes in consumer behavior and health concerns may continue to impact consumer demand for our
products and customer traffic at our Galleries, restaurants and outlets and may make it more difficult to staff our
business operations. As a result of these developments, the Company expects an unfavorable impact on its sales,
results of operations and cash flows in fiscal 2020. In addition, our near term decisions regarding the sources and
uses of capital in our business will reflect and adapt to changes in market conditions and disruption in our
business related to COVID-19.

In response to the impact of COVID-19, we are implementing 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. We
also intend to negotiate with third parties to whom we have payment obligations. These negotiations may include
changes in the cadence of payments to vendors, modifications to rent and other obligations. We plan 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. We had outstanding borrowings
under our asset based credit facility of $35.0 million as of March 27, 2020 and the amount under the revolving
line of credit borrowing base that could be available pursuant to the asset based credit facility was
$307.9 million, net of $13.2 million in outstanding letters of credit. We believe that these actions mitigate risks
arising from COVID-19 and 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.

Our decision to reopen retail locations will be affected by a number of factors including applicable
regulatory restrictions and there is substantial uncertainty regarding the manner and timing in which we can
return to normal business operations. The precise impact on our business from the disruption of financial markets
and the weakening of overall economic conditions is unknown.

We extended and amended our asset based credit facility in June 2017, which has a total availability of

$600 million, of which $10 million is available to Restoration Hardware Canada, Inc., and includes a
$200 million accordion feature under which the revolving line of credit may be expanded by agreement of the

78

parties from $600 million to up to $800 million if and to the extent the lenders revise their credit commitments to
encompass a larger facility. The revolving line of credit has a maturity date of June 28, 2022.

During the first quarter of fiscal 2017, we received cash of $4.9 million for the sale of an aircraft, net of

$0.3 million of costs to dispose of the aircraft, which was classified as an asset held for sale, and during the
second quarter of fiscal 2017 we received cash of $10.2 million for the sale of a real estate parcel that we owned
on which one of our retail Galleries was located, which was classified as an asset held for sale. During the third
quarter of fiscal 2019, we executed a sale-leaseback transaction for the Yountville Design Gallery for sales
proceeds of $23.5 million, which qualified for sale-leaseback accounting in accordance with ASC 842. We may
pursue strategies in the future, through the use of existing assets and debt facilities, or through the pursuit of new
external sources of liquidity and debt financing, to fund our strategies to enhance stockholder value. There can be
no assurance that additional capital, whether raised through the sale of assets, utilization of our existing debt
financing sources, or pursuit of additional debt financing sources, will be available to us on a timely manner, on
favorable terms or at all. To the extent we pursue additional debt as a source of liquidity, our capitalization
profile may change and may include significant leverage, and as a result we may be required to use future
liquidity to repay such indebtedness and may be subject to additional terms and restrictions which affect our
operations and future uses of capital.

In addition, our capital needs may change in the future due to changes in our business or new opportunities

that we choose to pursue. We have invested significant capital expenditures in remodeling and opening new
Design Galleries, and these capital expenditures have increased in the past and may continue to increase in future
periods as we open additional Design Galleries, which may require us to undertake upgrades to historical
buildings or construction of new buildings. We anticipate substantial reductions to the level of our fiscal 2020
capital expenditures in response to the change in business conditions as a result of the global health crisis from
COVID-19, but the exact scope of changes in our capital plans is evolving and will depend on a variety of
factors.

Our adjusted net capital expenditures include (i) capital expenditures from investing activities and (ii) cash

outflows of capital related to construction activities to design and build landlord leased assets, net of tenant
allowances received. Adjusted net capital expenditures in fiscal 2019 were $157.9 million, inclusive of cash
received related to landlord tenant allowances of $28.3 million, and we had proceeds from sales of real estate
assets of $24.1 million.

Certain lease arrangements require the landlord to fund a portion of the construction related costs through
payments directly to us. Other lease arrangements for our new Design Galleries require the landlord to fund a
portion of the construction related costs directly to third parties, rather than through traditional construction
allowances and accordingly, under these arrangements we do not expect to receive contributions directly from
our landlords related to the building of our Design Galleries. As we develop new Galleries, as well as other
potential strategic initiatives in the future like our integrated hospitality experience, we may explore other models
for our real estate, which could include longer lease terms or further purchases of, or joint ventures or other
forms of equity ownership in, real estate interests associated with new sites and buildings. These approaches
might require greater capital investment on our part than a traditional store lease with a landlord. We also believe
there is an opportunity to transition our real estate strategy from a leasing model to a development model, where
we potentially buy and develop our Design Galleries then recoup the investments through a sale-leaseback
arrangement resulting in lower capital investment and lower rent. In the event that such capital and other
expenditures require us to pursue additional funding sources, we can provide no assurances that we will be
successful in securing additional funding on attractive terms or at all. In addition, the effects of COVID-19 on
our business, including decisions by us to curtail the deployment of capital and due to actions taken by federal,
state and local government authorities, and in some instances mall and shopping center owners, in response to the
outbreak, may require changes to our real estate strategy and related capital expenditure and financing plans. For
example, we may be required to suspend or defer planned construction projects and Gallery openings and delay
expansions into new markets including our anticipated international expansion. In addition, we may continue to

79

be required to make lease payments in whole or in part for our Galleries, restaurants and outlets that have been
closed. Our efforts to mitigate the costs of construction delays and deferrals, store closures and other operational
difficulties resulting from COVID-19, including negotiating with landlords and other third parties regarding the
timing and amount of payments under existing contractual arrangements, may not be successful, and as a result,
our real estate strategy may have ongoing significant liquidity needs even as we scale back our operations and
expansion cadence.

There can be no assurance that we will have sufficient financial resources, or will be able to arrange
financing on favorable terms to the extent necessary to fund all of our initiatives, or that sufficient incremental
debt will be available to us in order to fund our cash payments in respect of the repayment of our outstanding
convertible senior notes in an aggregate principal amount of $985 million at maturity of such senior convertible
notes. In addition, agreements governing existing or new debt facilities may restrict our ability to operate our
business in the manner we currently expect or to make required payments with respect to existing commitments
including the repayment of the principal amount of our convertible senior notes in cash upon maturity of such
senior notes. To the extent we need to seek waivers from any provider of debt financing, or we fail to observe the
covenants or other requirements of existing or new debt facilities, any such event could have an impact on our
other commitments and obligations including triggering cross defaults or other consequences with respect to
other indebtedness. Our current level of indebtedness, and any additional indebtedness that we may incur,
exposes us to certain risks with regards to interest rate increases and fluctuations. Our ability to make interest
payments or to refinance any of our indebtedness to manage such interest rates may be limited or negatively
affected by credit market conditions, macroeconomic trends and other risks.

Given the fast moving nature of the COVID-19 health crisis, and the corresponding impact on financial
markets and the economy as a whole, there is an enhanced degree of uncertainty regarding the Company’s capital
position and availability of capital to fund the Company’s liquidity requirements. In recognition of the significant
threat to the liquidity of financial markets posed by COVID-19, the Federal Reserve and Congress have taken
dramatic actions to provide liquidity to businesses and the banking system in the U.S. For example, on March 27,
2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”),
a sweeping stimulus bill intended to bolster the U.S. economy, among other things, and provide emergency
assistance to qualifying businesses and individuals. There can be no assurance that these interventions by the
government will be successful, and the financial markets may experience significant contractions in available
liquidity. While the Company may receive financial, tax or other relief and other benefits under and as a result of
the CARES Act, it is not possible to estimate at this time the availability, extent or impact of any such relief. In
addition, store closures and other operational difficulties faced by the Company may negatively affect the
Company’s financial condition and restrict the availability of liquidity for its operational needs, including due to,
among other reasons, increased and unforeseeable liquidity needs and limited flexibility to control expenses in
line with potential decreases in revenue. Any further weakening of, or other adverse developments in, the U.S. or
global credit markets could affect our ability to manage our debt obligations and our ability to access future debt.
We cannot assure you that we will be able to raise necessary funds on favorable terms, if at all, or that future
financing requirements would not require us to raise money through an equity financing or by other means that
could be dilutive to holders of our capital stock. If we fail to raise sufficient additional funds, we may be required
to delay or abandon some of our planned future expenditures or aspects of our current operations.

80

Cash Flow Analysis

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

Provided by operating activities . . . . . . . . . . . . . . . .
Provided by (used in) investing activities . . . . . . . .
Used in financing activities . . . . . . . . . . . . . . . . . . .
Increase (decrease) in cash and cash equivalents

February 1,
2020

$ 339,188
(122,545)
(174,804)

Year Ended

February 2,
2019

(in thousands)
$ 249,603
(79,992)
(188,992)

February 3,
2018

$ 474,505
122,531
(686,941)

and restricted cash equivalents . . . . . . . . . . . . . . .

41,855

(19,511)

(89,753)

Cash and cash equivalents and restricted cash

equivalents at end of period . . . . . . . . . . . . . . . . .

47,658

5,803

25,314

Net Cash Provided By Operating Activities

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

For fiscal 2019, net cash provided by operating activities was $339.2 million and consisted of net income of

$220.4 million and non-cash items of $199.3 million, partially offset by a decrease in cash used for working
capital and other activities of $80.5 million. Working capital and other activities consisted primarily of decreases
in operating lease liabilities of $77.0 million primarily due to payments made under the agreements, increases in
landlord assets under construction of $64.3 million, and decreases in other current liabilities and other
non-current obligations of $45.8 million and $25.1 million, respectively. These decreases to working capital were
partially offset by decreases in merchandise inventories of $93.3 million and decreases in prepaid expenses and
other current assets of $28.4 million.

For fiscal 2018, net cash provided by operating activities was $249.6 million and consisted of net income of

$135.7 million and non-cash items of $296.5 million, partially offset by an increase in cash used for working
capital and other activities of $182.6 million. Working capital and other activities consisted primarily of
increases in prepaid expenses and other current assets of $88.4 million related to (i) adoption of Topic 606,
(ii) vendor deposits and (iii) federal and state tax receivables due to prepayments, decreases in operating lease
liabilities of $70.9 million, increases in landlord assets under construction of $59.0 million and decreases in other
non-current obligations of $18.1 million. These decreases to working capital were partially offset by increases in
other current liabilities of $51.2 million.

For fiscal 2017, net cash provided by operating activities was $474.5 million and consisted of non-cash

items of $317.4 million and an increase in cash provided by working capital and other activities of
$159.7 million, partially offset by a net loss of $2.6 million. Working capital and other activities consisted
primarily of decreases in inventory of $220.8 million due to our SKU rationalization initiative, outlet inventory
optimization efforts and revised supply chain strategy, increases in accounts payable and accrued liabilities of
$65.1 million related to timing of payments, and decreases in prepaid expenses and other current assets of
$27.9 million. These increases to working capital were partially offset by increases in landlord assets under
construction of $81.1 million and decreases in operating lease liabilities of $70.5 million.

Net Cash Provided By (Used In) Investing Activities

Investing activities consist primarily of investments in capital expenditures related to investments in retail

stores, information technology and systems infrastructure, as well as supply chain investments. In addition,
investing activities include proceeds from assets held for sale and activities associated with investing in
available-for-sale securities.

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For fiscal 2019, net cash used in investing activities was $122.5 million, of which $93.6 million primarily

related to investments in retail stores, information technology and systems infrastructure, and supply chain
investments. In addition, we made deposits on an asset under construction of $53.0 million, offset by net
proceeds from the sale of building and land of $24.1 million.

For fiscal 2018, net cash used in investing activities was $80.0 million due to investments in retail stores,

information technology and systems infrastructure, and supply chain investments.

For fiscal 2017, net cash provided by investing activities was $122.5 million primarily as a result of sales of

investments and maturities of investments of $145.0 million and $46.9 million, respectively, the proceeds of
which were used to fund the share repurchases made under the $300 Million Repurchase Program. In addition,
we had net proceeds from the sale of building and land and the sale of an aircraft of $10.2 million and
$4.9 million, respectively. These increases to cash were partially offset by investments in retail stores,
information technology and systems infrastructure, and supply chain investments of $68.4 million, as well as
purchases of investments in available-for-sale securities of $16.1 million.

Net Cash Used In Financing Activities

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

For fiscal 2019, net cash used in financing activities was $174.8 million. The $350.0 million 2019 Notes

matured in June 2019, of which $278.6 million is presented within net cash used in financing activities and
$70.5 million is reflected as non-cash accretion of debt discount upon settlement of debt presented in net cash
provided by operating activities. Net cash used in financing activities included repurchases of approximately
2.2 million shares of our common stock for an aggregate repurchase amount of $250.0 million, as well as net
repayments of $57.5 million under the asset based credit facility. Net cash used in financing activities included
borrowings under a $350.0 million convertible senior notes agreement issued in September 2019, which provided
net proceeds of $304.1 million after taking into consideration the convertible note hedge and warrant
transactions, as well as discounts upon original issuance and offering costs. Net repayments under the term loan
facilities (as defined below) were $4.0 million, and net borrowings under promissory and equipment notes of
$105.5 million were comprised of $52.5 million of promissory notes secured by certain equipment and
$53.0 million related to promissory notes on asset under construction. Equity related transactions provided
$20.1 million due to $27.1 million of proceeds from exercise of employee stock options, partially offset by
$7.1 million of cash paid for employee taxes related to net settlement of equity awards. Principal payments under
finance lease agreements totaled $9.7 million.

For fiscal 2018, net cash used in financing activities was $189.0 million primarily due to net repayments of

debt of $254.4 million under the asset based credit facility, LILO term loan, equipment loans and promissory
note secured by our aircraft, as well as due to $250 million of share repurchases made under the $950 Million
Repurchase Program. The repayments of debt described above were partially funded by the $335 million
convertible senior notes issued in June 2018, which provided net proceeds of $287.8 million after taking into
consideration the convertible note hedge and warrant transactions, as well as discounts upon original issuance
and offering costs. Equity related transactions provided $34.5 million due to $44.0 million of proceeds from
exercise of employee stock options, partially offset by $9.5 million of cash paid for employee taxes related to net
settlement of equity awards. Principal payments under finance lease agreements totaled $6.9 million.

For fiscal 2017, net cash used in financing activities was $686.9 million primarily due to $1.0 billion of
share repurchases made under the $300 Million Repurchase Program and $700 Million Repurchase Program.
Cash funding for the share repurchase programs was provided by available cash balances, net borrowings under
the asset based credit facility of $200.0 million, as well as net borrowings under the term loans of $77.0 million

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and net borrowings under promissory and equipment notes of $31.7 million. Equity related transactions provided
$19.1 million due to $24.9 million of proceeds from exercise of employee stock options, partially offset by
$5.8 million of cash paid for employee taxes related to net settlement of equity awards. Principal payments under
finance lease agreements totaled $6.1 million.

Non-Cash Transactions

Non-cash transactions consist of non-cash additions of property and equipment and landlord assets,

reclassification of assets from landlord assets under construction to finance lease right-of-use assets and issuance
of non-current notes payable related to share repurchases from former employees.

Convertible Senior Notes

0.00% Convertible Senior Notes due 2024

In September 2019, we issued in a private offering $300 million principal amount of 0.00% convertible

senior notes due 2024 and issued an additional $50 million principal amount in connection with the
overallotment option granted to the initial purchasers as part of the offering (collectively, 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, which is equivalent to an initial conversion price of approximately $211.40 per
share. The conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will
not be adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole
fundamental change” as defined in the indenture, we will, in certain circumstances, increase the conversion rate
by a number of additional shares for a holder that elects to convert its 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 February 1, 2020, none of these conditions have occurred

83

and, as a result, the 2024 Notes were not convertible as of February 1, 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.

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 (deficit).
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 consolidated balance sheets.

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 1.7 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 1.7 million shares of our
common stock at a price of $338.24 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
3.3 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 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

84

transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the
consolidated balance sheets.

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 us and U.S. Bank National Association, as the Trustee.
The 2023 Notes will mature on June 15, 2023, unless earlier purchased by us or converted. The 2023 Notes will
not bear interest, except that the 2023 Notes will be subject to “special interest” in certain limited circumstances
in the event of our failure to perform certain of our obligations under the indenture governing the 2023 Notes.
The 2023 Notes are unsecured obligations and do not contain any financial covenants or restrictions on the
payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by us or any of
our subsidiaries. Certain events are also considered “events of default” under the 2023 Notes, which may result in
the acceleration of the maturity of the 2023 Notes, as described in the indenture governing the 2023 Notes.
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, 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 February 1, 2020, none of these conditions have occurred
and, as a result, the 2023 Notes were not convertible as of February 1, 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.

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.

85

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 (deficit).
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 2023 balance on the consolidated balance sheets.

2023 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2023 Notes and the exercise of the overallotment option in June 2018,

we entered into convertible note hedge transactions whereby we have the option to purchase a total of
approximately 1.7 million shares of our common stock at a price of approximately $193.65 per share. The total
cost of the convertible note hedge transactions was $91.9 million. In addition, we sold warrants whereby the
holders of the warrants have the option to purchase a total of approximately 1.7 million shares of our common
stock at a price of $309.84 per share. The warrants contain certain adjustment mechanisms whereby the total
number of shares to be purchased under such warrants may be increased up to a cap of 3.5 million shares of
common stock (which cap may also be subject to adjustment). We received $51.0 million in 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 (deficit), are not accounted for as derivatives and
are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge
and warrant transactions were recorded as a reduction to additional paid-in capital on the 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
consolidated balance sheets.

0.00% Convertible Senior Notes due 2020

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

86

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, the Company is 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, the Company may settle the par value at the Company’s election, in cash, shares
of the Company’s common stock, or a combination of cash and shares of the Company’s common stock. The
conversion rate will be subject to adjustment upon the occurrence of certain specified events, but will not be
adjusted for any accrued and unpaid special interest. In addition, upon the occurrence of a “make-whole
fundamental change” as defined in the indenture, we will, in certain circumstances, increase the conversion rate
by a number of additional shares for a holder that elects to convert its 2020 Notes in connection with such make-
whole fundamental change.

Prior to March 15, 2020, the 2020 Notes are 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 quarter ended
December 31, 2019 and, accordingly, holders may convert their 2020 Notes during the calendar quarter ending
March 31, 2020. Regardless of the foregoing circumstances, 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 the
Company’s 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

87

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 (deficit).
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 consolidated balance sheets.

2020 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment
option in July 2015, we entered into convertible note hedge transactions whereby we have the option to purchase
a total of approximately 2.5 million shares of our common stock at a price of approximately $118.13 per share.
The total cost of the convertible note hedge transactions was $68.3 million. In addition, we sold warrants
whereby the holders of the warrants have the option to purchase a total of approximately 2.5 million shares of our
common stock at a price of $189.00 per share. The warrants contain certain adjustment mechanisms whereby the
total number of shares to be purchased under such warrants may be increased up to a cap of 5.1 million shares of
common stock (which cap may also be subject to adjustment). We received $30.4 million in cash proceeds from
the sale of these warrants. Taken together, the purchase of the convertible note hedges and sale of the warrants
are intended to offset any actual earnings dilution from the conversion of the 2020 Notes until our common stock
is above approximately $189.00 per share. As these transactions meet certain accounting criteria, the convertible
note hedges and warrants are recorded in stockholders’ equity (deficit), are not accounted for as derivatives and
are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge
and warrant transactions were recorded as a reduction to additional paid-in capital on the 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 deferred tax assets on the
consolidated balance sheets.

Our provision for income taxes in fiscal 2017 included $1.1 million of income tax benefit as a result of the
Tax Act for the provisional re-measurement of the deferred tax asset and liability related to the 2020 Notes for
the reduction in the U.S. corporate income tax rate from 35% to 21%.

0.00% Convertible Senior Notes due 2019

In June 2014, we issued $350 million aggregate principal amount of 0.00% convertible senior notes due

2019 (the “2019 Notes”) in a private offering. The 2019 Notes were governed by the terms of an indenture

88

between us and U.S. Bank National Association, as the Trustee. The 2019 Notes did not bear interest, except that
the 2019 Notes were subject to “special interest” in certain limited circumstances in the event of our failure to
perform certain of our obligations under the indenture governing the 2019 Notes. The 2019 Notes were
unsecured obligations and did 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 were also considered “events of default” under the 2019 Notes, which could result in the acceleration of
the maturity of the 2019 Notes, as described in the indenture governing the 2019 Notes. The 2019 Notes matured
on June 15, 2019.

The initial conversion rate applicable to the 2019 Notes was 8.6143 shares of common stock per $1,000

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

In June 2019, upon the maturity of the 2019 Notes, $350.0 million in aggregate principal amount of the

2019 Notes were settled for $349.0 million in cash and 42 shares of our common stock. As a result, we
recognized a gain on extinguishment of debt of $1.0 million. As of February 1, 2020, the 2019 Notes are no
longer outstanding.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to

be separately accounted for as liability and equity components of the instrument in a manner that reflects the
issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2019 Notes, we
separated the 2019 Notes into liability and equity components. The carrying amount of the liability component
was calculated by measuring the fair value of a similar liability that does not have an associated convertible
feature. The carrying amount of the equity component, which is recognized as a debt discount, represents the
difference between the proceeds from the issuance of the 2019 Notes and the fair value of the liability component
of the 2019 Notes. The debt discount was amortized to interest expense using an effective interest rate of 4.51%
over the expected life of the 2019 Notes. The equity component was not remeasured as long as it continued to
meet the conditions for equity classification.

Debt issuance costs related to the 2019 Notes were comprised of discounts and commissions payable to the

initial purchasers of $4.4 million and third party offering costs of $1.0 million. In accounting for the debt
issuance costs related to the issuance of the 2019 Notes, we allocated the total amount incurred to the liability
and equity components based on their relative values. Debt issuance costs attributable to the liability component
were amortized to interest expense using the effective interest method over the expected life of the 2019 Notes,
and debt issuance costs attributable to the equity component were netted with the equity component in
stockholders’ equity (deficit). Discounts, commissions payable to the initial purchasers 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 2019 balance on the consolidated balance sheets.

2019 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2019 Notes, we entered into convertible note hedge transactions

whereby we have the option to purchase a total of approximately 3.0 million shares of our common stock at a
price of approximately $116.09 per share. The total cost of the convertible note hedge transactions was
$73.3 million. In addition, we sold warrants whereby the holders of the warrants had the option to purchase a
total of approximately 3.0 million shares of our common stock at a price of $171.98 per share. We received
$40.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible
note hedges and sale of the warrants were intended to offset any actual dilution from the conversion of the 2019

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

During fiscal 2019, we delivered approximately 167,100 shares upon exercise of the warrants under the

terms of the warrant agreements. The warrant agreements expired on December 6, 2019.

We recorded a deferred tax liability of $27.5 million in connection with the debt discount associated with

the 2019 Notes and recorded a deferred tax asset of $28.6 million in connection with the convertible note hedge
transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax assets on the
consolidated balance sheets. There is no deferred tax asset or liability remaining as of February 1, 2020 due to
the maturity of the 2019 Notes.

Our provision for income taxes in fiscal 2017 included $0.1 million of income tax expense as a result of the

Tax Act for the provisional re-measurement of the deferred tax asset and liability related to the 2019 Notes for
the reduction in the U.S. corporate income tax rate from 35% to 21%.

Asset Based Credit Facility and Term Loan Facilities

On June 28, 2017, Restoration Hardware, Inc. entered into an eleventh amended and restated credit
agreement (the “Credit Agreement”) among Restoration Hardware, Inc., Restoration Hardware Canada, Inc.,
various subsidiaries of RH named therein as borrowers or guarantors, the lenders party thereto and Bank of
America, N.A. as administrative agent and collateral agent (“First Lien Administrative Agent”). 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 Credit Agreement has a maturity date of June 28, 2022.

In June 2018, we repaid the LILO term loan in full. As a result of the repayment, we incurred a $0.5 million
loss on extinguishment of debt in fiscal 2018, which represents the acceleration of amortization of debt issuance
costs. We did not incur any prepayment penalties upon the early extinguishment of the LILO term loan.

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

On November 23, 2018, Restoration Hardware, Inc. entered into a Consent and Second Amendment to the
Credit Agreement (the “Second Amendment”). The Second Amendment included certain clarifying changes to,
among other things: (a) address the processing of payments from insurance proceeds in connection with casualty
or other insured losses with respect to property or assets of a Loan Party, and (b) add an additional category of
permitted restricted payment to allow the lead borrower to make annual restricted payments of up to $3 million
per fiscal year to cover payments of certain administrative and other obligations of RH in the ordinary course of
business.

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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, (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 and, as a result, 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, amended 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.

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.

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 February 1, 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 lesser of (x) the domestic
revolving 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, including an event of default in connection with certain events
constituting a “Material Adverse Effect” (as defined in the Credit Agreement) 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.

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As of February 1, 2020, we had no 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 February 1, 2020 was $321.7 million, net of $13.2 million in outstanding letters of credit.

The Credit Agreement contains various restrictive covenants, including, among others, required financial
reporting, limitations on the ability to incur liens, make loans or other investments, incur additional debt, issue
additional equity, merge or consolidate with or into another person, sell assets, pay dividends or make other
distributions, or enter into transactions with affiliates, along with other restrictions and limitations typical to
credit agreements of this type and size. 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).

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, 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. As a
result of the repayment, we incurred a $6.7 million loss on extinguishment of debt, which includes a prepayment
penalty of $4.0 million and acceleration of amortization of debt issuance costs of $2.7 million.

The Second Lien Term Loan bore interest at an annual rate generally based on 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 is no longer in effect
after 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

92

equipment security note setting forth the terms for each particular equipment loan. Each equipment loan is
secured by a purchase money security interest in the financed equipment. As of February 1, 2020, we had
$53.4 million in aggregate amounts outstanding under the equipment security notes, of which $22.0 million was
included in other current liabilities and $31.4 million was included in other non-current obligations on the
consolidated balance sheets. 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.

Share Repurchase Programs

We regularly review share repurchase activity and consider various factors in determining whether and

when to execute share repurchases, including, among others, current cash needs, capacity for leverage, cost of
borrowings, results of operations and the market price of the our common stock.

During fiscal 2017, we repurchased approximately 20.2 million shares of our common stock under two
separate repurchase programs for an aggregate repurchase amount of approximately $1 billion. During fiscal
2018, we repurchased approximately 2.0 million shares of our common stock under a separate repurchase
program for an aggregate repurchase amount of approximately $250 million. During fiscal 2019, we repurchased
approximately 2.2 million shares of our common stock under a separate repurchase program for an aggregate
repurchase amount of approximately $250 million. Total repurchases made in fiscal 2019, fiscal 2018 and fiscal
2017 represent 59.8% of the shares outstanding as of the end of fiscal 2016.

We believe that these share repurchase programs will continue to be an excellent allocation of capital for the
long-term benefit of our shareholders. We may undertake other repurchase programs in the future with respect to
our securities.

We generated $330 million, $163 million and $415 million in free cash flow in fiscal 2019, fiscal 2018 and

fiscal 2017, respectively, which supported our share repurchase programs. Free cash flow is calculated as net
cash provided by operating activities, the non-cash accretion of debt discount upon settlement of debt and
proceeds from sale of assets, less capital expenditures and principal payments under finance leases. Free cash
flow excludes all non-cash items. Free cash flow is included in this filing because management believes that free
cash flow provides meaningful supplemental information for investors regarding the performance of our business
and facilitates a meaningful evaluation of operating results on a comparable basis with historical results. Our
management uses this non-GAAP financial measure in order to have comparable financial results to analyze
changes in our underlying business from quarter to quarter. A reconciliation of our net cash provided by
operating activities to free cash flow is as follows:

Net cash provided by operating activities . . . . . . . . .
Accretion of debt discount upon settlement of

debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sale of assets . . . . . . . . . . . . . . . . . . .
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . .
Principal payments under finance leases . . . . . . . . .

February 2,
2020

$339,188

Year Ended

February 2,
2019

(in thousands)
$249,603

February 3,
2018

$474,505

70,482
24,078
(93,623)
(9,682)

—
—
(79,992)
(6,885)

—
15,123
(68,393)
(6,105)

Free cash flow . . . . . . . . . . . . . . . . . . . . . . . . . .

$330,443

$162,726

$415,130

$300 Million Share Repurchase Program (Completed)

On February 21, 2017, our Board of Directors authorized a share repurchase program of up to $300 million

(the “$300 Million Repurchase Program”) through open market purchases, privately negotiated transactions or

93

other means, including through Rule 10b18 open market repurchases, Rule 10b5-1 trading plans or through the
use of other techniques such as accelerated share repurchases. In the first quarter of fiscal 2017, we repurchased
approximately 7.8 million shares of our common stock under the $300 Million Repurchase Program at an
average price of $38.24 per share, for an aggregate repurchase amount of approximately $300 million. No
additional shares will be repurchased in future periods under the $300 Million Repurchase Program.

$700 Million Share Repurchase Program (Completed)

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

$950 Million Share Repurchase Program (Existing)

On October 10, 2018, our Board of Directors authorized a share repurchase program of up to $700 million
through open market purchases, privately negotiated transactions or other means, including through Rule 10b18
open market repurchases, Rule 10b5-1 trading plans or through the use of other techniques such as accelerated
share repurchases including through privately-negotiated arrangements in which a portion of the share repurchase
program is committed in advance through a financial intermediary and/or in transactions involving hedging or
derivatives, of which $250.0 million in share repurchases were completed in fiscal 2018. The $700 million
authorization amount was replenished by the Board of Directors on March 25, 2019 (as replenished, the “$950
Million Repurchase Program”). In the first quarter of fiscal 2019, we repurchased approximately 2.2 million
shares of our common stock under the $950 Million Repurchase Program at an average price of $115.36 per
share, for an aggregate repurchase amount of approximately $250.0 million. As of February 1, 2020, there was
$450 million remaining for future share repurchases under this program.

Contractual Obligations

As of February 1, 2020, our future contractual cash obligations were as follows:

Payments Due by Fiscal Year

Total

2020

2021-2022

2023-2024

Thereafter

(in thousands)

$

Asset based credit facility (1) . . . . . . . . . . . . . . . . . . .
Equipment promissory notes (2) . . . . . . . . . . . . . . . . .
Convertible senior notes due 2020 . . . . . . . . . . . . . .
Convertible senior notes due 2023 . . . . . . . . . . . . . .
Convertible senior notes due 2024 . . . . . . . . . . . . . .
Notes payable for share repurchases . . . . . . . . . . . . .
. . .
Promissory notes on asset under construction (3)
Operating lease liabilities (4)
. . . . . . . . . . . . . . . . . . .
Finance lease liabilities (5) . . . . . . . . . . . . . . . . . . . . .
Letters of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

— $ — $ — $ — $ —
—
30,819
—
—
—
—
—
—
243
15,920
—
—
246,482
130,054
568,856
71,070
—
—

544
—
335,000
350,000
2,578
—
108,690
72,830
—

22,009
300,000
—
—
—
53,000
75,634
32,138
13,186

53,372
300,000
335,000
350,000
18,741
53,000
560,860
744,894
13,186

Total

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,429,053

$495,967

$247,863

$869,642

$815,581

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(1) Under the Credit Agreement, the asset based credit facility has a maturity date of June 28, 2022. As of

February 1, 2020, we had no outstanding borrowings under our asset based credit facility.

(2) Equipment promissory note obligations do not include interest of $2.0 million and $1.1 million for the fiscal

periods 2020 and 2021-2022, respectively.

(3) The promissory notes on asset under construction is not expected to be settled in cash. Refer to “Lease

Accounting” within Note 3—Significant Accounting Policies in our consolidated financial statements within
Part II of this Annual Report on Form 10-K.

(4) We enter into operating and finance leases in the normal course of business. Most lease arrangements

provide us with the option to renew the leases at defined terms. The table above includes future obligations
for renewal options that are reasonably certain to be exercised and are included in the measurement of the
lease liability. Amounts above do not include future lease payments under leases that have not commenced
or estimated contingent rent due under operating and finance leases. As of February 1, 2020, our obligation
for legally binding payments for leases signed but not yet commenced and contingent rent was
$360.9 million and $6.1 million, respectively. Refer to Note 9—Leases in our consolidated financial
statements within Part II of this Annual Report on Form 10-K.

Other Commitments

The Company enters into various cancellable commitments related to the procurement of merchandise

inventory. As of February 1, 2020, these merchandise inventory purchase commitments were $368.2 million.

As of February 1, 2020, the liability of $8.5 million for unrecognized tax benefits associated with uncertain

tax positions (refer to Note 13—Income Taxes in our consolidated financial statements within Part II of this
Annual Report on Form 10-K) has not been included in the contractual obligations table above as we are not able
to reasonably estimate when cash payments for these liabilities will occur or the amount by which these liabilities
will increase or decrease over time.

Off Balance Sheet Arrangements

We have no material off balance sheet arrangements as of February 1, 2020.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the

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

Information on all of our significant accounting policies can be found in Note 3—Significant Accounting

Policies in our audited consolidated financial statements. Management evaluates the development and selection
of its critical accounting policies and estimates and believes that certain of our significant accounting policies
involve a higher degree of judgment or complexity and are most significant to reporting our consolidated results
of operations and financial position, and are therefore discussed as critical. The following critical accounting
policies reflect the significant estimates and judgments used in the preparation of our consolidated financial
statements. The following items require significant estimation or judgment in the preparation of the consolidated
financial statements.

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Merchandise Inventories—Reserves

Our merchandise inventories are comprised of finished goods and are carried at the lower of cost or net
realizable value, with cost determined on a weighted-average cost method. To determine if the value of inventory
should be marked down below original cost, we use estimates to determine the lower of cost or net realizable
value, which considers current and anticipated demand, customer preference and the merchandise age. The
inventory value is adjusted periodically to reflect current market conditions, which requires management
judgments that may significantly affect the ending inventory valuation, as well as gross margin. The estimates
used in inventory valuation are lower of cost or net realizable value reserves and obsolescence (including excess
and slow-moving inventory).

Our inventory reserves contain uncertainties that require management to make assumptions and to apply

judgment regarding a number of factors, including market conditions, the selling environment, historical results
and current inventory trends. We adjust our inventory reserves for net realizable value and obsolescence based on
trends, aging reports, specific identification and estimates of future retail sales prices. If actual results change
from our prior estimates, we adjust our inventory reserves accordingly throughout the period. We have not made
any material changes to our assumptions included in the calculations of the lower of cost or net realizable value
reserves during the periods presented.

Impairment

Tradenames, Trademarks and Domain Names

We annually evaluate whether tradenames, trademarks and domain names continue to have an indefinite

life. Tradenames, trademarks and domain names are reviewed for impairment annually in the fourth quarter and
may be reviewed more frequently if indicators of impairment are present. Conditions that may indicate
impairment include, but are not limited to, a significant adverse change in customer demand or business climate
that could affect the value of an asset, a product recall or an adverse action or assessment by a regulator.

We qualitatively assesses indefinite-lived intangible asset impairment to determine whether it is more likely

than not that the fair value of the asset is less than its carrying amount. If tradenames, trademarks and domain
names are not qualitatively assessed or if such intangible assets are qualitatively assessed and it is determined it
is not more likely than not that the asset’s fair value is greater than its carrying amount, an impairment review is
performed by comparing the carrying value to the estimated fair value, determined using a discounted cash flow
methodology, which requires management judgments that may significantly affect the ending asset valuation.
Factors used in the valuation of intangible assets with indefinite lives include, but are not limited to,
management’s plans for future operations, brand initiatives, recent results of operations and projected future cash
flows.

In the event we quantitatively assess a reporting unit’s indefinite-lived intangible asset for impairment, we
perform an impairment test which utilizes the discounted cash flow methodology under the relief-from-royalty
method. Under the relief-from-royalty method, our significant assumptions include the forecasted future revenues
and the estimated royalty rate, expressed as a percentage of revenues.

Long-Lived Assets

Long-lived assets, such as property and equipment and lease right-of-use assets, are reviewed for

impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Conditions that may indicate impairment include, but are not limited to, a significant adverse
change in customer demand or business climate that could affect the value of an asset, change in the intended use
of an asset, a product recall or an adverse action or assessment by a regulator. If the sum of the estimated
undiscounted future cash flows over the remaining life of the primary asset is less than the carrying value, we
recognize a loss equal to the difference between the carrying value and the fair value, usually determined by the

96

estimated discounted cash flow analysis of the asset or asset group. The asset group is defined as the lowest level
for which identifiable cash flows are available and largely independent of the cash flows of other groups of
assets, which for our stores is the individual gallery level.

Since there is typically no active market for our long-lived assets, we estimate fair values based on the
expected future cash flows of the asset or asset group, using a discount rate commensurate with the related risk.
The estimate of fair value requires management judgments that may significantly affect the ending asset
valuation. Future cash flows are estimated based on gallery-level historical results, current trends, and operating
and cash flow projections. Our estimates are subject to uncertainty and may be affected by a number of factors
outside our control, including general economic conditions and the competitive environment. While we believe
our estimates and judgments about future cash flows are reasonable, future impairment charges may be required
if the expected cash flow estimates, as projected, do not occur or if events change requiring us to revise our
estimates.

Lease Accounting

Reasonably Certain Lease Term

In recognizing the lease right-of-use assets and lease liabilities, we utilize the lease term for which we are
reasonably certain to use the underlying asset, including consideration of options to extend or terminate the lease.
At lease commencement, we evaluate whether we are reasonably certain to exercise available options based on
consideration of a variety of economic factors and the circumstances related to the leased asset. Factors
considered include, but are not limited to, (i) the contractual terms compared to estimated market rates, (ii) the
uniqueness or importance of the asset or its location, (iii) the potential costs of obtaining an alternative asset,
(iv) the potential costs of relocating or ceasing use of the asset, including the consideration of leasehold
improvements and other invested capital, and (v) any potential tax consequences.

The determination of the reasonably certain lease term affects the inclusion of rental payments utilized in
the incremental borrowing rate calculations, the results of the lease classification test, and our consideration of
certain assets held for sale or planned for sale-leaseback. The reasonably certain lease term may materially
impact our financial position related to certain Design Galleries or distribution center facilities which typically
have greater lease payments. Although the above factors are considered in our analysis, the assessment involves
subjectivity considering our strategy, expected future events and market conditions. While we believe our
estimates and judgments in determining the lease term are reasonable, future events may occur which may
require us to reassess this determination.

Incremental Borrowing Rate

As most of our leases do not include an implicit interest rate, we determine the discount rate for each lease
based upon the incremental borrowing rate (“IBR”) in order to calculate the present value of the lease liability at
the commencement date. The IBR is computed as the rate of interest that we would have to pay to (i) borrow on a
collateralized basis (ii) over a similar term (iii) an amount equal to the total lease payments (iv) in a similar
economic environment. We utilize our asset based credit facility as the basis for determining the applicable IBR
for each lease. We estimate the incremental borrowing rate for each lease primarily by reference to (i) yield rates
on debt issuances by companies of a similar credit rating; (ii) the weighted-average lease term; and
(iii) adjustments for differences between the yield rates and the actual term of the credit facility. In determining
the yield rates, we utilize market information as of the beginning of the quarter in which the lease commenced.
For Design Galleries, we utilize market information on the lease commencement date.

Fair Market Value

We determine the fair value of the underlying asset, and the lease components such as land and building, for

purposes of determining the lease classification and allocating our contractual rental payments to the lease

97

components. The fair value of the underlying asset and lease components also impact our assets held for sale and
sale-leaseback transactions. The fair value assessments may materially impact our financial position related to
certain Design Galleries or distribution center facilities which typically have greater fair values.

The determination of fair value requires subjectivity and estimates, including the use of multiple valuation

techniques and uncertain inputs, such as market price per square foot and assumed capitalization rates or the
replacement cost of the assets, where applicable. Where real estate valuation expertise is required we obtain
independent third-party appraisals to determine the fair value of the underlying asset and lease components.
While determining fair value requires a variety of input assumptions and judgment, we believe our estimates of
fair market value are reasonable.

Recently Issued Accounting Pronouncements

Refer to “Recently Issued Accounting Standards” within Note 3—Significant Accounting Policies in our

consolidated financial statements within Part II of this Annual Report on Form 10-K.

Item 7A. Quantitative and Qualitative Disclosure of Market Risks

Interest Rate Risk

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

foreseeable future.

We are subject to interest rate risk in connection with borrowings under our revolving line of credit under
the Credit Agreement which bears interest at variable rates and we may incur additional indebtedness that bears
interest at variable rates. At February 1, 2020, no amounts were outstanding under the revolving line of credit.
The Credit Agreement provides for a borrowing amount based on the value of eligible collateral and a formula
linked to certain borrowing percentages based on certain categories of collateral. Under the terms of such
provisions, the amount under the revolving line of credit borrowing base that could be available pursuant to the
Credit Agreement as of February 1, 2020 was $321.7 million, net of $13.2 million in outstanding letters of credit.
Based on the average interest rate on the revolving line of credit at February 1, 2020, and to the extent that
borrowings were outstanding on such line of credit, we do not believe that a 10% change in the interest rate
would have a material effect on our consolidated results of operations or financial condition. To the extent that
we incur additional indebtedness, we may increase our exposure to risk from interest rate fluctuations.

A number of our current debt agreements, including the Credit Agreement, have an interest rate tied to
LIBOR, which is expected to be discontinued after 2021. A number of alternatives to LIBOR have been proposed
or are being developed, but it is not clear which, if any, will be adopted. Any of these alternative methods may
result in interest payments that are higher than expected or that do not otherwise correlate over time with the
payments that would have been made on such indebtedness for the interest periods if the applicable LIBOR rate
was available in its current form.

As of February 1, 2020, we had $300 million principal amount of 0.00% convertible senior notes due 2020

outstanding (the “2020 Notes”). As this instrument does not bear interest, we do not have interest rate risk
exposure related to this debt.

As of February 1, 2020, we had $335 million principal amount of 0.00% convertible senior notes due 2023

outstanding (the “2023 Notes”). As this instrument does not bear interest, we do not have interest rate risk
exposure related to this debt.

As of February 1, 2020, we had $350 million principal amount of 0.00% convertible senior notes due 2024

outstanding (the “2024 Notes”). As this instrument does not bear interest, we do not have interest rate risk
exposure related to this debt.

98

Market Price Sensitive Instruments

0.00% Convertible Senior Notes due 2019

In connection with the issuance of the 0.00% convertible senior notes due 2019 (the “2019 Notes”), we

entered into privately-negotiated convertible note hedge transactions with certain counterparties. The 2019
Notes matured on June 15, 2019, and the convertible note hedge terminated upon the maturity date of the 2019
Notes. We also entered into separate warrant transactions with the same group of counterparties initially relating
to the number of shares of our common stock underlying the convertible note hedge transactions, subject to
customary anti-dilution adjustments. The strike price of the warrant transactions was initially $171.98 per share.
Refer to Note 10—Convertible Senior Notes in our consolidated financial statements within Part II of this Annual
Report on Form 10-K.

During fiscal 2019, we delivered approximately 167,100 shares upon exercise of the warrants under the

terms of the warrant agreements. The warrants expired on December 6, 2019.

0.00% Convertible Senior Notes due 2020

In connection with the issuance of the 2020 Notes, we entered into privately-negotiated convertible note
hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively,
2.5 million shares of our common stock, which represents the number of shares of our common stock underlying
the 2020 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2020 Notes.
These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to
our common stock upon conversion of the 2020 Notes and/or reduce our exposure to potential cash or stock
payments that may be required upon conversion of the 2020 Notes.

We also entered into separate warrant transactions with the same group of counterparties initially relating to

the number of shares of our common stock underlying the convertible note hedge transactions, subject to
customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our
common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants
unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant
transactions is initially $189.00 per share. Refer to Note 10—Convertible Senior Notes in our consolidated
financial statements within Part II of this Annual Report on Form 10-K.

0.00% Convertible Senior Notes due 2023

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

We also entered into separate warrant transactions with the same group of counterparties initially relating to

the number of shares of our common stock underlying the convertible note hedge transactions, subject to
customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our
common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants
unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant
transactions is initially $309.84 per share. Refer to Note 10—Convertible Senior Notes in our consolidated
financial statements within Part II of this Annual Report on Form 10-K.

99

0.00% Convertible Senior Notes due 2024

In connection with the issuance of the 2024 Notes, we entered into privately-negotiated convertible note
hedge transactions with certain counterparties. The convertible note hedge transactions relate to, collectively,
1.7 million shares of our common stock, which represents the number of shares of our common stock underlying
the 2024 Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2024 Notes.
These convertible note hedge transactions are expected to reduce the potential earnings dilution with respect to
our common stock upon conversion of the 2024 Notes and/or reduce our exposure to potential cash or stock
payments that may be required upon conversion of the 2024 Notes.

We also entered into separate warrant transactions with the same group of counterparties initially relating to

the number of shares of our common stock underlying the convertible note hedge transactions, subject to
customary anti-dilution adjustments. The warrant transactions will have a dilutive effect with respect to our
common stock to the extent that the price per share of our common stock exceeds the strike price of the warrants
unless we elect, subject to certain conditions, to settle the warrants in cash. The strike price of the warrant
transactions is initially $338.24 per share. Refer to Note 10—Convertible Senior Notes in our consolidated
financial statements.

Impact of Inflation

Our results of operations and financial condition are presented based on historical cost. While it is difficult

to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the
effects of inflation, if any, on our consolidated results of operations and financial condition have been
immaterial.

100

Item 8.

Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of RH

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of RH and its subsidiaries (the “Company”) as of
February 1, 2020 and February 2, 2019, and the related consolidated statements of operations, comprehensive
income (loss), stockholders’ equity (deficit) and cash flows for each of the three years in the period ended
February 1, 2020, including the related notes (collectively referred to as the “consolidated financial statements”).
We also have audited the Company’s internal control over financial reporting as of February 1, 2020, based on
criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of the Company as of February 1, 2020 and February 2, 2019, and the results of its operations
and its cash flows for each of the three years in the period ended February 1, 2020 in conformity with accounting
principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in
all material respects, effective internal control over financial reporting as of February 1, 2020, based on criteria
established in Internal Control - Integrated Framework (2013) issued by the COSO.

Changes in Accounting Principles

As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it
accounts for leases in fiscal 2019 and the manner in which it accounts for revenues from contracts with
customers in fiscal 2018. The adoption of the accounting standard on leases is also discussed below as a critical
audit matter.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective
internal control over financial reporting, and for its assessment of the effectiveness of internal control over
financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing
under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and
on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm
registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to
be independent with respect to the Company in accordance with the U.S. federal securities laws and the
applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are
free of material misstatement, whether due to error or fraud, and whether effective internal control over financial
reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material
misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures
that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts
and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of
the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an

101

understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the circumstances. We
believe that our audits provide a reasonable basis for our opinions.

Emphasis of Matter

As discussed in Note 20 to the consolidated financial statements, in response to the public health crisis posed by
COVID-19, effective from March 17, 2020, the Company temporarily closed its retail locations for an
indeterminate period of time. As a result of these developments, the Company expects an unfavorable impact on
its sales, results of operations and cash flows in fiscal 2020. Management’s evaluation of the events and
conditions and management’s plans to mitigate these matters are also described in Note 20.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

Critical Audit Matters

The critical audit matter communicated below is a matter arising from the current period audit of the
consolidated financial statements that was communicated or required to be communicated to the audit committee
and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and
(ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit
matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we
are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit
matter or on the accounts or disclosures to which it relates.

Adoption of Accounting Standard on Leases

As described above and in Note 3 to the consolidated financial statements, the Company adopted the new
accounting standard on leases using a modified retrospective approach. Under this adoption method, the results
of prior comparative periods are presented with an adjustment to opening retained earnings of the earliest
comparative period presented. As of February 3, 2019, the adoption of the new accounting standard on leases
resulted in an increase of $617 million and $633 million to consolidated total assets and liabilities, respectively.
In addition, the Company recorded an increase to the fiscal 2017 (the earliest comparative period presented)
opening retained earnings balance of $4.0 million, inclusive of the tax impact. The adoption of the new
accounting standard on leases included the derecognition of non-Company owned properties that were
capitalized under previously existing build-to-suit accounting policies and are now classified as either an

102

operating or finance lease upon lease commencement. In addition, any capital amounts contributed by the
Company toward the construction of the leased asset are recorded as landlord assets under construction within
other non-current assets. Upon lease commencement, the Company reclassifies amounts of the construction
project determined to be the landlord asset to lease right-of-use assets.

The principal considerations for our determination that performing procedures relating to adoption of the new
accounting standard on leases is a critical audit matter are that there was significant judgment by management
when (i) identifying and evaluating the impact of varying terms and conditions within leasing contracts,
highlighted by the treatment of non-Company owned properties that were capitalized under previously existing
build-to-suit accounting policies, and (ii) applying the transition guidance to all current and comparative periods
presented in accordance with the modified retrospective method. This in turn led to significant auditor judgment,
subjectivity and effort in performing audit procedures relating to the accounting treatment for each lease
arrangement and the application of the transition guidance to all current and comparative periods presented. The
audit effort involved the use of professionals with specialized skill and knowledge.

Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming
our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness
of controls relating to the adoption of the new accounting standard on leases, including the treatment of
non-Company owned properties and the transition guidance to all current and comparative periods presented.
These procedures also included, among others, evaluating management’s lease classification and accounting
treatment of all non-Company owned properties that were capitalized under previously existing build-to-suit
accounting policies and the recognition of right-of-use assets and liabilities to all current and comparative periods
presented. Professionals with specialized skill and knowledge were used to assist in evaluating the Company’s
technical application of the accounting standard related to non-Company owned properties that were capitalized
under previously existing build-to-suit accounting policies, and the application of the transition guidance to all
current and comparative periods presented.

/s/ PricewaterhouseCoopers LLP

San Francisco, California
March 30, 2020

We have served as the Company’s auditor since 2008.

103

RH
CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

February 1,
2020

February 2,
2019

ASSETS
Current assets:

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Merchandise inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expense and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Property and equipment—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating lease right-of-use assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tradenames, trademarks and domain names . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

47,658
48,979
438,696

—
61,619

596,952

967,599
410,904
124,367
86,022
45,005
214,845

$

5,803
40,224
531,947
21,795
104,198

703,967

952,957
440,504
124,379
86,022
35,603
79,586

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,445,694

$2,423,018

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:

Accounts payable and accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred revenue and customer deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2019—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2020—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Asset based credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment promissory notes—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2020—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2023—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2024—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-current operating lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-current finance lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other non-current obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 330,309
162,433

—
290,532
58,924
140,714

982,912

—
31,053
—
266,658
264,982
409,930
442,988
28,520

$ 320,497
152,595
343,789

—
66,249
109,456

992,586

57,500
—
271,157
249,151

—
437,557
421,245
32,512

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2,427,043

2,461,708

Commitments and contingencies (Note 18)

Stockholders’ (deficit):

Preferred stock—$0.0001 par value per share, 10,000,000 shares authorized, no shares issued
or outstanding as of February 1, 2020 and February 2, 2019 . . . . . . . . . . . . . . . . . . . . . . . . .

Common stock—$0.0001 par value per share, 180,000,000 shares authorized, 19,236,681
shares issued and outstanding as of February 1, 2020; 20,480,613 shares issued and
20,477,813 shares outstanding as of February 2, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated deficit
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury stock—at cost, no shares as of February 1, 2020 and 2,800 shares as of February 2,
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—

—

2
430,662
(2,760)
(409,253)

2
356,422
(2,334)
(392,537)

—

(243)

Total stockholders’ (deficit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

18,651

(38,690)

Total liabilities and stockholders’ (deficit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$2,445,694

$2,423,018

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

104

RH
CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 2,647,437
1,552,426

$ 2,505,653
1,520,076

$ 2,440,174
1,600,876

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selling, general and administrative expenses . . . . . . . . . . . . . . . . . . .

1,095,011
732,180

Income from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

362,831

Other expenses

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense—net
Goodwill and tradename impairment
. . . . . . . . . . . . . . . . . . . . .
Loss on extinguishment of debt—net . . . . . . . . . . . . . . . . . . . . .

Total other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

87,177
—
6,472

93,649

269,182
48,807

985,577
723,841

261,736

67,769
32,086
917

100,772

160,964
25,233

839,298
722,183

117,115

56,002
33,700
4,880

94,582

22,533
25,132

Net income (loss)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$

220,375 $

135,731

$

(2,599)

Weighted-average shares used in computing basic net income (loss)
per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Basic net income (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted-average shares used in computing diluted net income

19,082,303
11.55

$

21,613,678
6.28
$

27,053,616
(0.10)
$

(loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted net income (loss) per share . . . . . . . . . . . . . . . . . . . . . . . . . . .

24,299,034
9.07

$

26,533,225
5.12
$

27,053,616
(0.10)
$

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

105

RH
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (losses) gains from foreign currency translation . . . . . . . . . . . . . . . . . . .
Net unrealized gains on investment securities . . . . . . . . . . . . . . . . . . . . . . . .

$220,375
(426)
—

$135,731
(2,163)
—

$(2,599)
1,510
11

Total comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$219,949

$133,568

$(1,078)

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

106

RH
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands, except share amounts)

Common Stock

Shares Amount

Balances—January 28, 2017 . . 40,828,633
Stock-based compensation . . . .
—
Issuance of restricted stock . . . .
Vested and delivered restricted

$
—
15,631 —

4

stock units . . . . . . . . . . . . . . .
Exercise of stock options . . . . .
Repurchases of common

197,660 —
695,546 —

stock . . . . . . . . . . . . . . . . . . . (20,220,132)

(2)

Retirement of treasury stock . . .
Net loss . . . . . . . . . . . . . . . . . . .
Net gains from foreign currency
translation . . . . . . . . . . . . . . .
Net unrealized holding gains on
investments . . . . . . . . . . . . . .

Balances—February 3,

—
—

—

—

—
—

—

—

Accumulated
Other
Comprehensive
Income
(Loss)

$(1,692)
—
—

Additional
Paid-In
Capital

$ 790,866
50,283
—

(4,504)
23,643

—
(19,523)
—

—

—

—
—

—
—
—

1,510

11

Retained
Earnings
(Accumulated
Deficit)

$ 154,174

—
—

—
—

—
—
(2,599)

—

—

2018 . . . . . . . . . . . . . . . . . . . . 21,517,338
—

Stock-based compensation . . . .
Issuance of restricted stock . . . .
Vested and delivered restricted

$
—
6,405 —

2

$ 840,765
23,557
—

$ (171)
—
—

$ 151,575
—
—

stock units . . . . . . . . . . . . . . .
Exercise of stock options . . . . .
Repurchases of common

stock . . . . . . . . . . . . . . . . . . .
Retirement of treasury stock . . .
Equity component value of

convertible note issuance—
net

. . . . . . . . . . . . . . . . . . . . .

Sale of common stock

warrant

. . . . . . . . . . . . . . . . .

Purchase of convertible note

hedge . . . . . . . . . . . . . . . . . . .

Impact of Topic 606

adoption . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . .
Net losses from foreign

currency translation . . . . . . . .

Balances—February 2,

122,177 —
882,272 —

(9,502)
44,024

(2,050,379) —
—
—

—

(591,519)

—

—

—

—
—

—

—

—

—

—
—

—

89,933

51,021

(91,857)

—
—

—

—
—

—
—

—

—

—

—
—

—
—

—

(658,807)

—

—

—

(21,036)
135,731

(2,163)

—

2019 . . . . . . . . . . . . . . . . . . . . 20,477,813
—

Stock-based compensation . . . .
Issuance of restricted stock . . . .
Vested and delivered restricted

$
—
7,014 —

2

$ 356,422
21,406
—

$(2,334)
—
—

stock units . . . . . . . . . . . . . . .
Exercise of stock options . . . . .
Repurchases of common

stock . . . . . . . . . . . . . . . . . . .
Retirement of treasury stock . . .
Shares issued in connection

with warrant agreements . . . .

Equity component value of

convertible note issuance—
net

. . . . . . . . . . . . . . . . . . . . .

Sale of common stock

warrant

. . . . . . . . . . . . . . . . .

Purchase of convertible note

hedge . . . . . . . . . . . . . . . . . . .

Conversion of convertible

senior notes . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . .
Net losses from foreign

109,062 —
643,090 —

(2,167,396) —
—
—

(7,069)
27,138

—
(13,180)

167,056 —

—

—

—

—

—

—

—

42 —
—

—

87,070

50,225

(91,350)

—
—

—

—
—

—
—

—

—

—

—

—
—

$(392,537)

—
—

—
—

—

(237,091)

—

—

—

—

—
220,375

Treasury Stock

Shares

Amount

Total
Stockholders’
Equity
(Deficit)

294,888 $
—
—

(19,523) $
—
—

923,829
50,283
—

—
—

—
—

(4,504)
23,643

20,220,132 (1,000,326)
19,523
—

(294,888)

—

—

—

—

—

20,220,132 $(1,000,326) $

—
—

—
—

—
—

—
—

(1,000,328)

—
(2,599)

1,510

11

(8,155)
23,557
—

(9,502)
44,024

2,050,379

(250,243)
(22,267,711) 1,250,326

(250,243)

—

—

—

—

—
—

—

2,800 $
—
—

—
—

—

—

—

—

(42)
—

—

— $

—

—

—

—
—

—

89,933

51,021

(91,857)

(21,036)
135,731

(2,163)

(243) $
—
—

(38,690)
21,406
—

—
—

—

—

—

—

4
—

—

(7,069)
27,138

(250,032)

—

—

87,070

50,225

(91,350)

4
220,375

(426)

2,167,396
(2,170,154)

(250,032)
250,271

currency translation . . . . . . . .

—
Balances—February 1, 2020 . . 19,236,681

—

(426)

—

$

2

$ 430,662

$(2,760)

$(409,253)

— $

18,651

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

107

RH
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments to reconcile net income (loss) to net cash provided by operating activities:

Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-cash operating lease cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset impairments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill and tradename impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset held for sale loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of debt discount
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accretion of debt discount upon settlement of debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock-based compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-cash finance lease interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Product recalls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net non-cash charges resulting from inventory step-up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of purchase premiums and accretion of purchase discount—net . . . . . . . . . . . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss on extinguishment of debt—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other non-cash interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Merchandise inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expense and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Landlord assets under construction—net of tenant allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable and accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred revenue and customer deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current and non-current operating lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other non-current obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposits on asset under construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sale of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchase of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Maturities of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by (used in) investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under asset based credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayments under asset based credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings under term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayments under term loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings under promissory and equipment security notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayments under promissory and equipment security notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt issuance costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from issuance of convertible senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from issuance of warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchase of convertible note hedges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt issuance costs related to convertible senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayments of convertible senior notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal payments under finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repurchases of common stock—including commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax withholdings related to issuance of stock-based awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effects of foreign currency exchange rate translation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase (decrease) in cash and cash equivalents and restricted cash equivalents . . . . . . . . . . . . . . . .

Cash and cash equivalents and restricted cash equivalents

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

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

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid for interest
Cash paid for taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-cash transactions:

Property and equipment additions in accounts payable and accrued expenses at period-end . . . . . . . . . . .
Landlord asset additions in accounts payable and accrued expenses at period-end . . . . . . . . . . . . . . . . . . .
Landlord asset additions from unpaid construction related deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reclassification of assets from landlord assets under construction to finance lease right-of-use assets . . .
Issuance of non-current notes payable related to share repurchases from former employees . . . . . . . . . . .

5,161
19,640
195
19,503
—
The accompanying notes are an integral part of these Consolidated Financial Statements.

$

108

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

$ 220,375

$

135,731 $

(2,599)

100,739
65,195
15,168
—
(1,529)
46,245
(70,482)
21,832
22,608
(3,517)
—
—
(7,709)
6,472
4,334

(7,309)
93,266
28,404
(64,300)
7,445
9,799
(45,767)
(77,004)
(25,077)
339,188

(93,623)
(53,000)
24,078
—
—
—

(122,545)

322,500
(380,000)
320,000
(324,000)
122,000
(16,520)
(4,636)
350,000
50,225
(91,350)
(4,818)
(278,560)
(9,682)
(250,032)
27,138
(7,069)
(174,804)
16
41,855

5,803
—
5,803

$

47,658
—
$ 47,658

$ 43,278
40,126

91,372
68,612
6,533
32,086
8,497
41,868
—
23,983
16,785
6,874
380
—
(5,018)
917
3,639

(8,583)
(7,399)
(88,434)
(59,001)
10,148
8,413
51,214
(70,875)
(18,139)
249,603

(79,992)
—
—
—
—
—
(79,992)

83,176
75,610
8,876
33,700
—
30,457
—
50,709
11,154
7,707
2,527
99
3,733
4,880
4,768

2,458
220,767
27,920
(81,065)
65,105
3,366
5,008
(70,541)
(13,310)
474,505

(68,393)
—
15,123
(16,109)
46,890
145,020
122,531

866,500
(1,008,970)

—
(80,000)
—
(31,974)
—
335,000
51,021
(91,857)
(6,349)
—
(6,885)
(250,000)
44,024
(9,502)
(188,992)
(130)
(19,511)

600,000
(400,030)
180,000
(103,000)
34,000
(2,319)
(8,298)
—
—
—
—
—
(6,105)
(1,000,326)
24,896
(5,759)
(686,941)
152
(89,753)

$

$

$

$

17,907
7,407
25,314 $

87,023
28,044
115,067

5,803
—

5,803 $

31,154 $
41,289

7,837
12,142
2,807
79,685
243

17,907
7,407
25,314

28,180
4,025

7,640
17,543
5,091
57,990
—

RH
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—NATURE OF BUSINESS

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

As of February 1, 2020, the Company operated a total of 68 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.

NOTE 2—ORGANIZATION

The Company was formed on August 18, 2011 and capitalized on September 2, 2011 as a holding company

for the purposes of facilitating an initial public offering of common equity and was at such time a direct
subsidiary of Home Holdings, LLC, a Delaware limited liability company (“Home Holdings”).

On November 1, 2012, the Company acquired all of the outstanding shares of capital stock of Restoration

Hardware, Inc., a Delaware corporation, and Restoration Hardware, Inc. became a direct, wholly owned
subsidiary of the Company. Restoration Hardware, Inc. was a direct, wholly owned subsidiary of Home Holdings
prior to the Company’s initial public offering. Outstanding units issued by Home Holdings under its equity
compensation plan, referred to as the Team Resto Ownership Plan, were replaced with common stock of the
Company at the time of its initial public offering. These transactions are referred to as the “Reorganization.” On
November 7, 2012, the Company completed its initial public offering.

On December 15, 2016, Restoration Hardware Holdings, Inc. filed a Certificate of Amendment to its

Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware to change
its name to “RH,” effective January 1, 2017.

Convertible Senior Notes

In September 2019, the Company issued in a private offering $350 million principal amount of 0.00%

convertible senior notes due 2024 (the “2024 Notes”). In connection with the issuance of these notes, the
Company entered into convertible note hedge transactions for which it paid an aggregate amount of
$91.4 million. In connection with the issuance of the 2024 Notes, the Company sold warrants to purchase shares
of common stock of the Company, for which it received aggregate proceeds of approximately $50.2 million.
Taken together, the Company received total cash proceeds of $304.1 million, net of discounts upon original
issuance and offering costs of $4.8 million, from the issuance of the 2024 Notes and the related warrants. Refer
to Note 10—Convertible Senior Notes.

Subsequent Event

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus disease
(“COVID-19”) as a pandemic, which continues to spread throughout the United States and globally. Refer to
Note 20—Subsequent Event for further information.

NOTE 3—SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

These consolidated financial statements are prepared in conformity with accounting principles generally

accepted in the United States (“GAAP”). The consolidated financial statements include the accounts of the

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Company and its wholly owned subsidiaries. Accordingly, all intercompany balances and transactions have been
eliminated through the consolidation process.

Revision

As previously disclosed within the Company’s quarterly reports on Form 10-Q for its fiscal quarters during

the year ended February 1, 2020, during the adoption process of the new lease accounting standard (refer to
“Recently Issued Accounting Standards—Leases” below), the Company identified a lease agreement that was
incorrectly accounted for as an impaired lease under Accounting Standard Codification (“ASC”) 420—Exit or
Disposal Cost Obligations in fiscal 2017 and the first quarter of fiscal 2018. This error resulted in an
overstatement of net income of $1.4 million and $0.9 million for fiscal 2017 and fiscal 2018, respectively. This
error also resulted in an overstatement of retained earnings as of February 3, 2018 of $1.4 million, from
$152.4 million as reported to $151.0 million as revised, and understatement of accumulated deficit of
$2.3 million, from $376.8 million as reported to $379.1 million, prior to the impact of the modified retrospective
application of the new lease accounting standard as further discussed under “Recently Issued Accounting
Standards—Leases” below. In addition, as of February 2, 2019, this error resulted in an understatement of other
non-current obligations of $3.3 million, and an overstatement of other current liabilities of $1.0 million, as
revised. Although these errors are not considered to be material to any of the previously issued financial
statements, the Company has revised the accompanying consolidated financial statements to reflect the correction
of these errors.

In addition, during the adoption process of the new lease accounting standard, the Company identified an

error in its previously reported consolidated statement of cash flows for fiscal 2018. This error resulted in an
understatement of $9.2 million of net cash provided by operating activities and an understatement of $9.2 million
of net cash used in investing activities for fiscal 2018. There was no impact on the consolidated balance sheets,
consolidated statements of operations or the consolidated statement of stockholders’ equity (deficit) related to
this error. Although these errors are not considered to be material to any of the previously issued financial
statements, the Company has revised the accompanying consolidated financial statements to reflect the correction
of these errors.

The following are selected line items from the Company’s consolidated statements of cash flows illustrating

the effect of the corrections, prior to the adoption of the modified retrospective application of the new lease
accounting standard (in thousands):

Year Ended February 2, 2019

As Reported Adjustment

As Revised

Cash flows from operating activities:

Change in accounts payable and accrued expenses . . . . . . . . . . . . . . . .
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . .

$

(452)
300,556

$ 9,201
9,201

$

8,749
309,757

Cash flows from investing activities:

Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . .

(136,736)
(136,736)

(9,201)
(9,201)

(145,937)
(145,937)

Fiscal Years

The Company’s fiscal year ends on the Saturday closest to January 31. As a result, the Company’s

fiscal year may include 53 weeks. The fiscal years ended February 1, 2020 (“fiscal 2019”) and February 2, 2019
(“fiscal 2018”) each consisted of 52 weeks. The fiscal year ended February 3, 2018 (“fiscal 2017”) consisted of
53 weeks.

Use of Accounting Estimates

The preparation of the Company’s consolidated financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and

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disclosures of contingent assets and liabilities at the date of the 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 consolidated financial statements.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of 90 days or less to be cash

equivalents.

Concentration of Credit Risk

The Company maintains its cash and cash equivalent accounts in financial institutions in both U.S. dollar

and Canadian dollar denominations. Accounts at the U.S. institutions are insured by the Federal Deposit
Insurance Corporation (“FDIC”) up to $250,000 and accounts at the Canadian institutions are insured by the
Canada Deposit Insurance Corporation (“CDIC”) up to $100,000 Canadian dollars. As of February 1, 2020 and
February 2, 2019, and at various times throughout these fiscal years, the Company had cash in financial
institutions in excess of the amount insured by the FDIC and CDIC. The Company performs ongoing evaluations
of these institutions to limit its concentration of credit risk.

Accounts Receivable

Accounts receivable consist primarily of receivables from the Company’s credit card processors for sales

transactions, receivables related to the Company’s contract business and other miscellaneous receivables.
Accounts receivable is presented net of allowance for doubtful accounts, which is recorded on a specific
identification basis. The allowance for doubtful accounts was $2.2 million and $1.9 million as of February 1,
2020 and February 2, 2019, respectively.

Merchandise Inventories

The Company’s merchandise inventories are comprised of finished goods and are carried at the lower of

cost or net realizable value, with cost determined on a weighted-average cost method. To determine if the value
of inventory should be marked down below original cost, the Company uses estimates to determine the lower of
cost or net realizable value, which considers current and anticipated demand, customer preference and the
merchandise age. The inventory value is adjusted periodically to reflect current market conditions, which
requires management judgments that may significantly affect the ending inventory valuation, as well as gross
margin. The estimates used in inventory valuation are lower of cost or net realizable value reserves and
obsolescence (including excess and slow-moving inventory). Additionally, the Company estimates and accrues
for inventory shrinkage for the period between the last physical count and the balance sheet date.

The Company’s inventory reserves contain uncertainties that require management to make assumptions and
to apply judgment regarding a number of factors, including market conditions, the selling environment, historical
results and current inventory trends. The Company adjusts inventory reserves for net realizable value and
obsolescence based on trends, aging reports, specific identification and estimates of future retail sales prices.

Reserves for shrinkage are estimated and recorded throughout the year as a percentage of shipped sales for
the direct channels, and a percentage of cost of goods sold for the outlet business, based on historical shrinkage
results and current inventory levels. Actual shrinkage is recorded throughout the year based upon periodic cycle
counts and the results of the Company’s annual physical inventory counts. Actual inventory shrinkage and
obsolescence can vary from estimates due to factors including the mix of the Company’s inventory (which ranges
from large furniture to décor) and execution against loss prevention initiatives in the Company’s stores,
distribution centers, home delivery center locations, off-site storage locations and with its third-party
transportation providers. Accordingly, there is no shrinkage reserve at year-end, with the exception of a cycle

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count reserve for the Company’s distribution centers and home delivery center locations based on the historical
cycle count results.

If actual net realizable value, obsolescence or shrinkage estimates change from the Company’s original
estimates, the Company will adjust its inventory reserves accordingly throughout the period. The Company’s
inventory reserve balances were $25.6 million and $30.7 million as of February 1, 2020 and February 2, 2019,
respectively.

Product Recalls

During fiscal 2019, fiscal 2018 and fiscal 2017, the Company initiated product recalls for certain of its
products, as well as adjusted accruals related to certain product recalls previously initiated due to changes in
estimates based on customer response and vendor and insurance recoveries. Product recalls had the following
effect on the Company’s income before income taxes (in thousands):

(Increase) decrease to net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase (decrease) to cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Increase) decrease to gross profit
Increase (decrease) to selling, general and administrative expenses . . . . . . .

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

$ (391)
(3,372)

(3,763)
(225)

$ 4,733
(4,139)

594
1,025

$3,207
4,315

7,522
185

(Increase) decrease to income before income taxes . . . . . . . . . . . . . . . .

$(3,988)

$ 1,619

$7,707

The product recall accrual as of February 1, 2020 and February 2, 2019 was $2.1 million and $7.8 million,

respectively, and is included in other current liabilities on the consolidated balance sheets.

Advertising Expenses

Advertising expenses primarily represent the costs associated with the Company’s catalog mailings, as well

as print and website marketing. Total advertising expense, which is recorded in selling, general and
administrative expenses on the consolidated statements of operations, was $107.6 million, $97.0 million and
$106.6 million in fiscal 2019, fiscal 2018 and fiscal 2017, respectively.

Capitalized Catalog Costs

Capitalized catalog costs consist primarily of third-party incremental direct costs to prepare, print and
distribute Source Books. Such costs are capitalized and recognized as expense upon the delivery of the Source
Books to the carrier. In the case of multiple printings of a Source Book, the creative costs will be expensed in full
upon the initial delivery of Source Books to the carrier.

The Company had $13.7 million and $16.2 million of capitalized catalog costs as of February 1, 2020 and

February 2, 2019, respectively, which are included in prepaid expense and other current assets on the
consolidated balance sheets.

Website and Print Advertising

Website and print advertising expenses, which include e-commerce advertising, web creative content and
direct marketing activities such as print media, radio and other media advertising, are expensed as incurred or
upon the release of the content or the initial advertisement.

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Property and Equipment

Property and equipment is recorded at cost, net of accumulated depreciation and amortization. Depreciation

is calculated using the straight-line method, generally using the following useful lives:

Category of Property and Equipment

Building and building improvements . . . . . . . . . . . . . . . .
Machinery, equipment and aircraft . . . . . . . . . . . . . . . . . .
Furniture, fixtures and equipment
. . . . . . . . . . . . . . . . . .
Computer software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Useful Life

40 years
3 to 10 years
3 to 7 years
3 to 10 years

The cost of leasehold improvements is amortized over the lesser of the useful life of the asset or the

applicable lease term, which could include option periods reasonably certain to be exercised.

The Company expenses all internal-use software costs incurred in the preliminary project stage and

capitalizes certain direct costs associated with the development and purchase of internal-use software, including
external costs of materials and services and internal payroll costs related to the software project, within property
and equipment. Capitalized costs are amortized on a straight-line basis over the estimated useful lives of the
software, generally between three and ten years.

Interest is capitalized on construction in progress and software projects during the period in which
expenditures have been made, activities are in progress to prepare the asset for its intended use and interest
expense is being incurred. The Company capitalized interest of $4.9 million, $3.1 million and $3.3 million in
fiscal 2019, fiscal 2018 and fiscal 2017, respectively. During fiscal 2019, $3.7 million of the $4.9 million
capitalized interest relates to the capitalization of non-cash interest associated with the amortization of the
convertible senior notes debt discount. During fiscal 2018, $2.7 million of the $3.1 million capitalized interest
relates to the capitalization of non-cash interest associated with the amortization of the convertible senior notes
debt discount. During fiscal 2017, $2.5 million of the $3.3 million capitalized interest relates to the capitalization
of non-cash interest associated with the amortization of the convertible senior notes debt discount.

Land purchased by the Company is recorded at cost and is a non-depreciable asset.

Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate

that the carrying amount of assets may not be recoverable. For further discussion regarding the impairment
accounting policy refer to “Impairment—Long-Lived Assets” below.

Asset Held for Sale

Upon designation as an asset held for sale, the carrying value of the asset is recorded at the lower of its

carrying value or its estimated fair value less estimated costs to sell, and the Company ceases depreciating the
asset.

Lease Accounting

The Company leases nearly all of its retail and outlet store locations, corporate headquarters, distribution

and home delivery facilities, as well as other storage and office space. The initial lease terms of the Company’s
real estate leases generally range from ten to fifteen years, and certain leases contain renewal options for up to an
additional 25 years, the exercise of which is at the Company’s sole discretion. The Company also leases certain
equipment with lease terms generally ranging from three to seven years. The Company’s lease agreements
generally do not contain any material residual value guarantees or material restrictions or covenants.

The Company accounts for lease and non-lease components as a single lease component for real estate

leases, and for all other asset classes the Company accounts for the components separately. The Company

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determines the lease classification and begins to recognize lease and any related financing expenses upon the
lease’s commencement, which for real estate leases is generally upon store opening or, to a lesser extent, when
the Company takes possession or control of the asset.

The Company subleases certain real estate locations to third parties under operating leases and recognizes

rental income received on a straight-line basis over the lease term, which is recorded as an offset to selling,
general and administrative expenses on the consolidated statements of operations.

Lease arrangements may require the landlord to provide tenant allowances directly to the Company.
Standard tenant allowances received from landlords, typically those received under operating lease agreements,
are recorded as cash and cash equivalents with an offset recorded in lease right-of-use assets on the consolidated
balance sheets. Tenant allowances that are reasonably certain to be received subsequent to lease commencement
are reflected as a reduction of both the lease liabilities and right-of-use assets on the consolidated balance sheets
at the commencement date.

In certain instances tenant allowances are provided for the Company to design and build the leased asset.

Tenant allowances received from landlords during the construction phase of a leased asset and prior to lease
commencement are recorded as cash and cash equivalents with an offset recorded in other non-current assets (to
the extent the Company has incurred related capital expenditure for construction costs) or in other current
liabilities (to the extent that payments are received prior to capital construction expenditures by the Company) on
the consolidated balance sheets. After the leased asset is constructed and the lease commences, the Company
reclassifies the tenant allowance from other non-current assets or other current liabilities to lease right-of-use
assets on the consolidated balance sheets, and such allowances are amortized over the reasonably certain lease
term.

Lease Classification

Certain of the Company’s real estate and equipment leases are classified as finance leases. Lease

characteristics that the Company evaluates to determine lease classification include, but are not limited to, the
reasonably certain lease term, and the economic life and fair value of the leased asset. Lease related assets under
such classification are included in finance lease right-of-use assets within property and equipment—net on the
consolidated balance sheets.

Leases that do not meet the definition of a finance lease are considered operating leases. Lease related assets

classified as operating leases are included in operating lease right-of-use assets on the consolidated balance
sheets.

Reasonably Certain Lease Term

In recognizing the lease right-of-use assets and lease liabilities, the Company utilizes the lease term for

which it is reasonably certain to use the underlying asset, including consideration of options to extend or
terminate the lease. At lease commencement, the Company evaluates whether it is reasonably certain to exercise
available options based on consideration of a variety of economic factors and the circumstances related to the
leased asset. Factors considered include, but are not limited to, (i) the contractual terms compared to estimated
market rates, (ii) the uniqueness or importance of the asset or its location, (iii) the potential costs of obtaining an
alternative asset, (iv) the potential costs of relocating or ceasing use of the asset, including the consideration of
leasehold improvements and other invested capital, and (v) any potential tax consequences.

The determination of the reasonably certain lease term affects the inclusion of rental payments utilized in

the incremental borrowing rate calculations, the results of the lease classification test, and consideration of
certain assets held for sale or planned for sale-leaseback. The reasonably certain lease term may materially
impact the Company’s financial position related to certain Design Galleries or distribution center facilities which

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typically have greater lease payments. Although the above factors are considered in management’s analysis, the
assessment involves subjectivity considering the Company’s strategy, expected future events and market
conditions. While the Company believes its estimates and judgments in determining the lease term are
reasonable, future events may occur which may require the Company to reassess this determination.

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

Lease Payments

The majority of the Company’s real estate lease agreements include minimum rent payments which are
subject to stated lease escalations over the lease term and eligible renewal periods. These fixed payments through
the reasonably certain lease term are included in the Company’s measurement of the lease right-of-use assets and
lease liabilities upon lease commencement.

Certain of the Company’s lease agreements include rental payments based on a percentage of retail sales

over contractual levels. Additionally, certain lease agreements include rental payments based solely on a
percentage of retail sales. Due to the variable and unpredictable nature of such payments, the Company does not
recognize a lease right-of-use asset and lease liability related to such payments. Estimated variable rental
payments are included in accounts payable and accrued expenses on the consolidated balance sheets in the period
they are incurred and until such payments are made, and the related lease cost is included in cost of goods sold on
the consolidated statements of operations.

The Company has a small group of real estate leases that include rental payments periodically adjusted for
inflation (e.g., based on the consumer price index). The Company includes these variable payments in the initial
measurement of the lease right-of-use asset and lease liability according to the index or rate at the
commencement date and incorporates adjustments to rental payments in future periods if such increases have a
minimum rent escalation (e.g., floor). Changes due to differences between the variable lease payments estimated
at least commencement and actual amounts incurred are recognized in the consolidated statement of operations in
the period such costs are incurred.

Incremental Borrowing Rate

As the Company’s real estate leases and most of its equipment leases do not include an implicit interest rate,

the Company determines the discount rate for each lease based upon the incremental borrowing rate (“IBR”) in
order to calculate the present value of lease payments at the commencement date. The IBR is computed as the
rate of interest that the Company would have to pay to (i) borrow on a collateralized basis (ii) over a similar term
(iii) an amount equal to the total lease payments (iv) in a similar economic environment. The Company utilizes
its asset based credit facility as the basis for determining the applicable IBR for each lease. The Company
estimates the incremental borrowing rate for each lease primarily by reference to (i) yield rates on debt issuances
by companies of a similar credit rating; (ii) the weighted-average lease term; and (iii) adjustments for differences
between the yield rates and the actual term of the credit facility. In determining the yield rates for leases other
than new Design Galleries, the Company utilizes market information as of the beginning of the quarter in which
the lease commenced. For Design Galleries, the Company utilizes market information on the lease
commencement date.

Fair Market Value

The Company determines the fair value of the underlying asset, and the lease components such as land and
building, for purposes of determining the lease classification and allocating its contractual rental payments to the
lease components. The fair value of the underlying asset and lease components also impact the evaluation and

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accounting for assets held for sale and sale-leaseback transactions. The fair value assessments may materially
impact the Company’s financial position related to certain Design Galleries or distribution center facilities which
typically have greater fair values.

The determination of fair value requires subjectivity and estimates, including the use of multiple valuation

techniques and uncertain inputs, such as market price per square foot and assumed capitalization rates or the
replacement cost of the assets, where applicable. Where real estate valuation expertise is required the Company
obtains independent third-party appraisals to determine the fair value of the underlying asset and lease
components. While determining fair value requires a variety of input assumptions and judgment, management
believes its estimates of fair market value are reasonable.

Construction Related Activities

The Company is often involved in the construction of leased stores for its newer Design Galleries. Prior to

construction commencement, the Company evaluates whether or not it, as lessee, controls the asset being
constructed and, depending on the extent to which it is involved, the Company may be the “deemed owner” of
the leased asset for accounting purposes during the construction period under a build-to-suit arrangement.

If the Company is not the “deemed owner” for accounting purposes during the construction period, such
lease is classified as either an operating or finance lease upon lease commencement. During the construction
period and prior to lease commencement, any capital amounts contributed by the Company toward the
construction of the leased asset (excluding normal leasehold improvements, which are recorded within property
and equipment—net) are recorded as “Landlord assets under construction” within other non-current assets on the
consolidated balance sheets (refer to Note 4—Prepaid Expense and Other Assets). Upon completion of the
construction project, and upon lease commencement, the Company reclassifies amounts of the construction
project determined to be the landlord asset to lease right-of-use assets on the consolidated balance sheets based
on the lease classification determined at lease commencement. The construction costs determined not to be part
of the leased asset are classified as property and equipment—net on the consolidated balance sheets.

If the Company is the “deemed owner” for accounting purposes, upon commencement of the construction

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

Upon completion of the construction project, the Company performs a sale-leaseback analysis to determine

if it can derecognize the build-to-suit asset and corresponding financing obligation. If the asset and liability
cannot be derecognized, the Company accounts for the agreement as a debt-like arrangement.

If the Company is involved in a debt-like arrangement for a non-real estate asset under construction for

which the Company plans to lease such asset upon construction completion and makes deposits during the
construction period, the Company recognizes the related deposits as “Deposits on asset under construction”
within other non-current assets on the consolidated balance sheets (refer to Note 4—Prepaid Expense and Other
Assets). In the event the Company executes promissory notes related to the deposits, such promissory notes are
recorded as “Promissory notes on asset under construction” within other current liabilities on the consolidated
balance sheets (refer to Note 7—Accounts Payable, Accrued Expenses and Other Current Liabilities). The
Company recognizes the constructive disbursements and receipts of such debt-like arrangements on a gross basis

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on the consolidated statements of cash flows within cash flows from investing activities and cash flows from
financing activities, respectively.

Sale-Leaseback Activities

The Company occasionally enters into sale-leaseback transactions to finance certain property acquisitions
and capital expenditures, pursuant to which the Company sells the property to a third party and agrees to lease
the property back for a certain period of time. To determine whether the transfer of the property should be
accounted for as a sale, the Company evaluates whether it has transferred control to the third party in accordance
with the guidance set forth in ASC Topic 606.

If the transfer of the asset is a sale at market terms, the Company recognizes the transaction price for the

sale based on the cash proceeds received, derecognizes the carrying amount of the underlying asset and
recognizes a gain or loss in the consolidated statements of operations for any difference between the carrying
value of the asset and the transaction price. The Company then accounts for the leaseback in accordance with its
lease accounting policy.

If the transfer of the asset is determined not to be a sale, the Company accounts for the transaction as a
financing arrangement. The Company continues to present the asset within property and equipment—net on the
consolidated balance sheets and recognizes a non-current obligation on the consolidated balance sheets for the
transaction price, with the financial liability subsequently measured in accordance with other applicable GAAP.

Intangible Assets

Intangible assets reflect the value assigned to tradenames, trademarks and domain names. The Company

does not amortize its intangible assets as the Company defines the life of these assets as indefinite.

Impairment

Goodwill

The Company evaluates goodwill annually to determine whether it is impaired or whenever events occur or

circumstances change that would indicate that the fair value of a reporting unit is less than its carrying amount.
Conditions that may indicate impairment include, but are not limited to, a significant adverse change in customer
demand or business climate that could affect the value of an asset; general economic conditions, such as
increasing Treasury rates or unexpected changes in gross domestic product growth; a change in the Company’s
market share; budget-to-actual performance and consistency of operating margins and capital expenditures; a
product recall or an adverse action or assessment by a regulator; or changes in management or key personnel.

The Company performs its annual goodwill impairment testing in the fourth fiscal quarter by comparing the

fair value of a reporting unit with its carrying amount, limited to the total amount of goodwill of the reporting
unit. The Company will recognize an impairment charge for the amount by which the carrying amount exceeds
the reporting unit’s fair value.

The Company determines fair values using the discounted cash flow approach (“income approach”) or the
market multiple valuation approach (“market approach”), when available and appropriate, or a combination of
both. The Company assesses the valuation methodology based upon the relevance and availability of the data at
the time it performs the valuation. If multiple valuation methodologies are used, the results are weighted
appropriately.

Under the income approach, fair value is determined based on the present value of estimated future cash
flows, discounted at an appropriate risk-adjusted rate. The Company uses its internal forecasts to estimate future

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cash flows and includes an estimate of long-term future growth rates based on its most recent views of the long-
term outlook for each respective reporting unit. Actual results may differ from those assumed in the Company’s
forecasts. The Company derives its discount rates using a capital asset pricing model and analyzing published
rates for industries relevant to its reporting units to estimate the cost of equity financing. The Company uses
discount rates that are commensurate with the risks and uncertainty inherent in the respective businesses and in
its internally developed forecasts.

Valuations using the market approach are derived from metrics of publicly traded companies or historically

completed transactions of comparable businesses. The selection of comparable businesses is based on the
markets in which the reporting units operate giving consideration to risk profiles, size, geography, and diversity
of products and services. A market approach is limited to reporting units for which there are publicly traded
companies that have the characteristics similar to the Company’s businesses.

Estimating the fair value of reporting units requires the use of estimates and significant judgments that are
based on a number of factors including actual operating results. It is reasonably possible that the judgments and
estimates described above could change in future periods.

A reporting unit is an operating segment, or a business unit one level below that operating segment for
which discrete financial information is prepared and regularly reviewed by the Chief Operating Decision Maker
(“CODM”), which is the Company’s Chief Executive Officer. The Company has deemed RH Segment and
Waterworks to be the reporting units for which goodwill is independently tested, as these operating segments are
the lowest level for which discrete financial information is prepared and regularly reviewed by the CODM.

RH Segment Reporting Unit

During fiscal 2019, fiscal 2018 and fiscal 2017, the Company reviewed the RH Segment reporting unit
goodwill for impairment by assessing qualitative factors to determine whether it was more likely than not that the
fair value of the reporting unit was less than its carrying amount. Based on the qualitative tests performed in each
fiscal year, the Company determined that it was not more likely than not that the fair value of the reporting unit
was less than its carrying amount for fiscal 2019, fiscal 2018 and fiscal 2017, and therefore the Company did not
recognize goodwill impairment with respect to the RH Segment in any such fiscal year.

Waterworks Reporting Unit

During the fourth fiscal quarters of 2018 and 2017, the Company conducted its annual strategic planning

process. Based upon the outcome of this process in each fiscal year, management identified indicators that there
could be an impairment of the Waterworks reporting unit. These indicators included (i) an updated long-range
financial plan provided by the Waterworks segment management that indicated a reduction of revenues and
EBITDA as compared to prior long-range financial plans, (ii) a review of the strategic initiatives of the
Waterworks segment and (iii) the Waterworks segment not achieving revenue and operating income objectives
compared to plans.

In determining the Waterworks reporting unit estimated fair value using the income approach in both fiscal
2018 and fiscal 2017, the Company projected future cash flows based on management’s estimates and long-term
plans and applied a discount rate based on a weighted-average cost of capital. This analysis required the
Company to make judgments about revenues, expenses, fixed asset and working capital requirements, the impact
of updated tax legislation and other subjective inputs. In determining the Waterworks reporting unit estimated
fair value using the market approach, the Company considered assumptions that it believes market participants
would use in valuing the Waterworks reporting unit, based on EBITDA multiples and including the application
of a control premium. For purposes of this analysis, in both fiscal years, the Company weighted the results 80%
towards the income approach and 20% towards the market approach.

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Based on the estimated fair value of the Waterworks reporting unit as of the assessment date of each of its

fiscal 2018 and fiscal 2017 analysis, the Company recorded a $17.4 million and $33.7 million non-cash
impairment in the fourth quarter of fiscal 2018 and fiscal 2017, respectively, to reduce the carrying value of
goodwill in the Waterworks reporting unit. The impairment is recorded in goodwill and tradename impairment
on the consolidated statements of operations and the Waterworks reporting unit goodwill was fully impaired as of
February 2, 2019.

Tradenames, Trademarks and Domain Names

The Company annually evaluates whether tradenames, trademarks and domain names continue to have an
indefinite life. Tradenames, trademarks and domain names are reviewed for impairment annually in the fourth
quarter and may be reviewed more frequently if indicators of impairment are present. Conditions that may
indicate impairment include, but are not limited to, a significant adverse change in customer demand or business
climate that could affect the value of an asset, a product recall or an adverse action or assessment by a regulator.

The Company qualitatively assesses indefinite-lived intangible asset impairment to determine whether it is

more likely than not that the fair value of the asset is less than its carrying amount. If tradenames, trademarks and
domain names are not qualitatively assessed or if such intangible assets are qualitatively assessed and it is
determined it is not more likely than not that the asset’s fair value is greater than its carrying amount, an
impairment review is performed by comparing the carrying value to the estimated fair value, determined using a
discounted cash flow methodology, which requires management judgments that may significantly affect the
ending asset valuation. Factors used in the valuation of intangible assets with indefinite lives include, but are not
limited to, management’s plans for future operations, brand initiatives, recent results of operations and projected
future cash flows.

In the event the Company quantitatively assesses a reporting unit’s indefinite-lived intangible asset for

impairment, the Company performs an impairment test which utilizes the discounted cash flow methodology
under the relief-from-royalty method. Under the relief-from-royalty method, significant assumptions include the
forecasted future revenues and the estimated royalty rate, expressed as a percentage of revenues.

RH Segment Reporting Unit

During fiscal 2019, fiscal 2018 and fiscal 2017, the Company qualitatively assessed the indefinite-lived

intangible assets of the RH Segment reporting unit for impairment and determined it was more likely than not
that the fair value of the assets were greater than their carrying amounts. Based on the qualitative tests performed
in each fiscal year, the Company did not perform quantitative impairment tests in any year. The Company did not
recognize any impairment with respect to intangible assets for the RH Segment reporting unit in fiscal 2019,
fiscal 2018 and fiscal 2017.

Waterworks Reporting Unit

In connection with the goodwill impairment test performed for the Waterworks reporting unit in fiscal 2017,

described above, the Company performed an impairment test on the tradenames allocated to the reporting unit
which utilized the discounted cash flow methodology under the relief-from-royalty method. Under the relief-
from-royalty method, the Company’s significant assumptions include the forecasted future revenues and the
estimated royalty rate, expressed as a percentage of revenues. Based on the quantitative impairment test
performed, which resulted in fair value of the tradename in excess of book value by approximately 26%, the
Company concluded that the tradename allocated to the Waterworks reporting unit was not impaired as of
February 3, 2018 and did not recognize any impairment with respect to the tradename for the Waterworks
reporting unit in fiscal 2017.

At the end of each of the first three fiscal quarters of 2018, the Company determined that there were no
events or circumstances that indicated any impairment for the Waterworks reporting unit tradename. During the
fourth fiscal quarter of 2018, management updated the fiscal 2019 budget and financial projections beyond fiscal
2019 for the Waterworks reporting unit. There were certain factors that caused the key financial inputs for the

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tradename valuation model to significantly decrease from the previous inputs, the most significant of which was
a reduction of future forecasted net revenues resulting from an expected shift in product mix, challenges in
continuing to grow the showrooms business and supply chain constraints.

These factors arising during the fourth fiscal quarter of 2018 had a significant and negative impact on the
estimated future cash flows of the Waterworks reporting unit. In connection with the goodwill impairment test
performed for the Waterworks reporting unit in fiscal 2018, described above, the Company performed an
impairment test on the tradename allocated to the reporting unit which utilized the discounted cash flow
methodology under the relief-from-royalty method. Under the relief-from-royalty method, the Company’s
significant assumptions include the forecasted future revenues and the estimated royalty rate, expressed as
a percentage of revenues. Based on the quantitative impairment test performed and the result of changes in
forecasted revenues and the valuation assumption around future royalty rates, the Company concluded that the
Waterworks reporting unit tradename was impaired as of February 2, 2019. As a result, the Company recognized
a $14.6 million non-cash impairment with respect to the tradename for the Waterworks reporting unit in fiscal
2018, which was recorded in goodwill and tradename impairment on the consolidated statements of operations.

The Company performed its annual impairment procedures on the tradename allocated to the Waterworks

reporting unit which utilized the discounted cash flow methodology under the relief-from-royalty method. Under
the relief-from-royalty method, the Company’s significant assumptions include the forecasted future revenues
and the estimated royalty rate, expressed as a percentage of revenues. Based on the quantitative impairment test
performed, the Company concluded that the Waterworks reporting unit tradename was not impaired as of
February 1, 2020. The Company did not recognize any impairment for the Waterworks reporting unit tradename
in fiscal 2019, and the Waterworks tradename balance was $37.5 million as of February 1, 2020.

Long-Lived Assets

Long-lived assets, such as property and equipment and lease right-of-use assets, are reviewed for

impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Conditions that may indicate impairment include, but are not limited to, a significant adverse
change in customer demand or business climate that could affect the value of an asset, change in intended use of
an asset, a product recall or an adverse action or assessment by a regulator. If the sum of the estimated
undiscounted future cash flows over the remaining life of the primary asset is less than the carrying value, the
Company recognizes a loss equal to the difference between the carrying value and the fair value, usually
determined by the estimated discounted cash flow analysis of the asset or asset group. The asset group is defined
as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of
other groups of assets, which for the stores is the individual gallery level.

Since there is typically no active market for the Company’s long-lived assets, the Company estimates fair
values based on the expected future cash flows of the asset or asset group, using a discount rate commensurate
with the related risk. The estimate of fair value requires management judgments that may significantly affect the
ending asset valuation. Future cash flows are estimated based on gallery-level historical results, current trends,
and operating and cash flow projections. The Company’s estimates are subject to uncertainty and may be affected
by a number of factors outside its control, including general economic conditions and the competitive
environment. While the Company believes its estimates and judgments about future cash flows are reasonable,
future impairment charges may be required if the expected cash flow estimates, as projected, do not occur or if
events change requiring the Company to revise its estimates.

The Company did not record impairment for long-lived tangible assets at the individual gallery level in
fiscal 2019, fiscal 2018 or fiscal 2017. Due to certain distribution center closures and business line integrations in
fiscal 2019, fiscal 2018 and fiscal 2017, the Company recorded impairment for certain corporate assets and other
long-lived assets as discussed below under “Distribution Center Closures” and “RH Contemporary Art
Impairment,” as well as in Note 9—Leases. No additional impairment has been recorded for corporate assets and
other long-lived assets in fiscal 2019, fiscal 2018 and fiscal 2017.

120

Distribution Center Closures

During the third quarter of fiscal 2018, the Company initiated and executed a plan to close its distribution
center located in Essex, MD. As a result of the distribution center closure, the Company incurred restructuring
related costs in the RH Segment in fiscal 2018, including a lease impairment charge of $2.2 million and a loss on
disposal of capitalized property and equipment of $0.2 million, as well as costs for employee termination benefits
of $0.2 million. The impact to selling, general and administrative expenses on the consolidated statements of
operations was $2.6 million, which represents the total charges incurred with this distribution center closure. The
Company did not incur any charges in fiscal 2019 and does not expect to incur additional charges in the future
associated with this distribution center closure.

During the third quarter of fiscal 2017, the Company initiated a plan to close two of its distribution centers,

one located in Mira Loma, CA and one located in Dallas, TX. The Mira Loma distribution center closure was
finalized in November 2017 and the Dallas distribution center closure was finalized in January 2018, both of
which occurred in the fourth quarter of fiscal 2017. As a result of the distribution center closures, the Company
incurred restructuring related costs in the RH Segment in fiscal 2017, including estimated loss on disposal of
capitalized property and equipment of $4.4 million, as well as costs for employee termination benefits of
$0.9 million. The total expense of $5.3 million was included in selling, general and administrative expenses on
the consolidated statements of operations.

During the first quarter of fiscal 2018, the Company recognized a $0.8 million reversal of an estimated loss

on disposal of asset due to negotiations of the sales price being finalized. The Company did not incur any charges
in fiscal 2019 and does not expect to incur additional charges in the future associated with these distribution
center closures.

RH Contemporary Art Impairment

In fiscal 2016, the Company initiated and executed a plan to integrate the RH Contemporary Art (“RHCA”)

product line into the broader RH platform and no longer operates RHCA as a separate division. The Company
recorded additional operating lease right-of-use asset impairment associated with RHCA of $4.6 million,
$3.4 million and $4.4 million during fiscal 2019, fiscal 2018 and fiscal 2017, respectively. These impairment
charges, which are recorded in the RH Segment, resulted from an update to both the timing and the amount of
future estimated lease related cash inflows based on present market conditions, which is included in selling,
general and administrative expenses on the consolidated statements of operations.

Debt Issuance Costs

Debt issuance costs related to debt, excluding the asset based credit facility, are recorded as a contra-liability

and are presented net against the respective debt balance on the consolidated balance sheets. Debt issuance costs
are amortized utilizing the effective interest method over the expected life of the respective debt. Such
amortization is included in interest expense—net on the consolidated statements of operations.

Deferred financing fees related to the asset based credit facility are included in non-current assets on the

consolidated balance sheets. Deferred financing fees related to the asset based credit facility are amortized
utilizing the straight-line method. Such amortization is included in interest expense—net on the consolidated
statements of operations.

Revenue Recognition

The Company recognizes revenues and the related cost of goods sold when a customer obtains control of the

merchandise, which is when the customer has the ability to direct the use of and obtain the benefits from the
merchandise. Revenue recognized for merchandise delivered via the home-delivery channel is recognized upon

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delivery. Revenues recognized for merchandise delivered via all other delivery channels are recognized upon
shipment. Revenues from “cash-and-carry” store sales are recognized at the point of sale in the store. Discounts
or other accommodations provided to customers are accounted for as a reduction of sales.

The Company recognizes shipping and handling fees as activities to fulfill the promise to transfer the
merchandise to customers. The Company applies this policy consistently across all of its distribution channels. In
instances where revenue is recognized for the related merchandise upon delivery to customers, the related costs
of shipping and handling activities are accrued for in the same period. In instances where revenue is recognized
for the related merchandise prior to delivery to customers (i.e., revenue recognized upon shipment), the related
costs of shipping and handling activities are accrued for in the same period. Costs of shipping and handling are
included in cost of goods sold.

Sales tax collected is not recognized as revenue but is included in accounts payable and accrued expenses on

the consolidated balance sheets as it is ultimately remitted to governmental authorities.

The Company reserves for projected merchandise returns. Merchandise returns are often resalable

merchandise and are refunded by issuing the same payment tender of the original purchase. Merchandise
exchanges of the same product and price are not considered merchandise returns and, therefore, are excluded
when calculating the sales returns reserve.

The Company’s customers may return purchased items for a refund. The Company provides an allowance

for sales returns based on historical return rates, which is presented on a gross basis. The allowance for sales
returns is presented within other current liabilities and the estimated value of the right of return asset for
merchandise is presented within prepaid expense and other assets on the consolidated balance sheets.

A summary of the allowance for sales returns is as follows (in thousands):

Balance at beginning of fiscal year . . . . . . . . . . . . .
Impact of Topic 606 adoption . . . . . . . . . . . . . . . . .
Provision for sales returns . . . . . . . . . . . . . . . . . . . .
Actual sales returns . . . . . . . . . . . . . . . . . . . . . . . . .

February 1,
2020

$ 19,821
—

107,811
(108,426)

Year Ended

February 2,
2019

$ 10,565
5,862
112,218
(108,824)

February 3,
2018

$ 10,077
—
108,134
(107,646)

Balance at end of fiscal year

. . . . . . . . . . . . . .

$ 19,206

$ 19,821

$ 10,565

Deferred Revenue and Customer Deposits

The Company defers revenue associated with merchandise delivered via the home-delivery channel. In
instances where the Company recognizes revenue when the merchandise is delivered to customers, it is included
as deferred revenue on the consolidated balance sheets while in-transit. Deferred revenue also includes the
unrecognized portion of the annual RH Members Program fee. New membership fees are recorded as deferred
revenue when collected from customers and recognized as revenue based on expected product revenues over the
annual membership period, based on historical trends of sales to members. Membership renewal fees are
recorded as deferred revenue when collected from customers and are recognized as revenue on a straight-line
basis over the membership period, or one year.

Customer deposits represent payments made by customers on custom orders. At the time of purchase the
Company collects deposits for all custom orders equivalent to 50% of the customer purchase price. Custom order
deposits are recognized as revenue when the customer obtains control of the merchandise.

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The Company expects that substantially all of the deferred revenue, customer deposits and deferred

membership fees as of February 1, 2020 will be recognized within the next six months as the performance
obligations are satisfied.

Gift Cards and Merchandise Credits

The Company sells gift cards and issues merchandise credits to its customers in its stores and through its

websites and product catalogs. Such gift cards and merchandise credits do not have expiration dates. The
Company defers revenue when cash payments are received in advance of performance for unsatisfied obligations
related to its gift cards and merchandise credits. During fiscal 2019 and fiscal 2018, the Company recognized
$19.8 million and $21.6 million, respectively, of revenue related to previous deferrals related to its gift cards and
merchandise credits. Customer liabilities related to gift cards and merchandise credits was $16.6 million and
$17.2 million as of February 1, 2020 and February 2, 2019, respectively.

The Company recognizes breakage associated with gift cards and merchandise credits proportional to actual
gift card redemptions. Breakage of $1.6 million and $1.5 million was recorded in net revenues in fiscal 2019 and
fiscal 2018, respectively. Breakage resulted in a reduction of selling, general and administrative expenses of
$3.0 million in fiscal 2017.

The Company expects that approximately 70% of the remaining gift card and merchandise credit liabilities

will be recognized when the gift cards are redeemed by customers.

Self Insurance

The Company maintains insurance coverage for significant exposures, as well as those risks that, by law,

must be insured. In the case of the Company’s health care coverage for employees, the Company has a managed
self insurance program related to claims filed. Expenses related to this self insured program are computed on an
actuarial basis, based on claims experience, regulatory requirements, an estimate of claims incurred but not yet
reported (“IBNR”) and other relevant factors. The projections involved in this process are subject to uncertainty
related to the timing and amount of claims filed, levels of IBNR, fluctuations in health care costs and changes to
regulatory requirements. The Company had liabilities of $2.2 million and $2.0 million related to health care
coverage as of February 1, 2020 and February 2, 2019, respectively.

The Company carries workers’ compensation insurance subject to a deductible amount for which the
Company is responsible on each claim. The Company had liabilities of $4.7 and $3.3 million related to workers’
compensation claims, primarily for claims that do not meet the per-incident deductible, as of February 1, 2020
and February 2, 2019, respectively.

Stock-Based Compensation

The Company recognizes the fair value of stock-based compensation in the consolidated financial
statements as compensation expense over the requisite service period. For service-only awards, compensation
expense is recognized on a straight-line basis, net of forfeitures, over the requisite service period for the fair
value of awards that actually vest. Fair value for restricted stock units is valued using the closing price of the
Company’s stock on the date of grant. The fair value of each option award granted under the Company’s award
plan is estimated on the date of grant using a Black-Scholes Merton option pricing model (“OPM”) which
requires the input of assumptions regarding the expected term, expected volatility, dividend yield and risk-free
interest rate. The Company elected to calculate the expected term of the option awards using the “simplified
method.” This election was made based on the lack of sufficient historical exercise data to provide a reasonable
basis upon which to estimate expected term. Under the “simplified” calculation method, the expected term is
calculated as an average of the vesting period and the contractual life of the options.

123

Cost of Goods Sold

Cost of goods sold includes, but is not limited to, the direct cost of purchased merchandise, inventory
shrinkage, inventory reserves and write-downs, inbound freight, all freight costs to get merchandise to the
Company’s stores, design and buying costs, occupancy costs related to store operations and supply chain, such as
rent, property tax and common area maintenance, depreciation and amortization and all logistics costs associated
with shipping product to customers.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include all operating costs not included in cost of goods sold.

These expenses include payroll and payroll related expenses, store expenses other than occupancy, and expenses
related to many of the Company’s operations at its corporate headquarters, including utilities, depreciation and
amortization, credit card fees and marketing expense, which primarily includes catalog production, mailing and
print advertising costs. All store pre-opening costs are included in selling, general and administrative expenses
and are expensed as incurred.

Net Income (Loss) Per Share

Basic net income (loss) per share is computed as net income (loss) divided by the weighted-average number
of common shares outstanding for the period. Diluted net income per share is computed as net income divided by
the weighted-average number of common shares outstanding for the period, common share equivalents under
equity plans using the treasury-stock method and the calculated common share equivalents in excess of the
respective conversion rates related to each of the convertible senior notes. Diluted net loss per share is computed
as net loss divided by the weighted-average number of common shares outstanding for the period. Potential
dilutive securities are excluded from the computation of diluted net income (loss) per share if their effect is anti-
dilutive.

Treasury Stock

The Company records its purchases of treasury stock at cost as a separate component of stockholders’ equity

(deficit). Upon retirement of treasury stock, the Company allocates the excess of the purchase price over par
value to additional paid-in capital subject to certain limitations with any remaining purchase price allocated to
retained earnings (accumulated deficit).

Income Taxes

The Company accounts for income taxes under an asset and liability approach that requires the recognition

of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized
in the Company’s consolidated financial statements or tax returns. In estimating future tax consequences, the
Company generally takes into account all expected future events then known to it, other than changes in the tax
law or rates which have not yet been enacted and which are not permitted to be considered. Accordingly, the
Company may record a valuation allowance to reduce its net deferred tax assets to the amount that is more-
likely-than-not to be realized. The determination as to whether a deferred tax asset will be realized is made on a
jurisdictional basis and is based upon management’s best estimate of the recoverability of the Company’s net
deferred tax assets. Future taxable income and ongoing prudent and feasible tax planning are considered in
determining the amount of the valuation allowance, and the amount of the allowance is subject to adjustment in
the future. Specifically, in the event the Company were to determine that it is not more-likely-than-not able to
realize its net deferred tax assets in the future, an adjustment to the valuation allowance would decrease income
in the period such determination is made. This allowance does not alter the Company’s ability to utilize the
underlying tax net operating loss and credit carryforwards in the future, the utilization of which is limited to
achieving future taxable income.

124

The accounting standard for uncertainty in income taxes prescribes a recognition threshold that a tax
position is required to meet before being recognized in the financial statements and provides guidance on
derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and
transition issues. Differences between tax positions taken in a tax return and amounts recognized in the financial
statements generally result in an increase in liability for income taxes payable or a reduction of an income tax
refund receivable, or a reduction in a deferred tax asset or an increase in a deferred tax liability, or both. The
Company recognizes interest and penalties related to unrecognized tax benefits in tax expense.

Comprehensive Income

Comprehensive income is comprised of net income and other gains and losses affecting equity that are
excluded from net income. The components of other comprehensive income consist of net gains (losses) on
foreign currency translation and net unrealized holding gains (losses) on available-for-sale investments, both of
which are presented net of tax.

Foreign Currency Translation

Local currencies are generally considered the functional currencies outside the United States. Assets and

liabilities denominated in non-U.S. currencies are translated at the rate of exchange prevailing on the date of the
consolidated balance sheets and revenues and expenses are translated at average rates of exchange for the period.
The related translation gains (losses) are reflected in the accumulated other comprehensive income section on the
consolidated statements of stockholders’ equity (deficit). Foreign currency gains (losses) resulting from foreign
currency transactions are included in selling, general and administrative expenses on the consolidated statements
of operations and are not material for all periods presented.

Recently Issued Accounting Standards

Revenue from Contracts with Customers

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

Adoption and Accounting Policy

The Company adopted Topic 606, on February 4, 2018, using the modified retrospective transition method

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

125

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

Policy under Topic 605

Policy under Topic 606

for the following:

Description

Advertising
expenses

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

Gift card breakage Recognized gift card breakage (amounts not

Membership
revenue

expected to be redeemed) within selling,
general and administrative expenses.

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

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

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

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

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

Revenue
recognition

Allowance for
sales returns

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

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

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

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

126

Adoption Impact on Fiscal 2019 and Fiscal 2018 Results

The following tables summarize the impact of adopting Topic 606 on the Company’s consolidated statement

of income (in thousands):

Year Ended

February 1, 2020

February 2, 2019

As
Reported

Adjustments

Balances
without
Adoption of
Topic 606

As Adjusted
and Revised (1) Adjustments

Balances
without
Adoption of
Topic 606

Net revenues . . . . . . . . . . . . . . . $2,647,437
1,552,426
Cost of goods sold . . . . . . . . . . .

$ (2,030) $2,645,407
1,553,287

861

$2,505,653
1,520,076

$(9,868)
(3,485)

$2,495,785
1,516,591

Gross profit . . . . . . . . . . . .

1,095,011

(2,891)

1,092,120

985,577

(6,383)

979,194

Selling, general and

administrative expenses . . . . .

732,180

(10,742)

Income from operations . .

362,831

7,851

721,438

370,682

723,841

261,736

(2,616)

(3,767)

Other expenses

Interest expense—net
Goodwill and tradename

. . . .

impairment

. . . . . . . . . .
Loss on extinguishment of
. . . . . . . . . . . . . . . .

debt

Total other expenses . . . . . . . . .

Income before income

87,177

—

6,472

93,649

—

—

—

—

87,177

67,769

—

32,086

6,472

93,649

917

100,772

—

—

—

—

721,225

257,969

67,769

32,086

917

100,772

taxes . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . .

269,182
48,807

7,851
1,336

277,033
50,143

160,964
25,233

(3,767)
(3,945)

157,197
21,288

Net income . . . . . . . . . . . . $ 220,375

$ 6,515

$ 226,890

$ 135,731

$

178

$ 135,909

(1) Reflects the modified retrospective application of the new lease accounting standard (Accounting Standards

Update 2016-02—Leases). Refer to “Leases” below.

The following table summarizes the impact of adopting Topic 606 on certain line items of the Company’s

consolidated balance sheet (in thousands):

As of February 1, 2020

As of February 2, 2019

As
Reported

Adjustments

Balances
without
Adoption of
Topic 606

As
Adjusted
and
Revised (1)

Balances
without
Adoption of
Topic 606

Adjustments

$ 61,619
45,005

$ 30,980
(6,561)

$ 92,599
38,444

$ 104,198
35,603

$33,587
(6,561)

$ 137,785
29,042

Prepaid expense and other current

assets . . . . . . . . . . . . . . . . . . . . . .
Deferred tax assets . . . . . . . . . . . . .
Accounts payable and accrued

expenses . . . . . . . . . . . . . . . . . . .

330,309

(570)

329,739

320,497

(686)

319,811

Deferred revenue and customer

deposits . . . . . . . . . . . . . . . . . . . .
Other current liabilities . . . . . . . . . .
. . . . . . . . . . . .
Accumulated deficit

162,433
140,714
(409,253)

7,894
(10,634)
27,729

170,327
130,080
(381,524)

152,595
109,456
(392,537)

9,304
(2,806)
21,214

161,899
106,650
(371,323)

(1) Reflects the modified retrospective application of the new lease accounting standard (Accounting Standards

Update 2016-02—Leases). Refer to “Leases” below.

127

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards
Update 2016-02—Leases, which requires a lessee to distinguish all leases as operating leases or finance leases
and recognize all leases on the balance sheet as a right-of-use asset with a corresponding lease liability
representing the present value of lease payments. The standard also requires a lessee to recognize a single lease
cost for operating leases, calculated so that the cost of the lease is allocated over the lease term, generally on a
straight-line basis. The lease cost for finance leases includes both principal and interest components, and is
higher than the corresponding cash payment at the beginning of the lease term and declines over the lease term as
the liability is reduced. In July 2018, the FASB issued Accounting Standards Update 2018-10—Codification
Improvements to Topic 842 (Leases), and Accounting Standards Update 2018-11—Leases (Topic 842)—Targeted
Improvements, which (i) narrows amendments to clarify how to apply certain aspects of the new lease standard,
(ii) provides entities with an additional transition method to adopt the new standard, and (iii) provides lessors
with a practical expedient for separating components of a contract. In March 2019, the FASB also Accounting
Standards Update 2019-01—Leases (Topic 842)—Codification Improvements. These Accounting Standards
Updates are collectively referred to as the “ASUs.”

The Company adopted the ASUs as of February 3, 2019 using a modified retrospective approach. Under this

adoption method, the results of prior comparative periods are presented with an adjustment to opening retained
earnings of the earliest comparative period presented. In addition, the Company elected to adopt the package of
transition practical expedients, which permitted the Company not to reassess its prior conclusions regarding lease
identification, lease classification and initial direct costs. The Company adopted the policy election to not
separate lease and non-lease components for certain asset classes (such as real estate leases), as well as the short-
term lease policy election offered under the ASUs whereby the Company does not recognize right of use assets
and lease liabilities for leases with terms of 12 months or less. The Company did not apply the hindsight practical
expedient upon adoption.

As a result of the adoption of the ASUs, the Company recorded an increase to the fiscal 2017 (earliest

comparative period) opening retained earnings balance of $4.0 million, inclusive of the tax impact.

128

The following table presents the impact of adopting the ASUs, as well as the correction of an immaterial

error as discussed in “Revision” above, on the Company’s consolidated balance sheet (in thousands):

February 2, 2019

As Reported

Adjustments
and Other (1)

As Adjusted
and Revised

ASSETS
Current assets:

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable—net
Merchandise inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset held for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expense and other current assets . . . . . . . . . . . . . . . . . . .

$

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property and equipment—net . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating lease right-of-use assets . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tradenames, trademarks and domain names . . . . . . . . . . . . . . . .
Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other non-current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5,803
40,224
531,947
—
104,719

682,693
863,562
—
124,379
86,022
30,033
19,345

$

$

—
—
—
21,795(2)
(521)(3)

21,274
89,395(4)
440,504(5)
—
—
5,570(6)
60,241(7)

5,803
40,224
531,947
21,795
104,198

703,967
952,957
440,504
124,379
86,022
35,603
79,586

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,806,034

$ 616,984

$2,423,018

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:

Accounts payable and accrued expenses . . . . . . . . . . . . . . . . . . .
Deferred revenue and customer deposits . . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2019—net
. . . . . . . . . . . . . . . . . . .
Operating lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 320,441
152,595
343,789
—
101,347

$

56(8)
—
—
66,249(5)
8,109(1)(9)

$ 320,497
152,595
343,789
66,249
109,456

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset based credit facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . .
Convertible senior notes due 2020—net
Convertible senior notes due 2023—net
. . . . . . . . . . . . . . . . . . .
Financing obligations under build-to-suit lease transactions . . . .
Deferred rent and lease incentives . . . . . . . . . . . . . . . . . . . . . . . .
Non-current operating lease liabilities . . . . . . . . . . . . . . . . . . . . .
Non-current finance lease liabilities . . . . . . . . . . . . . . . . . . . . . . .
Other non-current obligations . . . . . . . . . . . . . . . . . . . . . . . . . . .

918,172
57,500
271,157
249,151
228,928
53,742
—
—
50,346

74,414
—
—
—
(228,928)(10)
(53,742)(10)
437,557(5)
421,245(9)
(17,834)(1)(11)

992,586
57,500
271,157
249,151
—
—
437,557
421,245
32,512

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1,828,996

632,712

2,461,708

Stockholders’ deficit:

Preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . .
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

—

2
356,422
(2,333)
(376,810)
(243)

—
—
—

(1)
(15,727)(1)(12)

—

Total stockholders’ deficit . . . . . . . . . . . . . . . . . . . . . . . . . .

(22,962)

(15,728)

—

2
356,422
(2,334)
(392,537)
(243)

(38,690)

Total liabilities and stockholders’ deficit . . . . . . . . . . . . . . .

$1,806,034

$ 616,984

$2,423,018

129

(1) During the adoption process of the ASUs, the Company identified a lease agreement that was incorrectly
accounted for as an impaired lease under ASC 420—Exit or Disposal Cost Obligations in fiscal 2017 and
the first quarter of fiscal 2018. Refer to “Revision” above.

(2) Represents recognition of asset held for sale under a sale-leaseback transaction.
(3) Represents reclassification of prepaid rent to operating lease liabilities and other current liabilities (for

finance leases).

(4) Represents (i) recognition of finance lease right-of-use assets, partially offset by (ii) derecognition of

non-Company owned properties that were capitalized under previously existing build-to-suit accounting
policies, (iii) reclassification of construction in progress assets determined to be landlord assets to other
non-current assets and (iv) reclassification of initial direct costs related to operating leases to operating lease
right-of-use assets.

(5) Represents recognition of operating lease right-of-use assets and corresponding current and non-current

lease liabilities. The operating lease right-of-use asset also includes the reclassification of deferred rent and
unamortized lease incentives related to operating leases and the reclassification of initial direct costs from
property and equipment—net.

(6) Represents recognition of net deferred tax assets related to the adoption of the ASUs.
(7) Primarily represents reclassification from property and equipment—net of construction in progress assets

determined to be landlord assets for which the lease has not yet commenced.

(8) Represents a reclassification of an accrual for real estate taxes.
(9) Represents recognition of the current and non-current finance lease liabilities. The other current liabilities
line item also includes the reclassification of current obligations associated with leases previously reported
as capital leases to finance lease liabilities.

(10) Represents (i) derecognition of liabilities related to non-Company owned properties that were consolidated
under previously existing build-to-suit accounting policies and (ii) reclassification of deferred rent and
unamortized lease incentives to operating lease right-of-use assets upon adoption of the ASUs.

(11) Represents (i) derecognition of the net lease loss liabilities as such balances were reclassified to operating
lease right-of-use assets and operating current and non-current liabilities and (ii) the reclassification of
non-current obligations associated with leases previously reported as capital leases to finance lease
liabilities.

(12) Represents a decrease to the consolidated net income for fiscal 2017 and fiscal 2018, as well as an increase

of $4.0 million to beginning fiscal 2017 retained earnings related to the adoption of the ASUs.

Cloud Computing

In August 2018, the FASB issued Accounting Standards Update 2018-15—Intangibles—Goodwill and
Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in
a Cloud Computing Arrangement that is a Service Contract, which amends Accounting Standards Update
2015-05—Customers Accounting for Fees in a Cloud Computing Agreement. The amendments in this ASU more
closely align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a
service contract with the requirements for capitalizing implementation costs incurred to develop or obtain
internal-use software (and hosting arrangements that include an internal use software license). The ASU is
effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.
Early adoption is permitted.

The Company will adopt the new accounting standard in the first quarter of fiscal 2020 using the
prospective method. The related assets will be recorded within other non-current assets on the Company’s
consolidated balance sheets, and the amortization of assets placed in service will be recorded in cost of goods
sold or selling, general and administrative expenses on the consolidated statements of operations on a straight-
line basis over the term of the hosting arrangement, which includes reasonably certain renewal periods. The
Company is in process of finalizing the adoption of the new accounting standard which is not expected to
materially impact the Company’s financial position or results of operations.

130

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. The ASU amends 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 this ASU applies to financial assets measured at amortized cost
basis, such as receivables that result from revenue transactions. The ASU is effective for fiscal years beginning
after December 15, 2019, including interim periods within those fiscal years. The Company is in process of
assessing the impact of the new accounting standard.

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. The Company is currently evaluating the effects
that the adoption of this new accounting standard will have on its consolidated financial statements.

NOTE 4—PREPAID EXPENSE AND OTHER ASSETS

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

February 1,
2020

February 2,
2019

Prepaid expense and other current assets . . . . . . . . . . . .
Capitalized catalog costs . . . . . . . . . . . . . . . . . . . . . . . . .
Vendor deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Right of return asset for merchandise . . . . . . . . . . . . . . .
Federal and state tax receivable . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . .
Insurance recovery receivable (1)

$30,678
13,740
11,258
5,746
197
—

$ 15,439
16,178
11,836
5,883
4,862
50,000

Total prepaid expense and other current assets . . .

$61,619

$104,198

(1) Refer to Note 18—Commitments and Contingencies.

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

February 1,
2020

February 2,
2019

Landlord assets under construction . . . . . . . . . . . . . . . . .
Deposits on asset under construction . . . . . . . . . . . . . . .
Promissory note receivable, including interest . . . . . . . .
Other deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred financing fees . . . . . . . . . . . . . . . . . . . . . . . . . .
Other non-current assets . . . . . . . . . . . . . . . . . . . . . . . . .

$138,315
60,000
5,354
5,157
2,602
3,417

$63,159

—
5,104
5,068
3,415
2,840

Total other non-current assets . . . . . . . . . . . . . . . . .

$214,845

$79,586

131

NOTE 5—PROPERTY AND EQUIPMENT

Property and equipment consists of the following (in thousands):

. . . . . . . . . . . . . . . .
Finance lease right-of-use assets (1)
Leasehold improvements (2)
. . . . . . . . . . . . . . . . . . . . . .
Computer software . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . .
Furniture, fixtures and equipment
Machinery, equipment and aircraft
. . . . . . . . . . . . . . . .
Building and building improvements . . . . . . . . . . . . . . .
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Built-to-suit property . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total property and equipment

Less—accumulated depreciation and amortization (3)

. . . . . . . . . . . . . . . .
. .

February 1,
2020

February 2,
2019

$ 734,425 $ 702,379
311,416
143,776
76,194
54,207
2,750
7,110
—

318,313
138,328
79,575
66,228
33,370
6,061
2,882

1,379,182
(411,583)

1,297,832
(344,875)

Total property and equipment—net . . . . . . . . . . . .

$ 967,599 $ 952,957

(1) Refer to “Lease Accounting” within Note 3—Significant Accounting Policies and Note 9—Leases.
(2) Leasehold improvements include construction in progress of $16.0 million and $14.7 million as of

(3)

February 1, 2020 and February 2, 2019, respectively.
Includes accumulated amortization related to finance lease right-of-use assets of $92.3 million and
$55.5 million as of February 1, 2020 and February 2, 2019, respectively. Refer to Note 9—Leases.

The Company recorded depreciation and amortization of property and equipment, excluding amortization

for finance lease right-of-use assets, of $63.7 million, $62.6 million and $63.7 million in fiscal 2019, fiscal 2018
and fiscal 2017, respectively.

NOTE 6—GOODWILL, TRADENAMES, TRADEMARKS AND DOMAIN NAMES

The following sets forth the fiscal 2019 goodwill, tradenames, trademarks and domain names activity for the

RH Segment and Waterworks (in thousands):

February 2,
2019

Foreign
Currency
Translation

February 1,
2020

RH Segment

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tradenames, trademarks and domain names . .

$124,379
48,563

$ (12)
—

$124,367
48,563

Waterworks

Tradename (1) . . . . . . . . . . . . . . . . . . . . . . . . . . .

37,459

—

37,459

(1) Presented net of an impairment charge of $14.6 million recorded in fiscal 2018.

132

The following sets forth the fiscal 2018 goodwill, tradenames, trademarks and domain names activity for the

RH Segment and Waterworks (in thousands):

February 3,
2018

Impairment (1)

Foreign
Currency
Translation

February 2,
2019

RH Segment

Goodwill
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tradenames, trademarks and domain names . . . . . . . . . .

$124,448
48,563

$ —
—

$ (69)
—

$124,379
48,563

Waterworks

Goodwill (2)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tradename (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

17,445
52,100

(17,445)
(14,641)

—
—

—
37,459

(1) Refer to “Impairment” within Note 3—Significant Accounting Policies.
(2) Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was fully
impaired as of February 2, 2019, with $17.4 million and $33.7 million impairment recorded in fiscal 2018
and fiscal 2017, respectively.

(3) Presented net of an impairment charge of $14.6 million recorded in fiscal 2018.

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

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

February 1,
2020

February 2,
2019

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued compensation . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued freight and duty . . . . . . . . . . . . . . . . . . . . . . . .
Accrued sales taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued catalog costs . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued professional fees . . . . . . . . . . . . . . . . . . . . . . . .
Other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . .

$180,714
64,659
25,170
19,618
12,067
8,267
4,381
15,433

$183,039
64,192
20,787
18,354
10,839
10,276
2,050
10,960

Total accounts payable and accrued expenses . . . .

$330,309

$320,497

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

Promissory notes on asset under construction . . . . . . . .
Current portion of debt . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for sales returns . . . . . . . . . . . . . . . . . . . . . . .
Unredeemed gift card and merchandise credit

liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal and state taxes payable . . . . . . . . . . . . . . . . . . . .
Finance lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . .
Product recall reserve . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for legal settlement (1) . . . . . . . . . . . . . . . . . . .

February 1,
2020

February 2,
2019

$ 53,000
22,009
19,206

$ —
892
19,821

16,625
13,591
9,188
2,055
5,040
—

17,192
719
9,184
7,767
3,881
50,000

Total other current liabilities . . . . . . . . . . . . . . . . . .

$140,714

$109,456

(1) Refer to Note 18—Commitments and Contingencies.

133

NOTE 8—OTHER NON-CURRENT OBLIGATIONS

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

February 1,
2020

February 2,
2019

Notes payable for share repurchases . . . . . . . . . . . . . . . .
Rollover units and profit interests (1) . . . . . . . . . . . . . . . .
Unrecognized tax benefits . . . . . . . . . . . . . . . . . . . . . . .
Deferred contract incentive (2) . . . . . . . . . . . . . . . . . . . . .
Other non-current obligations . . . . . . . . . . . . . . . . . . . . .

$18,741
3,064
3,020
595
3,100

Total other non-current obligations . . . . . . . . . . . .

$28,520

$18,741
2,637
2,992
2,976
5,166

$32,512

(1) Represents rollover units and profit interests associated with the acquisition of Waterworks. Refer to Note

16—Stock-Based Compensation.

(2) Represents the non-current portion of an incentive payment received in relation to a 5-year service

agreement, which will be amortized over the term of the agreement.

NOTE 9—LEASES

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

Operating lease cost (1)(2) . . . . . . . . . . . . . . . . . . . . . .
Finance lease costs

Amortization of leased assets (1)
. . . . . . . . . . . .
Interest on lease liabilities (3) . . . . . . . . . . . . . . .
Variable lease costs (4) . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
Sublease income (5)

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

$ 86,448

$ 87,742

$ 95,499

36,991
22,608
23,471
(9,609)

28,848
16,785
21,889
(7,794)

19,542
11,154
23,280
(1,003)

Total lease costs—net . . . . . . . . . . . . . . . . . . . .

$159,909

$147,470

$148,472

(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 consolidated statements of operations based on the
Company’s policy. Refer to Note 3—Significant Accounting Policies.
Includes short-term operating lease costs which are not material.
Included in interest expense—net on the consolidated statements of operations.

(2)
(3)
(4) 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 $14.6 million, $13.0 million
and $13.8 million and charges associated with common area maintenance of $8.9 million, $8.9 million, and
$9.5 million in fiscal 2019, fiscal 2018, and fiscal 2017, 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 in fiscal 2019, fiscal 2018,
and fiscal 2017.
Included in selling, general and administrative expenses on the consolidated statements of operations.

(5)

134

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

Assets
Operating leases . . . . . . . . . . . . . . . . . . . . . . . Operating lease right-of-use assets
Finance leases (1)(2)

. . . . . . . . . . . . . . . . . . . . . Property and equipment—net

Balance Sheet Classification

Total lease right-of-use assets . . . . . . . .

Liabilities
Current (3)
Operating leases . . . . . . . . . . . . . . . . . . . . . . . Operating lease liabilities
Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . Other current liabilities

Total lease liabilities—current . . . . . . . .

Non-current
Operating leases . . . . . . . . . . . . . . . . . . . . . . . Non-current operating lease liabilities
Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . Non-current finance lease liabilities

Total lease liabilities—non-current

. . . .

Total lease liabilities . . . . . . . . . . . . . . . .

February 1,
2020

February 2,
2019

$ 410,904
642,117

$ 440,504
646,875

$1,053,021

$1,087,379

$

$

58,924
9,188

68,112

66,249
9,184

75,433

409,930
442,988

852,918

437,557
421,245

858,802

$ 921,030

$ 934,235

(1) Finance lease right-of-use assets include capitalized amounts related to the Company’s 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 $92.3 million and

$55.5 million as of February 1, 2020 and February 2, 2019, 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 February 1, 2020 (in thousands):

Fiscal year

2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Operating
Leases

$ 75,634
69,343
60,711
56,266
52,424
246,482

Finance
Leases

$ 32,138
35,323
35,747
36,170
36,660
568,856

Total

$ 107,772
104,666
96,458
92,436
89,084
815,338

Total lease payments (1)

. . . . . . . . . . . . . . . . . . . . . .

560,860

744,894

1,305,754

Less—imputed interest (2) . . . . . . . . . . . . . . . . . . . . .

(92,006)

(292,718)

(384,724)

Present value of lease liabilities (3) . . . . . . . . . . . . . .

$468,854

$ 452,176

$ 921,030

(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
$360.9 million of legally binding payments under the noncancellable term for leases signed but not yet
commenced as of February 1, 2020.

(2) Calculated using the incremental borrowing rate for each lease at lease commencement.
(3) Excludes future commitments under short-term lease agreements of $0.9 million as of February 1, 2020.

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Supplemental information related to leases consists of the following:

Weighted-average remaining lease term (years)

Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . .
Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Weighted-average discount rate

Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . .
Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

February 1,
2020

February 2,
2019

8.9
18.6

3.82%
5.25%

9.2
19.6

3.78%
5.28%

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

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

Cash paid for amounts included in the measurement of lease liabilities

Operating cash flows from operating leases . . . . . . . . . . . . . . . . . . . . .
Operating cash flows from finance leases . . . . . . . . . . . . . . . . . . . . . . .
Financing cash flows from finance leases . . . . . . . . . . . . . . . . . . . . . . .

$ (95,329) $ (91,965) $ (95,279)
(11,154)
(16,785)
(6,105)
(6,885)

(25,260)
(9,682)

Total cash outflows from leases . . . . . . . . . . . . . . . . . . . . . . . . . . .

$(130,271) $(115,635) $(112,538)

Lease right-of-use assets obtained in exchange for lease obligations—net

of lease terminations (non-cash)

Finance leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 34,063
42,122

$ 174,977
33,790

$ 26,770
33,710

Asset Held for Sale and Sale-Leaseback Transaction

During the fourth quarter of fiscal 2018, the Company committed to a plan to sell the Yountville Design
Gallery, which resulted in a reclassification of such Gallery from property and equipment—net to assets held for
sale on the consolidated balance sheets as of February 2, 2019. The Company performed an assessment and
determined that based on management’s best estimate of the fair value of such Gallery as of February 2, 2019, it
had an impairment of $8.5 million in fiscal 2018 in the RH Segment. In October 2019, the Company executed a
sale-leaseback transaction for the Yountville Design Gallery for sales proceeds of $23.5 million, which qualified
for sale-leaseback accounting in accordance with ASC 842. Concurrently with the sale, the Company entered into
an operating leaseback arrangement with an initial lease term of 15 years and renewal options for up to an
additional 30 years. The Company recognized a gain related to the execution of the sale transaction of
$1.2 million in fiscal 2019, which was recorded in selling, general and administrative expenses on the
consolidated statements of operations.

NOTE 10—CONVERTIBLE SENIOR NOTES

$350 million 0.00% Convertible Senior Notes due 2024

In September 2019, the Company 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 the Company 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 the failure of the Company to perform certain of its 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 the

136

Company or any of its 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, the Company 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 the Company’s common stock on such trading day is
greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five
consecutive business day period after any ten consecutive trading day period in which, for each day of that
period, the trading price per $1,000 principal amount of 2024 Notes for such trading day was less than 98% of
the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on
such trading day; or (3) upon the occurrence of specified corporate transactions. As of February 1, 2020, none of
these conditions have occurred and, as a result, the 2024 Notes were not convertible as of February 1, 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 the Company’s election, in cash,
shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock.
If the Company has not delivered a notice of its election of settlement method prior to the final conversion period
it will be deemed to have elected combination settlement with a dollar amount per note to be received upon
conversion of $1,000.

The Company may not redeem the 2024 Notes; however, upon the occurrence of a fundamental change (as

defined in the indenture governing the 2024 Notes), holders may require the Company 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, the
Company 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%

137

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, the Company allocated the total amount incurred to the liability and equity
components based on their relative values. Debt issuance costs attributable to the liability component are
amortized to interest expense using the effective interest method over the expected life of the 2024 Notes, and
debt issuance costs attributable to the equity component are netted with the equity component in stockholders’
equity (deficit).

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 consolidated balance
sheets. During fiscal 2019 the Company 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):

Liability component
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal
Less: Debt discount . . . . . . . . . . . . . . . . . . . . . . . . . . . .

February 1,
2020

$350,000
(81,634)

Net carrying amount . . . . . . . . . . . . . . . . . . . . . . .

$268,366

Equity component (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 87,252

(1)

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

The Company recorded interest expense of $5.6 million for the amortization of the debt discount related to

the 2024 Notes during fiscal 2019.

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, the Company entered into convertible note hedge transactions whereby the Company has the option to
purchase a total of approximately 1.656 million shares of its 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,
the Company sold warrants whereby the holders of the warrants have the option to purchase a total of
approximately 1.656 million shares of the Company’s 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). The Company 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 the Company’s 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 consolidated balance sheets.

The Company 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

138

convertible note hedge transactions. The deferred tax liability and deferred tax asset are recorded in deferred tax
assets on the consolidated balance sheets.

$335 million 0.00% Convertible Senior Notes due 2023

In June 2018, the Company issued in a private offering $300 million principal amount of 0.00% convertible

senior notes due 2023 and issued an additional $35 million principal amount in connection with the
overallotment option granted to the initial purchasers as part of the offering (collectively, the “2023 Notes”). The
2023 Notes are governed by the terms of an indenture between the Company and U.S. Bank National
Association, as the Trustee. The 2023 Notes will mature on June 15, 2023, unless earlier purchased by the
Company or converted. The 2023 Notes will not bear interest, except that the 2023 Notes will be subject to
“special interest” in certain limited circumstances in the event of the failure of the Company to perform certain of
its obligations under the indenture governing the 2023 Notes. The 2023 Notes are unsecured obligations and do
not contain any financial covenants or restrictions on the payments of dividends, the incurrence of indebtedness
or the issuance or repurchase of securities by the Company or any of its subsidiaries. Certain events are also
considered “events of default” under the 2023 Notes, which may result in the acceleration of the maturity of the
2023 Notes, as described in the indenture governing the 2023 Notes. 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, the Company will, in certain
circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its
2023 Notes in connection with such make-whole fundamental change.

Prior to March 15, 2023, the 2023 Notes 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 the Company’s common stock on such trading day is
greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five
consecutive business day period after any ten consecutive trading day period in which, for each day of that
period, the trading price per $1,000 principal amount of 2023 Notes for such trading day was less than 98% of
the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on
such trading day; or (3) upon the occurrence of specified corporate transactions. As of February 1, 2020, none of
these conditions have occurred and, as a result, the 2023 Notes were not convertible as of February 1, 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 the Company’s election, in cash,
shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock.
If the Company has not delivered a notice of its election of settlement method prior to the final conversion period
it will be deemed to have elected combination settlement with a dollar amount per note to be received upon
conversion of $1,000.

The Company may not redeem the 2023 Notes; however, upon the occurrence of a fundamental change (as

defined in the indenture governing the 2023 Notes), holders may require the Company to purchase all or a

139

portion of their 2023 Notes for cash at a price equal to 100% of the principal amount of the 2023 Notes to be
purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to

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

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

Discounts and third party offering costs attributable to the liability component are recorded as a contra-
liability and are presented net against the convertible senior notes due 2023 balance on the consolidated balance
sheets. The Company recorded $0.9 million and $0.5 million related to the amortization of debt issuance costs in
fiscal 2019 and fiscal 2018, respectively, related to the 2023 Notes.

The carrying values of the 2023 Notes, excluding the discounts upon original issuance and third party

offering costs, are as follows (in thousands):

February 1,
2020

February 2,
2019

Liability component
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal
Less: Debt discount . . . . . . . . . . . . . . . . . . . . . . . . .

$ 335,000
(64,729)

$ 335,000
(81,311)

Net carrying amount . . . . . . . . . . . . . . . . . . . .

$ 270,271

$ 253,689

Equity component (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 90,990

$ 90,990

(1)

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

The Company recorded interest expense of $16.5 million and $9.7 million for the amortization of the debt

discount related to the 2023 Notes during fiscal 2019 and fiscal 2018, respectively.

2023 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2023 Notes and exercise of the overallotment option in June 2018, the

Company entered into convertible note hedge transactions whereby the Company has the option to purchase a
total of approximately 1.730 million shares of its common stock at a price of approximately $193.65 per share.
The total cost of the convertible note hedge transactions was approximately $91.9 million. In addition, the
Company sold warrants whereby the holders of the warrants have the option to purchase a total of approximately
1.730 million shares of the Company’s common stock at a price of $309.84 per share. The warrants contain

140

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). The Company 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 the Company’s common stock is
above approximately $309.84 per share. As these transactions meet certain accounting criteria, the convertible
note hedges and warrants are recorded in stockholders’ equity (deficit), are not accounted for as derivatives and
are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge
and warrant transactions were recorded as a reduction to additional paid-in capital on the consolidated balance
sheets.

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

$300 million 0.00% Convertible Senior Notes due 2020

In June 2015, the Company issued in a private offering $250 million principal amount of 0.00% convertible

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

The initial conversion rate applicable to the 2020 Notes is 8.4656 shares of common stock per $1,000
principal amount of 2020 Notes, which is equivalent to an initial conversion price of approximately $118.13 per
share. To the extent the stock price is less than $118.13 per share, the Company is 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, the Company may settle the par value at the Company’s election, in cash, shares
of the Company’s common stock, or a combination of cash and shares of the Company’s common stock. 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, the Company will, in certain
circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert its
2020 Notes in connection with such make-whole fundamental change.

141

Prior to March 15, 2020, the 2020 Notes are 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 the Company’s common stock on such trading day is
greater than or equal to 130% of the applicable conversion price on such trading day; (2) during the five
consecutive business day period after any ten consecutive trading day period in which, for each day of that
period, the trading price per $1,000 principal amount of 2020 Notes for such trading day was less than 98% of
the product of the last reported sale price of the Company’s common stock and the applicable conversion rate on
such trading day; or (3) upon the occurrence of specified corporate transactions. The first condition was satisfied
during the calendar quarter ended December 31, 2019 and, accordingly, holders may convert their 2020
Notes during the calendar quarter ending March 31, 2020. Regardless of the foregoing circumstances, 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 the Company’s election, in cash, shares of the Company’s common stock, or a
combination of cash and shares of the Company’s common stock to the extent the Company’s 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.

The Company may not redeem the 2020 Notes; however, upon the occurrence of a fundamental change (as

defined in the indenture governing the 2020 Notes), holders may require the Company to purchase all or a
portion of their 2020 Notes for cash at a price equal to 100% of the principal amount of the 2020 Notes to be
purchased plus any accrued and unpaid special interest to, but excluding, the fundamental change purchase date.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to

be separately accounted for as liability and equity components of the instrument in a manner that reflects the
issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2020 Notes, the
Company separated the 2020 Notes into liability and equity components. The carrying amount of the liability
component was calculated by measuring the fair value of a similar liability that does not have an associated
convertible feature. The carrying amount of the equity component, which is recognized as a debt discount,
represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the
liability component of the 2020 Notes. The 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, the Company allocated the total amount incurred to the liability and equity
components based on their relative values. Debt issuance costs attributable to the liability component are
amortized to interest expense using the effective interest method over the expected life of the 2020 Notes, and
debt issuance costs attributable to the equity component are netted with the equity component in stockholders’
equity (deficit).

Discounts and third party offering costs attributable to the liability component are recorded as a contra-
liability and are presented net against the convertible senior notes due 2020 balance on the consolidated balance
sheets. The Company recorded $1.2 million, $1.1 million and $1.0 million related to the amortization of debt
issuance costs in fiscal 2019, fiscal 2018 and fiscal 2017, respectively, related to the 2020 Notes.

The carrying values of the 2020 Notes, excluding the discounts upon original issuance and third party

offering costs, are as follows (in thousands):

142

February 1,
2020

February 2,
2019

Liability component
Principal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Debt discount . . . . . . . . . . . . . . . . . . . . . . . . .

$ 300,000
(8,890)

$ 300,000
(27,081)

Net carrying amount . . . . . . . . . . . . . . . . . . . .

$ 291,110

$ 272,919

Equity component (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 84,003

$ 84,003

(1)

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

The Company recorded interest expense of $18.2 million, $17.1 million and $16.0 million for the
amortization of the debt discount related to the 2020 Notes during fiscal 2019, fiscal 2018 and fiscal 2017,
respectively.

2020 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment
option in July 2015, the Company entered into convertible note hedge transactions whereby the Company has the
option to purchase a total of approximately 2.540 million shares of its common stock at a price of approximately
$118.13 per share. The total cost of the convertible note hedge transactions was approximately $68.3 million. In
addition, the Company sold warrants whereby the holders of the warrants have the option to purchase a total of
approximately 2.540 million shares of the Company’s common stock at a price of $189.00 per share. The
warrants contain certain adjustment mechanisms whereby the total number of shares to be purchased under such
warrants may be increased up to a cap of approximately 5.1 million shares of common stock (which cap may also
be subject to adjustment). The Company 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 the Company’s common stock
is above approximately $189.00 per share. As these transactions meet certain accounting criteria, the convertible
note hedges and warrants are recorded in stockholders’ equity (deficit), are not accounted for as derivatives and
are not remeasured each reporting period. The net costs incurred in connection with the convertible note hedge
and warrant transactions were recorded as a reduction to additional paid-in capital on the consolidated balance
sheets.

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

The provision for income taxes in fiscal 2017 included $1.1 million of income tax benefit as a result of the
Tax Act for the provisional re-measurement of the deferred tax asset and liability related to the 2020 Notes for
the reduction in the U.S. corporate income tax rate from 35% to 21%.

$350 million 0.00% Convertible Senior Notes due 2019

In June 2014, the Company issued $350 million principal amount of 0.00% convertible senior notes due

2019 (the “2019 Notes”) in a private offering. The 2019 Notes were governed by the terms of an indenture
between the Company and U.S. Bank National Association, as the Trustee. The 2019 Notes did not bear interest,
except that the 2019 Notes were subject to “special interest” in certain limited circumstances in the event of the
failure of the Company to perform certain of its obligations under the indenture governing the 2019 Notes. The
2019 Notes were unsecured obligations and did not contain any financial covenants or restrictions on the
payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by the
Company or any of its subsidiaries. Certain events were also considered “events of default” under the 2019

143

Notes, which could result in the acceleration of the maturity of the 2019 Notes, as described in the indenture
governing the 2019 Notes. The 2019 Notes matured on June 15, 2019.

The initial conversion rate applicable to the 2019 Notes was 8.6143 shares of common stock per $1,000

principal amount of 2019 Notes, which was equivalent to an initial conversion price of approximately $116.09
per share. The conversion rate was subject to adjustment upon the occurrence of certain specified events, but was
not 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 2019 Notes, the Company would, in certain
circumstances, increase the conversion rate by a number of additional shares for a holder that elected to convert
its 2019 Notes in connection with such make-whole fundamental change.

Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to

be separately accounted for as liability and equity components of the instrument in a manner that reflects the
issuer’s non-convertible debt borrowing rate. Accordingly, in accounting for the issuance of the 2019 Notes, the
Company separated the 2019 Notes into liability and equity components. The carrying amount of the liability
component was calculated by measuring the fair value of a similar liability that does not have an associated
convertible feature. The carrying amount of the equity component, which is recognized as a debt discount,
represents the difference between the proceeds from the issuance of the 2019 Notes and the fair value of the
liability component of the 2019 Notes. The debt discount was amortized to interest expense using an effective
interest rate of 4.51% over the expected life of the 2019 Notes. The equity component was not remeasured as
long as it continued to meet the conditions for equity classification.

Debt issuance costs related to the 2019 Notes were comprised of discounts and commissions payable to the

initial purchasers of $4.4 million and third party offering costs of $1.0 million. In accounting for the debt
issuance costs related to the issuance of the 2019 Notes, the Company allocated the total amount incurred to the
liability and equity components based on their relative values. Debt issuance costs attributable to the liability
component were amortized to interest expense using the effective interest method over the expected life of the
2019 Notes, and debt issuance costs attributable to the equity component were netted with the equity component
in stockholders’ equity (deficit).

Discounts, commissions payable to the initial purchasers and third party offering costs attributable to the

liability component were recorded as a contra-liability and were presented net against the convertible senior
notes due 2019 balance on the consolidated balance sheets. The Company recorded $0.4 million, $0.9 million
and $0.9 million related to the amortization of debt issuance costs in fiscal 2019, fiscal 2018 and fiscal 2017,
respectively, related to the 2019 Notes.

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

As of February 1, 2020, the 2019 Notes are no longer outstanding. As of February 2, 2019, the carrying
value of the 2019 Notes, excluding the discounts and commissions payable to the initial purchasers and third
party offering costs, was as follows (in thousands):

Liability component
Principal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Debt discount . . . . . . . . . . . . . . . . . . . . . . . . . . . .

February 2,
2019

$ 350,000
(5,854)

Net carrying amount . . . . . . . . . . . . . . . . . . . . . . .

$ 344,146

Equity component (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 70,482

(1)

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

144

The Company recorded interest expense of $5.9 million, $15.1 million and $14.5 million for the
amortization of the debt discount related to the 2019 Notes in fiscal 2019, fiscal 2018 and fiscal 2017,
respectively.

2019 Notes—Convertible Bond Hedge and Warrant Transactions

In connection with the offering of the 2019 Notes, the Company entered into convertible note hedge

transactions whereby the Company had the option to purchase a total of approximately 3.015 million shares of its
common stock at a price of approximately $116.09 per share. The total cost of the convertible note hedge
transactions was approximately $73.3 million. The convertible note hedge terminated upon the maturity date of
the 2019 Notes. In addition, the Company sold warrants whereby the holders of the warrants had the option to
purchase a total of approximately 3.015 million shares of the Company’s common stock at a price of $171.98 per
share. The Company received $40.4 million in cash proceeds from the sale of these warrants. Taken together, the
purchase of the convertible note hedges and sale of the warrants were intended to offset any actual dilution from
the conversion of the 2019 Notes and to effectively increase the overall conversion price from $116.09 per share
to $171.98 per share. As these transactions met certain accounting criteria, the convertible note hedges and
warrants were recorded in stockholders’ equity (deficit), were not accounted for as derivatives and were 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 consolidated balance sheets.

During fiscal 2019, the Company delivered approximately 167,100 shares upon exercise of the warrants

under the terms of the warrant agreements. The warrants expired on December 6, 2019.

The Company recorded a deferred tax liability of $27.5 million in connection with the debt discount
associated with the 2019 Notes and recorded a deferred tax asset of $28.6 million in connection with the
convertible note hedge transactions. The provision for income taxes in fiscal 2017 included $0.1 million of
income tax expense as a result of the Tax Act for the provisional re-measurement of the deferred tax asset and
liability related to the 2019 Notes for the reduction in the U.S. corporate income tax rate from 35% to 21%. The
deferred tax liability and deferred tax assets were included in non-current deferred tax assets on the consolidated
balance sheets. There is no deferred tax asset or liability remaining as of February 1, 2020 due to the maturity of
the 2019 Notes.

NOTE 11—CREDIT FACILITIES

The outstanding balances under the Company’s credit facilities were as follows (in thousands):

February 1,
2020

February 2,
2019

Outstanding
Amount

Unamortized Debt
Issuance Costs

Net Carrying
Amount

Outstanding
Amount

Unamortized Debt
Issuance Costs

Net Carrying
Amount

Asset based credit facility (1) . . . $ —
Equipment promissory

notes (2)

. . . . . . . . . . . . . . . . .

53,372

Total credit facilities . . . . . $53,372

$ —

$ —

$57,500

(310)

$(310)

53,062

—

$53,062

$57,500

$ —

—

$ —

$57,500

—

$57,500

(1) Deferred financing fees associated with the asset based credit facility as of February 1, 2020 and February 2,
2019 were $2.6 million and $3.4 million, respectively, and are included in other non-current assets on the
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 the Company’s property and equipment, of
which $22.0 million outstanding was included in other current liabilities. The remaining $31.4 million
outstanding, included in other non-current obligations on the consolidated balance sheets, has principal
payments due of $23.0 million, $7.9 million and $0.5 million in fiscal 2021, fiscal 2022 and fiscal 2023,
respectively.

145

Asset Based Credit Facility & Term Loan Facilities

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 (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.

In June 2018, the Company repaid the LILO term loan in full. As a result of the repayment, the Company

incurred a $0.5 million loss on extinguishment of debt in fiscal 2018, which represents the acceleration of
amortization of debt issuance costs. The Company did not incur any prepayment penalties upon the early
extinguishment of the LILO term loan.

On June 12, 2018, Restoration Hardware, Inc. entered into a First Amendment (the “First Amendment”) to

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

On November 23, 2018, Restoration Hardware, Inc. entered into a Consent and Second Amendment (the
“Second Amendment”) to the Credit Agreement. The Second Amendment included certain clarifying changes to
among other things: (a) address the processing of payments from insurance proceeds in connection with casualty
or other insured losses with respect to property or assets of a Loan Party, and (b) add an additional category of
permitted restricted payment to allow the lead borrower to make annual restricted payments of up to $3 million
per fiscal year to cover payments of certain administrative and other obligations of RH in the ordinary course of
business.

On April 4, 2019, Restoration Hardware, Inc., entered into a third amendment to the Credit Agreement (the
“Third Amendment”). The Third Amendment, among other things, (a) established a $120.0 million first in, last
out (“FILO”) term loan facility, 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.

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

146

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, amended 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, the Company is required to meet specified financial ratios in order
to undertake certain actions, and the Company may be required to maintain certain levels of excess availability or
meet a specified consolidated fixed-charge coverage ratio (“FCCR”). Subject to certain exceptions, the trigger for
the FCCR occurs if the domestic availability under the revolving line of credit is less than the greater of (i)
$40.0 million and (ii) 10% of the 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 February 1, 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

147

principal, accrued and unpaid interest and all other amounts payable under the Credit Agreement to be
immediately due and payable.

As of February 1, 2020, the Company had no 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 February 1, 2020 was $321.7 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, 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. As a
result of the repayment, the Company incurred a $6.7 million loss on extinguishment of debt, which includes a
prepayment penalty of $4.0 million and acceleration of amortization of debt issuance costs of $2.7 million.

The Second Lien Term Loan bore interest at an annual rate generally based on 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 is no longer in effect
after 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 the Company agreed that BAL
would finance certain equipment of the Company from time to time, with each such equipment financing to be
evidenced by an equipment security note setting forth the terms for each particular equipment loan. Each
equipment loan is secured by a purchase money security interest in the financed equipment. As of February 1,
2020, the Company had $53.4 million in aggregate amounts outstanding under the equipment security notes at a
weighted-average interest rate of 4.56%. The maturity dates of the equipment security notes vary, but generally
have a maturity of three or four years. The Company is required to make monthly installment payments under the
equipment security notes.

148

NOTE 12—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, the Company utilizes market data or
assumptions that it believes market participants would use in pricing the asset or liability, which would maximize
the use of observable inputs and minimize the use of unobservable inputs to the extent possible, including
assumptions about risk and the risks inherent in the inputs of the valuation technique.

The degree of judgment used in measuring the fair value of financial instruments generally correlates to the

level of pricing observability. Pricing observability is impacted by a number of factors, including the type of
financial instrument, whether the financial instrument is new to the market and not yet established and the
characteristics specific to the transaction. Financial instruments with readily available active quoted prices for
which fair value can be measured generally will have a higher degree of pricing observability and a lesser degree
of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will
generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.

The Company’s financial assets and liabilities measured and reported at fair value are classified and

disclosed in one of the following categories:

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

reporting date.

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

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

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 2019 Notes, 2020 Notes, 2023 Notes and
2024 Notes were as follows (in thousands):

. . . . . . . . . . .
Convertible senior notes due 2019 (2)
Convertible senior notes due 2020 . . . . . . . . . . . . .
Convertible senior notes due 2023 . . . . . . . . . . . . .
Convertible senior notes due 2024 . . . . . . . . . . . . .

February 1,
2020

February 2,
2019

Fair
Value

$ —
295,573
272,623
255,849

Carrying
Value (1)

$ —
291,110
270,271
268,366

Fair
Value

$334,756
260,258
230,684
—

Carrying
Value (1)

$344,146
272,919
253,689
—

(1) Carrying value represents the principal amount less the equity component of the 2019 Notes, 2020 Notes,
2023 Notes and 2024 Notes classified in stockholders’ equity (deficit), and does not exclude the discounts
upon original issuance, discounts and commissions payable to the initial purchasers and third party offering
costs, as applicable.

(2) The 2019 Notes matured on June 15, 2019.

149

The fair value of each of the 2019 Notes, 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 the Company’s convertible notes, when available, the Company’s stock price
and interest rates based on similar debt issued by parties with credit ratings similar to the Company (Level 2).

Fair Value Measurements—Non-Recurring

The fair value of the Waterworks reporting unit and tradename as of February 2, 2019 was determined based

on unobservable (Level 3) inputs and valuation techniques, as discussed in “Impairment” within Note 3—
Significant Accounting Policies. The fair value of the asset held for sale as of February 2, 2019 was determined
based on an appraisal prepared using unobservable (Level 3) inputs and valuation techniques.

NOTE 13—INCOME TAXES

The United States enacted the Tax Cuts and Jobs Act (the “Tax Act”) on December 22, 2017, which had a
significant impact to the Company’s provision for income taxes as of and for the years ended February 2, 2019
and February 3, 2018. The Tax Act included a number of changes to existing U.S. tax laws that impact the
Company, including the reduction of the U.S. corporate income tax rate from 35% to 21% for tax years
beginning after December 31, 2017.

Reduction of the U.S. Corporate Income Tax Rate

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years

in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred
tax assets and liabilities were re-measured to reflect the reduction in the U.S. corporate income tax rate from 35%
to 21%, resulting in a provisional $6.1 million increase in income tax expense for the year ended February 3,
2018 and a corresponding provisional $6.1 million decrease in net deferred tax assets as of February 3, 2018. The
Company completed the accounting for re-measurement of its deferred tax assets and liabilities as of February 2,
2019, and recorded $0.5 million to income tax expense and a corresponding $0.5 million decrease in net deferred
tax assets as of February 2, 2019. The cumulative impact to the Company’s provision for income tax expense in
fiscal 2017 and fiscal 2018 for the re-measurement of the Company’s deferred tax assets and liabilities as result
of the Tax Act was $6.6 million.

Transition Tax on Foreign Earnings

The Company recognized a provisional income tax expense of $1.0 million for the year ended February 3,
2018 related to the one-time transition tax on indefinitely reinvested foreign earnings. The Company completed
its computation of transition tax liability in 2018 and did not recognize additional income tax expense or benefit
for the year ended February 2, 2019. The cumulative impact to the Company’s provision for income tax expense
for the one-time transition tax on indefinitely reinvested foreign earnings as result of the Tax Act was
$1.0 million.

The following is a summary of the income before income taxes (in thousands):

Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

February 1,
2020

$267,538
1,644

Year Ended

February 2,
2019

$157,827
3,137

Total income before income taxes . . . . . .

$269,182

$160,964

February 3,
2018

$21,241
1,292

$22,533

150

The following is a summary of the income tax expense (benefit) (in thousands):

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

Current

Federal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$45,985
10,806
403

Total current tax expense . . . . . . . . . . . . .

57,194

Deferred

Federal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total deferred tax expense (benefit) . . . . .

(7,173)
(1,477)
263

(8,387)

$24,012
6,275
1,270

31,557

(4,428)
(2,049)
153

(6,324)

$18,593
2,761
933

22,287

3,692
(844)
(3)

2,845

Total income tax expense . . . . . . . . . . . . .

$48,807

$25,233

$25,132

A reconciliation of the federal statutory tax rate to the Company’s effective tax rate is as follows:

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

Provision at federal statutory tax rate . . . . . . . . . . . .
State income taxes—net of federal tax impact . . . . .
Tax rate adjustments . . . . . . . . . . . . . . . . . . . . . . . . .
Meals and entertainment . . . . . . . . . . . . . . . . . . . . . .
Aircraft expenses . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock compensation—excess benefits . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
Goodwill impairment
Non-deductible stock-based compensation . . . . . . .
Federal statutory tax rate change . . . . . . . . . . . . . . .
Foreign income inclusion—transition tax . . . . . . . .
. . . . . . . .
Net adjustments to tax accruals and other
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . .
Donation of appreciated property . . . . . . . . . . . . . . .
Foreign income . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other permanent items . . . . . . . . . . . . . . . . . . . . . . .

Effective tax rate . . . . . . . . . . . . . . . . . . . . . . . .

21.0%
2.5
0.2
0.1
0.1
(6.6)
—
—
—
—
—
—
—
—
0.8

18.1%

21.0%
1.7
0.1
0.3
0.1
(9.9)
1.8
—
—
—
—
0.3
—
—
0.3

15.7%

33.7%
4.7
(0.8)
1.9
4.8
(27.9)
23.9
35.7
27.4
4.4
1.9
1.5
(0.2)
(1.3)
1.8

111.5%

151

Significant components of the Company’s deferred tax assets and liabilities are as follows (in thousands):

Non-current deferred tax assets (liabilities)

February 1,
2020

February 2,
2019

Lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock-based compensation . . . . . . . . . . . . . . . . .
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . .
Merchandise inventories . . . . . . . . . . . . . . . . . . .
Deferred lease credits . . . . . . . . . . . . . . . . . . . . .
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . .
Net operating loss carryforwards . . . . . . . . . . . .
Convertible senior notes . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 249,243
22,400
21,362
8,028
6,395
2,235
1,763
717
1,846

$ 253,826
22,721
16,657
14,735
1,188
—
1,654
—
2,591

Non-current deferred tax assets . . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . .

313,989
(1,007)

313,372
(1,623)

Net non-current deferred tax assets . . . . . . .

$ 312,982

$ 311,749

Property and equipment
. . . . . . . . . . . . . . . . . . .
Lease right-of-use assets . . . . . . . . . . . . . . . . . . .
Tradename, trademarks and intangibles . . . . . . .
Prepaid expense and other . . . . . . . . . . . . . . . . . .
State benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Convertible senior notes . . . . . . . . . . . . . . . . . . .
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . .

$ (137,448)
(110,075)
(13,026)
(4,882)
(2,546)
—
—

$ (137,240)
(118,549)
(12,386)
(4,209)
(2,556)
(1,054)
(152)

Non-current deferred tax liabilities . . . . . . .

(267,977)

(276,146)

Total net non-current deferred tax assets . .

$

45,005

$

35,603

A reconciliation of the valuation allowance is as follows (in thousands):

Balance at beginning of fiscal year . . . . . . . . . . . . . . . . . . . . . . . . .
Net changes in deferred tax assets and liabilities . . . . . . . . . . . . . .

$1,623
(616)

Balance at end of fiscal year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$1,007

$1,190
433

$1,623

Year Ended

February 1,
2020

February 2,
2019

The Company has recorded deferred tax assets and liabilities based upon estimates of their realizable value,
such estimates are based upon likely future tax consequences. In assessing the need for a valuation allowance, the
Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax
assets. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not
be realized, the Company records a valuation allowance.

As of February 1, 2020 and February 2, 2019, the Company had $1.0 million and $1.6 million, respectively,

in valuation allowances against deferred tax assets in certain state and foreign jurisdictions due to historical
losses.

As of February 1, 2020, the Company had state net operating loss carryovers of $6.5 million and foreign net
operating loss carryovers of $8.2 million. The state net operating loss carryovers will begin to expire in 2022, and
the foreign net operating loss carryovers will begin to expire in 2023. Internal Revenue Code Section 382 and

152

similar state rules place a limitation on the amount of taxable income which can be offset by net operating loss
carryforwards after a change in ownership (generally greater than 50% change in ownership). The Company
cannot give any assurances that it will not undergo an ownership change in the future resulting in further
limitations on utilization of net operating losses.

A reconciliation of the exposures related to unrecognized tax benefits is as follows (in thousands):

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

Balance at beginning of fiscal year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross increases (decreases)—prior period tax positions . . . . . . . . . . . . . . . .
Gross increases (decreases)—current period tax positions . . . . . . . . . . . . . .
Reductions based on the lapse of the applicable statutes of limitations . . . . .

$8,459
(2)
438
(381)

Balance at end of fiscal year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$8,514

$8,152
239
375
(307)

$8,459

$2,190
5,491
471
—

$8,152

As of February 1, 2020, the Company has $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. In October 2017, the Company filed an amended
federal tax return claiming a $5.4 million refund, however, no income tax benefit was recorded during fiscal
2019, fiscal 2018 or fiscal 2017 given the technical nature and amount of the refund claim. An income tax benefit
related to this refund claim could be recorded in a future period upon settlement with the respective taxing
authority. As of February 1, 2020, the Company has $6.3 million of exposures related to unrecognized tax
benefits that are expected to decrease in the next 12 months.

The Company accounts for interest and penalties related to exposures as a component of income tax
expense. The Company had interest accruals of $0.5 million associated with exposures as of both February 1,
2020 and February 2, 2019, respectively.

The Company is subject to taxation in the United States and various states and foreign jurisdictions. As of

February 1, 2020, the Company is subject to examination by the tax authorities for fiscal 2015 through fiscal
2018. With few exceptions, as of February 1, 2020, the Company is no longer subject to U.S. federal, state, local,
or foreign examinations by tax authorities for years before fiscal 2015.

NOTE 14—NET INCOME (LOSS) PER SHARE

The weighted-average shares used for net income (loss) per share are as follows:

Weighted-average shares—basic . . . . . . . . . . . .
Effect of dilutive stock-based awards . . . . . . . . .
Effect of dilutive convertible senior notes (1) . . . .

February 1,
2020

19,082,303
4,554,682
662,049

Year Ended

February 2,
2019

21,613,678
4,567,303
352,244

February 3,
2018

27,053,616
—
—

Weighted-average shares—diluted . . . . . . .

24,299,034

26,533,225

27,053,616

(1) The 2019 Notes, 2020 Notes, 2023 Notes and 2024 Notes have an impact on the Company’s dilutive share
count beginning at stock prices of $116.09 per share, $118.13 per share, $193.65 per share and $211.40 per

153

share, respectively. The 2019 Notes matured on June 15, 2019 and did not have an impact of the Company’s
dilutive share count post-maturity.

The following number of options and restricted stock units were excluded from the calculation of diluted net

income (loss) per share because their inclusion would have been anti-dilutive:

Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Restricted stock units . . . . . . . . . . . . . . . . . . . . . . . .

360,496
—

February 1,
2020

Year Ended

February 2,
2019

351,145
2,625

February 3,
2018

2,895,471
229,308

Total anti-dilutive stock-based awards . . . . . . .

360,496

353,770

3,124,779

NOTE 15—SHARE REPURCHASES AND SHARE RETIREMENTS

$950 Million Share Repurchase Program

On October 10, 2018, the Company’s Board of Directors authorized a share repurchase program of up to

$700.0 million. In fiscal 2018, the Company repurchased approximately 2.0 million shares of its common stock
under this share repurchase program at an average price of $122.10 per share, for an aggregate repurchase
amount of approximately $250.0 million. Subsequent to the repurchases under this share repurchase program in
fiscal 2018, the initial $700.0 million authorization amount was replenished by the Board of Directors on
March 25, 2019 (as replenished, the $950 million Repurchase Program”). In fiscal 2019, the Company
repurchased approximately 2.2 million shares of its common stock under the $950 million Repurchase Program
at an average price of $115.36 per share, for an aggregate repurchase amount of approximately $250.0 million.
As of February 1, 2020, there was $450.0 million remaining for future share repurchases under this program.

$700 Million Share Repurchase Program

On May 2, 2017, the Company’s Board of Directors authorized a share repurchase program of up to

$700 million (the “$700 Million Repurchase Program”). Under the $700 Million Repurchase Program, the
Company repurchased approximately 12.4 million shares of its common stock at an average price of $56.60 per
share, for an aggregate repurchase amount of approximately $700 million in fiscal 2017. As the $700 Million
Repurchase Program was completed during fiscal 2017, there will be no repurchases in future periods under this
repurchase authorization.

$300 Million Share Repurchase Program

On February 21, 2017, the Company’s Board of Directors authorized a share repurchase program of up to

$300 million (the “$300 Million Repurchase Program”). Under the $300 Million Repurchase Program, the
Company repurchased approximately 7.8 million shares of its common stock at an average price of $38.24 per
share, for an aggregate repurchase amount of approximately $300 million in fiscal 2017. As the $300 Million
Repurchase Program was completed during fiscal 2017, there will be no repurchases in future periods under this
repurchase authorization.

Share Repurchases Under Equity Plans

As of February 1, 2020 and February 2, 2019, the aggregate unpaid principal amount of the notes payable
for share repurchases was $18.7 million and $19.6 million, respectively. As of February 1, 2020, $18.7 million
was included in other non-current obligations on the consolidated balance sheets. As of February 2, 2019,
$0.9 million and $18.7 million were included in other current liabilities and other non-current obligations on the
consolidated balance sheets, respectively. The Company recorded interest expense on the outstanding notes of
$0.9 million, $1.0 million and $1.0 million in fiscal 2019, fiscal 2018 and fiscal 2017, respectively.

154

Of the $18.7 million and $19.6 million notes payable for share repurchases outstanding as of February 1,

2020 and February 2, 2019, respectively, $15.5 million was due to a current board member of the Company.

Share Retirements

In fiscal 2019, the Company retired 2,170,154 shares of its common stock related to shares it had
repurchased under the $950 Million Repurchase Program. As a result of this retirement, the Company
reclassified a total of $250.3 million from treasury stock, of which $13.2 million was allocated to additional
paid-in capital and $237.1 million was allocated to retained earnings (accumulated deficit) on the consolidated
balance sheets and consolidated statements of shareholders’ equity (deficit) as of February 1, 2020.

In fiscal 2018, the Company retired 22,267,711 shares of its common stock related to shares it had

repurchased under the $300 Million Repurchase Program, $700 Million Repurchase Program and $950 Million
Repurchase Program. As a result of this retirement, the Company reclassified a total of $1,250.3 million from
treasury stock, of which $591.5 million was allocated to additional paid-in capital and $658.8 million was
allocated to retained earnings (accumulated deficit) on the consolidated balance sheets and consolidated
statements of shareholders’ equity (deficit) as of February 2, 2019.

In fiscal 2017, the Company retired 294,888 shares of its common stock related to shares it had repurchased

under the Company’s equity plans. As a result of this retirement, the Company reclassified a total of
$19.5 million from treasury stock, all of which was allocated to additional paid-in capital on the consolidated
balance sheets and consolidated statements of shareholders’ equity (deficit) as of February 3, 2018.

There was no impact on the consolidated statements of operations or cash flows related to these share

retirement activities.

NOTE 16—STOCK-BASED COMPENSATION

The Company estimates the value of equity grants based upon an OPM and recognizes this estimated value

as compensation expense over the vesting periods. The Company recognizes expense associated with
performance-based awards when it becomes probable that the performance condition will be met. Once it
becomes probable that an award will vest, the Company recognizes compensation expense equal to the number of
shares which are probable to vest multiplied by the fair value of the related shares measured at the grant date.

Stock-based compensation expense is included in selling, general and administrative expenses on the

consolidated statements of operations. The Company recorded stock-based compensation expense of
$21.8 million, $24.0 million and $50.7 million in fiscal 2019, fiscal 2018 and fiscal 2017, respectively. No stock-
based compensation cost has been capitalized in the accompanying consolidated financial statements.

2012 Stock Incentive Plan and 2012 Stock Option Plan

The Restoration Hardware 2012 Stock Incentive Plan (the “Stock Incentive Plan”) was adopted on

November 1, 2012. The Stock Incentive Plan provides for the grant of incentive stock options to the Company’s
employees, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, dividend
equivalent rights, cash-based awards and any combination thereof to the Company’s employees, directors and
consultants and the Company’s parent and subsidiary corporations’ employees, directors and consultants.

The Restoration Hardware 2012 Stock Option Plan (the “Option Plan”) was adopted on November 1, 2012

and on such date 6,829,041 fully vested options were granted under this plan to certain of the Company’s
employees and advisors. Aside from these options granted on November 1, 2012, no other awards will be granted
under the Option Plan.

155

As of February 2, 2019, there were a total of 1,419,552 shares issuable under the Stock Incentive Plan. On

February 4, 2019, an additional 409,556 shares became issuable under the Stock Incentive Plan in accordance
with the Stock Incentive Plan evergreen provision, increasing the total number of shares issuable under the Stock
Incentive Plan to 1,829,108. Awards under the plans reduce the number of shares available for future issuance.
Cancellations and forfeitures of awards previously granted under the Stock Incentive Plan increase the number of
shares available for future issuance. Cancellations and forfeitures of awards previously granted under the Option
Plan are immediately retired and are no longer available for future issuance.

The number of shares available for future issuance under the Stock Incentive Plan as of February 1, 2020

was 1,630,107. Shares issued as a result of award exercises under the Stock Incentive Plan and Option Plan will
be funded with the issuance of new shares. On February 3, 2020, an additional 384,734 shares became issuable
under the Stock Incentive Plan in accordance with the Stock Incentive Plan evergreen provision.

2012 Stock Incentive Plan and 2012 Stock Option Plan—Stock Options

A summary of stock option activity under the Stock Incentive Plan and the Option Plan is as follows:

Outstanding—February 2, 2019 . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Options

7,499,416
534,050
(643,090)
(255,641)

Outstanding—February 1, 2020 . . . . . . . . . . . . . .

7,134,735

Weighted-Average
Exercise Price

$ 54.37
110.17
42.20
90.88

$ 58.34

The fair value of stock options issued was estimated on the date of grant using the following assumptions:

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

Expected volatility . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected life (years) . . . . . . . . . . . . . . . . . . . . . . . . .
Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . .
Dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

55.7%
7.1
2.3%
—

54.7%
6.7
2.9%
—

48.3%
9.3
2.2%
—

A summary of additional information about stock options is as follows:

Weighted-average fair value per share of stock options granted . . . . . . $ 63.35
82,718
Aggregate intrinsic value of stock options exercised (in thousands)
. .
11,816
Fair value of stock options vested (in thousands) . . . . . . . . . . . . . . . . .

$ 69.60
77,311
13,915

$ 24.24
27,362
38,402

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

156

Information about stock options outstanding, vested or expected to vest, and exercisable as of February 1,

2020 is as follows:

Options Outstanding

Options Exercisable

Range of Exercise Prices

$25.39 - $45.82 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$46.50 - $46.50 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$47.53 - $61.30 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$68.30 - $90.92 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$91.67 - $212.77 . . . . . . . . . . . . . . . . . . . . . . . . . . .
$241.97 - $241.97 . . . . . . . . . . . . . . . . . . . . . . . . . .

Number of
Options

1,011,010
2,876,826
1,294,395
1,160,604
781,900
10,000

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7,134,735

Weighted-
Average
Remaining
Contractual
Life (in years)

6.08
2.75
6.64
3.68
8.79
9.84

4.75

Weighted-
Average
Exercise
Price

$ 35.59
46.50
52.47
77.21
110.66
241.97

Number of
Options

431,410
2,876,826
1,270,635
1,101,689
53,150
—

Weighted-
Average
Exercise
Price

$ 34.70
46.50
52.38
76.67
107.11
—

$ 58.34

5,733,710

$ 53.27

Vested or expected to vest . . . . . . . . . . . . . . . . . . . .

6,819,795

$ 56.93

The aggregate intrinsic value of options outstanding, options vested or expected to vest, and options
exercisable as of February 1, 2020 was $1,073.5 million, $1,035.6 million, and $891.5 million, respectively.
Stock options exercisable as of February 1, 2020 had a weighted-average remaining contractual life of 4.10 years.

The Company recorded stock-based compensation expense for stock options of $14.0 million, $13.6 million

and $37.5 million in fiscal 2019, fiscal 2018 and fiscal 2017, respectively. The fiscal 2017 expense of
$37.5 million includes the $23.9 million of expense associated with the option grant to Mr. Friedman in
May 2017. Refer to Chairman and Chief Executive Officer Option Grant below. As of February 1, 2020, the total
unrecognized compensation expense related to unvested options was $35.5 million, which is expected to be
recognized on a straight-line basis over a weighted-average period of 3.13 years.

2012 Stock Incentive Plan—Restricted Stock Awards

The Company grants restricted stock awards, which include restricted stock and restricted stock units, to its

employees and members of its Board of Directors. A summary of restricted stock award activity is as follows:

Outstanding—February 2, 2019 . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . .
Released . . . . . . . . . . . . . . . . . . . . . .
Cancelled . . . . . . . . . . . . . . . . . . . . .

Awards

415,469
7,014
(176,508)
(25,990)

Weighted-Average
Grant Date Fair Value

Intrinsic
Value

$ 52.40
129.21
59.61
53.05

Outstanding—February 1, 2020 . . . . . . . .

219,985

$ 49.00

$45,921,869

A summary of additional information about restricted stock awards is as follows:

Year Ended

February 1,
2020

February 2,
2019

February 3,
2018

Weighted-average fair value per share of awards granted . . . $129.21
10,522
Grant date fair value of awards released (in thousands) . . . .

$111.38
11,477

$ 55.31
16,839

157

The Company recorded stock-based compensation expense for restricted stock awards of $7.3 million,
$10.0 million and $12.8 million in fiscal 2019, fiscal 2018 and fiscal 2017, respectively. As of February 1, 2020,
the total unrecognized compensation expense related to unvested restricted stock awards was $5.5 million, which
is expected to be recognized on a straight-line basis over a weighted-average period of 1.47 years.

Chairman and Chief Executive Officer Option Grant

On May 2, 2017, the Company’s Board of Directors granted Mr. Friedman an option to purchase 1,000,000

shares of the Company’s common stock with an exercise price equal to $50 per share.

The option contains dual-condition restrictions consisting of both time-based service restrictions over four
years and performance-based restrictions linked to achieving the Company’s common stock price objectives of
$100, $125 and $150 per share. The option is fully vested on the date of grant but the shares underlying the
option remain subject to transfer restrictions to the extent the performance-based and time-based requirements
have not been met. The option resulted in a non-cash stock compensation charge of $23.9 million in fiscal 2017,
which is included in the $37.5 million stock-based compensation expense for stock options recorded in fiscal
2017 discussed above.

Time-Based Restrictions

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

Performance-Based Restrictions

The stock price objectives are measured each year and are set at prices for the Company’s common stock of

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

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

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

Rollover Units

In connection with the acquisition of Waterworks, $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 consolidated statements of operations. The fair value of
the Appreciation Rights is determined based on an OPM. The Company did not record any expense related to the
Appreciation Rights during fiscal 2019, fiscal 2018 or fiscal 2017. As of both February 1, 2020 and February 2,
2019, the liability associated with the Rollover Units and related Appreciation Rights was $1.5 million, which is
included in other non-current obligations on the consolidated balance sheets.

158

Profit Interests

In connection with the acquisition of Waterworks, 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
consolidated statements of operations. The fair value of the Profit Interests is determined based on an OPM. The
Company recorded $0.5 million, $0.4 million and $0.4 million related to the Profit Interests in fiscal 2019, fiscal
2018 and fiscal 2017, respectively, which is included in selling, general and administrative expenses on the
consolidated statements of operations. As of February 1, 2020 and February 2, 2019, the liability associated with
the Profit Interests was $1.6 million and $1.1 million, respectively, which is included in other non-current
obligations on the consolidated balance sheets.

NOTE 17—EMPLOYEE BENEFIT PLANS

The Company has a 401(k) plan for its employees who meet certain service and age requirements.

Participants may contribute up to 50% of their salaries limited to the maximum allowed by the Internal Revenue
Service regulations. The Company, at its discretion, may contribute funds to the 401(k) plan. The Company made
no contributions to the 401(k) plan during fiscal 2019, fiscal 2018, or fiscal 2017.

NOTE 18—COMMITMENTS AND CONTINGENCIES

Commitments

The Company had no material off balance sheet commitments as of February 1, 2020.

Contingencies

The Company is involved in lawsuits, claims and proceedings incident to the ordinary course of its business.

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

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

159

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 Company 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 the Company’s 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, the Company 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 the Company’s 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 the
Company’s shareholders, and a hearing at which time the court will consider the fairness, reasonableness and
adequacy of the settlement. On June 21, 2019, the court issued an order preliminarily approving the settlement.
The court granted final approval of the settlement on October 25, 2019.

As a result of signing the settlement agreement in fiscal 2018, the Company recorded a provision for legal

settlement and unpaid legal fees for $50 million within other current liabilities on the consolidated balance sheets
as of February 2, 2019. Additionally, the Company recorded a litigation insurance recovery receivable of
$50 million as of February 2, 2019 within prepaid expense and other current assets on the consolidated balance
sheets, which represented the estimated insurance claims proceeds from the Company’s insurance carriers.

As a result of the court approval and adjudication of the claims in fiscal 2019, as well as the Company’s

insurance carriers funding the settlement amount, the Company has derecognized the provision for legal
settlement and unpaid legal fees within other current liabilities and the associated litigation insurance recovery
receivable on the consolidated balance sheets as of February 1, 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 RH as a nominal
defendant and Gary Friedman, Karen Boone, Carlos Alberini, Keith Belling, Eri Chaya, Mark Demilio, Katie
Mitic, Ali Rowghani and Leonard Schlesinger as defendants. The allegations substantially track those in the
securities class action described above. Plaintiffs bring claims against all individual defendants under
Section 14(a) of the Exchange Act, as well as claims for breach of fiduciary duty, unjust enrichment, and waste
of corporate assets. The plaintiffs also allege insider trading and misappropriation of information claims against
two of the individual defendants. The amended complaint seeks monetary damages, corporate governance
changes, restitution, and an award of costs and attorneys’ fees. The Company believes that plaintiffs lack
standing to bring this derivative action. On September 28, 2018, the Company filed a motion to stay proceedings
and a motion to dismiss the consolidated complaint. 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 the Company’s 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 the Company’s insurance carriers.

160

NOTE 19—SEGMENT REPORTING

The Company defines reportable and operating segments on the same basis that it uses to evaluate
performance internally by the CODM. The Company has determined that the Chief Executive Officer is its
CODM.

The Company has two operating segments: RH Segment and Waterworks. The two operating segments
include all sales channels accessed by the Company’s customers, including sales through catalogs, websites,
stores, and the commercial channel.

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

The Company uses operating income to evaluate segment profitability. Operating income is defined as net
income before interest expense—net, goodwill and tradename impairment, loss on extinguishment of debt—net
and income tax expense.

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):

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

RH Segment Waterworks

Total

RH Segment Waterworks

Total

RH Segment Waterworks

Total

Net revenues . . . . $ 2,514,296
Gross profit . . . . .
1,038,722
Depreciation and

amortization . .

96,148

$133,141
56,289

$2,647,437
1,095,011

$2,375,472
933,805

$130,181 $2,505,653
985,577

51,772

$2,319,332
791,730

$120,842 $2,440,174
839,298

47,568

4,591

100,739

86,719

4,653

91,372

78,772

4,404

83,176

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

thousands):

Goodwill (1)
Tradenames, trademarks and

. . . . . . . . . . . . . . . .

domain names (2) . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . .

February 1,
2020

February 2,
2019

RH Segment Waterworks

Total

RH Segment Waterworks

Total

$ 124,367

$ — $ 124,367

$ 124,379

$ — $ 124,379

48,563
2,301,823

37,459
143,871

86,022
2,445,694

48,563
2,273,951

37,459
149,067

86,022
2,423,018

(1) The Waterworks reporting unit goodwill of $51.1 million recognized upon acquisition in fiscal 2016 was
fully impaired as of February 2, 2019, with $17.4 million and $33.7 million impairment recorded in fiscal
2018 and fiscal 2017, respectively.

(2) The Waterworks reporting unit tradename is presented net of an impairment charge of $14.6 million

recorded in fiscal 2018.

The Company uses segment operating income to evaluate segment performance and allocate resources.
Segment operating income excludes (i) asset impairments and lease losses, (ii) severance costs associated with a
reorganizations, (iii) product recall accruals and adjustments—net, (iv) asset held for sale gain (loss),
(v) favorable legal settlements, net of legal expenses, (vi) disposals of inventory and property and equipment,

161

lease related charges, inventory transfer costs and other costs and adjustments associated with distribution center
closures, (vii) non-cash amortization of the inventory fair value adjustment recorded in connection with the
acquisition of Waterworks, (viii) a non-cash compensation charge related to a fully vested option grant made to
Mr. Friedman in May 2017, (ix) the release of the remaining reserve for potential claims regarding anti-dumping
duties which the Company believes have lapsed and (x) the gain on sale of building and land for one of the
Company’s previously owned retail galleries. 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
reviews.

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

Operating income:
RH Segment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Waterworks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset impairments and lease losses . . . . . . . . . . .
Reorganization related costs . . . . . . . . . . . . . . . . .
Recall accrual . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset held for sale gain (loss) . . . . . . . . . . . . . . . .
Legal settlements . . . . . . . . . . . . . . . . . . . . . . . . .
Distribution center closures . . . . . . . . . . . . . . . . .
Impact of inventory step-up . . . . . . . . . . . . . . . . .
Executive non-cash compensation . . . . . . . . . . . .
Anti-dumping exposure . . . . . . . . . . . . . . . . . . . .
Gain on sale of building and land . . . . . . . . . . . . .

Income from operations . . . . . . . . . . . . . . . . . .
Interest expense—net . . . . . . . . . . . . . . . . . . . . . .
Goodwill and tradename impairment . . . . . . . . . .
Loss on extinguishment of debt—net . . . . . . . . . .

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

$ 375,315
3,780
(21,899)
(1,075)
3,988
1,529
1,193
—
—
—
—
—

362,831
87,177
—
6,472

$ 288,106
(922)
(7,218)
(9,977)
(1,619)
(8,497)
5,289
(3,046)
(380)
—
—
—

261,736
67,769
32,086
917

$ 161,111
(1,615)
(4,417)
(949)
(7,707)
—
—
(7,230)
(2,527)
(23,872)
2,202
2,119

117,115
56,002
33,700
4,880

Income before income taxes . . . . . . . . . . . . . . .

$ 269,182

$ 160,964

$ 22,533

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

February 1,
2020

Year Ended

February 2,
2019

February 3,
2018

Furniture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Non-furniture . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 1,794,317
853,120

$ 1,625,553
880,100

$ 1,543,404
896,770

Total net revenues . . . . . . . . . . . . . . . . . .

$ 2,647,437

$ 2,505,653

$ 2,440,174

The Company is domiciled in the United States and primarily operates its retail and outlet stores in the
United States. As of February 1, 2020, the Company operates 4 retail and 2 outlet stores in Canada and 1 retail
store in the U.K. Revenues from Canadian and U.K. operations, and the long-lived assets in Canada and the U.K.,
are not material to the Company. Canada and U.K. geographic revenues are based upon revenues recognized at
the retail store locations in the respective country.

No single customer accounted for more than 10% of the Company’s revenues in fiscal 2019, fiscal 2018 or

fiscal 2017.

162

NOTE 20—SUBSEQUENT EVENT

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic, which

continues to spread throughout the United States and globally. The COVID-19 health crisis poses significant and
widespread risks to the Company’s business as well as to the business environment and the markets in which the
Company operates. In response to the public health crisis posed by COVID-19, effective from March 17, 2020,
the Company temporarily closed its retail locations for an indeterminate period of time. Although the Company
continues to serve its customers virtually through its Gallery representatives and designers, as well as its online
websites, the Company’s business operations are being substantially affected by applicable regulatory restrictions
including stay-at-home requirements applicable in California where its corporate headquarters is located. The
Company’s decision to reopen retail locations will be affected by a number of factors including applicable
regulatory restrictions and there is substantial uncertainty regarding the manner and timing in which the
Company can return some or all of its business to more normal business operations. The Company may face
longer term closure requirements and other operational restrictions with respect to some or all of its physical
locations for prolonged periods of time due to, among other factors, evolving and increasingly stringent federal,
state and local restrictions including shelter-in-place orders. Even once the Company is able to reopen closed
physical locations, changes in consumer behavior and health concerns may continue to impact consumer demand
for the Company’s products and customer traffic at its Galleries, restaurants and outlets and may make it more
difficult to staff its business operations. As a result of these developments, the Company expects an unfavorable
impact on its sales, results of operations and cash flows in fiscal 2020.

The Company has already experienced significant disruption to its business as a result of the rapid

development of COVID-19 and the corresponding reduction in sales associated with its retail location closures.
The Company may face longer term closure requirements with respect to some or all of its physical locations for
prolonged periods of time due to, among other factors, evolving and increasingly stringent federal, state and local
restrictions and shelter-in-place orders. Even once the Company is able to reopen its physical locations, changes
in consumer behavior and health concerns may continue to impact customer traffic at the Company’s retail
locations and may make it more difficult to staff these locations. Additionally, customer purchasing patterns are
influenced by economic factors including the health of the stock market and the Company has correlated
previous downturns in the stock market with a reduction in consumer demands for its products. Accordingly,
adverse conditions and events have occurred that will impact the Company’s operations and liquidity.

The Company has relied on cash flows from operations, net cash proceeds from the issuance of the

convertible senior notes, as well as borrowings under credit facilities as primary sources of liquidity. The current
events and economic conditions are significant in relation to the Company’s ability to fund its business
operations, as well as debt repayments when due, such as the $300 million convertible senior notes maturing in
July 2020 and payments under equipment promissory notes. The Company expects 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.

In response to the impact of COVID-19, the Company is implementing 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. The
Company plans to utilize its asset based credit facility, and the Company may pursue other sources of capital that
may include other forms of external financing, in order to increase its 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 10—Convertible Senior Notes and Note 11—Credit Facilities for further information on the terms and
conditions of the Company’s outstanding debt agreements. The Company had outstanding borrowings under the
Credit Agreement of $35.0 million as of March 27, 2020 and the amount under the revolving line of credit
borrowing base that could be available pursuant to the Credit Agreement was $307.9 million, net of $13.2 million
in outstanding letters of credit. The Company believes that these actions mitigate risks arising from COVID-19

163

and will be sufficient to repay the Company’s debt obligations as they become due, meet working capital
requirements and fulfill other capital needs for more than the next 12 months.

NOTE 21—SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Quarterly financial data for fiscal 2019 and fiscal 2018 are set forth below (in thousands, except share and

per share amounts):

Fiscal 2019

Net revenues . . . . . . . . . . . . . . . . . . . .
Gross profit . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . .
Weighted-average shares used in

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

computing diluted net income per
share . . . . . . . . . . . . . . . . . . . . . . . .
Diluted net income per share . . . . . . . .

Fiscal 2018

Net revenues . . . . . . . . . . . . . . . . . . . .
Gross profit . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . .
Weighted-average shares used in

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

computing diluted net income per
share . . . . . . . . . . . . . . . . . . . . . . . .
Diluted net income per share . . . . . . . .

Three Months Ended

May 4,
2019

August 3,
2019

November 2,
2019

February 1,
2020

$

598,421
232,814
35,722

$

706,514
294,958
63,757

$

677,526
284,166
52,463

$

664,976
283,073
68,433

19,976,858
1.79

$

18,465,876
3.45

$

18,765,769
2.80

$

19,120,709
3.58

$

24,933,987
1.43

$

22,324,112
2.86

$

24,170,172
2.17

$

25,767,864
2.66

$

Three Months Ended

May 5,
2018

August 4,
2018

November 3,
2018

February 2,
2019

$

557,406
209,333
25,461

$

640,798
268,344
62,906

$

636,558
250,021
20,114

$

670,891
257,879
27,250

21,545,025
1.18

$

21,925,702
2.87

$

22,082,141
0.91

$

20,901,841
1.30

$

25,230,228
1.01

$

27,496,561
2.29

$

27,703,319
0.73

$

25,702,791
1.06

$

164

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial

reporting, as defined in Exchange Act Rule 13a-15(f). Management conducted an assessment of our internal
control over financial reporting as of February 1, 2020 based on the framework established by the Committee of
Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013).
Based on the assessment, management concluded that our internal control over financial reporting was effective
as of February 1, 2020. The effectiveness of the Company’s internal control over financial reporting as of
February 1, 2020 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting
firm, as stated in their report which is included herein.

Changes in Internal Control over Financial Reporting

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

Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting

In designing and evaluating the disclosure controls and procedures and internal control over financial
reporting, management recognizes that any controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of
disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are
resource constraints and that management is required to apply judgment in evaluating the benefits of possible
controls and procedures relative to their costs.

Item 9B. Other Information

None.

165

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The information required by this item will be contained in our definitive Proxy Statement for the 2020

Annual Meeting of Stockholders (the “Proxy Statement”) and is incorporated herein by reference.

Item 11. Executive Compensation

The information required by this item will be contained in our Proxy Statement and is incorporated herein

by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder

Matters

The information required by this item will be contained in our Proxy Statement and is incorporated herein

by reference.

Item 13. Certain Relationships and Related Transactions and Director Independence

The information required by this item will be contained in our Proxy Statement and is incorporated herein

by reference.

Item 14. Principal Accountant Fees and Services

The information required by this item will be contained in our Proxy Statement and is incorporated herein

by reference.

166

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a) The following documents are filed as part of this Annual Report on Form 10-K:

1. Consolidated Financial Statements

The following financial statements are included in Part II, Item 8 of this Annual Report on Form 10-K:

•

•

•

•

•

•

•

Report of Independent Registered Public Accounting Firm on Consolidated Financial
Statements

Consolidated Balance Sheets as of February 1, 2020 and February 2, 2019

Consolidated Statements of Operations for the fiscal years ended February 1, 2020,
February 2, 2019 and February 3, 2018

Consolidated Statements of Comprehensive Income (Loss) for the fiscal years ended
February 1, 2020, February 2, 2019 and February 3, 2018

Consolidated Statements of Stockholders’ Equity (Deficit) for the fiscal years ended
February 1, 2020, February 2, 2019 and February 3, 2018

Consolidated Statements of Cash Flows for the fiscal years ended February 1, 2020,
February 2, 2019 and February 3, 2018

Notes to the Consolidated Financial Statements

2.

Financial Statement Schedules

Separate financial statement schedules have been omitted either because they are not applicable or
because the required information is included in the consolidated financial statements or notes described
in Item 15(a)(1) above.

3. Exhibits

The Exhibits listed in the Index to Exhibits, which appears immediately before the signature page and
is incorporated herein by reference, are filed or incorporated by reference as part of this Annual Report
on Form 10-K.

Item 16. Form 10-K Summary

The Company has elected not to include summary information.

167

Exhibit
Number

Exhibit Description

Form File Number

Date of
First Filing

Exhibit
Number

Filed Herewith

EXHIBIT INDEX

Incorporated by Reference

3.1

3.2

4.1

4.2

4.3

4.4

4.5

4.6

4.7

Restated Certificate of
Incorporation of RH.

Amended and Restated Bylaws
of RH.

Description of Securities of
Registrant.

Form of RH Common Stock
Certificate.

Indenture dated June 24, 2014,
between Restoration Hardware
Holdings, Inc. and U.S. Bank
National Association, as
Trustee, including form of
0.00% Convertible Senior
Note due 2019.

Indenture dated June 23, 2015,
between Restoration Hardware
Holdings, Inc., the Guarantor
and U.S. Bank National
Association, as Trustee,
including form of 0.00%
Convertible Senior Note due
2020.

Indenture dated June 18, 2018,
between RH and U.S. Bank
National Association, as
Trustee, including form of
0.00% Convertible Senior
Note due 2023.

First Supplemental Indenture
dated as of August 31, 2018,
between RH and U.S. Bank
National Association, as
Trustee, relating to the 0.00%
Convertible Senior Note due
2023.

Indenture dated September 17,
2019, between RH and U.S.
Bank National Association, as
Trustee, including form of
0.00% Convertible Senior Note
due 2024.

10-K 001-35720

March 29, 2017

8-K 001-35720

March 3, 2017

10-K 001-35720

March 29, 2017

8-K 001-35720

June 24, 2014

3.1

3.1

4.1

4.1

X

8-K 001-35720

June 24, 2015

4.1

8-K 001-35720

June 19, 2018

4.1

10-Q 001-35720

September 5, 2018

4.2

8-K 001-35720 September 18, 2019

4.1

168

Exhibit
Number

10.1

10.2*

10.3*

10.4*

10.5*

10.6*

10.7*

10.8*

Exhibit Description

Form

File Number

Date of
First Filing

Exhibit
Number

Filed Herewith

Incorporated by Reference

Form of Indemnification
Agreement entered into by
and between Restoration
Hardware Holdings, Inc. and
each of its directors.

Executive Employment
Agreement, dated as of July 2,
2013, by and between
Restoration Hardware, Inc.
and Gary Friedman.

2012 Equity Replacement
Plan and related documents.

2012 Stock Incentive Plan and
related documents.

2012 Stock Option Plan and
related documents.

Form of 2012 Stock Incentive
Plan and 2012 Stock Option
Plan related documents, as
amended and restated.

Form of Notice of Restricted
Stock Unit Award and
Restricted Stock Unit
Agreement under 2012 Stock
Incentive Plan.

Notice of Stock Option Award
and Stock Option Award
Agreement by and between
RH and Gary Friedman.

S-1/A 333-176767

October 23, 2012

10.4

8-K

001-35720

July 3, 2013

10.1

S-8

333-184716 November 2, 2012

4.2

S-8

333-184716 November 2, 2012

4.3

S-8

333-184716 November 2, 2012

4.4

10-Q 001-35720 December 17, 2013

10.2

10-K 001-35720

March 31, 2014

10.17

8-K

001-35720

May 3, 2017

10.1

10.9*

Cash Incentive Bonus Plan.

10-Q 001-35720

September 9, 2017

10.2

10.10*

10.11

10.12

Form of Compensation
Protection Agreement for
Section 16 Presidents.

Form of Base Convertible
Bond Hedge Confirmation,
dated June 18, 2015, between
Restoration Hardware
Holdings, Inc. and each of the
Counterparties.

Form of Base Warrant
Confirmation, dated June 18,
2015, between Restoration
Hardware Holdings, Inc. and
each of the Counterparties.

10-K 001-35720

March 29, 2018

10.11

8-K

001-35720

June 24, 2015

10.1

8-K

001-35720

June 24, 2015

10.2

169

Exhibit
Number

10.13

10.14

10.15

10.16

10.17

10.18

10.19

10.20

Exhibit Description

Form File Number

Date of
First Filing

Exhibit
Number

Filed Herewith

Incorporated by Reference

Form of Base Convertible Bond
Hedge Confirmation, dated
June 13, 2018, between RH and
each of the counterparties
thereto.

Form of Base Warrant
Confirmation, dated June 13,
2018, between RH and each of
the counterparties thereto.

Form of Base Convertible Bond
Hedge Confirmation, dated
September 12, 2019, between
RH and each of the
Counterparties.

Form of Base Warrant
Confirmation, dated
September 12, 2019, between
RH and each of the
Counterparties.

Form of Additional Convertible
Bond Hedge Confirmation,
dated September 13, 2019,
between RH and each of the
Counterparties.

Form of Additional Warrant
Confirmation, dated
September 13, 2019, between
RH and each of the
Counterparties.

Amended and Restated Aircraft
Time Sharing Agreement
entered into on March 29, 2016
by and between Restoration
Hardware, Inc. and Gary G.
Friedman.

Eleventh Amended and Restated
Credit Agreement dated as of
June 28, 2017 among
Restoration Hardware, Inc., as
lead borrower, various other
subsidiaries of RH named
therein as borrowers, the
guarantors party thereto, the
lenders party thereto and Bank
of America, N.A. as
administrative agent and
collateral agent.

8-K 001-35720

June 19, 2018

10.1

8-K 001-35720

June 19, 2018

10.2

8-K 001-35720 September 18, 2019

10.1

8-K 001-35720 September 18, 2019

10.2

8-K 001-35720 September 18, 2019

10.3

8-K 001-35720 September 18, 2019

10.4

10-K 001-35720

March 30, 2016

10.13

8-K 001-35720

July 3, 2017

10.1

170

Exhibit
Number

10.21

10.22

10.23

Exhibit Description

Form File Number

Date of
First Filing

Exhibit
Number

Filed Herewith

Incorporated by Reference

10-Q 001-35720

June 12, 2018

10.1

8-K 001-35720 November 23, 2018

10.1

8-K 001-35720

April 5, 2019

10.1

First Amendment to Eleventh
Amended and Restated Credit
Agreement, dated June 12,
2018, among Restoration
Hardware, Inc., as lead
borrower, various other
subsidiaries of RH named
therein as borrowers, the
guarantors party thereto, the
lenders party thereto and Bank
of America, N.A., as
administrative agent and
collateral agent.

Consent and Second
Amendment to Eleventh
Amended and Restated Credit
Agreement, dated November 23,
2018, among Restoration
Hardware, Inc., as lead
borrower, various other
subsidiaries of RH named
therein as borrowers, the
guarantors party thereto, the
lenders party thereto and Bank
of America, N.A. as
administrative agent and
collateral agent.

Third Amendment to Eleventh
Amended and Restated Credit
Agreement, dated April 4, 2019,
among Restoration Hardware,
Inc., as lead borrower, various
other subsidiaries of RH named
therein as borrowers, the
guarantors party thereto, the
lenders party thereto and Bank
of America, N.A. as
administrative agent and
collateral agent.

171

Exhibit Description

Form File Number

Date of
First Filing

Incorporated by Reference

8-K 001-35720

July 13, 2017

Exhibit
Number

10.1

Filed Herewith

Exhibit
Number

10.24

10.25

10.26

21.1

23.1

24.1

31.1

31.2

32.1

Credit Agreement, dated as of
July 7, 2017, among Restoration
Hardware, Inc., as lead
borrower, various other
subsidiaries of RH named
therein as borrowers, the
guarantors party thereto, the
lenders party thereto and
Wilmington Trust, National
Association as administrative
agent and collateral agent.

Credit Agreement, dated as of
April 9, 2019 and effective as of
April 10, 2019, among
Restoration Hardware, Inc., as
lead borrower, various other
subsidiaries of RH named
therein as borrowers, the
guarantors party thereto, the
lenders party thereto and BSP
Agency, LLC, as administrative
agent and collateral agent.

Intercreditor Agreement, dated
as of April 9, 2019 and effective
as of April 10, 2019, among
Restoration Hardware, Inc.,
Bank of America, N.A. and BSP
Agency, LLC.

Subsidiary List

Consent of
PricewaterhouseCoopers LLP

Power of Attorney (included on
signature page)

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

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

Certification of Chief Executive
Officer pursuant to 18 U.S.C.
Section 1350, as adopted
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

8-K 001-35720

April 16, 2019

10.1

8-K 001-35720

April 16, 2019

10.2

—

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—

—

—

—

—

—

—

—

—

X

X

X

X

X

X

—

—

—

—

—

—

—

—

—

—

—

—

172

Incorporated by Reference

Form

—

File
Number

—

Date of
First Filing

—

Exhibit
Number

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

Filed Herewith

X

X

X

X

X

X

X

X

Exhibit
Number

32.2

101.INS

101.SCH

101.CAL

Exhibit Description

Certification of Chief Financial
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-
Oxley Act of 2002.

XBRL Instance Document––the
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Inline XBRL Taxonomy
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101.DEF

Inline XBRL Extension Definition —

101.LAB

101.PRE

104

Inline XBRL Taxonomy
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*

Indicates management contract or compensatory plan or arrangement.

173

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant

has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SIGNATURES

RH

By:

/s/ Gary Friedman
Gary Friedman
Chairman of the Board of Directors and Chief Executive
Officer

Date: March 30, 2020

POWER OF ATTORNEY

Know all persons by these presents, that each person whose signature appears below constitutes and
appoints Gary Friedman and Jack Preston, and each of them, as such person’s true and lawful attorneys-in-fact
and agents, with full power of substitution and resubstitution, for such person and in such person’s name, place
and stead, in any and all capacities, to sign any and all amendments to this annual report on Form 10-K, and to
file the same, with all exhibits thereto, and all other documents in connection therewith, with the Securities and
Exchange Commission, granting unto each said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of them or their or such person’s substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by

the following persons on behalf of the Registrant and in the capacities on March 30th, 2020.

/s/ Gary Friedman

Gary Friedman
Chairman of the Board of Directors and Chief
Executive Officer
(Principal Executive Officer)

/s/ Glenda Citragno

Glenda Citragno
SVP, Chief Accounting Officer
(Principal Accounting Officer)

/s/ Keith Belling

Keith Belling
Director

/s/ Mark Demilio

Mark Demilio
Director

/s/ Katie Mitic

Katie Mitic
Director

/s/ Leonard Schlesinger
Leonard Schlesinger
Director

174

/s/ Jack Preston

Jack Preston
Chief Financial Officer
(Principal Financial Officer)

/s/ Carlos Alberini

Carlos Alberini
Director

/s/ Eri Chaya

Eri Chaya
Director

/s/ Hilary Krane

Hilary Krane
Director

/s/ Ali Rowghani

Ali Rowghani
Director