Annual Reports

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  • 10-K (Apr 17, 2008)
  • 10-K (Apr 11, 2007)
  • 10-K (Feb 16, 2007)
  • 10-K (Apr 12, 2006)
  • 10-K (Apr 14, 2005)

 
Quarterly Reports

 
8-K

 
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Restoration Hardware 10-K 2006

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(MARK ONE)

x     Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended JANUARY 28, 2006

or

o     Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                   to                   

Commission file number 000-24261


RESTORATION HARDWARE, INC.

(Exact Name of Registrant as Specified in Its Charter)

DELAWARE

 

68-0140361

(State or Other Jurisdiction of

 

(IRS Employer

Incorporation or Organization)

 

Identification No.)

 

15 KOCH ROAD, SUITE J, CORTE MADERA, CA 94925
(Address of Principal Executive Offices) (Zip Code)

(415) 924-1005
(Registrant’s Telephone Number, Including Area Code)

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

Title of each class

 

Name of each exchange
on which registered

NONE

 

NONE

 

Securities registered pursuant to Section 12 (g) of the Act:

COMMON STOCK, $0.0001 PAR VALUE

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes    x 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. o Yes    x No

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 requirement for the past 90 days. x Yes    o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

Large accelerated filer   o

 

Accelerated filer   x

 

Non-accelerated filer   o

 

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

The aggregate market value of common stock, par value $0.0001 per share, held by non-affiliates of the registrant based on the closing price for the common stock on The Nasdaq National Market on the last business day of the registrant’s most recently completed fiscal second quarter (July 30, 2005), was approximately $305 million. For purposes of this calculation, the registrant has assumed that only shares beneficially held by executive officers and directors of the registrant are deemed shares held by affiliates of the registrant. This assumption of affiliate status is not necessarily a conclusive determination of affiliate status for any other purpose. 37,773,289 shares of the registrant’s common stock were outstanding on March 30, 2006.

 




This annual report on Form 10-K contains forward-looking statements that are based on the beliefs of, and estimates made by and information currently available to, our management. The words “believe,” “anticipate,” “expect,” “may,” “intend,” “plan” and similar expressions identify forward-looking statements. These statements are subject to risks and uncertainties. Actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in “Risk Factors” and elsewhere in this annual report on Form 10-K. We assume no obligation to update this information.

Documents Incorporated by Reference

Portions of the registrant’s proxy statement for its 2006 annual meeting of stockholders are incorporated by reference into Item 5 of Part II and Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K.

TABLE OF CONTENTS

 

 

 

PAGE

 

PART I

 

 

 

 

 

 

 

Item 1.

 

Business

 

 

3

 

 

Item 1A.

 

Risk Factors

 

 

5

 

 

Item 1B.

 

Unresolved Staff Comments

 

 

14

 

 

Item 2.

 

Properties

 

 

15

 

 

Item 3.

 

Legal Proceedings

 

 

15

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

15

 

 

PART II

 

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

16

 

 

Item 6.

 

Selected Financial Data and Other Non-Financial Information

 

 

17

 

 

Item 7.

 

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

 

 

18

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

32

 

 

Item 8.

 

Consolidated Financial Statements and Supplementary Data

 

 

33

 

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

 

57

 

 

Item 9A.

 

Controls and Procedures

 

 

57

 

 

Item 9B.

 

Other Information

 

 

58

 

 

PART III

 

 

 

 

 

 

 

Item 10.

 

Directors and Executive Officers of the Registrant

 

 

58

 

 

Item 11.

 

Executive Compensation

 

 

58

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

58

 

 

Item 13.

 

Certain Relationships and Related Transactions

 

 

58

 

 

Item 14.

 

Principal Accountant Fees and Services

 

 

58

 

 

PART IV

 

 

 

 

 

 

 

Item 15.

 

Exhibits and Consolidated Financial Statement Schedules

 

 

59

 

 

SIGNATURES

 

 

60

 

 

EXHIBIT INDEX

 

 

61

 

 

 

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PART I

ITEM 1.                BUSINESS

Restoration Hardware, Inc., and subsidiaries, (the “Company”, “we”, or “our”) is a specialty retailer of hardware, bathware, furniture, lighting, textiles, accessories and related merchandise that reflects our classic and authentic American point of view. We commenced business in 1979 as a purveyor of fittings and fixtures for older homes. Since then, we have evolved into a unique home furnishings retailer offering consumers an array of distinctive and high quality merchandise. Our merchandise strategy and our stores’ architectural style create a unique and attractive selling environment designed to appeal to an affluent, well educated, 35 to 60 year old customer. Our plan is to fill the void in the marketplace above the current home lifestyle retailers, and below the interior design trade.

We were incorporated in California in June 1987 and were reincorporated in Delaware in 1998. We operated 103 stores and six outlet stores in 30 states, the District of Columbia and Canada at January 28, 2006. We operate on a 52 - 53 week fiscal year ending on the Saturday closest to January 31. The fiscal years ended January 28, 2006 (“fiscal 2005”), January 29, 2005 (“fiscal 2004”), and January 31, 2004 (“fiscal 2003”) consisted of 52 weeks.

In addition to our retail stores, we operate a direct-to-customer (“direct”) sales channel, which includes both Catalog and Internet, and a wholly-owned furniture manufacturer. For additional information on our business segments, see Note 12 to our Consolidated Financial Statements in Part II, Item 8 of this annual report on Form 10-K.

We are a multi-channel business and our catalog distribution drives sales across our retail, catalog and Internet businesses. We use our catalog as our primary marketing vehicle, marketing to new customers and return customers, both in and outside the retail trade area. We believe our catalog is a key resource to further market our brand to all our current and new customers.

Since 2002, the Company history is as follows:

In 2002, we launched a new merchandising strategy which included new merchandise offerings, adjustments of overall product mix, and the remodeling of our stores in order to best present the new merchandise. In addition, to drive sales in our direct channels, we expanded our product assortment of catalog and Internet only items.

In 2003, we built on the prior year’s successful launch by refining and expanding our core merchandise offerings, which included premium textiles, bath fixtures and hardware, lighting, and furniture.

In 2004, we re-merchandised our furniture assortment and revamped our accessories offering. We also redesigned our catalog in 2004 to improve the presentation of our core businesses and more clearly communicate the quality positioning of our offerings. In addition, we opened our first outlet store.

In 2005, we remodeled the majority of our stores and opened one traditional retail store and five outlet stores. The remodeled stores enabled us to expand the merchandise offerings in certain core categories, particularly lighting and textiles, and present those offerings with more clarity and focus. The expansion of our outlet store strategy will enable us to more effectively liquidate overstocked, discontinued and damaged merchandise and over time, we believe will substantially reduce the need for the less productive warehouse sales events that we have historically held. During the year, we also continued to upgrade our management team, particularly in the area of operations.

Our customers have continued to respond positively to the new merchandise introductions presented in all channels. We believe the re-merchandising focus, the remodeling efforts and added operational leadership will provide a strong foundation for margin expansion, operational efficiencies and cost reductions, as well as provide a springboard for future growth.

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We make available free of charge through our website at www.restorationhardware.com under “Company Information” our annual reports on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; and amendments to these and other reports filed or furnished by us pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we file such materials with the Securities and Exchange Commission.

RETAIL STORES

Merchandising Mix

We offer a broad but carefully edited selection of merchandise that provides a consistent point of view throughout our stores. Our collection of merchandise, not traditionally found in a single store environment, includes hardware, bathware, furniture, lighting, textiles, accessories and related merchandise. Our merchandise mix also includes proprietary products selected from non-traditional distribution channels that appear unique to our customers.

Product Selection, Purchasing and Sourcing

We make merchandise purchases from over 400 vendors and source some of our furniture through our wholly-owned subsidiary, The Michaels Furniture Company, Inc. (“Michaels”). Our vendors include major domestic manufacturers, specialty niche manufacturers and importers. We maintain agents in China, England, France, Germany, India, Indonesia, Italy, Japan, Philippines, Portugal, Vietnam and Eastern Europe. Approximately 62% of our purchases are sourced from vendors located abroad. By sourcing a large proportion of products offshore, we seek to achieve increased buying effectiveness and ensure exclusivity for a portion of our product line. In many instances, we also work closely with our vendors to develop products that are unique to us.

DIRECT-TO-CUSTOMER—CATALOG AND INTERNET

Our catalog business complements our retail business by building customer awareness of our merchandise concepts, increasing customer traffic in our stores, enhancing brand image and acting as an effective advertising vehicle. In addition, we maintain a website, www.restorationhardware.com, designed to sell our products, promote consumer awareness of our brand and generate store traffic.

In fiscal 2005, we circulated approximately 1% more catalogs but approximately 19% more catalog pages than in fiscal 2004. We mail catalogs to persons with demographic profiles similar to those of our retail customers and who also possess previous mail order purchase histories. In fiscal 2005, approximately 61% of catalogs were circulated to past customers, and the remaining catalogs were mailed to prospects. These prospects were obtained primarily from customer lists of other high-end mail order companies sharing similar customer demographics. We outsource to a third party the fulfillment aspects of the direct-to-customer business, including customer service and non-furniture distribution.

THE MICHAELS FURNITURE COMPANY, INC. (“Michaels”)

Purchased by Restoration Hardware in 1998, Michaels offers a line of high quality furniture for the home and office. Specific product lines include bedroom, living room, dining room, home office and occasional items. Intercompany sales to Restoration Hardware represented all of Michaels’ total sales in fiscal 2005, fiscal 2004 and fiscal 2003, and this is expected to continue. Michaels is located in Sacramento, California.

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MANAGEMENT INFORMATION SYSTEMS

Our retail management information systems include integrated store, merchandising, distribution and financial systems. We utilize one vendor for our point-of-sale, merchandise management and warehouse management systems, and rely on that vendor for software support as well.

COMPETITION

The retail market is highly competitive. We compete against a diverse group of retailers ranging from specialty stores to traditional furniture stores and department stores. Our product offerings also compete with a variety of national, regional and local retailers. We compete with these and other retailers for customers, suitable retail locations, suppliers, qualified employees and management personnel. Many of our competitors have significantly greater financial, marketing and other resources. Moreover, increased competition may result, and has resulted, in potential or actual litigation between us and our competitors relating to such activities as competitive sales and hiring practices, exclusive relationships with key suppliers and manufacturers and other matters. As a result, increased competition may adversely affect our financial performance, and we cannot assure you that we will be able to compete successfully in the future.

We believe that our ability to compete successfully is determined by several factors, including, among other things, the strength of our management team, the breadth and quality of our product selection, effective merchandise presentation, customer service, pricing and store locations. Although we believe that we are able to compete favorably on the basis of these factors, we may not ultimately succeed in competing with other retailers in our market.

TRADEMARKS

We have registered our trademark “Restoration Hardware” in the United States of America, Mexico and Canada. Trademarks are generally valid as long as they are in use and their registrations typically can be renewed indefinitely so long as the marks are in use. Our trademark is of material importance to us.

EMPLOYEES

At January 28, 2006, we had approximately 1,600 full-time employees and 2,200 part-time employees. We consider our employee relations to be good.

ITEM 1A.        RISK FACTORS

We face a variety of risks that may affect our operations or financial results and many of those risks are driven by factors that we cannot control or predict. The following discussion addresses those risks that management believes are the most significant, although there may be other risks that could arise, or may prove to be more significant than expected, that may affect our operations or financial results.

Our success depends upon consumer responses to our product offerings; if we fail to successfully anticipate changes in consumer trends or consumers otherwise do not respond to our product offerings, our results of operations may be adversely affected.

Our success depends on consumer responses to our product offerings and our ability to anticipate and respond to changing merchandise trends and consumer demands in a timely manner. If, for example, consumers do not respond to our product offering or we misjudge market trends, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our operating results. Conversely, shortages of popular items could result in loss of potential sales revenue and have a material adverse effect on our operating results.

We believe there is a lifestyle trend toward increased interest in home renovation and interior decorating, and we further believe we are benefiting from such a trend. If this trend fails to continue to

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directly benefit us or if there is an overall decline in the trend, we could experience an adverse decline in consumer interest in our major product lines. Moreover, our products must appeal to a broad range of consumers whose preferences cannot always be predicted with certainty and may change between sales seasons. If we misjudge either the market for our merchandise or our customers’ purchasing habits, we may experience a material decline in sales or be required to sell inventory at reduced margins. We could also suffer a loss of customer goodwill if we do not maintain a high level of quality control and service procedures or if we otherwise fail to ensure satisfactory quality of our products. These outcomes may have a material adverse effect on our business, operating results and financial condition.

In addition, a material decline in sales and other adverse conditions resulting from our failure to accurately anticipate changes in merchandise trends and consumer demands could cause us to close underperforming stores. While we believe that we benefit in the long run financially by closing underperforming stores and reducing nonproductive costs, the closure of such stores would subject us to additional increased short-term costs including, but not limited to, employee severance costs, charges in connection with the impairment of assets and costs associated with the disposition of outstanding lease obligations. At January 28, 2006, we did not expect, and therefore did not reserve for, any store closures.

Our success is highly dependent on improvements to our planning, order acceptance and fulfillment and supply chain processes.

Our product mix is increasingly dependent upon the efficiency of our supply chain infrastructure and order acceptance and fulfillment processes. Our in store customer sales have recently consisted of higher percentages of merchandise that must be shipped to the customer or is custom ordered as we have refined our product offerings. Such transactions put additional pressure on our order acceptance and fulfillment processes. An important part of our efforts to achieve efficiencies, cost reductions and sales growth is the identification and implementation of improvements to our planning, logistical and distribution infrastructure and our supply chain, including merchandise ordering, transportation and receipt processing. An inability to improve our planning and supply chain processes or to take full advantage of supply chain opportunities could result in loss of potential sales revenue, increase our costs and have a material adverse effect on our operating results.

Because our revenue is subject to seasonal fluctuations, significant deviations from projected demand for products in our inventory during a selling season could have a material adverse effect on our financial condition and results of operations.

Our business is highly seasonal. We make decisions regarding merchandise well in advance of the season in which it will be sold, particularly for the holiday selling season. The general pattern associated with the retail industry is one of peak sales and earnings during the holiday season. Due to the importance of the holiday selling season, the fourth quarter of each fiscal year has historically contributed, and we expect it will continue to contribute, a disproportionate percentage of our net revenue and our gross profit for the entire fiscal year. In anticipation of increased sales activity during the fourth quarter, we incur significant additional expenses both prior to and during the fourth quarter. These expenses may include acquisition of additional inventory, catalog preparation and mailing, advertising, in-store promotions, seasonal staffing needs and other similar items. If, for any reason, our sales were to fall below our expectations in the fourth quarter, our business, financial condition and annual operating results may be materially adversely affected.

Increased catalog and other marketing expenditures without increased revenue may have a negative impact on our operating results.

Over the past several fiscal years, we have substantially increased the amount that we spend on catalog and other marketing costs, and we expect to continue to invest at these increased levels in the current fiscal year and in the future. As a result, if we misjudge the directions or trends in our market, we may expend large amounts of cash that generate little return on investment, which would have a negative effect on our operating results.

6




Our quarterly results fluctuate due to a variety of factors and are not a meaningful indicator of future performance.

Our quarterly results have fluctuated in the past and may fluctuate significantly in the future, depending upon a variety of factors, including, among other things, the mix of products sold, the timing and level of markdowns, promotional events, store openings, closings, seasonality, remodelings or relocations, shifts in the timing of holidays, timing of catalog releases or sales, timing of delivery of orders, competitive factors and general economic conditions. Accordingly, our profits or losses may fluctuate. Moreover, in response to competitive pressures, we may take certain pricing or marketing actions that could have a material adverse effect on our business, financial condition and results of operations. Therefore, we believe that period-to-period comparisons of our operating results are not necessarily meaningful and cannot be relied upon as indicators of future performance. If our operating results in any future period fall below the expectations of securities analysts or investors, or if our operating results do not meet the guidance that we issue from time to time, the market price of our shares of common stock would likely decline.

Fluctuations in comparable store sales may cause our revenue and operating results from period-to-period to vary.

A variety of factors affect our comparable store sales including, among other things, the general retail sales environment, our ability to efficiently source and distribute products, changes in our merchandise mix, promotional events, the impact of competition, the timing of delivery of orders and our ability to execute our business strategy efficiently. Our comparable store sales decreased 0.3% in fiscal 2005. Past comparable store sales results may not be indicative of future results. As a result, the unpredictability of our comparable store sales may cause our revenue and operating results to vary from quarter to quarter, and an unanticipated decline in comparable store sales may cause our stock price to fluctuate.

We depend on a number of key vendors to supply our merchandise and provide critical services, and the loss of any one of our key vendors may result in a loss of sales revenue and significantly harm our operating results.

We make merchandise purchases from over 400 vendors. Our performance depends on our ability to purchase our merchandise in sufficient quantities at competitive prices. Our smaller vendors generally have limited resources, production capacities and operating histories, and some of our vendors have limited the distribution of their merchandise in the past. We have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products, and any vendor or distributor could discontinue selling to us at any time. We may not be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future, or be able to develop relationships with new vendors to expand our offerings or replace discontinued vendors. Our inability to acquire suitable merchandise in the future or the loss of one or more key vendors and our failure to replace any one or more of them may have a material adverse effect on our business, results of operations and financial condition.

In addition, a single vendor supports our point-of-sale, merchandise management and warehouse management systems. We also rely on the same vendor for software support. A failure by this vendor to adequately support our management information systems in the future could have a material adverse effect on our business, results of operations and financial condition.

We routinely purchase products from new vendors, many of whom are located abroad. We cannot assure you that they will be reliable sources of our products. Moreover, a number of these manufacturers and suppliers are small and undercapitalized firms that produce limited numbers of items. Given their limited resources, these firms might be susceptible to production difficulties, quality control issues and problems in delivering agreed-upon quantities on schedule. We cannot assure you that we will be able, if

7




necessary, to return products to these suppliers and manufacturers and obtain refunds of our purchase price or obtain reimbursement or indemnification from them if their products prove defective. These suppliers and manufacturers also may be unable to withstand a downturn in the U.S. or worldwide economy. Significant failures on the part of these suppliers or manufacturers could have a material adverse effect on our operating results.

In addition, many of these suppliers and manufacturers require extensive advance notice of our requirements in order to produce products in the quantities we desire. This long lead time requires us to place orders far in advance of the time when certain products will be offered for sale, thereby exposing us to risks relating to shifts in customer demands and trends, and any downturn in the U.S. economy.

Operational difficulties in any of our distribution and order acceptance and fulfillment operations would materially affect our operating results.

A growing percentage of our business depends upon the successful operation of our distribution and order acceptance and fulfillment services either because the business is generated through our Catalog and Internet channels or because the customer’s purchase in the store must be completed through a shipment of product to the customer. The distribution functions for our stores as well as all of our furniture orders are currently handled from our facilities in Hayward and Tracy, California and Baltimore, Maryland. Operational difficulties such as a significant interruption in the operation of any of these facilities may delay shipment of merchandise to our stores and our customers, damage our reputation or otherwise have a material adverse effect on our financial condition and results of operations. Moreover, a failure to successfully coordinate the operations of these facilities could also have a material adverse effect on our financial condition and results of operations. Separately, significant disruptions to the operations of the third party vendor who handles, among other things, the distribution and fulfillment functions for our direct-to-customer business on an outsourced basis could be expected to have similar negative consequences.

Labor activities could cause labor relations difficulties for us.

As of January 28, 2006, we had approximately 3,800 full and part-time employees, and while we believe our relations with our employees are generally good, we cannot predict the effect that any future organizational 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.

We are dependent on external funding sources, including the terms of our revolving credit facility, which may not make available to us sufficient funds when we need them.

We have significantly relied and may rely in the future on external funding sources to finance our operations and growth. Any reduction in cash flow from operations could increase our external funding requirements to levels above those currently available to us. While we currently have in place a $150.0 million revolving credit facility, the amount available under this facility will be less than the stated amount (i) if there is a shortfall in the availability of eligible collateral to support the borrowing base and reserves as established by the terms of the revolving credit facility and (ii) at times when we are not in compliance with the requirements of the fixed charge coverage ratio for us to access incremental advances under the credit facility when the remaining availability for additional borrowing under the facility is less than 10% of the applicable borrowing base for the line of credit at the time . We currently believe that our cash flow from operations and funds available under our revolving credit facility will satisfy our capital and operating requirements for at least the next 12 months. However, the weakening of, or other adverse developments concerning our sales performance or adverse developments concerning the availability of credit under our revolving credit facility due to covenant limitations or other factors could limit the overall amount of funds available to us.

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Our revolving credit facility provides for incremental advances with availability determined from the application of a higher advance rate on eligible inventory and eligible accounts receivables. In order to obtain these incremental advances, we are required to maintain a minimum fixed charge coverage ratio if the remaining availability for additional borrowing under the facility is less than 10% of the applicable borrowing base for the line of credit at the time.

Our revolving credit facility also contains a clause which allows our lenders to forego additional advances should they determine there has been a material adverse change in our operations, business, properties, assets, liabilities, condition or prospects or a condition or event that is reasonably likely to result in a material adverse change in our financial position or prospects reasonably likely to result in a material adverse effect on our business, condition (financial or otherwise), operations, performance or properties taken as a whole. However, our lenders have not notified us of any indication that a material adverse effect exists at January 28, 2006 or that a material adverse change has occurred. We believe that no material adverse change has occurred and we believe that we will continue to borrow on the line of credit subject to its terms and conditions of availability in order to fund our operations over the term of the revolving credit facility which expires in June 2009. We do not anticipate any changes in our business practices that would result in any determination that there has been a material adverse effect in our operations, business, properties, assets, liabilities, condition or prospects. However, we cannot be certain that our lenders will not make such a determination in the future.

We may experience cash flow shortfalls in the future and we may otherwise require additional external funding beyond the amounts available under our revolving credit facility. However, we cannot assure you that we will be able to raise funds on favorable terms, if at all, or that future financing requirements would not be dilutive to holders of our capital stock. In the event that we are unable to obtain additional funds on acceptable terms or otherwise, we may be unable or determine not to take advantage of new opportunities or defer on taking other actions that otherwise may be important to our operations. Additionally, we may need to raise funds to take advantage of unanticipated opportunities. We also may need to raise funds to respond to changing business conditions or unanticipated competitive pressures. 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.

Because our business requires a substantial level of liquidity, we are dependent upon a revolving credit facility with certain restrictive covenants that limit our flexibility.

Our business requires substantial liquidity in order to finance inventory purchases, the employment of sales personnel for the peak holiday period, mailings of catalogs and other advertising costs for the holiday buying season and other similar advance expenses. As described above, we currently have in place a revolving credit facility that provides for an overall commitment of $150.0 million. Over the past several years, we have entered into modifications, amendments and restatements of this revolving credit facility, primarily to address changes in the requirements applicable to us under the revolving credit facility documents, and, most recently, to increase the stated amount of commitment under the facility amongst other things.

Covenants in the revolving credit facility include, among others, ones that limit our ability to incur additional debt, make liens, make investments, consolidate, merge or acquire other businesses, sell assets, pay dividends or other distributions, and enter into transactions with affiliates. In addition, the incremental advance portion of our revolving credit facility includes a fixed charge coverage ratio covenant that is expected to limit our ability to access incremental advances during certain months of the year. Although we have been able to obtain incremental advances when needed to provide the capital required for our business to date, there may be times in the future when the terms and conditions of availability for our line of credit, including the restrictions applicable to the incremental advance provisions, would limit our ability

9




to access working capital as and to the extent we require for the operation of our business, potentially having an adverse affect on our results of operation.

These covenants restrict numerous aspects of our business. The revolving credit facility also includes a borrowing base formula (which includes an adjustment to the advance rate against eligible inventory and eligible accounts receivable for incremental advances as described above) to address the availability of credit at any given time based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, in each case, subject to the overall aggregate cap on borrowings. Consequently, for purposes of the borrowing base formula, the value of eligible inventory and eligible accounts receivable may limit our ability to borrow under the revolving credit facility.

We have drawn upon the revolving credit facility in the past and we expect to draw upon it in the future. Failure to comply with the terms of the revolving credit facility would entitle the secured lenders to prevent us from further borrowing, and upon acceleration by the lenders, they would be entitled to begin foreclosure procedures against our assets, including accounts receivable, inventory, general intangibles, equipment, goods, and fixtures. The secured lenders would then be repaid from the proceeds of such foreclosure proceedings, using all available assets. Only after such repayment and the payment of any other secured and unsecured creditors would the holders of our capital stock receive any proceeds from the liquidation of our assets. Our ability to comply with the terms of the revolving credit facility may be affected by events beyond our control.

Future increases in interest and other expense may impact our future operations.

High levels of interest and other expense have had in the past, and could have in the future, negative effects on our operations. An increase in the variable interest rate under our revolving credit facility, coupled with an increase in our outstanding debt, could result in material amounts otherwise available for other business purposes being used to pay for interest expense.

Our ability to continue to meet our future debt and other obligations and to minimize our average debt level depends on our future operating performance and on economic, financial, competitive and other factors. Many of these factors are beyond our control. In addition, we may need to incur additional indebtedness in the future. We cannot assure you that our business will generate sufficient cash flow or that future financings will be available to provide sufficient proceeds to meet our needs or obligations or to service our total debt.

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

During fiscal 2005, we purchased approximately 62% of our merchandise directly from vendors located abroad. As an importer, our future success will depend in large measure upon our ability to maintain our existing foreign supplier relationships and to develop new ones. While we rely on our long-term relationships with our foreign vendors, we have no long-term contracts with them. Additionally, many of our imported products are subject to existing duties, tariffs and quotas that may limit the quantity of some types of goods which we may import into the United States of America. 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 of America, changes in import duties, tariffs and quotas, loss of “most favored nation” trading status by the United States of America in relation to a particular foreign country, 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 of America, freight cost increases, economic uncertainties, including inflation, foreign government regulations, and political unrest and trade restrictions, including the United States of America retaliating

10




against protectionist foreign trade practices. Furthermore, some or all of our foreign vendors’ operations may be adversely affected by political, financial or other instabilities that are particular to their home countries, including without limitation local acts of terrorism or economic, environmental or health and welfare-related crises, which may in turn result in limitations or temporary or permanent halts to their operations, restrictions on the transfer of goods or funds and/or other trade disruptions. If any of these or other factors were to render the conduct of business in particular countries undesirable or impractical, our financial condition and results of operations could be materially adversely affected.

While we believe that we could find alternative sources of supply, 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. Moreover, products from alternative sources may be of lesser quality and/or more expensive than those we currently purchase, resulting in reduction or loss of our profit margin on such items.

As an importer we are subject to the effects of currency fluctuations related to our purchases of foreign merchandise.

While most of our purchases outside of the United States of America currently are settled in U.S. dollars, it is possible that a growing number of them in the future may be made in currencies other than the U.S. dollar. Historically, we have not hedged our currency risk and we do not currently anticipate doing so in the future. However, because our financial results are reported in U.S. dollars, fluctuations in the rates of exchange between the U.S. dollar and other currencies may decrease our sales margins or otherwise have a material adverse effect on our financial condition and results of operations in the future.

Rapid growth in our direct-to-customer business may not be sustained and may not generate a corresponding increase in profits to our business.

For fiscal 2005, revenue through our direct-to-customer channel grew by 34% as compared to the prior fiscal year. Increased activity in our direct-to-customer business could result in material changes in our operating costs, including increased merchandise inventory costs and costs for paper and postage associated with the distribution and shipping of catalogs and products. Although we intend to attempt to mitigate the impact of these increases by improving sales revenue and efficiencies, we cannot assure you that we will succeed in mitigating expenses with increased efficiency or that cost increases associated with our direct-to-customer business will not have an adverse effect on the profitability of our business. Additionally, while we outsource to a third party the fulfillment of our direct-to-customer division, including customer service and non-furniture distribution, the third party may not have the capacity to accommodate our growth. This lack of capacity may result in delayed customer orders and deficiencies in customer service, both of which may adversely affect our reputation, cause us to lose sales revenue and limit or counter recent growth in our direct-to-customer business.

We depend on key personnel and could be affected by the loss of their services because of the limited number of qualified people in our industry.

The success of our business will continue to depend upon our key personnel, including our Chairman, President, and Chief Executive Officer, Gary Friedman. We recently announced the intention of our Chief Operating Officer to resign and that we have commenced a search for a new Chief Operating Officer. Competition for qualified employees and personnel in the retail industry is intense. The process of locating 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, in particular store managers, and upon the continued contributions of these people. We cannot assure you that we will be successful in attracting and retaining qualified executives and personnel. In addition, our employees may voluntarily terminate their

11




employment with us at any time. We do not maintain any key man life insurance. The loss of the services of key management personnel, employee turnover in important areas of our business or our failure to attract additional qualified personnel or effectively handle management transitions could have a material adverse effect on our business, financial condition and results of operations.

Regulatory changes may increase our costs.

Changes in the laws, regulations and rules affecting public companies may increase our expenses in connection with our compliance with these new requirements. Compliance with these new requirements could also result in continued diversion of management’s time and attention, which could prove to be disruptive to normal business operations. Further, the impact of these laws, regulations and rules and activities in response to them could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers, which could harm our business.

Changes in general economic conditions affect consumer spending and may significantly harm our revenue and results of operations.

The success of our business depends to a significant extent upon the level of consumer spending. A number of economic conditions affect the level of consumer spending on merchandise that we offer, including, among other things, the general state of the economy, general business conditions, the level of consumer debt, interest rates, rising oil prices, taxation and consumer confidence in future economic conditions. More generally, reduced consumer confidence and spending may result in reduced demand for discretionary items and luxury retail products, such as our products. Reduced consumer confidence and spending also may result in limitations on our ability to increase prices and may require increased levels of selling and promotional expenses. Adverse economic conditions and any related decrease in consumer demand for discretionary items such as those offered by us could have a material adverse effect on our business, results of operations and financial condition.

We face an extremely competitive specialty retail business market.

The retail market is highly competitive. We compete against a diverse group of retailers ranging from specialty stores to traditional furniture stores and department stores. Our product offerings also compete with a variety of national, regional and local retailers. We compete with these and other retailers for customers, suitable retail locations, suppliers, qualified employees and management personnel. Many of our competitors have significantly greater financial, marketing and other resources. Moreover, increased competition may result, and has resulted in the past, in potential or actual litigation between us and our competitors relating to such activities as competitive sales and hiring practices, exclusive relationships with key suppliers and manufacturers and other matters. As a result, increased competition may adversely affect our future financial performance, and we cannot assure you that we will be able to compete successfully in the future.

We believe that our ability to compete successfully is determined by several factors, including, among other things, the breadth and quality of our product selection, effective merchandise presentation, customer service, pricing and store locations. Although we believe that we are able to compete favorably on the basis of these factors, we may not ultimately succeed in competing with other retailers in our market.

Terrorist attacks, war, natural disasters and other catastrophic events may negatively impact all aspects of our operations, revenue, costs and stock price.

Threats of terrorist attacks in the United States of America, as well as future events occurring in response to or in connection with them, including, without limitation, future terrorist attacks or threats against United States of America targets, rumors or threats of war, actual conflicts involving the United States of America or its allies, including the on-going U.S. conflicts in Iraq and Afghanistan, further

12




conflicts in the Middle East and in other developing countries, or military or trade disruptions affecting our domestic or foreign suppliers of merchandise, may impact our operations. Our operations also may be affected by natural disasters or other similar events, including floods, hurricanes, earthquakes, or fires. The potential impact of any of these events to our operations includes, among other things, delays or losses in the delivery of merchandise to us or our customers and decreased sales of the products we carry. Additionally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the United States of America and worldwide financial markets and economies. Also, any of these events could result in economic recession in the United States of America or abroad. Any of these occurrences could have a significant impact on our operating results, revenue and costs and may result in the volatility of the future market price of our common stock.

Our common stock price may be volatile.

The market price of our common stock has fluctuated significantly in the past, and is likely to continue to be highly volatile. In addition, the trading volume in our common stock has fluctuated, and significant price variations can occur as a result. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. In addition, the United States of America equity markets have from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the stocks of companies such as ours. These broad market fluctuations may materially adversely affect the market price of our common stock in the future. Variations in the market price of our common stock may be the result of changes in the trading characteristics that prevail in the market for our common stock, including low trading volumes, trading volume fluctuations and other similar factors that are particularly common among highly volatile securities. Variations also may be the result of changes in our business, operations or prospects, announcements or activities by our competitors, entering into new contractual relationships with key suppliers or manufacturers by us or our competitors, proposed acquisitions by us or our competitors, financial results that fail to meet our guidance or public market analysts’ expectations, changes in stock market analysts’ recommendations regarding us, other retail companies or the retail industry in general, and domestic and international market and economic conditions.

Future sales of our common stock in the public market could adversely affect our stock price and our ability to raise funds in new equity offerings.

We cannot predict the effect, if any, that future sales of shares of our common stock or the availability for future sale of shares of our common stock or securities convertible into or exercisable for our common stock will have on the market price of our common stock prevailing from time to time. For example, in connection with our March 2001 preferred stock financing, we filed a registration statement on Form S-3 with the Securities and Exchange Commission to register approximately 6.4 million shares of our common stock issued, or to be issued, upon the conversion of our Series A preferred stock to some of our stockholders. The registration statement was declared effective by the Securities and Exchange Commission on October 31, 2002 and may remain effective under certain circumstances until as long as March 2009. During fiscal 2005, the remaining holders of the Series A preferred stock elected to convert their shares of Series A preferred stock into common stock. Sale, or the availability for sale, of substantial amounts of common stock by our existing stockholders pursuant to an effective registration statement or under Rule 144, through the exercise of registration rights or the issuance of shares of common stock upon the exercise of stock options, or the conversion of our preferred stock, or the perception that such sales or issuances could occur, could adversely affect prevailing market prices for our common stock and could materially impair our future ability to raise capital through an offering of equity securities.

13




Newly adopted accounting regulations that require companies to expense stock options will result in a decrease in our earnings and our stock price may decline.

The Financial Accounting Standards Board (“FASB”) recently adopted regulations that will eliminate the Company’s ability to account for share-based compensation transactions using the intrinsic method and would require that such transactions be accounted for using a fair-value-based method and be recognized as an expense in our Consolidated Statement of Operations. We are required to expense stock options effective in periods beginning after January 28, 2006. For prior periods, we only disclosed such expenses on a pro forma basis in the Notes to our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America. Effective with the beginning of the first quarter of fiscal 2006, we will adopt Statement of Financial Accounting Standards No. 123 (R) (“SFAS 123(R)”) using the modified prospective method. Under this method, the unvested portions of previously granted share-based payments, as well as the fair value of awards granted after adoption are included in operating expenses over the appropriate service period. We have decided to use the Black Scholes model to estimate the fair value of our stock options, unless additional information becomes available in the future that indicates another model would be more appropriate for us, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model. Based on stock options granted to employees through January 28, 2006, we expect the adoption of SFAS 123(R) will increase first quarter expenses by approximately $1.3 million ($0.03 per share, basic) and increase full year fiscal 2006 expenses by approximately $4.0 million ($0.11 per share, basic).

We are subject to anti-takeover provisions and other terms and conditions that could delay or prevent an acquisition and could adversely affect the price of our common stock.

Our Second Amended and Restated Certificate of Incorporation, as amended, and Amended and Restated Bylaws, certain provisions of Delaware law and the Certificate of Designation governing the rights, preferences and privileges of our preferred stock may make it difficult in some respects to cause a change in control of our Company and replace incumbent management. For example, our Second Amended and Restated Certificate of Incorporation, as amended, and Amended and Restated Bylaws provide for a classified board of directors. With a classified board of directors, at least two annual meetings of stockholders, instead of one, will generally be required to effect a change in the majority of the board. As a result, a provision relating to a classified board may discourage proxy contests for the election of directors or purchases of a substantial block of our common stock because its provisions could operate to prevent obtaining control of the board in a relatively short period of time.

In addition our board of directors has the authority to fix the rights and preferences of, and to issue shares of, our preferred stock, which may have the effect of delaying or preventing a change in control of our Company without action by holders of our common stock. These provisions may create a potentially discouraging effect on, among other things, any third party’s interest in completing a merger, consolidation, acquisition or similar type of transaction with us. Consequently, the existence of these anti-takeover provisions may collectively have a negative impact on the price of our common stock, may discourage third-party bidders from making a bid for our Company or may reduce any premiums paid to our stockholders for their common stock.

ITEM 1B.       UNRESOLVED STAFF COMMENTS

None.

14




ITEM 2.                PROPERTIES

We currently lease approximately 112,000 square feet of space for use as our headquarters, including approximately 44,000 square feet of warehouse space, located in Corte Madera, California. The leases for this space expire between April 2006 and May 2010. We lease approximately 7,000 square feet of office space in New York, New York. The lease for this space expires between May 2006 and January 2011.

As of January 28, 2006, we leased space in three separate distribution facilities and outsourced the distribution efforts for non-furniture in the direct-to-customer channel. We lease approximately 160,000 square feet of warehouse space in Hayward, California, which primarily supports our non-furniture distribution for the west coast of the United States of America. This lease expires in October 2006 with an option to extend for a twelve-month term. We lease approximately 284,000 square feet of warehouse space in Tracy, California, which acts as a furniture distribution center. The lease for this facility expires in September 2011, with an option to renew for one additional five-year term. We also lease approximately 508,000 square feet of warehouse space in Baltimore, Maryland, for use as our east coast distribution center. The lease for this space expires in September 2008.

As of January 28, 2006, we leased approximately 1,263,000 gross square feet for our 103 retail stores, six outlet stores, and an outlet store that will open in April 2006. The initial lease term of our retail stores generally range from 10 to 20 years. Certain leases contain renewal options for up to 15 years. Most leases for our retail stores provide for a minimum rent, typically including escalating rent increases, plus a percentage rent based upon sales after certain minimum thresholds are achieved. The leases generally require us to pay insurance, utilities, real estate taxes and repair and maintenance expenses.

In connection with our wholly-owned furniture manufacturing subsidiary, Michaels, we lease two properties used for the manufacturing and storage of furniture, in Sacramento, California. We lease one of the properties from the previous owner and current president of Michaels. The main property consists of approximately 100,000 square feet of manufacturing space and 7,000 square feet of office space. The lease expires in February 2008, with options to extend the lease for two additional five-year terms. The second property consists of approximately 46,000 square feet of warehouse space, which is used to house finished goods. This lease expires in July 2006.

We intend to renew those leases expiring in the near term.

ITEM 3.                LEGAL PROCEEDINGS

There are no material pending legal proceedings against us. We are, however, involved from time to time in legal proceedings, including litigation arising in the ordinary course of our business. At the present time, we believe no legal proceedings will have a material adverse effect on our financial condition or results of operations. However, we cannot assure you that the results of any proceeding will be in our favor. Moreover, due to the uncertainties inherent in any legal proceeding, we cannot accurately predict the ultimate outcome of any proceeding and may incur substantial costs to defend the proceeding, irrespective of the merits. The unfavorable outcome of any legal proceeding could have an adverse impact on our business, financial condition and results of operations.

ITEM 4.                SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this annual report on Form 10-K.

15




PART II

ITEM 5.                MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

MARKET INFORMATION

Our common stock is listed on The Nasdaq National Market (“NASDAQ”) under the symbol “RSTO.” The closing price of our common stock on Nasdaq was $5.75 on March 30, 2006.

STOCKHOLDERS

As of March 30, 2006 there were 470 stockholders of record of our common stock. This number excludes stockholders whose stock is held in nominee or street name by brokers.

DIVIDEND POLICY

No dividends have been declared on our common stock since our 1998 initial public offering and it is not anticipated that we will pay any dividends in the foreseeable future on our common stock. In addition, restrictive covenants in our revolving credit facility limit our ability to pay dividends.

STOCK PRICE INFORMATION

Set forth below are the high and low closing sale prices for shares of our common stock for each quarter during the fiscal years ended January 28, 2006 and January 29, 2005, as reported by The Nasdaq National Market.

Quarter Ending

 

 

 

High

 

Low

 

May 1, 2004

 

7.25

 

3.57

 

July 31, 2004

 

8.00

 

4.99

 

October 30, 2004

 

6.68

 

4.82

 

January 29, 2005

 

6.37

 

4.87

 

April 30, 2005

 

6.71

 

5.05

 

July 30, 2005

 

9.00

 

5.63

 

October 29, 2005

 

8.63

 

5.47

 

January 28, 2006

 

6.60

 

4.94

 

 

Information relating to the securities authorized for issuance under equity compensation plans will be set forth in the section with the caption “Equity Compensation Plan Information” in our definitive proxy statement. This information is incorporated herein by reference.

16




ITEM 6.                SELECTED FINANCIAL DATA AND OTHER NON-FINANCIAL INFORMATION

The following table sets forth selected, consolidated financial information and other non-financial information as of and for the years indicated. This information is qualified by reference to, and should be read in conjunction with, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Consolidated Financial Statements, related notes thereto and other financial data included elsewhere in this annual report on Form 10-K. The following results may not be indicative of our future operating results.

 

 

Fiscal Year

 

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

(Dollars in thousands, except per share and selected operating data)

 

 

 

 

 

 

 

 

 

 

 

 

Results of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

581,657

 

$

525,823

 

$

438,508

 

$

400,337

 

$

366,473

 

 

(Loss) income before income taxes

 

(3,106

)

1,604

 

(4,029

)

(10,864

)

(39,704

)

 

Net (loss) income

 

(29,307

)

1,704

 

(2,518

)

(2,845

)

(32,136

)

 

(Loss) income attributable to common stockholders

 

(29,307

)

1,704

 

(2,518

)

(3,203

)

(34,953

)

 

(Loss) income per common stock—basic

 

$

(0.83

)

$

0.05

 

$

(0.08

)

$

(0.11

)

$

(1.49

)

 

(Loss) income per common stock—diluted

 

$

(0.83

)

$

0.04

 

$

(0.08

)

$

(0.11

)

$

(1.49

)

 

Financial Position:

 

 

 

 

 

 

 

 

 

 

 

 

Working capital

 

$

87,483

 

$

51,791

 

$

52,097

 

$

49,398

 

$

56,094

 

 

Total assets

 

274,268

 

279,263

 

233,895

 

228,135

 

209,460

 

 

Line of credit & other current debt

 

 

33,819

 

10,286

 

13,909

 

 

 

Long term debt and other long-term obligations

 

58,177

 

143

 

352

 

144

 

3,236

 

 

Redeemable convertible preferred stock

 

 

8,331

 

8,541

 

13,328

 

14,106

 

 

Stockholders’ equity

 

$

80,132

 

$

99,286

 

$

96,532

 

$

90,142

 

$

84,105

 

 

Retail Stores:

 

 

 

 

 

 

 

 

 

 

 

 

Store count at year-end(1)

 

103

 

102

 

103

 

105

 

104

 

 

Comparable store sales (decline) growth(2)

 

(0.3

)%

7.8

%

5.2

%

6.2

%

(4.6

)%

 

Store selling square feet at year-end(1)

 

685,672

 

676,520

 

679,300

 

688,634

 

682,936

 

 

Direct-to-Customer:

 

 

 

 

 

 

 

 

 

 

 

 

Total direct-to-customer net revenue

 

$

159,991

 

$

118,990

 

$

67,899

 

$

44,705

 

$

33,647

 

 

Net revenue growth percentage

 

34

%

75

%

52

%

33

%

49

%

 


(1)          Store count at year-end excludes the outlet locations. At January 28, 2006 and January 29, 2005, the Company had six outlets and one outlet, respectively.

(2)          Comparable store sales are defined as sales from stores whose gross square footage did not change by more than 20% in the previous 12 months and which have been open at least 12 full months and excludes warehouse and outlet store sales.

17




ITEM 7.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Our Company, Restoration Hardware, Inc. (Nasdaq: RSTO), together with our subsidiaries, is a specialty retailer of high quality bathware, hardware, lighting, furniture, textiles and accessories that reflect our classic and authentic American point of view. We commenced business in 1979 as a purveyor of fittings and fixtures for older homes. Since then, we have evolved into a unique home furnishings retailer offering consumers an array of distinctive and high quality merchandise. We market our merchandise through retail locations, mail order catalogs and on the Internet at www.restorationhardware.com.

Our merchandise strategy and our stores’ architectural style create a unique and attractive selling environment designed to appeal to an affluent, well-educated, 35 to 60 year old customer. Over the next decade, we believe the fastest growing segment of the U.S. population will be 45 to 60 year olds. We believe that as these customers evolve, so will their purchasing needs and desires. We believe that our products can fulfill their aspirations to have homes designed with a high quality, classic and timeless style. Our plan is to fill the void in the marketplace above the current home lifestyle retailers, and below the interior design trade, by providing products targeted to 35 to 60 year olds and centered around our core businesses that reflect a predictable, high-quality promise to our customers.

We operate on a 52 - 53 week fiscal year ending on the Saturday closest to January 31. Our current fiscal year ended on January 28, 2006 (“fiscal 2005”), the prior fiscal year ended on January 29, 2005 (“fiscal 2004”) and the prior fiscal year ended on January 31, 2004 (“fiscal 2003”). Fiscal 2005, 2004 and 2003 each consisted of 52 weeks.

As of January 28, 2006, we operated 103 stores and six outlet stores in 30 states, the District of Columbia and Canada. In addition to our retail stores, we operate a direct-to-customer (“direct”) sales channel that includes both catalog and Internet, and a wholly-owned furniture manufacturer.

Over the past several years, we have made significant progress in our evolution.

·       In 2002, we began the transformation required to reposition our brand. This included new merchandise offerings, the adjustment of our overall product mix, and also the remodeling of our stores in order to best present the new merchandise. In addition, to drive sales in our direct channels, we expanded our product assortment of catalog and internet only items.

·       In 2003, we built on the prior year’s successful launch by further refining and expanding our core merchandise offerings, including the repositioning of our premium textiles, bath fixtures and hardware categories and enhancements in our lighting and furniture categories.

·       We re-merchandised our furniture assortment in 2004 and revamped our accessories offering. We also redesigned our catalog in fiscal 2004 to improve the presentation of our core businesses and more clearly communicate the quality positioning of our offerings.

In 2005, we finalized the major changes in our assortment with a repositioning of our lighting and window categories. In addition, our efforts focused on three key priorities:

·       Create dominant assortments in key categories.   We reconfigured our stores to appropriately present our repositioned lighting and window treatment categories. These changes, in addition to the remodeling work done in 2002, allow us to project dominance in our key core categories:  textiles, bath fixtures and hardware, lighting, and window treatments. Our Catalog and Internet presentations also reflected this improved presentation.

18




·       Maximize product margin opportunities.   We target core categories that are high-margin businesses. The product and merchandising differentiation we offer our customers, and our sourcing strategies, supports this margin improvement strategy. Additionally, we believe we can further strengthen the overall business’s margin through the use of outlet stores to liquidate overstocked and discontinued goods. In 2005, we expanded our outlet strategy by opening five new outlet stores. We believe these stores will help us efficiently and cost-effectively manage our inventories, reducing the need for the less productive warehouse sales events that we have historically held. In 2006, we intend to open an additional 2-3 outlet stores.

·       Strengthen the supply chain.   In 2005, we made progress on improving our in-stock position in key categories. Additionally, we began work on upgrading the systems and processes for placing and fulfilling customer orders. In 2006, we plan to continue this work.

The store remodeling program in 2005 required an investment of approximately $16.5 million and has been reflected as capital expenditures in our Consolidated Statements of Cash Flow. The effort also required the removal of some existing store fixtures. The cost of accelerating the depreciation associated with those fixtures of $1.6 million was fully expensed in the second quarter and reflected in selling, general and administrative expense in fiscal 2005.

In 2006, while we continue to drive further progress against our key priorities, we will also pursue brand category extensions such as the Restoration Hardware outdoor catalog which we initiated in the first quarter of 2006. In addition, we expect to test a new concept targeting a broader-value market with a catalog mailing in September.

On an ongoing basis, we evaluate stores for closure based on underperformance. During fiscal 2005, we did not close any underperforming stores. In fiscal 2005, we recorded a $0.3 million impairment charge on the long-lived assets of two underperforming stores. Cumulatively since fiscal 2001, we have closed nine stores. A material decline in sales and other adverse conditions resulting from our failure to accurately anticipate changes in merchandise trends and consumer demands may cause us to close additional underperforming stores. For fiscal 2006, we have no current plans to close any stores.

Summary Consolidated Statements of Operations

The following table sets forth for the periods indicated the amount and percentage of net revenue represented by certain line items in our Consolidated Statements of Operations:

 

 

Fiscal
2005

 

% of Net
Revenue

 

Fiscal
2004

 

% of Net
Revenue

 

Fiscal
2003

 

% of Net
Revenue

 

 

 

(Dollars in thousands, except per share data)

 

Retail net revenue

 

$

421,666

 

 

72.5

%

 

$

406,833

 

 

77.4

%

 

$

370,609

 

 

84.5

%

 

Direct-to-customer net revenue

 

159,991

 

 

27.5

 

 

118,990

 

 

22.6

 

 

67,899

 

 

15.5

 

 

Net revenue

 

581,657

 

 

100.0

 

 

525,823

 

 

100.0

 

 

438,508

 

 

100.0

 

 

Cost of revenue and occupancy

 

384,244

 

 

66.1

 

 

359,808

 

 

68.4

 

 

305,265

 

 

69.6

 

 

Gross profit

 

197,413

 

 

33.9

 

 

166,015

 

 

31.6

 

 

133,243

 

 

30.4

 

 

Selling, general and administrative expense

 

196,469

 

 

33.7

 

 

161,939

 

 

30.8

 

 

135,118

 

 

30.8

 

 

Income (loss) from operations

 

944

 

 

0.2

 

 

4,076

 

 

0.8

 

 

(1,875

)

 

(0.4

)

 

Interest expense, net

 

(4,050

)

 

(0.7

)

 

(2,472

)

 

(0.5

)

 

(2,154

)

 

(0.5

)

 

(Loss) income before income taxes

 

(3,106

)

 

(0.5

)

 

1,604

 

 

0.3

 

 

(4,029

)

 

(0.9

)

 

Income tax (expense) benefit

 

(26,201

)

 

(4.5

)

 

100

 

 

 

 

1,511

 

 

0.3

 

 

Net (loss) income

 

$

(29,307

)

 

(5.0

)

 

$

1,704

 

 

0.3

 

 

$

(2,518

)

 

(0.6

)

 

(Loss) income per share of common
stock—basic

 

$

(0.83

)

 

 

 

 

$

0.05

 

 

 

 

 

$

(0.08

)

 

 

 

 

(Loss) income per share of common
stock—diluted

 

$

(0.83

)

 

 

 

 

$

0.04

 

 

 

 

 

$

(0.08

)

 

 

 

 

 

19




2005 Results

Income from operations decreased to $0.9 million in fiscal 2005 from $4.1 million in fiscal 2004. We recorded a net expense for income taxes for fiscal 2005 of $26.2 million, which includes a full valuation allowance provided against our net deferred tax assets of $27.9 million. Net loss was $0.83 per share, or $29.3 million for fiscal 2005, compared to net income of $0.04 per fully diluted share, or $1.7 million, for fiscal 2004.

The decrease in operating results of $3.2 million to $0.9 million of income from operations in fiscal 2005 is primarily the result of a 290 basis point increase in selling, general, and administrative expense expressed as a percentage of revenue, offset by a 230 basis point improvement in cost of revenue and occupancy expressed as a percentage of revenue. Due to the expected growth of our direct-to-customer channel as a percentage of our total business mix, we believe that catalog circulation costs will continue to increase to support the growth, thus causing selling, general and administrative costs to continue deleveraging as a percentage of revenue in future quarters. Net revenue increased $55.8 million, or 11%, in fiscal 2005 as compared to fiscal 2004, which largely resulted from a $41.0 million, or 34%, increase in our direct-to-customer net revenue, and a $14.8 million increase in revenue generated from our retail segment. Comparable store sales for fiscal 2005 decreased 0.3%, or $1.2 million, compared to fiscal 2004. Net revenue related to our outlet stores and warehouse sales events was $18.2 million for fiscal 2005 compared to $5.7 million for fiscal 2004. Outlet store and warehouse sales events revenue is included in retail revenue, but is excluded from comparable store sales. The increase in net revenue in both our retail and direct channels can also be attributed to our focus on growing our catalog page count, as the catalog is our primary advertising vehicle.

The cost of revenue and occupancy increased by $24.4 million, or 7%, in fiscal 2005 as compared to fiscal 2004, primarily in support of our revenue growth. The 230 basis point expansion of our gross margin to 33.9% in fiscal 2005 from 31.6% in fiscal 2004 was attributable to continued improvements in our product margin of 120 basis points, a 100 basis point improvement in supply chain and distribution costs, and a 10 basis point improvement in occupancy costs as a percentage of net revenue. Selling, general and administrative expense increased $34.5 million, or 21%, in fiscal 2005 over fiscal 2004. As a percent of revenue, selling, general and administrative expense increased to 33.7% of net revenue in fiscal 2005 from 30.8% in fiscal 2004. This included the $1.6 million non-cash charge for the acceleration of depreciation of certain fixtures removed as part of the store remodeling effort, and expressed as a percentage of revenue, was higher than fiscal 2004. We also recorded a $0.3 million impairment charge on the long-lived assets of two underperforming stores. The increase of 290 basis points was driven primarily by a combination of higher catalog circulation costs expressed as a percent of revenue of 130 basis points, increased occupancy and related costs of 60 basis points, increased direct-to-customer call center and fulfillment costs of 50 basis points, increased other variable costs of 20 basis points, and a 30 basis point increase for the non-cash charge associated with the store remodeling efforts.

We recorded an income tax expense for fiscal 2005 of $26.2 million on a pre-tax loss of $3.1 million which included a fourth quarter non-cash charge of $27.9 million to provide a full valuation allowance against our net deferred tax assets. We concluded, under the guidance provided in Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”, that our cumulative losses through 2003 and our three year cumulative loss through 2005 necessitated providing a valuation allowance against our net deferred tax assets as of January 28, 2006. Under generally accepted accounting principles, when our results demonstrate a pattern of future profitability, in reversal of the current cumulative loss trend, this valuation allowance may be adjusted and may result in the reinstatement of all or a part of the net deferred tax assets. This fiscal 2005 adjustment will have no impact on our cash flow or future prospects, nor does it alter our 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. Due to

20




the valuation allowance provided against our net deferred tax assets, we do not expect any significant income tax benefit or expense for fiscal 2006.

2004 Results

Income from operations improved to $4.1 million in fiscal 2004 as compared to a loss from operations of $1.9 million in fiscal 2003. We recorded a net benefit for income taxes for the year of $0.1 million. This reflects the reduction of the income tax provision of $3.0 million from the reversal of the valuation allowance established in prior years, offset by $2.1 million of tax contingency and other adjustments. Net income was $0.04 per fully diluted share, or $1.7 million for fiscal 2004, compared to a net loss of $0.08 per share, or $2.5 million in fiscal 2003.

The improvement in the income from operations in fiscal 2004 of $6.0 million, to an income of $4.1 million as compared to a loss from operations of $1.9 million in fiscal 2003, is the result of cost leverage achieved on higher sales, expansion of product margins and leverage of store occupancy which was somewhat offset by increased costs of distribution. The increase in net revenue of $87.3 million in fiscal 2004 as compared to fiscal 2003, or 20%, resulted from a 7.8% increase in comparable store sales, and growth of our direct-to-customer business, which increased $51.1 million, or 75%, over fiscal 2003. The increase in comparable store sales over fiscal 2003 was driven by our brand-building initiatives for our core merchandise offerings and the growth of our catalog circulation, which is our primary advertising vehicle.

The cost of revenue and occupancy increased by $54.5 million in fiscal 2004 as compared to fiscal 2003, or 18%, primarily in support of our revenue growth. These costs rose at a lower rate than revenue as the expansion of product margins by 130 basis points and the leverage of our store occupancy costs of 220 basis points more than offset the higher costs that we continued to experience throughout most of fiscal 2004 in our distribution and supply chain activities of 230 basis points. Product margins expanded in 2004 due to continued shifts in our product mix to higher margin core businesses such as premium textiles, as well as cost improvements realized from the expansion of our international sourcing programs. The increase in selling, general and administrative expense of $26.8 million in fiscal 2004 over fiscal 2003, or 20%, was primarily incurred in support of higher sales. Approximately half of the increase was related to catalog production and mailing costs, with one fourth of the increase attributable to higher payroll costs. The remaining increase is primarily attributable to various selling related expense such as credit card fees and to a lesser extent administrative expenses including professional fees as well as brand advertising costs. As a percent of revenue we generated savings in store payroll costs which declined by approximately 90 basis points, reflecting continued management focus and the implementation of tools to manage payroll expense, as well as reductions in other store expenses. However, due to rapid growth in our direct-to-customer segment, higher levels of catalog production and mailing had the effect of deleveraging selling, general and administrative costs by 150 basis points and offset the improvements in payroll expense leverage realized in other cost areas. As a percent of revenue, selling, general and administrative expense remained at 30.8% of net revenue in fiscal 2004 and cost of revenue and occupancy improved 120 basis points to 68.4% of net revenue in fiscal 2004.

Our business is highly seasonal, which reflects a general pattern in the retail industry wherein the highest sales and earnings occur during the holiday season. Historically, a significant percentage of our sales have occurred in the fourth fiscal quarter. In our peak holiday selling season, we incur significant additional expenses in connection with, among other things, the hiring of additional seasonal employees in our retail stores and the production and mailing of a higher volume of our catalogs.

21




REVENUE AND SEGMENT RESULTS

Retail Net Revenue and Segment Results

 

 

Fiscal Year

 

 

 

2005

 

2004

 

2003

 

 

 

(Dollars in thousands)

 

Retail net revenue

 

$

421,666

 

$

406,833

 

$

370,609

 

Retail net revenue growth percentage

 

4

%

10

%

4

%

Comparable store sales (decline) growth

 

(0.3

)%

7.8

%

5.2

%

Income from retail operations

 

$

49,154

 

$

51,932

 

$

39,611

 

Income from retail operations—percent of retail net revenue

 

11.7

%

12.8

%

10.7

%

Number of retail stores at beginning of year

 

102

 

103

 

105

 

Number of retail stores opened

 

1

 

1

 

2

 

Number of retail stores closed

 

 

2

 

4

 

Number of retail stores at year-end

 

103

 

102

 

103

 

Retail store selling square feet at year-end

 

685,672

 

676,520

 

679,300

 

Number of outlet stores at year-end

 

6

 

1

 

 

 

Retail net revenue for fiscal 2005 increased by $14.8 million, or 4%, as compared to fiscal 2004, primarily due to a $12.6 million increase in revenue generated from our outlet stores. Comparable store sales for fiscal 2005 declined 0.3%, or $1.2 million, compared to fiscal 2004. Additionally, several previously opened stores, although not open long enough to be included in the calculation of comparable store sales, contributed approximately $7.3 million to fiscal 2005 results. Warehouse sales decreased by approximately $1.0 million compared to fiscal 2004, primarily due to the opening of additional outlet stores. Outlet store and warehouse sales revenue is included in retail revenue, but is excluded from comparable store sales. In the fourth quarter of fiscal 2004, we opened our first outlet store. During fiscal 2005 we opened five additional outlet stores. The expansion of our outlet store strategy enables us to more effectively liquidate overstocked, discontinued, damaged merchandise and over time, we believe will substantially reduce the need for the less productive warehouse sales events that we have historically held.

For fiscal 2005, income from operations for the retail segment decreased to $49.2 million from $51.9 million in fiscal 2004. As a percent of segment net revenue, income from operations for the retail segment decreased 110 basis points, to 11.7% of retail net revenue, as compared to 12.8% for the prior fiscal year. This decrease was primarily due to a 190 basis point increase in selling, general and administrative expense, somewhat offset by an 80 basis point improvement in gross margin. Selling, general and administrative expense for the segment increased by 190 basis points, due to a 110 basis point increase in store selling expenses, 40 basis points related to advertising costs and 40 basis points related to the $1.6 million remodeling non-cash charge. Gross margin improved 80 basis points from a combination of the following: supply chain and distribution cost savings of 90 basis points and an increase in product margin of 70 basis points, partially offset by an increase in store occupancy costs of 80 basis points as a percent of revenue. Income from operations for the retail segment includes the costs of retail stores results less the direct costs of the store field operations.

Retail net revenue for fiscal 2004 increased by $36.2 million, or 10%, from fiscal 2003 primarily due to a $27.7 million, or 7.8%, increase in comparable store sales. The 7.8% increase in comparable store sales in fiscal 2004 was driven primarily by strong performance in our core merchandise offerings.

Income from operations for the retail segment for fiscal 2004 was $51.9 million, as compared to $39.6 million in fiscal 2003. Income from operations for the retail segment, as a percent of segment revenue, increased 210 basis points, to 12.8% of retail net revenue from 10.7% of retail net revenue for fiscal 2003,

22




primarily due to occupancy cost leverage of 140 basis points from increases in comparable stores sales and improved margins, offset by higher costs of distribution.

Comparable store sales are defined as sales from stores whose gross square footage did not change by more than 20% in the previous 12 months and which have been open at least 12 full months. We believe that comparable store sales are a more useful indicator of store performance than the change in total net revenue, since comparable store sales exclude the effects of changes in the number of stores open. Revenue from outlet stores and warehouse sales events are not included in comparable store sales.

Direct-to-Customer Net Revenue and Segment Results

 

 

Fiscal Year

 

 

 

2005

 

2004

 

2003

 

 

 

(Dollars in thousands)

 

Catalog revenue

 

$

83,695

 

$

65,458

 

$

40,909

 

Internet revenue

 

76,296

 

53,532

 

26,990

 

Total direct-to-customer net revenue

 

$

159,991

 

$

118,990

 

$

67,899

 

Income from direct-to-customer operations

 

$

21,329

 

$

14,280

 

$

8,538

 

Income from direct-to-customer operations—percent of direct-to-customer net revenue

 

13.3

%

12.0

%

12.6

%

Growth percentages:

 

 

 

 

 

 

 

Direct-to-customer net revenue

 

34

%

75

%

52

%

Number of catalogs mailed

 

1

%

15

%

9

%

Pages circulated

 

19

%

48

%

40

%

 

Direct-to-customer (“direct”) net revenue consists of both Catalog and Internet sales. Direct net revenue for fiscal 2005 increased $41.0 million, or 34%, as compared to fiscal 2004. This increase was attributable to an expansion of the merchandise offerings in both the Catalog and on the Internet, as well as a continued focus on increasing Catalog and Internet only merchandise which drives improved response rates and catalog productivity.

For fiscal 2005, income from operations for the direct segment increased to $21.3 million, or 13.3% of segment net revenue, as compared to $14.3 million, or 12.0% of segment net revenue, for fiscal 2004. This increase of $7.0 million, or 49%, represents a 130 basis point improvement and is primarily the result of a 250 basis point increase in gross margin due to a 140 basis point improvement in supply chain and distribution costs and a 110 basis point improvement in product margin. This is offset by a 120 basis point increase in selling, general and administrative expense from higher payroll costs of 40 basis points, call center and fulfillment costs of 20 basis points, higher catalog circulation costs of 50 basis points, and higher other variable costs of 10 basis points. Income from operations for the direct segment reflects the results associated with Catalog and Internet sales, less direct management costs.

Direct net revenue during fiscal 2004 increased $51.1 million, or 75%, from fiscal 2003. A portion of this increase was the result of a 15% increase in the number of catalogs mailed in fiscal 2004, as well as a change in our product mix in the Catalog and an increase in Catalog-only furniture offerings. Additionally, we believe our website marketing efforts coupled with growing consumer familiarity with the Internet and growth in high-speed Internet consumers also helped drive customers to our website.

Income from operations for fiscal 2004 increased to $14.3 million, or 12.0%, of related segment net revenue, from $8.5 million, or 12.6%, of related segment net revenue for fiscal 2003, primarily due to the 75% increase in our revenue and improvements in our product margins of 20 basis points, offset by increases in selling general and administrative expense of 80 basis points primarily due to advertising costs related to catalog production and mailing costs.

23




EXPENSES

Cost of Revenue and Occupancy Expense

For fiscal 2005, cost of revenue and occupancy expense expressed as a percentage of net revenue improved approximately 230 basis points to 66.1%, from 68.4% in fiscal 2004. These improvements were attributable to a 120 basis point increase in product margins, a 100 basis point improvement in our supply chain and distribution costs and the decrease of relatively fixed store occupancy costs by 10 basis points.

In fiscal 2004, cost of revenue and occupancy expense expressed as a percentage of net revenue improved approximately 120 basis points to 68.4%, from 69.6% in fiscal 2003. These costs rose at a lower rate than revenue due to the expansion of product margins by 130 basis points and the leverage of our store occupancy costs of 220 basis points which more than offset the higher costs that we continued to experience throughout most of fiscal 2004 in our distribution and supply chain activities of 230 basis points.

Selling, General and Administrative Expense

Selling, general and administrative expense expressed in absolute dollars increased $34.5 million, to $196.5 million for fiscal 2005 from $161.9 million in fiscal 2004. Expressed as a percentage of net revenue, selling, general, and administrative expense increased to 33.7% for fiscal 2005 from 30.8% in fiscal 2004. The 290 basis point increase in expense was driven by higher catalog circulation costs expressed as a percent of revenue of 130 basis points, increased direct-to-customer call center and fulfillment costs as a percent of revenue of 50 basis points, increased occupancy and related costs of 60 basis points and 30 basis points for the $1.6 million non-cash charge for accelerated depreciation of certain fixtures associated with remodeling efforts. We expect that as the direct-to-customer channel revenue grows at a faster rate than retail revenue, the costs of catalog circulation will continue to have the effect of deleveraging selling, general and administrative expense as a percentage of net revenue, as occurred in fiscal 2005 and fiscal 2004.

Selling, general and administrative expense increased $26.8 million, to $161.9 million for fiscal 2004 from $135.1 million in fiscal 2003. Approximately half of the increase was related to catalog production and mailing costs, with one fourth of the increase attributable to higher payroll costs. Both of these increases were largely incurred in support of higher sales. The remaining increase is primarily attributable to various selling related expenses such as credit card fees and to a lesser extent administrative expenses including professional fees as well as brand advertising costs. Selling, general and administrative expense expressed as a percentage of net revenue was consistent at 30.8% for fiscal 2004 and 2003. We did generate savings in store payroll costs which declined by approximately 90 basis points, reflecting continued management focus and the implementation of tools to manage payroll expense, as well as reductions in other store expenses. However, due to rapid growth in our direct-to-customer segment, higher levels of catalog production and mailing had the effect of deleveraging selling, general and administrative costs by 150 basis points and offset the improvements in payroll expense leverage realized in other cost areas.

Interest Expense, Net

Interest expense, net includes interest on borrowings under our revolving credit facility and amortization of debt issuance costs. For fiscal 2005, interest expense, net was $4.1 million compared to $2.5 million in fiscal 2004. Of the $1.6 million increase, approximately half was due to higher average debt levels and approximately half was due to higher average interest rates year over year.

In fiscal 2004, interest expense, net was $2.5 million, an increase of $0.3 million as compared to $2.2 million in fiscal 2003. The increase was due to higher average borrowing rates and higher average borrowings outstanding.

24




Income Tax (Expense) Benefit

We recorded an income tax expense for fiscal 2005 of $26.2 million on a pre-tax loss of $3.1 million, which includes a full valuation allowance provided against our net deferred tax assets of $27.9 million.

Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be established when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence must be considered in judging the likelihood of realizing tax benefits. Forming a conclusion that a valuation allowance is not needed can be difficult when there is negative evidence such as cumulative losses in recent years. During the fourth quarter of fiscal 2005, it became evident that we would not meet our forecast of profitability in fiscal 2005, and this lessened the weight that we could assign to future prospects for returning to consistent profitability. That, combined with our history of losses through fiscal 2003 and cumulative losses for the last three years, represented sufficient negative evidence and it was difficult to overcome this with positive evidence under the evaluation guidance of SFAS No. 109. As a result of our assessment in applying SFAS 109, we concluded that a full valuation allowance against our net deferred tax assets was required as of January 28, 2006. The effect was to include a non-cash charge of $27.9 million in the fourth quarter of fiscal 2005. This adjustment will have no impact on our cash flow or future prospects, nor does it alter our 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. Due to the valuation allowance provided against our net deferred tax assets, we do not expect any significant income tax benefit or expense for the fiscal 2006.

In fiscal 2004 our effective tax rate was 6% compared to an effective tax rate of 38% in fiscal 2003. We recorded an income tax benefit for fiscal 2004 of $0.1 million on pre-tax income of $1.6 million. The fiscal 2004 income tax benefit reflects a net benefit of $0.9 million from the reversal of the valuation allowance established in prior years, somewhat offset by reserves established for certain income tax contingencies. Excluding these items, our effective tax rate would have been 47% for fiscal 2004.

As of January 28, 2006, we had net deferred tax assets of zero reflecting net deferred tax assets totaling $27.9 million, which primarily represented the income tax benefit associated with losses reported in prior years and differences in fixed asset bases offset by a full valuation allowance of $27.9 million. These losses are subject to federal and state carry-forward provisions of up to 20 years.

LIQUIDITY AND CAPITAL RESOURCES

 

 

Fiscal Year

 

 

 

2005

 

2004

 

2003

 

 

 

(Dollars in thousands)

 

Net cash provided (used) by operating activities

 

$

4,401

 

$

(9,804

)

$

11,444

 

Net cash used by investing activities

 

(29,695

)

(13,380

)

(9,229

)

Net cash provided (used) by financing activities

 

25,398

 

23,536

 

(2,576

)

Net increase (decrease) in cash and cash
equivalents

 

$

86

 

$

(99

)

$

373

 

 

Operating Cash Flows

For fiscal 2005, net cash provided by operating activities was $4.4 million compared to $9.8 million of net cash used by operating activities for fiscal 2004. Net cash provided by operating activities reflects the effect of the $27.9 million non-cash charge for establishing a full valuation allowance for our net deferred tax assets. The majority of the increase in net cash provided in fiscal 2005 compared to net cash used in fiscal 2004 results from the smaller increases in inventory and accounts payable in fiscal 2005 compared to fiscal 2004. The increase in inventory in fiscal 2005 of 10% is consistent with the higher sales recorded in

25




the period and does not reflect the same timing of inventory receipts at year-end as occurred in the prior year.

For fiscal 2004, net cash used by operating activities was $9.8 million compared to $11.4 million of net cash provided by operating activities for fiscal 2003. The increase in net cash used by operating activities resulted primarily from higher inventory purchases in support of higher sales and the acceleration of inventory receipts at year-end (including $20 million of shipments in transit) due to outdoor furniture and other spring selling programs. We also experienced acceleration of the timing of payment for goods due to increases in the levels of foreign sourced merchandise that tend to have faster payment terms than domestic vendors. Additionally, net cash used by operating activities increased due to higher prepaid expenses. These increases in net cash used were partially offset by higher accounts payable and accrued expenses balances.

Investing Cash Flows

Net cash used by investing activities was $29.7 million for fiscal 2005, an increase of $16.3 million compared to $13.4 million for fiscal 2004. The cash used for investing activities for fiscal 2005 primarily related to the $16.5 million expenditure for the remodeling of the majority of our retail stores, the opening of one retail store and five outlet stores, and capital associated with distribution facility improvements.

Net cash used by investing activities was $13.4 million in fiscal 2004, an increase of $4.2 million compared to $9.2 million of cash used by investing activities in fiscal 2003. The $13.4 million of cash used for investing activities in fiscal 2004 primarily related to capital expenditures associated with the opening and remodeling of two retail stores, the opening of our first outlet store and distribution facility improvements and relocations.

Financing Cash Flows

Net cash provided by financing activities in fiscal 2005 was $25.4 million, compared to $23.5 million for fiscal 2004. The $1.9 million increase in cash provided by financing activities for fiscal 2005 primarily related to a $0.9 million increase in borrowings under our revolving credit facility, net of debt issuance costs and a $0.9 million increase in proceeds from the exercise of stock options.

Net cash provided by financing activities was $23.5 million in fiscal 2004, and net cash used by financing activities was $2.6 million in fiscal 2003. Substantially all of the change in net cash provided (used) by financing activities resulted from an increase in net borrowings under our revolving credit facility of $23.2 million for fiscal 2004, as compared to a repayment of borrowings of $3.9 million for fiscal 2003. Cash financing requirements were higher in fiscal 2004 as compared to the same period of fiscal 2003, primarily due to the effect of higher inventory levels overall, and higher inventory of predominately foreign sourced merchandise, which have resulted in an acceleration of the timing of payment for our goods. We reduced the borrowings outstanding under our line of credit in fiscal 2003 due to expense leverage gained on increased sales. In addition, we received $1.1 million during fiscal 2003 in connection with the settlement of a claim, and $1.1 million from the exercise of stock options.

On July 29, 2005 the Company entered into an agreement (the “Amendment”) to amend its existing revolving credit facility. The Amendment increased the revolving loan commitment available to the Company under the facility from $100.0 million to $150.0 million and provided for an extension of the maturity date of the revolving loan from June 30, 2006 to June 30, 2009. In addition, the Amendment reduced the interest rate on base rate advances and provided for incremental advances with availability determined from the application of a higher advance rate on eligible inventory and eligible accounts receivables constituting part of the Company’s borrowing base. Those incremental advances would be subject to higher interest rates. To the extent that borrowings are outstanding under the incremental advance provision and if the remaining availability for additional borrowing under the facility is less than

26




10% of the applicable borrowing base for the line of credit at the time, the Company would be required to maintain a minimum fixed charge coverage ratio. The Amendment also eliminated the lock box restriction except upon the occurrence of certain events, such as an event of default. Other elements of the revolving credit facility remain materially unchanged.

As of January 28, 2006, $58.1 million was outstanding under the facility, net of unamortized debt issuance costs of $0.9 million, and there was $11.8 million in outstanding letters of credit. As a result of the Amendment, the balance of $58.1 million at January 28, 2006 is considered a long-term liability rather than a current liability and has been classified accordingly. Borrowings made under the revolving credit facility are subject to interest at either the bank’s reference rate or LIBOR plus a margin. As of January 28, 2006, the bank’s reference rate was 7.25% and the LIBOR plus margin rate was 5.97%. Borrowings that are incremental advances under the revolving credit facility are subject to interest at either the bank’s reference rate plus a margin or LIBOR plus a higher margin. The availability of credit at any given time under the revolving credit facility is limited by reference to a borrowing base formula (which includes an adjustment to the advance rate against eligible inventory and eligible accounts receivables for incremental advances as described above) based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, and reserves established by the agent of the revolving credit facility. As a result of the borrowing base formula, and the other terms and conditions of the credit facility, the actual borrowing availability under the facility could be less than the stated amount of the facility (reduced by the actual borrowings and outstanding letters of credit). As of January 28, 2006, we had availability under the facility of $25.5 million.

The revolving credit facility contains various restrictive covenants, including limitations on the ability to make liens, make investments, sell assets, incur additional debt, merge, consolidate or acquire other businesses, pay dividends or other distributions, and enter into transactions with affiliates. The revolving credit facility does not contain any other significant financial or coverage ratio covenants unless the Company takes advantage of the incremental advance provision. If we receive an advance under the incremental advance provision and if the remaining availability for additional borrowing under the facility is less than 10% of the applicable borrowing base for the line of credit at the time, the Company is required to maintain a fixed charge coverage ratio. The revolving credit facility also does not require that we repay all borrowings for a prescribed “clean-up” period each year.

We currently believe that our cash flows from operations and funds available under our revolving credit facility will satisfy our expected working capital and capital requirements for at least the next 12 months. However, the weakening of, or other adverse developments concerning, our sales performance or adverse developments concerning the availability of credit under our revolving credit facility due to covenant limitations or other factors could limit the overall availability of funds to us. We may not have successfully anticipated our future capital needs or the timing of such needs and we may need to raise additional funds in order to take advantage of unanticipated opportunities. We also may need to raise additional funds to respond to changing business conditions or unanticipated competitive pressures. However, should the need arise, additional sources of financing may not be available or, if available, may not be on terms favorable to our stockholders or us. If we fail to raise sufficient funds, we may be required to delay or abandon some of our planned future expenditures or aspects of our current operations. For more information, please see the section “Risk Factors,” in particular the sections “We are dependent on external funding sources, including the terms of our revolving credit facility, which may not make available to us sufficient funds when we need them,” and “Because our business requires a substantial level of liquidity, we are dependent upon a revolving credit facility with certain restrictive covenants that limit our flexibility.”

27




Contractual Commitments

The following table summarizes our significant contractual cash obligations and other commercial commitments as of January 28, 2006:

 

 

Payments Due By Period

 

 

 

Total

 

Fiscal 2006

 

Fiscal 2007
through 2008

 

Fiscal 2009
through 2010

 

Thereafter

 

 

 

(Dollars in thousands)

 

Operating leases (1)

 

$

271,025

 

 

$

42,754

 

 

 

$

82,280

 

 

 

$

65,282

 

 

 

$

80,709

 

 

Capital leases

 

180

 

 

153

 

 

 

27

 

 

 

 

 

 

 

 

Line of credit (2)

 

59,025

 

 

 

 

 

 

 

 

59,025

 

 

 

 

 

Interest (3)

 

16,275

 

 

6,025

 

 

 

8,250

 

 

 

2,000

 

 

 

 

 

Standby letters of credit

 

9,967

 

 

9,967

 

 

 

 

 

 

 

 

 

 

 

Trade letters of credit

 

1,839

 

 

1,839

 

 

 

 

 

 

 

 

 

 

 

Purchase obligations for inventory (4)

 

88,397

 

 

88,397

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

446,708

 

 

$

149,135

 

 

 

$

90,557

 

 

 

$

126,307

 

 

 

$

80,709

 

 


(1)          Operating lease contractual commitments exclude insurance, real estate taxes, and repair and maintenance expenses related to those operating leases. In fiscal 2005, the Company incurred $18.8 million for these costs.

(2)          The costs reflect our long-term debt, gross of debt issuance costs of $0.9 million.

(3)          Interest payments in the future periods have been reflected based on fiscal 2005 debt and interest levels and reflects the June 2009 maturity date of the line of credit.

(4)          Represents estimated commitments at year-end to purchase inventory in the normal course of business to meet operating requirements.

OFF-BALANCE SHEET ARRANGEMENTS

Except for our operational lease commitments, we do not have any other off-balance sheet arrangements, as such term is defined by the Securities and Exchange Commission, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

RELATED PARTY TRANSACTIONS

Jason Camp, a Senior Vice President of our Company and the son of one of our directors, Robert E. Camp, was asked to relocate to California in 2001 as part of his job function. In connection with this relocation, we made a full recourse loan to him in the principal amount of $200,000. The interest on the outstanding principal amount of the loan is 8.0% per annum, compounded annually, and the entire amount of interest and all outstanding principal is due and payable on August 15, 2006, if not earlier pre-paid in full with interest.

We lease one of our properties from the previous owner and current employee of Michaels. Annual payments made in fiscal 2005, 2004 and 2003 were $456,000 per year.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). For a complete review of those policies,

28




reference is made to our “Notes to our Consolidated Financial Statements, Summary of Business and Significant Accounting Policies.” The preparation of our Consolidated Financial Statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to sales returns, inventories, goodwill, income taxes, financing operations, contingencies and litigation. We base our estimates on historical experience and on various other facts and assumptions, including current and expected economic conditions and product mix, that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our management believes the following critical accounting policies require significant judgments and estimates in the preparation of our Consolidated Financial Statements:

Sales Returns Reserve

We provide an allowance for sales returns based on historical return rates which generally considers both the level of merchandise returns and the time elapsed from the date of sale to the date of the return. This reserve is booked on a gross basis, reducing both total sales and cost of sales each period. Should actual return rate levels increase by 10% in fiscal 2006 or the customer return time lengthen by 10% in fiscal 2006, our results would be negatively impacted by approximately $0.2 million. At January 28, 2006 and January 29, 2005, the allowance for sales returns was approximately $1.8 million and $1.3 million, respectively.

Merchandise Inventories

Our retail inventories are carried at the lower of cost or market with cost determined on a weighted average cost method. Manufacturing inventories are carried at the lower of cost or market with cost determined at standard costs, approximating average costs. Costs include certain buying and distribution costs, including payroll and other costs related to the purchase of inventory. We write down inventories whenever markdowns reduce the selling price below cost. Additionally, we provide for monthly reserves on inventory based upon our estimate of shrinkage losses. Actual shrinkage is recorded at year-end based on the results of our physical inventory count. We also write down our slow-moving and discontinued inventory to its estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, or if liquidation of the inventory is more difficult than anticipated, additional inventory write-downs may be required.

Impairment of Long-Lived Assets

We review long-lived tangible assets for impairment whenever events or changes in circumstances indicate that their carrying values may not be recoverable. Using our best estimates based on reasonable assumptions and projections, we record an impairment loss to write the assets down to their estimated fair values if the carrying values of such assets exceed their related discounted expected future cash flows.

We review goodwill and other intangibles with indefinite useful lives for impairment annually, or more frequently if events or changes in circumstances warrant. If the carrying values of such assets exceed their estimated fair values, we record an impairment loss to write the assets down to their estimated fair values.

We generally evaluate long-lived tangible assets at an individual store level, which is the lowest level at which independent cash flows can be identified. We evaluate corporate assets or other long-lived assets that are not store-specific at a consolidated entity or reporting unit level, as appropriate.

29




Since there is typically no active market for our long-lived tangible and intangible assets, we estimate fair values based on the expected future cash flows. We estimate future cash flows based on store-level historical results, current trends and operating and cash flow projections. Our estimates are subject to substantial uncertainty and may be affected by a number of factors outside our control, including general economic conditions, the competitive environment and regulatory changes. If actual results differ from our estimates of future cash flows, we may record significant additional impairment charges in the future. For the fiscal year ended January 28, 2006, the Company recorded a $0.3 million impairment charge on the long-lived assets of two underperforming stores.

Self Insurance

We obtain insurance coverage for significant exposures as well as those risks that, by law, must be insured. It is generally our policy to retain a significant portion of certain losses related to workers’ compensation, general liability, property losses, business interruption and employee health care. We record provisions for these items based on an actuary report, claims experience, regulatory changes, an estimate of claims incurred but not yet reported and other relevant factors. The projections involved in this process are subject to substantial uncertainty because of several unpredictable factors, including actual future claims experience, regulatory changes, litigation trends and changes in inflation. Should the amount of claims be more or less than what we estimated or should the costs of claims increase or decrease beyond what we anticipated, reserves may need to be adjusted accordingly in future periods. At January 28, 2006 and January 29, 2005, we had recorded accruals for these liabilities of approximately $4.6 million and $3.1 million, respectively.

Income Taxes and Valuation Allowance

We account for income taxes under SFAS No. 109, “Accounting for Income Taxes.” SFAS No.109 requires income taxes to be accounted for 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 our Consolidated Financial Statements or tax returns. In estimating future tax consequences, we generally take into account all expected future events then known to us, other than changes in the tax law or rates, which are not permitted to be considered. Accordingly, if needed we may record a valuation allowance to reduce our net deferred tax assets to the amount that is more likely than not to be realized. The amount of valuation allowance would be based upon management’s best estimate of the recoverability of our net deferred tax assets. While future taxable income and ongoing prudent and feasible tax planning are considered in determining the amount of the valuation allowance, the necessity for an allowance is subject to adjustment in the future. Specifically, in the event we were to determine that we would not be able to realize our net deferred tax assets in the future in excess of their net recorded amounts, an adjustment to the deferred tax assets would decrease income in the period such determination was made. Accordingly, we recorded a full valuation allowance for our net deferred tax assets of $27.9 million in the fourth quarter of fiscal 2005. The effect was to include a non-cash charge of $27.9 million in the fourth quarter of fiscal 2005. This fiscal 2005 adjustment will have no impact on our cash flow or future prospects, nor does it alter our 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. Due to the valuation allowance provided against our net deferred tax assets, we do not expect any significant income tax benefit or expense for the fiscal 2006.

Other Considerations

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas

30




in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited Consolidated Financial Statements and notes thereto in this annual report on Form 10-K, which contain accounting policies and other disclosures required by generally accepted accounting principles.

RECENTLY ISSUED ACCOUNTING STANDARDS

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs,” which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). This statement is effective for our 2006 fiscal year. We believe the adoption of SFAS 151 will not have a significant impact on the overall results of operations or financial position.

In December 2004, the FASB issued SFAS No. 123(R) ”Share-Based Payment.”  SFAS 123(R) requires the recognition of compensation expense relating to share-based payment transactions in consolidated financial statements. That expense will be measured based on the fair value of the equity or liability instruments issued as of the grant date, for the estimated number of awards that are expected to vest. SFAS 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS 123(R) replaces SFAS 123, “Accounting for Stock Based Compensation,” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) is effective for interim periods that begin after December 15, 2005. Effective with the beginning of the first quarter of fiscal 2006, we will adopt SFAS 123(R) using the modified prospective method. Under this method, the unvested portions of previously granted share-based payments, as well as the fair value of awards granted after adoption are included in operating expenses over the appropriate service period. We have decided to use the Black Scholes model to estimate the fair value of our stock options, unless additional information becomes available in the future that indicates another model would be more appropriate for us, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model. Based on stock options granted to employees through January 28, 2006, we expect the adoption of SFAS 123(R) will increase first quarter expenses by approximately $1.3 million ($0.03 per share, basic) and increase full year fiscal 2006 expenses by approximately $4.0 million ($0.11 per share, basic).

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which changes the requirements for reporting a change in accounting principle. This statement is effective beginning January 1, 2006. SFAS 154 replaces APB No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” We believe the adoption of SFAS 154 will not have a significant impact on the overall results of operations or financial position.

In October 2005, the FASB issued FASB Staff Position (“FSP”) 13-1, “Accounting for Rental Costs Incurred During a Construction Period,” to clarify the proper accounting for rental costs incurred on building or ground operating leases during a construction period. The FSP requires that rental costs incurred during a construction period be expensed, not capitalized. The statement is effective for the first reporting period beginning after December 15, 2005. The Company believes the adoption of FSP 13-1 will not have a significant impact on the overall results of operations or financial position.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This annual report on Form 10-K contains “forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995, that involve known and unknown risks. Such forward-looking statements include without limitation statements relating to our future plans, in particular with respect to store openings and closings; statements relating to anticipated future costs and expenses;

31




statements about new merchandise initiatives and website marketing efforts; statements relating to anticipated future revenue growth, including statements about margin expansion, operational efficiencies and cost reductions; statements relating to future availability under our revolving credit facility; statements relating to our working capital and capital expenditure needs; statements relating to the level of deferred revenue and other categories of delayed sales in future periods and the impact thereof on quarterly results; and other statements containing words such as “believe,” “anticipate,” “expect,” “may,” “intend,” and words of similar import or statements of our management’s opinion. These forward-looking statements and assumptions involve known and unknown risks, uncertainties and other factors that may cause our actual results, market performance or achievements to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause such differences include, but are not limited to, customer reactions to our current and anticipated merchandising and marketing programs and strategies, timely introduction and customer acceptance of our merchandise, positive customer reaction to our Catalog and Internet offerings, revised product mix, prototype stores and core businesses, timely and effective sourcing of our merchandise from our foreign and domestic vendors and delivery of merchandise through our supply chain to our stores and customers, changes in product supply, effective inventory and catalog management, actual achievement of cost savings and improvements to operating efficiencies, effective sales performance, the actual impact of key personnel of the Company on the development and execution of our strategies, changes in investor perceptions of the Company, changes in economic or business conditions in general, fluctuations in comparable store sales, limitations resulting from restrictive covenants in our revolving credit facility, consumer responses to our product offerings and changes in consumer trends, loss of key vendors, changes in the competitive environment in which we operate, changes in our management information needs, changes in management, failure to raise additional funds when required, changes in customer needs and expectations, governmental actions, and other factors described above in the section “Risk Factors.” We undertake no obligation to update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this annual report on Form 10-K.

ITEM 7A.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks, which include changes in interest rates and, to a lesser extent, foreign exchange rates. We do not engage in financial transactions for trading or speculative purposes.

The interest payable on our revolving credit facility is based on variable interest rates and is, therefore, affected by changes in market interest rates. If interest rates on existing variable rate debt rose more than 10% from the bank’s reference rate, our results of operations and cash flows would not be materially affected.

We do enter into a significant amount of purchase obligations outside of the United States of America which, to date, have been settled mostly in U.S. dollars and, therefore, we have only minimal exposure at present to foreign currency exchange risks. Historically, we have not hedged our currency risk and do not currently anticipate doing so in the future. However, it is possible that in the future a growing number of our purchases outside of the United States of America will be made in currencies other than the U.S. dollar. Consequently, fluctuations in the rates of exchange between the U.S. dollar and other currencies may subject us to foreign currency exchange risks in the future.

32




ITEM 8.                CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

RESTORATION HARDWARE, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

 

January 28,
2006

 

January 29,
2005

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

1,990

 

 

 

$

1,904

 

 

Accounts receivable

 

 

5,884

 

 

 

6,945

 

 

Merchandise inventories

 

 

158,647

 

 

 

144,185

 

 

Deferred tax assets, current portion, net

 

 

 

 

 

7,119

 

 

Prepaid expense and other current assets

 

 

9,590

 

 

 

12,455

 

 

Total current assets

 

 

176,111

 

 

 

172,608

 

 

Property and equipment, net

 

 

92,360

 

 

 

81,886

 

 

Goodwill

 

 

4,560

 

 

 

4,560

 

 

Deferred tax assets, net

 

 

 

 

 

18,745

 

 

Other assets

 

 

1,237

 

 

 

1,464

 

 

Total assets

 

 

$

274,268

 

 

 

$

279,263

 

 

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

 

$

62,818

 

 

 

$

63,920

 

 

Line of credit, net of debt issuance

 

 

 

 

 

33,819

 

 

Deferred revenue and customer deposits

 

 

8,304

 

 

 

8,130

 

 

Other current liabilities

 

 

17,506

 

 

 

14,948

 

 

Total current liabilities

 

 

88,628

 

 

 

120,817

 

 

Long-term debt, net of debt issuance

 

 

58,126

 

 

 

 

 

Deferred lease incentives

 

 

27,465

 

 

 

30,365

 

 

Deferred rent

 

 

19,866

 

 

 

20,321

 

 

Other long-term obligations

 

 

51

 

 

 

143

 

 

Total liabilities

 

 

194,136

 

 

 

171,646

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

 

Series A redeemable convertible preferred stock, $.0001 par value, 28,037 shares designated, 0 and 8,473 shares outstanding at January 28, 2006 and January 29, 2005, respectively

 

 

 

 

 

8,331

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

Common stock, $.0001 par value, 60,000,000 shares authorized, 37,762,629 and 33,084,223 shares issued and outstanding at January 28, 2006 and January 29, 2005, respectively

 

 

4

 

 

 

3

 

 

Additional paid-in capital

 

 

169,187

 

 

 

159,233

 

 

Unearned compensation

 

 

 

 

 

 

 

Accumulated other comprehensive income

 

 

1,010

 

 

 

812

 

 

Accumulated deficit

 

 

(90,069

)

 

 

(60,762

)

 

Total stockholders’ equity

 

 

80,132

 

 

 

99,286

 

 

Total liabilities, redeemable convertible preferred stock and stockholders’ equity

 

 

$

274,268

 

 

 

$

279,263

 

 

 

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

33




RESTORATION HARDWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)

 

 

Fiscal Year Ended

 

 

 

January 28,
2006

 

January 29,
2005

 

January 31,
2004

 

Net revenue

 

 

$

581,657

 

 

 

$

525,823

 

 

 

$

438,508

 

 

Cost of revenue and occupancy

 

 

384,244

 

 

 

359,808

 

 

 

305,265

 

 

Gross profit

 

 

197,413

 

 

 

166,015

 

 

 

133,243

 

 

Selling, general and administrative expense

 

 

196,469

 

 

 

161,939

 

 

 

135,118

 

 

Income (loss) from operations

 

 

944

 

 

 

4,076

 

 

 

(1,875

)

 

Interest expense, net

 

 

(4,050

)

 

 

(2,472

)

 

 

(2,154

)

 

(Loss) income before income taxes

 

 

(3,106

)

 

 

1,604

 

 

 

(4,029

)

 

Income tax (expense) benefit

 

 

(26,201

)

 

 

100

 

 

 

1,511

 

 

Net (loss) income

 

 

$

(29,307

)

 

 

$

1,704

 

 

 

$

(2,518

)

 

(Loss) income per share of common stock, basic

 

 

$

(0.83

)

 

 

$

0.05

 

 

 

$

(0.08

)

 

(Loss) income per share of common stock, diluted

 

 

$

(0.83

)

 

 

$

0.04

 

 

 

$

(0.08

)

 

Weighted average shares outstanding, basic

 

 

35,441

 

 

 

32,940

 

 

 

30,873

 

 

Weighted average shares outstanding, diluted

 

 

35,441

 

 

 

38,183

 

 

 

30,873

 

 

 

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

34




RESTORATION HARDWARE, INC.

CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE

PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Total

 

 

 

 

Convertible

 

 

 

Additional

 

 

 

Other

 

 

 

Total

 

Comprehensive

 

 

 

 

Preferred Stock

 

Common Stock

 

Paid-In

 

Unearned

 

Comprehensive

 

Accumulated

 

Stockholders’

 

(Loss)

 

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Compensation

 

Income

 

Deficit

 

Equity

 

Income

 

 

BALANCE AT FEBRUARY 1, 2003

 

 

13,470

 

 

$ 13,328

 

30,050,994

 

 

$ 3

 

 

 

$ 150,878

 

 

 

$ (659

)

 

 

$ (132

)

 

 

$ (59,948

)

 

 

$ 90,142

 

 

 

 

 

 

Issuance of common stock

 

 

 

 

 

311,775

 

 

 

 

 

1,110

 

 

 

 

 

 

 

 

 

 

 

 

1,110

 

 

 

 

 

 

Stockholder settlement

 

 

 

 

 

 

 

 

 

 

1,050

 

 

 

 

 

 

 

 

 

 

 

 

1,050

 

 

 

 

 

 

Tax benefit on exercise of stock options

 

 

 

 

 

 

 

 

 

 

276

 

 

 

 

 

 

 

 

 

 

 

 

276

 

 

 

 

 

 

Conversion of preferred stock to common stock

 

 

(4,787

)

 

(4,787

)

2,405,296

 

 

 

 

 

4,787

 

 

 

 

 

 

 

 

 

 

 

 

4,787

 

 

 

 

 

 

Stock compensation

 

 

 

 

 

 

 

 

 

 

73

 

 

 

(73

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of unearned stock compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

498

 

 

 

 

 

 

 

 

 

498

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,187

 

 

 

 

 

 

1,187

 

 

 

1,187

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,518

)

 

 

(2,518

)

 

 

(2,518

)

 

BALANCE AT JANUARY 31, 2004

 

 

8,683

 

 

8,541

 

32,768,065

 

 

3

 

 

 

158,174

 

 

 

(234

)

 

 

1,055

 

 

 

(62,466

)

 

 

96,532

 

 

 

(1,331

)

 

Issuance of common stock

 

 

 

 

 

210,606

 

 

 

 

 

704

 

 

 

 

 

 

 

 

 

 

 

 

704

 

 

 

 

 

 

Tax benefit on exercise of stock options

 

 

 

 

 

 

 

 

 

 

145

 

 

 

 

 

 

 

 

 

 

 

 

145

 

 

 

 

 

 

Conversion of preferred stock to common stock

 

 

(210

)

 

(210

)

105,552

 

 

 

 

 

210

 

 

 

 

 

 

 

 

 

 

 

 

210

 

 

 

 

 

 

Amortization of unearned stock compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

234

 

 

 

 

 

 

 

 

 

234

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(243

)

 

 

 

 

 

(243

)

 

 

(243

)

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,704

 

 

 

1,704

 

 

 

1,704

 

 

BALANCE AT JANUARY 29, 2005

 

 

8,473

 

 

8,331

 

33,084,223

 

 

3

 

 

 

159,233

 

 

 

 

 

 

812

 

 

 

(60,762

)

 

 

99,286

 

 

 

1,461

 

 

Issuance of common stock

 

 

 

 

 

418,262

 

 

 

 

 

1,623

 

 

 

 

 

 

 

 

 

 

 

 

1,623

 

 

 

 

 

 

Conversion of preferred stock to common stock

 

 

(8,473

)

 

(8,331

)

4,260,144

 

 

1

 

 

 

8,331

 

 

 

 

 

 

 

 

 

 

 

 

8,332

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

198

 

 

 

 

 

 

198

 

 

 

198

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(29,307

)

 

 

(29,307

)

 

 

(29,307

)

 

BALANCE AT JANUARY 28, 2006

 

 

 

 

 

37,762,629

 

 

$ 4

 

 

 

$ 169,187

 

 

 

 

 

 

$ 1,010

 

 

 

$ (90,069

)

 

 

$ 80,132

 

 

 

$ (29,109

)

 

 

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

35

 




RESTORATION HARDWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)

 

 

Fiscal Year Ended

 

 

 

January 28,
2006

 

January 29,
2005

 

January 31
2004

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

 

$ (29,307

)

 

 

$   1,704