Table of Contents

As filed with the Securities and Exchange Commission on September 9, 2011

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

RESTORATION HARDWARE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   5712   45-3052669
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

15 Koch Road, Suite J

Corte Madera, CA 94925

(415) 924-1005

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Gary G. Friedman

Chairman and Co-Chief Executive Officer

Carlos E. Alberini

Co-Chief Executive Officer

15 Koch Road, Suite J

Corte Madera, CA 94925

(415) 924-1005

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Stewart L. McDowell, Esq.

Steven R. Shoemate, Esq.

Gibson Dunn & Crutcher, LLP

555 Mission Street

San Francisco, CA 94105

Tel: (415) 393-8200

Fax: (415) 986-5309

 

Gavin B. Grover, Esq.

John M. Rafferty, Esq.

Andrew D. Thorpe, Esq.

Morrison & Foerster LLP

425 Market Street

San Francisco, CA 94105

Tel: (415) 268-7000

Fax: (415) 268-7522

 

Sharon R. Flanagan, Esq.

Bradley S. Fenner, Esq.

Connie P. Wu, Esq.

Sidley Austin LLP

555 California Street

San Francisco, CA 94104

Tel: (415) 772-1200

Fax: (415) 772-7400

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class

of Securities to be Registered

  Proposed Maximum
Aggregate Offering Price(1)(2)
 

Amount of

Registration Fee

Common Stock, $0.0001 par value

  $150,000,000   $17,415

 

 

(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Includes offering price of shares that the underwriters have the option to purchase.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this preliminary prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state or other jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated September 9, 2011.

             Shares

 

LOGO

 

Common Stock

 

 

This is Restoration Hardware Holdings, Inc.’s initial public offering.

We are selling             shares of our common stock and the selling stockholders identified in this prospectus are selling             shares of our common stock. We will not receive any of the proceeds from the sale of shares to be offered by the selling stockholders.

We expect the public offering price to be between $              and $            . Since June 2008 and prior to this offering, there has been no public market for the shares. After pricing this offering, we expect that the shares will trade on the             under the symbol “        .”

Investing in our common stock involves risks that are described in the “Risk Factors” section beginning on page 14 of this prospectus.

 

 

 

     Per Share      Total  

Public offering price

   $                    $                

Underwriting discount

   $         $     

Proceeds, before expenses, to us

   $         $     

Proceeds, before expenses, to the selling stockholders

   $         $     

The underwriters may also purchase up to an additional             shares from the selling stockholders, at the public offering price, less the underwriting discount.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The shares will be ready for delivery on or about             , 2011.

 

 

Joint Book-Running Managers

 

BofA Merrill Lynch   Goldman, Sachs & Co.

 

 

The date of this prospectus is             , 2011.


Table of Contents

TABLE OF CONTENTS

 

     Page  

Basis of Presentation

     ii   

Prospectus Summary

     1   

Risk Factors

     14   

Forward-Looking Statements and Market Data

     35   

Use of Proceeds

     37   

Dividend Policy

     37   

Capitalization

     38   

Dilution

     40   

Selected Historical Consolidated Financial and Operating Data

     42   

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

     47   

Business

     77   

Management

     94   

Executive Compensation

     101   

Principal and Selling Stockholders

     120   

Certain Relationships and Related Party Transactions

     122   

Description of Certain Indebtedness

     127   

Description of Capital Stock

     129   

Shares Eligible for Future Sale

     132   

Material U.S. Federal Income Tax Considerations to Non-U.S. Holders

     134   

Underwriting (Conflicts of Interest)

     138   

Legal Matters

     145   

Experts

     145   

Where You Can Find More Information

     146   

Index To Consolidated Financial Statements

     F-1   

 

 

You should rely only on the information contained in this prospectus or in any free writing prospectus that we authorize be delivered to you. Neither we nor the selling stockholders or underwriters have authorized anyone to provide you with additional or different information. If anyone provides you with additional, different or inconsistent information, you should not rely on it. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 

i


Table of Contents

BASIS OF PRESENTATION

We use a 52 – 53 week fiscal year ending on the Saturday closest to January 31. Fiscal years are identified in this prospectus according to the calendar year prior to the calendar year in which they end. For example, references to “2010,” “fiscal 2010” or similar references refer to the fiscal year ended January 29, 2011.

All of the outstanding capital stock of Restoration Hardware, Inc. was acquired on June 16, 2008, by Home Holdings, LLC, which we refer to in this prospectus as the “Acquisition.” Home Holdings’ equity interests are held primarily by (i) CP Home Holdings, LLC, an investment entity managed by funds affiliated with Catterton Management Company, LLC, (ii) Tower Three Home LLC, an investment fund managed by Tower Three Partners, LLC, and (iii) funds affiliated with Glenhill Capital. In this prospectus, we refer to CP Home Holdings, LLC and its affiliated funds as “Catterton,” we refer to Tower Three Home LLC and its affiliated funds as “Tower Three” and we refer to Glenhill Capital and its affiliated funds as “Glenhill.” As a result of the Acquisition, a new basis of accounting was created beginning June 17, 2008. In this prospectus, the periods prior to the Acquisition are referred to as the “Predecessor” periods and the periods after the Acquisition are referred to as the “Successor” periods. The Predecessor periods presented in this prospectus for 2008 include the period from February 3, 2008 through June 16, 2008, reflecting approximately 19 weeks of operations, and the Successor periods presented in this prospectus for 2008 include the period from June 17, 2008 through January 31, 2009, reflecting approximately 33 weeks of operations. Due to the Acquisition, the financial statements presented in this prospectus for the Successor periods are not comparable to those of the Predecessor periods.

In the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we have presented pro forma consolidated financial data for the 52-week period ended January 31, 2009, which gives effect to the Acquisition as if such transaction had occurred on February 3, 2008, and which we refer to as “pro forma 2008,” in addition to the Predecessor and Successor periods for 2008. We believe that presenting the discussion and analysis of the results of operations in this manner promotes the overall usefulness of the comparison given the complexities involved with comparing two significantly different periods.

In this prospectus, when we refer to “retail assortment square footage,” we mean the square footage of the largest retail assortment in any one store in a particular market. Generally, retail assortment square footage is the selling square footage of our largest store in a particular market and does not include the selling square footage of any other store in that market because the product assortment in the smaller stores will generally be redundant with products shown in the largest store. In this prospectus, when we refer to “store level cash contribution margin,” we mean store net revenues less product costs and cash operating costs related to store operations, divided by store net revenues.

 

ii


Table of Contents

PROSPECTUS SUMMARY

This summary highlights some of the information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider in making your investment decision. You should read the following summary together with the entire prospectus carefully, including “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the more detailed information regarding our Company and the common stock being sold in this offering, as well as our consolidated financial statements and the related notes appearing elsewhere in this prospectus, before deciding to invest in our common stock. Some of the statements in this prospectus constitute forward-looking statements. See “Forward-Looking Statements and Market Data.”

Except where the context otherwise requires or where otherwise indicated, the terms “Restoration Hardware,” “we,” “us,” “our,” “our Company” and “our business” refer, prior to the Reorganization discussed below, to Restoration Hardware, Inc. and, after the Reorganization, to Restoration Hardware Holdings, Inc., in each case together with its consolidated subsidiaries, including Restoration Hardware, Inc., as a combined entity. The term “Restoration Hardware Holdings” refers to Restoration Hardware Holdings, Inc. and the term “Home Holdings” refers to Home Holdings, LLC, and, in each case, not to any of their subsidiaries.

Our Company

We believe Restoration Hardware is one of the fastest growing and most innovative luxury brands in the home furnishings marketplace. We believe our brand stands alone and is redefining this highly fragmented and growing market. Restoration Hardware is positioned as a lifestyle brand and design authority, offering dominant assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, as well as baby and child products. We operate as a curator of the finest historical design the world has to offer. Our collections of timeless, updated classics and reproductions are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers. Our culture of innovation, superior product development capabilities, integrated multi-channel infrastructure and significant scale enable us to offer what we believe is an unmatched combination of design, quality and value.

Our business is fully integrated across our multiple channels of distribution, consisting of our stores, catalogs and websites. As of July 30, 2011, we operated 87 retail stores and 10 outlet stores throughout the United States and Canada. In fiscal 2010, we distributed approximately 46.5 million catalogs, and our websites logged over 12.1 million unique visits.

We have recently experienced strong growth in sales and profitability, including:

 

   

For the twelve months ended July 30, 2011, we grew our net revenues 26% to $862.3 million over the prior twelve month period, increased our Adjusted EBITDA 90% to $59.9 million and increased our net income by $16.5 million to a net income of $4.4 million. Our stores net revenues, comparable store sales and direct net revenues grew by 17%, 17% and 38%, respectively.

 

   

In the first half of fiscal 2011, we grew our net revenues 27% to $420.4 million over the comparable period in fiscal 2010, increased our Adjusted EBITDA 209% to $27.7 million and increased our net income by $12.4 million to a net income of $1.1 million. Our stores net revenues, comparable store sales and direct net revenues grew by 21%, 20% and 36%, respectively.

 

 

1


Table of Contents
   

In fiscal 2010, we grew our net revenues 24% to $772.8 million over fiscal 2009, increased our Adjusted EBITDA 134% to $41.1 million and decreased our net loss by $20.6 million to a net loss of $8.1 million. Our stores net revenues, comparable store sales and direct net revenues grew by 15%, 19% and 37%, respectively.

See “Prospectus Summary—Summary Historical Consolidated Financial and Operating Data” for a discussion of Adjusted EBITDA and a reconciliation of the differences between Adjusted EBITDA and net income (loss).

Our Competitive Strengths

Market-Redefining Luxury Brand. We believe Restoration Hardware stands alone as a leading luxury brand and is redefining the highly fragmented home furnishings market by offering an unmatched combination of design, quality and value. We believe we are disrupting the competitive landscape by attracting affluent consumers from designer showrooms and high-end boutiques with our compelling value proposition, as well as aspirational consumers trading up to our more sophisticated aesthetic relative to what can be found in department stores and other home furnishings retailers. In a market characterized by smaller, independent competitors, we believe our luxury positioning, superior quality and significant scale position us to continue to rapidly grow our market share.

Culture of Innovation. Innovation is at the core of what we do. We are dedicated to offering products that push established boundaries and influence the manner in which our customers envision their homes. The scope of our innovation is demonstrated company-wide, including in our product development platform, our stores, our direct channels and our infrastructure. We believe our ability to successfully innovate and introduce new products enables us to gain market share, adapt our business to emerging trends and stay relevant with our customers.

Superior Product Development Capabilities. We have architected a proprietary product development platform that is fully integrated from ideation to presentation. We have established a cross-functional organization centered on product leadership, with teams that collaborate across functions and that work closely with our network of artisan partners who act as an extension of our product development team. Our product development platform and significant scale have enabled us to introduce an increasing number of new products with each collection and dramatically shorten our product lead times while allowing us to deliver differentiated products to our customers at a great value.

Multi-Channel Go-To-Market Strategy. We pursue a market-based rather than a channel-based sales strategy and allocate resources by market to maximize our return on invested capital. Our strategy is to size our stores and assortments to the potential of the market area that each location serves, while leveraging our direct channels to maximize reach and allow customers to access our complete product offering. Our channels are fully integrated and complement each other, with our stores acting as showrooms for our brand while our catalogs and websites act as virtual extensions of our stores. This approach is designed to enhance our customer experience, generate greater sales, increase our market share and deliver higher returns on invested capital.

Fully Integrated Infrastructure. Our infrastructure is integrated across our multiple channels, providing three key advantages: (i) strong direct sourcing capabilities and direct vendor relationships; (ii) centrally managed inventory across our channels to drive working capital efficiency and to optimize our product availability; and (iii) a reconfigured distribution network and new order management, warehouse management and point-of-sale systems that have reduced our product return rates and improved customer service levels. Our systems platform also includes business intelligence reporting capabilities that provide multi-channel information to enable us to make timely and informed decisions. We believe our infrastructure provides us with a sophisticated operating platform and significant capabilities to support our future growth.

 

 

2


Table of Contents

High Performance, Values-Driven Organization Led by Accomplished Team. We have built a high performance organization driven by a company-wide commitment to our core values of People, Quality, Service and Innovation. Our leadership team, led by our Co-Chief Executive Officers, Gary Friedman and Carlos Alberini, has over 100 years of specialty home experience and significant expertise across all of our core functions, including brand management, product development, sourcing, supply chain, merchandising, finance and operations. With over 24 years of experience in executive roles in the specialty home industry, Mr. Friedman is recognized as a creative force and design leader. Prior to joining us in 2001, Mr. Friedman spent 13 years at Williams Sonoma, Inc. in various executive roles, most recently as President and Chief Operating Officer. Mr. Alberini is a highly respected financial and operational leader in the retail sector, having most recently served as President and Chief Operating Officer of Guess? from 2000 until 2010, when he joined us as Co-Chief Executive Officer. We believe our leadership team, including the complementary skills of Mr. Friedman and Mr. Alberini, is a key driver of our success and positions us to execute our long term growth strategy.

Our Growth Strategy

Increase Market Share by Expanding Existing and Entering New Product Categories. We participate in the highly fragmented, $143 billion U.S. home furnishings market, and our net revenues currently represent less than 1% of this market. We believe there is a substantial opportunity to continue to increase our market share as more consumers are exposed to our growing merchandise assortment and as introductions of new products and categories allow existing customers to add to their collections. We apply our unique design aesthetic and superior product development capabilities to bring a differentiated perspective to both existing and new product categories. Over the past few years we have successfully expanded our offering in all of our categories. We also have a successful record of new category introductions, and plan to continue introducing select new product categories, such as Tabletop in 2012, where we can offer a dominant assortment consistent with our brand positioning in other product categories.

Expand Our Retail Assortment Square Footage. We plan to increase our retail assortment square footage by opening full line Design Galleries in key metropolitan markets, expanding select existing Galleries and opening Galleries in new markets. Our experience has proven that when we display a product in our stores, we sell substantially greater quantities of that product across all of our channels. Most of our existing Galleries display under 50% of our current merchandise assortment. We see a significant growth opportunity with our full line Design Galleries, in which we can showcase approximately 80% of our current product assortment in a highly differentiated retail setting. These stores will have approximately 15,000 – 20,000 square feet of interior selling space and 4,000 – 7,000 square feet of outdoor selling space. This larger store format provides an opportunity to increase sales, consolidate markets, reduce operating costs and enhance return on capital. Following the opening of our first full line Design Gallery in Los Angeles, we are opening a full line Design Gallery in Houston in the Fall of 2011, followed by planned full line Design Galleries in Greenwich, Connecticut; Boston; New York City; Scottsdale; Orange County, California; Atlanta; Chicago and Dallas over the next few years. We have identified over 35 markets in which we plan to open full line Design Galleries.

Grow our Direct-to-Consumer Business. We will grow our direct business by expanding our catalog page count and circulation, reaching new households with our catalogs and implementing our e-commerce marketing initiatives. As with our stores, we have found when we display a product in our catalogs, we experience increased sales of that product across all of our channels. In our Spring 2011 Home catalog, we significantly increased the average page count and circulated pages, and reached approximately 20% more households than in Spring 2010 while reducing the number of catalog mailings in that season. This strategy contributed to a 36% increase in net revenues for our direct business in the first six months of fiscal 2011 compared to the same period in the prior year. Based on the success of our Spring 2011 Home catalog, we increased the page count of our recently released Fall 2011 Home catalog to over 600 pages, which now displays over 90% of our current product assortment. We plan to circulate this catalog to more than double the number of households we reached with our

 

 

3


Table of Contents

Spring 2011 catalog. In the aggregate, we plan to increase circulated pages by more than 40% in 2011 and by more than 30% in 2012. We are also investing in enhanced marketing initiatives for our e-commerce business, which we believe will result in greater website traffic and sales.

Increase Operating Margins. We have the opportunity to improve our operating margins by leveraging occupancy costs and operating expenses, and by expanding our merchandise margins. We believe that our real estate strategy will allow us to better leverage our fixed occupancy costs by consolidating multiple Galleries into single full line Design Galleries, opening locations outside of malls that tend to have lower lease costs per square foot, reducing non-selling backroom space and closing unproductive stores. We have a well-developed, scalable infrastructure that is positioned to support our revenue growth without a proportionate increase in operating expenses. We believe we can further increase our merchandise margins by: (i) continuing to benefit from our direct sourcing initiatives; (ii) optimizing product pricing and utilizing more targeted promotions; and (iii) using new merchandise planning systems to manage inventory more efficiently across all of our channels.

Pursue International Expansion. We plan to strategically expand our business in select countries outside of the United States and Canada over the next several years. We believe that our luxury brand, product innovation, and unique aesthetic will have strong international appeal.

Evolution of Our Business

When Gary Friedman joined us as Chief Executive Officer in 2001, we began to reposition Restoration Hardware from a nostalgic, discovery-items business to a leading home furnishings brand. Starting in 2008 when we were taken private by investment funds affiliated with Catterton, Tower Three and Glenhill, we significantly accelerated the transformation of our brand and the development of our multi-channel business model and infrastructure. Over the last ten years, we built a new company as we:

 

   

Elevated our brand positioning;

 

   

Enhanced our product development process;

 

   

Refined our go-to-market strategy;

 

   

Reconceptualized our stores and developed our full line Design Gallery format;

 

   

Built a new supply chain and systems infrastructure; and

 

   

Strengthened our management team.

We believe these initiatives have contributed to our recent strong performance and increased profitability, and position us for sustained growth and profitability.

Our Market

We participate in the large and growing domestic housewares and home furnishings market. Based on third-party research, this market generated $143 billion in retail sales in 2010 and is projected to grow at a compound annual growth rate of 3% – 4% between 2011 and 2015. Our net revenues currently represent less than 1% of this market, providing us with a substantial opportunity to gain market share.

According to Euromonitor International, a market research and analysis firm, the housewares and home furnishings market is highly fragmented. The top 20 companies comprised only 30% of the total market in 2008, with the largest player representing less than 3% of the total market. As a result of the weakening housing market and economic downturn in 2007, many home furnishings retailers were forced to close stores, dramatically scale back operations or lower prices. This disruption created an opportunity for us. We believe we are well positioned to gain market share in the current competitive environment as a result of our unmatched combination of design, quality and value.

 

 

4


Table of Contents

We target high income households that drive a disproportionate share of spending in the home furnishings market. According to third-party research, the higher income consumer group represents approximately 31% of the U.S. population but comprises 50% of the total housewares and home furnishings market sales. We believe that these consumers are highly attractive as they tend to be less impacted by an economic downturn and return to spending more quickly in an economic recovery.

Summary Risk Factors

We are subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows and prospects. You should carefully consider the following risks, including the risks discussed in the section entitled “Risk Factors,” before investing in our common stock:

We are undertaking a large number of business initiatives at the same time and if these new initiatives are not successful, they may have a negative impact on our operating results. Growth in our business may not be sustained and may not generate a corresponding improvement in our results of operations. If we fail to successfully anticipate consumer preferences and demand, and manage our inventory commensurate with demand, our results of operations may be adversely affected. Our performance and our growth strategy depend on our ability to purchase our merchandise in sufficient quantities at competitive prices, and any disruptions we experience in our ability to obtain our products in a timely fashion or in the quantities required could have a material adverse effect on our business. We may not have adequate remedies with our vendors for defective merchandise, which could damage our reputation and brand image and harm our business. Changes in consumer spending or the housing market may significantly harm our revenue and results of operations. If we lose key personnel or are unable to hire additional qualified personnel, our business may be harmed. Our operations have significant liquidity and capital requirements and depend on the availability of adequate financing on reasonable terms and if we are unable to borrow significant capital, it could have a significant negative effect on our business.

Reorganization

Restoration Hardware Holdings was incorporated as a Delaware corporation on August 18, 2011, by our sole stockholder, Home Holdings, for the purpose of acquiring all of the stock of Home Holdings’ wholly owned subsidiary, Restoration Hardware, Inc. Restoration Hardware Holdings will acquire all of the outstanding shares of Restoration Hardware, Inc. prior to the effectiveness of this offering. Outstanding units under the 2008 Home Holdings equity compensation plan, which we refer to as our Team Resto Ownership Plan, will be converted in connection with this offering into our common stock on a              for              basis, and the vesting status of the Home Holdings units will carry over to our common stock, with unvested shares constituting restricted stock. In this prospectus, we refer to these transactions as the “Reorganization.”

Principal Equity Holders

Home Holdings’ equity interests are held primarily by funds affiliated with Catterton, Tower Three and Glenhill. In this prospectus, we refer to Catterton, Tower Three and Glenhill as our “Principal Equity Holders.”

Home Holdings will remain in place after the completion of this offering and will continue to be the single largest holder of our common stock. Interests of Catterton, Tower Three and Glenhill in our Company will continue to be held indirectly through their ownership interests in Home Holdings.

 

 

 

5


Table of Contents

Catterton. Catterton is a leading private equity firm with an exclusive focus on providing equity capital in support of small to middle-market consumer companies that are positioned for attractive growth. Since its founding in 1989, Catterton has invested in approximately 80 companies and led equity investments totaling over $3.3 billion. Presently, Catterton is actively managing more than $2.5 billion of equity capital focused on all sectors of the consumer industry: food, beverage, retail, restaurants, consumer products, consumer services and media and marketing services. Catterton’s combination of investment capital, strategic operating skills and industry network has enabled it to become a highly sought after firm within this industry.

Tower Three. Tower Three is an operationally-focused private equity fund formed to create a concentrated portfolio of investments in U.S.-based middle-market businesses. Tower Three’s professionals are experienced with operational management, financial restructuring, private equity and credit markets. With long-term committed capital from major institutional investors, Tower Three has the flexibility to participate in a variety of transactions.

Glenhill. Glenhill is a privately owned investment partnership that invests primarily in public equity markets internationally. Founded in 2001, Glenhill is led by Glenn J. Krevlin, who has served as the managing member of Krevlin Advisors, LLC, an investment management firm, which is the general partner of Glenhill.

 

 

 

6


Table of Contents

The following chart sets forth our anticipated ownership structure as of the completion of this offering assuming no exercise by the underwriters of their option to purchase additional shares:

LOGO

Corporate and Other Information

Restoration Hardware Holdings, Inc., the issuer of the common stock in this offering, is a Delaware corporation. Our corporate headquarters are located at 15 Koch Road, Suite J, Corte Madera, CA 94925. Our telephone number is (415) 924-1005. Our principal website address is www.restorationhardware.com. We also operate a website for our Baby & Child brand at www.rhbabyandchild.com. The information on any of our websites is not deemed to be incorporated in this prospectus or to be part of this prospectus.

This prospectus includes our trademarks, such as “Restoration Hardware” and “Restoration Hardware Baby & Child,” which are protected under applicable intellectual property laws and are the property of Restoration Hardware. This prospectus also contains trademarks, service marks, trade names and copyrights of other companies, which are the property of their respective owners. Solely for convenience, trademarks and trade names referred to in this prospectus may appear without the ® or TM symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the right of the applicable licensor to these trademarks and trade names.

 

 

7


Table of Contents

The Offering

 

Total common stock offered

             shares

 

Common stock offered by us

             shares

 

Common stock offered by the selling stockholders

             shares                                                                                              

 

Common stock to be outstanding immediately after this offering

             shares                                                                                            

 

Use of proceeds

We estimate that the net proceeds to us from this offering, after deducting the underwriting discount and estimated offering expenses, will be approximately $             million, assuming the shares are offered at $             per share (the midpoint of the estimated price range set forth on the cover of this prospectus).

 

  We will not receive any proceeds from the sale of shares by the selling stockholders.

 

  We intend to use the net proceeds from the sale of common stock by us in this offering to repay all or a portion of the outstanding amounts under the Restoration Hardware, Inc. revolving line of credit, for general corporate purposes, including working capital and capital expenditures, and to pay other fees and expenses incurred in connection with this offering, including payments to Catterton, Tower Three and Glenhill pursuant to the terms of the management services agreement we have entered into with them. See “Use of Proceeds.”

 

Principal stockholders

Upon completion of this offering, Home Holdings will own approximately              shares, or     %, of our outstanding common stock. Of that amount, Catterton will beneficially own approximately              shares, or     %, of our outstanding common stock, Tower Three will beneficially own approximately              shares, or     %, of our outstanding common stock, and Glenhill will beneficially own approximately              shares, or     %, of our outstanding common stock.

 

  We are a “controlled company” within the meaning of the listing rules, and therefore will be exempt from certain of the corporate governance listing requirements of the             . See “Management—Corporate Governance.”

 

Dividend policy

We currently intend to retain all available funds and any future earnings for use in the operation of our business, and therefore we do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon our results of operations, financial condition, capital requirements and other factors that our board of directors deems relevant. We are a holding company, and substantially all of our operations are carried out by our subsidiary, Restoration Hardware, Inc., and its subsidiaries. Restoration

 

 

8


Table of Contents
 

Hardware, Inc.’s ability to pay dividends to us is limited by its line of credit, which may in turn limit our ability to pay dividends on our common stock. Our ability to pay dividends may also be restricted by the terms of any future credit agreement or any future debt or preferred securities of ours or of our subsidiaries. See “Dividend Policy.”

 

Conflicts of interest

As described under “Use of Proceeds,” Bank of America, N.A., an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, an underwriter in this offering, is a lender under the Restoration Hardware, Inc. revolving line of credit and may receive more than five percent of the net proceeds of this offering. Thus, Merrill Lynch, Pierce, Fenner & Smith Incorporated may be deemed to have a “conflict of interest” under the applicable provisions of Rule 5121 of the Conduct Rules of the Financial Industry Regulatory Authority, Inc., or FINRA. Accordingly, this offering will be made in compliance with the applicable provisions of Rules 5110 and 5121 of the Conduct Rules regarding the underwriting of securities of a company with a member that has a conflict of interest within the meaning of those rules. Goldman, Sachs & Co. has agreed to serve as a “qualified independent underwriter” as defined by FINRA and performed due diligence investigations and reviewed and participated in the preparation of the registration statement of which this prospectus forms a part. No underwriter with a conflict of interest will execute sales in discretionary accounts without the prior written specific approval of the customers. See “Underwriting—Conflicts of Interest.”

 

Risk factors

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 14 of this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.

 

Proposed symbol for trading on

“        ”

Unless otherwise indicated, all information in this prospectus relating to the number of shares of our common stock to be outstanding immediately after this offering:

 

   

excludes              unvested restricted shares of our common stock that will be issued to our executive officers and other employees and consultants under the Restoration Hardware 2011 Equity Replacement Plan, which we refer to as the Replacement Plan, as replacement grants for awards previously issued pursuant to the Team Resto Ownership Plan;

 

   

excludes options to purchase              shares of our common stock, each with an exercise price equal to the initial public offering price, that we expect to grant in connection with this offering under the Restoration Hardware 2011 Stock Incentive Plan, which we refer to as our 2011 Plan;

 

   

excludes              additional shares of common stock reserved for future grants under our 2011 Plan;

 

   

assumes an initial public offering price of $             per share (the midpoint of the estimated price range set forth on the cover of this prospectus); and

 

   

assumes no exercise by the underwriters of their option to purchase up to              additional shares from the selling stockholders.

 

 

9


Table of Contents

Summary Historical Consolidated Financial and Operating Data

The following tables present Restoration Hardware, Inc.’s summary historical consolidated financial and operating data as of the dates and for the periods indicated. Restoration Hardware Holdings was formed as a Delaware corporation on August 18, 2011. Restoration Hardware Holdings will acquire all of the outstanding shares of capital stock of Restoration Hardware, Inc. prior to the effectiveness of this offering in connection with the Reorganization, and will therefore control Restoration Hardware, Inc. Restoration Hardware Holdings has not engaged in any business or other activities except in connection with its formation and the Reorganization. Accordingly, all financial and other information herein relating to periods prior to the completion of the Reorganization is that of Restoration Hardware, Inc.

All of the outstanding capital stock of Restoration Hardware, Inc. was acquired on June 16, 2008, by Home Holdings, which we refer to in this prospectus as the “Acquisition.” As a result of the Acquisition, a new basis of accounting was created beginning June 17, 2008. The periods prior to the Acquisition are referred to as the “Predecessor” periods and the periods after the Acquisition are referred to as the “Successor” periods in this prospectus. The Predecessor periods presented in this prospectus include the period from February 3, 2008, through June 16, 2008, reflecting approximately 19 weeks of operations, and the Successor periods presented in this prospectus include the period from June 17, 2008, through January 31, 2009, reflecting approximately 33 weeks of operations. Due to the Acquisition, the financial statements for the Successor periods are not comparable to those of the Predecessor periods presented in this prospectus.

The summary consolidated financial data for the periods ended June 16, 2008, and January 31, 2009, and for the fiscal years ended January 30, 2010, and January 29, 2011, were derived from Restoration Hardware, Inc.’s consolidated financial statements included elsewhere in this prospectus.

The summary consolidated financial data for the six months ended July 31, 2010, and July 30, 2011, and as of July 30, 2011, were derived from Restoration Hardware, Inc.’s unaudited consolidated interim financial statements included elsewhere in this prospectus. The unaudited consolidated interim financial statements were prepared on a basis consistent with that used in preparing our audited consolidated financial statements and include all adjustments, consisting of normal and recurring items, that we consider necessary for a fair presentation of our financial position and results of operations for the unaudited periods. The unaudited financial information for the twelve months ended July 31, 2010, has been derived by adding our financial information for the year ended January 30, 2010, to the financial information for the six months ended July 31, 2010, and subtracting the financial information for the six months ended August 1, 2009. The unaudited financial information for the twelve months ended July 30, 2011, has been derived by adding our financial information for the year ended January 29, 2011, to the financial information for the six months ended July 30, 2011, and subtracting the financial information for the six months ended July 31, 2010.

Restoration Hardware, Inc.’s historical results are not necessarily indicative of future operating results, and interim results for the six months ended July 30, 2011, are not projections for the results to be expected for the fiscal year ending January 28, 2012. The summary historical consolidated data presented below should be read in conjunction with the sections entitled “Risk Factors,” “Selected Historical Consolidated Financial and Operating Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto and other financial data included elsewhere in this prospectus.

 

 

10


Table of Contents
    Predecessor    

 

  Successor  
    Period
from
February 3,
2008
Through
June 16,
2008
         Period
from
June 17,
2008,
Through
January 31,
2009
    Year Ended     Six Months Ended     Last Twelve
Months Ended (1)
 
        January 30,
2010
    January 29,
2011
    July 31,
2010
    July 30,
2011
    July 31,
2010
    July 30,
2011
 
              (dollars in thousands, excluding per share and per square foot data)  

Statement of Operations Data:

                   

Net revenues

  $ 195,437          $ 498,581      $ 625,685      $ 772,752      $ 330,854      $ 420,383      $ 686,787      $ 862,281   

Cost of goods sold

    140,088            308,448        412,629        501,132        214,084        265,953        447,762        553,001   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    55,349            190,133        213,056        271,620        116,770        154,430        239,025        309,280   

Selling, general and administrative expenses

    75,396            213,011        238,889        275,859        126,453        150,619        248,603        300,025   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (20,047         (22,878     (25,833     (4,239     (9,683     3,811        (9,578     9,255   

Interest expense

    (2,731         (4,907     (3,241     (3,150     (1,579     (1,888     (3,087     (3,459
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (22,778         (27,785     (29,074     (7,389     (11,262     1,923        (12,665     5,796   

Income tax expense (benefit)

    508            (201     (423     685        41        783        (584     1,427   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (23,286       $ (27,584   $ (28,651   $ (8,074   $ (11,303   $ 1,140      $ (12,081   $ 4,369   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net income (loss) per share

  $ (0.60       $ (275,840   $ (286,510   $ (80,740   $ (113,030   $ 11,400      $ (120,810   $ 43,690   

Basic and diluted average number of shares outstanding

    38,969,000            100        100        100        100        100        100        100   

Pro forma net income (loss) per share (2):

                   

Basic

            $                     $                    

Diluted

            $                     $                    

Pro forma average number of shares outstanding (2):

                   

Basic

                   

Diluted

                   

Other Financial and Operating Data:

                   

Growth in net revenues:

                 

Stores (3)

    —            —          (6 )%      15     17     21     6     17

Direct

    —            —          (15 )%      37     31     36     10     38

Total

    —            —          (10 )%      24     23     27     7     26

Retail (4):

                   

Comparable store sales change (5)

    (12 )%          (8 )%      (7 )%      19     26     20     10     17

Retail stores open at end of period

    100            99        95        91        96        87        96        87   

Average gross square footage (in thousands) (6)

    1,072            1,060        1,042        1,014        1,019        946        1,024        977   

Average selling square footage (in thousands) (6)

    677            671        660        641        645        599        648        619   

Retail sales per selling square foot (7)

  $ 147          $ 406      $ 525      $ 635      $ 277      $ 351      $ 584      $ 710   

Direct:

                   

Catalogs circulated (in thousands) (8)

    13,771            26,831        31,336        46,507        18,893        12,768        38,266        40,382   

Catalog pages circulated (in millions) (8)

    2,168            3,507        4,418        6,260        2,823        3,293        5,560        6,730   

Direct as a percentage of net revenues (9)

    43         41     39     43     42     45     41     45

Capital expenditures

  $ 3,821          $ 13,428      $ 2,024      $ 39,907      $ 14,181      $ 12,168      $ 15,670      $ 37,894   

Adjusted EBITDA (10)

  $ (8,219       $ 4,386      $ 17,596      $ 41,097      $ 8,994      $ 27,747      $ 31,516      $ 59,850   

 

 

11


Table of Contents
     As of July 30, 2011  
     Actual      Pro Forma As
Adjusted (11)
 
     (in thousands)  

Balance Sheet Data:

     

Cash and cash equivalents

   $ 9,139       $                

Working capital (excluding cash and cash equivalents) (12)

     136,765      

Total assets

     565,529      

Line of credit

     136,609      

Total debt (including current portion) (13)

     146,492      

Total stockholders’ equity

     218,354      

 

(1) The unaudited financial information for the twelve months ended July 31, 2010, has been derived by adding our financial information for the year ended January 30, 2010, to the financial information for the six months ended July 31, 2010, and subtracting the financial information for the six months ended August 1, 2009. The unaudited financial information for the twelve months ended July 30, 2011, has been derived by adding our financial information for the year ended January 29, 2011, to the financial information for the six months ended July 30, 2011, and subtracting the financial information for the six months ended July 31, 2010.

 

(2) Pro forma net income (loss) per share gives effect to (i) the Reorganization, (ii) the issuance of              shares of common stock in this offering and (iii) the application of a portion of the estimated net proceeds from the sale of common stock by us in this offering to repay a portion of the outstanding amounts under Restoration Hardware, Inc.’s revolving line of credit as if the offering and those transactions had occurred on January 31, 2010. This assumes net proceeds of this offering of $             million, assuming the shares are offered at $             per share, the midpoint of the estimated price range set forth on the cover of this prospectus, after deducting the underwriting discount and estimated offering expenses.

 

(3) Store data represent retail stores plus outlet stores.

 

(4) Retail data have been calculated based upon retail stores, including our Baby & Child Gallery, and excludes outlet stores.

 

(5) Comparable store sales have been calculated based upon retail stores that were open at least fourteen full months as of the end of the reporting period and did not change square footage by more than 20% between periods. Comparable store net revenues exclude revenues from outlet stores.

 

(6) Average square footage (gross or selling, as applicable) is calculated for each quarter by taking the total applicable square footage at the beginning of the quarter plus the total applicable square footage at the end of the quarter and dividing by two. Average square footage for periods of six, nine and twelve months is calculated by averaging the average square footage for the quarters within such periods.

Average square footage (gross or selling, as applicable) for the 2008 Predecessor period is calculated by adding the average applicable square footage for the first quarter of the year ended January 31, 2009, and for the period May 4, 2008, through June 16, 2008, and dividing by two. Average square footage (gross or selling, as applicable) for the period May 4, 2008, through June 16, 2008, is calculated by taking the total applicable square footage at the beginning of the period plus the total applicable square footage at the end of the period and dividing by two.

Average square footage (gross or selling, as applicable) for the 2008 Successor period is calculated by adding the average square footage for three periods, being the period June 17, 2008, through August 2, 2008, the third quarter of the year ending January 31, 2009, and the fourth quarter of the year ended January 31, 2009, and dividing by three. Average square footage (gross or selling, as applicable) for the period June 17, 2008, through August 2, 2008, is calculated by taking the total applicable square footage at the beginning of the period plus the total applicable square footage at the end of the period and dividing by two.

 

(7) Retail sales per selling square foot is calculated by dividing total net revenues for all retail stores, comparable and non-comparable, by the average selling square footage for the period.

 

 

(8) The catalogs and catalog pages circulated from period to period do not take into account different page sizes per catalog distributed. Page sizes and page counts vary for different catalog mailings and we sometimes mail different versions of a catalog at the same time. Accordingly, period to period comparisons of catalogs circulated and catalog pages circulated do not take these variations into account. In fiscal 2010, we mailed a larger number of catalogs that contained fewer pages and in some cases significantly smaller page sizes than in prior periods. In the first six months of fiscal 2011, we mailed fewer catalogs that contained a significant increase in number of pages as compared to the first six months of fiscal 2010.

 

(9) Direct revenues include sales through our catalogs and websites.

 

(10) A reconciliation of net income (loss) under accounting principles generally accepted in the United States (“GAAP”) to EBITDA and Adjusted EBITDA is set forth below in “Selected Historical Consolidated Financial and Operating Data.”

EBITDA and Adjusted EBITDA have been presented in this prospectus and are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We have presented Adjusted EBITDA for the Predecessor periods consistently with the Successor periods to present such adjustments on a comparable basis for those periods. EBITDA is defined as consolidated net income (loss) before depreciation and amortization, interest expense and provision for income taxes. Adjusted EBITDA is calculated in accordance with and is the basis of our Management Incentive Program (or “MIP”) as described further under “Executive Compensation—Compensation Discussion and Analysis,” and reflects further adjustments to EBITDA to eliminate the impact of certain items, including non-cash or other items that we do not consider representative of our

 

 

12


Table of Contents

ongoing operating performance as discussed in more detail in the section entitled “Selected Historical Consolidated Financial and Operating Data.”

EBITDA and Adjusted EBITDA are included in this prospectus because they are key metrics used by management, our board of directors, and our Principal Equity Holders to assess our financial performance, and Adjusted EBITDA is used in connection with determining incentive compensation under our MIP. Additionally, EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use Adjusted EBITDA, alongside other GAAP measures such as gross profit, operating income (loss) and net income (loss), to measure profitability, to make budgeting decisions, and to compare our performance against that of other peer companies. We believe that Adjusted EBITDA provides useful information facilitating operating performance comparisons from period to period and company to company.

EBITDA and Adjusted EBITDA are not GAAP measures of our financial performance or liquidity and should not be considered as alternatives to net income (loss) as a measure of financial performance, cash flows from operating activities as a measure of liquidity, or any other performance measure derived in accordance with GAAP and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Additionally, EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management’s discretionary use, as they do not consider certain cash requirements such as tax payments and debt service requirements and certain other cash costs that may recur in the future. EBITDA and Adjusted EBITDA contain certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized, and exclude certain unusual charges that may recur in the future. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed to imply that our future results will be unaffected by any such adjustments. Management compensates for these limitations by relying primarily on our GAAP results and by using EBITDA and Adjusted EBITDA only supplementally. Our measures of EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions of other companies due to different methods of calculation.

 

(11) Pro Forma as Adjusted amounts give effect to (i) the Reorganization, (ii) the issuance of              shares of common stock in this offering, (iii) the application of $             million of estimated net proceeds of this offering to repay a portion of the outstanding amounts under the revolving line of credit, (iv) the use of $             million of the estimated net proceeds to pay other fees and expenses incurred in connection with this offering, including management fees of $             to Catterton, Tower Three and Glenhill pursuant to the terms of the management services agreement with them, (v) $             non cash impact to accumulated deficit for stock based compensation charges related to the              shares of restricted stock that become vested upon this offering, plus (vi) additional cash payments of $             to former employees that are due as a result of this stock offering. A $1.00 increase (decrease) in the assumed initial public offering price of $             per share, the midpoint of the estimated price range set forth on the cover of this prospectus, would increase (decrease) the pro forma as adjusted amount of cash and cash equivalents by approximately $             million, total assets by approximately $             million, line of credit by approximately $             million, total debt (including current portion) by approximately $             million and total stockholders’ equity by approximately $             million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses.

 

(12) Working capital is defined as current assets, excluding cash and cash equivalents, less current liabilities, excluding the current portion of long-term debt.

 

(13) Total debt (including current portion) includes amounts outstanding under the line of credit and capital lease obligations.

 

 

 

 

13


Table of Contents

RISK FACTORS

This offering and an investment in our common stock involve a high degree of risk. You should carefully consider the risks and uncertainties described below, together with the risks and uncertainties described elsewhere in this prospectus, including our consolidated financial statements and the related notes contained elsewhere in this prospectus, before you decide to purchase shares of our common stock. If any of the following risks or uncertainties actually occurs, our business, financial condition, results of operations, cash flow and prospects could be materially and adversely affected. As a result, the price of our common stock could decline and you could lose all or part of your investment in our common stock.

Risks Related to Our Business

We are undertaking a large number of business initiatives at the same time and if these new initiatives are not successful, they may have a negative impact on our operating results.

We are in the process of an ongoing major transformation of our business characterized by a period of rapid growth and a large number of new business initiatives. For example, we recently developed a new full line Design Gallery format which involves larger store square footage. We plan to open full line Design Galleries in select major metropolitan markets and we expect to close a number of our older stores and replace them with the new full line Design Gallery format. We are currently contemplating other new product lines and extensions, as well as expanding sales to other channels and international markets. In addition, we are continuing a number of new initiatives in other areas of our business, including product sourcing and distribution and management information systems. For example, we recently eliminated the use of third party buying agents in most foreign locations. In addition, we have recently significantly expanded the page counts of our catalogs, increased the number of households receiving our catalogs and reduced the number of catalog mailings.

The number of current business initiatives could strain our financial, operational and management resources. In addition, these initiatives may not be successful. For example, if customers do not respond favorably to our new full line Design Gallery format or our larger Source Book catalogs over time, our financial results may be adversely affected. All of the foregoing risks may be compounded during the current or any future economic downturn. If we are not successful in managing our current growth and the large number of new initiatives that are underway, we might experience an adverse impact on our financial performance and results of operations. In addition, if we fail to achieve the intended results of our current business initiatives, or if the implementation of these initiatives is delayed or abandoned, diverts management’s attention or resources from other aspects of our business, or costs more than anticipated, we may experience inadequate return on investment for some of our business initiatives, which would have a negative effect on our operating results.

Growth in our business may not be sustained and may not generate a corresponding improvement in our results of operations.

We may not be able to maintain or improve the levels of growth that we have experienced in the recent past. For example, although our net revenue for the first six months of fiscal 2011 grew by approximately 27% over the same period of fiscal 2010, there can be no assurance that we can achieve these levels of growth in the future.

In addition, we have also recently experienced strong comparable store sales. Comparable store sales increased 20% during the first six months of fiscal 2011 as compared to the same period of fiscal 2010, and comparable store sales increased 19% during fiscal 2010 compared to fiscal 2009. If our future comparable store sales fail to meet market expectations or decline, the price of our common stock could decline. Various factors affect comparable store sales, including the number, size and location of stores we open, close, remodel or expand in any period, the overall economic and general retail sales environment, consumer preferences and demand, our ability to efficiently source and distribute products, changes in our product offerings, competition,

 

14


Table of Contents

current local and global economic conditions, changes in catalog circulation and the success of marketing programs. These factors may cause our comparable store sales results to be materially lower than recent periods and our expectations, which could harm our results of operations and result in a decline in the price of our common stock.

Although we have recently experienced sales growth as a result of a number of new business initiatives, this sales growth may not continue and the level of our sales could return to prior levels if customer response to our product offerings is not sustained. Many factors can influence customer response to our product offerings and store formats including responses from our competitors who may introduce similar products or merchandise formats. In addition, sales levels for particular merchandise or product categories may not continue over time if customer demand levels are not sustained. The level of customer response to new store formats including our full line Design Galleries may vary in different markets and store locations. Similarly, the level of customer response to our new Source Book may vary in different markets. In addition, there can be no assurance that we will be able to migrate customer demand successfully when we choose to close a store in a particular location in favor of a new full line Design Gallery in the same or an adjacent market location. While our objective is to retain a high percentage of customer demand from store locations that we closed during fiscal 2010, there can be no assurance that we will retain a high percentage of sales from stores closed in the future or that we will continue to retain a high percentage of sales from stores previously closed.

In addition, continued increased activity in our business could result in material changes in our operating costs, including increased merchandise inventory costs and costs for paper and postage associated with the mailing and shipping of catalogs and products. We cannot assure you that we will succeed in offsetting these expenses with increased efficiency or that cost increases associated with our business will not have an adverse effect on our financial results.

If we fail to successfully anticipate consumer preferences and demand, and manage our inventory commensurate with demand, our results of operations may be adversely affected.

Our success depends in large part on our ability to originate and define home product trends, as well as to anticipate, gauge and react to changing consumer demands in a timely manner. Our products must appeal to a range of consumers whose preferences cannot always be predicted with certainty. We cannot assure you that we will be able to continue to develop products that customers positively respond to or that we will successfully meet consumer demands in the future. Any failure on our part to anticipate, identify or respond effectively to consumer preferences and demand could adversely affect sales of our products. If this occurs, our sales may decline significantly, and we may be required to mark down certain products to sell the resulting excess inventory or to sell such inventory through our outlet stores, either of which could have a material adverse effect on our financial condition and results of operations.

In addition, we must manage our merchandise in stock and inventory levels to track consumer demand. Much of our merchandise requires that we provide vendors with significant ordering lead time, frequently before market factors are known. In addition, the seasonal nature of our products requires us to carry a significant amount of inventory prior to peak selling seasons. If we are not able to anticipate consumer demand for our different product offerings, or successfully manage inventory levels for products that are in demand, we may experience:

 

   

back orders, order cancellations and lost sales for products that are in high demand for which we did not stock adequate inventory; and

 

   

overstock inventory levels for products that have lower consumer demand, requiring us to take markdowns or other steps to sell slower moving merchandise.

As a result of these and other factors, we are vulnerable to demand and pricing shifts and to misjudgments in the selection and timing of merchandise purchases.

 

15


Table of Contents

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

We do not own or operate any manufacturing facilities. We instead purchase all of our merchandise from a large number of vendors, many of which are the sole sources for particular products. Our growth strategy includes expanding the amount of products we sell, and our performance depends on our ability to purchase our merchandise in sufficient quantities at competitive prices. However, many of our key products are produced by artisans, specialty vendors and other vendors that may have limited production capacity. In addition, some of our vendors are small and undercapitalized firms. A number of our vendors, particularly our artisan vendors, may have limited resources, production capacities and operating histories. As a result, the capacity of some of our vendors to meet our supply requirements has been, and may in the future be, constrained at various times and our vendors may be susceptible to production difficulties or other factors that negatively affect the quantity or quality of their production during future periods. A disruption in the ability of our significant vendors to access liquidity could also cause serious disruptions or an overall deterioration of their businesses which could lead to a significant reduction in their ability to manufacture or ship products to us.

In addition, any difficulties that we experience in our ability to obtain products in sufficient quality and quantity from our vendors could have a material adverse effect on our business. In fiscal 2010, we purchased approximately 84% of our merchandise from vendors that are located abroad. Our ability to obtain desired merchandise in sufficient quantities could be impaired by events that adversely affect our vendors or the locations in which they operate, such as difficulties or problems associated with our vendors’ operations, business, finances, labor, importation of products, costs, production, insurance and reputation. Failure of vendors to produce adequate quantities of merchandise in a timely manner has resulted in back orders and lower revenue in certain periods of our business operation including during fiscal 2010. While we believe our vendors have increased their capacity to meet our demand and have addressed the issues encountered in fiscal 2010, we cannot assure you that our vendors will be able to produce adequate quantities of merchandise in a timely manner in the future.

We also do not have long-term contracts or other contractual assurances of continued supply, pricing or access to new products with our vendors, and generally we transact business with our vendors on an order by order basis. Therefore, any vendor could discontinue selling to us at any time. Any disruptions we experience in our ability to obtain our products in a timely fashion or in the quantities required could have a material adverse effect on our business.

We may not be able to locate and develop relationships with a sufficient number of new vendors, which could lead to product shortages and customer backorders, which could harm our business.

In the event that one or more of our vendors is unable to meet our quantity or quality demands, we may not be able to identify new vendors in a timely fashion, or at all. Even if we do identify such new vendors, we may not be able to develop relationships with them quickly enough to replace any discontinued vendors without experiencing product shortages and customer backorders. In addition, we cannot assure you that any new vendor with which we contract, particularly any new vendor abroad, would not be subject to the same or similar quality and quantity risks.

We do not have exclusive relationships with many of our vendors, and there is a risk that our vendors may sell similar or identical products to our competitors, which could harm our business.

Our arrangements with our vendors are generally not exclusive. As a result, most of our vendors might be able to sell similar or identical products to certain of our competitors, some of whom purchase products in significantly greater volume, or enter into arrangements with suppliers that could impair our ability to sell their products, including by requiring suppliers to enter into exclusive arrangements, which could limit our access to

 

16


Table of Contents

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

We may not have adequate remedies with our vendors for defective merchandise, which could damage our reputation and brand image and harm our business.

If products that we purchase from vendors are damaged or prove to be defective, we may not be able to return products to these vendors and obtain refunds of our purchase price or obtain other indemnification from them. Our vendors’ limited capacities may result in a vendor’s inability to replace any defective merchandise in a timely manner. In addition, our vendors’ limited capitalization or liquidity may mean that a vendor that has supplied defective merchandise will not be able to refund the purchase price to us or pay us any penalties or damages.

In addition, our vendors may not adhere to our quality control standards, and we might not identify the deficiency before merchandise ships to our stores or customers. Our vendors’ failure to manufacture or import quality merchandise in a timely and effective manner could damage our reputation and brand image, and could lead to an increase in customer litigation against us and a corresponding increase in our routine and non-routine litigation costs. Further, any merchandise that does not meet our quality standards or other government requirements could become subject to a recall, which could damage our reputation and brand image and harm our business.

Changes in consumer spending or the housing market may significantly harm our revenue and results of operations.

Our business depends on consumer demand for our products and, consequently, is sensitive to a number of factors that influence consumer spending, including, among other things, the general state of the economy, capital and credit markets, consumer confidence, general business conditions, the availability and cost of consumer credit, conditions in the retail home furnishings sector, the level of consumer debt, interest rates, level of taxes affecting consumers, housing prices, new construction and other activity in the housing sector and the state of the mortgage industry and other aspects of consumer credit tied to housing, including the availability and pricing of mortgage refinancings and home equity lines of credit. We believe that a number of these factors have had, and may continue to have, an adverse impact on our business and results, and these factors may make it difficult for us to accurately predict our operating and financial results for future periods.

For example, the general economic uncertainty over the last several quarters has led to decreased discretionary spending. The economic environment, together with other factors in the financial markets, have contributed to a prolonged slump in the housing market. Our business is dependent upon home purchases and remodelings. The slowdown in the housing sector has affected the level of home purchases and remodelings and we anticipate this slowdown may continue for the foreseeable future. All of these factors have adversely affected the level of consumer spending on home furnishings and we believe these factors have caused reduction in consumer demand for our product offerings. In addition, prolonged periods of reduced consumer confidence and continuation of adverse economic conditions may adversely affect consumer demand for discretionary items and luxury retail products and may drive our customers to seek lower cost alternatives to our product offerings. Our sales results were adversely affected in 2007, 2008 and 2009 due at least in part to macroeconomic factors affecting housing, as well as the economic recession and decreased consumer spending in North America. The future of the North American economy is uncertain and there can be no assurance that the recent trends in economic recovery will be sustained or that the housing market will recover.

Reduced consumer confidence and spending may also limit our ability to increase prices or sustain price increases and may require increased levels of selling and promotional expenses. We may be required to launch cost-cutting initiatives to reduce operating costs, and these initiatives may not be successful in reducing costs significantly or may impair our ability to operate effectively.

 

17


Table of Contents

If we lose key personnel or are unable to hire additional qualified personnel, our business may be harmed.

The success of our business depends upon the continued service of our key personnel, including our Co-Chief Executive Officers, Gary Friedman and Carlos Alberini. The loss of the services of our key personnel could make it more difficult to successfully operate our business and achieve our business goals. In addition, we do not maintain key man life insurance policies on any of our key personnel. As a result, we may not be able to cover the financial loss we may incur in losing the services of any of our key personnel.

We also may be unable to retain other existing personnel that are important to our business or hire additional qualified personnel. 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 success depends in part upon our ability to attract, motivate and retain a sufficient number of store employees who understand and appreciate our corporate culture and customers. Turnover in the retail industry is generally high. Excessive store employee turnover will result in higher employee costs associated with finding, hiring and training new store employees. If we are unable to hire and retain store personnel capable of consistently providing a high level of customer service, our ability to open new stores may be impaired, the performance of our existing and new stores could be materially adversely affected and our brand image may be negatively impacted.

Our operations have significant liquidity and capital requirements and depend on the availability of adequate financing on reasonable terms, and if we are unable to borrow sufficient capital, it could have a significant negative effect on our business.

Our operations have significant liquidity and capital requirements. Among other things, the seasonality of our businesses requires us to purchase merchandise well in advance of the outdoor selling season in our second fiscal quarter and the holiday selling season in our fourth fiscal quarter. In addition, we have invested significant capital expenditures in remodeling and opening new stores and these capital expenditures will continue in fiscal 2011 and succeeding fiscal periods as we open new full line Design Gallery formats. During fiscal 2010, we spent approximately $32 million for capital expenditures related to new stores and remodeling, and we expect to incur approximately $14 million of additional capital expenditures during fiscal 2011 in connection with new stores and remodeling, of which we have spent $8 million in the first six months of fiscal 2011. We plan to continue our growth and expansion, including opening full line Design Galleries in select major metropolitan markets and pursuing category extensions of our brand.

We depend on our ability to generate cash flows from operating activities, as well as borrowings under the Restoration Hardware, Inc. line of credit, to finance the carrying costs of our inventory, to pay for capital expenditures and operating expenses and to support our growth strategy. Various factors may impact our lenders’ willingness to provide funds to us, including:

 

   

our continuing compliance with the terms of the facility;

 

   

the amount of availability under the facility, which depends on various factors, including the amount of collateral available under the facility, which relies on a borrowing base formula tied principally to the value of our assets, including our inventory; and

 

   

our lenders’ financial strength and ability to perform under the facility.

If the cash flows from our operating activities are not sufficient to finance the carrying costs of inventory and to pay for capital expenditures and operating costs, and if we are unable to borrow a sufficient amount under the line of credit to finance or pay for such expenditures and costs, it could have a significant negative effect on our business.

 

18


Table of Contents

We currently believe that our cash flow from operations and funds available under the revolving line of credit will satisfy our capital and operating requirements for 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 the revolving line of credit, could limit the overall amount of funds available to us.

In addition, we may experience cash flow shortfalls in the future and we may otherwise require additional external funding, or we may need to raise funds to take advantage of unanticipated opportunities, to make acquisitions of other businesses or companies, or to respond to changing business conditions or unanticipated competitive pressures. 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. 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.

A number of factors that affect our ability to successfully open new stores or optimize our store footprint are beyond our control, and these factors may harm our ability to execute our strategy of sizing stores to the potential market, which may negatively affect our results of operations.

We are focused on sizing our assortments and our stores to the potential of the market by adjusting the square footage and number of stores on a geographic market by market basis. We plan to optimize our real estate by opening larger square footage full line Design Galleries in key markets and we expect to relocate or close selected stores in these or adjacent markets. As we address the introduction of new stores in a particular market or changes or closure of existing stores, we must make a series of decisions regarding the size and location of new stores (or the existing stores slated to undergo changes or closure) and the impact on our other existing stores in the area.

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

 

   

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

 

   

size the store locations to the market opportunity;

 

   

retain customers in certain geographic markets when we close stores in that market;

 

   

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

 

   

efficiently build and equip new stores or further remodel existing locations;

 

   

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

 

   

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

 

   

obtain or maintain adequate capital resources on acceptable terms;

 

   

avoid construction delays and cost overruns in connection with the expansion or further remodeling of existing stores and the opening of new stores;

 

   

maintain adequate distribution facilities, information systems and other operational systems to serve our new stores and remodeled stores; and

 

   

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

Any of these challenges could delay or prevent us from completing store openings or the additional remodeling of existing stores or hinder the operations of stores we open or remodel. New or remodeled stores may not be profitable or achieve our target return on investment. Unfavorable economic and business conditions

 

19


Table of Contents

and other events could also interfere with our plans to expand or modify store footprints. Our failure to effectively address challenges such as these could adversely affect our ability to successfully open new stores or change our store footprint in a timely and cost-effective manner and could have a material adverse effect on our business, results of operations and financial condition.

Our operating results are subject to quarterly and seasonal fluctuations, and results for any quarter may not necessarily be indicative of the results that may be achieved for the full fiscal year.

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, our product offerings, the timing and level of markdowns, promotional events, store openings, store closings, the weather, remodeling 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.

In addition, we historically have realized, and expect to continue to realize, higher net revenue and profitability in the fourth quarter of our fiscal year due to the holiday selling season and to a lesser extent in the second quarter due to the outdoor selling season. In fiscal 2010, we recorded net revenues of $198.3 million and $255.9 million in the second and fourth fiscal quarters or approximately 26% and 33%, respectively, of our fiscal 2010 net revenue. In fiscal 2010, our gross profit for the second and fourth quarters was $74.7 million and $95.9 million or approximately 27% and 35% of our fiscal 2010 gross profit, respectively. In anticipation of increased sales activity for the outdoor selling season during our second fiscal quarter and the holiday selling season during our fourth fiscal quarter, our working capital requirements are typically higher in the first and third fiscal quarters due to inventory-related working capital requirements for the outdoor selling season and the holiday selling season.

Accordingly, our results of operations may fluctuate on a seasonal basis and relative to corresponding periods in prior years. Moreover, we may take certain pricing or marketing actions that could have a disproportionate effect on our business, financial condition and results of operations in a particular quarter or selling season. During fiscal 2011, we have undertaken initiatives related to the opening of new full line Design Gallery locations and the closure of some existing stores. In addition, during fiscal 2011, we are introducing a number of new products and we have introduced our new Source Book large catalog format that displays a greater percentage of our product assortment. These initiatives may disproportionately impact results in a particular quarter and 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.

Our business depends in part on a strong brand image. We continue to invest in the development of our brand and the marketing of our business, and if we are not able to maintain and enhance our brand or market our product offerings, we may be unable to attract a sufficient number of customers or sell sufficient quantities of our products.

We believe that the brand image we have developed, and the lifestyle image associated with our brand, have contributed significantly to the success of our business to date. We also believe that maintaining and enhancing the Restoration Hardware brand is integral to our business and to the implementation of our strategies for expanding our business. This will require us to continue to make investments in areas such as marketing and advertising, as well as the day-to-day investments required for store operations, catalog mailings, website operations and employee training. Our brand image may be diminished if new products fail to maintain or enhance our distinctive brand image. Furthermore, our reputation could be jeopardized if we fail to maintain high standards for merchandise quality, if we fail to maintain high ethical, social and environmental standards for all of our operations and activities, if we fail to comply with local laws and regulations or if we experience other negative events that affect our image or reputation. Any failure to maintain a strong brand image could have an adverse effect on our sales and results of operations.

 

20


Table of Contents

We compete in the home furnishings sector of the retail market, which is highly competitive.

The home furnishings sector within the retail market is highly competitive. We compete with the interior design trade and specialty stores, as well as antique dealers and other merchants that provide unique items and custom-designed product offerings at higher price points. We also compete with national and regional home furnishing retailers and department stores. In addition, we compete against mail order catalogs focused on home furnishings. We compete with these and other retailers for customers, suitable retail locations, vendors, qualified employees and management personnel. Many of our competitors have significantly greater financial, marketing and other resources than we do and therefore may be able to adapt to changes in customer preferences more quickly, devote greater resources to the marketing and sale of their products, generate greater national brand recognition or adopt more aggressive pricing policies than we can. In addition, increased catalog mailings by our competitors may adversely affect response rates to our own catalog mailings. 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, hiring practices 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 quality of our product selection, our brand, our merchandise presentation and value proposition, customer service, pricing and store locations. We may not ultimately succeed in competing with other retailers in our market.

Disruptions in the global financial markets may make it difficult for us to borrow a sufficient amount of capital to finance the carrying costs of inventory and to pay for capital expenditures and operating costs, which could negatively affect our business.

Disruptions in the global financial markets and banking systems have made credit and capital markets more difficult for companies to access, even for some companies with established revolving or other credit facilities. Under the Restoration Hardware, Inc. revolving line of credit, each financial institution, which is part of the syndicate for the revolving line of credit, is responsible for providing a portion of the loans to be made under the facility. Factors that have previously affected our borrowing ability under the revolving line of credit have included the borrowing base formula limitations, adjustments in the appraised value of our inventory used to calculate the borrowing base and the availability of each of our lenders to advance its portion of requested borrowing drawdowns under the facility. If, in connection with a disruption in the global financial markets or otherwise, any participant, or group of participants, with a significant portion of the commitments in the revolving line of credit fails to satisfy its obligations to extend credit under the facility and we are unable to find a replacement for such participant or group of participants on a timely basis (if at all), our liquidity and our business may be materially adversely affected.

Reductions in the volume of mall traffic or closing of shopping malls as a result of unfavorable economic conditions or changing demographic patterns could significantly reduce our sales and leave us with unsold inventory.

Most of our stores are currently located in shopping malls. Sales at these stores are derived, in part, from the volume of traffic in those malls. These stores benefit from the ability of the malls’ “anchor” tenants, generally large department stores and other area attractions, to generate consumer traffic in the vicinity of our stores and the continuing popularity of the malls as shopping destinations. Unfavorable economic conditions, particularly in certain regions, have adversely affected mall traffic and resulted in the closing of certain anchor stores and have threatened the viability of certain commercial real estate firms which operate major shopping malls. A continuation of this trend, including failure of a large commercial landlord or continued declines in the popularity of mall shopping generally among our customers, could reduce our sales and leave us with excess inventory. We may respond by increasing markdowns or initiating marketing promotions to reduce excess inventory, which would further adversely impact our results of operations.

 

21


Table of Contents

Our business depends upon the successful operation of our distribution facilities, furniture home delivery hubs and customer care center, as well as our ability to fulfill orders and to deliver our merchandise to our customers in a timely manner.

Our business depends upon the successful operation of our distribution centers, furniture home delivery hubs and customer care center, as well as our order management and fulfillment services and the re-stocking of inventories within our stores. The efficient flow of our merchandise requires that our facilities have adequate capacity to support our current level of operations, and any anticipated increased levels that may follow from any growth of our business.

If we encounter difficulties associated with any of our facilities or if any of our facilities were to shut down for any reason, including as a result of fire, earthquakes (to which our California-based distribution and home delivery facilities in Tracy and Mira Loma and our corporate headquarters in Corte Madera are particularly vulnerable), power outages or other natural disasters, we could face shortages of inventory resulting in “out of stock” conditions in our stores, significantly higher costs and longer lead times associated with distributing our products to both our stores and online customers and the inability to process orders in a timely manner or ship goods to our customers. Further, any significant interruption in the operation of our customer care center, including the call center, could also reduce our ability to receive and process orders and provide products and services to our stores and customers, which could result in lost sales, cancelled sales and a loss of loyalty to our brand.

In October 2011, we will open a new furniture home delivery hub in Avenel, New Jersey, and we recently expanded our West Coast distribution center in Mira Loma, California. In addition, we recently reduced the size of our furniture delivery hub in Tracy, California. As a result of these and other efforts with respect to our distribution facilities, we may encounter operational difficulties with respect to our facilities, such as disruptions in transitioning fulfillment orders to the new distribution facilities and problems or increased expenses associated with operating new facilities or reducing the size and changing functions of existing facilities, and any such difficulties could have a material adverse effect on our business, financial condition and results of operations.

Our results may be adversely affected by fluctuations in raw materials and energy costs.

Increases in the prices of the components and raw materials used in our products could negatively affect the sales of our merchandise and our product margins. These prices may fluctuate based on a number of factors beyond our control, including: commodity prices including prices for oil, lumber and cotton, changes in supply and demand, general economic conditions, labor costs, competition, import duties, tariffs, currency exchange rates and government regulation. In addition, energy costs have fluctuated dramatically in the past. These fluctuations may result in an increase in our transportation costs for freight and distribution, utility costs for our retail stores (particularly our facility located in Tracy, California, which has experienced problems with its power supply in recent years) and overall costs to purchase products from our vendors. Accordingly, changes in the value of the U.S. dollar relative to foreign currencies may increase our vendors’ cost of business and ultimately our cost of goods sold and our selling, general and administrative costs. If we are unable to pass such cost increases on to our customers or the higher cost of the products results in decreased demand for our products, our results of operations would be harmed. Any such cost increase could reduce our earnings to the extent we are unable to adjust the prices of our products.

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

Based on total volume dollar purchases, in fiscal 2010 we purchased approximately 84% of our merchandise from vendors located outside the United States, including 73% from Asia, the majority of which originated from China. In addition, some of the merchandise we purchase from vendors in the United States also depends, in whole or in part, on vendors located outside the United States. As a result, our business highly depends on global trade, as well as trade and cost factors that impact the specific countries where our vendors are located, including

 

22


Table of Contents

Asia. Our future success will depend in large part upon our ability to maintain our existing foreign vendor 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 and transact business on an order by order basis. 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. 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, charges on or assessment of additional import duties, tariffs and quotas, loss of “most favored nation” trading status by the United States 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, freight cost increases, economic uncertainties, including inflation, foreign government regulations, trade restrictions, including the United States retaliating against protectionist foreign trade practices and political unrest, increased labor costs and other similar factors that might affect the operations of our vendors in specific countries such as China.

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.

In addition, there is a risk that compliance lapses by our vendors could occur which could lead to investigations by U.S. government agencies responsible for international trade compliance. Resulting penalties or enforcement actions could delay future imports/exports or otherwise negatively impact our business. In addition, there remains a risk that one or more of our foreign vendors will not adhere to applicable legal requirements or our global compliance standards such as fair labor standards, the prohibition on child labor and other product safety or manufacturing safety standards. The violation of applicable legal requirements by any of our vendors or the failure to adhere to labor, manufacturing safety and other laws by any of our vendors, or the divergence of the labor practices followed by any of our vendors from those generally accepted in the United States, could disrupt our supply of products from our vendors or the shipment of products to us, result in potential liability to us and harm our reputation and brand, any of which could negatively affect our business and operating results.

We rely upon independent third-party transportation providers for the majority of our product shipments.

We currently rely upon independent third-party transportation providers for the majority of our product shipments, including shipments to all of our stores and to customers. Our utilization of their delivery services for shipments, or those of any other shipping companies we may elect to use, is subject to risks, including increases in fuel prices, which would increase our shipping costs, and strikes, work stoppages and inclement weather, which may impact the shipping companies’ abilities to provide delivery services that adequately meet our shipping needs. If we change shipping companies, we could face logistical difficulties that could adversely affect deliveries and we would incur costs and expend resources in connection with such change. Moreover, we may not be able to obtain terms as favorable as those received from the third-party transportation providers we currently use, which in turn would increase our costs.

We may be exposed to risks and costs associated with protecting the integrity and security of our customers’ information.

A significant number of customer purchases from us across all of our channels are made using credit cards. Additionally, approximately 50% of our customer orders are placed through our website. In order for our business to function successfully, we and other market participants must be able to handle and transmit confidential information, including credit card information, securely. There can be no assurance that we currently can, or in the future will be able to, operate our facilities and our customer service and sales operations in accordance with industry recommended practices such as Payment Card Industry, or PCI, Data Security

 

23


Table of Contents

Standards. Even if we are compliant with such standards, we still may not be able to prevent security breaches involving customer transaction data. Any breach could cause consumers to lose confidence in the security of our website and choose not to purchase from us. For example, in 2008 we terminated the employment of certain employees in our call center as a result of unauthorized credit card charges. If a computer hacker or other criminal is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and harm our reputation, any of which could adversely affect our business.

In addition, states and the federal government have recently enacted additional laws and regulations to protect consumers against identity theft. We collect and store personal information from consumers in the course of doing business. These laws have increased the costs of doing business and, if we fail to implement appropriate safeguards or we fail to detect and provide prompt notice of unauthorized access as required by some of these laws, we could be subject to potential claims for damages and other remedies. If we were required to pay any significant amounts in satisfaction of claims under these laws, or if we were forced to cease our business operations for any length of time as a result of our inability to comply fully with any such law, our business, operating results and financial condition could be adversely affected.

Material damage to, or interruptions in, our information systems as a result of external factors, staffing shortages and difficulties in updating our existing software or developing or implementing new software could have a material adverse effect on our business or results of operations.

We depend largely upon our information technology systems in the conduct of all aspects of our operations, many of which we have only adopted and implemented recently in connection with rebuilding our supply chain and infrastructure. Such systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches and natural disasters. Damage or interruption to our information systems may require a significant investment to fix or replace them, and we may suffer interruptions in our operations in the interim. Management information system failures or telecommunications system problems may disrupt operations. In addition, costs and potential problems and interruptions associated with the implementation of new or upgraded systems and technology or with maintenance or adequate support of existing systems could also disrupt or reduce the efficiency of our operations. Any material interruptions or failures in our systems may have a material adverse effect on our business or results of operations.

We also rely heavily on our information technology staff. If we cannot meet our staffing needs in this area, we may not be able to fulfill our technology initiatives while continuing to provide maintenance on existing systems.

We rely on certain software vendors to maintain and periodically upgrade many of these systems so that they can continue to support our business. The software programs supporting many of our systems were licensed to us by independent software developers. The inability of these developers or us to continue to maintain and upgrade these information systems and software programs would disrupt or reduce the efficiency of our operations if we were unable to convert to alternate systems in an efficient and timely manner.

We are vulnerable to various risks and uncertainties associated with our websites, including changes in required technology interfaces, website downtime and other technical failures, costs and technical issues as we upgrade our website software, computer viruses, changes in applicable federal and state regulation, security breaches, legal claims related to our website operations and e-commerce fulfillment and other consumer privacy concerns. Our failure to successfully respond to these risks and uncertainties could reduce website sales and have a material adverse effect on our business or results of operations.

 

24


Table of Contents

Our failure to successfully manage the costs of our catalog and promotional mailings could have a negative impact on our business.

Catalog mailings are an important component of our business. Increases in costs relating to paper, printing, postal rates and other catalog distribution costs would affect the cost of our catalog mailings. We have recently significantly expanded the page counts of our catalogs, increased the number of households receiving our catalogs and reduced the number of catalog mailings. While we expect to send fewer of these catalogs overall, we cannot assure you that this strategy will be successful. We rely on customary discounts from the basic postal rate structure that are available for our catalog mailings, which could be changed or discontinued at any time. The market price for paper has fluctuated significantly during the past three fiscal years and may continue to fluctuate in the future. Future increases in postal rates, paper costs or printing costs would have a negative impact on our operating results to the extent that we are unable to offset such increases by raising prices, by implementing more efficient printing, mailing, delivery and order fulfillment systems or through the use of alternative direct-mail formats.

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

Our failure to successfully anticipate merchandise returns might have a negative impact on our business.

We record a reserve for merchandise returns based on historical return trends together with current product sales performance in each reporting period. If actual returns are greater than those projected and reserved for by management, additional sales returns might be recorded in future periods. In addition, to the extent that returned merchandise is damaged, we often do not receive full retail value from the resale or liquidation of the merchandise. Further, the introduction of new merchandise, changes in merchandise mix, changes in consumer confidence, or other competitive and general economic conditions may cause actual returns to exceed merchandise return reserves. Adverse economic conditions in the past have resulted in an increase in our merchandise returns. Any significant increase in merchandise returns that exceeds our reserves could harm our business and operating results.

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

Certain of the products we sell are subject to regulation by the Consumer Product Safety Commission and similar state and international regulatory authorities, which require certification and testing of certain regulated substances, among other requirements. For example, in August 2008, the Consumer Product Safety Improvement Act of 2008, or CPSIA, was signed into law. In general, the CPSIA bans the sale of children’s products containing lead in excess of certain maximum standards, and imposes other restrictions and requirements on the sale of children’s products, including importing, testing and labeling requirements. Our products have, from time to time, been subject to recall for product safety reasons, and issues of product safety could result in future product recalls, other actions by applicable government authorities or product liability claims. Product safety concerns may also require us, whether on a voluntary or involuntary basis, to remove selected products from our stores, particularly with respect to our Restoration Hardware Baby & Child brand. Product recalls and removal of products and defending such product liability claims can result in, among other things, lost sales, diverted resources, potential harm to our reputation and increased customer service costs, any of which could have a material adverse effect on our business and results of operations.

 

25


Table of Contents

There are claims made against us from time to time that can result in litigation or regulatory proceedings which could distract management from our business activities and result in significant liability.

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

Labor activities could cause labor relations difficulties for us.

Currently none of our employees is represented by a union. However, our employees have the right at any time to form or affiliate with a union, and union organizational activities have occurred previously at our Baltimore distribution center. We cannot predict the negative effects 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.

Our failure or inability to protect our intellectual property rights could diminish the value of our brand and weaken our competitive position.

We currently rely on a combination of copyright, trademark, trade dress and unfair competition laws, as well as confidentiality procedures and licensing arrangements, to establish and protect our intellectual property rights. We believe that our trademarks and other proprietary rights have significant value and are important to identifying and differentiating certain of our products and brand from those of our competitors and creating and sustaining demand for certain of our products. We cannot assure you that the steps taken by us to protect our intellectual property rights will be adequate to prevent infringement of such rights by others, including imitation of our products and misappropriation of our brand.

Furthermore, third parties may assert intellectual property claims against us, particularly as we expand our business and the number of products we offer. Our defense of any claim, regardless of its merit, could be expensive and time consuming and could divert management resources. Successful infringement claims against us could result in significant monetary liability or prevent us from selling some of our products. In addition, resolution of claims may require us to redesign our products, license rights from third parties or cease using those rights altogether. If we fail to protect and maintain our intellectual property rights, the value of our brand could be diminished and our competitive position may suffer.

We are subject to risks associated with leasing substantial amounts of space, including future increases in occupancy costs.

We lease all but one of our retail store locations and we also lease our outlet stores, our corporate headquarters and our four distribution facilities. The initial lease term of our retail stores generally ranges from 10 – 20 years, and certain leases contain renewal options for up to 15 years. Most leases for our retail stores

 

26


Table of Contents

provide for a minimum rent, typically including escalating rent increases, plus a percentage rent based upon sales after certain minimum thresholds are achieved, as well as common area maintenance charges, real property insurance and real estate taxes.

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

Compliance with laws may be costly, and changes in laws could make conducting our business more expensive or otherwise change the way we do business.

We are subject to numerous regulations, including labor and employment, customs, truth-in-advertising, consumer protection, privacy, safety, environmental and zoning and occupancy laws and other laws, including consumer protection regulations that regulate retailers generally or govern our business. If these regulations were to change or were violated by us or our vendors or buying agents, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our products and harm our business and results of operations.

In addition to increased regulatory compliance requirements, changes in laws could make ordinary conduct of our business more expensive or require us to change the way we do business. For example, changes in laws related to employee benefits and treatment of employees, including laws related to limitations on employee hours, supervisory status, leaves of absence, mandated health benefits or overtime pay, could negatively impact us by increasing compensation and benefits costs for overtime and medical expenses. In addition, newly enacted U.S. health care laws and potential global and domestic greenhouse gas emission requirements and other environmental legislation and regulations could result in increased direct costs for us for compliance or may cause our vendors to raise the prices they charge us in order to maintain profitable operations because of increased compliance costs or reduced availability of raw materials.

Because of our international operations, we could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery and anti-kickback laws.

We source a significant portion of our products abroad, and we are increasing the level of our international sourcing activities in an effort to obtain more of our products directly from vendors located aboard. The U.S. Foreign Corrupt Practices Act, and other similar laws and regulations that generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. While our policies mandate compliance with these anti-bribery laws, we cannot assure you that we will be successful in preventing our employees or other agents from taking actions in violation of these laws or regulations. Such violations, or allegations of such violations, could disrupt our business and result in a material adverse effect on our financial condition, results of operations and cash flows.

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

Our business operations depend on our ability to maintain and protect our facilities, computer systems and personnel. Our operations may be affected by natural disasters or other similar events, including floods, hurricanes, earthquakes, widespread illness or fires. Moreover, geopolitical or public safety conditions which

 

27


Table of Contents

affect consumer behavior and spending may impact our business. Terrorist attacks in the United States or threats of terrorist attacks in the United States in the future, as well as future events occurring in response to or in connection with them, could again result in reduced levels of consumer spending. Any of these occurrences could have a significant impact on our operating results, revenue and costs.

We have experienced net losses in the past and we may experience net losses in the future.

We experienced net losses of $58.8 million, $28.7 million and $8.1 million in pro forma 2008, fiscal 2009 and fiscal 2010, respectively. We only recently achieved profitability, as we reported net income of $1.1 million in the first half of fiscal 2011. We may experience net losses in the future, and we cannot assure you that we will sustain recently achieved profitability in future periods.

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

We are subject to income taxes in many U.S. and certain foreign jurisdictions. We record tax expense based on our estimates of future payments, which include reserves for uncertain tax positions in multiple tax jurisdictions, and valuation allowances related to certain net deferred tax assets, including net operating loss carryforwards. At any one time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. Under U.S. federal and state income tax laws, if over a rolling three-year period, the cumulative change in our ownership exceeds 50%, our ability to utilize our net operating loss carry-forwards to offset future taxable income may be limited. Changes in ownership can occur due to transactions in our stock or the issuance of additional shares of our common stock or, in certain circumstances, securities convertible into our common stock. Certain transactions we have completed, including our going private transaction in June 2008, and the sale of shares contemplated in this offering, may impact the timing of the utilization of our net operating loss carryforwards. Furthermore, it is possible that transactions in our stock that may not be within our control may cause us to exceed the 50% cumulative change threshold and may impose a limitation on the utilization of our net operating loss carry-forwards in the future. We expect that throughout the year there could be ongoing variability in our quarterly tax rates as events occur and exposures are evaluated.

In addition, our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of earnings, timing of the utilization of net operating loss carryforwards, or by changes to existing accounting rules or regulations. Further, tax legislation may be enacted in the future which could negatively impact our current or future tax structure and effective tax rates.

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

New accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. A change in accounting rules or regulations may even affect our reporting of transactions completed before the change is effective, and future changes to accounting rules or regulations or the questioning of current accounting practices may adversely affect our results of operations. For example, in August 2010, the Financial Accounting Standards Board (“FASB”) issued an exposure draft outlining proposed changes to current lease accounting in FASB Accounting Standards Codification (“Codification” or “ASC”) 840, “Leases.” In July 2011, the FASB made the decision to issue a revised exposure draft, which is expected to occur in the fourth quarter of 2011, with a final standard expected to be issued by mid to late 2012. The proposed new accounting pronouncement, if ultimately adopted in its proposed form, could result in significant changes to current accounting, including the capitalization of leases on the balance sheet that currently are recorded off balance sheet as operating leases. While this change would not impact the cash flow related to our store leases, it could adversely impact our balance sheet and could therefore impact our ability to raise financing from banks or other sources.

 

28


Table of Contents

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

Our total assets include intangible assets with an indefinite life, goodwill and trademarks, and substantial amounts of property and equipment. We make certain estimates and projections in connection with impairment analyses for these long lived assets, in accordance with FASB ASC 360, “Property, Plant and Equipment (“ASC 360”), and ASC 350, “Intangibles—Goodwill and Other” (“ASC 350”). We also review the carrying value of these assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable in accordance with ASC 360 or ASC 350. We will record an impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. These calculations require us to make a number of estimates and projections of future results. If these estimates or projections change, we may be required to record additional impairment charges on certain of these assets. If these impairment charges are significant, our results of operations would be adversely affected. In that regard, we recorded a $2.1 million impairment charge on long-lived assets of certain underperforming stores in fiscal 2010, and we recorded charges amounting to $3.6 million related to retail store closures in the first six months of fiscal 2011.

Risks Related to this Offering and Ownership of Our Common Stock

An active public market for our common stock may not develop following this offering, which could limit your ability to sell your shares of our common stock at an attractive price, or at all.

Since 2008 and prior to this offering, there has been no public market for our common stock. We cannot predict the extent to which investor interest in our Company will lead to the development of an active trading market in our common stock or how liquid that market might become. An active public market for our common stock may not develop or be sustained after the offering. If an active public market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you, or at all.

Our stock price may be volatile or may decline regardless of our operating performance, and you may not be able to resell your shares at or above the initial public offering price.

After this offering, the market price for our common stock is likely to be volatile, in part because our shares have not been traded publicly. In addition, the market price of our common stock may fluctuate significantly in response to a number of factors, including those described elsewhere in this “Risk Factors” section and this prospectus, as well as the following:

 

   

quarterly variations in our operating results compared to market expectations;

 

   

changes in preferences of our customers;

 

   

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

 

   

size of the public float;

 

   

stock price performance of our competitors;

 

   

fluctuations in stock market prices and volumes;

 

   

default on our indebtedness;

 

   

actions by competitors or other shopping center tenants;

 

   

changes in senior management or key personnel;

 

   

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

 

   

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

 

   

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

 

29


Table of Contents
   

natural disasters or other similar events;

 

   

issuances or expected issuances of capital stock; and

 

   

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

The initial public offering price of our common stock will be determined by negotiations between us and the underwriters based upon a number of factors and may not be indicative of prices that will prevail following the consummation of this offering. Volatility in the market price of our common stock may prevent investors from being able to sell their common stock at or above the initial public offering price. As a result, you may suffer a loss on your investment.

In addition, stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many retail companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were involved in securities litigation, we could incur substantial costs and our resources and the attention of management could be diverted from our business.

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

Sales of substantial amounts of our common stock in the public market after this offering, or the perception that these sales could occur, could adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional shares. Upon completion of this offering, we will have             million shares of common stock outstanding. The shares of common stock offered in this offering will be freely tradable without restriction under the Securities Act of 1933, as amended (the “Securities Act”), except for any shares of our common stock that may be held or acquired by our directors, executive officers and other affiliates, as that term is defined in the Securities Act, which will be restricted securities under the Securities Act. Restricted securities may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available. Moreover, under a stockholders agreement, Home Holdings will have registration rights whereby, at any time following our initial public offering, Home Holdings can require us to register under the Securities Act any shares in our Company not sold in this offering. See “Certain Relationships and Related Party Transactions—Stockholders Agreement” for a more detailed description of the stockholders agreement. If our existing stockholders sell substantial amounts of our common stock in the public market, or if the public perceives that such sales could occur, this could have an adverse impact on the market price of our common stock, even if there is no relationship between such sales and the performance of our business.

We, our executive officers and directors, the selling stockholders and our other existing security holders have agreed, subject to certain exceptions, not to sell or transfer any common stock, or securities convertible into, exchangeable for, exercisable for, or repayable with common stock, for 180 days after the date of this prospectus, without first obtaining written consent of Merrill Lynch, Pierce Fenner & Smith Incorporated and Goldman, Sachs & Co., representatives of the underwriters. In certain events, the restrictions described above shall continue to apply until the expiration of the 18-day period beginning on the issuance of an earnings release or the occurrence of a material news or material event, unless the representatives waive, in writing, such extension. See “Underwriting.”

All of our shares of common stock outstanding as of the date of this prospectus may be sold in the public market by existing stockholders 180 days after the date of this prospectus (or such additional 18-day period noted above), subject to applicable limitations imposed under federal securities laws. See “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling shares of our common stock after this offering.

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

 

30


Table of Contents

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

Our certificate of incorporation and bylaws, as each will be in effect upon completion of this offering, will contain provisions that may make the acquisition of our Company more difficult without the approval of our board of directors. These provisions:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

Our certificate of incorporation will also contain a provision that provides us with protections similar to Section 203 of the Delaware General Corporation Law (“DGCL”), and will prevent us from engaging in a business combination with a person who acquires at least 15% of our common stock for a period of three years from the date such person acquired such common stock and unless board or stockholder approval is obtained prior to the acquisition, except that             and any persons to whom             sells their common stock will be deemed to have been approved by our board of directors, and thereby not subject to these restrictions. These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our Company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.

If you purchase shares of common stock sold in this offering, you will incur immediate and substantial dilution.

If you purchase shares of common stock in this offering, you will incur immediate and substantial dilution in the amount of $         per share based upon an assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus), which is substantially higher than the pro forma net tangible book value per share of our outstanding common stock. In addition, you may also experience additional dilution, or potential dilution, upon future equity issuances to investors or to our employees, consultants and directors under our stock option and equity incentive plans. See “Dilution.”

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business or our operating results fall below the expectations of securities analysts, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our Company, the trading price for our stock would be negatively impacted. If we obtain securities or industry analyst coverage and if one or more of the analysts who covers us downgrades our stock or publishes unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases

 

31


Table of Contents

coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline. Moreover, 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.

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

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

We may apply the proceeds of this offering to uses that do not improve our operating results or increase the value of your investment.

We intend to use a portion of the net proceeds from the sale of common stock by us in this offering to repay all or a portion of the outstanding amounts under the Restoration Hardware, Inc. revolving line of credit, for general corporate purposes, including working capital and capital expenditures, and to pay fees and expenses incurred in connection with this offering of approximately $            , including management fees of $         to Catterton, Tower Three and Glenhill pursuant to the terms of the management services agreement we entered into with them. We may also use a portion of our net proceeds to acquire or invest in other businesses or products. However, we do not have more specific plans for the net proceeds from this offering and will have broad discretion in how we use the net proceeds of this offering. These proceeds could be applied in ways that do not improve our operating results or increase the value of your investment.

Catterton, Tower Three and Glenhill will continue to have significant influence over us after this offering, including control over decisions that require the approval of stockholders, and their interests in our business may be different from yours.

Upon completion of this offering, Home Holdings will own approximately             shares, or     %, of our outstanding common stock. Of that amount, Catterton will beneficially own approximately             shares, or     %, of our outstanding common stock, Tower Three will beneficially own approximately             shares, or     %, of our outstanding common stock, and Glenhill will beneficially own approximately             shares, or     %, of our outstanding common stock.

Home Holdings, and through Home Holdings, Catterton, Tower Three and Glenhill (which we refer to as our Principal Equity Holders), will have significant influence over our reporting and corporate management and affairs and will be able to control certain matters requiring stockholder approval. Home Holdings is able to, subject to applicable law, designate a majority of the members of our board of directors and control actions to be taken by us and our board of directors, including amendments to our certificate of incorporation and bylaws and approval of significant corporate transactions. It is possible that the interests of our Principal Equity Holders may in some circumstances conflict with the interests of our other stockholders, including you.

Our Principal Equity Holders are also in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Our Principal Equity Holders may also pursue acquisition opportunities that are complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as Home Holdings or our Principal Equity Holders, or other funds controlled by or associated with our Principal Equity Holders, continue to indirectly own

 

32


Table of Contents

a significant amount of our outstanding common stock, even if such amount is less than 50%, Home Holdings and our Principal Equity Holders will continue to be able to strongly influence or effectively control our decisions. The concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our Company, could deprive stockholders of an opportunity to receive a premium for their common stock as part of a sale of our Company and might ultimately affect the market price of our common stock.

We are a “controlled company” within the meaning of the             listing requirements and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.

Because of the aggregate beneficial ownership interests held by Home Holdings in our Company, we are considered a “controlled company” for the purposes of the             listing requirements. As such, we are exempt from the             corporate governance requirements that our board of directors, our compensation committee and our nominating and corporate governance committee meet the standard of independence established by those corporate governance requirements. The             independence standards are intended to ensure that directors who meet the independence standard are free of any conflicting interest that could influence their actions as directors. Following this offering, we intend to utilize these exemptions afforded to a “controlled company.” Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the             .

Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 may require significant expenditures and effort by management, and if our independent registered public accounting firm is unable to provide an unqualified attestation report on our internal controls, our stock price could be adversely affected.

Until June 2008, Restoration Hardware, Inc. was a public company and was required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and related rules and regulations. Following the completion of this offering and beginning with our Annual Report on Form 10-K for the year ending February 2, 2013, our management again will be required to report on, and we expect that our independent registered public accounting firm will have to attest to, the effectiveness of our internal control over financial reporting. We are currently in the process of reviewing, documenting and testing our internal control over financial reporting. We may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal control over financial reporting. In addition, in connection with the attestation process by our independent registered public accounting firm, we may encounter problems or delays in completing the implementation of any requested improvements and receiving a favorable attestation.

In 2008, we reported a material weakness that resulted in us incorrectly reporting the amount of indirect costs capitalized into inventory for the first three quarters of fiscal 2007. As a result, we restated our unaudited quarterly financial information for three quarters in fiscal 2007. Under rules of the Securities and Exchange Commission (the “SEC”), a material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. We cannot assure you that other material weaknesses will not be identified in the future.

If other material weaknesses or other deficiencies occur in the future, or if we fail to fully maintain effective internal controls in the future, it could result in a material misstatement of our financial statements that would not be prevented or detected on a timely basis, which could require a restatement, cause investors to lose confidence in our financial information or cause our stock price to decline.

We will incur increased costs as a result of becoming a public company.

As a public company, we will incur significant legal, accounting, insurance and other expenses that we have not incurred as a private company, including costs associated with public company reporting requirements. The

 

33


Table of Contents

expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect compliance with these public reporting requirements and associated rules and regulations to increase our legal and financial costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations could also make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as our executive officers. Further, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory action and, potentially, civil litigation.

 

34


Table of Contents

FORWARD-LOOKING STATEMENTS AND MARKET DATA

This prospectus contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this prospectus are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our store openings, new store operating model, estimated and projected costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives or strategies are forward-looking statements. All forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those that we expected, including:

 

   

our ability to successfully manage our business initiatives;

 

   

our ability to successfully execute our growth strategy;

 

   

our ability to successfully anticipate consumer preferences and demand and manage our inventory commensurate with demand;

 

   

our ability to purchase merchandise in sufficient quantities and at competitive prices;

 

   

our ability to locate and develop relationships with a sufficient number of new vendors;

 

   

exposure to risks and costs associated with not having exclusive relationships with many of our vendors;

 

   

lack of adequate remedies with our vendors for defective merchandise;

 

   

changes in consumer spending, the housing market and general economic conditions;

 

   

our retention of key personnel and our ability to hire additional qualified personnel;

 

   

the significant liquidity and capital requirements of our operations;

 

   

our ability to successfully open new stores, optimize our store footprint and size our stores to the applicable market;

 

   

fluctuations in quarterly and seasonal sales, which could adversely affect the market price of our common stock;

 

   

our maintenance and enhancement of our brand and the marketing of our business;

 

   

our competitiveness in the home furnishings sector of the retail market;

 

   

disruptions in the global financial markets;

 

   

reductions in the volume of mall traffic or closing of shopping malls;

 

   

our ability to successfully operate our distribution facilities, furniture home delivery hubs and customer care center, fulfill orders and deliver merchandise to customers in a timely manner;

 

   

fluctuations in raw materials and energy costs;

 

   

our dependence on foreign imports for our merchandise;

 

   

reliance upon independent third-party transportation providers;

 

   

exposure to risks and costs associated with the integrity and security of our customers’ information;

 

   

damage to, or interruptions in, our software and information systems;

 

35


Table of Contents
   

our ability to manage the costs and performance of our catalog and promotional mailings;

 

   

our ability to anticipate merchandise returns;

 

   

product recalls or other actions by regulatory authorities;

 

   

claims made against us resulting in litigation or regulatory proceedings;

 

   

difficulties in labor relations;

 

   

our ability to protect our intellectual property rights;

 

   

increases in occupancy costs related to leasing substantial amounts of space;

 

   

compliance with existing and future laws, including the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws;

 

   

risks of natural disasters, acts of war, terrorism or widespread illness;

 

   

past net losses and the possibility of future net losses;

 

   

fluctuations in our tax obligations and effective tax rate and realization of our deferred tax assets;

 

   

changes to accounting rules or regulations; and

 

   

impairment charges related to the fair value of our intangible assets and long lived assets.

We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, are disclosed under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this prospectus. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this prospectus in the context of these risks and uncertainties.

We caution you that the important factors referenced above may not contain all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this prospectus are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

We obtained the industry, market and competitive position data throughout this prospectus from (i) our own internal estimates and research, (ii) industry and general publications and research and (iii) studies and surveys conducted by third parties. Industry publications, research, studies and surveys generally do not guarantee the accuracy or completeness of such information. While we believe that the information included in this prospectus from such publications, research, studies and surveys is reliable, we have not independently verified data from these third-party sources. While we believe our internal estimates and research are reliable and the definitions of our market and industry are appropriate, neither such estimates and research nor such definitions have been verified by any independent source.

 

36


Table of Contents

USE OF PROCEEDS

We estimate that the net proceeds to us from this offering, after deducting the underwriting discount and estimated offering expenses, will be approximately $         million, assuming the shares are offered at $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus). We will not receive any proceeds from the sale of shares by the selling stockholders.

Each $1.00 increase or decrease in the assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) would increase or decrease, as applicable, the net proceeds we receive from this offering by approximately $         million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses.

We intend to use a portion of the net proceeds from the sale of common stock by us in this offering to repay all or a portion of the outstanding amounts under the Restoration Hardware, Inc. revolving line of credit, for general corporate purposes, including working capital and capital expenditures, and to pay fees and expenses incurred in connection with this offering of approximately $            , including management fees of $         to Catterton, Tower Three and Glenhill pursuant to the terms of the management services agreement we entered into with them.

As of August 27, 2011, $149.3 million was outstanding under the revolving line of credit. Borrowings under the revolving line of credit bear interest at a rate equal to either the bank’s reference rate or the London Interbank Offered Rate as published by Reuters, referred to as “LIBOR,” plus an applicable margin rate. See “Description of Certain Indebtedness.”

Pending use of the net proceeds from this offering described above, we intend to invest the net proceeds in short- and intermediate-term interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

Bank of America, N.A. is a lender under the revolving line of credit and an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated, an underwriter in this offering, and may receive more than five percent of the net proceeds of this offering. Thus, Merrill Lynch, Pierce, Fenner & Smith Incorporated may be deemed to have a “conflict of interest” under the applicable provisions of Rule 5121 of the Conduct Rules of FINRA. Accordingly, this offering will be made in compliance with the applicable provisions of Rules 5110 and 5121 of the Conduct Rules regarding the underwriting of securities of a company with a member that has a conflict of interest within the meaning of those rules. Goldman, Sachs & Co. has agreed to serve as a “qualified independent underwriter” as defined by FINRA and performed due diligence investigations and reviewed and participated in the preparation of the registration statement of which this prospectus forms a part. No underwriter with a conflict of interest will execute sales in discretionary accounts without the prior written specific approval of the customers. For more information, see “Underwriting—Conflicts of Interest.”

DIVIDEND POLICY

We currently intend to retain all available funds and any future earnings for use in the operation of our business, and therefore we do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon our results of operations, financial condition, capital requirements and other factors that our board of directors deems relevant. We are a holding company, and substantially all of our operations are carried out by our subsidiary, Restoration Hardware, Inc., and its subsidiaries. Restoration Hardware, Inc.’s ability to pay dividends to us is limited by its line of credit, which may in turn limit our ability to pay dividends on our common stock. Our ability to pay dividends may also be restricted by the terms of any future credit agreement or any future debt or preferred securities of ours or of our subsidiaries.

 

37


Table of Contents

CAPITALIZATION

The following table sets forth Restoration Hardware, Inc.’s consolidated cash and cash equivalents and capitalization as of July 30, 2011:

 

   

on an actual basis; and

 

   

on a pro forma as adjusted basis to give effect to the following:

 

   

the Reorganization as described under the section entitled “Prospectus Summary—Reorganization” as if it had occurred on July 30, 2011;

 

   

the sale of              shares of our common stock in this offering by us at an assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) after deducting the underwriting discount and estimated offering expenses;

 

   

the use of $         million of the estimated net proceeds of this offering from the sale of common stock by us in this offering to repay a portion of the outstanding amounts under the Restoration Hardware, Inc. revolving line of credit; and

 

   

the use of $         million of the estimated net proceeds of this offering to pay other fees and expenses incurred in connection with this offering, including management fees of $         to Catterton, Tower Three and Glenhill pursuant to the terms of the management services agreement we entered into with them.

You should read the following table in conjunction with the sections entitled “Use of Proceeds,” “Selected Historical Consolidated Financial and Operating Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    As of July 30, 2011  
    Actual     Pro Forma as
Adjusted (1)
 
   

(dollars in thousands, except 

per share data)

 

Cash and cash equivalents

  $ 9,139      $                
 

 

 

   

 

 

 

Debt, including current portion:

   

Long-term liabilities:

   

Revolving line of credit

  $ 136,609      $     
 

 

 

   

 

 

 

Total long term debt, including current portion

    136,609     

Stockholders’ equity:

   

Common stock, $0.01 par value per share, 1,000 shares authorized, 100 issued and outstanding, actual; $0.0001 par value per share,              shares authorized,              shares issued and outstanding, pro forma as adjusted

   

Additional paid-in capital

    280,226     

Accumulated other comprehensive income

    1,297     

Accumulated deficit

    (63,169                  (2) 
 

 

 

   

 

 

 

Total stockholders’ equity

    218,354     
 

 

 

   

 

 

 

Total capitalization

  $ 354,963      $     
 

 

 

   

 

 

 

 

38


Table of Contents

 

(1) A $1.00 increase (decrease) in the assumed initial public offering price of $             per share, the midpoint of the estimated price range set forth on the cover of this prospectus, would increase (decrease) the pro forma as adjusted amount of cash and cash equivalents by approximately $             million, total assets by approximately $             million, line of credit by approximately $             million, total debt (including current portion) by approximately $             million and total stockholders’ equity by approximately $             million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses.

 

(2) Reflects the $         impact to accumulated deficit for the              shares of restricted stock that become vested upon this offering and exchanged for common stock on a          for          basis, based on an assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus), plus additional cash payments to former employees that are due as a result of the initial public offering.

The information set forth above excludes:

 

   

             unvested restricted shares of our common stock that will be issued to our executive officers and other employees and consultants under the Replacement Plan as replacement grants for awards previously issued pursuant to our Team Resto Ownership Plan;

 

   

options to purchase              shares of our common stock, each with an exercise price equal to the initial public offering price, that we expect to grant in connection with this offering under our 2011 Plan; and

 

   

             additional shares of common stock reserved for future grants under our 2011 Plan.

 

39


Table of Contents

DILUTION

Our pro forma net tangible book value as of July 30, 2011, before giving effect to the sale by us of              million shares of common stock offered in this offering, but after giving effect to the Reorganization as if it had occurred on July 30, 2011, was approximately $         million, or approximately $         per share. Pro forma net tangible book value per share represents the amount of our total tangible assets less the amount of our total liabilities, divided by the number of shares of common stock that would have been outstanding at July 30, 2011, after giving effect to the Reorganization as if it had occurred on July 30, 2011. Dilution in pro forma net tangible book value per share represents the difference between the amount per share paid by investors in this offering and the net tangible book value per share of our common stock outstanding immediately after this offering.

After giving further effect to (i) the sale of              shares of our common stock in this offering by us at an assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) after deducting the underwriting discount and estimated offering expenses; (ii) the use of $         million of the estimated net proceeds to us in this offering from the sale of              million shares to repay all or a portion of the outstanding amounts under the Restoration Hardware, Inc. revolving line of credit; and (iii) the use of $         million of the estimated net proceeds to pay other fees and expenses incurred in connection with this offering, including management fees of $         million to Catterton, Tower Three and Glenhill pursuant to the terms of the management services agreement we entered into with them, our pro forma as adjusted net tangible book value as of July 30, 2011, would have been approximately $         million, or $         per share of common stock. This represents an immediate increase in pro forma net tangible book value of $         per share to our existing stockholder and immediate dilution of $         per share to new investors purchasing shares of common stock in this offering at the initial public offering price.

The following table illustrates this dilution to new investors:

 

Assumed initial public offering price per share

      $                

Pro forma net tangible book value per share as of July 30, 2011 (after giving effect to the Reorganization)

   $                   

Decrease in pro forma net tangible book value per share attributable to fees and other expenses discussed above

     

Increase in pro forma tangible book value per share to existing stockholders attributable to this offering

     
  

 

 

    

Pro forma as adjusted net tangible book value per share as of July 30, 2011

     
     

 

 

 

Pro forma as adjusted dilution per share to new investors

      $     
     

 

 

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) would increase (decrease) our pro forma as adjusted net tangible book value by approximately $         million, or $         per share, and the pro forma as adjusted dilution to investors in this offering by $         per share, assuming that the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses. This pro forma information is illustrative only, and following the completion of this offering, will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.

 

40


Table of Contents

The following table summarizes, as of July 30, 2011, on a pro forma as adjusted basis, the number of shares of our common stock purchased from us, the aggregate cash consideration paid to us and the average price per share paid by our existing stockholder in connection with the Acquisition. The table is based on the initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus), after deducting the underwriting discount and estimated offering expenses in connection with this offering:

 

    Shares Purchased     Total Consideration     Average Price
Per Share
 
    Number    Percentage     Amount      Percentage    

Existing stockholder before this offering

       $           $     

New investors participating in this offering

           
 

 

  

 

 

   

 

 

    

 

 

   

Total

       100        100  
 

 

  

 

 

   

 

 

    

 

 

   

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share (the midpoint of the estimated price range set forth on the cover of this prospectus) would increase (decrease) the total consideration paid by investors participating in this offering by $         million, or increase (decrease) the percent of total consideration paid by investors participating in this offering by     %, assuming that the number of shares offered by us and the selling stockholders, as set forth on the cover of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses.

Except as otherwise indicated, the discussion and tables above assume no exercise of the underwriters’ option to purchase additional shares, no exercise of any outstanding options to purchase our common stock and no sale of common stock by the selling stockholders. The sale of              million shares of common stock to be sold by the selling stockholders in this offering will reduce the number of shares held by such stockholders to              million, or     % of the total shares outstanding, and will increase the number of shares held by investors participating in this offering to              million, or     % of the total shares outstanding. In addition, if the underwriters’ option to purchase additional shares is exercised in full, the number of shares of common stock held by our existing stockholders will be further reduced to              million, or     % of the total number of shares of common stock to be outstanding upon the closing of this offering, and the number of shares of common stock held by investors participating in this offering will be further increased to              million shares or     % of the total number of shares of common stock to be outstanding upon the closing of this offering.

The tables and calculations above exclude:

 

   

            unvested restricted shares of our common stock that will be issued to our executive officers and other employees and consultants under the Replacement Plan as replacement grants for awards previously issued pursuant to our Team Resto Ownership Plan;

 

   

options to purchase              shares of our common stock, each with an exercise price equal to the initial public offering price, that we expect to grant in connection with this offering under our 2011 Plan; and

 

   

             additional shares of common stock reserved for future grants under our 2011 Plan.

To the extent that any options or other equity awards are granted in the future and those options or other equity awards are exercised or become vested, new investors will experience further dilution.

 

41


Table of Contents

SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

The following tables present Restoration Hardware, Inc.’s consolidated financial and operating data as of the dates and for the periods indicated. Restoration Hardware Holdings was formed as a Delaware corporation on August 18, 2011. Restoration Hardware Holdings will acquire all of the outstanding shares of capital stock of Restoration Hardware, Inc. prior to the effectiveness of this offering in connection with the Reorganization, and will therefore control Restoration Hardware, Inc. Restoration Hardware Holdings has not engaged in any business or other activities except in connection with its formation and the Reorganization. Accordingly, all financial and other information herein relating to periods prior to the completion of the Reorganization is that of Restoration Hardware, Inc.

All of the outstanding capital stock of Restoration Hardware, Inc. was acquired on June 16, 2008, by Home Holdings, which we refer to in this prospectus as the “Acquisition.” As a result of the Acquisition, a new basis of accounting was created beginning June 17, 2008. The periods prior to the Acquisition are referred to as the “Predecessor” periods and the periods after the Acquisition are referred to as the “Successor” periods in this prospectus. The Predecessor periods presented in this prospectus include the period from February 3, 2008 through June 16, 2008, reflecting approximately 19 weeks of operations, and the Successor periods presented in this prospectus include the period from June 17, 2008 through January 31, 2009, reflecting approximately 33 weeks of operations. Due to the Acquisition, the financial statements for the Successor periods are not comparable to those of the Predecessor periods presented in this prospectus.

The selected consolidated financial data as of and for the years ended February 3, 2007, and February 2, 2008, and as of January 31, 2009, were derived from Restoration Hardware, Inc.’s consolidated financial statements for such years not included herein. The selected consolidated financial data for the periods ended June 16, 2008, and January 31, 2009, and as of and for the fiscal years ended January 30, 2010, and January 29, 2011, were derived from Restoration Hardware, Inc.’s consolidated financial statements included elsewhere in this prospectus.

The selected consolidated financial data for the six months ended July 31, 2010, and July 30, 2011, and as of July 30, 2011, were derived from Restoration Hardware, Inc.’s unaudited consolidated interim financial statements included elsewhere in this prospectus. The unaudited consolidated interim financial statements were prepared on a basis consistent with that used in preparing our audited consolidated financial statements and include all adjustments, consisting of normal and recurring items, that we consider necessary for a fair presentation of our financial position and results of operations for the unaudited periods. The unaudited financial information for the twelve months ended July 31, 2010, has been derived by adding our financial information for the year ended January 30, 2010, to the financial information for the six months ended July 31, 2010, and subtracting the financial information for the six months ended August 1, 2009. The unaudited financial information for the twelve months ended July 30, 2011, has been derived by adding our financial information for the year ended January 29, 2011, to the financial information for the six months ended July 30, 2011, and subtracting the financial information for the six months ended July 31, 2010.

Restoration Hardware, Inc.’s historical results are not necessarily indicative of future operating results, and interim results for the six months ended July 30, 2011, are not projections for the results to be expected for the fiscal year ending January 28, 2012. The selected historical consolidated data presented below should be read in conjunction with the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto and other financial data included elsewhere in this prospectus.

 

42


Table of Contents
    Predecessor          Successor  
    Year Ended     Period
from
February 3,
2008
Through
June 16,
2008
         Period
from
June 17,
2008,
Through
January 31,
2009
    Year Ended     Six Months Ended     Last Twelve
Months Ended(1)
 
    February 3,
2007
    February 2,
2008
          January 30,
2010
    January 29,
2011
    July 31,
2010
    July 30,
2011
    July 31,
2010
    July  30,
2011
 
    (dollars in thousands, excluding per share and per square foot data)  

Statement of Operations Data:

                       

Net revenues

  $ 712,810      $ 722,243      $ 195,437          $ 498,581      $ 625,685      $ 772,752      $ 330,854      $ 420,383      $ 686,787      $ 862,281   

Cost of goods sold

    463,105        490,935        140,088            308,448        412,629        501,132        214,084        265,953        447,762        553,001   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    249,705        231,308        55,349            190,133        213,056        271,620        116,770        154,430        239,025        309,280   

Selling, general and administrative expenses

    239,077        274,454        75,396            213,011        238,889        275,859        126,453        150,619        248,603        300,025   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    10,628        (43,146     (20,047         (22,878     (25,833     (4,239     (9,683     3,811        (9,578     9,255   

Interest expense

    (7,233     (8,663     (2,731         (4,907     (3,241     (3,150     (1,579     (1,888     (3,087     (3,459
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    3,395        (51,809     (22,778         (27,785     (29,074     (7,389     (11,262     1,923        (12,665     5,796   

Income tax expense (benefit)

    143        127        508            (201     (423     685        41        783        (584     1,427   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 3,252      $ (51,936   $ (23,286       $ (27,584   $ (28,651   $ (8,074   $ (11,303   $ 1,140      $ (12,081   $ 4,369   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

                       

Basic

  $ 0.09      $ (1.34   $ (0.60       $ (275,840   $ (286,510   $ (80,740   $ (113,030   $ 11,400      $ (120,810   $ 43,690   

Diluted

  $ 0.08      $ (1.34   $ (0.60       $ (275,840   $ (286,510   $ (80,740   $ (113,030   $ 11,400      $ (120,810   $ 43,690   

Average number of shares outstanding:

                       

Basic

    38,184,000        38,831,000        38,969,000            100        100        100        100        100        100        100   

Diluted

    39,221,000        38,831,000        38,969,000            100        100        100        100        100        100        100   

Pro forma net income (loss) per share (2):

                       

Basic

                $          $         

Diluted

                $          $         

Pro forma average number of shares outstanding (2):

                       

Basic

                       

Diluted

                       

Other Financial and Operating Data:

                       

Growth in net revenues:

                       

Stores (3)

    14     (10 )%      —              —          (6 )%      15     17     21     6     17

Direct

    48     28     —              —          (15 )%      37     31     36     10     38

Total

    23     1     —              —          (10 )%      24     23     27     7     26

Retail (4):

                       

Comparable store sales change (5)

    6     (10 )%      (12 )%          (8 )%      (7 )%      19     26     20     10     17

Retail stores open at end of period

    103        102        100            99        95        91        96        87        96        87   

Average gross square footage (in thousands) (6)

    1,089        1,084        1,072            1,060        1,042        1,014        1,019        946        1,024        977   

Average selling square footage (in thousands) (6)

    687        685        677            671        660        641        645        599        648        619   

Retail sales per selling square foot (7)

  $ 678      $ 600      $ 147          $ 406      $ 525      $ 635      $ 277      $ 351      $ 584      $ 710   

Direct:

                       

Catalogs circulated (in thousands) (8)

    54,267        57,501        13,771            26,831        31,336        46,507        18,893        12,768        38,266        40,382   

Catalog pages circulated (in millions) (8)

    8,110        8,636        2,168            3,507        4,418        6,260        2,823        3,293        5,560        6,730   

Direct as a percentage of net revenues (9)

    30     38     43         41     39     43     42     45     41     45

Capital expenditures

  $ 15,152      $ 13,282      $ 3,821          $ 13,428      $ 2,024      $ 39,907      $ 14,181      $ 12,168      $ 15,670      $ 37,894   

Adjusted EBITDA (10)

  $ 40,909      $ (4,033   $ (8,219       $ 4,386      $ 17,596      $ 41,097      $ 8,994      $ 27,747      $ 31,516      $ 59,850   

 

43


Table of Contents
    Predecessor          Successor  
    February 3,
2007
    February 2,
2008
         January 31,
2009
    January 30,
2010
    January 29,
2011
    July 30,
2011
 
    (in thousands)  

Balance Sheet Data:

               

Cash and cash equivalents

  $ 1,461      $ 1,229          $ 8,603      $ 13,186      $ 13,364      $ 9,139   

Working capital (excluding cash and cash equivalents) (11)

    109,154        103,734            102,850        57,058        103,894        136,765   

Total assets

    316,367        342,546            494,773        431,528        501,991        565,529   

Line of credit

    68,384        78,367            110,696        57,442        111,837        136,609   

Total debt (including current portion) (12)

    70,783        110,774            117,515        61,652        116,995        146,492   

Total stockholders’ equity

    92,108        43,830            238,670        221,079        215,804        218,354   

 

(1) The unaudited financial information for the twelve months ended July 31, 2010, has been derived by adding our financial information for the year ended January 30, 2010, to the financial information for the six months ended July 31, 2010, and subtracting the financial information for the six months ended August 1, 2009. The unaudited financial information for the twelve months ended July 30, 2011, has been derived by adding our financial information for the year ended January 29, 2011, to the financial information for the six months ended July 30, 2011, and subtracting the financial information for the six months ended July 31, 2010.

 

(2) Pro forma net income (loss) per share gives effect to (i) the Reorganization, (ii) the issuance of              shares of common stock in this offering and (iii) the application of a portion of the estimated net proceeds from the sale of common stock by us in this offering to repay a portion of the outstanding amounts under Restoration Hardware, Inc.’s revolving line of credit as if the offering and those transactions had occurred on January 31, 2010. This assumes net proceeds of this offering of $         million, assuming the shares are offered at $         per share, the midpoint of the estimated price range set forth on the cover of this prospectus, after deducting the underwriting discount and estimated offering expenses.

 

(3) Store data represent retail stores plus outlet stores.

 

(4) Retail data have been calculated based upon retail stores, including our Baby & Child Gallery, and excludes outlet stores.

 

(5) Comparable store sales have been calculated based upon retail stores that were open at least fourteen full months as of the end of the reporting period and did not change square footage by more than 20% between periods. Comparable store net revenues exclude revenues from outlet stores.

 

(6) Average square footage (gross or selling, as applicable) is calculated for each quarter by taking the total applicable square footage at the beginning of the quarter plus the total applicable square footage at the end of the quarter and dividing by two. Average square footage for periods of six, nine and twelve months is calculated by averaging the average square footage for the quarters within such periods.

Average square footage (gross or selling, as applicable) for the 2008 Predecessor period is calculated by adding the average applicable square footage for the first quarter of the year ended January 31, 2009, and for the period May 4, 2008, through June 16, 2008, and dividing by two. Average square footage (gross or selling, as applicable) for the period May 4, 2008, through June 16, 2008, is calculated by taking the total applicable square footage at the beginning of the period plus the total applicable square footage at the end of the period and dividing by two.

Average square footage (gross or selling, as applicable) for the 2008 Successor period is calculated by adding the average square footage for three periods, being the period June 17, 2008, through August 2, 2008, the third quarter of the year ending January 31, 2009, and the fourth quarter of the year ended January 31, 2009, and dividing by three. Average square footage (gross or selling, as applicable) for the period June 17, 2008, through August 2, 2008, is calculated by taking the total applicable square footage at the beginning of the period plus the total applicable square footage at the end of the period and dividing by two.

 

(7) Retail sales per selling square foot is calculated by dividing total net revenues for all retail stores, comparable and non-comparable, by the average selling square footage for the period.

 

(8) The catalogs and catalog pages circulated from period to period do not take into account different page sizes per catalog distributed. Page sizes and page counts vary for different catalog mailings and we sometimes mail different versions of a catalog at the same time. Accordingly, period to period comparisons of catalogs circulated and catalog pages circulated do not take these variations into account. In fiscal 2010, we mailed a larger number of catalogs that contained fewer pages and in some cases significantly smaller page sizes than in prior periods. In the first six months of fiscal 2011, we mailed fewer catalogs that contained a significant increase in number of pages as compared to the first six months of fiscal 2010.

 

(9) Direct revenues include sales through our catalogs and websites.

 

(10) EBITDA and Adjusted EBITDA have been presented in this prospectus and are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We have presented Adjusted EBITDA for the Predecessor periods consistently with the Successor periods to present such adjustments on a comparable basis for those periods. EBITDA is defined as consolidated net income (loss) before depreciation and amortization, interest expense and provision for income taxes. Adjusted EBITDA is calculated in accordance with and is the basis of our Management Incentive Program (or “MIP”) as described further under “Executive Compensation—Compensation Discussion and Analysis,” and reflects further adjustments to EBITDA to eliminate the impact of certain items, including non-cash or other items that we do not consider representative of our ongoing operating performance as discussed further below.

EBITDA and Adjusted EBITDA are included in this prospectus because they are key metrics used by management, our board of directors, and our Principal Equity Holders to assess our financial performance, and Adjusted EBITDA is used in connection

 

44


Table of Contents

with determining incentive compensation under our MIP. Additionally, EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use Adjusted EBITDA, alongside other GAAP measures such as gross profit, operating income (loss) and net income (loss), to measure profitability, to make budgeting decisions, and to compare our performance against that of other peer companies. We believe that Adjusted EBITDA provides useful information facilitating operating performance comparisons from period to period and company to company.

EBITDA and Adjusted EBITDA are not GAAP measures of our financial performance or liquidity and should not be considered as alternatives to net income (loss) as a measure of financial performance, cash flows from operating activities as a measure of liquidity, or any other performance measure derived in accordance with GAAP and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Additionally, EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management’s discretionary use, as they do not consider certain cash requirements such as tax payments and debt service requirements and certain other cash costs that may recur in the future. EBITDA and Adjusted EBITDA contain certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized, and exclude certain unusual charges that may recur in the future. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed to imply that our future results will be unaffected by any such adjustments. Management compensates for these limitations by relying primarily on our GAAP results and by using EBITDA and Adjusted EBITDA only supplementally. Our measures of EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions of other companies due to different methods of calculation.

A reconciliation of net income (loss) to EBITDA and Adjusted EBITDA is set forth below:

 

    Predecessor (a)          Successor  
    Year Ended     Period
from
February 3,
2008
Through
June 16,
2008
         Period
from
June 17,
2008,
Through
January 31,
2009
    Year Ended     Six Months
Ended
    Last Twelve
Months Ended (1)
 
    February 3,
2007
    February 2,
2008
          January 30,
2010
    January 29,
2011
    July 31,
2010
    July 30,
2011
    July 31,
2010
    July 30,
2011
 
    (in thousands)  

Net income (loss)

  $ 3,252      $ (51,936   $ (23,286       $ (27,584   $ (28,651   $ (8,074   $ (11,303   $ 1,140      $ (12,081   $ 4,369   

Depreciation and amortization

    21,696        23,120        7,934            50,222        43,065        31,263        13,747        14,983        28,419        32,499   

Interest expense

    7,233        8,663        2,731            4,907        3,241        3,150        1,579        1,888        3,087        3,459   

Income tax expense (benefit)

    143        127        508            (201     (423     685        41        783        (584     1,427   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

    32,324        (20,026     (12,113         27,344        17,232        27,024        4,064        18,794        18,841        41,754   

Management and board fees (b)

    350        517        91            1,985        4,620        4,793        2,474        2,396        4,944        4,715   

Non-cash compensation (c)

    4,021        2,706        2,319            —          592        2,142        1,255        1,100        1,674        1,987   

Terminated operations (d)

    4,214        6,800        884            3,821        2,604        352        419        1,666        1,444        1,599   

Severance and other transaction costs (e)

    —          886        600            368        1,521        1,797        501        28        1,323        1,324   

Impairment of long-lived assets (f)

    —          5,084        —              3,868        2,304        2,115        —          3,571        2,304        5,686   

Amortization of inventory fair value adjustment (g)

    —          —          —              (35,075     (12,780     —          —          —          —          —     

Non-capitalized IPO costs (h)

    —          —          —              —          —          2,351        —          —          —          2,351   

Other adjustments allowable under our agreements with our stockholders (i)

    —          —          —              2,075        1,503        523        281        192        986        434   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 40,909      $ (4,033   $ (8,219       $ 4,386      $ 17,596      $ 41,097      $ 8,994      $ 27,747      $ 31,516      $ 59,850   
 

 

 

   

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a) We have presented Adjusted EBITDA for the Predecessor periods consistently with the Successor periods to present information on a comparable basis for those periods.
  (b) Includes fees paid in accordance with our management services agreement with Home Holdings in the Successor periods, as well as fees and expense reimbursements paid to our board of directors in both the Predecessor and Successor periods.
  (c) Represents non-cash charges related to stock-based compensation programs.
  (d) Includes the impact of divesting our Brocade Home brand, closing four temporary clearance centers operated from October 2008 to March 2010, costs related to closing of The Michaels Furniture Company and costs related to the closure of our Shanghai office location.
  (e) Amounts in fiscal 2007, the 2008 Predecessor period and the 2008 Successor period include severance costs, and transaction costs associated with our Acquisition by Home Holdings. Amounts in fiscal 2009, fiscal 2010 and the first six months of fiscal 2011 generally include executive severance and other related costs.
  (f) Includes costs related to impairment of long-lived assets related to our retail store operations.
  (g) Represents non-cash impact of amortizing the net fair value adjustment to inventory recorded at the Acquisition over the period of the inventory turn.

 

45


Table of Contents
  (h) Represents costs related to our efforts to pursue an initial public offering.
  (i) Represents consulting fees related to organizational matters following the Acquisition in the 2008 Successor period and fiscal 2009, foreign exchange gains and losses in all periods, as well as other items which management believes are not indicative of our ongoing operating performance.

 

(11) Working capital is defined as current assets, excluding cash and cash equivalents, less current liabilities, excluding the current portion of long-term debt.

 

(12) Total debt (including current portion) includes the line of credit and capital lease obligations.

 

46


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We believe Restoration Hardware is one of the fastest growing and most innovative luxury brands in the home furnishings marketplace. Our collections of timeless, updated classics and reproductions are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers. We offer dominant assortments across a growing number of categories, including furniture, lighting, textiles, bathware, décor, outdoor and garden, as well as baby and child products. Our business is fully integrated across our multiple channels of distribution, consisting of our stores, catalogs and websites. We position our stores as showrooms for our brand, while our catalogs and websites act as virtual extensions of our stores. As of July 30, 2011, we operated 87 retail stores and 10 outlet stores throughout the United States and Canada. In fiscal 2010, we distributed approximately 46.5 million catalogs, and our websites logged over 12.1 million unique visits.

When Gary Friedman joined us as Chief Executive Officer in 2001, we began to reposition Restoration Hardware from a nostalgic, discovery-items business to a leading home furnishings brand. Starting in 2008 when we were taken private by investment funds affiliated with Catterton, Tower Three and Glenhill, we significantly accelerated the transformation of our brand and the development of our multi-channel business model and infrastructure. Over the last ten years, we have built a new company through the following initiatives:

 

   

Elevated Our Brand Positioning – We significantly enhanced the quality and design of our merchandise, elevating our brand to a luxury positioning. We believe this strategy, along with our unmatched combination of design, quality and value, has allowed us to disrupt the highly fragmented home furnishings market and positions us to further grow our market share.

 

   

Enhanced Our Product Development Process – We established a collaborative organization with cross-functional teams in product development, sourcing, merchandising, inventory and creative, all focused on product leadership. We built the Restoration Hardware Center of Innovation & Product Leadership, a facility which supports and streamlines the entire product development process. In addition, we have developed direct sourcing relationships with our artisan partners. The transformation of our creative process has dramatically shortened our typical product lead times, reduced our product costs and enhanced our ability to successfully introduce new categories.

 

   

Refined Our Go-To-Market Strategy – We aligned our organization and the way in which we approach the consumer to pursue a market-based rather than channel-based sales strategy across our stores and direct channels. Our strategy is to size our stores and assortments to the potential of the market area that each location serves by positioning our stores as showrooms for our brand, while our catalogs and websites act as virtual extensions of our stores. We believe this approach enables us to strategically deploy our resources by market to maximize return on invested capital.

 

   

Reconceptualized Our Stores and Developed Full Line Design Gallery Format – In 2009 and 2010, we remodeled substantially all of our existing retail stores into our Gallery format that reconceptualizes the store experience by presenting our products in sophisticated lifestyle settings. We experienced enhanced productivity and profitability as a result of our Gallery conversions. In 2011, we developed our full line Design Gallery format, which offers approximately three times the selling square footage of an existing Gallery store.

 

   

Built a New Supply Chain and Systems Infrastructure – We invested over $60 million in our supply chain and systems infrastructure, including: (i) reconfiguring and adding to our distribution network; (ii) implementing new point-of-sale, warehouse management, order management and customer service systems; and (iii) enhancing our direct sourcing capabilities.

 

47


Table of Contents
   

Strengthened Our Management Team – We strengthened our management team by adding a new Co-Chief Executive Officer as well other senior leaders in merchandising, product development, finance, information technology and inventory planning who bring extensive experience in their respective fields.

We have recently experienced strong growth in sales and profitability, including:

 

   

For the twelve months ended July 30, 2011, we grew our net revenues 26% to $862.3 million over the prior twelve month period, increased our Adjusted EBITDA 90% to $59.9 million and increased our net income by $16.5 million to a net income of $4.4 million. Our stores net revenues, comparable store sales and direct net revenues grew by 17%, 17% and 38%, respectively.

 

   

In the first half of fiscal 2011, we grew our net revenues 27% to $420.4 million over the comparable period in fiscal 2010, increased our Adjusted EBITDA 209% to $27.7 million and increased our net income by $12.4 million to a net income of $1.1 million. Our stores net revenues, comparable store sales and direct net revenues grew by 21%, 20% and 36%, respectively.

 

   

In fiscal 2010, we grew our net revenues 24% to $772.8 million over fiscal 2009, increased our Adjusted EBITDA 134% to $41.1 million and decreased our net loss by $20.6 million to a net loss of $8.1 million. Our stores net revenues, comparable store sales and direct net revenues grew by 15%, 19% and 37%, respectively.

While our growth strategy has contributed to our improving operating results, it also presents significant risks and challenges, including that the current strong response of consumers to our product offerings may not be sustained, and that we may not be able to obtain products from our vendors in the quantity, or within the time frame, required to support our growth plans. In addition, we must seek to ensure that implementation of our strategic initiatives does not divert management’s attention from continuing to build on the strengths that we believe have driven our recent success.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of financial and operating measures. These key measures for determining how our business is performing are net revenues, gross profit, gross margin, and net income (loss). Additionally, we review other important metrics such as comparable store sales and selling, general and administrative expenses, catalogs circulated and circulated catalog pages. In addition, EBITDA and Adjusted EBITDA are key metrics used by management, our board of directors and our Principal Equity Holders to assess our operating performance.

Net Revenues. Net revenues reflect our sale of merchandise plus shipping and handling revenue collected from our customers, less returns and discounts. Revenues are recognized upon receipt of product by our customers.

Comparable Store Sales. Comparable store sales have been calculated based upon retail stores that were open at least fourteen full months as of the end of the reporting period. A store is not considered a part of the comparable store sales base if the square footage of the store changed by more than 20% due to remodel or relocation activities. If a store is closed for seven days during a month, that month will be excluded from comparable store sales. Outlet stores are not included in calculations of comparable store sales.

Comparable store sales allow us to evaluate how our retail store base is performing by measuring the change in period-over-period net revenues in stores that have been open for fourteen months or more. While we review comparable store sales as one measure of our performance, this measure is less relevant to us than it may be to other retailers due to our fully integrated, multi-channel, go-to-market strategy, which makes measures that analyze one of our channels in isolation less indicative of the performance of our business than it might be for other companies that operate their distribution channels as separate businesses. In addition to comparable store

 

48


Table of Contents

sales, we also review retail sales per selling square foot, among other metrics, to evaluate the performance of individual stores. Various factors affect comparable store sales and net revenues, including:

 

   

the ongoing success of existing Gallery stores, and any new Gallery stores opened;

 

   

the success of our new full line Design Galleries;

 

   

our ability to size stores to the market opportunity by expanding stores, relocating stores and reducing square footage where appropriate;

 

   

our ability to develop and offer a compelling product assortment responsive to customer preferences and design trends;

 

   

our ability to maintain our appeal to existing customers and attract new customers;

 

   

competition;

 

   

pricing and changes in our merchandise mix;

 

   

the success and timing of our catalog mailings and promotions; and

 

   

our ability to source and distribute products efficiently.

The industry in which we operate is cyclical, and consequently our revenues are affected by general economic conditions. Purchases of our products are sensitive to a number of factors that influence the levels of consumer spending, including economic conditions, consumer disposable income, housing market conditions, consumer debt, interest rates and consumer confidence.

Our business is seasonal. As a result, our revenues fluctuate from quarter to quarter, which often affects the comparability of our results between periods. Net revenues are historically higher in the second and fourth fiscal quarters due primarily to the impact of the outdoor selling season and the holiday selling season, respectively.

Selling Square Footage. Selling square footage is retail space at our stores used to sell our products. Selling square footage excludes backrooms at retail stores used for storage, office space or similar matters. Selling square footage may include exterior sales space located outside a store, such as courtyards, gardens and rooftops.

Retail Sales Per Selling Square Foot. Retail sales per selling square foot is calculated by dividing total net revenues for all retail stores, comparable and non-comparable, by the average selling square footage for the period. Sales per square foot for interior sales space may be significantly higher than sales per square foot for exterior sales space, as products are generally presented more densely within our stores.

Gross Profit. Gross profit is equal to our net revenues less cost of goods sold. Gross profit as a percentage of our net revenues is referred to as gross margin. Cost of goods sold include the direct cost of purchased merchandise; inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and lower of cost or market reserves; inbound freight; all freight costs to get merchandise to our stores; design, buying and allocation costs; occupancy costs related to store operations, such as rent and common area maintenance; depreciation and amortization of leasehold improvements, equipment and other assets in our stores and distribution centers; and all logistics costs associated with shipping product to our customers. We expect gross profit to increase to the extent that we successfully grow our net revenues and leverage the fixed portion of cost of goods sold.

Our gross profit can be favorably impacted by sales volume increases, as occupancy and certain other costs that are largely fixed do not necessarily increase proportionally with volume increases. Changes in the mix of our products may also impact our gross profit. We review our inventory levels on an ongoing basis in order to identify slow-moving merchandise and use product markdowns and our outlet stores to efficiently sell these products. The timing and level of markdowns are driven primarily by customer acceptance of our merchandise.

 

49


Table of Contents

The primary drivers of the costs of individual goods are raw materials costs, labor costs in the countries where we source our merchandise, and logistics costs.

Our gross profit may not be comparable to other specialty retailers, as some companies may not include all or a portion of the costs related to their distribution network and store occupancy in calculating gross profit as we and many other retailers do, but instead may include them in selling, general and administrative expenses.

Selling, General and Administrative Expenses. Selling, general and administrative expenses include all operating costs not included in cost of goods sold. These expenses include all payroll and payroll-related expenses, store expenses other than occupancy, and expenses related to many of our operations at our headquarters, including utilities, depreciation and amortization, and marketing expense, which primarily includes catalog production, mailing and print advertising costs. Selling, general and administrative expenses as a percentage of net revenues is usually higher in lower volume quarters and lower in higher volume quarters because a significant portion of the costs are relatively fixed.

Our recent revenue growth has been accompanied by increased selling, general and administrative expenses. The most significant components of these increases are marketing and payroll costs. We expect these expenses to continue to increase as we grow our business.

In addition to the metrics described above, EBITDA and Adjusted EBITDA are key metrics used by management, our board of directors, and our Principal Equity Holders to assess our operating and financial performance. Additionally, Adjusted EBITDA and EBITDA are frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use EBITDA, alongside other GAAP measures such as gross profit, operating income (loss) and net income (loss), to measure profitability, to make budgeting decisions, and to compare our performance against that of other peer companies. We believe that Adjusted EBITDA provides useful information facilitating operating performance comparisons from period to period by eliminating the impact of certain items that are not representative of either our core operating results or business outlook. Our management does not view EBITDA and Adjusted EBITDA as measures of free cash flow as they do not consider certain cash requirements such as tax payments and debt service requirements. EBITDA and Adjusted EBITDA contain certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized, and exclude certain unusual charges. We compensate for these limitations by relying primarily on our GAAP results and by using EBITDA and Adjusted EBITDA only supplementally.

Other Factors Affecting Our Results

Other important factors that affected our results for the periods presented in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are as follows:

Purchase Accounting Impact of the Acquisition. All of the outstanding capital stock of Restoration Hardware, Inc. was acquired on June 16, 2008, by Home Holdings (which we refer to as the Acquisition) through a transaction that was accounted for under Statement of Financial Accounting Standards 141, “Business Combinations.” The purchase price was allocated to state our assets and liabilities at fair value. The allocation of the purchase price had the net effect of reducing the carrying amount of inventory by $47.9 million, increasing property and equipment by $17.6 million and increasing amortizable intangible assets by $55.7 million. The $47.9 million decrease in inventory value was amortized to cost of goods sold over approximately nine months and resulted in increased gross profit during the 2008 Successor period and fiscal 2009. We are depreciating the $17.6 million increase in property and equipment over the useful life of each asset, which has had the effect of reducing gross profit and increasing selling, general and administrative expenses in the Successor periods. The $55.7 million increase in amortizable intangible assets is being amortized over the remaining life of each asset and has had the effect of reducing gross profit and increasing selling, general and administrative expenses in the Successor periods. We also recorded intangible assets with an indefinite life, goodwill and trademarks, at their fair values of $122.3 million and $47.1 million, respectively.

 

50


Table of Contents

The following table summarizes the financial impact of purchase accounting adjustments on gross profit and selling, general and administrative expense in dollars, and as a percentage of net revenues, in the Successor periods, including our pro forma 2008 year, which is provided supplementally and has been prepared to give effect to the Acquisition as if such transaction had occurred on February 3, 2008:

 

    Successor     Pro Forma     Successor  
    Period from
June 17, 2008
Through
January 31,
2009
    Year Ended     Six Months Ended  
    January 31,
2009
    January 30,
2010
    January 29,
2011
    July 31,
2010
    July 30,
2011
 
    (dollars in thousands)  

Net revenues

  $ 498,581        100   $ 694,018        100   $ 625,685        100   $ 772,752        100   $ 330,854        100   $ 420,383        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit increase (decrease)

                       

Amortization of inventory fair value adjustment

  $ 35,075        7.0   $ 35,075        5.0   $ 12,780        2.0   $ —          —     $ —          —     $ —          —  

Increased depreciation related to property and equipment

    (4,390     (0.9 )%      (6,452     (0.9 )%      (5,427     (0.9 )%      (3,076     (0.4 )%      (1,649     (0.5 )%      (984     0.2

Amortization of net fair value of leases

    (1,856     (0.3 )%      (2,783     (0.4 )%      (2,899     (0.4 )%      (1,975     (0.3 )%      (1,033     (0.3 )%      (857     0.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 28,829        5.8   $ 25,840        3.7   $ 4,454        0.7   $ (5,051     (0.7 )%    $ (2,682     (0.8 )%    $ (1,841     0.4
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selling general and administrative increase (decrease)

                       

Amortization of intangible related to customer relationships

  $ 25,000        5.0   $ 25,000        3.6   $ 12,500        2.0   $ —          —     $ —          —     $ —          —  

Amortization of intangible related to core technologies

    878        0.2     1,316        0.2     1,316        0.2     1,316        0.2     658        0.2     658        0.2

Increased depreciation related to property and equipment

    300        —       451        —       451        0.1     150        —       150        —       —          —  

Amortization of intangible related to net fair value of leases

    310        0.1     465        0.1     465        0.1     140        —       151        0.1     (11     —  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 26,488        5.3   $ 27,232        3.9   $ 14,732        2.4   $ 1,606        0.2   $ 959        0.3   $ 647        0.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Public Company Costs. In connection with our initial public offering, we will incur additional legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting and corporate governance requirements. These requirements include compliance with the Sarbanes-Oxley Act and other rules implemented by the SEC, and applicable stock exchange rules. We expect these rules and regulations to substantially increase our legal and financial compliance costs and to make certain financial reporting and other activities more time-consuming and costly. We previously incurred similar public company costs prior to the Acquisition in 2008.

Basis of Presentation and Results of Operations

The following discussion contains references to fiscal years 2009, 2010 and 2011, which represent our fiscal years ended or ending January 30, 2010, January 29, 2011, and January 28, 2012, respectively, and pro forma 2008, which represents the two periods within the pro forma year ended January 31, 2009, as described below. Our fiscal year ends on the Saturday closest to January 31. Fiscal years 2009, 2010 and 2011 were 52-week periods. The two periods in pro forma 2008 collectively consisted of 52 weeks. The first six months of fiscal 2010 and fiscal 2011 were 26-week periods.

The 19-week period from February 3, 2008, through June 16, 2008, the date of the Acquisition, is referred to as the “2008 Predecessor period,” and the 33-week period from June 17, 2008, through January 31, 2009, is referred to as the “2008 Successor period.” Due to the Acquisition, the financial statements for all Successor periods are not comparable to that of the Predecessor periods.

 

51


Table of Contents

Prior to the completion of this offering, all of the outstanding shares of capital stock of Restoration Hardware, Inc., will be contributed by Home Holdings to Restoration Hardware Holdings, Inc. as a capital contribution. Outstanding units under the Team Resto Ownership Plan will be converted in connection with this offering into common stock on a              for              basis, and the vesting status of the Home Holdings units will carry over to our common stock, with unvested shares constituting restricted stock.

The summary unaudited pro forma condensed consolidated financial data presented in the table below for the year ended January 31, 2009, which is referred to as “pro forma 2008,” is provided supplementally and has been prepared to give effect to the Acquisition as if such transaction had occurred on February 3, 2008. For additional discussion of pro forma 2008, see “Unaudited Pro Forma Condensed Consolidated Financial Information” below.

 

    Predecessor           Successor     Pro Forma (1)     Successor  
    Period from
February 3,
2008
Through
June 16,
2008
          Period from
June 17,
2008
Through
January 31,
2009
    Year Ended     Six Months Ended  
         January 31,
2009
    January 30,
2010
    January 29
2011,
    July 31,
2010
    July 30,
2011
 
    (in thousands, excluding per square foot store data)        

Statement of Operations Data:

                  

Net revenues

  $ 195,437           $ 498,581      $ 694,018      $ 625,685      $ 772,752      $ 330,854      $ 420,383   

Cost of goods sold

    140,088             308,448        444,108        412,629        501,132        214,084        265,953   
 

 

 

        

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    55,349             190,133        249,910        213,056        271,620        116,770        154,430   

Selling, general and administrative expenses

    75,396             213,011        301,485        238,889        275,859        126,453        150,619   
 

 

 

        

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (20,047          (22,878     (51,575     (25,833     (4,239     (9,683     3,811   

Interest expense

    (2,731          (4,907     (6,876     (3,241     (3,150     (1,579     (1,888
 

 

 

        

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (22,778          (27,785     (58,451     (29,074     (7,389     (11,262     1,923   

Income tax expense (benefit)

    508             (201     307        (423     685        41        783   
 

 

 

        

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (23,286        $ (27,584   $ (58,758   $ (28,651   $ (8,074   $ (11,303   $ 1,140   
 

 

 

        

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Financial and Operating Data:

                  

Growth in net revenues:

                  

Stores (2)

    —               —          (9)     (6)     15     17     21

Direct

    —               —          4     (15)     37     31     36

Total

    —               —          (4)     (10)     24     23     27

Retail (3):

                  

Comparable store sales change (4)

    (12)          (8)     (9)     (7)     19     26     20

Retail stores open at end of period

    100             99        99        95        91        96        87   

Average gross square footage (in thousands) (5)

    1,072             1,060        1,066        1,042        1,014        1,019        946   

Average selling square footage (in thousands) (5)

    677             671        674        660        641        645        599   

Retail sales per selling square foot (6)

  $ 147           $ 406      $ 551      $ 525      $ 635      $ 277      $ 351   

Direct:

                  

Catalogs circulated (in thousands) (7)

    13,771             26,831        40,602        31,336        46,507        18,893        12,768   

Catalog pages circulated (in millions) (7)

    2,168             3,507        5,675        4,418        6,260        2,823        3,293   

Direct as a percentage of net revenues (8)

    43          41     41     39     43     42     45

Capital expenditures

  $ 3,821           $ 13,428      $ 17,249      $ 2,024      $ 39,907      $ 14,181      $ 12,168   

 

52


Table of Contents

 

(1) See details of calculation of pro forma 2008 statement of operations data within the “Unaudited Pro Forma Condensed Consolidated Financial Information” presented below. Pro forma 2008 other financial and operating data amounts are obtained by adding amounts for the 2008 Predecessor period and the 2008 Successor period or by calculating amounts as of January 31, 2009, where appropriate.

 

(2) Store data represent retail stores plus outlet stores.

 

(3) Retail data have been calculated based upon retail stores, including our Baby & Child Gallery, and excludes outlet stores.

 

(4) Comparable store sales have been calculated based upon retail stores that were open at least fourteen full months as of the end of the reporting period and did not change square footage by more than 20% between periods. Comparable store net revenues exclude revenues from outlet stores.

 

(5) Average square footage (gross or selling, as applicable) is calculated for each quarter by taking the total applicable square footage at the beginning of the quarter plus the total applicable square footage at the end of the quarter and dividing by two. Average square footage for periods of six, nine and twelve months is calculated by averaging the average square footage for the quarters within such periods.

Average square footage (gross or selling, as applicable) for the 2008 Predecessor period is calculated by adding the average applicable square footage for the first quarter of the year ended January 31, 2009, and for the period May 4, 2008, through June 16, 2008, and dividing by two. Average square footage (gross or selling, as applicable) for the period May 4, 2008, through June 16, 2008, is calculated by taking the total applicable square footage at the beginning of the period plus the total applicable square footage at the end of the period and dividing by two.

Average square footage (gross or selling, as applicable) for the 2008 Successor period is calculated by adding the average square footage for three periods, being the period June 17, 2008, through August 2, 2008, the third quarter of the year ending January 31, 2009, and the fourth quarter of the year ended January 31, 2009, and dividing by three. Average square footage (gross or selling, as applicable) for the period June 17, 2008, through August 2, 2008, is calculated by taking the total applicable square footage at the beginning of the period plus the total applicable square footage at the end of the period and dividing by two.

 

(6) Retail sales per selling square foot is calculated by dividing total net revenues for all retail stores, comparable and non-comparable, by the average selling square footage for the period.

 

(7) The catalogs and catalog pages circulated from period to period do not take into account different page sizes per catalog distributed. Page sizes and page counts vary for different catalog mailings and we sometimes mail different versions of a catalog at the same time. Accordingly, period to period comparisons of catalogs circulated and catalog pages circulated do not take these variations into account. In fiscal 2010, we mailed a larger number of catalogs that contained fewer pages and in some cases significantly smaller page sizes than in prior periods. In the first six months of fiscal 2011, we mailed fewer catalogs that contained a significant increase in number of pages as compared to the first six months of fiscal 2010.

 

(8) Direct revenues include sales through our catalogs and websites.

 

53


Table of Contents

The following table sets forth, for the periods presented, our consolidated statement of operations data as a percentage of total revenues.

 

    Predecessor          Successor     Pro Forma (1)     Successor  
    Period from
February 3,
2008
Through
June  16,
2008
         Period from
June 17,
2008
Through
January  31,
2009
   

 

Year Ended

   

 

Six Months Ended

 
        January 31,
2009
    January 30,
2010
    January 29,
2011
    July 31,
2010
    July 30,
2011
 

Statement of Operations Data:

                 

Net revenues

    100.0         100.0     100.0     100.0     100.0     100.0     100.0

Cost of goods sold

    71.7            61.9        64.0        65.9        64.9        64.7        63.3   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

    28.3            38.1        36.0        34.1        35.1        35.3        36.7   

Selling, general and administrative expenses

    38.6            42.7        43.4        38.2        35.7        38.2        35.8   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (10.3         (4.6     (7.4     (4.1     (0.6     (2.9     0.9   

Interest expense

    (1.4         (1.0     (1.0     (0.6     (0.4     (0.5     (0.4
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (11.7         (5.6     (8.4     (4.7     (1.0     (3.4     0.5   

Income tax expense (benefit)

    0.2            (0.1     0.1        (0.1     —          —          0.2   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (11.9 )%          (5.5 )%      (8.5 )%      (4.6 )%      (1.0 )%      (3.4 )%      0.3
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) See details of calculation of pro forma 2008 statement of operations data within the “Unaudited Pro Forma Condensed Consolidated Financial Information” presented below.

We operate a fully integrated distribution model through our stores, catalogs and websites. The following table shows a summary of our store revenues, which include all sales for orders placed in retail stores as well as sales through outlet stores, and our direct revenues which include sales through our catalogs and websites:

 

    Predecessor          Successor     Pro Forma (1)     Successor  
    Period from
February 3,
2008
through
June  16,
2008
         Period from
June 17,
2008
through
January  31,
2009
   

 

Year Ended

   

 

Six Months Ended

 
        January 31,
2009
    January 30,
2010
    January 29,
2011
    July 31,
2010
    July 30,
2011
 
    (in thousands)  

Stores (2)

  $ 110,907          $ 296,214      $ 407,121      $ 380,854      $ 438,463      $ 190,994      $ 230,722   

Direct

    84,530            202,367        286,897        244,831        334,289        139,860        189,661   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net revenues

  $ 195,437          $ 498,581      $ 694,018      $ 625,685      $ 772,752      $ 330,854      $ 420,383   
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Pro forma 2008 amounts are obtained by adding amounts for the 2008 Predecessor period and the 2008 Successor period.
(2) Stores net revenues in the Predecessor period have been conformed to Successor period presentations. Stores net revenues include retail stores, including our Baby & Child Gallery, and outlet stores.

Unaudited Pro Forma Condensed Consolidated Financial Information

The supplemental unaudited pro forma condensed consolidated statement of operations data set forth below for pro forma 2008 have been derived by applying pro forma adjustments to our historical consolidated statements of operations. All of the equity interests in our business were acquired in the Acquisition effective June 16, 2008. As a result of the Acquisition, we applied purchase accounting and had a new basis of accounting effective June 17, 2008. The unaudited pro forma condensed consolidated statements of operations for the year ended January 31, 2009 gives effect to the Acquisition as if it had occurred on February 3, 2008. Assumptions

 

54


Table of Contents

underlying the pro forma adjustments are described in the accompanying notes, which should be read in conjunction with this unaudited pro forma condensed consolidated financial information.

The unaudited pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable under the circumstances. The unaudited pro forma condensed consolidated financial information is presented for supplemental informational purposes only. The unaudited pro forma condensed consolidated financial information does not purport to represent what our results of operations would have been had the Acquisition and related transactions actually occurred on February 3, 2008, and they do not purport to project our results of operations or financial condition for any future period. The unaudited pro forma condensed consolidated statement of operations should be read in conjunction with other sections of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as “Selected Historical Consolidated Financial and Operating Data” and our consolidated financial statements and related notes thereto appearing elsewhere in this prospectus.

 

     Predecessor          Successor     Total
Adjustments
         Pro Forma  
     Period from
February 3,
2008
Through
June 16,

2008
         Period from
June  17,

2008
Through
January  31,

2009
         Year Ended
January 31, 2009
 
                     (in thousands)             

Net revenues

   $ 195,437          $ 498,581      $ —           $ 694,018   

Cost of goods sold

     140,088            308,448        (4,428   (a) (b) (c)
(d) (e) (f)
     444,108   
  

 

 

       

 

 

   

 

 

      

 

 

 

Gross profit

     55,349            190,133        4,428           249,910   

Selling, general and administrative expenses

     75,396            213,011        13,078      (a) (b) (c)
(e) (f) (g)
     301,485   
  

 

 

       

 

 

   

 

 

      

 

 

 

Loss from operations

     (20,047         (22,878     (8,650        (51,575

Interest expense

     (2,731         (4,907     762      (h)      (6,876
  

 

 

       

 

 

   

 

 

      

 

 

 

Loss before income taxes

     (22,778         (27,785     (7,888        (58,451

Income tax expense (benefit)

     508            (201     —        (i)      307   
  

 

 

       

 

 

   

 

 

      

 

 

 

Net loss

   $ (23,286       $ (27,584   $ (7,888      $ (58,758
  

 

 

       

 

 

   

 

 

      

 

 

 

 

(a) In connection with the Acquisition, we recorded amortizable intangible assets at fair value, including core technologies, customer relationships and certain net favorable lease obligations based on purchase accounting standards at a total amount of $55.7 million. These assets amortize over varying periods and the unaudited pro forma financials have been adjusted to reflect this amortization over the full fiscal year with a charge to cost of goods sold of $0.9 million and selling, general and administrative expenses of $0.6 million. Customer relationships with a value of $37.5 million at the time of Acquisition have an estimated life of one year or less, and have not been given pro forma treatment in the results above.

 

(b) In connection with the Acquisition, we adjusted property and equipment to reflect a fair value increase equal to $17.6 million. These assets depreciate over various periods greater than two years and the unaudited pro forma financials have been adjusted to reflect this additional depreciation expense over the full fiscal year with a charge to cost of goods sold of $2.1 million and selling, general and administrative expenses of $0.1 million.

 

(c) We have leases that contain pre-determined fixed escalations of minimum rents. The related rent expense is recognized on a straight-line basis. The unaudited pro forma financials have been adjusted to reflect an effective straight-line reset date of February 3, 2008, rather than the Acquisition date of June 16, 2008, resulting in an additional charge to cost of goods sold of $0.7 million and selling, general and administrative expense of $1.9 million.

 

55


Table of Contents
(d) In connection with the Acquisition, we adopted a new policy of accounting for inventory and no longer capitalize certain merchandising and distribution indirect costs. The unaudited pro forma financials have been adjusted to remove the impact of previously capitalized indirect costs prior to the Acquisition resulting in a charge to cost of goods sold of $3.3 million. A net adjustment of $47.9 million to reduce inventory to its fair value at the time of the Acquisition has an estimated life of less than one year and has not been given pro forma treatment in the results above.

 

(e) In connection with the Acquisition, we revised our classification of certain expenses related to occupancy costs, payroll related to our operations and certain other costs between cost of goods sold and selling, general and administrative expenses in our consolidated statements of operations. The unaudited pro forma financials have been adjusted to reflect a reclassification of $10.8 million from cost of goods sold to selling, general and administrative expenses to present the financials as if adoption of such accounting policy had been made in the 2008 Predecessor period.

 

(f) In connection with the Acquisition, stock-based compensation was eliminated as all outstanding options previously granted were cancelled and were not replaced with new grants. The unaudited pro forma financials have been adjusted to remove stock-based compensation charges included prior to the Acquisition resulting in a reduction to cost of goods sold of $0.6 million and a reduction to selling, general and administrative expenses of $1.7 million.

 

(g) In connection with the Acquisition, we entered into a management services agreement with affiliates of Catterton, Tower Three and Glenhill to provide services to us in exchange for a management fee. See “Certain Relationships and Related Party Transactions.” The unaudited pro forma financials have been adjusted to reflect this fee for the full fiscal year resulting in an additional charge to selling, general and administrative expenses of $1.4 million.

 

(h) Prior to the Acquisition, we had $25.0 million in borrowings outstanding to affiliates of Catterton that were exchanged for equity in Home Holdings at the time of the Acquisition. The unaudited pro forma financials have been adjusted to remove the associated interest expense of $0.8 million included prior to the Acquisition.

 

(i) The unaudited pro forma financials have not been adjusted to record the tax effect of pro forma adjustments at our estimated statutory tax rate of approximately 40%, since we are in a loss position and all deferred tax assets had a full valuation allowance at January 31, 2009.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010

The following table summarizes the financial impact of purchase accounting adjustments on gross profit and selling, general and administrative expense in dollars, and as a percentage of net revenues, for the first six months of fiscal 2011 and the first six months of fiscal 2010:

 

     Six Months Ended               
     July 31, 2010     July 30, 2011     

Increase (Decrease)

 
     (dollars in thousands)  

Net revenues

   $ 330,854        100.0   $ 420,383        100.0    $ 89,529     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

Gross profit excluding purchase accounting adjustments

   $ 119,452        36.1   $ 156,271        37.2    $ 36,819        1.1

Decrease in gross profit from purchase accounting adjustments

     (2,682     (0.8 )%      (1,841     (0.5 )%       841        0.3
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit

   $ 116,770        35.3   $ 154,430        36.7    $ 37,660        1.4
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Selling, general and administrative expenses excluding purchase accounting adjustments

   $ 125,494        37.9   $ 149,972        35.7    $ 24,478        (2.2 )% 

Increase in selling, general and administrative expenses from purchase accounting adjustments

     959        0.3     647        0.1      (312     (0.2 )% 
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Selling, general and administrative expenses

   $ 126,453        38.2   $ 150,619        35.8    $ 24,166        (2.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

56


Table of Contents

Net revenues

Net revenues increased $89.5 million, or 27.1%, to $420.4 million in the first six months of fiscal 2011 compared to $330.9 million in the first six months of fiscal 2010. We had 87 and 96 retail stores open at July 30, 2011, and July 31, 2010, respectively. Stores sales increased $39.7 million, or 20.8%, to $230.7 million in the first six months of fiscal 2011 compared to $191.0 million in the first six months of fiscal 2010. This increase was due in large part to our comparable store sales increase of 20% in the first six months of fiscal 2011 compared to the first six months of 2010. Direct sales increased $49.8 million, or 35.6%, to $189.7 million in the first six months of fiscal 2011 compared to $139.9 million in the first six months of fiscal 2010. We believe that the increase in both store and direct sales was due primarily to our customers’ favorable reaction to our merchandise assortment, including expansions of existing product categories and new product categories, an increase in circulated catalog pages and positive customer reaction to our new Gallery format.

Gross profit

Gross profit increased $37.7 million, or 32.3%, to $154.4 million in the first six months of fiscal 2011 from $116.8 million in the first six months of fiscal 2010. Gross profit in the first six months of fiscal 2011 included $1.8 million of unfavorable gross profit impact due to purchase accounting compared to $2.7 million of unfavorable gross profit impact due to purchase accounting in the first six months of fiscal 2010. The increase in gross profit of $36.8 million excluding the effect of purchase accounting adjustments was primarily the result of increased net revenues and improved product margins, partially offset by $11.6 million of increased freight costs associated with delivering merchandise to our customers.

Gross margin increased to 36.7% of net revenues in the first six months of fiscal 2011 from 35.3% of net revenues in the first six months of fiscal 2010. Gross margin in the first six months of fiscal 2011 included an unfavorable impact of purchase accounting that reduced gross margins by 0.5%, compared to the unfavorable impact of purchase accounting in the first six months of fiscal 2010 that reduced gross margins by 0.8%. The improvement in gross margin percentage of 1.1% excluding the effect of purchase accounting adjustments was driven primarily by 290 basis points of improved leverage of occupancy costs for stores and the supply chain, due to fewer stores open in fiscal 2010 compared to fiscal 2009 as well as leverage on the fixed portion of occupancy costs as volumes increased. This margin improvement was partially offset by higher freight costs as a percentage of net revenues of 130 basis points due to a higher percentage of furniture in our product mix, 30 basis points of higher product costs and 20 basis points of costs associated with the opening of a new distribution center during the first six months of fiscal 2011.