Restoration Hardware 2015 Annual Report Download - page 72

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Merchandise Inventories
The Company’s merchandise inventories are comprised of finished goods and are carried at the lower of cost or market, with
cost determined on a weighted-average cost method and market determined based on the estimated net realizable value. To determine
if the value of inventory should be marked down below original cost, the Company considers current and anticipated demand,
customer preference and the merchandise age. The inventory value is adjusted periodically to reflect current market conditions, which
requires management judgments that may significantly affect the ending inventory valuation, as well as gross margin. The significant
estimates used in inventory valuation are obsolescence (including excess and slow-moving inventory and lower of cost or market
reserves) and estimates of inventory shrinkage. The Company adjusts its inventory for obsolescence based on historical trends, aging
reports, specific identification and its estimates of future retail sales prices.
Reserves for shrinkage are estimated and recorded throughout the period as a percentage of shipped sales based on historical
shrinkage results and current inventory levels. Actual shrinkage is recorded throughout the year based upon periodic cycle counts and
the results of the Company’s annual physical inventory count. Actual inventory shrinkage and obsolescence can vary from estimates
due to factors including the mix of the Company’s inventory (which ranges from large furniture to decorative accessories) and
execution against loss prevention initiatives in the Company’s stores, distribution centers, off-site storage locations and with its third-
party transportation providers.
Due to these factors, the Company’s obsolescence and shrinkage reserves contain uncertainties. Both estimates have
calculations that require management to make assumptions and to apply judgment regarding a number of factors, including market
conditions, the selling environment, historical results and current inventory trends. If actual obsolescence or shrinkage estimates
change from the Company’s original estimates, the Company will adjust its inventory reserves accordingly throughout the period.
Management does not believe that changes in the assumptions used in these estimates would have a significant effect on the
Company’s net income or inventory balances. The Company’s inventory reserve balances were $19.3 million and $14.6 million as of
January 30, 2016 and January 31, 2015, respectively.
Advertising Expenses
Advertising expenses primarily represent the costs associated with the Company’s catalog mailings, as well as print and website
marketing. Total advertising expense, recorded in selling, general and administrative expenses on the consolidated statements of
income, were $107.7 million, $114.7 million, and $83.0 million in fiscal 2015, fiscal 2014, and fiscal 2013, respectively.
Capitalized Catalog Costs
Capitalized catalog costs consist primarily of third-party incremental direct costs to prepare, print and distribute Source Books.
Such costs are capitalized and amortized over their expected period of future benefit. Such amortization is based upon the ratio of
actual revenues to the total of actual and estimated future revenues on an individual Source Book basis. Estimated future revenues are
based upon various factors such as the total number of Source Books and pages circulated, the probability and magnitude of consumer
response and the merchandise assortment offered. Each Source Book is generally fully amortized within a twelve-month period after
they are mailed and the majority of the amortization occurs within the first five to nine months, with the exception of the Holiday
Source Books, which are generally fully amortized within a three-month period after they are mailed. Capitalized catalog costs are
evaluated for realizability on a regular basis by comparing the carrying amount associated with each Source Book to the estimated
probable remaining future sales associated with that Source Book.
The Company’s catalog amortization calculation requires management to make assumptions and to apply judgment regarding a
number of factors, including market conditions, the selling environment and the probability and magnitude of consumer response to
certain Source Books and merchandise assortment offered. If actual revenues associated with the Company’s Source Books differ
from its original estimates, the Company adjusts its catalog amortization schedules accordingly. Management does not believe that
changes in the assumptions used in these estimates would have a significant effect on the Company’s net income as changes in the
assumptions do not impact the total cost of the Source Books to be amortized. However, changes in the assumptions could impact the
timing of the future catalog amortization expense recorded to the consolidated statements of income.
During fiscal 2013, the Company modified its Source Book strategy and eliminated its Fall Source Book. The Company
therefore made changes to its assumptions regarding the estimated future revenues and the period over which such revenues would be
earned related to its Spring 2013 Source Books. As a result, the amortization period for the Spring 2013 Source Books increased from
an eight- to nine-month period to a twelve-month period.
The Company had $35.8 million and $46.9 million of capitalized catalog costs that are included in prepaid expense and other
current assets on the consolidated balance sheets as of January 30, 2016, and January 31, 2015, respectively.