Restoration Hardware 2015 Annual Report Download - page 85

82
Under GAAP, certain convertible debt instruments that may be settled in cash on conversion are required to be separately
accounted for as liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt
borrowing rate. Accordingly, in accounting for the issuance of the 2020 Notes, the Company separated the 2020 Notes into liability
and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar
liability that does not have an associated convertible feature. The carrying amount of the equity component, which is recognized as a
debt discount, represents the difference between the proceeds from the issuance of the 2020 Notes and the fair value of the liability
component of the 2020 Notes. The excess of the principal amount of the liability component over its carrying amount (“debt
discount”) will be amortized to interest expense using an effective interest rate of 6.47% over the term of the 2020 Notes. The equity
component is not remeasured as long as it continues to meet the conditions for equity classification.
In accounting for the debt issuance costs related to the issuance of the 2020 Notes, the Company allocated the total amount
incurred to the liability and equity components based on their relative values. Debt issuance costs attributable to the liability
component are amortized to interest expense using the effective interest method over the term of the 2020 Notes, and debt issuance
costs attributable to the equity component are netted with the equity component in stockholders’ equity.
Debt issuance costs related to the 2020 Notes were comprised of discounts upon original issuance of $3.8 million and third party
offering costs of $2.3 million. Discounts were recorded as a contra-liability and are presented net against the convertible senior notes
due 2020 balance on the consolidated balance sheets. Third party offering costs attributable to the liability component were recorded
as an asset and are presented in other non-current assets on the consolidated balance sheets. During fiscal 2015, the Company recorded
$0.6 million related to the amortization of debt issuance costs related to the 2020 Notes.
The carrying value of the 2020 Notes is as follows (in thousands):
January 30,
2016
Liability component .....................................................................
Principal .................................................................................. $ 300,000
Less: Debt discount................................................................. (75,113 )
Net carrying amount .......................................................... $ 224,887
Equity component
(
1
)
.................................................................... $ 84,003
(1) Included in additional paid-in capital on the consolidated balance sheets.
The Company recorded interest expense of $8.9 million for the amortization of the debt discount related to the 2020 Notes
during fiscal 2015.
2020 Notes—Convertible Bond Hedge and Warrant Transactions
In connection with the offering of the 2020 Notes in June 2015 and the exercise in full of the overallotment option in July 2015,
the Company entered into convertible note hedge transactions whereby the Company has the option to purchase a total of
approximately 5.1 million shares of its common stock at a price of approximately $118.13 per share. The total cost of the convertible
note hedge transactions was $68.3 million. In addition, the Company sold warrants whereby the holders of the warrants have the
option to purchase a total of approximately 5.1 million shares of the Company’s common stock at a price of $189.00 per share. The
Company received $30.4 million in cash proceeds from the sale of these warrants. Taken together, the purchase of the convertible note
hedges and sale of the warrants are intended to offset any actual earnings dilution from the conversion of the 2020 Notes until the
Company’s common stock is above approximately $189.00 per share. As these transactions meet certain accounting criteria, the
convertible note hedges and warrants are recorded in stockholders’ equity, are not accounted for as derivatives and are not remeasured
each reporting period. The net costs incurred in connection with the convertible note hedge and warrant transactions were recorded as
a reduction to additional paid-in capital on the consolidated balance sheets.
The Company recorded a deferred tax liability of $32.8 million in connection with the debt discount associated with the 2020
Notes and recorded a deferred tax asset of $26.6 million in connection with the convertible note hedge transactions. The deferred tax
liability and deferred tax asset are recorded in non-current deferred tax assets on the consolidated balance sheets.