Restoration Hardware 2014 Annual Report Download - page 38

structurally subordinated to any and all debt and other obligations that such subsidiary may incur (including trade
payables). In the event of a bankruptcy, liquidation, dissolution, reorganization or of a similar proceeding with
respect to any of our subsidiaries, we, as a common equity owner of such subsidiary, and, therefore, the holders
of the Notes, rank behind such subsidiary’s creditors, including such subsidiary’s trade creditors. Even if we were
a creditor of one of our subsidiaries, our rights as a creditor would be subordinate to any security interest in the
assets of that subsidiary and any indebtedness of that subsidiary senior to that held by us.
Our ability to service our indebtedness, including the Notes, may be substantially dependent on the earnings
and the distribution of funds (whether by dividend, distribution or loan) from our subsidiaries. None of our
subsidiaries is obligated to make funds available to us for payment on the Notes. We can provide no assurances
that the agreements governing the existing and future indebtedness of our subsidiaries will permit our
subsidiaries to provide us with sufficient dividends, distributions or loans to fund payments on the Notes when
due. In particular, the current credit agreement of our primary operating subsidiary, Restoration Hardware, Inc.,
restricts the ability of such subsidiary to make restricted payments to the holding company that would enable us
to make payments with respect to the Notes unless certain minimum fixed charge coverage ratio or availability
requirements are met and a default under the credit agreement would not otherwise occur as a result of the
payment. This minimum fixed charge coverage ratio requirement entails a minimum 1.1:1 ratio of (a) earnings,
minus capital expenditures, minus taxes, to (b) debt service payments, plus all dividends/distributions made to
Restoration Hardware Holdings, Inc. or any other non-borrower/guarantor of the credit agreement, plus debt
prepayments. Although Restoration Hardware, Inc. currently meets these requirements under the credit
agreement for purposes of making restricted payments to us to fund our payments with respect to the Notes, there
can be no assurance that it will continue to meet these requirements in the future. In addition, any payment of
dividends, distributions or loans to us by our subsidiaries could be subject to restrictions on dividends or
repatriation of earnings under applicable local law and monetary transfer restrictions in the jurisdictions in which
our subsidiaries operate.
The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could
have a material effect on our reported financial results.
In May 2008, the FASB, issued FASB Staff Position No. APB 14-1—Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), which has
subsequently been codified as ASC 470-20—Debt with Conversion and Other Options (“ASC 470-20”). Under
ASC 470-20, an entity must separately account for the liability and equity components of the convertible debt
instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that
reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the
equity component is required to be included in the additional paid-in capital section of stockholders’ equity on
our consolidated balance sheet at the issuance date and the value of the equity component is treated as debt
discount for purposes of accounting for the debt component of the Notes. As a result, we are required to record a
greater amount of non-cash interest expense in current periods presented as a result of the amortization of the
discounted carrying value of the Notes to their face amount over the term of the Notes. We will report lower net
income in our financial results because ASC 470-20 will require interest to include the amortization of the debt
discount, which could adversely affect our future financial results, the trading price of our common stock and the
trading price of the Notes.
The settlement feature of the Notes may have adverse consequences.
The settlement feature of the Notes may:
• result in holders receiving no shares upon conversion or fewer shares relative to the conversion value
of the Notes;
• reduce our liquidity;
• delay holders’ receipt of the consideration due upon conversion; and
• subject holders to the market risks of our shares before receiving any shares upon conversion.
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