Restoration Hardware 2014 Annual Report Download - page 71

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Certain of our property and equipment are held under capital leases. These assets are included in property and
equipment and depreciated over the lesser of the useful life of the asset or the lease term. For buildings held under
capital leases, unless the fair value of the land at lease inception exceeds 25% of the aggregate fair value of the leased
land and buildings, rent payments under the leases are recognized using the effective interest method as a reduction of
the capital lease obligation and interest expense. Pursuant to ASC 840, at lease inception, if the fair value of the
underlying land exceeds 25% of the fair value of the real estate (land and buildings), we allocate a portion of the cash
payments under the lease to land rent expense equal to the product of the fair value of the leased land at construction
commencement and our incremental borrowing rate. The remaining cash payment is treated as debt-service payments
and recognized as a reduction of the capital lease obligation and an increase in interest expense.
All other leases are considered operating leases in accordance with ASC 840. Assets subject to an operating
lease and the related lease payments are not recorded on the consolidated balance sheets. For leases that contain
lease incentives, premiums and minimum rent expenses, we recognize rent expense on a straight-line basis over
the lease term. Tenant improvement allowances received from landlords under operating leases are recorded as
deferred rent, reported as a non-current liability on the consolidated balance sheets, and are amortized on a
straight-line basis over the lease term, including the construction period.
Stock-Based Compensation
We use the straight-line method of accounting for stock-based compensation, which we believe is the
predominant method used in our industry. We recognize the fair value of stock-based compensation in the
consolidated financial statements as compensation expense over the requisite service period. In addition, excess
tax benefits related to stock-based compensation awards are reflected as financing cash flows. For service-only
awards, compensation expense is recognized on a straight-line basis, net of forfeitures, over the requisite service
period for the fair value of awards that actually vest. Fair value for restricted stock units is valued using the
closing price of our stock on the date of grant. The fair value of each option award granted under our award plans
subsequent to our initial public offering is estimated on the date of grant using a Black-Scholes Merton option
pricing model with the following assumptions:
• Expected volatility—Based on the lack of historical data for our own shares, we base our expected
volatility on a representative peer group that takes into account industry, market capitalization, stage of
life cycle and capital structure.
• Expected term—Represents the period of time that options granted are expected to be outstanding. We
elected to calculate the expected term of the option awards using the “simplified method.” This election
was made based on the lack of sufficient historical exercise data to provide a reasonable basis upon
which to estimate expected term. Under the “simplified” calculation method, the expected term is
calculated as an average of the vesting period and the contractual life of the options.
• Risk-free interest rate—Based on the U.S. Treasury zero-coupon bond rate with a remaining term
approximate of the expected term of the option.
• Dividend yield—As we have not paid dividends, nor do we currently plan to pay dividends in the
future, the assumed dividend yield is zero.
Prior to the Reorganization, Home Holdings had granted performance-based units that vested and became
deliverable upon achievement or satisfaction of performance conditions specified in the performance agreement or
upon the return on investment attained by certain of the equity investors in Home Holdings at defined liquidity events,
including an initial public offering or certain sale or merger transactions. We estimated the fair value of performance-
based units awarded to employees at the grant date based on the fair value of the Company on such date. We also
considered the probability of achieving the established performance targets in determining our stock-based
compensation with respect to these awards. We recognize compensation cost over the performance period. When the
performance is related to a specific event occurring in the future, we recognize the full expense at the time of the event.
In connection with the initial public offering, shares of our common stock with substantially similar restrictions, terms
and conditions were issued in replacement of these performance-based units.
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