UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.

 

Yes ý    No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ý    No o

 

As of May 29, 2004, 32,878,796 shares of the registrant’s common stock, $0.0001 par value per share, were outstanding.

 

 

FORM 10-Q

 

FOR THE QUARTER ENDED MAY 1, 2004

 

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of May 1, 2004, January 31, 2004, and May 3, 2003 (as restated)
	Condensed Consolidated Statements of Operations for the three months ended May 1, 2004 and May 3, 2003
	Condensed Consolidated Statements of Cash Flows for the three months ended May 1, 2004 and May 3, 2003
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX

 

2

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

RESTORATION HARDWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

(Unaudited)

 

		May 1, 2004			January 31, 2004			May 3, 2003
ASSETS
Current assets:
Cash and cash equivalents		$	2,550		$	2,003		$	1,814
Accounts receivable		5,863			5,745			3,989
Merchandise inventories		117,786			102,926			100,023
Prepaid expense and other current assets		16,263			16,968			12,306
Total current assets		142,462			127,642			118,132
Property and equipment, net		80,843			83,518			86,023
Goodwill		4,560			4,560			4,560
Deferred tax asset		15,119			15,138			15,369
Other assets		4,202			1,422			6,080
Total assets		$	247,186		$	232,280		$	230,164
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses		$	41,656		$	45,292		$	33,061
Line of credit, net of debt issuance costs (as restated for May 3, 2003, see Note 2)		34,384			10,286			27,250
Deferred revenue and customer deposits		7,068			7,231			5,073
Other current liabilities		11,394			11,438			8,659
Total current liabilities		94,502			74,247			74,043
Deferred lease incentives		32,555			33,999			37,290
Deferred rent		14,470			14,455			14,324
Other long-term obligations		301			352			109
Total liabilities		141,828			123,053			125,766
Series A redeemable convertible preferred stock, $.0001 par value, 28,037 shares designated, 8,613, 8,683 and 13,470 shares issued and outstanding at May 1, 2004, January 31, 2004 and May 3, 2003, respectively, aggregate liquidation preference and redemption value of $10,569 at May 1, 2004		8,471			8,541			13,328
Stockholders’ equity:
Common stock, $.0001 par value; 60,000,000 shares authorized; 32,848,088, 32,768,065 and 30,054,900 issued and outstanding at May 1, 2004, January 31, 2004 and May 3, 2003, respectively		3			3			3
Additional paid-in capital		158,404			158,174			151,935
Unearned compensation		(133		)	(234		)	(534		)
Accumulated other comprehensive income		892			1,040			211
Accumulated deficit		(62,279		)	(58,297		)	(60,545		)
Total stockholders’ equity		96,887			100,686			91,070
Total liabilities, redeemable convertible preferred stock and stockholders’ equity		$	247,186		$	232,280		$	230,164

 

See Notes to Condensed Consolidated Financial Statements.

 

3

 

RESTORATION HARDWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

 

		First Quarter
		2004			2003
Net revenue		$	98,858		$	81,766
Cost of revenue and occupancy		71,443			61,825
Gross profit		27,415			19,941
Selling, general and administrative expense		33,516			28,029
Loss from operations		(6,101		)	(8,088		)
Interest expense, net		(427		)	(562		)
Loss before income taxes		(6,528		)	(8,650		)
Income tax benefit		2,546			3,460
Net loss		$	(3,982	)	$	(5,190	)
Loss per share, basic and diluted		$	(0.12	)	$	(0.17	)
Weighted average shares outstanding, basic and diluted		32,791			30,052

 

See Notes to Condensed Consolidated Financial Statements.

 

4

 

RESTORATION HARDWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		First Quarter
		2004			2003
Cash flows from operating activities:
Net loss		$	(3,982	)	$	(5,190	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		4,114			4,955
Deferred income taxes		—			(3,429		)
Changes in operating assets and liabilities:
Accounts receivable		(118		)	(637		)
Merchandise inventories		(14,860		)	(5,523		)
Prepaid expenses and other assets		(2,075		)	1,894
Accounts payable and accrued expenses		(3,636		)	(2,587		)
Deferred revenue and customer deposits		(163		)	(797		)
Other current liabilities		(44		)	(663		)
Deferred rent		15			161
Deferred lease incentives		(1,444		)	(1,818		)
Net cash used by operating activities		(22,193		)	(13,634		)
Cash flows from investing activities:
Capital expenditures		(1,318		)	(352		)
Net cash used by investing activities		(1,318		)	(352		)
Cash flows from financing activities:
Borrowings under line of credit, net		23,984			13,110
Repayments of other long-term obligations		(51		)	(36		)
Proceeds received from stockholder settlement		—			1,050
Issuance of common stock		160			7
Net cash provided by financing activities		24,093			14,131
Effects of foreign currency exchange rate translation on cash		(35		)	39
Net increase in cash and cash equivalents		547			184
Cash and cash equivalents:
Beginning of period		2,003			1,630
End of period		$	2,550		$	1,814
Additional cash flow information:
Cash paid during the period for interest (net of amount capitalized)		$	358		$	393
Cash paid (received) during the period for taxes		98			(30		)
Non-cash transactions:
Conversion of preferred stock to common stock		$	70		$	—

 

See Notes to Condensed Consolidated Financial Statements.

 

5

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

 

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

 

Nature of Business

 

Restoration Hardware, Inc., a Delaware corporation, and its subsidiaries (collectively, the “Company”) is a specialty retailer of high-quality home furnishings, functional and decorative hardware, bath ware and bath fixtures and related merchandise that reflects its classic and authentic American point of view. These products are sold through retail locations, catalogs and the Internet. As of May 1, 2004, the Company operated 102 retail stores in 30 states, the District of Columbia and Canada.

 

Basis of Presentation

 

The accompanying interim condensed consolidated financial statements have been prepared from the Company’s records without audit and, in management’s opinion, include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position at May 1, 2004 and May 3, 2003 and results of operations and changes in cash flows for the first quarter ended May 1, 2004 and May 3, 2003. The balance sheet at January 31, 2004, as presented, has been derived from the Company’s audited financial statements for the fiscal year then ended.

 

Accounting policies followed by the Company are described in Note 1 to the audited consolidated financial statements included in the Company’s Form 10-K, for the fiscal year ended January 31, 2004 (“fiscal 2003”). Certain information and disclosures normally included in the notes to annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted for purposes of the interim condensed consolidated financial statements. The interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including the notes, for fiscal 2003.

 

The results of operations for the three months presented in this Form 10-Q are not necessarily indicative of the results to be expected for the full year.

 

Certain reclassifications have been made to the prior year financials statements in order to conform to the current year presentation.

 

Stock-based Compensation

 

The Company has one stock-based employee compensation plan. The Company accounts for stock-based employee compensation using the intrinsic value method in accordance with the provisions of Accounting Principals Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to all stock-based employee compensation:

 

6

 

		First Quarter
(Dollars in thousands, except per share data)		2004			2003
Net loss as reported		$	(3,982	)	$	(5,190	)
Add stock-based employee compensation expense for all options granted below fair market value included in reported net loss (net of tax)		62			75
Deduct compensation expense for all stock - based employee compensation (net of tax) calculated in accordance with the fair value method		(672		)	(450		)
Pro forma net loss		$	(4,592	)	$	(5,565	)
Loss per share:
Basic and diluted, as reported		$	(0.12	)	$	(0.17	)
Basic and diluted, pro forma		$	(0.14	)	$	(0.19	)

 

Comprehensive Loss

 

Comprehensive loss consists of net loss and foreign currency translation adjustments.  The components of comprehensive loss for the three months ended May 1, 2004 and May 3, 2003, are as follows:

 

		First Quarter
(In thousands)		2004			2003
Components of comprehensive loss:
Net loss		$	(3,982	)	$	(5,190	)
Foreign currency translation adjustment		(148		)	343
Total comprehensive loss		$	(4,130	)	$	(4,847	)

 

2. LINE OF CREDIT, NET

 

As of May 1, 2004, the Company’s revolving credit facility provided for an overall commitment of $72.0 million. The revolving credit facility was amended in June 2004 to  provide for additional borrowing capacity, reduced borrowing rates and elimination of  limitations on capital expenditures and store openings. In support of continued growth of the Company, the amendment increases the initial available commitment to $100.0 million, and further allows the Company to request and receive incremental increases beyond the initial available commitment of $100.0 million up to a maximum commitment of $150.0 million, provided no default or event of default then exists and certain other conditions are met.  The amendment also increases the amount available for letters of credit from $30.0 million to $50.0 million and modifies certain other terms in the revolving credit facility, which have the effect of expanding the borrowing base.  The Company had previously amended its revolving credit facility in March 2004 to make minor revisions and clarifications to certain covenants. As of May 1, 2004, $34.4 million was outstanding under the line of credit, net of unamortized debt issuance costs of $0.9 million, and there was $18.6 million in outstanding letters of credit.  Borrowings made under the revolving credit facility are subject to interest at either the bank’s reference rate or LIBOR plus a margin. As of May 1, 2004, the bank’s reference rate was 5.0% and the LIBOR plus margin rate was 3.375%. The availability of credit at any given time under the revolving credit facility is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, and reserves established by the agent of the revolving credit facility.  The revolving credit facility is structured to increase availability to meet seasonal needs. As a result of the borrowing base formula, the actual borrowing availability under the revolving credit facility could be less than the stated amount of the revolving credit facility reduced by the actual borrowings and outstanding letters of credit.  The revolving credit facility contains various

 

7

 

restrictive covenants, including limitations on the ability to incur additional debt, acquisition of other businesses and payment of dividends and other distributions.  The revolving credit facility does not contain any other significant financial or coverage ratio covenants, nor does the revolving credit facility require the Company to repay all borrowings for a proscribed “clean-up” period each year.

 

The Company’s revolving credit facility requires a lock-box arrangement, which provides for all receipts to be swept daily to reduce borrowings outstanding under the revolving credit facility.  This arrangement, combined with the existence of a subjective acceleration clause in the revolving credit facility, necessitates the revolving credit facility be classified a current liability on the balance sheet pursuant to guidance in the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement.”  The acceleration clause allows the Company’s lenders to forego additional advances should they determine there has been a material adverse effect in the Company’s operations, business, properties, assets, liabilities, condition or prospects or a material adverse change in its financial position or prospects reasonably likely to result in a material adverse effect on the Company’s business, condition (financial or otherwise), operations, performance or properties.  Management believes that no such material adverse change has occurred; further, at May 1, 2004, the Company’s lenders had not informed the Company that any such event had occurred.  The revolving credit facility expires in June 2006.  Management believes that it will continue to borrow on the line of credit to fund its operations over the term of the revolving credit facility.   The May 3, 2003 balance sheet has been restated to classify as a current liability $27.3 million of borrowings under the revolving credit facility, which was previously reported as a long-term liability.

 

3. INCOME TAXES

 

SFAS No. 109, “Accounting for Income Taxes,” requires income taxes to be accounted for under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. In estimating future tax consequences, the Company generally takes into account all expected future events then known to it, other than changes in the tax law or rates, which are not permitted to be considered. Accordingly, the Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. The amount of valuation allowance is based upon management’s best estimate of the recoverability of its deferred tax assets. While future taxable income and ongoing prudent and feasible tax planning are considered in determining the amount of the valuation allowance, this allowance is subject to adjustment in the future.  Specifically, in the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of their net recorded amounts, an adjustment to the deferred tax assets would increase income in the period such determination was made.  Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.

 

As of May 1, 2004 and January 31, 2004, the Company recorded net deferred tax assets totaling $21 million, which primarily represent the income tax benefit associated with losses reported in prior years.  These losses are subject to federal and state carryforward provisions of up to 20 years.  As of May 1, 2004 and January 31, 2004, the Company concluded that the net deferred tax asset balance of $21 million was more likely than not to be recovered.  If the Company is not able to achieve positive operating results in the future, a valuation allowance for some or all of the net deferred tax would need to be recorded against future operations.

 

4. LOSS PER SHARE

 

Basic loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted loss per share is computed by dividing net loss by the weighted average number of common stock and potentially dilutive common stock equivalents outstanding during the period. Diluted loss per share reflects the potential dilution that could occur if options or warrants to issue common stock were exercised, or preferred stock was converted into common stock. The following table details potential dilutive effects of the weighted average number of certain common stock equivalents that have been excluded from diluted loss per share, because their inclusion would be anti-dilutive, since the Company experienced a net loss in each of the first quarters of fiscal 2004 and 2003, respectively:

 

8

 

		First Quarter
		2004		2003
Common stock issuable upon conversion of the Series A preferred stock		4,356,205		6,762,386
Common stock subject to outstanding stock options		571,995		169,905
Total		4,928,200		6,932,291

 

The above stock options represent only those stock options whose exercise prices are less than the average market price of the stock for the quarter.  In addition to the stock options included in the table above, there were an additional 3,898,946, and 3,620,445 stock options for the three months ended May 1, 2004 and May 3, 2003, respectively, that were excluded from the table because the option exercise price for those stock options exceeded the average stock price for those periods.

 

5.SEGMENT REPORTING

 

The Company classifies its business interests into three identifiable segments: retail; direct-to-customer; and furniture manufacturing. The retail segment includes revenue and expenses associated with the Company’s retail locations. The direct-to-customer segment includes all revenue and expenses associated with catalog and Internet revenue. The furniture manufacturing segment includes all revenue and expenses associated with the Company’s wholly-owned furniture manufacturer, The Michaels Furniture Company, Inc. The Company evaluates performance and allocates resources based on results from operations, which excludes unallocated corporate general and administrative costs. Certain segment information, including segment assets, asset expenditures and related depreciation expense, is not presented as all of the Company’s assets are commingled and are not available by segment.

 

Financial information for the Company’s business segments is as follows:

 

(In thousands)		First Quarter
		2004			2003
Net Revenue:
Retail		$	76,991		$	70,471
Direct-to-customer		21,861			11,291
Furniture manufacturing		4,472			4,883
Intersegment furniture revenue		(4,466		)	(4,879		)
Consolidated net revenue		$	98,858		$	81,766

 

		First Quarter
		2004			2003
Income (loss) from operations:
Retail		$	4,720		$	2,733
Direct-to-customer		3,261			1,653
Furniture manufacturing		(98		)	(102		)
Unallocated		(14,279		)	(12,364		)
Intersegment income (loss) from operations		295			(8		)
Consolidated loss from operations		$	(6,101	)	$	(8,088	)

 

9

 

Item 2.    Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

OVERVIEW

 

Our company, Restoration Hardware, Inc. (Nasdaq: RSTO), together with our subsidiaries, is a specialty retailer of high quality home furnishings, bath fixtures and bath ware, functional and decorative hardware and related merchandise that reflects our classic and authentic American point of view. We commenced business in 1979 as a purveyor of fittings and fixtures for older homes. Since then, we have evolved into a unique home furnishings retailer offering consumers an array of distinctive, high quality and often hard-to-find merchandise.  Our core merchandise offerings include premium textiles, bath fixtures and hardware, lighting, decorative accessories and furniture. We market our merchandise through retail locations, mail order catalogs and on the Internet at www.restorationhardware.com.

 

Our merchandise strategy and our stores’ architectural style create a unique and attractive selling environment designed to appeal to an affluent, well educated 35 to 60 year old customer. Over the next decade, we believe the fastest growing segment of the U.S. population will be the 45 to 60 year olds. We believe that as these customers evolve, so will their purchasing needs and desires. We believe that our products can fulfill their aspirations to have homes designed with a high quality, classic and timeless style. Our plan is to fill the void in the marketplace above the current home lifestyle retailers, and below the interior design trade, by providing products targeted to 35 to 60 year olds and centered around our core businesses that reflect a predictable, high-quality promise to our customers.

 

We operate on a 52-53 week fiscal year ending on the Saturday closest to January 31st.  Our current fiscal year is 52 weeks and ends on January 29, 2005 (“fiscal 2004”) and the prior fiscal year was 52 weeks and ended on January 31, 2004 (“fiscal 2003”).

 

As of May 1, 2004, we operated 102 stores in 30 states, the District of Columbia and Canada. In addition to our retail stores, we operate a direct-to-customer sales channel that includes both catalog and Internet, and a wholly owned furniture manufacturer.

 

In the first quarter of fiscal 2004, we began a core business excellence approach to merchandising our business. In particular, in March 2004, we increased the number of vice presidents in merchandising from two to four individuals, each of whom is in charge of separate core merchandise offerings, such as furniture or textiles and added complementary support in product development, design and sourcing. To oversee this new organization, we have placed a new senior vice president, who previously ran our direct-to-customer division, in charge of our entire merchandising process.

 

During the first quarter of fiscal 2004, we closed one under-performing store and have temporarily closed another store for expansion.  Additionally, during the second quarter of fiscal 2004, we closed one under-performing store, and we anticipate opening a new store during the remainder of fiscal 2004. While we do not currently have any reserves established for store closures, we periodically make judgments about which stores we should close and which stores we should continue to operate.  A material decline in sales and other adverse conditions resulting from our failure to accurately anticipate changes in merchandise trends and consumer demands may cause us to close additional under-performing stores.

 

The following table sets forth for the periods indicated the amount and percentage of net revenue represented by certain line items in our Condensed Consolidated Statements of Operations.

 

(Dollars in thousands, except per share data)		First Quarter 2004			% of Net Revenue		First Quarter 2003			% of Net Revenue
Retail net revenue (1)		$	76,997		77.9	%	$	70,475		86.2	%
Direct-to-customer net revenue		21,861			22.1		11,291			13.8
Net revenue		98,858			100.0		81,766			100.0
Cost of revenue and occupancy		71,443			72.3		61,825			75.6
Gross profit		27,415			27.7		19,941			24.4
Selling, general and administrative expense		33,516			33.9		28,029			34.3
Loss from operations		(6,101		)	(6.2	)	(8,088		)	(9.9	)
Interest expense, net		(427		)	(0.4	)	(562		)	(0.7	)
Loss before income taxes		(6,528		)	(6.6	)	(8,650		)	(10.6	)
Income tax benefit		2,546			2.6		3,460			4.3
Net loss		(3,982		)	(4.0	)%	(5,190		)	(6.3	)%
Loss per share—basic and diluted		$	(0.12	)			$	(0.17	)

 

10

 

(1)                                  Furniture manufacturing revenue of six thousand and four thousand for the first quarters of fiscal 2004 and 2003, respectively, has been allocated to retail net revenue for purposes of the following discussion.

 

Loss from operations improved to $6.1 million for the first quarter of fiscal 2004 as compared to a loss from operations of $8.1 million for the first quarter of fiscal 2003. Net loss was $0.12 per common share, or $4.0 million, for the first quarter of fiscal 2004, compared to a net loss of $0.17 per common share, or $5.2 million, for the first quarter of fiscal 2003.

 

The $2.0 million improvement in the loss from operations for the first quarter of fiscal 2004 over the same period of the prior fiscal year is primarily driven by a $17.1 million, or 21%, increase in net revenue, which largely resulted from the continued growth of our direct-to-customer business, which increased $10.6 million, or 94%, over the first quarter of fiscal 2003, as well as a 9.0% increase in comparable store sales. This increase in comparable store sales over the first quarter of fiscal 2003 was driven by our continued focus on building “brand authority” in our core merchandise offerings. The increase in net revenue in both our retail and direct-to-customer channels can also be attributed to our focus on growing both our catalog circulation and page count per catalog, as the catalog is our primary advertising vehicle. The increase in net revenue drove higher gross margins as we leveraged fixed infrastructure costs. Results were also affected by an increase of $5.5 million in selling, general and administrative expense, primarily attributable to increases in catalog production costs, payroll expense, professional services and credit card fees; these increases were primarily incurred in support of our revenue growth. However, selling, general and administrative expense, expressed as a percentage of revenue, declined 40 basis points for the first quarter of fiscal 2004 versus the same period of fiscal 2003 from leverage on higher sales.

 

Our business is highly seasonal, which reflects a general pattern in the retail industry wherein the highest sales and earnings occur during the holiday season. Historically, a significant portion of our sales are in the fourth fiscal quarter. In our peak holiday selling season, we incur significant additional expenses in connection with, among other things, the hiring of additional seasonal employees in our retail stores and the production and mailing of a higher volume of our catalogs.

 

REVENUE

 

Retail Net Revenue

 

		First Quarter
(Dollars in thousands)		2004			2003
Retail net revenue		$	76,997		$	70,475
Retail net revenue growth percentage		9		%	12		%
Comparable store sales growth		9.0		%	11.9		%
Total transactions growth (decline) percentage		—			(7		)%
Average revenue per transaction growth percentage		11		%	21		%
Number of stores at beginning of quarter		103			105
Number of stores opened		—			—
Number of stores closed		1			—
Number of stores at quarter-end		102			105
Store selling square feet at quarter-end		672,604			688,634

 

11

 

Retail net revenue for the first quarter of fiscal 2004 increased by $6.5 million, or 9%, as compared to the first quarter of fiscal 2003 primarily due to a $6.1 million, or 9.0%, increase in comparable store sales. The 9.0% increase in comparable store sales for the first quarter of fiscal 2004 was driven primarily by strong performance in our furniture and other core merchandise offerings.

 

Average revenue per retail transaction increased 11% for the first quarter of fiscal 2004 as compared to the first quarter of fiscal 2003, and the total number of retail transactions by customers was consistent with the prior year quarter. The increase in average revenue per retail transaction for the first quarter of fiscal 2004 was primarily due to a change in our product mix to include more textiles and furniture and proportionally fewer lower priced products, such as accessories.  Average revenue per transaction is calculated by dividing the amount of gross sales, exclusive of delivery revenue and sales taxes, by the gross number of transactions.

 

Comparable store sales are defined as sales from stores whose gross square footage did not change by more than 20% in the previous 12 months and which have been open at least 12 full months. Stores generally become comparable in their 14th full month of operation. We believe that comparable store sales are a more useful indicator of store performance than the change in total net revenue, since comparable store sales exclude the effects of changes in the number of stores open.

 

Direct-to-Customer Net Revenue

 

		First Quarter
(Dollars in thousands)		2004			2003
Catalog revenue		$	12,464		$	7,247
Internet revenue		9,397			4,044
Total direct-to-customer net revenue		$	21,861		$	11,291
Growth percentages:
Direct-to-customer net revenue		94		%	72		%
Number of catalogs mailed		25		%	23		%
Total transactions		51		%	38		%
Average revenue per transaction		34		%	11		%

 

Direct-to-customer net revenue consists of both catalog and Internet sales. Direct-to-customer net revenue for the first quarter of fiscal 2004 increased $10.6 million, or 94%, as compared to the first quarter of fiscal 2003. A portion of this increase was the result of a 25% increase in the number of catalogs mailed for the first quarter of fiscal 2004, to 8.0 million from 6.4 million for the first quarter of fiscal 2003. Average revenue per direct-to-customer transaction for the first quarter of fiscal 2004 increased 34% as compared to the first quarter of fiscal 2003. We believe this increase related to a change in our product mix in the catalog and an increase in catalog-only furniture offerings. Total direct-to-customer transactions for the first quarter of fiscal 2004 increased 51% as compared to the first quarter of fiscal 2003. We believe this increase in direct-to-customer transactions is due in part to our initiative to increase page count in our catalog and in part due to improved product content. Additionally, we believe our website marketing efforts coupled with growing consumer familiarity with the Internet and growth in high-speed Internet consumers also helped drive customers to our website.

 

Shipping income related to and included in our direct-to-customer net revenue above was $2.9 million and $1.4 million for the first quarters of fiscal 2004 and 2003, respectively.

 

Furniture Manufacturing

 

We have a wholly owned furniture manufacturing company located in Sacramento, California, The Michaels Furniture Company, Inc. (“Michaels”). Virtually all of the furniture produced at Michaels is sold through our retail or direct-to-customer revenue channels, and such sales have been recognized in the revenue channel from which the sale

 

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originated. We have eliminated sales by Michaels to third parties, in order to increase production capacity for our retail and direct channel customers.

 

EXPENSES

 

Cost of Revenue and Occupancy Expense

 

For the first quarter of fiscal 2004, cost of revenue and occupancy expense expressed as a percentage of net revenue improved approximately 330 basis points to 72.3%, from 75.6% for the first quarter of fiscal 2003. Approximately 370 and 140 basis points of improvement was achieved due to the leveraging of relatively fixed store occupancy costs and improved retail product margins, respectively; these improvements were partially offset by approximately 190 basis points related to customer shipping distribution costs.

 

Selling, General and Administrative Expense

 

Selling, general and administrative expense expressed as a percentage of net revenue improved approximately 40 basis points to 33.9% for the first quarter of fiscal 2004, from 34.3% for the first quarter of fiscal 2003. Selling, general and administrative expense expressed in absolute dollars increased $5.5 million, to $33.5 million for the first quarter of fiscal 2004 from $28.0 million for the first quarter of fiscal 2003. The increase in absolute dollars primarily related to an increase in catalog production costs, and to a lesser degree, an increase in payroll expense, professional services and credit card fees. The improvement in selling, general and administrative expense as a percentage of net revenue was primarily due to the leveraging of payroll and corporate occupancy costs (approximately 230 basis points), which declined as a percentage of net revenue; and cost savings initiatives for supplies (approximately 40 basis points), partially offset by increases in advertising costs, professional fees and credit card fees related to the conclusion in fiscal 2003 of our incentive program related to our private label credit card (approximately 230 basis points in total).  Payroll costs as a percentage of net revenue also declined, reflecting increased management focus on this area and the implementation of tools to aggressively manage payroll expense.  Advertising costs primarily represent expenses associated with catalog production and mailing. We expect that as the direct-to-customer channel revenue grows at a faster rate than retail revenue, the costs of this advertising will necessarily have the effect of de-leveraging selling, general and administrative expense, as occurred for the first quarter of fiscal 2004. In contrast, the cost of retail occupancy has declined as a percentage of net revenue, which benefit is reflected in improved gross margins. The increases in selling, general and administrative expense in absolute dollars were incurred largely to support our increase in net revenue. Professional fee expenses have been incurred, and will continue to be incurred, with respect to the implementation of the requirements of the Sarbanes-Oxley Act of 2002, in particular, with respect to Section 404 requiring management to report on, and the independent auditors to attest to, internal controls.  Professional fee expenses for the first quarter of fiscal 2004 also include costs incurred to enhance our customer order and delivery process.

 

Interest Expense, Net

 

Interest expense, net includes interest on borrowings under our revolving credit facility and amortization of debt issuance costs. For the first quarter of fiscal 2004, interest expense, net was $0.4 million, a decrease of $0.2 million as compared to $0.6 million for the first quarter of fiscal 2003. The decrease was due to a decline in amortization of debt issuance costs and lower average borrowing rates.

 

Income Tax Benefit

 

Our effective tax benefit rate was 39% for the first quarter of fiscal 2004 as compared to 40% for the first quarter of fiscal 2003.  As of May 1, 2004 and January 31, 2004, we recorded net deferred tax assets totaling $21 million, which primarily represent the income tax benefit associated with losses reported in prior years.  These losses are subject to federal and state carryforward provisions of up to 20 years.  As of May 1, 2004 and January 31, 2004, we concluded that the net deferred tax asset balance of  $21 million was more likely than not to be recovered.  If we are not able to achieve positive operating results in the future, a valuation allowance for some or all of the net deferred tax would need to be recorded against future operations.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

Operating Cash Flows

 

For the first quarter of fiscal 2004, net cash used by operating activities was $22.2 million compared to $13.6 million of net cash used by operating activities for the first quarter of fiscal 2003. The increase in net cash used by operating activities resulted primarily from higher merchandise inventory purchases related to the expansion of our textiles assortments and in anticipation of our growing sales levels; an increase in prepaid expenses and other assets; and a decrease in our accounts payable and accrued expenses. The impact of these items was partially offset by our improved operating results.

 

Investing Cash Flows

 

Net cash used by investing activities was $1.3 million for the first quarter of fiscal 2004, an increase of $0.9 million compared to $0.4 million of cash used by investing activities for the first quarter of fiscal 2003. The cash used for investing activities for the first quarter of fiscal 2004 primarily related to the expansion of one of our stores.

 

Financing Cash Flows

 

Net cash provided by financing activities was $24.1 million for the first quarter of fiscal 2004, and net cash provided by financing activities was $14.1 million for the first quarter of fiscal 2003. Substantially all of the increase in net cash provided by financing activities resulted from net borrowings of $24.0 million for the first quarter of fiscal 2004, as compared to net borrowings of $13.1 million for the first quarter of fiscal 2003, under our revolving credit facility. We also received $0.2 million from the exercise of stock options during the first quarter of fiscal 2004.

 

As of May 1, 2004, our revolving credit facility provided for an overall commitment of $72.0 million. The revolving credit facility was amended in June 2004 to  provide for additional borrowing capacity, reduced borrowing rates and elimination of  limitations on capital expenditures and store openings. In support our continued growth, the amendment increases the initial available commitment to $100.0 million, and further allows us to request and receive incremental increases beyond the initial available commitment of $100.0 million up to a maximum commitment of $150.0 million, provided no default or event of default then exists and certain other conditions are met.  The amendment also increases the amount available for letters of credit from $30.0 million to $50.0 million and modifies certain other terms in the revolving credit facility, which have the effect of expanding the borrowing base.  We had previously amended our revolving credit facility in March 2004 to make minor revisions and clarifications to certain covenants. As of May 1, 2004, $34.4 million was outstanding under the line of credit, net of unamortized debt issuance costs of $0.9 million, and there was $18.6 million in outstanding letters of credit.  Borrowings made under the revolving credit facility are subject to interest at either the bank’s reference rate or LIBOR plus a margin. As of May 1, 2004, the bank’s reference rate was 5.0% and the LIBOR plus margin rate was 3.375%. The availability of credit at any given time under the revolving credit facility is limited by reference to a borrowing base formula based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, and reserves established by the agent of the revolving credit facility.  The revolving credit facility is structured to increase availability to meet seasonal needs. As a result of the borrowing base formula, the actual borrowing availability under the revolving credit facility could be less than the stated amount of the revolving credit facility reduced by the actual borrowings and outstanding letters of credit.  The revolving credit facility contains various restrictive covenants, including limitations on the ability to incur additional debt, acquisition of other businesses and payment of dividends and other distributions.  The revolving credit facility does not contain any other significant financial or coverage ratio covenants, nor does the revolving credit facility require us to repay all borrowings for a proscribed “clean-up” period each year.

 

Our revolving credit facility requires a lock-box arrangement, which provides for all receipts to be swept daily to reduce borrowings outstanding under the revolving credit facility. This arrangement, combined with the existence of a subjective acceleration clause in the revolving credit facility, necessitates that the revolving credit facility be classified as a current liability on our balance sheet, pursuant to guidance in the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 95-22, “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement.” However, we do not expect to repay, or be required to repay, within one year, the balance of the revolving credit facility classified as a current liability. The acceleration clause, which is a typical requirement in commercial credit agreements such as ours, allows our lenders to forego additional advances should they determine there has been a material adverse effect in our operations, business, properties, assets, liabilities, condition or prospects or a material adverse change in our financial position or prospects reasonably likely to result in a material adverse effect on our business, condition (financial or otherwise), operations, performance or properties. However, the revolving credit facility does not expire or have a maturity date within one year, but rather has a final expiration date in June 2006. Additionally, our lenders have

 

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not notified us of any indication that a material adverse effect exists at May 1, 2004 or that a material adverse change has occurred. We believe that no material adverse change has occurred and we believe that we will continue to borrow on the line of credit to fund our operations over the term of the revolving credit facility. We do not anticipate any changes in our business practices that would result in any determination that there has been a material adverse effect in our operations, business, properties, assets, liabilities, condition or prospects. However, we cannot be certain that our lenders will not make such a determination in the future.

 

We currently believe that our cash flows from operations and funds available under our revolving credit facility will satisfy our expected working capital and capital requirements, for at least 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 our revolving credit facility due to covenant limitations or other factors could limit the overall availability of funds to us. Moreover, we may not have successfully anticipated our future capital needs and we may need to raise additional funds in order to take advantage of unanticipated opportunities. We also may need to raise additional funds to respond to changing business conditions or unanticipated competitive pressures. However, should the need arise, additional sources of financing may not be available or, if available, may not be on terms favorable to our stockholders or us. If we fail to raise sufficient funds, we may be required to delay or abandon some of our planned future expenditures or aspects of our current operations. For more information, please see the section “Factors That May Affect Our Future Operating Results,” below, in particular the sections “We are dependent on external funding sources which may not make available to us sufficient funds when we need them,” and “Because our business requires a substantial level of liquidity, we are dependent upon a revolving credit facility with numerous restrictive covenants that limit our flexibility.”

 

CRITICAL ACCOUNTING POLICIES

 

The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to sales returns, inventories, goodwill, income tax benefits, financing operations, contingencies and litigation. We base our estimates on historical experience and on various other facts and assumptions, including current and expected economic conditions and product mix, that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Our management believes the following critical accounting policies require significant judgments and estimates in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

Revenue:  Revenue is recognized at the time of customer receipt.  This can occur when an item is purchased in the store, or when the item is delivered to the customer.  We record the sale as revenue in the channel where the transaction originated.

 

Shipping and handling:  We record shipping and handling fees as revenue in the revenue channel that originated the sales transaction.  Costs of shipping and handling are included in cost of revenue and occupancy.

 

Returns:  We provide an allowance for sales returns based on historical return rates.

 

Merchandise Inventory

 

Our retail inventories are carried at the lower of cost or market with cost determined on a weighted average cost method.  Manufacturing inventories are carried at the lower of cost or market with cost determined at standard costs, approximating average costs.  Costs include certain buying and distribution costs, including payroll and other costs related to the purchase of inventory.  We write down inventories whenever markdowns reduce the selling price below cost. Additionally, we provide for reserves on inventory based upon our estimate of shrinkage losses.  We also write down our slow-moving and discontinued inventory equal to its estimated market value based upon assumptions about future demand and market conditions.  If actual market conditions are less favorable than those projected by management, or if liquidation of the inventory is more difficult than anticipated, additional inventory write-downs may be required.

 

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Prepaid Catalog Expenses

 

Prepaid catalog expenses consist of the cost to prepare, print and distribute catalogs.  Such costs are amortized over the expected revenue generated from each catalog based on historical experience. Typically the cost of a catalog is amortized over approximately four months.

 

Property and Equipment

 

Property and equipment are stated at cost.  Depreciation is calculated using the straight-line method over the estimated useful life of the asset, typically ranging from three to ten years for all property and equipment except for leasehold improvements and lease acquisition costs.  The cost of leasehold improvements and lease acquisitions is amortized over the useful life of the asset or applicable lease term, whichever is less.

 

Impairment of Long-lived Assets

 

We review long-lived tangible assets and intangible assets with finite useful lives for impairment whenever events or changes in circumstances indicate that their carrying values may not be recoverable.  Using our best estimates based on reasonable assumptions and projections, we record an impairment loss to write the assets down to their estimated fair values if the carrying values of such assets exceed their related undiscounted expected future cash flows.

 

We review goodwill and other intangibles with indefinite useful lives for impairment annually, or more frequently if events or changes in circumstances warrant.  If the carrying values of such assets exceed their estimated fair values, we record an impairment loss to write the assets down to their estimated fair values.

 

We generally evaluate long-lived tangible assets and intangible assets with finite useful lives at an individual store level, which is the lowest level at which independent cash flows can be identified.  We evaluate corporate assets or other long-lived assets that are not store-specific at a consolidated entity or reporting unit level, as appropriate.

 

Since there is typically no active market for our long-lived tangible and intangible assets, we estimate fair values based on the expected future cash flows.  We estimate future cash flows based on store-level historical results, current trends and operating and cash flow projections.  Our estimates are subject to substantial uncertainty and may be affected by a number of factors outside our control, including general economic conditions, the competitive environment and regulatory changes.  If actual results differ from our estimates of future cash flows, we may record significant additional impairment charges in the future.

 

Store Closure Reserves

 

The Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” requires that for exit or disposal activities, we recognize a liability for costs associated with closing a store when the liability is incurred.  These costs include direct costs to terminate a lease, lease rental payments net of expected sublease income, and the difference between the carrying values and estimated recoverable values of long-lived tangible and intangible assets.  We record the present value of expected future lease costs and other closure costs when the store is closed.  We record severance and other employee-related costs in the period in which we communicate the closure and related severance packages to the affected employees.

 

While we do not currently have any reserves established for store closures, we periodically make judgments about which stores we should close and which stores we should continue to operate.  All stores are subject to regular monitoring of their financial performance and cash flows, and many stores are subject to “kick out clauses” which allow us to terminate the store lease if certain contractually specified sales levels are not achieved.  If we decide to close a number of these stores, we may incur significant store closure costs for which we are not currently reserved.

 

Our calculation of store closure costs includes significant estimates about the amounts and timing of potential lease termination costs and future sublease income.  These estimates are based on our historical experience, the condition and location of the property, the lease terms and current real estate leasing market conditions.  If actual results differ from our estimates, we may significantly adjust our store closure reserves in future periods.

 

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Self- Insurance

 

We obtain insurance coverage for significant exposures as well as those risks required to be insured by law.  It is generally our policy to retain a significant portion of certain losses related to workers’ compensation, general liability, property losses, business interruption and employee health care.  We record provisions for these items based on an actuary report, claims experience, regulatory changes, an estimate of claims incurred but not yet reported and other relevant factors.  The projections involved in this process are subject to substantial uncertainty because of several unpredictable factors, including actual future claims experience, regulatory changes, litigation trends and changes in inflation.

 

Our self-insurance exposure is concentrated in California, where many of our operations are located.  California has experienced significant increases in workers’ compensation costs as a result of legislative changes and rising medical costs.

 

While the number of claims and days outstanding our claims remain open have been declining for the past three years, if claims are greater than we originally estimate, or if costs increase beyond what we have anticipated, our recorded reserves may not be sufficient, and we may record additional expense.

 

Income Taxes

 

We account for income taxes under SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires income taxes to be accounted for under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns.  In estimating future tax consequences, we generally take into account all expected future events then known to us, other than changes in the tax law or rates, which are not permitted to be considered. Accordingly, we record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. The amount of valuation allowance is based upon management’s best estimate of the recoverability of our deferred tax assets. While future taxable income and ongoing prudent and feasible tax planning are considered in determining the amount of the valuation allowance, this allowance is subject to adjustment in the future.  Specifically, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amounts, an adjustment to the deferred tax assets would increase income in the period such determination was made.  Likewise, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made.

 

As of May 1, 2004 and January 31, 2004, we recorded net deferred tax assets totaling $21 million, which primarily represent the income tax benefit associated with losses reported in prior years.  These losses are subject to federal and state carryforward provisions of up to 20 years.  As of May 1, 2004 and January 31, 2004, we concluded that the net deferred tax asset balance of $21 million was more likely than not to be recovered.  If we are not able to achieve positive operating results in the future, a valuation allowance for some or all of the net deferred tax would need to be recorded against future operations.

 

Other Considerations

 

The above listing is not intended to be a comprehensive list of all of our accounting policies.  In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application.  There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.  See our audited consolidated financial statements and notes thereto in our annual report on Form 10-K for the fiscal year ended January 31, 2004, which contain accounting policies and other disclosures required by generally accepted accounting principles.

 

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FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS

 

We may not be able to successfully anticipate changes in consumer trends and our failure to do so may lead to loss of sales revenue and the closing of under-performing stores.

 

Our success depends on our ability to anticipate and respond to changing merchandise trends and consumer demands in a timely manner. If, for example, we misjudge market trends, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our operating results. Conversely, shortages of popular items could result in loss of potential sales revenue and have a material adverse effect on our operating results.

 

We believe there is a lifestyle trend toward increased interest in home renovation and interior decorating, and we further believe we are benefiting from such a trend. The failure of this trend to materialize or a decline in such a trend could adversely affect consumer interest in our major product lines. Moreover, our products must appeal to a broad range of consumers whose preferences cannot always be predicted with certainty and may change between sales seasons. If we misjudge either the market for our merchandise or our customers’ purchasing habits, we may experience a material decline in sales or be required to sell inventory at reduced margins. We could also suffer a loss of customer goodwill if we do not adhere to our quality control or service procedures or otherwise fail to ensure satisfactory quality of our products. These outcomes may have a material adverse effect on our business, operating results and financial condition.

 

During the first quarter of fiscal 2004, we closed one under-performing store and we closed one additional under-performing store during the second quarter of fiscal 2004.  A material decline in sales and other adverse conditions resulting from our failure to accurately anticipate changes in merchandise trends and consumer demands may cause us to close additional under-performing stores. While we believe that we benefit financially in the aggregate by closing under-performing stores and reducing nonproductive costs, the closure of such stores would subject us to additional increased short-term costs including, but not limited to, employee severance costs, charges in connection with the impairment of assets and costs associated with the disposition of outstanding lease obligations.

 

Our success is highly dependent on improvements to our planning and supply chain processes.

 

An important part of our efforts to achieve efficiencies, cost reductions and sales growth is the identification and implementation of improvements to our planning, logistical and distribution infrastructure and our supply chain, including merchandise ordering, transportation and receipt processing.  An inability to improve our planning and supply chain processes or to take full advantage of supply chain opportunities could have a material adverse effect on our operating results.

 

Because our revenue is subject to seasonal fluctuations, significant deviations from projected demand for products in our inventory during a selling season could have a material adverse effect on our financial condition and results of operations.

 

Our business is highly seasonal. We make decisions regarding merchandise well in advance of the season in which it will be sold, particularly for the holiday selling season. The general pattern associated with the retail industry is one of peak sales and earnings during the holiday season. Due to the importance of the holiday selling season, the fourth quarter of each year has historically contributed, and we expect it will continue to contribute, a disproportionate percentage of our net revenue and our gross profit for the entire year. In anticipation of increased sales activity during the fourth quarter, we incur significant additional expenses both prior to and during the fourth quarter. These expenses may include acquisition of additional inventory, catalog preparation and mailing, advertising, in-store promotions, seasonal staffing needs and other similar items. If, for any reason, our sales were to fall below our expectations in November and December, our business, financial condition and annual operating results may be materially adversely affected.

 

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Increased catalog and other marketing expenditures without increased revenue may have a negative impact on our operating results.

 

Over the past several fiscal years, we have substantially increased the amount that we spend on catalog and other marketing costs, and we expect to continue to invest at these increased levels in the current fiscal year and in the future.  As a result, if we misjudge the directions or trends in our market, we may expend large amounts of cash that generate little return on investment, which would have a negative effect on our operating results.

 

Our quarterly results fluctuate due to a variety of factors and are not a meaningful indicator of future performance.

 

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, the mix of products sold, the timing and level of markdowns, promotional events, store openings, closings, remodelings or relocations, shifts in the timing of holidays, timing of catalog releases or sales, competitive factors and general economic conditions. Accordingly, our profits or losses may fluctuate. Moreover, in response to competitive pressures, we may take certain pricing or marketing actions that could have a material adverse effect on our business, financial condition and results of operations. Therefore, 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. If our operating results in any future period fall below the expectations of securities analysts and investors, or if our operating results do not meet the guidance that we issue from time to time, the market price of our shares would likely decline.

 

Fluctuations in comparable store sales may cause our revenue and operating results from period-to-period to vary.

 

A variety of factors affect our comparable store sales including, among other things, the general retail sales environment, our ability to efficiently source and distribute products, changes in our merchandise mix, promotional events, the impact of competition and our ability to execute our business strategy efficiently. Our comparable store sales results have fluctuated significantly in the past, and we believe that such fluctuations may continue. Our comparable store sales increased 9.0% for the first quarter of fiscal 2004 and 11.9% for the first quarter of fiscal 2003. Past comparable store sales results may not be indicative of future results. As a result, the unpredictability of our comparable store sales may cause our revenue and operating results to vary from quarter to quarter, and an unanticipated decline in revenue may cause our stock price to fluctuate.

 

We depend on a number of key vendors to supply our merchandise and provide critical services, and the loss of any one of our key vendors may result in a loss of sales revenue and significantly harm our operating results.

 

We make merchandise purchases from over 500 vendors. Our performance depends on our ability to purchase our merchandise in sufficient quantities at competitive prices. Although we have many sources of merchandise, two of our vendors - one, a manufacturer of upholstered furniture, and the other, a buying agent - together accounted for approximately 22% of our aggregate merchandise purchases for fiscal 2003. In addition, our smaller vendors generally have limited resources, production capacities and operating histories, and some of our vendors have limited the distribution of their merchandise in the past. We have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to new products, and any vendor or distributor could discontinue selling to us at any time. We may not be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future, or be able to develop relationships with new vendors to expand our options or replace discontinued vendors. Our inability to acquire suitable merchandise in the future or the loss of one or more key vendors and our failure to replace any one or more of them may have a material adverse effect on our business, results of operations and financial condition.

 

In addition, a single vendor supports the majority of our management information systems. A failure by the vendor to support our management information systems adequately in the future could have a material adverse effect on our business, results of operations and financial condition.

 

We routinely purchase products from new vendors from time to time, many of whom are located abroad. We cannot assure you that they will be reliable sources of our products. Moreover, a number of these manufacturers and suppliers are small and undercapitalized firms that produce limited numbers of items. Given their limited resources, these firms might be susceptible to production difficulties, quality control issues and problems in delivering agreed-upon quantities on schedule. We cannot assure you that we will be able, if necessary, to return products to these suppliers and obtain refunds of our purchase price or obtain reimbursement or indemnification from them if their products prove defective. These suppliers and manufacturers also may be unable to withstand a downturn in the U.S. or

 

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worldwide economy. Significant failures on the part of these suppliers or manufacturers could have a material adverse effect on our operating results.

 

In addition, many of these suppliers and manufacturers require extensive advance notice of our requirements in order to produce products in the quantities we desire. This long lead time requires us to place orders far in advance of the time when certain products will be offered for sale, thereby exposing us to risks relating to shifts in customer demands and trends, and any downturn in the U.S. economy.

 

A disruption in any of our distribution operations would materially affect our operating results.

 

The distribution functions for our stores as well as all of our furniture orders are currently handled from our facilities in Hayward and Tracy, California and Baltimore, Maryland. Any significant interruption in the operation of any of these facilities may delay shipment of merchandise to our stores and customers, damage our reputation or otherwise have a material adverse effect on our financial condition and results of operations. Moreover, a failure to successfully coordinate the operations of these facilities also could have a material adverse effect on our financial condition and results of operations.  For example, during the third and fourth quarters of fiscal 2003, we had delays in the delivery of some customer orders.  While we have been addressing these issues, we expect that through the first half of fiscal 2004 we may continue to have some distribution delays in the Eastern part of the United States, and further distribution problems, should they arise, may materially affect our net revenue in particular periods and/or the timing of the recognition of revenue from orders not yet delivered.  Separately, significant disruptions to the operations of the third party vendor who handles the distribution and fulfillment functions for our direct-to-customer business on an outsourced basis could be expected to have similar negative consequences.

 

Separately, in March 2004, we entered into a new lease for space located adjacent to our existing distribution facility in Tracy, California.  We expect to occupy this Tracy facility, which will support our furniture distribution to the Western part of the United States, beginning in June 2004.  Should we encounter difficulties or delays in carrying out this move, our distribution operations in Tracy may be disrupted and we may experience delays or errors in the shipment of merchandise to our stores and customers, which could damage our reputation or otherwise have a material adverse effect on our financial condition and results of operations.

 

Labor activities could cause labor relations difficulties for us.

 

As of May 1, 2004, we had approximately 3,300 full and part time employees, and we believe our relations with our employees are generally good.  Approximately 48 of our employees at our Baltimore, Maryland distribution facility voted in September 2003 to unionize and we are currently in contract negotiations with them.  Although our distribution facilities have not experienced any material work stoppages, we cannot predict the effect union representation or future organizational activities will have on our business and operations.  However, if additional employees were to vote to unionize, or 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.

 

We are dependent on external funding sources which may not make available to us sufficient funds when we need them.

 

We have significantly relied and may rely in the future on external funding sources to finance our operations and growth. Any reduction in cash flow from operations could increase our external funding requirements to levels above those currently available to us. While we currently have in place a $100.0 million revolving credit facility, which may be increased to $150.0 million under certain circumstances, the amount available under this facility could be less than stated amount if there is a shortfall in the availability of eligible collateral to support the borrowing base stated in the revolving credit facility. We currently believe that our cash flow from operations and funds available under our revolving credit facility will satisfy our capital and operating requirements for at least 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 our revolving credit facility due to covenant limitations or other factors could limit the overall amount of funds available to us.

 

Our revolving credit facility contains a subjective acceleration clause, which is a typical requirement in commercial credit agreements such as ours.  This acceleration clause allows our lenders to forego additional advances should they determine there has been a material adverse effect in our operations, business, properties, assets, liabilities,

 

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condition or prospects or a material adverse change in our financial position or prospects reasonably likely to result in a material adverse effect on our business, condition (financial or otherwise), operations, performance or properties.  However, our lenders have not notified us of any indication that a material adverse effect exists at May 1, 2004 or that a material adverse change has occurred.  We believe that no material adverse change has occurred and we believe that we will continue to borrow on the line of credit to fund our operations over the term of the revolving credit facility.  We do not anticipate any changes in our business practices that would result in any determination that there has been a material adverse effect in our operations, business, properties, assets, liabilities, condition or prospects.  However, we cannot be certain that our lenders will not make such a determination in the future.

 

In particular, we may experience cash flow shortfalls in the future and we may require additional external funding beyond the amounts available under our revolving credit facility. 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. In the event that we are unable to obtain additional funds on acceptable terms or otherwise, we may be unable or determine not to take advantage of new opportunities or defer on taking other actions that otherwise may be important to our operations. Additionally, we may need to raise funds to take advantage of unanticipated opportunities. We also may need to raise funds to respond to changing business conditions or unanticipated competitive pressures. 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.

 

Because our business requires a substantial level of liquidity, we are dependent upon a revolving credit facility with numerous restrictive covenants that limit our flexibility.

 

Our business requires substantial liquidity in order to finance inventory purchases, the employment of sales personnel for the peak holiday period, advertising for the holiday buying season and other similar advance expenses.  We currently have in place a revolving credit facility that provides for an overall commitment of $100.0 million, which may be increased to $150.0 million under certain circumstances. Over the past several years, we have entered into numerous modifications, amendments and restatements of this revolving credit facility, primarily to address changes in the requirements applicable to us under the revolving credit facility documents, and, most recently, to increase the overall commitment under the facility.

 

Covenants in the revolving credit facility include, among others, ones that limit our ability to incur additional debt, make liens, make investments, consolidate, merge or acquire other businesses, sell assets, pay dividends or other distributions, and enter into transactions with affiliates. These covenants restrict numerous aspects of our business. The revolving credit facility also includes a borrowing base formula to address the availability of credit at any given time based upon numerous factors, including the value of eligible inventory and eligible accounts receivable, in each case, subject to the overall aggregate cap on borrowings. Consequently, for purposes of the borrowing base formula, the value of eligible inventory and eligible accounts receivable may limit our ability to borrow under the revolving credit facility.

 

We have drawn upon the revolving credit facility in the past and we expect to draw upon it in the future.  As a result, failure to comply with the terms of the revolving credit facility would entitle the secured lenders to prevent us from further borrowing, and upon acceleration by the lenders, they would be entitled to begin foreclosure procedures against our assets, including accounts receivable, inventory, general intangibles, equipment, goods, and fixtures. The secured lenders would then be repaid from the proceeds of such foreclosure proceedings, using all available assets.  Only after such repayment and the payment of any other secured and unsecured creditors would the holders of our capital stock receive any proceeds from the liquidation of our assets.  Our ability to satisfy the restrictive covenants may be affected by events beyond our control.

 

Future increases in interest and other expense may impact our future operations.

 

High levels of interest and other expense have had in the past and could have in the future negative effects on our operations. While our revolving credit facility was amended at various times over the past several years to provide us with more favorable interest rates and changes to some requirements, a significant portion of our cash flow from operations was used in the past to pay our interest expense and was not available for other business purposes.  An increase in the variable interest rate under our revolving credit facility coupled with an increase in our outstanding debt could result in material amounts otherwise available for other business purposes being used to pay for interest expense.

 

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Our ability to continue to meet our future debt and other obligations and to minimize our average debt level depends on our future operating performance and on economic, financial, competitive and other factors.  Many of these factors are beyond our control.  In addition, we may need to incur additional indebtedness in the future. We cannot assure you that our business will generate sufficient cash flow or that future financings will be available to provide sufficient proceeds to meet our needs or obligations or to service our total debt.

 

We are subject to trade restrictions and other risks associated with our dependence on foreign imports for our merchandise.

 

During the first quarter of fiscal 2004, we purchased in excess of 60% of our merchandise directly from vendors located abroad and we do not expect that such purchases will decline as a percentage of total merchandise purchases for fiscal 2004. As an importer, our future success will depend in large measure upon our ability to maintain our existing foreign supplier 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. 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, changes in 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, and political unrest and trade restrictions, including the United States retaliating against protectionist foreign trade practices. Furthermore, some or all of our foreign vendors’ operations may be adversely affected by political, financial or other instabilities that are particular to their home countries, including without limitation local acts of terrorism or economic, environmental or health and welfare-related crises, which may in turn result in limitations or temporary or permanent halts to their operations, restrictions on the transfer of goods or funds and/or other trade disruptions.  If any of these or other factors were to render the conduct of business in particular countries undesirable or impractical, our financial condition and results of operations could be materially adversely affected.

 

While we believe that we could find alternative sources of supply, 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. Moreover, products from alternative sources may be of lesser quality and/or more expensive than those we currently purchase, resulting in reduction or loss of our profit margin on such items.

 

As an importer we are subject to the effects of currency fluctuations related to our purchases of foreign merchandise.

 

While most of our purchases outside of the United States currently are settled in U.S. dollars, it is possible that a growing number of them in the future may be made in currencies other than the U.S. dollar. Historically, we have not hedged our currency risk and do not currently anticipate doing so in the future. However, because our financial results are reported in U.S. dollars, fluctuations in the rates of exchange between the U.S. dollar and other currencies may decrease our sales margins or otherwise have a material adverse effect on our financial condition and results of operations in the future.

 

Rapid growth in our direct-to-customer business may not be sustained and may not generate a corresponding increase in profits to our business.

 

For the first quarter of fiscal 2004, revenue through our direct-to-customer channel grew by 94% as compared to the same period in the prior fiscal year. Increased activity in our direct-to-customer business could result in material changes in our operating costs, including increased merchandise inventory costs and costs for paper and postage associated with the distribution and shipping of catalogs and products. Although we intend to attempt to mitigate the impact of these increases by improving sales revenue and efficiencies, we cannot assure you that we will succeed in mitigating expenses with increased efficiency or that cost increases associated with our direct-to-customer business will not have an adverse effect on the profitability of our business. Additionally, while we outsource to a third party the fulfillment of our direct-to-customer division, including customer service and distribution, the third party may not have

 

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the capacity to accommodate our growth. This lack of capacity may result in delayed customer orders and deficiencies in customer service, both of which may adversely affect our reputation, cause us to lose sales revenue and limit or counter recent growth in our direct-to-customer business.

 

We depend on key personnel and could be affected by the loss of their services because of the limited number of qualified people in our industry.

 

The success of our business will continue to depend upon our key personnel, including our President and Chief Executive Officer, Gary G. Friedman. 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.  For example, during fiscal 2003, turnover in personnel and the recruitment and retention of new accounting staff for our finance department created challenges for us.  While we hired two new financial managers in mid-2003, retained an independent third party to serve as our internal audit department, retained a new Chief Financial Officer in October 2003, and have made additional changes to our finance department and its staff, our continual efforts to improve our accounting controls and procedures may be hampered if we experience difficulties in the transition and re-organization of our finance department.

 

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 employees may voluntarily terminate their employment with us at any time. We also do not maintain any key man life insurance. The loss of the services of key personnel or our failure to attract additional qualified personnel could have a material adverse effect on our business, financial condition and results of operations.

 

Recently enacted regulatory changes may cause us to incur increased costs.

 

Recently enacted changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, will increase our expenses as we evaluate the implications of new rules and devote resources to respond to the new requirements. In particular, we expect to incur additional expenses as we implement Section 404 of the Sarbanes Oxley Act of 2002, which requires management to report on, and our independent auditors to attest to, our internal controls.  Compliance with these new rules could also result in continued diversion of management’s time and attention, which could prove to be disruptive to normal business operations.  Further, the impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers, which could harm our business.

 

We are currently conducting evaluations required to ensure compliance with the management certification and auditor attestation requirements under Section 404 of the Sarbanes Oxley Act of 2002.  As this is an evolving process, we have no precedent available by which to measure compliance adequacy. Consequently, we cannot be certain as to the timing of completion of our evaluation and related actions or the impact of any of them on our operations. While we currently anticipate that we will timely complete all such actions, we are not certain of the consequences of a failure, although possible consequences include, sanction or investigation by regulatory authorities, such as the Securities and Exchange Commission or The Nasdaq National Market, and inability to timely file our next annual report on Form 10-K.

 

Changes in general economic conditions affect consumer spending and may significantly harm our revenue and results of operations.

 

The success of our business depends to a significant extent upon the level of consumer spending. A number of economic conditions affect the level of consumer spending on merchandise that we offer, including, among other things, the general state of the economy, general business conditions, the level of consumer debt, interest rates, taxation and consumer confidence in future economic conditions. More generally, reduced consumer confidence and spending may result in reduced demand for our products and limitations on our ability to increase prices, and may also require increased levels of selling and promotional expenses. Adverse economic conditions and any related decrease in consumer demand for discretionary items such as those offered by us could have a material adverse effect on our business, results of operations and financial condition.

 

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We face an extremely competitive specialty retail business market.

 

The retail market is highly competitive. We compete against a diverse group of retailers ranging from specialty stores to traditional furniture stores and department stores. Our product offerings also compete with a variety of national, regional and local retailers. We also compete with these and other retailers for customers, suitable retail locations, suppliers and qualified employees and management personnel. Many of our competitors have significantly greater financial, marketing and other resources. 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 and hiring practices, exclusive relationships with key suppliers and manufacturers 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 breadth and quality of our product selection, effective merchandise presentation, customer service, pricing and store location.  Although we believe that we are able to compete favorably on the basis of these factors, we may not ultimately succeed in competing with other retailers in our market.

 

Terrorist attacks and threats or actual war may negatively impact all aspects of our operations, revenue, costs and stock price.

 

Threats of terrorist attacks in the United States, as well as future events occurring in response to or in connection with them, including, without limitation, future terrorist attacks or threats against United States targets, rumors or threats of war, actual conflicts involving the United States or its allies, including the on-going U.S. wars in Iraq and Afghanistan, further conflicts in the Middle East and in other developing countries, or military or trade disruptions affecting our domestic or foreign suppliers of merchandise, may impact our operations. The potential impact to our operations includes, among other things, delays or losses in the delivery of merchandise to us and decreased sales of the products we carry. Additionally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economies. Also, any of these events could result in economic recession in the United States or abroad. Any of these occurrences could have a significant impact on our operating results, revenue and costs and may result in the volatility of the future market price of our common stock.

 

Our common stock price may be volatile.

 

The market price of our common stock has fluctuated significantly in the past, and is likely to continue to be highly volatile. In addition, the trading volume in our common stock has fluctuated, and significant price variations can occur as a result. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. In addition, the United States equity markets have from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the stocks of companies such as ours.  These broad market fluctuations may materially adversely affect the market price of our common stock in the future. Variations in the market price of our common stock may be the result of changes in the trading characteristics that prevail in the market for our common stock, including low trading volumes, trading volume fluctuations and other similar factors that are particularly common among highly volatile securities. Variations also may be the result of changes in our business, operations or prospects, announcements or activities by our competitors, entering into new contractual relationships with key suppliers or manufacturers by us or our competitors, proposed acquisitions by us or our competitors, financial results that fail to meet our guidance or public market analysts’ expectations, changes in stock market analysts’ recommendations regarding us, other retail companies or the retail industry in general, and domestic and international market and economic conditions.

 

Future sales of our common stock in the public market could adversely affect our stock price and our ability to raise funds in new equity offerings.

 

We cannot predict the effect, if any, that future sales of shares of our common stock or the availability for future sale of shares of our common stock or securities convertible into or exercisable for our common stock will have on the market price of our common stock prevailing from time to time. For example, in connection with our March 2001 preferred stock financing, we filed a registration statement on Form S-3 with the Securities and Exchange Commission to register approximately 6.4 million shares of our common stock issued, or to be issued, upon the conversion of our Series A preferred stock to some of our stockholders. The registration statement was declared effective by the Securities and Exchange Commission on October 31, 2002 and may remain effective under certain circumstances for as long as March 2009.  Sale, or the availability for sale, of substantial amounts of common stock by our existing stockholders

 

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pursuant to an effective registration statement or under Rule 144, through the exercise of registration rights or the issuance of shares of common stock upon the exercise of stock options, or the conversion of our preferred stock, or the perception that such sales or issuances could occur, could adversely affect prevailing market prices for our common stock and could materially impair our future ability to raise capital through an offering of equity securities.

 

We are subject to anti-takeover provisions and the terms and conditions of our preferred stock financing that could delay or prevent an acquisition and could adversely affect the price of our common stock.

 

Our Second Amended and Restated Certificate of Incorporation, as amended, and Amended and Restated Bylaws, certain provisions of Delaware law and the certificate of designation governing the rights, preferences and privileges of our preferred stock may make it difficult in some respects to cause a change in control of our company and replace incumbent management. For example, our Second Amended and Restated Certificate of Incorporation, as amended, and Amended and Restated Bylaws provide for a classified board of directors. With a classified board of directors, at least two annual meetings of stockholders, instead of one, will generally be required to effect a change in the majority of the board. As a result, a provision relating to a classified board may discourage proxy contests for the election of directors or purchases of a substantial block of our common stock because its provisions could operate to prevent obtaining control of the board in a relatively short period of time.

 

Separately, the holders of our preferred stock presently have the right to designate two members of our board of directors, and they also have a number of voting rights pursuant to the terms of the certificate of designation which could potentially delay, defer or prevent a change of control. In particular, the holders of our Series A preferred stock have the right to approve a number of actions by us, including mergers, consolidations, acquisitions and similar transactions in which the holders of Series A preferred stock and common stock do not receive at least three times the then existing conversion price per share of the Series A preferred stock. This right may create a potentially discouraging effect on, among other things, any third party’s interest in completing these types of transactions with us. Consequently, the terms and conditions under which we issued our preferred stock, coupled with the existence of other anti-takeover provisions, may collectively have a negative impact on the price of our common stock, may discourage third-party bidders from making a bid for our company or may reduce any premiums paid to our stockholders for their common stock.

 

In addition, our board of directors has the authority to fix the rights and preferences of, and to issue shares of, our preferred stock, which may have the effect of delaying or preventing a change in control of our company without action by holders of our common stock..

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This quarterly report on Form 10-Q contains “forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995, that involve known and unknown risks. Such forward-looking statements include without limitation statements relating to our future plans, statements relating to anticipated future costs and expenses, in particular in connection with Section 404 under the Sarbanes Oxley Act of 2002, statements based on expectations of future profitability, statements relating to our working capital and capital expenditure needs, and other statements containing words such as “believes,” “anticipates,” “estimates,” “expects,” “may,” “intends,” and words of similar import or statements of our management’s opinion. These forward-looking statements and assumptions involve known and unknown risks, uncertainties and other factors that may cause our actual results, market performance or achievements to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause such differences include, but are not limited to, changes in economic or business conditions in general, changes in product supply, fluctuations in comparable store sales, limitations resulting from restrictive covenants in our revolving credit facility, failure of our management to anticipate changes in consumer trends, loss of key vendors, changes in the competitive environment in which we operate, changes in our management information needs, changes in management, failure to raise additional funds when required, changes in customer needs and expectations and governmental actions and consequences stemming from the continued wars in Iraq and Afghanistan or from terrorist activities in or related to the United States. We undertake no obligation to update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this quarterly report on Form 10-Q.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Our market risk disclosures set forth in Item 7A of our Annual Report on Form 10-K, for the year ended January 31, 2004, have not changed materially during the quarter ended May 1, 2004.

 

Item 4. Controls and Procedures.

 

As of May 1, 2004, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures.  This evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”).  Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures as of May 1, 2004 were effective in timely alerting them to material information required to be included in this report.  There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

There are no material pending legal proceedings against us. We are, however, involved from time to time in legal proceedings, including litigation arising in the ordinary course of our business.  At the present time, we believe no legal proceedings will have a material adverse effect on our business, financial condition or results of operations. However, we cannot assure you that the results of any proceeding will be in our favor.  Moreover, due to the uncertainties inherent in any legal proceeding, we cannot accurately predict the ultimate outcome of any proceeding and may incur substantial costs to defend the proceeding, irrespective of the merits.  Unfavorable outcome of any legal proceeding could have an adverse impact on our business, financial condition, and results of operations.

 

Item 5. Other Information.

 

On June 3, 2004, we entered into Amendment No. 5 to the Seventh Amended and Restated Loan and Security Agreement with Fleet Retail Group, Inc. (previously, Fleet Capital Corporation) and The CIT Group/Business Credit, Inc.  The principle effect of the amendment was to increase our overall commitment from $72.0 million to $100.0 million, which amount may be increased to $150.0 million under certain circumstances, and to increase the amount available for letters of credit from $30.0 million to $50.0 million, reduce interest rates, eliminate limitations on capital expenditures and store openings, and expand the borrowing base.

 

Item 6. Exhibits and Reports on Form 8-K.

 

(a)          Exhibits.

 

See attached exhibit index.

 

(b)         Reports on Form 8-K.

 

On March 22, 2004, we filed with the Securities and Exchange Commission a current report on Form 8-K, which included reports under items 5, 7 and 12 thereto and attached a press release, dated March 18, 2004, announcing our financial results for the fourth quarter and year ended January 31, 2004.

 

On March 18, 2004, we filed with the Securities and Exchange Commission a current report on Form 8-K, which included reports under items 5, 7 and 12 thereto and attached a press release, dated March 18, 2004, announcing our financial results for the fourth quarter and year ended January 31, 2004.

 

On February 6, 2004, we filed with the Securities and Exchange Commission a current report on Form 8-K, which included reports under items 5, 7 and 12 thereto and attached a press release, issued February 5, 2004, announcing certain of our financial results for the month, quarter and year ended January 31, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Restoration Hardware, Inc.
Date:  June 7, 2004
	By:	/s/ Gary G. Friedman
		Gary G. Friedman
		President and Chief Executive Officer
	By:	/s/ Patricia McKay
		Patricia A. McKay
		Chief Financial Officer (Principal Financial Officer)

 

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EXHIBIT INDEX

 

EXHIBIT NUMBER		DOCUMENT DESCRIPTIONS
3.1		Second Amended and Restated Certificate of Incorporation, as amended (incorporated by reference to exhibit number 3.1 of the Form 8-K filed by Restoration Hardware, Inc. with the Securities and Exchange Commission on October 24, 2001)
3.2		Certificate of Designation of Series A and Series B Preferred Stock (incorporated by reference to exhibit number 4.6 of Form 8-K filed by Restoration Hardware, Inc. with the Securities and Exchange Commission on April 2, 2001)
3.3		Amended and Restated Bylaws, as amended to date (incorporated by reference to exhibit number 3.2 of Form 10-Q for the quarterly period ended October 31, 1998 filed by Restoration Hardware, Inc. with the Securities and Exchange Commission on December 15, 1998)
10.1		Distribution center lease, dated March 9, 2004, between Restoration Hardware, Inc. and ProLogis, a Maryland Real Estate Investment Trust.
10.2		Compensation and Severance Agreement, amended and restated February 5, 2004, by and between Restoration Hardware, Inc. and Gary G. Friedman.
10.3		Notice of Grant of Stock Option and Stock Option Agreement between Restoration Hardware, Inc. and Gary Friedman, dated February 5, 2004.
10.4		Notice of Grant of Stock Option and Stock Option Agreement between Restoration Hardware, Inc. and Gary Friedman, dated February 5, 2004.
10.5		Notice of Grant of Stock Option and Stock Option Agreement between Restoration Hardware, Inc. and Gary Friedman, dated February 5, 2004.
10.6		Amendment No. 4 to the Seventh Amended and Restated Loan and Security Agreement, dated March 15, 2004, by and among Restoration Hardware, Inc., The Michaels Furniture Company, Inc., Fleet Capital Corporation, and The CIT Group/Business Credit, Inc. (incorporated by reference to exhibit number 10.38 of Form 10-K for the year ended January 31, 2004 filed by Restoration Hardware, Inc. with the Securities and Exchange Commission on April 12, 2004).
10.7		2004 Senior Executive Bonus Plan.
10.8		Amendment No. 5 to the Seventh Amended and Restated Loan and Security Agreement, dated June 3, 2004, by and among Restoration Hardware, Inc., The Michaels Furniture Company, Inc., Fleet Retail Group, Inc., and The CIT Group/Business Credit, Inc.
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1		Section 1350 Certification of Chief Executive Officer
32.2		Section 1350 Certification of Chief Financial Officer