RH Form 10-Q Summary
Reporting period: Quarterly period ended November 2, 2013, covering 13 and 39 weeks. The request metadata identifies “2012 Q3,” but the filing is the third-quarter 2013 Form 10-Q; comparable periods ended October 27, 2012.
Business context
Restoration Hardware Holdings, Inc. is a luxury home furnishings retailer selling furniture, lighting, textiles, bathware, décor, outdoor and garden products, tableware, and children’s furnishings through stores, catalogs, and websites. As of November 2, 2013, the company operated 70 retail stores and 17 outlet stores in the United States and Canada.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net revenues | $395.8 million | $284.2 million | $1,079.3 million | $795.0 million |
| Gross profit | $140.8 million | $101.9 million | $381.9 million | $291.3 million |
| Gross margin | 35.6% | 35.9% | 35.4% | 36.6% |
| Operating income (loss) | $23.9 million | $2.0 million | $(3.4) million | $19.6 million |
| Net income (loss) | $9.5 million | $1.7 million | $(8.4) million | $15.6 million |
| Diluted EPS | $0.23 | Not directly comparable due to the 2012 reorganization and IPO | $(0.22) | Not directly comparable |
Q3 revenue increased 39% year over year, while nine-month revenue increased 36%. Comparable retail store sales increased 29% in the quarter and 31% for the nine-month period. Direct revenue increased 47% in Q3 and 39% for the nine months; store revenue increased 33% in both periods.
Q3 operating margin was 6.1% versus 0.7% in the prior-year quarter, and Q3 net margin was 2.4% versus 0.6%. Nine-month operating margin was negative 0.3% versus 2.5%, and nine-month net margin was negative 0.8% versus 2.0%.
Adjusted net income, a non-GAAP measure, was $13.0 million in Q3 2013 versus $2.7 million in Q3 2012, and $35.1 million for the first nine months versus $13.6 million. The filing defines this measure by excluding selected nonrecurring and other items.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $30.5 million, compared with $(20.0) million in the prior-year period.
- Capital expenditures were $57.6 million, compared with $25.6 million, primarily for supply-chain investments, new stores, and systems infrastructure.
- Net cash used in investing activities was $57.6 million; net cash provided by financing activities was $27.0 million.
- Cash and cash equivalents were $8.2 million at November 2, 2013, compared with $8.4 million at February 2, 2013.
- Merchandise inventories increased to $448.2 million from $353.3 million at February 2, 2013, reflecting preparation for fall and winter selling seasons and efforts to improve in-stock positions.
- Revolving credit borrowings were $108.2 million, with $290.6 million of undrawn availability and $18.0 million of outstanding letters of credit. The weighted-average interest rate was 2.9%; the facility matures August 3, 2016.
- The company was in compliance with its credit agreement covenants. Fiscal 2013 capital expenditures were planned at approximately $95 million to $100 million, with $57.6 million incurred through nine months.
Material changes versus the prior comparable period
- Revenue growth was strong across both channels, despite three fewer retail stores at period end than in the prior-year comparison.
- Gross margin declined by 30 basis points in Q3 and 120 basis points for the nine months, driven by strategic pricing, product mix, higher distribution-center occupancy costs, and higher freight costs associated with a greater furniture mix.
- Q3 SG&A increased 17% but declined to 29.5% of revenue from 35.2%, primarily due to lower advertising and marketing costs and improved expense leverage.
- Nine-month SG&A increased 42% and included $63.2 million of non-cash compensation, consisting principally of a $33.7 million charge for a fully vested option granted to Gary Friedman and a $29.5 million charge related to performance-based shares.
- Nine-month results also included $2.9 million of follow-on offering costs. These items contributed to the reported nine-month net loss despite substantial revenue growth.
- Three future Full Line Design Gallery leases were accounted for as build-to-suit transactions, adding $24.7 million to property and equipment and long-term obligations and $0.6 million of interest expense during the nine months.
- The company ceased to be a controlled company effective May 20, 2013, although it could rely on certain NYSE governance exemptions during a one-year transition period.
Outlook, commentary, risks, and unusual items
Management stated that operating cash flow and borrowing availability were expected to fund working capital, planned capital expenditures, and debt payments for at least the next 12 to 24 months. Results are seasonal, with inventory and borrowings generally increasing ahead of outdoor and holiday selling periods.
The filing identifies risks related to maintaining revenue growth and margins, inventory management, international sourcing, variable-rate debt, litigation and regulatory proceedings, conflict-minerals compliance, key-person dependence, leadership transitions, and potential sales of common stock. Carlos Alberini’s planned resignation as Co-Chief Executive Officer effective January 31, 2014 was identified as a potential operational and financial risk; the filing states that Mr. Friedman would serve as Chief Executive Officer thereafter.
As of November 2, 2013, the company had no material off-balance-sheet arrangements. It had recorded liabilities for estimated litigation losses but stated that additional losses could exceed accrued amounts. A proposed FASB lease standard could materially affect future financial statements, although the impact could not yet be determined.
Subsequent to quarter-end, the company entered into an agreement expected to close February 3, 2014, to acquire certain assets from an entity owned by an employee for $2.5 million.
Important facts for investors to verify
- Confirm the period designation: the filing covers Q3 2013, not Q3 2012.
- Assess whether revenue growth and comparable-store performance can offset declining gross margins and the cost of expansion.
- Separate recurring operating performance from the $63.2 million of nine-month non-cash compensation and other unusual charges.
- Monitor inventory growth, seasonal borrowing needs, cash of only $8.2 million, and availability under the revolving credit facility.
- Review the effects of leadership changes, including Alberini’s planned departure and Friedman’s expanded role.
- Review litigation exposure, unrecognized tax benefits, build-to-suit obligations, and the potential effect of future lease-accounting changes.