Business Context and Reporting Period
Restoration Hardware Holdings, Inc. (RH) is a luxury home furnishings retailer selling through stores, catalogs, and websites. As of August 3, 2013, it operated 70 retail stores and 17 outlet stores across the United States and Canada, with sourcing operations in Shanghai and Hong Kong.
This unaudited Form 10-Q covers the three and six months ended August 3, 2013, compared with July 28, 2012. The request metadata identifies “2012 Q2,” but the filing itself reports the 2013 second quarter.
Financial Results and Key Metrics
| Metric | Three Months Ended August 3, 2013 | Prior Comparable Period | Six Months Ended August 3, 2013 | Prior Comparable Period |
|---|---|---|---|---|
| Net revenues | $382.1 million | $292.9 million | $683.4 million | $510.8 million |
| Revenue growth | 30% | — | 34% | — |
| Gross profit | $139.2 million | $114.1 million | $241.1 million | $189.4 million |
| Gross margin | 36.4% | 39.0% | 35.3% | 37.1% |
| SG&A | $167.0 million | $94.5 million | $268.4 million | $171.8 million |
| Operating income (loss) | $(27.8) million | $19.7 million | $(27.3) million | $17.6 million |
| Net income (loss) | $(17.8) million | $17.6 million | $(18.0) million | $13.9 million |
| Basic and diluted EPS | $(0.46) | Not comparable in filing presentation | $(0.47) | Not comparable in filing presentation |
Stores revenue increased 28% to $204.3 million in the quarter and 33% to $363.6 million for the six-month period. Direct revenue increased 33% to $177.8 million in the quarter and 35% to $319.8 million for the six-month period. Comparable retail store sales increased 26% and 33%, respectively.
Adjusted net income, a non-GAAP measure, was $19.8 million for the quarter and $22.1 million for the six months, compared with $12.2 million and $10.9 million, respectively, in the prior-year periods.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $15.0 million at August 3, 2013, compared with $8.4 million at February 2, 2013.
- Six-month operating cash flow was $31.4 million, compared with cash used of $4.6 million in the prior-year period.
- Capital expenditures were $30.6 million for the six months, including investments in supply-chain and systems infrastructure and new stores. Fiscal 2013 capital expenditures were expected to total approximately $95 million to $100 million.
- Merchandise inventories increased to $406.7 million from $353.3 million at fiscal year-end, primarily to support the fall selling season, improve in-stock positions, and reduce backorders.
- Revolving-line borrowings were $87.6 million at August 3, 2013, with $207.6 million of undrawn availability. Outstanding letters of credit totaled $23.0 million.
- The weighted-average revolving-line interest rate was 2.52%. The facility matures August 3, 2016, is secured by substantially all of the operating subsidiary’s assets, and the company was in compliance with its covenants.
- Total assets were $929.4 million and total liabilities were $430.0 million at August 3, 2013. Stockholders’ equity was $499.4 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth remained strong, supported by comparable-store sales, expanded product categories, and increased direct-channel activity.
- Gross margin declined 260 basis points in the quarter and 180 basis points for the six months. Management attributed the decline to strategic pricing on new products, product mix, promotional timing, and higher freight costs associated with a greater furniture mix.
- SG&A increased substantially and included $60.7 million of quarterly stock-based compensation, including a $33.7 million one-time charge for a fully vested option granted to Gary Friedman and a $26.1 million charge related to performance-based shares. Six-month stock-based compensation was $64.3 million.
- Follow-on offering costs were $2.1 million in the quarter and $2.9 million for the six months. The offerings were sales by existing stockholders, so RH received no proceeds.
- Operating and GAAP net income changed from profits in the prior-year periods to losses in 2013, principally because of non-cash compensation and offering-related costs.
- Operating cash flow improved despite the net loss, primarily because of non-cash compensation and increases in accounts payable and accrued expenses.
Guidance, Outlook, Commentary, and Risks
- Management expected operating cash flow and revolving-line availability to meet working-capital requirements, planned capital expenditures, and debt payments for at least the next 12 to 24 months.
- RH planned to continue expanding Full Line Design Galleries, investing in infrastructure, adding product categories, and exploring complementary businesses. The filing identifies RH Kitchen as planned for 2014 and discusses other potential extensions.
- RH planned to eliminate the Fall 2013 Source Book and mail an annual edition each spring, relying more heavily on digital and electronic marketing. Management cautioned that customer response to this change was uncertain.
- Gary Friedman was reappointed Chairman and Co-Chief Executive Officer on July 2, 2013 after previously resigning in October 2012 following a special committee investigation. The filing identifies possible reputational, management, litigation, and transition risks.
- Major risks include sensitivity to consumer spending and housing conditions, inventory and markdown exposure, dependence on foreign vendors and imports, freight and commodity costs, execution of store expansion, liquidity requirements, variable-rate debt, distribution disruptions, information-security and PCI compliance issues, litigation, tax-rate volatility, and potential impairment of goodwill and long-lived assets.
- The company recorded $10.1 million of build-to-suit assets and related obligations for two future Full Line Design Gallery locations. The filing states there were no material off-balance-sheet arrangements.
- A proposed lease-accounting standard could materially affect RH’s future balance sheet and financial statements, although the filing states that the impact could not yet be determined.
Most Important Facts for Investors to Verify
- Whether strong comparable-store and direct-channel growth can continue after the planned reduction in Source Book circulation.
- Whether gross-margin pressure from pricing, mix, promotions, and freight costs persists as the furniture business expands.
- The recurring versus non-recurring components of SG&A and stock-based compensation, including the Friedman-related charges.
- Inventory growth, backorders, markdown exposure, and cash conversion as the company funds seasonal demand.
- Availability and borrowing-base limitations under the revolving credit facility, including the impact of outstanding letters of credit.
- Execution, cost, and returns from Full Line Design Galleries, infrastructure investments, and new product or complementary-business initiatives.
- Governance, related-party, litigation, and reputational implications of Gary Friedman’s reappointment and the acquisition of Hierarchy.
- Potential effects of future lease-accounting changes, tax-rate fluctuations, and any impairment or contingency charges.