RH Form 10-Q Summary
Business context and reporting period
Restoration Hardware Holdings, Inc. filed this unaudited Form 10-Q for the quarter ended October 27, 2012. The filing reports Restoration Hardware, Inc.’s historical consolidated results because the holding company completed its reorganization and initial public offering after the reporting date. The three- and nine-month periods comprised 13 and 39 weeks, respectively.
RH operated 73 retail stores and 12 outlet stores across the United States and Canada, with sales through stores, catalogs and websites. The company sells luxury home furnishings, including furniture, lighting, textiles, bathware, decor, outdoor, garden, and baby and child products.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net revenue | $284.2 million | $232.5 million | $795.0 million | $652.8 million |
| Revenue growth | 22.2% | — | 21.8% | — |
| Gross profit | $101.9 million | $84.4 million | $291.3 million | $238.8 million |
| Gross margin | 35.9% | 36.3% | 36.6% | 36.6% |
| Operating income (loss) | $2.0 million | $(4.1) million | $19.6 million | $(0.1) million |
| Net income (loss) | $1.7 million | $(4.8) million | $15.6 million | $(3.5) million |
| Adjusted EBITDA | $13.0 million | $11.1 million | $47.9 million | $38.8 million |
Q3 net income margin was 0.6%, versus a 2.1% loss margin in the prior-year quarter. Nine-month net income margin was 2.0%, versus a 0.5% loss margin. Comparable store sales increased 29% in both the quarter and nine-month period. Direct revenue increased 24.4% in the quarter and 24.7% year to date; store revenue increased 20.6% and 19.4%, respectively.
As of October 27, 2012, cash and cash equivalents were $15.6 million, merchandise inventories were $333.8 million, total assets were $742.2 million, and total liabilities were $475.0 million. Debt included $172.7 million outstanding under the revolving line of credit and $14.8 million under the term loan. Revolving availability was $122.7 million, with $22.8 million of outstanding letters of credit. The company was in compliance with its debt covenants.
For the first nine months, operating activities used $20.0 million of cash, investing activities used $25.9 million, and financing activities provided $53.0 million. Capital expenditures were $25.6 million, against planned full-year capital expenditures of approximately $52 million.
Material changes versus the prior comparable period
- Revenue rose 22.2% in Q3 and 21.8% for the first nine months, despite having fewer retail stores than in the prior-year periods.
- Gross margin declined 40 basis points in Q3 but was unchanged year to date. Product mix, promotional activity and higher furniture-related freight costs pressured margin, while occupancy leverage partially offset the pressure.
- Operating results improved substantially, with Q3 operating income of $2.0 million compared with a $4.1 million loss and nine-month operating income of $19.6 million compared with a nominal prior-year loss.
- SG&A increased 12.9% in Q3 and 13.7% year to date. Higher catalog and marketing costs, personnel, credit-card fees, occupancy costs, and legal and professional fees were key drivers.
- Cash used in operations improved from $48.3 million to $20.0 million, although inventory increased $87.9 million in preparation for the holiday season and prepaid expenses increased $35.2 million, primarily for catalog costs.
- The company changed its stock-based compensation recognition method for service-only awards from the graded method to the straight-line method and retrospectively restated prior periods. The change did not affect cash flows.
Guidance, outlook, risks and unusual items
Management stated that operating cash flow and available revolving credit were expected to fund working capital, planned capital expenditures and debt payments for at least the next 12 to 24 months. The filing does not provide formal revenue or earnings guidance.
On November 7, 2012, RH completed its IPO at $24.00 per share. The issuer received approximately $97.1 million of net proceeds after underwriting discounts and estimated offering expenses. The proceeds were used in part to repay $75.1 million of revolving debt and the $15.0 million term loan in full. The revolving facility was increased by $100 million on November 1, 2012.
The reorganization is expected to generate substantial non-cash compensation charges, including approximately $40 million for the equity replacement plan and approximately $53 million for option grants. Additional fourth-quarter charges of approximately $13 million and $8 million were expected for performance-based awards. These charges were not reflected in the October 27, 2012 balance sheet.
Q3 included $2.8 million of legal and professional fees related to a special committee investigation concerning former Chairman and Co-Chief Executive Officer Gary Friedman. Friedman resigned those roles effective October 20, 2012 and entered into a five-year advisory agreement. The company also disclosed related-party arrangements involving Home Holdings and Hierarchy, an entity controlled by Friedman.
Key risks include seasonal working-capital requirements, inventory and catalog spending, dependence on revolving credit, variable interest rates, promotional and product-mix pressure on margins, execution of store and infrastructure investments, legal and tax contingencies, and significant stock-based compensation. Management reported no material off-balance-sheet arrangements and no pending litigation expected to have a material adverse effect.
Important facts for investors to verify
- Confirm the post-IPO capital structure, share count, dilution from replacement-plan awards and options, and the effect of the approximately $40 million and $53 million non-cash compensation charges.
- Reconcile IPO proceeds, offering costs, debt repayments and the company’s post-IPO cash and revolving-credit balance.
- Assess whether inventory growth, catalog investment and seasonal borrowing translated into fourth-quarter sales and cash generation.
- Monitor gross-margin trends, especially promotional activity, furniture mix, freight costs and occupancy leverage.
- Review related-party arrangements with former executive Gary Friedman, Home Holdings, Hierarchy and the former sponsors.
- Evaluate the company’s tax valuation allowance, unrecognized tax benefits and the potential impact of future taxable income.
- Note that the request metadata identifies “2011 Q3,” but the filing text clearly covers the quarter ended October 27, 2012 and compares it with October 29, 2011.