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Restoration Hardware Beats Views, But Costs Disappoint

Restoration Hardware furnished Wall Street late Tuesday with better-than-expected second-quarter results and raised guidance. But shares retreated as the upscale retailer booked a loss for stock awards to Chairman and co-CEO Gary Friedman.

Adjusted earnings jumped 48% vs. a year earlier to 49 cents a share, 6 cents above Wall Street estimates. Revenue rose 30% to $382 million, $17 million ahead of analysts' consensus. Same-store sales grew 26%.

Operating income grew 56% to $34.2 million, excluding charges and costs related to follow-on offerings in July in the aftermath of Restoration Hardware's (RH) return to the public market in November. But including those costs and charges, the upscale home furnishings firm had a $27.8 million operating loss.

The gross profit margin fell to 36.4% from 39% a year earlier as overhead expenses jumped 77%.

Restoration Hardware fell 4% in after-hours trading. The stock slid 1% during the regular session after briefly hitting a record high intraday.

Galleries Vs. Catalog

To cut costs, Restoration Hardware would drop its fall 2013 catalog mailings in favor of an annual mailing in the spring, Friedman said.

The change would allow the firm to reach "double-digit operating margins and free cash flow positive significantly ahead of our prior expectations," he said. It's part of Restoration Hardware's new strategy of opening larger full-line design galleries to showcase its ever-growing clutch of products and its planned entry into kitchen and tablewares, apparel, footwear and accessories.

The company sees Q3 adjusted EPS of 27-29 cents vs. views of 16 cents. Its Q4 forecast was largely in line with analyst forecasts.

"It was a great quarter and the outlook continues to get better," said Jefferies & Co. analyst John Marrin. "The fact that they are looking at double-digit operating margins in the near future definitely is an incremental positive.

Full-line design galleries are driving strong results in the handful of markets where they have opened, co-CEO Carlos Alberini stated. Los Angeles and Houston delivered comparable sales in excess of 29% in Q2.

New locations in Scottsdale, Ariz., Boston and Indianapolis continue to perform ahead of expectations, he added. Negotiations are under way for stores in more than 30 other locations.

More Room, More Sales

Management has said that products sold in retail stores enjoy sales up to 150% higher than if they were only sold in catalogs and on the website.

Lack of space has confined most of the furniture to catalogs and the website. Store openings are expected to rev up strongly starting in 2015.

Piper Jaffray analyst Neely Tamminga raised her estimates for fiscal 2015 "and beyond" to reflect the larger-format store openings.

At the end of Q2, Restoration Hardware operated 70 stores, including five larger full-line design galleries and three Baby & Child stores, plus 17 outlets.

Friedman returned to his dual posts as chairman and co-CEO during the quarter. He had resigned before the November public offering to avoid any frictions that might crop up from an internal inquiry into his relationship with a female employee. But he continued to work as "creator" and "curator.

Friedman joined Restoration Hardware in 2001 from Williams-Sonoma (WSM) and is widely credited with saving the retailer from bankruptcy. He took the firm private in 2008 as it struggled during the recession.

Investors had warmed to Restoration Hardware's return to the market. At Tuesday's market close, the stock was up 217% from its November IPO price of 24.

Some analysts theorized that higher interest rates could curb demand for housing and thus home furnishings.

Fresh merchandise in the stores accounted for a lot of investor interest recently, said Dan Veru, chief investment officer at Palisade Capital Management, in an interview last month. Palisade owns shares in the company.

"This was a great turnaround story," he said.

But profits, though improving, have been mixed as expenses have increased. And EBIT margins have been lower than those typically posted by home furnishings companies, analysts have pointed out.

"We're waiting for them to show the earnings power of the business," Veru said.

Rival's Outlook Weak Williams-Sonoma on Aug. 28 reported strong second-quarter results on both the top and bottom lines. But shares fell more than 4% that day after it reported a lower gross margin and weak sales trends for the back half of the year.

The company's Pottery Barn brand, which is the most comparable to Restoration Hardware but with lower price points, saw same-store sales rise nearly 10% in Q2 — well below Restoration's.

The namesake Williams-Sonoma kitchen and housewares brand posted a slight dip in same-store sales and more store closings are expected.