Restoration Hardware Transition Produces Bumpy Q3

Restoration Hardware’s continued retooling of its business model produced a challenging third quarter, and the retailer lowered its fourth quarter outlook.

For the third quarter ended October 29, Restoration Hardware posted net income of $2.5 million, or six cents per diluted share, versus $20.7 million, or 49 cents per diluted share, in the year-earlier quarter. Adjusted net income was $8 million, or 20 cents per diluted share, versus $27.7 million, or 65 cents per diluted share, in the quarter a year prior. Despite the lower figure, RH beat an analyst average estimate of 16 cents per adjusted diluted share published by MarketBeat.

Net revenue was $549.3 million versus $532.4 million in the year-previous quarter but comparable sales fell 6%. Store revenues increased 9% to $306.8 million in the quarter year over year while direct revenue, including online sales, decreased 3% to $242.5 million. Store revenue was 56% of the total versus 53% in the quarter a year earlier.

Gary Friedman, RH chairman and CEO said, “Third quarter fiscal 2016 net revenues of $549 million and adjusted EPS of 20 cents were ahead of our guidance for the quarter. Net revenues were driven by a higher conversion of orders into sales than expected given our strong in stock levels and supply chain improvements. In addition, our margins continued to be negatively impacted by many of the temporal factors impacting our fiscal 2016 earnings in addition to one-time costs associated with the remodel and refresh of our legacy galleries during the quarter.”

Friedman noted that strategic investments and a change in the company’s business model, as its shifts from promotional to membership-based selling, are depressing short-term financial results but would strengthen the RH brand and market position. RH expects the result to be “accelerated growth in 2017 and beyond,” Friedman said. “These temporal issues include the costs related to the launch of RH Modern, the timing of recognizing membership revenues related to the transition from a promotional to a membership model, efforts to reduce inventories and rationalize our SKU count, and the decision to push our 2016 Source Book mailing from the spring to the fall.”

Still, the company lowered its fourth quarter outlook for fiscal 2016 net revenues and adjusted EPS based on trends early in the period.

“First, our business in November was below our expectations, which we largely attribute to consumer softness related to the U.S. election and our fall 2016 Source Books getting in homes later than planned,” Friedman said. “While our source books began mailing in mid-September, the vast majority of the circulation is just getting in homes over the last few weeks versus our original expectations for the books to be building earlier in the mailing cycle. This is resulting in a shift of sales that would have been booked in the fourth quarter into the first quarter of next year. In addition, sales of our holiday collection are trending lower than our expectations. We are taking a more aggressive approach to clear seasonal merchandise as well as taking deeper markdowns to accelerate our overall SKU rationalization efforts which are expected to result in lower product margins during the quarter.”

Friedman added, “While we are clearly disappointed in our fourth quarter outlook, we believe we are making the necessary investments and changes to position our business for the long-term. As we look forward to fiscal 2017, we expect to anniversary the costs related to the launch of RH Modern, benefit from the deferral of membership revenue, plus capture additional revenue from new members and renewals, cycle our efforts to reduce inventories and rationalize our SKU count, and expect revenues to build from the mailing of our source books. We also expect incremental revenues from the four new design galleries opened in 2016, and the six new design galleries opening in 2017. As we cycle these investments and changes, we expect sales to reaccelerate, operating margins to expand, and to generate free cash flow in 2017.”