Restoration Hardware 2012 Annual Report Download - page 110

Net Revenues. Net revenues reflect our sale of merchandise plus shipping and handling revenue collected from
our customers, less returns and discounts. Revenues are recognized upon receipt of product by our customers.
Gross Profit. Gross profit is equal to our net revenues less cost of goods sold. Gross profit as a percentage of
our net revenues is referred to as gross margin. Cost of goods sold include the direct cost of purchased merchandise;
inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and
lower of cost or market reserves; inbound freight; all freight costs to get merchandise to our stores; design, buying
and allocation costs; occupancy costs related to store operations, such as rent and common area maintenance;
depreciation and amortization of leasehold improvements, equipment and other assets in our stores and distribution
centers; and all logistics costs associated with shipping product to our customers, which are only partially offset by
shipping income collected from customers. We expect gross profit to increase to the extent that we successfully
grow our net revenues and leverage the fixed portion of cost of goods sold.
Our gross profit can be favorably impacted by sales volume increases, as occupancy and certain other costs
that are largely fixed do not necessarily increase proportionally with volume increases. Changes in the mix of our
products may also impact our gross profit. We review our inventory levels on an ongoing basis in order to
identify slow-moving merchandise and use product markdowns and our outlet stores to efficiently sell these
products. The timing and level of markdowns are driven primarily by customer acceptance of our merchandise.
The primary drivers of the costs of individual goods are raw materials costs, which fluctuate based on a number
of factors beyond our control, including commodity prices, changes in supply and demand, general economic
conditions, competition, import duties, tariffs and government regulation, logistics costs (which may increase in
the event of, for example, expansions of or interruptions in the operation of our distribution centers, furniture
home delivery hubs and customer service center or damage or interruption to our information systems) and labor
costs in the countries where we source our merchandise. We place orders with merchandise vendors primarily in
United States dollars and, as a result, are not exposed to significant foreign currency exchange risk.
Our gross profit may not be comparable to other specialty retailers, as some companies may not include all
or a portion of the costs related to their distribution network and store occupancy in calculating gross profit as we
and many other retailers do, but instead may include them in selling, general and administrative expenses.
Selling, General and Administrative Expenses. Selling, general and administrative expenses include all
operating costs not included in cost of goods sold. These expenses include all payroll and payroll-related
expenses, store expenses other than occupancy and expenses related to many of our operations at our
headquarters, including utilities, depreciation and amortization, credit card fees and marketing expense, which
primarily includes catalog production, mailing and print advertising costs. All store pre-opening costs are
included in selling, general and administrative expenses and are expensed as incurred. Selling, general and
administrative expenses as a percentage of net revenues is usually higher in lower-volume quarters and lower in
higher-volume quarters because a significant portion of the costs are relatively fixed.
Our recent revenue growth has been accompanied by increased selling, general and administrative expenses.
The most significant components of these increases are marketing and payroll costs. We expect these expenses to
continue to increase as we continue to open new stores, develop new product categories and otherwise grow our
business.
Adjusted EBITDA and Adjusted Net Income. We believe that adjusted EBITDA and adjusted net income are
useful measures of operating performance, as the adjustments eliminate non-recurring and other items that are
not reflective of underlying business performance, facilitate a comparison of our operating performance on a
consistent basis from period-to-period and provide for a more complete understanding of factors and trends
affecting our business. We also use adjusted EBITDA as one of the primary methods for planning and
forecasting overall expected performance and for evaluating on a quarterly and annual basis actual results against
such expectations, and as the basis of our MIP.
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