RH Report for Student Managed Investment Fund by USFMuma

RH RESTORATION HARDWARE

By Jonathan De Jesus, Julio Escalona and Aaron Mederos

Buy Recommendation Price

2018 Target

$87

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

$160

Value

$111

Cap.

$3.5b

Beta

.80

Description Restoration Hardware is a luxury home furnishing retailer that intends to offer the finest and most desirable designs at unmatched value. Its expanding merchandise offerings include: furniture, lighting, textiles, bathware, décor, and outdoor and garden. RH displays this home furnishing merchandise in its stand-alone galleries and sells directly through catalogs that it calls source books.

Performance

Key Statistics $Bln ex. EPS

13’

14’E

18’E

Sales

1.55

1.86

4.1

EPS (Non Adj.)

.45

2.36

7.6

1 yr Date: January 23, 2015

70%

Ann. Growth % Sales

S&P 500

50% 30%

Ratios Forward PE

EBIT %

3.2

ROE

ROA

Catalysts  RH continues to steal market share  Increasing economies of scale  Success of real estate transformation  Broadening of product offerings & lifestyle brand  Housing market improvement  Continued home improvement and renovation cycle

Risks  High comparison against prior growth  Market Expectations/ Valuations  Economic slowdown  Lower square footage growth  Changing consumer preferences  Loss of key personnel

10% -10%

Investment Thesis Brand Transformation RH has the ability to scale its unique lifestyle brand via expanding product offerings, growing square footage, and continuing superior sales growth. We see this allowing RH to propel its market share gains and market beating shareholder returns over our three to five year investment horizon. Strong competitive advantage From a competition perspective, RH’s combination of quality and display of merchandise, storefront appeal, and transforming economies of scale is unparalleled by any brand in its industry. Favorable Macro & Industry Environment Top-down tailwinds from the strength of the luxury consumer and the positive trend in housing and remodeling. The fragmented, stale, and inefficient industry environment in the retail home furnishing and interior design wholesale business create great opportunities as RH disrupts each of these models with a fresh shopping experience, economies of scale, and transparent pricing. Strategic Execution RH’s strategic focus, ambitious brand vision, burgeoning economies of scale, and impeccable record of executing its growth strategies make RH’s growth sustainable and these value creation goals feasible.

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Transformative Growth Model

Atlanta, Georgia: Buckhead

The Concept RH’s main retail locations are not stores; they are galleries. The gallery concept includes an architecture, interior design, and display that mimics sophisticated lifestyle settings. This concept, allows the customer to visualize and experience the assortment as it would be in a home by not including tags, barcodes, or cash registers. The concept offers the shopper an unparalleled experience and incentivizes higher average order values. With this experience, RH is capable of drawing in customers and enticing purchases in a manner that we don’t see anywhere else in the industry. This is supported by RH’s well above industry 30% sales growth. The Real Estate Transformation & Sales Growth Equation RH is in the process of fazing out its 7,400 square feet legacy galleries and replacing them with next generation 25,00060,000 square feet Full Line Design Galleries (FLDGs). RH’s plans for consolidation and assortment growth in its FLDGs will allow the firm to unlock significantly more value from its renowned brand.

Demand Surge Demand Growth

Stores

Direct

Los Angeles

90%

30%

Houston

60%

45%

Scottsdale

80%

75%

Unlocking RH’s Potential The key to RH’s growth is that it is just beginning to unlock value from its new, broader merchandise assortment while repositioning itself as a lifestyle brand that goes beyond home furnishings. RH will accomplish this by building its FLDGs that will accommodate its new collections and consolidate its smaller legacy stores. This leads us to a steady total store count with rapidly rising square footage. So far, RH has opened 7 FLDGs and management believes it has the potential for 60-70 FLDGs in North America. Four will open in 2015, and 25 more locations are in the development pipeline. In 2013 it experienced over $2000 sales per square foot in some markets and surpassed its initial goal of $850 sale per sq. ft. Its first three FLDGs opened in 2011 and 2012. Store and direct demand in the first year of operation increased in each market dramatically (Table: Demand Surge). Management is currently targeting 25,000-60,000 selling square ft. for its FLDGs. We expect square footage to double by Q2 OF 2017 and see revenues doubling by 2018. By 2018, we expect selling square footage to average 32,000 at its FLDGs. We expect sales per sq. ft. of 1224 by 2018 (Square-Footage Model Appendix) Design Galleries

Legacy Stores

Selling Sq. Foot

Annualized Sales Per Sell Sq Foot

1,800

100

1,600

1,400

1,200

70 60

1,000

50 800

600

400

200

10 0

2 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Growth Strategy: Store Transformation RH’s plans for consolidation and assortment growth in its new store concepts will allow the firm to unlock significantly more value from its renowned brand. We expect the process to be one of progress and diversion as management navigates its experimental growth.

Total Merchandise

As RH consolidates, RH will concentrate on markets with more productive stores by closing smaller stores that carry a fraction of RH merchandise and do not express its full brand potential. Less than 20% of RH’s merchandise is currently in stores, and lack the impressive shopping experience that the next generation stores will exhibit. The introduction of it new store concepts in Houston, New York, L.A., Boston, and Atlanta has facilitated higher productivity per store and further introductions will allow RH to leverage its scalable supply chain infrastructure and fixed leases. We expect this will enable RH to significantly increase operating margins beyond its expected FY 2014 9%. The FLDGs will also accommodate extensions of the RH brand by supporting offerings like wine bars, cafes, floral boutiques, valet parking, and outdoor spaces that exhibit RH’s outdoor collection.

In Legacy Stores <20% of Collection

Gross Margin Expansion Investments in its distribution network, updated software, economies of scale effects in its FLDGs, and product mix will lead to 200bps of gross margin expansion by 2018. On its growth path, RH has helped scale its artisan suppliers, which otherwise produced niche one-of-akind pieces. As its supplier and distribution network have grown and continue to grow, RH benefits from greater efficiencies and lower costs of goods sold. In addition, while RH continues to reposition its brand, we believe this is a unique opportunity for RH to embrace its same artisan supplier sourcing strategy with offerings such as apparel and contemporary art. It will also offer hospitality services in some of its new FLDGs. Management has communicated its intention to pursue these offerings, and we believe success in these categories is achievable. The combination of mix and distribution and store economies of scale will drive 200bps of gross margin improvement over the next 4 years.

Gross Margin, RHS 58%

42%

55%

40%

53%

38%

50%

36%

48%

34%

45%

32% 2011 2012 2013 2014 2015 2016 2017 2018

Operating Margin, RHS SG&A % of Sales, LHS

Operating Margin Expansion We expect fixed SG&A costs and the advertising benefit of the FLDGs to contribute an additional 200 bps to operating margins. RH’s dominating presence in high-end shopping districts with its FLDG’s will provide brand recognition to more and more communities as more open throughout the next 4 years. In markets where FLDG’s open, direct and store sales see significant demand boosts and the construction and display of the stores become the “talk of the town.” This form of advertisement will drive SG&A leverage. In addition, fixed cost structures for management pay will also contribute to the additional 200 bps to operating margins from SG&A leverage.

Furniture, LHS

34%

14% 12%

32% 10% 30%

8% 6%

28%

4% 26% 2%

In total, we expect 13% operating margins by 2018. Along with revenue growth from its square footage expansion this will lead to significant earnings power and over $7 in earnings per share.

24%

0% 2013

By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

2014

2015

2016

2017

2018

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Business Description In a continually evolving landscape of consumer preferences and design trends, RH attempts to curate and sell luxury products that are authentic, distinct, and fashionably relevant. RH distributes its product assortment through an integrated sales venue of stores, catalogs, and websites. Roughly half of the company’s sales come from each direct (catalogues, online) and store sales channels. RH operates over 60 retail locations throughout North America which are situated in prominent, high-profile shopping centers and street locations. RH displays its lines of products in a highly differentiated format and an aesthetic that resembles a first-rate interior designer setting. In addition to its physical locations, RH sends out catalogues of its offerings in each of its expanding categories: interiors, small spaces, outdoor, baby & child, upholstery, leather, furniture, and rugs. Merchandise Development RH’s product development team operates within a platform that provides fast scalability and integration from the start of an idea to a product display. Its internal team collaborates with a global network of third-party vendors and manufacturers that provide originals and reinterpretations of classic designs on a large scale. According to the latest 10k, this developing, scaling, and sourcing process results in average lead times of three to nine months. This represents an improvement from over year long lead times several years ago and enables more efficient management and a reduction in cost of goods sold. Sourcing, Distribution & Delivery To ensure quality, RH inspects pre-production samples, visits production facilities, and inspects shipments arriving at its distribution centers. Its supplier base is diversified, with 75% of its shipments, by dollar volume, sourcing from 33 vendors, with one vendor accounting for 13% of shipments. By dollar volume, 69% of shipments come from Asia (mostly China), 26% from the U.S. and the rest from other regions. RH transacts with suppliers on an order by order basis but tends to develop long-term relationships leading many to invest in greater capacity to meet RH’s growing demand. It intends to continue its sourcing initiatives that aim to increase efficiencies, improve the product development process, and lower costs.

Product Line Segments

Nonfurniture 44%

Furniture 56%

Sales Channel

Direct 47% Store 53%

Catalogue deliveries and website visits for 2013 totaled 12.3 million and 22.2 million respectively.

4 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Current Concepts

Business Description Organization Product/merchandise development teams integrate with a sourcing, merchandising, inventory, and creative team system that focuses on optimizing sales in each sales channel. We credit this integrative approach with a cohesive strategy that reduces the cannibalization effect of multiple channel operations. We expect this process to facilitate operating margin expansion as RH increases its offerings and store scale, while leveraging its cost base associated with its organizational structure.

Outlet Stores Baby & Child Galleries Full Line Design Galleries Galleries

Distribution/ Supply Chain RH manages the distribution and delivery of its goods with nine different centers across the US in Ohio, California(2), Maryland (2), Texas(2), New Jersey, and Florida. RH offers home delivery services of fully assembled items, and regions outside of these distribution hubs are outsourced to third-party vendors. Over the last seven years, RH expanded and improved its distribution infrastructure to support its future growth, improve cost effectiveness, and enhance customer service and will continue to do so. Source Books RH’s catalogs are called source books and are a primary means of branding as well as advertising, facilitating RH’s display of its total offerings. Control over production costs and brand representation is maintained by an in-house team that is in charge of the creative work in the source books. Catalogs are mailed to customers in RH’s database as well as to addresses obtained from third parties. Source book mailings and page counts were increased coming into 2014 as RH tested new expanded assortment offerings and laid the groundwork for successful growth with its FLDGs. As more FLDGs become operational, we expect RH’s reliance on source books to present its vast product assortment to diminish. Catalog and Store Sales Channel Synergies and Optimizations As more consumers view more RH catalogues and galleries, sales in each channel grow and consumer wants are better understood. Customers can order from the catalogue, online, or the stores. The benefit of combining direct sales via cataloguing and store sales results from introducing broader offerings in catalogs before stocking a physical location. In doing so, RH gauges the demand outlook by the popularity of catalog orders and optimizes its store productivity. Less than 20% of RH products are represented in the physical stores; however, in-store associates give customers access to RH’s total collection by carrying Ipads used to assist ordering. With a customer database of over 15 million, RH is able to analyze buying behavior across multiple sales channels and increase the productivity of its marketing and store assortment strategies.

Store Locations Ontario British Columbia Alberta District of… Washington Virginia Utah Texas Tennessee Rhode Island Pennsylvania Oregon Oklahoma Ohio North Carolina New York New Jersey Missouri Minnesota Michigan Massachusetts Maryland Louisiana Indiana Illinois Georgia Florida Connecticut Colorado California Arizona Alabama

By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

15 5

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Luxury Furniture Spending Model We model luxury furniture spending for the average top 50 potential markets in the U.S. Model factors include: average population, average percentage of year-round workers with earnings of $100,000 or more, and a normalized calculation for furniture spending in a typical market in the top 50 ranked markets in each of these factor categories. While expanding, RH will focus on opening its FLDGs in cities with strong demand potential. Our model indicates that the average top 50 markets in the U.S. provide a sizable market for RH’s luxury offerings and aligns with our projection of 49 FLDGs by 2018. Based on the combination of product style and quality, storefront size and appeal, and RH’s continued repositioning as a lifestyle brand for the high-end and aspirational consumer, we expect RH to capture the majority of these markets over then next 5-10 years.

Sensitivity Average Annual Furniture Spending in Each Top 50 Market, Mln Average Spending Per Person 831 1,031 1,231 1,431 1,631 % of 7,631 9,112 10,592 12,072 15% 6,151 Population 8,880 10,603 12,325 14,048 18% 7,158 Earning 8,164 10,129 14,059 16,024 12,094 20% Atleast 9,171 11,378 13,585 15,792 18,000 $100,000 23% 12,627 15,077 17,526 19,975 25% 10,178

Projected Share We project furniture spending in these 50 markets out till 2019 starting with our 2015 base case number. To project the growth in Total spending we use the Federal Reserve’s projected growth of Nominal Gross Domestic Product (NGDP). By 2018, we expect RH to grow its market share from 19% to 30% of our bottom-up addressable market in the top 50 locations for furniture spending.

50 Markets Furniture Spending, Mln 2015

2017

2018

2019

$12,094 $12,599 $13,125 $13,674 $14,245

Total RH Sales Share

$2,249 $2,884 $3,553 $4,082 $4,700 19% 23% 27% 30% 33% NGDP Growth 4.18%

Furniture Spending Market Since the mid 2000s, furnishing store sales as a percent of consumption have fallen. There is a strong correlation between homeownership rates, labor force participation, and rental vacancies (inverses) and furniture store sales as a percent of consumption (Economy appendix). While these secular trends, along with potentially other factors, have shifted the composition of the consumer basket, we still see growth in the home furnishing market and the high-end market as our furniture-spending-market model indicates..

2016

Homeownership Rate, NSA, LHS Furnishings Stores, SA. % of PCE Durable Goods, LHS 71%

0.85%

70% 69% 68%

0.80%

0.75%

67% 66% 65%

0.70%

0.65%

64% 63% 2003 2004 2005 2006 2007 2008 2010 2011 2012 2013

By Jonnathan De Jesus, Julio Escalona, and Aaron Mederos

0.60%

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Macro Analysis Remodeling According to the National Association of Homebuilders surveys, remodeling activity and planned activity across the country are accelerating to the upside along with consumer confidence. RH will benefit from increased remodeling and renovating activity. The graph to the right indicates that the strongest market is in the West where RH has its strongest presence. A positive remodeling environment will further demand for its hardware and home furnishing products and services in the midst of its FLDG openings, while reinforcing the market opportunities ahead for RH. Northeast

NAHB Economics Group: Remodeling Market Index, LHS US Consumer Confidence, OECD, RHS

National 101

Midwest

100

South

60 55

Remodeling Index

West

97 45

Housing We view 2014 as a generally weak year for housing activity and see 2015 as a marginally better year as comparisons against 2014 become much easier to beat. In addition, we see positive trends in google searches for terms like “realtor” and “real-estate agent” that correlate with home sales and indicate interest. The bottom right chart shows a weakening in the mean home sales price, which tracks well with furniture sales, we again view this as a easy comparison in 2015 and expect upside as housing has a low point in 2014 of a cycle within a longer cycle. Additional pertinent charts displayed in Economy Appendix. Mean Sales Price of Exisiting Homes, NSA Home Furnishings Stores, SA 7,500 7,000

6,500

6,000

5,500

5,000

10% 5% 0%

-5% 4,500

4,000

40 30 2004

15%

YoY

100

Thousands

Google Searches: Realtor, 1mma, LHS Existing Home Sales

2006

2008

2010

2012

2014

-10%

3,500

-15%

3,000

-20%

2001 2003 2004 2006 2008 2010 2011 2013 7

By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Differentiating Shopping Experience/Brand in Fragmented Industry

8 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Market Disruptor and Differentiated Brand in Fragmented Market

RH “Everything here feels like it’s one of a kind.” -Victoria Jones, Veranda Magazine

“The key to Gary’s (CEO Gary Friedman) success is the fact that he is always on trend.” Glenda Bailey Editor-in-Chief, Harper’s Bazaar

Wholesaler Disruption RH’s interior-design quality goods allows it to sustain a level of pricing power over its competitors in the traditional retail space, while offering lower priced furnishings than comparable quality offerings from the wholesale interiordesign and design-district market. Its competitors include homes goods retailers and the interior design wholesalers. By offering a myriad of categories under one roof and utilizing its significant distribution network, RH is able to disrupt the wholesaler market, led by design districts and their interior designer intermediaries, by offering interior design level styles. Simultaneously, it differentiates itself from its traditional retailer competitors by offering a more stylish and higher quality product that was once only available to those willing to pay for interior designer

Retail Differentiation RH markets to a range of customers starting in the upper-middle class with household income above $200,000. The company’s most direct competitors are Williams Sonoma and Ethan Allen, both companies cater to the upper-middle class customer and the high-end luxury furniture market. In the current market where retailers are struggling to find ways to bring more people into their stores, RH’s proposition of “Design Galleries” with amenities such as wine bars, restaurants, performance spaces, courtyards, rooftop gardens and free valet parking will position RH at the forefront of the luxury home furnishing industry.

Supplier Bargaining Power RH achieves a significant amount of power over its suppliers as it relies on a large number of manufacturers. This allows RH to dissipate supplier power over many firms. The company’s suppliers establish close relationships with RH, which allows its products to reach the American luxury market and this makes them dependent on RH’s terms and growth strategy. 9 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Gary Friedman, CEO and Chairman Mr. Friedman has over forty years of retail experience having held management positions at The Gap, Williams-Sonoma, and Potter Barn. Mr. Friedman immediately excelled in the retail environment leading him to become The Gap’s youngest store manager. At The Gap, upper management discovered Friedman’s enthusiasm and knack for creating impressive displays that attracted customers, a unique ability that he currently brings to RH. At 29, Friedman joined Williams-Sonoma, and over the course of 13 years was instrumental in transforming the home furnishing goods company from a $300 million to an over $2 billion company. He served as President and COO from May 2000 to March 2001, as Chief Merchandising Officer and President of Retail Stores from 1995 to 2000 and as Executive Vice President and President of the Williams-Sonoma and Pottery Barn brands from 1993 to 1995. Shareholder 14% Owner

“Gary takes calculated risks and I wouldn’t bet against him.” – Mickey Drexler, Chairman & CEO of J. Crew, Director at Apple, and former CEO of The Gap

Friedman made many decisions that transformed Pottery Barn and Williams-Sonoma stores into great successes in the home furnishing business. At Williams-Sonoma (WSM) he put working kitchens, food halls, and tasting bars in the stores. At Pottery Barn he turned around an unprofitable retailer and created a rapidly growing lifestyle home furnishing company; transforming it from a $50 million to $1.2 billion business. The turnaround included offering a broad assortment of home furnishing products in much larger stores. His unique vision, creativity and risk taking were essential to this turnaround and represent common threads throughout his career. When an outsider was given the Sonoma CEO job, Friedman left with 11 WSM executives and without $50 million in WSM stock options. In 2001 he put his own money into Restoration Hardware and led the firm through a massive merchandising transition by bringing style to the stores. By 2007 he faced a housing crash and a suffering retail environment through which the firm went private. Through tough times, Friedman lead the firm to offer more luxurious goods at a time when most retailers were focused on discounts. These actions exemplified his phrase: “great brands don’t chase customers, customers chase great brands.” Friedman’s experience in the home goods market and impressive leadership abilities make him the ideal manager for the growth path RH is embarking on. (Rest of team on Management Appendix)

Famous fashion designers, interior designers, musicians, models, actors, and celebrities with influence over the styles of the day often attend RH events and furnish their homes with RH products. RH’s brand represents elite taste and democratized access through its expanding square footage and supply-chain network that provides the economies of scale to offer world-class style with greater degrees of affordability. Mila Jovovich

Kardashians

Ashton Kutcher

10 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Valuation FCFE/Target Price To value RH we use a blended free cash flow to equity and PE price-target model. We use a share price of 20 times our projected 2018 earnings as the terminal value for our intrinsic value calculation. Our 20x 2018 PE multiple was chosen based on the industry average. In choosing our terminal value, a price target method is most useful because we do not expect RH to grow at a typical stable growth rate within five years. All our assumptions in this model represent our most probable or base case scenario. Our projections of square footage, store counts, and sales per square feet and our analysis of RH’s addressable market determine our revenue projections. Then, our cost leverage, or margin, and balance sheet analysis determine our cash flows.

Hurdle Risk Free 2.12% Beta

1.25

MRP

6.0%

FCFE Net Income D&A Capex NWC FCFE FCFE/Sh

2014

2015

97 128 49 54 (120) (174) (110) (76) (83) (67) ($2.00) ($1.62)

2016

2017

2018 Termin 252 315 al Value 78 90 20x (217) (249) 2018

178 63 (194) (59) (82) (12) 32 ($0.29) $0.77

(61) 95 $2.30

EPS $160

Discount 9.62%

Intrinsic Value $111.36 $87.13 Price

28% % Undervalued

PE Target Sensitivity Analysis

Margin

2018 3.7

3.8

Sales ($ Billions) 3.9 4.1 4.3 $ Price

12.0% 12.5%

109 113

118

128

142

157

168

134

148

163

13.0%

118

123 128

154

13.5%

123

133

160

14.0% 14.5% 15.0%

127

138 143

139 145 150

166

170 177 183

175 182

155

172

148

161

132 136

4.4

4.5 180 188 195

189

203 210

190

196 203

178

196

210

218 225

PE Multiple 11 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Scenario Analysis We compliment our core model with bull and bear cases. Different scenarios are based on varying sales per selling square feet, average square footage of FLDGs, and legacy store sales per square foot (Legacy Productivity). (Greater detail on these scenarios are provided in the Square Footage Scenario Model Appendix.) These inputs in 2018 are listed in the table to the right. Management has consistently seen higher than expected sales per square feet. Its most recent target for FLDGs was $850, which was surpassed. Our base case assumes slightly below this target, reflecting increased square footage per store, and considering the outlook for sales growth at RH over the next four years, this assumption is warranted from a conservative perspective. The overall downside/upside ratio makes RH a necessary addition to the SMIF. While the RH growth strategy is not void of risk, its successful execution and above expectation execution offers very attractive returns and the strategy itself offers a favorable risk/reward profile.

Bull $130 49%

Base $111 28%

Bear $88 2%

FLDG Ave. Lease Selling Sq. Ft.

32 Thousands

906

830

761

FLDG Sales per Sq. Ft. Legacy Productivity Bull Base Bear 2,380 2,240 2,107 16% 15% 14% Annual Growth Terminal Value & Discount Rate Sensitivity 10.50%

Valuation Sensitivity

9.75%

9.00%

8.25% $124

$121

$117

$118

$113

$114

$110

$111

$107

$108

$104

Intrinsic Value

Investors may make different assumptions regarding the use of a discount rate. Our capital asset pricing model method uses the current riskfree rate, an academic equity-risk premium calculation, and a beta of 1.25 for a stock with a sub-1 beta. No materially creative assumptions are made in this calculation for our core model discount rate. Nevertheless, in the chart to the right we test our intrinsic value with an up to +200bps greater discount rate. Meanwhile, we test our terminal value projection, as well, with a range of $20. The result yields a favorable intrinsic value range, with the bottom of the range yielding a 15% undervaluation and the top of the range yielding 42% undervaluation.

$101

$150

$155

$160

$165

$170

2018 Terminal Value 3

PEG Ratio

2.5

Current Multiple While RH currently trades at a higher PE multiple than its industry and the broader market, on a growth adjusted basis, current multiple levels are more than reasonable. The chart to the right shows that on a PEG basis RH is undervalued relative to Williams Sonoma, Home Depot, and Nordstroms. RH sells similar merchandise to these companies but is in a much earlier stage of its development warranting a higher multiple.

LOW RH CMG By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

2 1.5 1 0.5 0 WSM

JWN

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Valuation Sensitivity P/E Model We also conducted a P/E contraction analysis, based on our most probable, or base, earnings scenarios, which indicate high teens to twenty percent annual returns over our investment horizon. Our P/E contraction method includes contracting the multiple at a faster pace over the next four years. P/E contraction is warranted based on current RH growth expectations, which to some degree reflect an expectation of RH “growing” into its multiple, but our analysis indicates RH’s value proposition and growth strategy is not fully appreciated.

P/E Contraction Model 2014 EPS

2015E 2016E 2017E 2018E

$2.36

$3.10

$4.32

$6.11

$7.63

P/Ex 36.88 Price $87 CAGR

32.82 $102 17%

28.88 $125 20%

25.13 $154 21%

21.61 $165 17%

P/S Model A price to sale sensitivity and scenario analysis indicates similar returns and a similar risk/reward outlook to our other models. In this P/S table we test our revenue projections as well as our multiple assumptions. Our P/S multiples are derived from industry comparatives, taking into consideration each firms growth, leverage, and return on equity.

Price to Sales Model 2017E Sales/Sh Variance P/S Price

Bear 77

Base 86

-10%

2018E Bull 95

Bear 89

10%

-10%

Base 99

Bull 109 10%

1.52 $118

1.60 $138

1.68 $159

1.52 $135

1.60 $158

1.68 $183

CAGR 11%

16%

22%

12%

16%

20%

Home Goods Retailers Tickers

P/S

WSM RH HD HVT ETH BBBY PIR LOW MFRM

1.59 1.92 1.81 0.77 1.04 1.19 0.58 1.29 1.37

% of Average P/S

127% 154% 145% 62% 83% 95% 46% 103% 110%

Q rtly Rev Growth (YoY)

9% 22% 5% 3% 2% 3% 4% 6% 42%

% of Average Rev. Growth

87% 224% 54% 30% 21% 27% 41% 56% 421%

By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

RO E

Debt/Equity

26% 13% 49% 10% 12% 27% 21% 22% 13%

8.09 61.96 165.45 12.62 34.66 47.03 69.12 105.84 179.76

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Risks Loss of key personnel. RH has a strong management team and if RH loses key personnel, it could be difficult for RH to sustain its ambitious growth strategy. RH has an exceptional business model and company culture and we expect this to allow RH to survive the loss of key personnel. Equity & housing market collapse. A collapse in the equity and housing market will not only affect RH but the worldwide economy. This type of economic decline is not firm specific and will affect all our portfolio positions. Having said this, we think that RH has a customer base that could sustain an economic decline better than the rest of the population, the company customer is in the upper-middle class and wealthier segment of the population and this segment tend to do better in an economic decline. Changing consumer preferences. Fashion is constantly evolving and with it so do consumer preferences. RH must continue to evolve and change its category offerings to meet its consumer’s needs. RH has shown that it is willing and capable of meeting this challenge. This is evident in its massive source books which detail all of RH’s current category offerings. We think that the company strategy and unique products would allow it to continue being at the forefront of all competitors and setting trends in the housing furniture industry. Lower square footage growth. Our, as well as other analyst, projections are dependent on RH meeting square footage growth expectations. A miss could negatively impact RH’s performance. We see RH’s strong management team enabling RH to meet expectations. High Sales Comparisons. 2015 sale will compare against the high growth (27% comparable brand sale growth) RH experienced in 2014. While this offers a difficult compare, we note that RH has consistently achieved 20%+ growth over the last 5 years. In addition, its upcoming Q4 compares against last years weak sales numbers amidst the polar vortex. Upward Shock in Interest Rates. RH has the ability to access a revolving credit line that prices off interest rate changes. A rising rate environment will effect its cost of funding growth if it needs to use its revolver. RH recently raised funds through a convertible debt offering at favorable terms and with a hedging strategy that diminished its cost of funding. In the intermediate-term we believe RH has the funds to sustain its growth. Rising rates may also jeopardize the housing market and big-ticket purchases as the cost of financing rises. While nominal debt remains high relative to disposable income, debt service is at the lowest levels in over 35 years.

Strong Comp Against Strong Comps

Nominal Household Debt/DPI, LHS Household Debt Service Payments as a Percent of Disposable Personal Income, SA, RHS 1.3

14%

Comparable store sales change Growth in net revenues 30%

1.2 13% 1.1

20%

1.0

12%

0.9 11%

10%

0.8 0.7

10%

0.6 9% 0.5

-10%

0.4 1980 1983 1987 1990 1994 1997 2001 2004 2008 2011

2010

2011

2012

2013

2014

14 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Income Statement Restoration Hardware Stores Direct

2011 534 424 958

2012 643 550 1,193

2013 818 733 1,551

2014 934 934 1,868

2015 1,170 1,080 2,249

2016 1,500 1,385 2,884

2017 1,847 1,705 3,553

2018 2,123 1,960 4,082

Stores % Direct %

56% 44%

54% 46%

53% 47%

50% 50%

52% 48%

Cost of goods sold Gross profit Selling, general and administrative expenses Income (loss) from operations

602 356 330 27 (5)

757 436 505 (69) (6)

994 557 502 55 (6)

1,158 710 542 168 (6)

1,378 872 652 219 (6)

1,760 1,125 822 303 (6)

2,132 1,421 995 426 (6)

2,449 1,633 1,102 531 (6)

22 1 21 0 $44

(75) (62) (13) 9 -$1.36

49 31 18 40.4 $0.45

162 65 97 41.3 $2.36

214 85 128 41.3 $3.10

297 119 178 41.3 $4.32

421 168 252 41.3 $6.11

525 210 315 41.3 $7.63

Net revenues

Interest expense Income (loss) before income taxes Income tax expense (benefit) Net income (loss) Weighted-average shares EPS

Growth/Margin Breakdown Revenue Growth Stores Direct Total

2013

2014

2015

2016

2017

2018

27%

14%

25%

28%

23%

15%

33%

27%

16%

28%

23%

15%

30%

20%

28%

23%

15%

Margins COGS Gross SG&A EBIT

63% 36% 32% 4%

62% 38% 29% 9%

61% 39% 29% 10%

61% 39% 29% 11%

60% 40% 28% 12%

60% 40% 27% 13%

EBT Tax Net Income

2.0%

3.5%

3.8%

4.1%

4.7%

5.1%

63%

40%

15 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Balance Sheet Restoration Hardware

2012

2013

2014

2015

2016

2017

2018

422

Current assets Cash and cash equivalents

218

186

167

240

Accounts receivable-net

Merchandise inventories

353

454

614

746

932

1,088

1,189

Total current assets

77 493

103 614

122 1,004

147 1,132

185 1,346

224 1,623

248 1,938

Property and equipment-net

111

215

327

405

535

622

684

Goodwill

123

122

125

Current deferred tax assets Prepaid expense & other current assets

Trademarks Other intangible assets-net

Non-current deferred tax assets

6 790

8 1,025

11 1,533

14 1,742

18 2,090

22 2,458

24 2,837

Accounts payable and accrued expenses

145

207

243

290

369

448

515

Deferred revenue and customer deposits

115

156

163

Other assets Total assets

Current liabilities

Current deferred tax liabilities

Other current liabilities

166

169

168

Total current liabilities

219

317

393

477

651

773

846

281 -

Convertible senior notes Revolving line of credit Deferred rent and lease incentives Other long-term obligations

Total liabilities

117

338

480

829

912

1,086

1,208

1,281

506

585

646

(55)

(37)

603

910

(3)

184 -

357

452 790

545 1,025

705 1,533

830 1,742

1,003 2,090

1,249 2,458

1,556 2,837

Stockholders' equity Additional paid-in capital Accumulated other comprehensive income Accumulated deficit Treasury stock

Total stockholders' equity Total liabilities & stockholders' equity

16 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Cash Flow Statement Restoration Hardware

2011

2012

2013

2014

2015

2016

2017

2018

CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) Adjustments to net income to net cash provided by operating activities Depreciation and amortization Stock-based compensation expense

(13)

125

173

246

307

29 2

27 116

28 68

49 68

54 68

63 68

78 68

90 68

(5)

(7)

(5)

(7)

(3)

(9)

(7)

(39)

(107)

(101)

(160)

(132)

(186)

(155)

(102)

(36)

(24)

(23)

(18)

(25)

(63)

(77)

(63)

Accounts payable and accrued expenses

(1) 14

(0) 36

(3) 57

(3) 37

(3) 46

(4) 80

(4) 79

(2) 67

Deferred revenue and customer deposits Other current liabilities

11 4

16 3

7 30

(0) 14

Deferred income taxes Non-cash interest expense Change in assets and liabilities Accounts receivable Merchandise inventories Prepaid expense and other current assets Other assets

Deferred rent and lease incentives Other long-term obligations Net cash provided by (used in) operating activities CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures Purchase of trademarks and other intangible assets

(1)

(0)

Proceeds from issuance of convertible senior notes Proceeds from issuance of warrants Purchase of convertible note hedges Convertible debt issuance costs Payments on capital leases and other long-term obligations

(4)

150

152

205

233

361

(26)

(49)

(94)

(120)

(174)

(185)

(188)

(178)

Net cash used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES Gross borrowings under revolving line of credit Gross repayments under revolving line of credit

(1)

(0)

(26)

(49)

(94)

(120)

(174)

(185)

(188)

(178)

1,007 (1,012)

1,344 (1,369)

1,671 (1,668)

350

- (73)

- (5)

(4)

(3)

Stock options exercised

Excess tax benefit from exercise of stock options

(0) 12

(2) 324

(2) 12

(0)

(5)

(0)

205

(32)

(19)

182

13 9

9 8

8 13

13 218

218 186

186 167

167 240

240 422

Tax withholdings related to issuance of stock-based awards Net cash provided by financing activities Effects of foreign currency exchange rate translation Net increase (decrease) in cash and cash equivalents Cash and cash equivalents Beginning of period End of period

17 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Square-Footage Model Appendix Store Growth & Square Footage Model Q1 11 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14

Legacy Design Selling Sq. Sales Per Sell Stores Galleries Foot Sq Foot 89 0 613 190 85 1 590 210 83 1 570 220 72 2 516 222 72 2 522 225 71 2 516 281 71 2 502 282 70 3 501 284 68 3 495 294 67 4 521 358 66 4 521 368 65 5 551 375 64 5 551 300 63 6 556 355 63 6 569 372

Impl. Sales 116,470 123,900 125,400 114,552 117,450 144,996 141,564 142,284 145,530 186,518 191,728 206,625 165,300 197,380 211,668

Total Revenue

Retailer

Implied Outlet Sales

Annual

939,466

415,244 524,222 Growth

43,900

1,112,211 18%

511,617 23%

600,594 15%

54,300 24%

1,553,032 40%

733,031 43%

820,001 37%

89,600 65%

934,046

27%

14%

Q4 14E Q1 15E Q2 15E Q3 15E

63 63 60 58

7 7 9 11

648 648 675 765

381 375 370 364

246,698 242,997 249,518 278,545

1,868,091

Q4 15E Q1 16E Q2 16E Q3 16E Q4 16E Q1 17E Q2 17E Q3 17E Q4 17E Q1 18E Q2 18E Q3 18E

55 52 49 46 43 40 37 34 31 28 25 22

11 15 18 21 25 28 31 34 37 40 43 46

765 870 944 1017 1123 1196 1270 1343 1417 1490 1564 1637

359 353 348 343 338 333 328 323 318 313 308 304

274,187 307,344 328,310 348,578 378,967 397,724 415,834 433,311 450,170 466,425 482,092 497,184

2,249,128

Q4 18E

1711

299 1224

511,715

Direct

20%

1,079,582 16%

1,169,547 25%

113,000 26%

124,300 10%

2,884,479 28%

1,384,550 28%

1,499,929 28%

136,730 10%

3,552,773 23%

1,705,331 23%

1,847,442 23%

150,403 10%

4,082,422 15%

1,959,563 15%

2,122,859 15%

165,443 10%

2018 Total

18 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Square-Footage Scenario Model Appendix Store Growth & Square Footage Model Legacy Stores FLDG

Q4 14E Q1 15E Q2 15E Q3 15E Q4 15E Q1 16E Q2 16E Q3 16E Q4 16E Q1 17E Q2 17E Q3 17E Q4 17E Q1 18E Q2 18E Q3 18E Q4 18E

63 63 60 58 55 52 49 46 43 40 37 34 31 28 25 22 19

68 2018 Total

7 7 9 11 11 15 18 21 25 28 31 34 37 40 43 46 49

Leased Selling Sq. Foot

Sales Per Selling Sq Foot

Bull

Base

Bear

648 648 648 648 648 648 675 675 675 765 765 765 765 765 765 915 870 795 998 944 854 1080 1017 912 1198 1123 998 1280 1196 1056 1363 1270 1115 1445 1343 1173 1528 1417 1232 1610 1490 1290 1693 1564 1349 1775 1637 1407 1858 1711 1466 FLDG Ave. Lease Selling Sq. Ft. 35 32 27 Thousands FLDG Ave. Lease Selling Sq. Ft. 35 32 27

Base

Impl. Sales

Total Revenue

Bear

381 377 373 370 366 362 359 355 352 348 345 341 338 334 331 328 324

381 375 370 364 359 353 348 343 338 333 328 323 318 313 308 304 299

381 373 366 359 351 344 338 331 324 318 311 305 299 293 287 281 276

1317

1224

1137

906

830

761

Direct

Implied

Retailer Outlet Sales

Annual 246,698 1,868,091 934,046 934,046 27% 14% 242,997 20% 249,518 2,275,371 1,092,178 1,183,193 278,545 2,223,156 1,067,115 1,156,041 274,187 2,249,128 1,079,582 1,169,547 16% 25% 307,344 20% 328,310 3,135,755 1,505,163 1,630,593 348,578 2,545,316 1,221,751 1,323,564 378,967 2,884,479 1,384,550 1,499,929 28% 28% 397,724 28% 415,834 3,988,775 1,914,612 2,074,163 433,311 2,997,782 1,438,935 1,558,846 450,170 3,552,773 1,705,331 1,847,442 23% 23% 466,425 23% 482,092 4,707,974 2,259,828 2,448,147 497,184 3,328,219 1,597,545 1,730,674 511,715 4,082,422 1,959,563 2,122,859 15%

15%

113,000 26% Bull Bear 124,300 10% Bull Bear 136,730 10% Bull Bear 150,403 10% Bull Bear 165,443 10%

FLDG Sales per Sq. Ft.

Sales Per Sq. Qrtly Decline -1.0% -1.5% -2.0% Legacy Sales/Sq. Ft, Bull Base Bear 2,380 2,240 2,107 16% 15% 14% Annual Growth

19 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Multi-Stage DCF Appendix 2015

2016

3.10 1.32 (4.20) (1.84) (1.62) (1.48)

2017

4.32 1.54 (4.71) (1.43) (0.29) (0.24)

6.11 1.89 (5.25) (1.98) 0.77 0.61

2018

2019

7.63 2.18 (6.03) (1.47) 2.30 1.68

2020

9.43 2.56 (5.81) (1.73) 4.45 3.04

2021

11.35 2.93 (6.65) (1.98) 5.64 3.58

2022

13.64 3.35 (7.61) (2.27) 7.11 4.19

2023

15.40 3.78 (8.60) (2.56) 8.02 4.39

Terminal Value

FCFE Net Income D&A Capex NWC FCFE PV

18.20 4.26 (9.68) (2.88) 9.90 5.02

177.35 90.06

$111

Intrinsic Value

Terminal Growth Rate = 2.12%

Hurdle

2015

Risk Free Beta MRP Discount

2.12% 1.25 6.0% 9.62%

2016 2.12% 1.10 6.0% 8.72%

2017

2018

2.12% 1.03 6.0% 8.27%

2019

2.12% 0.99 6.0% 8.05%

2020

2.12% 0.97 6.0% 7.93%

2021

2.12% 0.96 6.0% 7.88%

2.12% 0.95 6.0% 7.85%

2022

2023

2.12% 0.95 6.0% 7.83%

Store Growth & Square Footage Model Continued Old Stores

New Store

Bull

Sq. Foot

Bear

Bull

Sales/ Sq. Ft

Bear

Bull

Sales

Bear

Q1 19E Q2 19E Q3 19E Q4 19E Q1 20E Q2 20E Q3 20E Q4 20E Q1 21E Q2 21E Q3 21E Q4 21E

19 18 17 16 15 14 13 12 11 10 9 8

49 50 51 52 53 54 55 56 57 58 59 60

1,875 1,920 1,967 2,014 2,062 2,111 2,161 2,212 2,264 2,307 2,349 2,392

1,825 1,869 1,914 1,960 2,006 2,054 2,102 2,152 2,202 2,243 2,283 2,325

1,479 1,512 1,546 1,581 1,616 1,653 1,690 1,727 1,766 1,796 1,827 1,858

328 331 334 338 341 344 348 351 355 358 362 366

301 302 304 305 307 308 310 311 313 314 316 318

276 276 276 276 276 276 276 276 276 276 276 276

614 635 657 680 703 727 752 777 803 827 850 874

549 565 581 598 615 633 651 670 689 705 722 738

408 417 426 436 446 456 466 476 487 495 504 513

Q1 22E Q2 22E Q3 22E Q4 22E Q1 23E Q2 23E Q3 23E Q4 23E

7 6 5 4 3 2 1 0

61 62 63 64 65 66 67 68

2,436 2,479 2,524 2,569 2,614 2,660 2,706 2,753

2,367 2,409 2,451 2,494 2,538 2,582 2,626 2,671

1,890 1,922 1,954 1,987 2,020 2,053 2,087 2,121

369

319 321 322 324 326 327 329 331

276 276 276 276 276 276 276 276

899

755 773 790 808 826 845 864 883

521

373 377 380 384 388 392 396

925 951 977 1,004 1,032 1,061 1,090

530 539 548 557 566 576 585

Terminal

2.12% 0.95 6.0% 7.83%

2.12% 0.95 6.0% 7.82%

PE Model Retailer Outlet Sales

EPS

Price

CAGR PE

Total Revenue

Direct

5,368 3,618 4,795

2,781 1,931 2,502

2,587 1,687 2,293

184 $11.09 180 $6.76 182 $9.43

$244 $122 $189

22 18 20

22% 6% 16%

6,274 4,050 5,496

3,315 2,207 2,926

2,959 1,844 2,570

203 $13.61 197 $7.95 200 $11.35

$286 $143 $227

21 18 20

21% 8% 17%

7,318 4,529 6,287

3,964 2,531 3,433

3,355 1,999 2,854

224 $16.67 216 $9.33 220 $13.64

$333 $168 $259

20 18 19

21% 9% 16%

8,428 5,005 7,100

4,676 2,867 3,973

3,751 2,138 3,127

248 $19.19 237 $10.31 242 $15.40

$365 $175 $277

19 17 18

19% 9% 15%

9,673 5,516 7,992

5,487 3,232 4,574

4,187 2,284 3,418

267 $23.13 256 $11.93 262 $18.20

$416 $191 $309

18 16 17

19% 9% 15%

Base Cases

20 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Square Footage and Sales/ Sq. Ft Sensitivity Appendix The following is a P/S and Sum Of The Parts P/S model. Uses multiples based on industry averages. Revenue numbers are derived from the scenario model on the previous page.

P/S Total Non SOTP

P/S

Price

SOTP Direct

P/S

Retail Stores

Price

P/S

Price

Outlets

P/S

Price

Total

P/S

Price

2015 Bull 1.96 Bear 1.84 Base 1.90

$108 $99 $103

2.06 1.94 2.00

$54 $50 $52

1.44 1.36 1.40

$41 $38 $40

0.82 0.78 0.80

$2.5 $2.3 $2.4

1.78 1.68 1.73

$98 $90 $94

$58 $43 $51

0.84 0.76 0.8

$2.8 $2.5 $2.6

1.81 1.64 1.73

$137 $101 $121

$75 $49 $63

0.86 0.74 1

$3.1 $2.7 $2.9

1.84 1.61 1.72

$178 $117 $148

$120 1.54 $91 0.88 $3.5 $70 1.26 $53 0.72 $2.9 $95 1.40 $72 0.8 $3.2 Compound Annual Return

1.89 1.55 1.72

$215 $125 $170 18%

2016 Bull 1.79 Bear 1.615 Base 1.7

$136 $100 $119

2.10 1.90 2.00

$77 $56 $67

1.47 1.33 1.40

2017 Bull 1.71 Bear 1.49 Base 1.60

$165 $108 $138

2.14 1.86 2.00

$99 $65 $83

1.50 1.30 1.40

2018 Bull 1.76 Bear 1.44 Base 1.60

$201 $116 $158

16%

2.20 1.80 2.00

21 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Management Appendix CFO: Karen Boone

Karen Boone joined RH as CFO in June 2012. She earned a Bachelor’s Degree in Economics from the University of California. She worked for Deloitte for 15 years where she served as Audit Partner specializing in the retail sector. Before becoming an Audit Partner, she served as a Senior Manager in Deloitte's audit practice from 2005 to 2010 and as a Manager from 2002 to 2005. She is capable of using her accounting and financial expertise from Deloitte to execute RH’s growth strategy in line with the interests of RH shareholders. Her plans include a goal of generating positive free cash flow within 12-24 months.

COO: Ken Dunaj Ken Dunaj served as COO since May 2006. From August 2005 to May 2006, Mr. Dunaj served as Senior VP of Global Logistics for Williams-Sonoma. From September 2000 to August 2005, Mr. Dunaj held other positions at Williams-Sonoma, including VP of Distribution. According to management in company conference calls, Dunaj and Friedman were responsible for turning around WilliamsSonoma’s dysfunctional distribution network. Mr. Dunaj also held various positions at Toys "R" Us, Inc., Genesis Direct, Inc., Reebok and Nike.

CDO: Douglas Diemoz Douglas Diemoz, Chief Development Officer, brings his extensive retail experience in international market to guide RH through it eventual expansion abroad. He served as CEO of MEXX, an Amsterdam-based, international fashion brand in over 46 countries and sold through 5,000 retail and wholesale stores worldwide. While at MEXX, he served as President, Chief Transformation Officer and CFO. Diemoz spent over nine years at Williams-Sonoma, in senior finance roles, including Divisional CFO and Senior VP of Financial Operations of the Pottery Barn Brands. He spent over five years at Gap, Inc, in key finance roles. He started his career as a financial analyst in Bank of America’s Corporate Real Estate group.

22 By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

Economy Appendix Consumer Confidence Accelerating YoY % Ch. 2nd Derivative

1/1/2014 2/1/2014 3/1/2014 4/1/2014 5/1/2014 6/1/2014 7/1/2014 8/1/2014 9/1/2014 10/1/2014 11/1/2014 12/1/2014 0.65% 0.62% 0.48% 0.34% -0.02% -0.23% -0.19% 0.19% 0.78% 1.29% 1.53% 1.63% 31 -3 -14 -14 -36 -20 3 38 59 52 23 10

Disposable Personal Income Accelerating 1/1/2014 2/1/2014 3/1/2014 4/1/2014 5/1/2014 6/1/2014 7/1/2014 8/1/2014 9/1/2014 10/1/2014 11/1/2014 12/1/2014 YoY Ch. 3.56% 3.30% 3.65% 3.86% 3.78% 3.77% 3.90% 3.71% 3.46% 4.04% 4.11% 4.48% 2nd Derivative 662 -26 35 21 -8 -1 13 -19 -25 57 7 37

Easy Comp YoY Change in New One Family Houses Sold, 3MA Housing Affordability Index, RHS

Furnishings Stores, SA. % of PCE Durable Goods, LHS LFPR - Bachelor's Deg. +, 25 +, NSA, RHS 220

0.90%

200

0.85%

83% 82%

180

81% 80%

0.80%

79% 160 -25 140

0.75%

78% 77%

0.70%

76%

-75 120

75%

0.65%

74% 100 0.60%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

-125

73%

Drivers of Furniture Store Sales as % of Personal Consumption Expenditures SUMMARY OUTPUT Regression Statistics Multiple R 0.963 R Square 0.927 Adjusted R Square 0.924 Standard Error 0.00019 Observations 88

df Regression Residual Total

Intercept LFPR 25+ Bachelors Deg. Home Ownership Rate Rental Vacancy

3 84 87

ANOVA SS MS F Significance F 3.78060E-05 1.2602E-05 353.0631261 1.70028E-47 2.99824E-06 3.56933E-08 4.08043E-05

Coefficients Standard Error -0.032125 0.001428 0.030496 0.001362 0.027021 0.002068 -0.023602 0.003416

t Stat -22.499928 22.397661 13.069138 -6.908508

P-value 0.000000 0.000000 0.000000 0.000000

Lower 95% Upper 95% Lower 95% Upper 95% -0.034964 -0.029286 -0.034964 -0.029286 0.027788 0.033204 0.027788 0.033204 0.022909 0.031132 0.022909 0.031132 -0.030396 -0.016808 -0.030396 -0.016808

By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Equity Research│February 26, 2015│NYSE: RH│Restoration Hardware

International Expansion- Long-Term Growth Catalyst RH is also developing an international expansion plan. In the company’s latest earnings call on Dec, 2014, CFO Karen Boone touched on the international stance for the brand and declared that RH is in talks with several of its international partners for future expansion of the brand in Europe, South America, Australia, Middle East, and Asia.

Appendix Web Searches by Country

Pottery Barn

60 40 20

Although the company is currently concentrated on its real-estate transformation in North America, we think that the international expansion will fuel continued long-term growth; we believe that a company like RH will be well received in luxury markets around the globe as the products the company offers have a unique artisan quality and design that is sought out by luxury market that are growing with the rising affluence of citizens in emerging nations.

Web Searches Europe 80

Europe (U.K. and France)

Below is a map as it appeared during the latest earnings call presentation where the company points to possible international locations of its stores. RH didn’t disclose the specific countries where it intends to build those stores. However, Doug Diemoz has joined the executive team as head of development in international markets (management). Mr. Diemoz’s extensive background in managing international brands will facilitate a wise expansion plan. In addition, we wanted to have an idea of the brand recognition internationally and looked on Google trends for users’ web searches for Restoration Hardware and its main competitor Pottery Barn between 2012 and 2015 among different countries. The data showed that although RH has no international stores at the moment, contrary to Pottery Barn that has a wide international exposure, the brand is recognized and searched internationally. This goes along with RH management observations on the 2013’ 4Q earnings call that 34% of their business in Miami was going to S. America.

40 20 0 RH

Pottery Barn

Web Search Interest LATAM Latin America (Chile, Colombia, Mexico) 80 60 40 20 0

By Jonathan De Jesus, Julio Escalona, and Aaron Mederos

Pottery Barn