For the first time in a year, home furnishings maker Restoration Hardware (NASDAQ:RSTO) surprised analysts last quarter, turning in a profit when a loss was expected. When the firm reports its latest batch of numbers on Tuesday, will investors be as pleasantly surprised?

What analysts say:

  • Buy, sell, or waffle? Ten analysts follow Restoration Hardware (RH). Seven of them rate it a buy, and three a hold.
  • Revenues. On average, they expect to see 18% year-over-year growth to $151.5 million.
  • Earnings. Profits are another story. The consensus calls for RH to lose 50% more this year than last, at $0.16 per share.

What management says:
RH doesn't earn profits in Q2. Or in Q1 or Q3 either, for that matter. It earns profits in Q4, and Q4 alone -- or that was the case up until last quarter. As CEO Gary Friedman crowed then: "We are proud to announce that for the first time in the Company's history, we were profitable outside of the fourth quarter," pointing to 4% growth in same-store sales, 24% growth in revenues overall, and improved margins as the primary contributors to the firm's remaking history. He went on to argue: "This milestone, and the strong customer response to our product offerings, validates our work to position Restoration Hardware as the premium home furnishings brand in the marketplace."

What management does:
Bold words, but it's hard to argue with success. And for the past three quarters, RH has succeeded in expanding its rolling gross margins. Operating margin improvement is following in the footsteps of the gross, and the only reason the firm's rolling net results look so ugly is because the firm recorded a huge, $32.7 million tax hit in the January quarter. Expect the rolling net to continue looking ugly next week because of that charge and improve only in Q4.

Margins %

4/05

7/05

10/05

1/06

4/06

7/06

Gross

32.0

32.5

33.1

33.9

34.6

35.3

Op.

1.1

1.2

0.9

0.5

0.8

1.5

Net

0.5

0.3

0.1

(5.0)

(5.2)

(4.5)
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
As good as those results look, though, fellow Fool Nathan Parmelee was a bit leery of all the cheering at RH last quarter, pointing to growth in inventories that significantly outpaced RH's sales growth. Looking over the results for the first half of the year, I, too, see a problem here. Against sales gains of 19%, accounts receivable are up 36% and inventories have risen 34% on average against the previous year's levels.

What's more, although RH failed to provide investors a cash flow statement last quarter, Nathan made a valiant effort to guesstimate how bad an effect RH's deteriorating working capital picture was having on RH's cash flow. Working the numbers, Nathan came up with likely negative operating cash flow in the $15 million range -- which was too generous by 10%, as it turned out. According to the cash flow statement that RH ultimately filed with the SEC, operating cash flow ran negative to the tune of $16.5 million. Add in capital expenditures, and the firm has so far run $23.1 million free cash flow-negative for the year.

Whatever good news RH reports on its income statement next week, keep in mind that until it begins including cash flow statements with its earnings releases, this firm may not be telling you the whole story.

Competitors:

  • Bed Bath & Beyond (NASDAQ:BBBY)
  • Bombay (NYSE:BBA)
  • Design Within Reach (NASDAQ:DWRI)
  • Pier 1 (NYSE:PIR)
  • Williams Sonoma (NYSE:WSM)

Get two views of last quarter's news in:

Bed Bath & Beyond is both a Stock Advisor and an Inside Value selection.

Fool contributor Rich Smith does not own shares of any company named above.