The following discussion and analysis of the financial condition and results of our operations should be read together with the condensed consolidated financial statements and the related notes of Restoration Hardware Holdings, Inc. and Restoration Hardware, Inc. included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and the related notes of Restoration Hardware Holdings, Inc. and Restoration Hardware, Inc. included in our final prospectus filed on November 5, 2012.

This quarterly report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as "anticipate," "estimate," "expect," "project," "plan," "intend," "believe," "may," "will," "should," "likely" and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.

Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those that we expected. We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon many detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors and it is impossible for us to anticipate all factors that could affect our actual results. Important factors that could cause actual results to differ materially from our expectations, or cautionary statements, are disclosed under the sections entitled "Risk Factors" in Part II of this quarterly report and in our final prospectus filed on November 5, 2012, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this quarterly report. All forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements, as well as other cautionary statements. You should evaluate all forward-looking statements made in this quarterly report in the context of these risks and uncertainties.

We cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our operations in the way we expect. The forward-looking statements included in this quarterly report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

Overview

We believe RH is one of the fastest growing and most innovative luxury brands in the home furnishings marketplace. Our collections of timeless, updated classics and reproductions are presented consistently across our sales channels in sophisticated and unique lifestyle settings that we believe are on par with world-class interior designers. We offer dominant merchandise assortments across a growing number of categories, including furniture, lighting, textiles, bathware, dιcor, outdoor, garden, and baby and child products. Our business is fully integrated across our multiple channels of distribution, consisting of our stores, catalogs and websites. We position our stores as showrooms for our brand, while our catalogs and websites act as virtual extensions of our stores. As of October 27, 2012, we operated 71 Galleries, 2 full line Design Galleries and 12 outlet stores throughout the United States and Canada.

In 2001, we began to reposition Restoration Hardware from a nostalgic, discovery-items business to a leading home furnishings brand. In 2008, we were taken private by investment funds affiliated with Catterton, Tower Three and Glenhill. As a private company, we were able to accelerate the transformation of our business and brand and the development of our multi-channel business model and infrastructure. Over the last eleven years, we have built a new company as we:

• Elevated our brand positioning;

• Enhanced our product development process;

• Refined our go-to-market strategy;

• Reconceptualized our stores and developed our full line Design Gallery format;

• Built a new supply chain and systems infrastructure; and

• Strengthened our management team.

Basis of Presentation and Results of Operations

The following table sets forth our statement of operations and other financial and operating data.

On November 7, 2012, the Restoration Hardware Holdings, Inc. completed an initial public offering and acquired all of the outstanding shares of capital stock of the Restoration Hardware, Inc. Outstanding units under the Team Resto Ownership Plan were exchanged for common stock of the Restoration Hardware Holdings, Inc. at the time of its initial public offering. These transactions are referred to as the "Reorganization." Restoration Hardware Holdings, Inc. has not engaged in any business or other activities except in connection with its formation and the Reorganization. Accordingly, all financial and other information herein relating to periods prior to the completion of the Reorganization is that of Restoration Hardware, Inc.

                                              Three Months Ended                        Nine Months Ended
                                       October 27,           October 29,         October 27,         October 29,
                                          2012                  2011                2012                2011
                                             (dollars in thousands, excluding per square foot store data)
Statement of Operations Data:
Net revenues                         $       284,171        $     232,459       $     794,991       $     652,842
Cost of goods sold                           182,291              148,066             503,716             414,019

Gross profit                                 101,880               84,393             291,275             238,823
Selling, general and
administrative expenses                       99,886               88,496             271,716             238,891

Income (loss) from operations                  1,994               (4,103 )            19,559                 (68 )
Interest expense                              (1,544 )             (1,598 )            (4,598 )            (3,486 )

Income (loss) before income taxes                450               (5,701 )            14,961              (3,554 )
Income tax benefit                            (1,235 )               (871 )              (612 )               (88 )

Net income (loss)                    $         1,685        $      (4,830 )     $      15,573       $      (3,466 )

Other Financial and Operating
Data:
Growth in net revenues:
Stores (1)                                        21 %                 32 %                19 %                25 %
Direct                                            24 %                 17 %                25 %                29 %
Total                                             22 %                 25 %                22 %                26 %
Retail (2):
Comparable store sales change (3)                 29 %                 36 %                29 %                25 %
Retail stores open at beginning
of period                                         73                   87                  74                  91
Stores opened                                     -                    -                    3                   3
Stores closed                                     -                     3                   4                  10
Retail stores open at end of
period                                            73                   84                  73                  84
Retail sales per selling square
foot (4)                             $           282        $         210       $         763       $         560
Total gross square footage at end
of period (in thousands)                         792                  896                 792                 896
Total selling square footage at
end of period (in thousands)                     516                  570                 516                 570
Direct:
Catalogs circulated (in
thousands) (5)                                11,721                8,356              26,851              21,079
Catalog pages circulated (in
millions) (5)                                  7,944                4,832              15,360               8,121
Direct as a percentage of net
revenues (6)                                      44 %                 43 %                46 %                44 %
Capital expenditures                 $        12,114        $       7,669       $      25,631       $      19,837
Adjusted EBITDA (7)                  $        12,973        $      11,102       $      47,870       $      38,849

(1) Store data represent retail stores plus outlet stores. Net revenues for outlet stores for the three months ended October 27, 2012 and October 29, 2011 were $13.9 million and $10.7 million, respectively. Net revenues for outlet stores for the nine months ended October 27, 2012 and October 29, 2011 were $38.2 million and $31.2 million, respectively.

(2) Retail data have been calculated based upon retail stores, which include our Baby & Child stores, and exclude outlet stores.

(3) Comparable store sales have been calculated based upon retail stores that were open at least fourteen full months as of the end of the reporting period and did not change square footage by more than 20% between periods. Comparable store net revenues exclude revenues from outlet stores.

(4) Retail sales per selling square foot is calculated by dividing total net revenues for all retail stores, comparable and non-comparable, by the average selling square footage for the period.

(6) Direct revenues include sales through our catalogs and websites.

(7) EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We define EBITDA as consolidated net income (loss) before depreciation and amortization, interest expense and provision for income taxes. Adjusted EBITDA is calculated in accordance with and is the basis of our MIP, which is our cash based-incentive compensation program designed to motivate and reward annual performance for eligible employees, and reflects further adjustments to EBITDA to eliminate the impact of certain items, including non-cash or other items that we do not consider representative of our ongoing operating performance as discussed further below.

EBITDA and Adjusted EBITDA are included in this Form 10-Q because they are key metrics used by management and our board of directors to assess our financial performance, and Adjusted EBITDA is used in connection with determining incentive compensation under our MIP. Additionally, EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use EBITDA and Adjusted EBITDA, alongside other GAAP measures such as gross profit, operating income (loss) and net income (loss), to measure profitability, as a key profitability target in our annual and other budgets, and to compare our performance against that of peer companies. We believe that Adjusted EBITDA provides useful information facilitating operating performance comparisons from period to period and company to company.

EBITDA and Adjusted EBITDA are not GAAP measures of our financial performance or liquidity and should not be considered as alternatives to net income (loss) as a measure of financial performance, cash flows from operating activities as a measure of liquidity, or any other performance measure derived in accordance with GAAP and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Additionally, EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management's discretionary use, as they do not consider certain cash requirements such as tax payments and debt service requirements and certain other cash costs that may recur in the future. EBITDA and Adjusted EBITDA contain certain other limitations, including the failure to reflect our cash expenditures, cash requirements for working capital needs and cash costs to replace assets being depreciated and amortized, and exclude certain unusual charges that are not expected to recur in the future. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed to imply that our future results will be unaffected by any such adjustments. Management compensates for these limitations by relying primarily on our GAAP results and by using EBITDA and Adjusted EBITDA only supplementally. Our measures of EBITDA and Adjusted EBITDA are not necessarily comparable to other similarly titled captions of other companies due to different methods of calculation.

A reconciliation of net income (loss) to EBITDA and Adjusted EBITDA is set forth below:

                                               Three Months Ended                    Nine Months Ended
                                         October 27,        October 29,        October 27,        October 29,
                                            2012               2011               2012               2011
                                                                    (in thousands)
Net income (loss)                       $       1,685      $      (4,830 )    $      15,573      $      (3,466 )
Depreciation and amortization                   6,593              7,373             19,485             22,356
Interest expense                                1,544              1,598              4,598              3,486
Income tax benefit                             (1,235 )             (871 )             (612 )              (88 )

EBITDA                                          8,587              3,270             39,044             22,288
Management and board fees (a)                   1,198              1,149              3,285              3,545
Non-cash compensation (b)                         364              6,687              1,102              7,563
Terminated operations (c)                          -                  14                 -               1,680
Severance and other transaction costs
(d)                                                -                 443                 -                 471
Lease termination costs (e)                        -                (461 )             (386 )            3,110
Special committee investigation and
remediation (f)                                 2,789                 -               4,778                 -
Other adjustments allowable under our
agreements with our stockholders (g)               35                 -                  47                192

Adjusted EBITDA                         $      12,973      $      11,102      $      47,870      $      38,849

(a) Includes fees paid in accordance with our management services agreement with Home Holdings, as well as fees and expense reimbursements paid to our board of directors.

(b) Represents non-cash charges related to stock-based compensation programs. The three and nine months ended October 29, 2011 include a $6.4 million compensation charge related to the repayment of loans owed to Home Holdings by our former Chairman and Co-Chief Executive Officer, Gary Friedman, through the reclassification by Home Holdings of Mr. Friedman's Class A and Class A-1 ownership units into an equal number of Class A Prime and Class A-1 Prime ownership units. Mr. Friedman served as our Chairman and Co-Chief Executive Officer at the time of such loan repayment.

(d) Amounts generally include executive severance and other related costs.

(e) Includes lease termination costs for retail stores that were closed prior to their respective lease termination dates. The amounts in the nine months ended October 27, 2012 and three months ended October 29, 2011 relate to changes in estimates regarding liabilities for future lease payments for closed stores.

(f) Represents legal and other professional fees, incurred in connection with the investigation conducted by the special committee of the board of directors relating to our former Chairman and Co-Chief Executive Officer, Gary Friedman, and our subsequent remedial actions.

(g) Represents items which management believes are not indicative of our ongoing operating performance. The nine months ended October 29, 2011 includes consulting fees related to organizational matters and state franchise tax amounts. All periods include foreign exchange gains and losses.

The following table sets forth our consolidated statement of operations data as a percentage of total revenues.

                                            Three Months Ended                          Nine Months Ended
                                     October 27,           October 29,           October 27,          October 29,
                                        2012                  2011                  2012                 2011
Statement of Operations Data:
Net revenues                                100.0 %               100.0 %               100.0 %              100.0 %
Cost of goods sold                           64.1                  63.7                  63.4                 63.4

Gross profit                                 35.9                  36.3                  36.6                 36.6
Selling, general and
administrative expenses                      35.2                  38.1                  34.1                 36.6

Income (loss) from operations                 0.7                  (1.8 )                 2.5                   -
Interest expense                             (0.5 )                (0.7 )                (0.6 )               (0.5 )

Income (loss) before income
taxes                                         0.2                  (2.5 )                 1.9                 (0.5 )
Income tax benefit                           (0.4 )                (0.4 )                (0.1 )                 -

Net income (loss)                             0.6 %                (2.1 )%                2.0 %               (0.5 )%

We operate a fully integrated distribution model through our stores, catalogs and websites. The following table shows a summary of our Stores revenues, which include all sales for orders placed in retail stores as well as sales through outlet stores, and our Direct revenues which include sales through our catalogs and websites.

                           Three Months Ended                   Nine Months Ended
                      October 27,       October 29,       October 27,       October 29,
                         2012              2011              2012              2011
                                               (in thousands)
      Stores         $     159,193     $     132,024     $     433,121     $     362,746
      Direct               124,978           100,435           361,870           290,096

      Net revenues   $     284,171     $     232,459     $     794,991     $     652,842

Three Months Ended October 27, 2012 Compared to Three Months Ended October 29, 2011

Net revenues

Net revenues increased $51.7 million, or 22.2%, to $284.2 million in the three months ended October 27, 2012 compared to $232.5 million in the three months ended October 29, 2011. We had 73 and 84 retail stores open at October 27, 2012 and October 29, 2011, respectively. Stores sales increased $27.2 million, or 20.6%, to $159.2 million in the three months ended October 27, 2012 compared to $132.0 million in the three months ended October 29, 2011 due in large part to our comparable store sales increase of 29% in the three months ended October 27, 2012 compared to the three months ended October 29, 2011, partially offset by having fewer stores open during the three months ended October 27, 2012 compared to the three months ended October 29, 2011. Direct sales increased $24.5 million, or 24.4%, to $125.0 million in the three months ended October 27, 2012 compared to $100.4 million in the three months ended October 29, 2011. We believe that the increase in both comparable store and direct sales was due primarily to our customers' favorable reaction to our merchandise assortment, including the expansion of existing product categories, new product categories, and an increase in catalog pages circulated.

Gross profit

Gross profit increased $17.5 million, or 20.7%, to $101.9 million in the three months ended October 27, 2012 from $84.4 million in the three months ended October 29, 2011. As a percentage of net revenues, gross margin decreased 0.4%, to 35.9% of net revenues in the three months ended October 27, 2012 from 36.3% of net revenues in the three months ended October 29, 2011.

This decrease was primarily due to a gross margin reduction of 130 basis points related to changes in product mix and higher sales during promotional events in the three months ended October 27, 2012. In addition, gross margin decreased by 110 basis points due to increased freight costs resulting from a higher percentage of furniture sales during the period, as furniture deliveries require greater shipping costs than our other products. The gross margin decrease was partially offset by a 200 basis point improvement in occupancy costs from improved leverage on the fixed portion of our store and distribution center occupancy costs.

Selling, general and administrative expenses

Selling, general and administrative expenses increased $11.4 million, or 12.9%, to $99.9 million in the three months ended October 27, 2012 compared to $88.5 million in the three months ended October 29, 2011. Excluding a $6.4 million compensation charge in the three months ended October 29, 2011 related to the repayment of loans to Mr. Friedman from Home Holdings through the reclassification by Home Holdings of certain ownership units in Home Holdings held by Mr. Friedman at that time, selling, general and administrative expenses increased $17.8 million, or 20.1%. The increase in selling, general and administrative expenses was primarily related to an increase of $8.5 million in advertising and marketing costs associated with increased catalog circulation and an increase of $3.5 million in legal and other professional fees which include a charge of $2.8 million incurred in connection with the investigation conducted by the special committee of the board of directors relating to our former Chairman and Co-Chief Executive Officer, Gary Friedman. Selling, general and administrative expenses in the three months ended October 27, 2012 also included an increase of $2.1 million in compensation related to additional personnel for our expanded distribution centers and an increase in retail store associates to service our increased sales, $1.5 million in credit card fees due to growth in revenues, an increase in occupancy costs of $1.4 million, and an increase in corporate costs of $0.7 million.

Interest expense

Interest expense was $1.5 million in the three months ended October 27, 2012 compared to $1.6 million in the three months ended October 29, 2011.

Income tax benefit

Income tax benefit increased $0.3 million to $1.2 million in the three months ended October 27, 2012 compared to $0.9 million in the three months ended October 29, 2011. Our effective tax rate was (274.4)% in the three months ended October 27, 2012 compared to (15.3)% in the three months ended October 29, 2011. The increase in our tax benefit was primarily due to a net favorable impact related to the conclusion of the Canada Revenue Agency audit examination of Restoration Hardware Canada, Inc. for the years ended 2006 and 2007 and for the period ended June 16, 2008, as well as our ability to utilize California net operating losses to fully offset California tax in the three months ended October 27, 2012.

Net income (loss)

Net income increased $6.5 million to $1.7 million in the three months ended October 27, 2012 compared to a net loss of $4.8 million in the three months ended October 29, 2011. This increase was due to an increase in gross profit of $17.5 million and an increase in income tax benefit of $0.3 million, partially offset by an increase in selling, general and administrative expenses of $11.4 million, discussed above.

Nine Months Ended October 27, 2012 Compared to Nine Months Ended October 29, 2011

Net revenues

Net revenues increased $142.2 million, or 21.8%, to $795.0 million in the nine months ended October 27, 2012 compared to $652.8 million in the nine months ended October 29, 2011. We had 73 and 84 retail stores open at October 27, 2012 and October 29, 2011, respectively. In the nine months ended October 27, 2012, we opened three stores and closed four stores. Of the four closed stores, two were closed at the lease expiration date and two were closed prior to the lease expiration date. There were no charges in 2012 associated with the early closures as the related leases allowed for early termination without charge. In the nine months ended October 29, 2011, we opened three stores and closed ten stores. Of the ten closed stores, six were closed at the lease expiration date and four were closed prior to the lease expiration date. Charges associated with the early store closures in 2011 is discussed in more detail below. Stores sales increased $70.4 million, or 19.4%, to $433.1 million in the nine months ended October 27, 2012 compared to $362.7 million in the nine months ended October 29, 2011 due in large part to our comparable store sales increase of 29% in the nine months ended October 27, 2012 compared to the nine months ended October 29, 2011, partially offset by having fewer stores open during the nine months ended October 27, 2012 compared to the nine months ended October 29, 2011. Direct sales increased $71.8 million, or 24.7%, to $361.9 million in the nine months ended October 27, 2012 compared to $290.1 million in the nine months ended October 29, 2011. We believe that the increase in both comparable store and direct sales was due primarily to our customers' favorable reaction to our merchandise assortment, including the expansion of existing product categories, new product categories, and an increase in catalog pages circulated.

Gross profit

. . .