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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549

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FORM 10-K/A
Amendment No. 1

|(MARK ONE)                                                     |                                                                                         
|-------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                              | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934    
|For the fiscal year ended FEBRUARY 1, 2003                    
|or                                                            
|o                                                              | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|For the transition period
from                              to

Commission file number 000-24261

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RESTORATION HARDWARE, INC.(Exact Name of Registrant as Specified in Its Charter)

|DELAWARE(State or Other Jurisdiction of
Incorporation or Organization) |  | 68-0140361(IRS Employer
Identification No.)
|---------------------------------------------------------------------- |  | -------------------------------------------

15 KOCH ROAD, SUITE J, CORTE MADERA, CA 94925(Address of Principal Executive Offices) (Zip Code)

(415) 924-1005(Registrant's Telephone Number, Including Area Code)

Securities
registered pursuant to Section 12(b) of the Act:None

Title of each class

Name of each exchange
on which registeredNONE

NONE


Securities registered pursuant to Section 12 (g) of the Act:

COMMON STOCK, $0.0001 PAR VALUE(Title of class)

Indicate
by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past
90 days.    ý  Yes    o  No

Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.    o

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act).    ý  Yes    o  No

The
aggregate market value of common stock held by non-affiliates of the registrant was approximately $126,350,988 as of August 2, 2002 based upon the closing price of
the registrant's common stock on The Nasdaq National Market reported for August 2, 2002. For purposes of this calculation, the registrant has assumed that only shares beneficially held by
executive officers and directors of the registrant are deemed shares held by affiliates of the registrant. This assumption of affiliate status is not necessarily a conclusive determination of
affiliate status for any other purpose.

30,054,567
shares of the registrant's $.0001 par value common stock were outstanding on April 25, 2003.

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EXPLANATORY NOTE

This Amendment No. 1 to our Annual Report on Form 10-K for the fiscal year ended February 1, 2003 is being filed for the sole purpose of
correcting a transpositional error regarding income per share, basic and diluted, for the fourth quarter of fiscal 2002 included in Note 16 to our consolidated financial statements for the year
ended February 1, 2003 filed with the Securities and Exchange Commission on May 2, 2003. All other information in the original filing remains unchanged.

2

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEPENDENT AUDITORS' REPORT

To
the Board of Directors and Stockholders
Restoration Hardware, Inc.
Corte Madera, California

We
have audited the accompanying consolidated balance sheets of Restoration Hardware, Inc. and its subsidiaries as of February 1, 2003 and February 2, 2002, and the
related consolidated statements of operations, redeemable convertible preferred stock and stockholders' equity, and cash flows for each of the three fiscal years in the period ended February 1,
2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Restoration Hardware, Inc. and its subsidiaries as of
February 1, 2003 and February 2, 2002, and the results of their operations and their cash flows for each of the three fiscal
years in the period ended February 1, 2003 in conformity with accounting principles generally accepted in the United States of America.

As
discussed in Note 17, the accompanying financial statements for the fiscal year ended February 2, 2002 have been restated.

/s/
Deloitte & Touche LLP

San
Francisco, California
May 2, 2003

3

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RESTORATION HARDWARE, INC.        CONSOLIDATED BALANCE SHEETS        (dollars in thousands)

|                                                                                                                                                                                                                                                                               |                                       | FEBRUARY 1,
2003                                                                   |         | FEBRUARY 2,
2002
(As restated,
see Note 17) |        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------- | ---------------------------------------------------------------------------------- | ------- | ------------------------------------------- | -------
|ASSETS                                                                                                                                                                                                                                                                         |                                      
|Current assets                                                                                                                                                                                                                                                                 |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               | Cash and cash equivalents             |                                                                                    | $       | 1,630                                       |        
|                                                                                                                                                                                                                                                                               | Accounts receivable                   |                                                                                    |         | 3,352                                       |        
|                                                                                                                                                                                                                                                                               | Merchandise inventories               |                                                                                    |         | 94,500                                      |        
|                                                                                                                                                                                                                                                                               | Prepaid expense and other             |                                                                                    |         | 12,445                                      |        
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               |                                       | Total current assets                                                               |         |                                             | 111,927
|                                                                                                                                                                                                                                                                               | Property and equipment, net           |                                                                                    |         | 90,038                                      |        
|                                                                                                                                                                                                                                                                               | Goodwill                              |                                                                                    |         | 4,560                                       |        
|                                                                                                                                                                                                                                                                               | Other assets                          |                                                                                    |         | 19,703                                      |        
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               |                                       | Total assets                                                                       |         | $                                           | 226,228
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY                                                                                                                                                                                                   |                                      
|Current liabilities                                                                                                                                                                                                                                                            |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               | Accounts payable and accrued expenses |                                                                                    | $       | 35,649                                      |        
|                                                                                                                                                                                                                                                                               | Deferred revenue                      |                                                                                    |         | 5,870                                       |        
|                                                                                                                                                                                                                                                                               | Other current liabilities             |                                                                                    |         | 9,322                                       |        
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               |                                       | Total current liabilities                                                          |         |                                             | 50,841 
|Long-term line of credit, net of debt issuance costs                                                                                                                                                                                                                           |                                       |                                                                                    | 13,909  |                                             |        
|Deferred lease incentives                                                                                                                                                                                                                                                      |                                       |                                                                                    | 39,109  |                                             |        
|Deferred rent                                                                                                                                                                                                                                                                  |                                       |                                                                                    | 14,163  |                                             |        
|Other long-term obligations                                                                                                                                                                                                                                                    |                                       |                                                                                    | 144     |                                             |        
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               | Total liabilities                     |                                                                                    |         | 118,166                                     |        
|Series A redeemable convertible preferred stock, $.0001 par value, 28,037 shares designated, 13,470 and 14,320 shares outstanding at February 1, 2003 and February 2, 2002, respectively, aggregate liquidation preference and redemption value
of $15,426 at February 1, 2003 |                                       |                                                                                    | 13,328  |                                             |        
|Stockholders' equity                                                                                                                                                                                                                                                           |                                       |                                                                                    |         |                                             |        
|Common stock, $.0001 par value, 60,000,000 shares authorized, 30,050,994 and 28,827,883 shares issued and outstanding at February 1, 2003 and February 2, 2002, respectively                                                                                                   |                                       |                                                                                    | 150,881 |                                             |        
|Stockholder loan                                                                                                                                                                                                                                                               |                                       |                                                                                    |        |                                             |        
|Unearned compensation                                                                                                                                                                                                                                                          |                                       |                                                                                    | (659    | )                                           |        
|Accumulated other comprehensive loss                                                                                                                                                                                                                                           |                                       |                                                                                    | (132    | )                                           |        
|Accumulated deficit                                                                                                                                                                                                                                                            |                                       |                                                                                    | (55,356 | )                                           |        
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               | Total stockholders' equity            |                                                                                    |         | 94,734                                      |        
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        
|                                                                                                                                                                                                                                                                               |                                       | Total liabilities, redeemable convertible preferred stock and stockholders' equity |         | $                                           | 226,228
|                                                                                                                                                                                                                                                                               |                                       |                                                                                    |         |                                             |        

The
accompanying notes are an integral part of these consolidated financial statements.

4

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RESTORATION HARDWARE, INC.        CONSOLIDATED STATEMENTS OF OPERATIONS        (in thousands, except per share amounts)

|                                                                               |                                                                           | Fiscal Year Ended             |        
|------------------------------------------------------------------------------ | ------------------------------------------------------------------------- | ----------------------------- | -------
|
|Net sales                                                                      |                                                                           | $                             | 400,337
|Cost of sales and occupancy                                                    |                                                                           |                               | 283,072
|                                                                               |                                                                           |                               |        
|                                                                               | Gross profit                                                              |                               |        
|Selling, general and administrative                                            |                                                                           |                               | 126,290
|                                                                               |                                                                           |                               |        
|                                                                               | Loss from operations                                                      |                               |        
|Interest expense                                                               |                                                                           |                               | (3,029 
|Interest income                                                                |                                                                           |                               | 211    
|Change in fair value of warrants                                               |                                                                           |                               | (278   
|                                                                               |                                                                           |                               |        
|                                                                               | Loss before income taxes                                                  |                               |        
|Income tax benefit                                                             |                                                                           |                               | 8,518  
|                                                                               |                                                                           |                               |        
|Loss before cumulative effect of change in accounting principle                |                                                                           |                               | (3,603 
|Cumulative effect of change in accounting principle, net of tax effect of $570 |                                                                           |                               |       
|                                                                               |                                                                           |                               |        
|Net loss                                                                       |                                                                           |                               | (3,603 
|Preferred shareholder return:                                                  |                                                                           |                               |        
|                                                                               |                                                                           | Dividends                     |        
|                                                                               |                                                                           | Beneficial conversion charges |        
|                                                                               |                                                                           |                               |        
|Loss attributable to common stockholders                                       |                                                                           | $                             | (3,961 
|                                                                               |                                                                           |                               |        
|Loss per common sharebasic and diluted:                                       |                                                                           |                               |        
|                                                                               | Loss per share before cumulative effect of change in accounting principle |                               | $      
|                                                                               | Cumulative effect of change in accounting principle                       |                               |        
|                                                                               |                                                                           |                               |        
|                                                                               | Loss per common share                                                     |                               | $      
|                                                                               |                                                                           |                               |        
|Weighted average shares outstanding, basic and diluted                         |                                                                           |                               | 29,754 

The
accompanying notes are an integral part of these consolidated financial statements.

5

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RESTORATION HARDWARE, INC.

CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY

(dollars in thousands)

|                                                       |  | Redeemable
Convertible
Preferred Stock |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     
|------------------------------------------------------ |  | -------------------------------------- | - | - | ------ | - | ---------- |  | - | ------- |  | - | ------ | - | - | ------ | - | - | ----
|
|
|
|BALANCE AT JANUARY 29, 2000                            |  |                                       |   | $ |       |   | 16,901,338 |  | $ | 94,318  |  | $ |       |   | $ |       |   | $ | 26  
|Issuance of common stock, net                          |  |                                       |   |   |       |   | 198,804    |  |   | 583     |  |   |       |   |   |       |   |   |    
|Foreign currency translation adjustment                |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   |       |   |   | (30 
|Net loss                                               |  |                                        |   |   |       |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|                                                       |  |                                        |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     
|BALANCE AT FEBRUARY 3, 2001                            |  |                                       |   |   |       |   | 17,100,142 |  |   | 94,901  |  |   |       |   |   |       |   |   | (4  
|                                                       |  |                                        |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     
|Issuance of common stock, net                          |  |                                       |   |   |       |   | 11,387,741 |  |   | 45,530  |  |   |       |   |   |       |   |   |    
|Issuance of stockholder loan                           |  |                                       |   |   |       |   |           |  |   |        |  |   | (2,050 | ) |   |       |   |   |    
|Issuance of preferred stock, net of issuance costs     |  | 15,000                                 |   |   | 13,440 |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|Beneficial conversion feature                          |  |                                       |   |   | (1,406 | ) |           |  |   | 1,406   |  |   |       |   |   |       |   |   |    
|Accretion of cumulative dividends of preferred stock   |  |                                       |   |   | 1,411  |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|Stock compensation                                     |  |                                       |   |   |       |   |           |  |   | 1,580   |  |   |       |   |   | (1,580 | ) |   |    
|Amortization of unearned stock compensation            |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   | 477    |   |   |    
|Beneficial conversion charge                           |  |                                        |   |   | 1,406  |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|Conversion of preferred stock to common stock          |  | (680                                   | ) |   | (745   | ) | 340,000    |  |   | 745     |  |   |       |   |   |       |   |   |    
|Foreign currency translation adjustment                |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   |       |   |   | (155
|Net loss (As restated, see Note 17)                    |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|                                                       |  |                                        |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     
|BALANCE AT FEBRUARY 2, 2002 (As restated, see Note 17) |  | 14,320                                 |   |   | 14,106 |   | 28,827,883 |  |   | 144,162 |  |   | (2,050 | ) |   | (1,103 | ) |   | (159
|                                                       |  |                                        |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     
|Issuance of common stock, net                          |  |                                       |   |   |       |   | 490,700    |  |   | 1,770   |  |   |       |   |   |       |   |   |    
|Repayment of stockholder loan                          |  |                                       |   |   |       |   |           |  |   |        |  |   | 2,050  |   |   |       |   |   |    
|Tax benefit on exercise of stock options               |  |                                       |   |   |       |   |           |  |   | 873     |  |   |       |   |   |       |   |   |    
|Preferred stock issuance costs                         |  |                                       |   |   | (201   | ) |           |  |   |        |  |   |       |   |   |       |   |   |    
|Conversion of preferred stock to common stock          |  | (850                                   | ) |   | (935   | ) | 425,809    |  |   | 935     |  |   |       |   |   |       |   |   |    
|Exercise of warrants                                   |  |                                       |   |   |       |   | 306,602    |  |   | 2,957   |  |   |       |   |   |       |   |   |    
|Accretion of cumulative dividends of preferred stock   |  |                                       |   |   | 358    |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|Stock compensation                                     |  |                                       |   |   |       |   |           |  |   | 184     |  |   |       |   |   | (92    | ) |   |    
|Amortization of unearned stock compensation            |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   | 536    |   |   |    
|Foreign currency translation adjustment                |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   |       |   |   | 27  
|Net loss                                               |  |                                       |   |   |       |   |           |  |   |        |  |   |       |   |   |       |   |   |    
|                                                       |  |                                        |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     
|BALANCE AT FEBRUARY 1, 2003                            |  | 13,470                                 |   | $ | 13,328 |   | 30,050,994 |  | $ | 150,881 |  | $ |       |   | $ | (659   | ) | $ | (132
|                                                       |  |                                        |   |   |        |   |            |  |   |         |  |   |        |   |   |        |   |   |     

The accompanying notes are an integral part of these consolidated financial statements.

6

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RESTORATION HARDWARE, INC.        CONSOLIDATED STATEMENTS OF CASH FLOWS        (dollars in thousands)

|                                                               |                                                                                          | Fiscal Year Ended                                    |                                                          
|-------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ---------------------------------------------------- | ---------------------------------------------------------
|
|Cash flows from operating activities:                          |                                                                                          |                                                      |                                                          
|                                                               | Net loss                                                                                 |                                                      | $                                                        
|                                                               | Adjustments to reconcile net income (loss) to net cash provided by operating activities: |                                                      |                                                          
|                                                               |                                                                                          | Cumulative effect of change in accounting principle  |                                                          
|                                                               |                                                                                          | Change in fair value of warrants                     |                                                          
|                                                               |                                                                                          | Depreciation and amortization                        |                                                          
|                                                               |                                                                                          | Impairment of fixed assets                           |                                                          
|                                                               |                                                                                          | Other                                                |                                                          
|                                                               |                                                                                          | Deferred income taxes                                |                                                          
|                                                               |                                                                                          | Changes in assets and liabilities:                   |                                                          
|                                                               |                                                                                          |                                                      | Accounts receivable                                      
|                                                               |                                                                                          |                                                      | Merchandise inventories                                  
|                                                               |                                                                                          |                                                      | Prepaid expenses and other assets                        
|                                                               |                                                                                          |                                                      | Accounts payable and accrued expenses                    
|                                                               |                                                                                          |                                                      | Tax payable                                              
|                                                               |                                                                                          |                                                      | Deferred revenue                                         
|                                                               |                                                                                          |                                                      | Other current liabilities                                
|                                                               |                                                                                          |                                                      | Deferred rent                                            
|                                                               |                                                                                          |                                                      | Deferred lease incentives and other long-term liabilities
|                                                               |                                                                                          |                                                      |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|Cash flows from investing activities:                          |                                                                                          |                                                      |                                                          
|                                                               | Proceeds from disposal of fixed assets                                                   |                                                      |                                                          
|                                                               | Capital expenditures                                                                     |                                                      |                                                          
|                                                               | Purchase of The Michaels Furniture Co.                                                   |                                                      |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|                                                               |                                                                                          | Net cash (used in) provided by investing activities  |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|Cash flows from financing activities:                          |                                                                                          |                                                      |                                                          
|                                                               | Net proceeds from private placement of preferred stock                                   |                                                      |                                                          
|                                                               | Net proceeds from private placements of common stock                                     |                                                      |                                                          
|                                                               | Borrowings (repayments) under revolving line of creditnet                               |                                                      |                                                          
|                                                               | Debt and preferred stock issuance costs                                                  |                                                      |                                                          
|                                                               | Repayment of shareholder loan                                                            |                                                      |                                                          
|                                                               | Borrowings (repayments)other debt                                                       |                                                      |                                                          
|                                                               | Issuance of common stock                                                                 |                                                      |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|                                                               |                                                                                          | Net cash provided by financing activities            |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|Effects of foreign currency exchange rate translation on cash: |                                                                                          |                                                      | 27                                                       
|                                                               |                                                                                          |                                                      |                                                          
|                                                               |                                                                                          | Net (decrease) increase in cash and cash equivalents |                                                          
|Cash and cash equivalents:                                     |                                                                                          |                                                      |                                                          
|                                                               | Beginning of period                                                                      |                                                      |                                                          
|                                                               |                                                                                          |                                                      |                                                          
|                                                               | End of period                                                                            |                                                      | $                                                        
|                                                               |                                                                                          |                                                      |                                                          
|Additional cash flow information:                              |                                                                                          |                                                      |                                                          
|                                                               | Cash paid during the year for interest (net of amount capitalized)                       |                                                      | $                                                        
|                                                               | Cash (received) paid during the year for taxes                                           |                                                      |                                                          
|Non-cash transactions:                                         |                                                                                          |                                                      |                                                          
|                                                               | Stockholder loan                                                                         |                                                      | $                                                        
|                                                               | Beneficial conversion featurepreferred stock                                            |                                                      |                                                          
|                                                               | Beneficial conversion chargepreferred stock                                             |                                                      |                                                          
|                                                               | Dividends attributable to preferred stock                                                |                                                      |                                                          
|                                                               | Exercise of warrants                                                                     |                                                      |                                                          
|                                                               | Conversion of preferred stock to common stock                                            |                                                      |                                                          

The accompanying notes are an integral part of these consolidated financial statements.

7

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RESTORATION HARDWARE, INC.        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)   SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

Restoration Hardware, Inc. and its subsidiaries (the "Company"), a Delaware corporation, is a specialty retailer of high-quality home
furnishings, decorative accessories and hardware. These products are sold through retail locations, catalogs and the Internet. At February 1, 2003, the Company operated a total of 105 retail
stores in 31 states, the District of Columbia and in Canada. The Company operates on a 5253 week fiscal year ending on the Saturday closest to January 31. The fiscal year ended
February 3, 2001 ("Fiscal 2000") included 53 weeks. The fiscal years ended February 1, 2003 ("Fiscal 2002") and February 2, 2002 ("Fiscal 2001") included 52 weeks.

Principles of Consolidation

The consolidated financial statements include the accounts of Restoration Hardware, Inc. and its subsidiaries. All inter-company balances and transactions
are eliminated in consolidation.

Use of Accounting Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the reporting period. The Company's significant accounting estimates include lower of cost or market write-downs on inventory,
expected future cash flows in the review for impairment on long-lived assets, the adequacy of self insurance reserves, realization of deferred tax assets, including the potential need for
valuation allowances on these tax assets, and sales returns reserves. Actual results for these and other estimates could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

Accounts Receivable

Accounts receivable consist primarily of receivables from the Company's credit card processors for sales transactions, and tenant improvement allowances from the
Company's landlords in connection with new leases. The Company has typically not provided an allowance for doubtful accounts for these receivables, as its bad debt experience has been insignificant.

Merchandise Inventories

The Company's retail inventories are stated at the lower of cost or market with cost determined on a weighted average cost method. Manufacturing inventories are
stated at the lower of cost or market with cost determined on a first-in, first-out method. Cost includes certain buying and distribution costs, including merchant payroll and
other costs related to the purchase of inventory, as well as payroll and other costs to process inventory at the Company's distribution centers. A write-down, when necessary, has been made
to reduce excess or obsolete inventory to its net realizable value.

8

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Deferred Catalog Expenses

Deferred catalog expenses consist of the cost to produce, print and distribute catalogs, primarily for creative design, paper, printing, postage and mailing
costs. Such costs are amortized over the expected sales volume of each catalog. The amortization is based on the ratio of actual sales to date to the total sales estimated for the life of the catalog.
Typically, over 90% of the cost of a catalog is amortized in the first four months, and all catalog costs are generally fully amortized within six months. At February 1, 2003 and
February 2, 2002, the Company had $1.6 million and $1.0 million, respectively, recorded as other assets.

Property and Equipment

Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful life of the asset,
typically ranging from three to ten years for all property and equipment except for leasehold improvements and lease acquisition costs. The cost of leasehold improvements is amortized over the useful
life of the asset or the applicable lease term, whichever is less.

Capitalization of Interest

The interest-carrying costs of capital assets under development or construction are capitalized based on the Company's weighted average borrowing rate. During the
fiscal years ended February 1, 2003, February 2, 2002 and February 3, 2001, $15,000, $15,000 and $195,000, respectively, of interest was capitalized and included as part of
property and equipment.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in the purchase of The Michaels Furniture Company. In fiscal
2001 and 2000, goodwill was amortized on a straight-line basis over 25 years. In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142,
"Goodwill and Other Intangible Assets," which became effective for the Company on February 1, 2002. The Company reviews goodwill and other
intangibles with indefinite useful lives for impairment annually, or more frequently if events or changes in circumstances warrant. If the carrying values of such assets exceed their estimated fair
values, the Company records an impairment loss to write the assets down to their estimated fair values. There were no impairment charges recorded against goodwill in fiscal 2002 or fiscal 2001. The
Company had $4.6 million of goodwill at February 1, 2003 and February 2, 2002.

Capitalized Leases

Noncancellable leases which meet the criteria of capital leases are capitalized as assets and amortized over the lease term, using the effective interest method.

Impairment of Long-Lived Assets

The Company's policy is to review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable based on estimated future cash flows calculated on a store by store basis. In the fiscal years ended February 1, 2003 and
February 2, 2002, the Company recorded $0.6 million and $10.2 million, respectively, of impairment charges on the long-lived assets of one and eight, respectively,
under-performing stores. The impairment charge was equal to the difference between the carrying value of such long-lived assets and the present value of estimated future cash flows for
those stores.

9

---

Store Closure Reserves

Prior to January 1, 2003, the Company recorded the estimated costs associated with closing a store during the period in which the store was identified and
approved by management under a plan of termination, which included the method of disposition and the expected date of completion. These costs included direct costs to terminate a lease, lease rental
payments net of expected sublease income, and the difference between the carrying values and estimated recoverable values of long-lived tangible and intangible assets. Severance and other
employee-related costs were recorded in the period in which the closure and related severance packages were communicated to the affected employees. No such reserves were provided for the reporting
periods presented.

Effective
with the adoption of Statement of Financial Accounting Standards ("SFAS") No. 146,Accounting for Costs Associated with Exit or Disposal
Activities, on January 1, 2003 (see "New Accounting Pronouncements"), the Company recognizes a liability for costs associated with closing a store when the liability is
incurred. The present value of expected future lease costs and other closure costs is recorded when the store is closed. Severance and other employee-related costs are recorded in the period in which
the closure and related severance packages are communicated to the affected employees. Accretion of the discounted present value of expected future costs is recorded in operations. Store closure
reserves are reviewed and adjusted periodically based on changes in estimates. No such reserves were recorded at February 1, 2003.

Accounts Payable

Accounts payable represents amounts owed to third parties at the end of the period. Accounts payable includes overdraft balances of approximately
$9.9 million and $13.7 million at February 1, 2003 and February 2, 2002, respectively.

Self Insurance

The Company is self insured for workers' compensation. The self-insurance liability is determined based on an independent third party actuarial
report. The liability is based on claims filed and an estimate of claims incurred but not yet reported. At February 1, 2003 and February 2, 2002, the Company had recorded accruals for
workers compensation of approximately $1.5 million and $2.1 million, respectively.

Deferred Rent

Certain of the Company's operating leases contain predetermined fixed escalations of the minimum rentals during the original term of the lease. For these leases,
the Company recognizes the related rental expense on a straight-line basis over the life of the lease and records the difference between the amount charged to operations and amounts paid
as deferred rent.

Deferred Lease Incentives

As part of its lease agreements, the Company receives certain lease incentives. These allowances have been deferred and are amortized on a
straight-line basis over the life of the lease as a reduction of rent expense.

Revenue Recognition

Retail Store Sales:Revenue is recognized at the point of sale for all purchases that are taken from the store by the
customer at the time of purchase.

10

---

Furniture Sales:Furniture sales are recorded in either the direct-to-customer or retail segments
depending upon where the sales transaction was originated. The majority of furniture sales are delivered to the customer. Revenue for these sales is recognized at the time of customer receipt.

Non-FurnitureDirect-to-Customer (Catalog and Internet) Sales:Revenue is
recognized upon delivery to the customer.

Shipping and Handling:The Company records shipping and handling fees as net revenue in the sales channel segment (retail
store or direct-to-customer) that originated the sales transaction. Shipping and handling fees included in revenues were approximately $8.4 million, $7.1 million
and $5.7 million in fiscal 2002, 2001 and 2000, respectively. Costs of shipping and handling are included in cost of sales and occupancy and were approximately $12.3 million,
$9.1 million and $7.3 million in fiscal 2002, 2001 and 2000, respectively.

Returns:The Company provides an allowance for sales returns based upon historical return rates. At each of
February 1, 2003 and February 2, 2002, the Company had recorded reserves for sales returns of $1.1 million.

Cost of Sales and Occupancy

Cost of sales and occupancy includes total cost of products sold, occupancy costs for all store locations, inventory shrink; letter of credit fees; inventory
write-downs; inbound freight costs; samples; employment and travel costs for product buying and development personnel; product distribution costs including facilities, equipment, personnel,
distribution center to store freight costs; and costs to deliver product to customers.

Selling, General and Administrative Expenses

Selling, general and administrative expense includes all costs related to sales associates, including payroll and benefits, all corporate personnel cost,
including payroll and benefits, supplies, store display and signage, store utility costs, the amortization of catalog production costs, print advertising and other marketing expenses, credit card
fees, third party fees including telemarketing expenses, internet hosting charges, telecommunications expense for the stores and corporate offices, toll free phone numbers for catalog and other direct
marketing orders, corporate insurance, depreciation on corporate assets such as computers and leasehold improvements, bad debt expense, check guarantee fees and professional fees.

Advertising Expense

Advertising costs are expensed as incurred. For the fiscal years ended February 1, 2003, February 2, 2002 and February 3, 2001, advertising
costs were approximately $23.5 million, $16.1 million and $14.9 million, respectively.

Start-up Activities

All start-up and pre-opening costs are expensed as incurred.

Concentrations

The Company made approximately 16% of its inventory purchases from two vendors in fiscal 2002.

Taxes on Earnings

SFAS 109,Accounting for Income Taxes, requires income taxes to be accounted for under an asset and
liability approach that requires the recognition of deferred tax assets and liabilities for the expected

11

---

future
tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, all expected future events then known to
management are considered other than changes in the tax law or rates. At February 1, 2003, the Company has recorded a $3 million tax valuation allowance against its deferred tax assets
to reduce such assets to the amount that are more likely than not to be realized.

Estimated Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, accounts receivable, accounts payable and borrowings under the revolving line of credit approximate their
estimated fair values. Estimated fair value disclosures have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment
is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize
in a current market exchange. The use of different market assumptions and estimation methodologies may have a material effect on the estimated fair value amounts.

Earnings Per Share

Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is
computed by dividing net income by the weighted average number of common stock and dilutive common stock equivalents (stock options, convertible preferred stock and warrants) outstanding during the
period. Diluted EPS reflects the potential dilution that could occur if options or warrants to issue common stock were exercised, or preferred stock was converted into common stock. The following
table details potential dilutive effects of certain common stock equivalents that have been excluded from diluted earnings per share, because their inclusion would be anti-dilutive, since
the Company experienced a net loss in each of the three fiscal years:

|                                                                                                                                                                      |                                                                                                                                                     | February 1, 2003 |           | February 2, 2002 |           | February 3, 2001
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------- | --------- | ---------------- | --------- | ----------------
|Convertible preferred stock, options and warrants that were excluded from weighted average diluted shares because their effect would be anti-dilutive in loss periods |                                                                                                                                                     |                  |           |                  |           |                 
|                                                                                                                                                                      | Shares of common stock subject to outstanding options                                                                                               |                  | 996,110   |                  | 573,867   |                 
|                                                                                                                                                                      | Shares of common stock subject to outstanding warrants                                                                                              |                  |          |                  | 405,226   |                 
|                                                                                                                                                                      | Shares of common stock subject to conversion from the Series A preferred stock                                                                      |                  | 6,764,425 |                  | 7,160,000 |                 
|                                                                                                                                                                      |                                                                                                                                                     |                  |           |                  |           |                 
|                                                                                                                                                                      | Total common stock equivalents excluded from the weighted average shares outstanding calculation because their effect would have been anti-dilutive |                  | 7,760,535 |                  | 8,139,093 |                 
|                                                                                                                                                                      |                                                                                                                                                     |                  |           |                  |           |                 

Comprehensive Income

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss) (primarily foreign currency translation adjustments). The
components of comprehensive income (loss) are presented in the consolidated statements of redeemable convertible preferred stock and stockholders' equity.

12

---

Foreign Currency Translation

In the preparation of consolidated financial statements, the assets and liabilities of the Company's Canadian subsidiary are denominated in Canadian dollars and
translated to US dollars at the rate of exchange in effect at the balance sheet date; income and expenses are translated at average rates of exchange prevailing during the year. The related
translation adjustments are reflected in the other comprehensive income section of the consolidated statements of redeemable convertible preferred stock and stockholders' equity. Almost all of the
revenues of the Company are generated in US dollars. However, foreign currency gains and losses resulting from transactions denominated in foreign currencies, including inter-company transactions, are
included in operations and have not been significant to date.

Derivative Instruments and Hedging Activities

SFAS
No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended, requires the Company to record all
derivatives as either assets or liabilities on the balance sheet and to measure those instruments at fair value. The Company did not hold or trade any derivative instruments in fiscal 2002, 2001 or
2000.

Stock-based Compensation

The Company has one stock-based employee compensation plan, as described in Note 9. The Company accounts for stock-based employee compensation using the
intrinsic value method in accordance with the provisions of APB Opinion No. 25,Accounting for Stock Issued to Employees. The following table
illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based
Compensation,to all stock-based employee compensation:

|                                                                                                                               |                                | FISCAL YEAR ENDED |       
|------------------------------------------------------------------------------------------------------------------------------ | ------------------------------ | ----------------- | ------
|
|Loss attributable to common stockholders                                                                                       |                                |                   |       
|                                                                                                                               | As reported                    |                   | $     
|Add: Stock based compensation expense for options granted below fair market value included in reported net loss (net of tax)   |                                |                   | 336   
|Deduct: Compensation expense for all stock based compensation (net of tax) calculated in accordance with the fair value method |                                |                   | (3,056
|                                                                                                                               |                                |                   |       
|Pro forma loss                                                                                                                 |                                | $                 | (6,681
|                                                                                                                               |                                |                   |       
|Net (loss) per share:                                                                                                          |                                |                   |       
|                                                                                                                               | Basic and diluted, as reported |                   | $     
|                                                                                                                               | Basic and diluted, pro forma   |                   | $     

13

---

The Company estimates the fair value of stock option grants using the Black-Scholes option pricing model, with the following weighted average assumptions:

FISCAL YEAR ENDEDFEBRUARY 1,
2003

FEBRUARY 2,
2002

FEBRUARY 3,
2001Dividend yield





Expected volatility

102
%
50
%
21
%Risk-free interest rate

3.71
%
2.28
%
4.90
%Expected life (years)

4.5

3.0

4.5


New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142,Goodwill and Other Intangible
Assets,which became effective for the Company on February 3, 2002. SFAS No. 142 specifies that goodwill and certain intangible assets will no longer be amortized
but instead will be
subject to periodic impairment testing. As discussed further in Note 2, the adoption of this standard did not have a material impact on the Company's financial position or results of
operations.

In
August 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.
SFAS No. 144 establishes accounting and reporting standards for the impairment of long-lived assets and for long-lived assets to be disposed of. The Company adopted SFAS
No. 144 in the first quarter of fiscal 2002. The initial adoption of SFAS No. 144 did not have a significant impact on the Company's reporting for impairment or disposals of
long-lived assets.

In
June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities, which
addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The
Company has adopted the provisions of SFAS No. 146 for restructuring activities, if any, initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of
recognizing future restructuring costs as well as the amounts recognized.

In
November 2002, the FASB issued Interpretation ("FIN") No. 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about
obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The disclosure requirements of FIN No. 45 are effective for interim and annual periods ending after December 15, 2002, and the initial recognition and measurement
requirements are effective prospectively for guarantees issued or modified after December 31, 2002. The initial adoption of FIN No. 45 did not have a material impact on the Company's
financial position or results of operations.

In
December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based CompensationTransition and Disclosure.SFAS
No. 148 amends SFAS No. 123,Accounting for Stock-Based Compensation,to provide alternative methods of transition for a voluntary change
to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition
guidance and annual disclosure provisions of SFAS No. 148 are effective for the Company's fiscal year ended

14

---

February 1,
2003. The interim disclosure provisions are effective for the first quarter of the fiscal year ending January 31, 2004. The Company continues to account for stock-based
compensation using the intrinsic value method in accordance with the provisions of APB Opinion No. 25,Accounting for Stock Issued to Employees,
as allowed by SFAS No. 123. As a result, the adoption of SFAS No. 148 did not have any impact on the Company's consolidated financial results.

In
November 2002, the Emerging Issues Task Force ("EITF") reached a consensus regarding EITF Issue No. 02-16,Accounting by a Customer
(including a Reseller) for Certain Consideration Received from a Vendor. Issue No. 02-16 addresses the timing of recognition and classification of
consideration received from vendors, including rebates and allowances. The adoption of Issue No. 02-16 did not have a material impact on the Company's financial statements.

In
January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entitiesan interpretation of ARB No. 51." FIN No. 46 requires that
variable interest entities be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or is entitled to receive a majority
of the entity's residual returns or both. FIN No. 46 also requires disclosures about variable interest entities that are not required to consolidate but in which a company has a significant
variable interest. The consolidation requirements of FIN No. 46 will apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements will
apply to entities established on or prior to January 31, 2003 in the first fiscal year or interim period beginning after June 15, 2003. The disclosure requirements will apply in all
financial statements issued after January 31, 2003. The Company has not evaluated whether the application of FIN 46 will have a material effect on its financial statements.

Reclassifications

The Company has reclassified $8.1 million and $9.4 million for fiscal 2001 and fiscal 2000, respectively, of distribution costs into cost of sales
and occupancy that were previously included in selling, general and administrative expenses. Certain other reclassifications have been made to the presentation of prior year results in order to
conform to the current year presentation.

(2)   GOODWILL

Upon the adoption of SFAS No. 142,Goodwill and Other Intangible Assets, at the beginning of fiscal 2002,
the Company discontinued the amortization of goodwill with a carrying value of $4.6 million. Had the non-amortization provisions of SFAS No. 142 been applied for the fiscal
years ended February 2, 2002 and February 3, 2001, the Company's net loss available to common stockholder and loss per common share would have been as follows (in thousands, except per
share amounts):

Fiscal Year Ended(Dollars in thousands, except per share amounts)2002

2001

2000Loss attributable to common stockholders:Reported loss attributable to common stockholders

$
(3,961
)
$
(35,373
)
$
(4,560
)Goodwill amortization, net of tax effect





138


138Adjusted loss attributable to common stockholders

$
(3,961
)
$
(35,235
)
$
(4,422
)Basic and diluted loss per common share:Reported loss per share

$
(0.13
)
$
(1.51
)
$
(0.27
)Goodwill amortization, net of tax effect





0.00


0.01Adjusted loss per common share

$
(0.13
)
$
(1.51
)
$
(0.26
)


15

---

(3)   PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):

FEBRUARY 1, 2003

FEBRUARY 2, 2002Leasehold improvements

$
109,902

$
101,487Furniture, fixtures and equipment


44,463


40,725Equipment under capital leases


1,041


1,035Total


155,406


143,247Less accumulated depreciation and amortization


(65,368
)

(55,313
)Property and equipment, net

$
90,038

$
87,934


(4)   LEASES

The Company leases certain property consisting of retail stores, corporate offices, distribution centers and equipment. Leases expire at various dates through
2018. The retail stores, distribution centers and corporate office leases generally provide that the Company assumes the maintenance and all or a portion of the property tax obligations on the leased
property. Most store leases also provide for minimum annual rentals, with provisions for additional rent based on a percentage of sales and for payment of certain expenses.

The
aggregate future minimum rental payments under leases in effect at February 1, 2003 are as follows (in thousands):

FISCAL YEAR ENDING

CAPITAL
LEASES

OPERATING
LEASES

TOTAL2003

$
238

$
36,195

$
36,4332004


20


35,231


35,2512005


18


34,755


34,7732006





34,072


34,0722007





33,284


33,284Thereafter





139,386


139,386Minimum lease commitments


276

$
312,923

$
313,199Less amount representing interest


(18
)Present value of capital lease obligations


258Less current portion


(224
)Long-term portion

$
34


Minimum
and contingent rental expense, which is based upon certain factors such as sales volume, under operating leases, are as follows (in thousands):

FISCAL YEAR ENDEDFEBRUARY 1, 2003

FEBRUARY 2, 2002

FEBRUARY 3, 2001Operating leases:Minimum rental expense

$
37,482

$
36,078

$
34,965Contingent rental expense


613


555


838Total

$
38,095

$
36,633

$
35,803


16

---

(5)   REVOLVING LINE OF CREDIT AND DEBT

At February 1, 2003, the Company had in place a credit facility with an overall commitment of $72.0 million, of which $25.0 million was
available for letters of credit. As of February 1, 2003, the Company had $15.2 million outstanding under the line of credit (before unamortized debt issuance costs of
$1.3 million), and $14.0 million in outstanding letters of credit. Interest is paid monthly at the bank's reference rate or LIBOR plus a margin. As of February 1, 2003, the bank's
reference rate was 5.75% and the LIBOR plus margin rate was 4.09%. The availability of credit at any given time under the credit facility is limited by reference to a borrowing base formula based upon
numerous factors, including eligible inventory and eligible accounts receivable. The amount available under the credit facility may be less than the stated maximum of the facility. As of
February 1, 2003, in addition to outstanding borrowings and letter of credit obligations totaling $29.2 million, the Company had availability to borrow up to $23.4 million. The
credit facility contains various restrictive covenants, including limitations on the Company's annual capital expenditures, ability to incur additional debt, acquisition of other businesses and
payment of dividends and other distributions. The agreement expires on June 30, 2004.

On
August 30, 2002, the Company amended its credit facility, primarily to (1) reduce the overall commitment from $80.0 million to $72.0 million; (2) to
provide, at the Company's election, for an additional $5.0 million of availability above the maximum available designated by formula for any continuous 60-day period between
August 1 and October 31 of any year (not to exceed the $72.0 million overall commitment); (3) to extend the expiration date by twelve months to June 30, 2004; and
(4) to provide a more favorable interest rate structure. In November 2002, the credit facility was further amended and restated to reflect a number of minor revisions and updates to the
then-existing credit facility documentation.

In
connection with an amendment to the Company's line of credit in September 2000, the Company issued putable warrants for the purchase of 550,000 shares of its common stock,
subject to anti-dilution protections at $3.75 per share. In connection with the amendment of the credit facility in March 2001, 200,000 of the 550,000 warrants were repriced to
$2.00 per share. The fair value of the warrants is calculated each quarter using the Black-Scholes model. The following assumptions were used in the Company's calculation as of February 2,
2002: expected life of 20 months, stock volatility considered to be 50%, risk free interest rate of 2.28%, and no dividends during the expected term. For fiscal 2001, the
mark-to-market revaluation of the warrants resulted in a charge of approximately $2.7 million against earnings. The warrants were to expire on September 27, 2005,
and, as of February 2, 2002 warrants for the purchase of approximately 405,000 shares of common stock remained outstanding. During the first quarter of fiscal 2002, all of the remaining
warrants were exercised.

(6)   INCOME TAXES

The Company accounts for income taxes using the asset and liability method under SFAS No. 109,Accounting for Income
Taxes. The Company provides a deferred tax expense or benefit for differences between financial accounting and tax reporting. Deferred income taxes represent future net tax
effects of temporary differences between the financial statement and tax basis of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to
reverse.

17

---

The
income tax benefit consisted of (in thousands):

FISCAL YEAR ENDEDFEBRUARY 1,
2003

FEBRUARY 2,
2002

FEBRUARY 3,
2001Current:Federal

$
(4,170
)
$
(1,970
)
$
1,394State


(243
)

(152
)

326Foreign





(2
)

Total current payable


(4,413
)

(2,124
)

1,720Deferred:Federal


(3,639
)

(3,462
)

(3,169
)State


(432
)

(2,605
)

(787
)Foreign


(34
)

(715
)

Total deferred


(4,105
)

(6,782
)

(3,956
)Income tax benefit

$
(8,518
)
$
(8,906
)
$
(2,236
)


Significant
components of the Company's deferred tax assets and liabilities are as follows (in thousands):

FEBRUARY 1,
2003

FEBRUARY 2,
2002

FEBRUARY 3,
2001Current deferred tax asset (liability)Accrued expense

$
2,390

$
1,656

$
827State tax benefit


(1,582
)

(1,433
)

(444
)Inventory


1,983


3,485


1,059Deferred Revenue


2,287


655


446Prepaid Expenses


(1,799
)

(615
)

(1,041
)Other


317





Net current deferred tax asset


3,596


3,748


847Long-term deferred tax asset (liability):Derivative warrant liability


1,238


1,121


Deferred lease credits


(2,137
)

(758
)

355Property and equipment


11,314


8,833


6,560Net operating loss carryforwards


7,882


8,398


239AMT Credit





441


Net long-term deferred tax asset


18,297


18,035


7,154Total deferred tax assets before valuation allowance


21,893


21,783


8,001Valuation Allowance


(3,000
)

(7,000
)

Net deferred tax asset

$
18,893

$
14,783

$
8,001


18

---

A
reconciliation of the federal statutory tax rate to the Company's effective state rate is as follows:

FISCAL YEAR ENDEDFEBRUARY 1,
2003

FEBRUARY 2,
2002

FEBRUARY 3,
2001Provision at statutory tax rate

(34.0
)%
(34.0
)%
(34.0
)%State income taxes, net of federal tax benefit

(3.7
)%
(4.4
)%
(5.1
)%Other

0.0
%
0.0
%
1.7
%Valuation allowance provided (reversals)

(32.7
)%
16.9
%
0.0
%Total

(70.4
)%
(21.5
)%
(37.4
)%


As
of February 1, 2003, the Company had federal, state and foreign net operating loss carryovers of approximately $15.1 million, $21.9 million and
$1.0 million, respectively. These net operating loss carryovers will expire between 2008 and 2022. Using its best estimates, the Company has established a valuation allowance of
$3.0 million at February 1, 2003, on certain of its federal and state deferred tax assets as it is not likely that they will be realized.

The
fiscal 2002 income tax benefit rate reflects a $4 million reduction in the valuation allowance established on the Company's deferred tax assets. The reduction in the valuation
allowance was due to the additional realization of net operating loss carryback amounts, resulting from the economic stimulus bill enacted on March 9, 2002. The fiscal 2001 income tax benefit
was net of a $7 million valuation
allowance provision to reduce deferred tax assets to an amount that management believed was more likely than not to be realized.

Internal
Revenue Code Section 382 and similar state rules place a limitation on the amount of taxable income which can be offset by net operating loss carryforwards after a change
in control (generally greater than 50% change in ownership). Due to these provisions, utilization of the net operating loss and tax credit carryforwards may be limited.

(7)   REDEEMABLE CONVERTIBLE PREFERRED STOCK

In March 2001, the Company completed a sale of the preferred stock with aggregate proceeds to the Company of approximately $15 million. The initial
sale in March 2001 included the sale of 6,820 shares of Series A preferred stock and 8,180 shares of Series B preferred stock, for $1,000 per share. The shares of Series B
were converted on a one-for-one basis into shares of Series A preferred stock upon the approval of such conversion by the Company's stockholders in July 2001.
Each share of preferred stock has a par value of $.0001 per share.

Convertibility

The Series A is immediately convertible at the option of the holder into shares of the Company's common stock. The initial conversion formula is equal to
the original issue price ($1,000) divided by $2.00 per share. Therefore, each share of Series A is initially convertible into 500 shares of common stock. The conversion price of the
Series A is subject to certain adjustments for future dilutive events. The Company may require conversion of the Series A, in whole or in part, by sending written notice of the request
for conversion to holders of Series A at any time after March 22, 2004, if the average closing price per share of the common stock exceeds three times the then-current
conversion price of the Series A for the 20 trading days ending 3 business days preceding the date that the written request is sent. Upon the Company's notice of conversion, holders of
Series A shall be deemed to have demanded registration of their shares of common stock received upon conversion of the Series A. If such holders subsequently choose not to include their
shares in a registration statement, they may request redemption of their shares of Series A, in which case the Company must redeem the shares of

19

---

Series A
in accordance with the terms of the Certificate of Designation of Series A and Series B Preferred Stock (the "Certificate of Designation"). Any such redemption would be
at a redemption price of $1,000 plus all accrued and unpaid dividends. If the holders do not include their common stock in the registration statement, but also do not request redemption, their shares
of Series A will automatically convert into common stock. The conversion price into common stock of $2.00 represents a discount to the fair market value of the common stock of $2.1875 at
March 21, 2001, the date on which the preferred stock equity financing was entered into (herein referred to as a "beneficial conversion feature"). The beneficial conversion feature on the
Series A of $639,375 was recorded as a return to the preferred stockholders in March 2001 since the Series A were immediately convertible into common stock. The beneficial
conversion feature on the Series B of $766,875 was initially being recorded as a return to the preferred stockholders over three years, the minimum period at which these stockholders could
realize a return through the conversion to common stock. In the second quarter of fiscal 2001, upon the conversion of Series B into Series A, the unamortized balance of the beneficial
conversion feature of approximately $707,000 was recorded as a return to the preferred stockholders as the shares became immediately convertible into common stock.

Redemption

The Company may redeem the Series A, in whole or part, at any time after March 22, 2006, on at least 30 days prior written notice requesting
redemption, at a redemption price per share equal to the greater of (a) the average of the closing price per share of the common stock for 20 trading days ending three business days prior to
the date that the written request is sent, or (b) $1,000 per share plus all accrued and unpaid dividends.

Dividends

If the Company's Board of Directors declares a dividend, each share of Series A is entitled to dividends at the rate of $100 per share per annum. Such
dividends are cumulative and deemed to have accrued from the original date of issuance of the Series A for purposes of determining the liquidation preferences of the holders of the
Series A and in connection with the exercise of the Company's redemption rights and the redemption rights of the holders of Series A electing to redeem the Company's conversion rights
described above and in the Certificate of Designation. Such dividends shall not be deemed to be cumulative and shall not be deemed to have so accrued upon any conversion of the Series A into
common stock. The Company shall not pay or declare any dividend on any common stock or any of its other securities that are junior to the Series A during any fiscal year unless and until full
dividends on the Series A are declared and paid for such fiscal year.

In
August 2002, the holders of the Company's Series A preferred stock agreed to waive their dividend participation right in the event the Company were to declare a dividend
on its common stock. In the same agreement, the Company agreed that it will not declare any dividends payable to its common stock holders until the Company first obtains the approval of the holders of
at least seventy percent of the then outstanding shares of Series A preferred stock. The Company has never declared or paid any dividends on its common stock and has no obligation to do so.
Beginning with the second quarter of fiscal 2002, the Company no longer records dividend charges related to its outstanding Series A preferred stock. Such charge totaled $0.4 million for
fiscal 2002.

Voting

Holders of the Series A generally have the right to one vote for each share of common stock into which such Series A is convertible. Subject to the
terms of the preferred stock purchase agreement entered into by and among the Company and the holders of Series A named therein and the Certificate of Designation, the holders of the
Series A are entitled to elect two designees to the Board of Directors. At least one of the designees shall also be entitled to serve on all committees of the

20

---

Board
of Directors. In addition, the holders of Series A vote separately as a class in certain circumstances, including, without limitation, amendments to the Company's Second Amended and
Restated Certificate of Incorporation, as amended, creation or issuance by the Company of any new class of securities having a preference senior to or on parity with the Series A, declaration
or payment by the Company of any dividends or other distributions on the common stock, or the Company entering into certain transactions involving a merger, consolidation, or sale of all or
substantially all of its assets.

Liquidation Preference

If the Company were dissolved or liquidated, voluntarily or involuntarily, the holders of the Series A would be entitled to receive, prior and in
preference to any distribution of the Company's assets to the holders of any of its other equity securities, an amount equal to the greater of: (a) $1,000 per share (as adjusted for any stock
splits, stock dividends and recapitalizations) plus accrued and unpaid dividends; or (b) the amount which such holder of the Series A would have received assuming all shares of
Series A had been converted into common stock at the then applicable conversion rate immediately prior to any such dissolution or liquidation. If the Company has insufficient assets and funds
to distribute to the holders of Series A their full liquidation preference, then all of its assets and funds legally available for distribution shall be distributed pro rata among the holders
of the Series A in proportion to the preferential amount each such holder is entitled to receive.

In
addition, certain events, including, without limitation, a sale of all or substantially all of the Company's assets, or a change of control of the Company, may be designated by
holders of Series A as a liquidation or dissolution, in which case, the above-described mechanisms for distribution of the Company's assets are applicable.

Registration

As part of this private placement of preferred stock, the Company filed with the Securities and Exchange Commission on October 1, 2001 a registration
statement on Form S-3 for the resale of the common stock issued or issuable upon conversion of the Series A preferred stock to certain stockholders. The registration
statement became effective on October 31, 2002.

(8)   COMMON STOCK

In June 1998, following the Company's reincorporation in Delaware, the Company adopted a Second Amended and Restated Certificate of Incorporation. In
October 2001, the Company amended its Second Amended and Restated Certificate of Incorporation to increase the number of authorized shares of the Company. The Second Amended and Restated
Certificate of Incorporation, as amended, authorizes the Company to issue up to 60,000,000 shares of common stock, par value $.0001 per share, and 5,000,000 shares of preferred stock, par value $.0001
per share.

21

---

At
February 1, 2003, the Company has reserved the following shares of common stock for issuance in connection with:

Issuable upon
conversion or
exercise of
outstanding
securities

Available for
future sales
and grants

Total shares of
common stock
reservedSeries A preferred stock

6,764,425



6,764,425Stock warrants





Stock options

4,157,456

2,687,644

6,845,100Employee stock purchase plans





Total

10,921,881

2,687,644

13,609,525


On
March 21, 2001, the Company entered into a stock purchase agreement with its Chief Executive Officer, Gary G. Friedman in connection with his employment. Mr. Friedman
purchased 571,429 shares of common stock at $1.75 per share for a total purchase price of approximately $1 million. The difference between the fair market value of $2.1875 per share on the
closing date of the equity financing on March 21, 2001 and the purchase price of $1.75 per share resulted in a $250,000 charge that was expensed as compensation on that date.

Additionally,
the Company granted Mr. Friedman an option to purchase 1,200,000 shares of common stock at $1.75 per share which he subsequently exercised. The terms of the option
allow the Company to repurchase shares not fully vested at the time Mr. Friedman ceases, for any reason, to be an employee of the Company. The 1,200,000 shares vest and are no longer subject to
the Company's repurchase option at the rate of 331/3% upon completion of each year of service by Mr. Friedman to the Company. The difference between the fair market value of
$2.1875 per share on the closing date of the equity financing and the purchase price of $1.75 results in a $525,000 charge that will be expensed as compensation over the option's
thirty-six month vesting period. Furthermore, the Company granted Mr. Friedman an option to purchase 200,000 shares of common stock at $6.00 per share. The 200,000 options vest at
the rate of 331/3% upon completion of each year of service by Mr. Friedman to the Company.

The
aggregate purchase price for Mr. Friedman's purchase of the common stock was approximately $3,100,000, of which approximately $1,050,000 was paid in cash by
Mr. Friedman and $2,050,000 was paid by Mr. Friedman in the form of a note, dated March 22, 2001, evidencing a loan from the Company to Mr. Friedman. Pursuant to the terms
of the note, the interest rate on the outstanding principal amount of the loan in the original principal amount of $2,050,000 was 8.5% per annum, payable on the first, second and third anniversaries
of the date of the note. The principal was due on March 22, 2004, but the due date could be accelerated due to a number of factors, including, Mr. Friedman's failure to make payments due
under the note, expiration of the six-month period following the date Mr. Friedman ceased to be in the Company's employment as a result of termination for cause, or 90 days
after the closing of an acquisition of the Company. The loan was a full recourse loan and was secured by shares of the common stock and preferred stock purchased by Mr. Friedman.
Mr. Friedman repaid the loan in full with interest in August 2002.

May
financingOn May 17, 2001, the Company completed a private placement sale with various institutional investors of 4,515,762 shares of common stock at $5.43 per
share, resulting in aggregate net proceeds of approximately $24.5 million. As part of this private placement financing, the Company filed with the Securities and Exchange Commission on
June 1, 2001, a registration statement on Form S-3 for the resale of the common stock acquired by these investors. The registration statement became effective on
July 6, 2001.

22

---

November
financingOn November 6, 2001, the Company completed a private placement sale with various institutional investors of 4,487,178 shares of the Company's common
stock at $3.90 per share, resulting in aggregate net proceeds of approximately $17.5 million. As part of this private placement financing, the Company filed with the Securities and Exchange
Commission on December 6, 2001, a registration statement on Form S-3 for the resale of the common stock acquired by these investors. The registration statement became
effective on October 31, 2002.

(9)   STOCK OPTION PLANS

STOCK-BASED COMPENSATION PLANS

In April 1998, the Company's Board of Directors approved the 1998 Stock Incentive Plan ("1998 Plan"), which serves as the successor to the Company's 1995
Stock Option Plan ("the Predecessor Plan"). The 1998 Plan is divided into five separate components: (i) the Discretionary Option Grant Program, (ii) the Stock Issuance Program,
(iii) the Salary Investment Option Grant Program, (iv) the Automatic Option Grant Program and (v) the Director Fee Option Grant Program. The Discretionary Option Grant Program and
Stock Issuance Program are administered by the Compensation Committee for Section 16 insiders and by a Secondary Committee of the Board of Directors for non-Section 16
insiders.

Under
the 1998 Plan, the Company originally authorized the Board of Directors to grant options of shares of common stock to key employees, directors, and consultants to purchase an
aggregate of 3,287,662 shares of common stock. Such share reserve consists of (i) the number of shares available for issuance under the Predecessor Plan on June 19, 1998, including the
shares subject to outstanding options, and (ii) an additional increase of 980,000 shares. In addition, the number of shares of common stock reserved for issuance under the 1998 Plan will
automatically be increased on the first trading day of each calendar year, beginning in calendar year 2000, by an amount equal to the lessor of (i) three percent of the total number of shares
of common stock outstanding on the last trading day of the preceding calendar year or (ii) 966,202 shares. On January 2, 2003, January 2, 2002 and January 2, 2001, the
Company added 901,520 shares, 853,670 shares and 512,668 shares, respectively, to the 1998 Plan in accordance with the automatic increase provisions. Additionally, in July 2001, the Company's
stockholders approved an increase of 1,000,000 shares of common stock under the 1998 Plan, as well as various other amendments to the 1998 Plan. In no event, however, may any one participant in the
1998 Plan receive option grants, separately exercisable stock appreciation rights or direct stock issuances for more than 1,000,000 shares of common stock in the aggregate per calendar year.

For
all options granted under the Discretionary Option Grant Program, the vesting, exercise prices and other terms of the options are fixed by the Compensation Committee or Secondary
Committee, as applicable. Under the Discretionary Option Grant Program and the Automatic Option Grant Program, both incentive stock options and non-statutory stock options are granted at
exercise prices not less than 100% of the fair market value on the date of grant. Under the Salary Investment Option Grant Program and the Director Fee Option Grant Program, the
non-statutory stock options are granted at exercise prices not less than 331/3% of the fair market value on the date of grant. These options generally expire ten years from
the date of grant and vest ratably either over a one-year period, three-year period or four-year period. If any options are exercised before becoming vested, the
holder cannot sell or vote the shares until such shares have vested. If the holder leaves the Company before the options are fully vested, the Company has the right to repurchase unvested options at
the employee's original exercise price.

23

---

In May 2001, the Company's Board of Directors adopted a stock option program (the "Program") outside of the Company's 1998 Plan pursuant to which options exercisable for up to
1,000,000 shares of common stock may be granted. Under the Program, the Board of Directors authorized a special purpose committee of the Board of Directors to administer the Program. The special
purpose committee may make non-statutory stock option grants to individuals as inducements to enter employment with the Company or, to the extent otherwise allowed under Nasdaq rules, as
inducements to continue their employment with the Company, provided that in either case the terms of such grants are substantially similar to the terms of the stock option grants made pursuant to the
1998 Plan. However, the special purpose committee may not grant an option to acquire more than 50,000 shares to any one individual. Additionally, under the Program, options may be granted with an
exercise price below the market price on The Nasdaq National Market on the date of grant, provided the special purpose committee first obtains approval of such grants from either the Board of
Directors or the Compensation Committee. In no event may any option have an exercise price less than $2.00 per share. Vesting, exercise prices and other terms of the options are fixed by the special
committee. Generally, options vest in one-third increments over a three-year period and have a term of not more than ten years from the grant date. The Board of Directors or
the Compensation Committee may, in either's sole discretion and at any time, restrict or withdraw from the special purpose committee, as to any particular matters or categories of matters, the
authority to make any or particular option grants under the Program.

A
summary of all employee option activity is set forth below (see Note 1 for fair value assumptions used):

NUMBER OF
SHARES

WEIGHTED
AVERAGE
EXERCISE
PRICEOutstanding and exercisable, January 29, 2000

2,409,798


11.00Granted with exercise price at fair value (weighted average fair value of $2.25)

1,235,316


4.17Exercised

(78,252
)

1.54Canceled

(623,902
)

12.18Outstanding and exercisable, February 3, 2001

2,942,960


8.06Granted with exercise price at fair value (weighted average fair value of $1.99)

1,723,597


4.40Granted with exercise price above fair value (weighted average fair value of $0.06)

205,000


6.00Granted with exercise price below fair value (weighted average fair value of $1.57)

1,460,000


1.79Exercised

(1,612,076
)

1.68Canceled

(882,703
)

8.39Outstanding and exercisable, February 2, 2002

3,836,778


6.52Granted with exercise price at fair value (weighted average fair value of $5.86)

1,147,820


7.03Granted with exercise price below fair value (weighted average fair value of $3.03)

48,607


1.14Exercised

(347,330
)

3.95Canceled

(528,419
)

8.85Outstanding and exercisable, February 1, 2003

4,157,456


6.44Vested at February 1, 2003

1,891,512

$
7.59Available for future grant at February 1, 2003

2,687,644


24

---

Additional
information regarding options outstanding as of February 1, 2003 is as follows:

|RANGE OF
EXERCISE PRICES |  | NUMBER
OUTSTANDING |  | WEIGHTED
AVERAGE
REMAINING
CONTRACTUAL
LIFE (YEARS) |  | WEIGHTED
AVERAGE
EXERCISE
PRICE |       | NUMBER
VESTED |           | WEIGHTED
AVERAGE
EXERCISE
PRICE
|------------------------ |  | ------------------ |  | --------------------------------------------------- |  | ------------------------------- | ----- | ------------- | --------- | -------------------------------
|$0.32 - $2.50            |  | 551,422            |  | 7.60                                                |  | $                               | 1.67  |               | 281,018   |                                
|$2.51 - $4.00            |  | 432,806            |  | 8.44                                                |  | $                               | 3.43  |               | 202,867   |                                
|$4.01 - $4.50            |  | 634,617            |  | 8.48                                                |  | $                               | 4.32  |               | 197,024   |                                
|$4.51 - $5.50            |  | 763,599            |  | 8.63                                                |  | $                               | 5.18  |               | 207,053   |                                
|$5.51 - $6.50            |  | 403,601            |  | 8.20                                                |  | $                               | 5.98  |               | 309,174   |                                
|$6.51 - $8.00            |  | 563,436            |  | 9.17                                                |  | $                               | 7.60  |               | 43,321    |                                
|$8.01 - $10.50           |  | 368,786            |  | 6.34                                                |  | $                               | 10.25 |               | 334,844   |                                
|$10.51 - $22.00          |  | 439,189            |  | 6.56                                                |  | $                               | 16.39 |               | 316,211   |                                
|                         |  |                    |  |                                                     |  |                                 |       |               |           |                                
|$0.32 - $22.00           |  | 4,157,456          |  | 8.06                                                |  | $                               | 6.44  |               | 1,891,512 |                                
|                         |  |                    |  |                                                     |  |                                 |       |               |           |                                

Employee Stock Purchase Plan

In April 1998, the Company's Board of Directors adopted the 1998 Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan is designed to allow
eligible employees, based on specified length of service requirements, of the Company and participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through
their periodic payroll deductions under the Purchase Plan. A reserve of 475,000 shares of common stock has been established for this purpose. Individuals who are eligible employees may enter the
Purchase Plan twice yearly and payroll deductions may not exceed 15% of total cash earnings. The purchase price per share will equal 85% of the lower of (i) the fair market value of the common
stock on the participant's entry date into the offering period or (ii) the fair market value on the semi-annual purchase date. During fiscal 2002, 2001 and 2000, employees purchased
approximately 140,967, 16,191 shares and 89,856 shares, respectively, of the Company's common stock under the Purchase Plan at weighted average per share prices of $2.20, $1.33, and $4.89,
respectively. Through February 1, 2003, approximately 443,606 shares had been issued
under the Purchase Plan. The Board of Directors suspended the Purchase Plan on August 30, 2002. Therefore, no shares are presently available for future issuance under the Purchase Plan.

The
Board of Directors may at any time alter, suspend or discontinue the Purchase Plan. However, certain amendments to the Purchase Plan may require stockholder approval.

(10) EMPLOYEE BENEFIT PLANS

The Company has a 401(k) plan for its employees who meet certain service and age requirements. Participants may contribute up to 15% of their salaries to a
maximum of $11,000 and qualify for favorable tax treatment under Section 401(k) of the Internal Revenue Code. The Company matches 50% of the employees' contribution up to a maximum of 3% of
their base salary. The Company contributed $369,000, $265,000 and $222,000 in the years ended February 1, 2003, February 2, 2002 and February 3, 2001, respectively.

(11) OTHER RELATED PARTY TRANSACTIONS

The Company leases a store from the Chairman of the Board of Directors and his spouse and a partnership of which the Chairman is a partner. For fiscal years 2002,
2001 and 2000, respectively, rents of $41,717, $65,657 and $65,657, respectively, were paid in the aggregate to the Chairman and the partnership, respectively. The lease term expires on May 31,
2004 and there are no renewal options.

25

---

In
connection with the Series A and B preferred stock financing completed in March 2001, Gary Friedman, our Chief Executive Officer, purchased 455 shares of the
Series A preferred stock and 545 shares of the Series B preferred stock for an aggregate purchase price of $1 million. In addition, as part of Mr. Friedman's compensation
package, the Company sold Mr. Friedman 571,429 shares of common stock at $1.75 per share and Mr. Friedman exercised his option to purchase 1.2 million shares of common stock at
$1.75 per share for an aggregate sales price of approximately $3.1 million. In connection with this sale of preferred and common stock to Mr. Friedman, the Company also made a loan to
Mr. Friedman in the amount of $2.1 million. All of the loan proceeds were used by Mr. Friedman to purchase a portion of this stock. The loan was a full recourse loan secured by
shares of the common stock and preferred stock purchased by Mr. Friedman. This loan was evidenced by a note, dated March 22, 2001. Pursuant to the terms of the note, the interest rate on
the outstanding principal amount of the loan was 8.5% per annum, payable on the first, second and third anniversaries of the date of the note. The principal was due on March 22, 2004 but the
due date could be accelerated due to a number of factors, including, failure to make payments due under the note, expiration of the six-month period following the date Mr. Friedman
ceases to be an employee of the
Company as a result of termination by the Company for cause, or 90 days after the closing of an acquisition of the Company. Mr. Friedman repaid the loan in full with interest in
August 2002.

(12) COMMITMENTS AND CONTINGENCIES

The Company is a party to various legal claims, actions and complaints. Although the ultimate resolution of legal proceedings cannot be predicted with certainty,
management believes that disposition of these matters will not have a material adverse effect on the Company's consolidated financial statements.

(13) SEGMENT REPORTING

The Company classifies its business interests into three identifiable segments: retail, direct-to-customer and furniture manufacturing.
The retail segment includes revenue and expenses associated with the 105 retail locations. The direct to customer segment includes revenue and expenses associated with catalog and Internet sales. The
furniture manufacturing segment includes all revenue and expenses associated with the Company's wholly-owned furniture manufacturer, The Michaels Furniture Company. The accounting policies of the
segments are the same as those described in the summary of significant accounting policies (Note 1). The Company evaluates performance and allocates resources based on income from operations
which excludes unallocated corporate general and administrative costs. Certain segment information, including segment assets, asset expenditures and related depreciation expense, is not presented as
all assets of the Company are commingled and are not available by segment.

26

---

Financial
information for the Company's business segments is as follows:

FISCAL YEAR ENDEDFEBRUARY 1,
2003

FEBRUARY 2,
2002

FEBRUARY 3,
2001Net salesRetail

$
355,597

$
332,783

$
342,687Direct-to-customer


44,705


33,647


22,554Furniture manufacturing


18,166


16,001


19,980Intersegment furniture sales


(18,131
)

(15,958
)

(18,985
)Consolidated net sales

$
400,337

$
366,473

$
366,236Income from operationsRetail


33,825


7,873


42,735Direct-to-customer


3,062


1,746


278Furniture manufacturing


(296
)

(966
)

(1,799
)Unallocated


(45,577
)

(40,577
)

(40,449
)Intersegment income from operations


(39
)

(2,394
)

(938
)Consolidated income (loss) from operations

$
(9,025
)
$
(34,318
)
$
(173
)


(14) ACQUISITION OF THE MICHAELS FURNITURE COMPANY

On March 20, 1998, the Company acquired 100% of the outstanding stock of The Michaels Furniture Company, Inc., a privately-owned manufacturer of
wood furniture, from its sole shareholder and then-current President, Michael Vermillion. The Michaels acquisition was accounted for under the purchase method of accounting and all
acquired assets and liabilities were recorded at their estimated fair market values.

Consideration
given for the Michaels' stock consisted of an initial cash payment of $5.0 million at March 20, 1998, the date of the closing of the acquisition.
Additionally, the Company was required to pay Mr. Vermillion contingent cash consideration based on a percentage of Michaels' earnings before interest, taxes, depreciation and amortization
("EBITDA"). For the fiscal years ended February 3, 2001, January 29, 2000 and January 30,1999, EBITDA based payments of $80,000, $592,000 and $647,000, respectively, were paid as
additional purchase price to Mr. Vermillion. The period for additional consideration ended at February 3, 2001, and, as a result, no further consideration has been paid to
Mr. Vermillion.

The
Company leases the manufacturing operations buildings from Mr. Vermillion. Rental payments totaling $346,560 were made to Mr. Vermillion in each of the fiscal years
2002, 2001 and 2000.

(15) SUBSEQUENT EVENT

In February 2003, the Company recorded additional paid in capital in the amount of $1.1 million, net of attorney's fees and expenses, which
represents cash received in connection with settlement of a claim under Section 16(b) of the Securities Exchange Act of 1934, as amended.

27

---

(16) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The Company's unaudited results for the first two quarterly periods of fiscal 2002 and the fourth quarter of fiscal 2001 have been restated. See the related
discussion in Note 17.

|                                                  |            | 2002 |        
|------------------------------------------------- | ---------- | ---- | -------
|
|Net sales                                         |            | $    | 69,377 
|Cost of sales and occupancy                       |            |      | 58,489 
|                                                  |            |      |        
|Gross profit                                      |            |      | 10,888 
|Selling, general and administrative               |            |      | 27,070 
|                                                  |            |      |        
|Income (loss) from operations                     |            |      | (16,182
|Interest expense                                  |            |      | (576   
|Interest income                                   |            |      | 83     
|Change in fair value of warrants                  |            |      | (278   
|                                                  |            |      |        
|Income (loss) before income taxes                 |            |      | (16,953
|Income tax benefit (expense)                      |            |      | 10,103 
|                                                  |            |      |        
|Net income (loss)                                 |            |      | (6,850 
|                                                  |            |      |        
|Income (loss) attributable to common stockholders |            |      | (7,208 
|                                                  |            |      |        
|Income (loss) per share:                          |            |      |        
|                                                  | Basic(1)   |      | $      
|                                                  | Diluted(2) |      | $      

|                                                  |            | 2001                                |        
|------------------------------------------------- | ---------- | ----------------------------------- | -------
|
|Net sales                                         |            | $                                   | 70,659 
|Cost of sales and occupancy                       |            |                                     | 56,791 
|                                                  |            |                                     |        
|Gross profit                                      |            |                                     | 13,868 
|                                                  |            | Selling, general and administrative |        
|                                                  |            |                                     |        
|Income (loss) from operations                     |            |                                     | (8,631 
|Interest expense                                  |            |                                     | (1,505 
|Interest income                                   |            |                                     | 26     
|Change in fair value of warrants                  |            |                                     | (1,480 
|                                                  |            |                                     |        
|Loss before income taxes                          |            |                                     | (11,590
|Income tax benefit (expense)                      |            |                                     | 4,165  
|                                                  |            |                                     |        
|Net loss                                          |            |                                     | (7,425 
|                                                  |            |                                     |        
|Income (loss) attributable to common stockholders |            |                                     | (8,370 
|                                                  |            |                                     |        
|Income (loss) per share:                          |            |                                     |        
|                                                  | Basic(1)   |                                     | $      
|                                                  | Diluted(2) |                                     | $      

---

28

---

(17) RESTATEMENT

Subsequent to the issuance of the Company's consolidated financial statements as of and for the year ended February 2, 2002, the Company's management
determined that certain errors existed in previously issued consolidated financial statements. The Company determined that its accounts payable balances at February 2, 2002 were overstated
resulting from the inclusion of fiscal 2002 payables in fiscal 2001. The Company also determined that its inventory at February 2, 2002 was understated as a result of owned inventories in
transit being excluded from its reported inventory balance. Additionally, for the year ended February 2, 2002, the Company determined that it had understated certain payroll and insurance costs
and overstated certain maintenance costs. As a result, the accompanying fiscal 2001
financial statements have been restated from amounts previously reported in Amendment No. 2 to Form 10-K/A filed on December 23, 2002. A summary of the effects of the restatement
is as follows:

In thousands

February 2, 2002As previously reported(1)

As restatedMerchandise inventories

60,987

61,590Prepaid expense and other

14,405

14,435Other assets

13,293

12,972Accounts payable and accrued expenses

34,065

33,922Deferred rent

12,703

12,689Accumulated deficit

(51,864
)
(51,395
)Total stockholders' equity

88,986

89,455


29

---

In thousands, except per share amounts

Fiscal Year Ended
February 2, 2002As previously reported(2)

As restatedNet sales


366,473


366,473Cost of sales and occupancy


295,061


293,951Gross profit


71,412


72,522Selling, general and administrative


106,500


106,840Loss from operations


(35,088
)

(34,318
)Interest expense


(4,780
)

(4,780
)Interest income


313


313Change in fair value of warrants


(2,677
)

(2,677
)Loss before income taxes


(42,232
)

(41,462
)Income tax benefit


9,207


8,906Net loss


(33,025
)

(32,556
)Preferred stockholder return:Dividends


(1,411
)

(1,411
)Beneficial conversion charges


(1,406
)

(1,406
)Loss attributable to common stockholders


(35,842
)

(35,373
)Net loss per share:Basic

$
(1.53
)
$
(1.51
)Diluted

$
(1.53
)
$
(1.51
)


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30

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PART IV

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K







31

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 1 to
the annual report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

| |  | RESTORATION HARDWARE, INC.
| |  | --------------------------
| |  | By:                       
| |  | Date: June 11, 2003       

Pursuant
to the requirements of the Securities Exchange Act of 1934, this Amendment No. 1 to the annual report on Form 10-K has been signed below by the following persons
on behalf of the registrant and in the capacities and on the dates indicated.

|SIGNATURE                           |  | TITLE                                                                               |  | DATE           
|----------------------------------- |  | ----------------------------------------------------------------------------------- |  | ---------------
|                                    |  |                                                                                     |  |                
|Stephen J. Gordon                   |  | Chairman                                                                            |  | June     , 2003
|/s/GARY G. FRIEDMANGary G. Friedman |  | President, Chief Executive Officer and Director (Principal Executive Officer)       |  | June 11, 2003  
|/s/KEVIN W. SHAHANKevin W. Shahan   |  | Vice President, Chief Financial Officer and Secretary (Principal Financial Officer) |  | June 11, 2003  
|Vivian C. Macdonald                 |  | Vice President, Corporate Controller (Principal Accounting Officer)                 |  | June     , 2003
|Thomas M. Bazzone                   |  | Executive Vice President, Chief Operating Officer, Assistant Secretary and Director |  | June     , 2003
|Damon H. Ball                       |  | Director                                                                            |  | June     , 2003
|Robert E. Camp                      |  | Director                                                                            |  | June     , 2003
|Raymond C. Hemmig                   |  | Director                                                                            |  | June     , 2003
|Glenn J. Krevlin                    |  | Director                                                                            |  | June     , 2003
|Mark J. Schwartz                    |  | Director                                                                            |  | June     , 2003
|John W. Tate                        |  | Director                                                                            |  | June     , 2003

32

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RESTORATION HARDWARE, INC.

CERTIFICATION

I,
Gary G. Friedman, certify that:



Date:
June 11, 2003

| |  | By: | /s/GARY G. FRIEDMANGary G. Friedman Chief Executive
Officer
| |  | --- | -----------------------------------------------------------

33

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RESTORATION HARDWARE, INC.

CERTIFICATION

I,
Kevin W. Shahan, certify that:



Date:
June 11, 2003

| |  | By: | /s/KEVIN W. SHAHANKevin W. Shahan Chief Financial Officer
| |  | --- | ---------------------------------------------------------

34

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EXHIBIT INDEX

|EXHIBIT
NUMBER |  | DOCUMENT DESCRIPTION                                                                                                                                                                                      
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1            |  | Amended and Restated Certificate of Incorporation, as amended(1)                                                                                                                                          
|3.2            |  | Bylaws, as amended to date(2)                                                                                                                                                                             
|3.3            |  | Reference is made to Exhibit 4.6                                                                                                                                                                          
|4.1            |  | Reference is made to Exhibit 3.1                                                                                                                                                                          
|4.2            |  | Reference is made to Exhibit 3.2                                                                                                                                                                          
|4.3            |  | Specimen Common Stock Certificate(4)                                                                                                                                                                      
|4.4            |  | Specimen Series A Preferred Stock Certificate(5)                                                                                                                                                          
|4.5            |  | Specimen Series B Preferred Stock Certificate(5)                                                                                                                                                          
|4.6            |  | Certificate of Designation of Series A and Series B Preferred Stock(5)                                                                                                                                    
|4.7            |  | Consent and Waiver Regarding Additional Financing(6)                                                                                                                                                      
|4.8            |  | Amended and Restated Letter Agreement, dated as of March 21, 2001, by and among certain holders of Series A preferred stock(7)                                                                            
|4.9            |  | Amendment to Letter Agreement, effective as of November 1, 2001, by and among certain holders of Series A preferred stock(8)                                                                              
|+10.1          |  | Form of 1995 Stock Option Plan(3)                                                                                                                                                                         
|+10.2          |  | Form of 1998 Stock Incentive Plan(4)                                                                                                                                                                      
|+10.3          |  | Form of 1998 Employee Stock Purchase Plan(3)                                                                                                                                                              
|10.4           |  | Form of Indemnity Agreement for Officers and Directors(3)                                                                                                                                                 
|10.5           |  | Restated Investors Rights Agreement, dated May 16, 1997, among Restoration Hardware, Inc., the Founders and Common Stock Warrantholders, Series D Warrantholders and Common Stock Holders and Investors(3)
|10.6           |  | Stock Purchase Agreement, dated March 20, 1998, between Restoration Hardware, Inc. and Michael Vermillion(3)                                                                                              
|10.7           |  | Supply Agreement, dated March 20, 1998, between Restoration Hardware, Inc., Michaels Concepts in Wood, Inc. and Michael Vermillion(3)                                                                     
|10.8           |  | Lease Agreement, dated May 4, 1994, between Restoration Hardware, Inc. and Stephen and Christine Gordon(3)                                                                                                
|10.9           |  | Commercial Lease and Deposit Receipt, dated October 18, 1994, and Addenda, dated October 20, 1994 and November 21, 1994, between the Restoration Hardware, Inc. and H. Koch and Sons(3)                   
|10.10          |  | Office Lease, dated February 21, 1997, between Restoration Hardware, Inc. and Paradise Point Partners(3)                                                                                                  
|10.11          |  | Standard Industrial/Commercial Multi-Tenant Lease, dated May 12, 1997, between Restoration Hardware, Inc. and Mortimer B. Zuckerman(3)                                                                    
|10.12          |  | Fourth Amended and Restated Loan and Security Agreement, dated April, 1998(3)                                                                                                                             
|               |  |                                                                                                                                                                                                           

35

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|10.13 |  | Second Amendment to the Fourth Amended and Restated Loan and Security Agreement, dated October, 1998(2)                                                                                   
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.14 |  | Fifth Amended and Restated Loan and Security Agreement, dated February 2, 2000(9)                                                                                                         
|10.15 |  | First Amendment to the Fifth Amended and Restated Loan and Security Agreement, dated March 31, 2000(9)                                                                                    
|10.16 |  | Sixth Amended and Restated Loan and Security Agreement, dated September 27, 2000(10)                                                                                                      
|10.17 |  | Warrant Agreement, dated as of September 27, 2000, by and among Restoration Hardware, Inc., Goldman Sachs & Co., and Enhanced Retail Funding, LLC(11)                                     
|10.18 |  | Amended and Restated Investors Rights Agreement, dated as of March 21, 2001, between Restoration Hardware, Inc. and the Series A and B Preferred Stock Investors(5)                       
|10.19 |  | Amended and Restated Series A and B Preferred Stock Purchase Agreement, dated as of March 21, 2001, between Restoration Hardware, Inc. and the Series A and B Preferred Stock Investors(5)
|10.20 |  | Third Amendment to the Sixth Amended and Restated Loan and Security Agreement, dated as of March 21, 2001(5)                                                                              
|10.30 |  | Offer of Employment Letter for Mr. Gary G. Friedman dated as of March 15, 2001(5)                                                                                                         
|10.31 |  | Compensation and Severance Agreement between Restoration Hardware, Inc. and Gary G. Friedman, effective as of March 21, 2001(5)                                                           
|10.32 |  | Stock Pledge Agreement between Restoration Hardware, Inc. and Gary G. Friedman, dated as of March 22, 2001(5)                                                                             
|10.33 |  | Stock Purchase Agreement between Restoration Hardware, Inc. and Gary G. Friedman, dated as of March 18, 2001(5)                                                                           
|10.34 |  | Early Exercise Stock Purchase Agreement between Restoration Hardware, Inc. and Gary G. Friedman, dated as of March 18, 2001(5)                                                            
|10.35 |  | Note Secured by Stock between Restoration Hardware, Inc. and Gary G. Friedman, dated as of March 22, 2001(5)                                                                              
|10.36 |  | Notice of Grant of Stock Option for Gary G. Friedman(5)                                                                                                                                   
|10.37 |  | Stock Option Agreement between Restoration Hardware, Inc. and Gary G. Friedman, dated as of March 18, 2001(5)                                                                             
|10.38 |  | Separation Agreement and Release between Restoration Hardware, Inc. and Thomas Christopher, dated as of March 20, 2001(12)                                                                
|10.39 |  | Amended and Restated Promissory Note by and among Restoration Hardware, Inc., Thomas Christopher and Barbara Christopher, dated as of May 1, 2001(12)                                     
|10.40 |  | Severance Agreement between Restoration Hardware, Inc. and Stephen J. Gordon, effective as of March 21, 2001(12)                                                                          
|10.41 |  | Stock Purchase Agreement, dated as of May 17, 2001, by and among Restoration Hardware, Inc. and certain investors named therein(13)                                                       
|10.42 |  | Offer Letter, dated June 26, 2001, from Restoration Hardware, Inc. to Tom Bazzone(14)                                                                                                     
|      |  |                                                                                                                                                                                           

36

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|10.43  |  | Fourth Amendment to the Fourth Amended and Restated Loan and Security Agreement, dated October 15, 1999(15)                                                                                                                                    
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|+10.44 |  | Amended and Restated 1998 Stock Incentive Plan(16)                                                                                                                                                                                             
|+10.45 |  | Form of Non-Plan Notice of Grant of Stock Option and Stock Option Agreement(17)                                                                                                                                                                
|10.46  |  | Stock Purchase Agreement, dated as of November 6, 2001, by and among Restoration Hardware, Inc. and certain investors named therein(18)                                                                                                        
|10.47  |  | Employment Offer Letter between Restoration Hardware, Inc. and Kevin Shahan, dated November 4, 2001(19)                                                                                                                                        
|10.48  |  | Option Agreement between Restoration Hardware, Inc. and Kevin Shahan, dated December 3, 2001(19)                                                                                                                                               
|10.49  |  | Option Agreement between Restoration Hardware, Inc. and Tom Bazzone, dated July 16, 2001(19)                                                                                                                                                   
|10.50  |  | Fourth Amendment to the Sixth Amended and Restated Loan and Security Agreement, dated September 27, 2001(19)                                                                                                                                   
|10.51  |  | Letter Agreement between Restoration Hardware, Inc. and certain investors named therein, dated as of August 2, 2002(20)                                                                                                                        
|10.52  |  | Option Agreement between Restoration Hardware, Inc. and Tom Bazzone, dated July 10, 2002(21)                                                                                                                                                   
|10.53  |  | Option Agreement between Restoration Hardware, Inc. and Gary G. Friedman, dated March 18, 2001(22)                                                                                                                                             
|10.54  |  | Amendment No. 5 to the Sixth Amended and Restated Loan and Security Agreement, dated May 1, 2002(23)                                                                                                                                           
|10.55  |  | Amendment No. 6 to the Sixth Amended and Restated Loan and Security Agreement, dated August 29, 2002(24)                                                                                                                                       
|+10.56 |  | 1998 Stock Incentive Plan Amended and Restated on October 9, 2002(25)                                                                                                                                                                          
|10.57  |  | Employment Agreement for Elizabeth Salamone(26)                                                                                                                                                                                                
|10.58  |  | Seventh Amended and Restated Loan and Security Agreement, dated as of November 26, 2002, by and among Restoration Hardware, Inc., The Michaels Furniture Company, Inc., Fleet Capital Corporation, and The CIT Group/Business Credit,
 Inc.(27)
|*10.59 |  | Separation Agreement and Release between Restoration Hardware, Inc. and Elizabeth ("Lisa") Salamone, effective as of March 6, 2003                                                                                                             
|*21    |  | List of Subsidiaries                                                                                                                                                                                                                           
|23.1   |  | Consent of Independent Auditors                                                                                                                                                                                                                

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