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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549




FORM 10-K/A





Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934





(Amendment No. 1)





For the fiscal year ended FEBRUARY 2, 2002
 
Commission file number 000-24261
 
RESTORATION HARDWARE, INC.
(Exact name of registrant as specified in its charter)


|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 68-0140361                          
|(State or other jurisdiction of
incorporation of organization) |  | (I.R.S. Employer Identification No.)

|                                               |  |           
|---------------------------------------------- |  | ----------
|15 KOCH ROAD, SUITE J
CORTE MADERA, CALIFORNIA |  | 94925     
|(Address of principal executive offices)       |  | (Zip Code)

Registrants telephone number, including area code (415) 924-1005
 
Securities registered pursuant to section 12(b) of the Act: None

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|NONE                |  | NONE                                     

Securities registered pursuant to section 12(g) of the Act:
 
COMMON STOCK, $.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 requirements for the past 90 days. [X] Yes [   ] No

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

The aggregate market value of common stock held by non-affiliates of the
registrant was approximately $171,499,690 as of April 23, 2002 based upon the
closing price of the registrants common stock on The Nasdaq National Market
reported for April 23, 2002. Shares of common stock held by each executive
officer and director and by each person who on that date beneficially owned more
than 5% of the outstanding common stock have been excluded in that such persons
may under certain circumstances be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination of affiliate
status for any other purpose.

29,709,356 shares of the registrants $.0001 par value common stock were
outstanding on April 23, 2002.



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TABLE OF CONTENTS



|              |                                                                                               |  |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | ITEM 1. BUSINESS                                                                             
|              | ITEM 2. PROPERTIES                                                                           
|              | ITEM 3. LEGAL PROCEEDINGS                                                                    
|              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II      
|              | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                
|              | ITEM 6. SELECTED FINANCIAL DATA                                                              
|              | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|              | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|              | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|              | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III     
|              | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|              | ITEM 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION                                        
|              | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|              | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|PART IV      
|              | ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K                      
|SIGNATURES   
|EXHIBIT INDEX
|10-K/A #1    
|Exhibit 23.1 



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TABLE OF CONTENTS

|         |  |                                                                                       |  |   
|-------- |  | ------------------------------------------------------------------------------------- |  | --
|PART I  
|        
|Item 1.  |  | Business                                                                              |  | 3 
|Item 2.  |  | Properties                                                                            |  | 14
|Item 3.  |  | Legal Proceedings                                                                     |  | 14
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  | 14
|        
|PART II 
|        
|Item 5.  |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  | 15
|Item 6.  |  | Selected Financial Data                                                               |  | 16
|Item 7.  |  | Managements Discussion and Analysis of Financial
Condition and Results of Operations |  | 17
|Item 7A  |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 26
|Item 8.  |  | Financial Statements and Supplementary Data                                           |  | 26
|Item 9.  |  | Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure  |  | 47
|        
|PART III
|        
|Item 10. |  | Directors and Executive Officers of the Registrant Executive Compensation             |  | 47
|Item 11. |  | Executive Compensation and Other Information                                          |  | 48
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 48
|Item 13. |  | Certain Relationships and Related Transactions                                        |  | 48
|        
|PART IV 
|        
|Item 14. |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 48




INTRODUCTORY NOTE

This amended annual report on Form 10-K/A (Amendment No. 1) for the fiscal year
ended February 2, 2002 is being filed to amend Part I, Item 4 (Submission of
Matters to a Vote of Security Holders), to add a description of a request for
approval by the holders of our Series A preferred stock in connection with our
November 6, 2001 common stock financing, to amend subsection Recent Accounting
Developments in Part II, Item 7 (Managements Discussion and Analysis of
Financial Condition and Results of Operations), to include additional disclosure
relating to the U.S. Securities and Exchange Commissions Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements, to amend note
1, subsection Earnings Per Share in Part II, Item 8 (Financial Statements and
Supplementary Data), to correctly label the column headings in the second table
in the subsection, to amend note 1, subsection New Accounting Pronouncements
in Part II, Item 8 (Financial Statements and Supplementary Data), to include
additional disclosure relating to Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets, and to correct minor
typographical errors in Part III.







This amended annual report on Form 10-K/A contains forward-looking statements that are
based on the beliefs of, and estimates made by and information currently
available to, our management. The words expect, anticipate, intend, plan
and similar expressions identify forward-looking statements. These statements
are subject to risks and uncertainties. Actual results could differ materially
from those discussed here. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed below in Factors
That May Affect Our Future Operating Results and elsewhere in
this amended annual
report on Form 10-K/A. We assume no obligation to update this information.




Documents incorporated by reference: portions of the registrants proxy
statement for its 2002 annual meeting of stockholders are incorporated by
reference.



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PART I




ITEM 1. BUSINESS

GENERAL

Our company, Restoration Hardware, Inc., together with our
subsidiaries, is a specialty retailer of home furnishings, functional and
decorative hardware and related merchandise that reflects our classic and
authentic American point of view. We market our merchandise through retail
locations, mail order catalogs and on the worldwide web at
www.restorationhardware.com. Our merchandise strategy and our stores
architectural style create a unique and attractive selling environment designed
to appeal to an affluent, well educated 35 to 60 year old customer. We operated
104 stores in 31 states, the District of Columbia and in Canada at February 2,
2002. We operate on a 52  53 week fiscal year ending on the Saturday closest to
January 31. The 2001 fiscal year was a 52-week year and ended on February 2,
2002.

In addition to our retail stores, we operate a direct-to-customer sales
channel which includes both catalog and Internet, and a wholly-owned furniture
manufacturer.

We commenced business more than 20 years ago as a purveyor of fittings
and fixtures for older homes. Since then, we have evolved into a unique home
furnishings retailer offering consumers an array of distinctive, high quality
and often hard-to-find merchandise. We display our broad assortment of
merchandise in an architecturally inviting setting. We believe that we create an
attractive and entertaining environment in our stores by virtue of our eclectic
product mix, which includes classic, high-quality furniture, lighting, home
furnishings, premium-positioned home textiles and functional and decorative
hardware. Integral to the shopping experience, most product displays are
complemented by our unique in-store signage program, which provides historical,
anecdotal and sometimes nostalgic descriptions of products.

In 2001 we developed and initiated a repositioning plan for the
company. The central component of this plan was the launch of a new
merchandising strategy targeted for April 2002, which included the introduction
of a number of new merchandise offerings, adjustment of overall product mix, and
remodeling of our stores in order to best present the new merchandise. Other key
elements of the plan included strengthening our balance sheet, upgrading the
management team, eliminating under-performing products and reducing the overall
number of items in the merchandise assortment, closing under-performing stores,
and growing our direct-to-customer business. Over the course of 2001 substantial
progress was made in each of these areas.

In the first quarter of 2002 we have introduced premium-positioned
home textiles and new bath hardware collections, as well as completed the
remodeling of our stores. Also in connection with our repositioning plan, in
April 2002 we redesigned our catalog and website to enhance the overall customer
experience.

RETAIL STORES

Merchandising Mix

We offer a broad but carefully edited selection of merchandise that
provides a consistent point of view throughout our stores. Our collection of
merchandise, not traditionally found in a single store environment, includes
classic American-styled furniture, home furnishings, lighting, functional and
decorative hardware, premium-positioned home textiles and discovery items. Our
merchandise mix also includes proprietary products and hard-to-find products
selected from non-traditional distribution channels that appear unique to our
customers.



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The percentage of total revenue contributed by major merchandising
categories is as follows:

|                         |  |      |    |      |  |      |    |   |  |  |    |  
|------------------------ |  | ---- | -- | ---- |  | ---- | -- | - |  |  | -- | -
|                         |  | 2001 |    | 2000 |  | 1999
|                         |  |      |    |      |  |     
|Home furnishings         |  |      | 45 | %    |  |      | 45 | % |  |  | 59 | %
|Hardware and accessories |  |      | 55 | %    |  |      | 55 | % |  |  | 41 | %

Product Selection, Purchasing and Sourcing

We make merchandise purchases from over 460 vendors. These vendors
include major domestic manufacturers, specialty niche manufacturers and
importers. We maintain agents in China, England, France, Japan, India, Portugal
and Eastern Europe, and our merchandising team travels to Asia and Europe in
search of new products. By sourcing products offshore, we seek to achieve
increased buying effectiveness and ensure exclusivity for a portion of our
product line. In many instances, we also work closely with our vendors to
develop products which are unique to us.

DIRECT-TO-CUSTOMER  CATALOG AND INTERNET

Our catalog business complements our retail business by building
customer awareness of a concept, increasing customer traffic in our stores,
enhancing brand image and acting as an effective advertising vehicle. In
addition, we maintain a website, www.restorationhardware.com, designed to sell
our products, promote consumer awareness of Restoration Hardware and generate
store traffic.

In fiscal 2001, we distributed approximately 20.5 million catalogs as
compared to approximately 12 million catalogs in fiscal 2000. We mail catalogs
to persons with demographic profiles similar to those of our retail customers
and who also possess previous mail order purchase histories. In fiscal 2001,
approximately 65% of catalogs were circulated to past customers, and the
remaining catalogs were mailed to prospects. These prospects were obtained
primarily from customer lists of other high-end mail order companies sharing
similar customer demographics. We out-source the fulfillment aspects of the
business, including telemarketing, customer service and distribution, to a third
party located in Portland, Tennessee.

We believe our catalog is a key resource to further market our brand to
both retail customers and customers outside of the retail trade areas.

THE MICHAELS FURNITURE COMPANY, INC.

Purchased by Restoration Hardware in 1998, Michaels offers a line of
furniture for the home and office. Specific product lines include living room,
bedroom, dining room, home office and accessory items. Inter-company sales to
Restoration Hardware represented virtually all of Michaels total sales during
the fiscal year ended February 2, 2002 and this trend is expected to continue.
Michaels is located in Sacramento, California.

MANAGEMENT INFORMATION SYSTEMS

Our retail management information systems include fully integrated
store, merchandising, distribution and financial systems. We utilize STS Systems
for our point-of-sale, merchandise management and warehouse management systems,
and rely on STS for software support. Recently we implemented a new e-commerce
application and upgraded our merchandise analysis tool.

COMPETITION

The retail market is highly competitive. We compete against a diverse
group of retailers ranging from specialty stores to traditional furniture stores
and department stores. Our product offerings also compete with a variety of
national, regional and local retailers. We also compete with these and other
retailers for customers, suitable retail locations, suppliers and qualified
employees and management personnel. Many of our competitors have significantly
greater financial, marketing and other resources. Moreover, increased
competition may result, and has resulted, in potential or actual litigation
between us and our competitors relating



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to such activities as competitive sales and hiring practices, exclusive
relationships with key suppliers and manufacturers and other matters. As a
result, increased competition may adversely affect our financial performance,
and we cannot assure you that we will be able to compete successfully in the
future.

We believe that our ability to compete successfully is determined by
several factors, including, among other things, the breadth and quality of our
product selection, effective merchandise presentation, customer service, pricing
and store location. Although we believe that we are able to compete favorably on
the basis of these factors, we may not ultimately succeed in competing with
other retailers in our market.

TRADEMARKS

We have registered our trademark Restoration Hardware in the United
States, Mexico and Canada.

EMPLOYEES

At February 2, 2002, we had approximately 1,500 full-time employees and
1,700 part-time employees. We consider our employee relations to be good. None
of our employees are represented by a collective bargaining agreement, nor have
we ever experienced any work stoppage.

Factors that may affect our future
operating results

We may not be able to successfully anticipate changes in consumer trends and our
failure to do so may lead to loss of sales revenues and the closing of
under-performing stores.

Our success depends on our ability to anticipate and respond to changing
merchandise trends and consumer demands in a timely manner. Moreover, our new
management team has adopted a repositioning strategy for the company which
includes redefining and redirecting the focus of our stores, remodeling our
stores, increasing our direct-to-customer business, and implementing a new
merchandising strategy which involves introducing a variety of new merchandise
offerings, as well as adjusting the overall mix of our product offerings. We
have incurred and continue to incur, substantial costs in implementing this
repositioning strategy. This repositioning strategy may create a number of
significant challenges for us. If, for example, we misjudge market trends, we
may significantly overstock unpopular products and be forced to take significant
inventory markdowns, which would have a negative impact on our operating
results. Conversely, shortages of popular items could result in loss of sales
revenues and have a material adverse effect on our operating results. Moreover,
the substantial costs we have incurred in implementing our repositioning
strategy may not generate a corresponding increase in profits to our business.

We believe there is a lifestyle trend toward increased interest in home
renovation and interior decorating, and we further believe we are benefiting
from such a trend. The failure of this trend to materialize or a decline in such
a trend could adversely affect consumer interest in our major product lines.
Moreover, our products must appeal to a broad range of consumers whose
preferences cannot always be predicted with certainty and may change between
sales seasons. If we misjudge either the market for our merchandise or our
customers purchasing habits, we may experience a material decline in sales or
be required to sell inventory at reduced margins. We could also suffer a loss of
customer goodwill if we do not adhere to our quality control or service
procedures or otherwise fail to ensure satisfactory quality of our products.
These outcomes may have a material adverse effect on our business, operating
results and financial condition.

In fiscal year 2001, we closed three underperforming stores. We anticipate
closing an additional six to eight underperforming stores through 2004. A
material decline in sales and other adverse conditions resulting from our
failure to accurately anticipate changes in merchandise trends and consumer
demands may require us to close additional under-performing stores. The closure
of such stores would subject us to additional costs including, but not limited
to, employee severance costs, charges in connection with the impairment of
assets and costs associated with the disposition of outstanding lease
obligations.



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Our success is highly dependent on improvements to our planning and control
processes and our supply chain.

An important part of our efforts to achieve efficiencies, cost reductions and
sales growth is the identification and implementation of improvements to our
planning, logistical and distribution infrastructure and our supply chain,
including merchandise ordering, transportation and receipt processing. An
inability to improve our planning and control processes or to take full
advantage of supply chain opportunities could have a material adverse effect on
our operating results.

In addition, we have recently incurred significant costs to implement a new
e-commerce application and upgrade our merchandise analysis tools. However, we
cannot assure you that these changes and the substantial costs we incurred to
effect these changes will generate a corresponding financial return for our
business.

Because our revenues are subject to seasonal fluctuations, significant
deviations from projected demand for products in our inventory during a selling
season could have a material adverse effect on our financial condition and
results of operations.

Our business is highly seasonal. We make decisions regarding merchandise well in
advance of the season in which it will be sold, particularly for the holiday
selling season. The general pattern associated with the retail industry is one
of peak sales and earnings during the holiday season. Due to the importance of
the holiday selling season, the fourth quarter of each year has historically
contributed, and we expect it will continue to contribute, a disproportionate
percentage of our net sales and most of our net income for the entire year. In
anticipation of increased sales activity during the fourth quarter, we incur
significant additional expenses both prior to and during the fourth quarter.
These expenses may include acquisition of additional inventory, catalog
preparation and mailing, advertising, in-store promotions, seasonal staffing
needs and other similar items. If, for any reason, our sales were to fall below
our expectations in November and December, our business, financial condition and
annual operating results may be materially adversely affected.

Increased advertising expenditure without increased revenues may have a negative
impact on our operating results.

We expend a large amount of our available funds on advertising in advance of a
particular season. Moreover, our advertising costs for the past three fiscal
years have increased from approximately $11.2 million per year to approximately
$16.1 million per year, and we expect to continue to increase our advertising
expenditures in fiscal 2002. As a result, if we misjudge the directions or
trends in our market, we may expend large amounts of our cash on advertising
that generates little return on investment, which would have a negative effect
on our operating results. During the last three fiscal years, our advertising
costs have increased while our overall revenues have declined. Accordingly, we
have spent increasing cash on advertising without achieving overall revenue
increases and, if this trend were to continue, it would have a negative impact
on our operating results.

Our quarterly results fluctuate due to a variety of factors and are not a
meaningful indicator of future performance.

Our quarterly results have fluctuated in the past and may fluctuate
significantly in the future, depending upon a variety of factors, including,
among other things, the mix of products sold, the timing and level of markdowns,
promotional events, store openings, closings, remodels or relocations, shifts in
the timing of holidays, timing of catalog releases or sales, competitive factors
and general economic conditions. Accordingly, our profits or losses may
fluctuate. Moreover, in response to competitive pressures, we may take certain
pricing or marketing actions that could have a material adverse effect on our
business, financial condition and results of operations. Therefore, we believe
that period-to-period comparisons of our operating results are not necessarily
meaningful and cannot be relied upon as indicators of future performance. If our
operating results in any future period fall below the expectations of securities
analysts and investors, the market price of our securities would likely decline.



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Fluctuations in comparable store sales may cause our revenues and operating
results from period to period to vary.

A variety of factors affect our comparable store sales including, among
other things, the general retail sales environment, our ability to efficiently
source and distribute products, changes in our merchandise mix, promotional
events, the impact of competition and our ability to execute our business
strategy efficiently. Our comparable store sales results have fluctuated
significantly in the past, and we believe that such fluctuations may continue.
Our comparable store sales decreased 4.6% in fiscal 2001, decreased 1% in
fiscal 2000, and increased 0.8% in fiscal 1999. Past comparable store sales
results may not be indicative of future results. As a result, the
unpredictability of our comparable store sales may cause our revenues and
operating results to vary quarter to quarter, and an unanticipated decline in
revenues may cause our stock price to fluctuate.

We depend on a number of key vendors to supply our merchandise and provide
critical services, and the loss of any one of our key vendors may result in a
loss of sales revenues and significantly harm our operating results.

We make merchandise purchases from over 460 vendors. Our performance depends on
our ability to purchase our merchandise in sufficient quantities at competitive
prices. Although we have many sources of merchandise, two of our vendors,
Mitchell Gold, a manufacturer of upholstered furniture, and Robert Abbey Inc., a
manufacturer of table and floor lamps, together accounted for approximately 19%
of our aggregate merchandise purchases in the fiscal year ended February 2,
2002. In addition, our smaller vendors generally have limited resources,
production capacities and operating histories, and some of our vendors have
limited the distribution of their merchandise in the past. We have no long-term
purchase contracts or other contractual assurances of continued supply, pricing
or access to new products, and any vendor or distributor could discontinue
selling to us at any time. We may not be able to acquire desired merchandise in
sufficient quantities on terms acceptable to us in the future, or be able to
develop relationships with new vendors to expand our options or replace
discontinued vendors. Our inability to acquire suitable merchandise in the
future or the loss of one or more key vendors and our failure to replace any one
or more of them may have a material adverse effect on our business, results of
operations and financial condition.

In addition, a single vendor supports the majority of our management information
systems, and we have historically employed a single general contractor to
oversee the construction of our new stores. A failure by the vendor to support
our management information systems or by the contractor to provide its services
adequately upon request in the future could have a material adverse effect on
our business, results of operations and financial condition.

A disruption in any of our three distribution centers operations would
materially affect our operating results.

The distribution functions for our stores are currently handled from our
facilities in Hayward and Tracy, California and Baltimore, Maryland. Any
significant interruption in the operation of any of these facilities may delay
shipment of merchandise to our stores and customers, damage our reputation or
otherwise have a material adverse effect on our financial condition and results
of operations. Moreover, a failure to successfully coordinate the operations of
these facilities also could have a material adverse effect on our financial
condition and results of operations.

We are dependent on external funding sources which may not make available to us
sufficient funds when we need them.

We, like other emerging-growth retailers, rely significantly on external funding
sources to finance our operations and growth. Any reduction in cash flow from
operations could increase our external funding requirements to levels above
those currently available to us. While we currently have in place an $80.0
million credit facility, the amount available under this facility is typically
much less than the



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$80.0 million stated maximum limit of the facility because the availability of
eligible collateral for purposes of the borrowing base limitations in the credit
facility usually reduces the overall credit amount otherwise available at any
given time. We currently believe that the combination of the March 2001
preferred stock financing, the May and November 2001 common stock financings,
our cash flow from operations and funds available under our credit facility will
satisfy our capital requirements for at least the next 12 months. However,
continued weakening of, or other adverse developments concerning, our sales
performance or adverse developments concerning the availability of credit under
our credit facility due to covenant limitations or other factors could limit the
overall availability of funds to us.

In particular, we may experience cash flow
shortfalls in the future and we may require additional external
funding. However, we cannot assure you that we will be
able to raise funds on favorable terms, if at all, or that future financing
requirements would not be dilutive to holders of our capital stock. In the event
that we are unable to obtain additional funds on acceptable terms or otherwise,
we may be unable or determine not to take advantage of new opportunities or take
other actions that otherwise may be important to our operations. Additionally,
we may need to raise additional funds in order to take advantage of
unanticipated opportunities. We also may need to raise additional funds to
respond to changing business conditions or unanticipated competitive pressures.
If we fail to raise sufficient funds, we may be required to delay or abandon
some of our planned future expenditures or aspects of our current operations.

Because our business requires a substantial level of liquidity, we are dependent
upon a credit facility with numerous restrictive covenants that limit our
flexibility.

Our business requires substantial liquidity in order to finance inventory
purchases, the employment of sales personnel for the peak holiday period,
publicity for the holiday buying season and other similar advance expenses. In
addition, other activities such as expenses of our direct-to-customer business
may require additional capital expenditures. We currently have in place a credit
facility with a syndicate of lenders, which includes, among others, Fleet
Capital Corporation. The facility provides for an overall commitment of $80.0
million, of which $20.0 million is available for letters of credit. Over the
past several years, we have entered into numerous modifications of this credit
facility, primarily to address changes in the covenant requirements to which we
are subject.

Covenants in the credit facility include, among others, ones that limit our
ability to incur additional debt, make liens, make investments, consolidate,
merge or acquire other businesses and sell assets, pay dividends and other
distributions, and enter into transactions with affiliates. These covenants
restrict numerous aspects of our business. Moreover, financial performance
covenants require us, among other things, not to exceed particular capital
expenditure limits. The credit facility also includes a borrowing base formula
to address the availability of credit under the facility at any given time based
upon numerous factors, including eligible inventory and eligible accounts
receivable (subject to the overall maximum cap on total borrowings).
Consequently, the availability of eligible collateral for purposes of the
borrowing base formula may limit our ability to borrow under the credit
facility.

As of February 2, 2002, we had no debt outstanding under our credit
facility. However, we expect to draw upon the credit facility in the future. If we do,
failure to comply with the terms of the credit facility would entitle the
secured lenders to foreclose on our assets, including our accounts
receivable, inventory,
general intangibles, equipment, goods, fixtures and chattel paper. The secured
lenders would be repaid from the proceeds of the liquidation of those assets
before the assets would be available for distribution to other creditors and,
lastly, to the holders of our capital stock. Our ability to satisfy the
financial and other restrictive covenants may be affected by events beyond our
control.



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Future increases in interest and other expense may impact our future operations.

High levels of interest and other expense have had and could have negative
effects on our future operations. Interest expense decreased $1.1 million to
$4.8 million in the fiscal year ended February 2, 2002, from $5.9 million the
fiscal year ended February 3, 2001. This decrease resulted from reduced debt
levels, partially offset by an increase in the average interest rate. In the
fiscal year ended February 3, 2001, interest expense increased $4.5 million to
$5.9 million from the prior year. In the fiscal year ended January 29, 2000,
interest expense increased $0.5 million to $1.4 million. The increased interest
expense in these fiscal years resulted primarily from an increase in the average
borrowings outstanding. In the fiscal year ended February 2, 2002, cash raised
in various equity financings together with cash generated from operations
allowed the Company to reduce during the course of the year the outstanding
balances under its credit facility and to end the year with no outstanding
balance under the facility. In addition, while our credit facility was amended
in March 2001 and September 2001 to provide us with more favorable interest
rates and changes to some financial covenants, a substantial portion of our cash
flow from operations was used to pay our interest expense and will not be
available for other business purposes.

Our ability to continue to meet our future debt and other obligations and to
minimize our average debt level depends on our future operating performance and
on economic, financial, competitive and other factors. In addition, we may need
to incur additional indebtedness in the future. Many of these factors are beyond
our control. We cannot assure you that our business will generate sufficient
cash flow or that future financings will be available to provide sufficient
proceeds to meet our obligations or to service our total debt.

we are subject to trade restrictions and other risks associated with our
dependence on foreign imports for our merchandise.

For the fiscal year ended February 2, 2002, we purchased approximately 32% of
our merchandise directly from vendors located abroad and expect that such
purchases will increase as a percentage of total merchandise purchases for the
fiscal year ending on February 1, 2003. As an importer, our future success will
depend in large measure upon our ability to maintain our existing foreign
supplier relationships and to develop new ones. While we rely on our long-term
relationships with our foreign vendors, we have no long-term contracts with
them. Additionally, many of our imported products are subject to existing
duties, tariffs and quotas that may limit the quantity of some types of goods
which we may import into the United States. Our dependence on foreign imports
also makes us vulnerable to risks associated with products manufactured abroad,
including, among other things, changes in import duties, tariffs and quotas,
loss of most favored nation trading status by the United States in relation to
a particular foreign country, work stoppages, delays in shipments, freight cost
increases, economic uncertainties, including inflation, foreign government
regulations, and political unrest and trade restrictions, including the United
States retaliating against protectionist foreign trade practices. If any of
these or other factors were to render the conduct of business in particular
countries undesirable or impractical, our financial condition and results of
operations could be materially adversely affected.

While we believe that we could find alternative sources of supply, an
interruption or delay in supply from our foreign sources, or the imposition of
additional duties, taxes or other charges on these imports, could have a
material adverse effect on our business, financial condition and results of
operations unless and until alternative supply arrangements are secured.
Moreover, products from alternative sources may be of lesser quality and/or more
expensive than those we currently purchase, resulting in a loss of sales
revenues to us.

As an importer we are subject to the effects of currency fluctuations related to
our purchases of foreign merchandise.



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While most of our purchases outside of the United States currently are settled
in U.S. dollars, it is possible that a growing number of them in the future may
be made in currencies other than the U.S. dollar. Historically, we have not
hedged our currency risk and do not currently anticipate doing so in the future.
However, because our financial results are reported in U.S. dollars,
fluctuations in the rates of exchange between the U.S. dollar and other
currencies may decrease our sales margins or otherwise have a material adverse
effect on our financial condition and results of operations in the future.

Increased investments related to our direct-to-customer business may not
generate a corresponding increase in profits to our business.

We have invested additional resources in the expansion of our direct-to-customer
business which could increase the risks associated with aspects of this
business. In fiscal year 2001, sales through our direct-to-customer channel grew
by 49 percent. Increased activity in our direct-to-customer business could
result in material changes in our operating costs, including increased
merchandise inventory costs and costs for paper and postage associated with the
distribution and shipping of catalogs and product. Although we intend to attempt
to mitigate the impact of these increases by improving efficiencies, we cannot
assure you that we will succeed in mitigating expenses with increased efficiency
or that cost increases associated with our direct-to-customer business will not
have an adverse effect on the profitability of our business. Additionally, while
we out-source the fulfillment of our direct-to-customer division, including
telemarketing, customer service and distribution, to a third party, the third
party may not have the capacity to accommodate our growth. This lack of capacity
may result in delayed customer orders and deficiencies in customer service, both
of which may adversely affect our reputation and cause us to lose sales revenue.

Our success is highly dependent on new manufacturers and suppliers with whom we
do not have a long history working together.

In connection with our repositioning strategy, we are implementing a new
merchandising strategy which will entail changing the nature and types of the
many products that we sell. We anticipate changes in some of the manufacturers
and suppliers of our products. Many of these manufacturers and suppliers will be
new to us, and many of them will be located abroad. We cannot assure you that
they will be reliable sources of our products. Moreover, these manufacturers and
suppliers may be small and undercapitalized firms which produce limited numbers
of items. Given their limited resources, these firms might be susceptible to
production difficulties, quality control issues and problems in delivering
agreed-upon quantities on schedule. We cannot assure you that we would be able,
if necessary, to return products to these suppliers and obtain refunds of our
purchase price or obtain reimbursement or indemnification from them if their
products prove defective. These suppliers and manufacturers also may be unable
to withstand the current downturn in the U.S. or worldwide economy. Significant
failures on the part of these new suppliers or manufacturers could have a
material adverse effect on our operating results.

In addition, many of these suppliers and manufacturers will require extensive
advance notice of our requirements in order to produce products in the
quantities we desire. This long lead time requires us to place orders far in
advance of the time when certain products will be offered for sale, thereby
exposing us to risks relating to shifts in customer demands and trends, and any
downturn in the U.S. economy.

We depend on key personnel and could be affected by the loss of their services
because of the limited number of qualified people in our industry.

The success of our business will continue to depend upon our key personnel,
including our President and Chief Executive Officer, Mr. Gary G. Friedman.
During the last year, we have experienced significant turnover in our executive
staff, including the departure of our Chief Operating Officer and Chief
Financial Officer. We have hired a new Chief Financial Officer, a new Chief
Operating Officer and a number of other new executive personnel. Eight out of
our twelve vice presidents are new. Although we believe that the hiring of such
personnel will offer an opportunity to expand our management team with persons
that can assist in implementing our new direction, turnover in personnel and the
recruitment and retention of a



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new executive staff created a number of significant challenges for us. For
instance, the responsibilities of the Chief Financial Officer include budgeting,
financial forecasting and related areas of financial management. We
have experienced transitional difficulties in administration in these areas in
connection with the departure of our former Chief Financial Officer. However, the retention of our new Chief Financial Officer has allowed us to move rapidly to
address these transitional issues. In so doing, we have discovered related and
unrelated problems which we have been obligated to address and resolve and in
certain cases, which we continue to work through. In particular, we are continuing to evaluate the various procedures used in our
accounting systems and as a part of this evaluation we will implement such changes as necessary.

Additionally, competition for qualified employees and personnel in the retail
industry is intense. The process of locating personnel with the combination of
skills and attributes required to carry out our goals is often lengthy. Our
success depends to a significant degree upon our ability to attract, retain and
motivate qualified management, marketing and sales personnel, in particular
store managers, and upon the continued contributions of these people. We cannot
assure you that we will be successful in attracting and retaining qualified
executives and personnel. In addition, our employees may voluntarily terminate
their employment with us at any time. We also do not maintain any key man life
insurance. The loss of the services of key personnel or our failure to attract
additional qualified personnel could have a material adverse effect on our
business, financial condition and results of operations.

Rapid growth of our company coupled with change in general economic conditions
has impacted our profitability.

In fiscal years 1999 and 2000, we experienced rapid growth and, as a result, our
costs and expenditures outpaced our revenues. Following this growth, the economy
in the United States of America began to weaken. The combination of these two
factors affected our profitability. As a result of these factors in fiscal years
1999, 2000 and 2001, we were not profitable. If similar factors continue to
operate unmitigated, there will be a material adverse effect on our business,
operating results and financial condition.

Changes in general economic conditions affect consumer spending and may
significantly harm our revenues and results of operations.

We believe that general trends in the economy have adversely affected retail
sales, and that we may continue to be hurt by such trends. In particular, a
weakening environment for retail sales could adversely affect consumer interest
in our major product lines. Our comparable store sales decreased 4.6% for
the fiscal year ended February 2, 2002. Additionally, in fiscal years 2001, 2000
and 1999, we were not profitable. The success of our business depends to a
significant extent upon the level of consumer spending. A number of economic
conditions affect the level of consumer spending on merchandise that we offer,
including, among other things, the general state of the economy, general
business conditions, the level of consumer debt, interest rates, taxation and
consumer confidence in future economic conditions. More generally, reduced
consumer confidence and spending may result in reduced demand for our products
and limitations on our ability to increase prices, and may also require
increased levels of selling and promotional expenses. Adverse economic
conditions and any related decrease in consumer demand for discretionary items
such as those offered by us could have a material adverse effect on our
business, results of operations and financial condition.

We face an extremely competitive specialty retail business market.

The retail market is highly competitive. We compete against a diverse group of
retailers ranging from specialty stores to traditional furniture stores and
department stores. Our product offerings also compete with a variety of
national, regional and local retailers. We also compete with these and other
retailers for customers, suitable retail locations, suppliers and qualified
employees and management personnel. Many of our competitors have significantly
greater financial, marketing and other resources. Moreover, increased
competition may result in potential or actual litigation between us and our
competitors relating to such activities as competitive sales and hiring
practices, exclusive relationships with key suppliers and manufacturers and
other matters. As a result, increased competition may adversely affect our
future



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financial performance, and we cannot assure you that we will be able to compete
successfully in the future.

Terrorist attacks and threats or actual war may negatively impact all aspects of
our operations, revenues, costs and stock price.

Recent terrorist attacks in the United States, as well as future events
occurring in response or connection to them, including, without limitation,
future terrorist attacks or threats against United States targets, rumors or
threats of war, actual conflicts involving the United States or its allies or
military or trade disruptions affecting our domestic or foreign suppliers of
merchandise, may impact our operations. The potential impact to our operations
includes, among other things, delays or losses in the delivery of merchandise to
us and decreased sales of the products we carry. Additionally, any of these
events could cause consumer confidence and spending to decrease or result in
increased volatility in the U.S. and worldwide financial markets and economy.
They also could result in economic recession in the U.S. or abroad. Any of these
occurrences could have a significant impact on our operating results, revenues
and costs and may result in the volatility of the market price for our common
stock and on the future price of our common stock.

Our common stock price may be volatile.

The market price of our common stock has fluctuated significantly in the past,
and is likely to continue to be highly volatile. In addition, the trading volume
in our common stock has fluctuated, and significant price variations can occur
as a result. We cannot assure you that the market price of our common stock will
not fluctuate or decline significantly in the future. In addition, the U.S.
equity markets have from time to time experienced significant price and volume
fluctuations that have particularly affected the market prices for the stocks of
emerging-growth companies. These broad market fluctuations may materially
adversely affect the market price of our common stock in the future. Such
variations may be the result of changes in the trading characteristics that
prevail in the market for our common stock, including low trading volumes,
trading volume fluctuations and other similar factors that are particularly
common among highly volatile securities of emerging-growth companies. Variations
also may be the result of changes in our business, operations or prospects,
announcements or activities by our competitors, entering into new contractual
relationships with key suppliers or manufacturers by us or our competitors,
proposed acquisitions by us or our competitors, financial results that fail to
meet public market analysts expectations, changes in stock market analysts
recommendations regarding us, other retail companies or the retail industry in
general, and domestic and international market and economic conditions.

Future sales of our common stock in the public market could adversely affect our
stock price and our ability to raise funds in new equity offerings.

We cannot predict the effect, if any, that future sales of shares of our common
stock or the availability for future sale of shares of our common stock or
securities convertible into or exercisable for our common stock will have on the
market price of our common stock prevailing from time to time. For example, in
connection with our May 2001 common stock financing, we filed a registration
statement on Form S-3 with the Securities and Exchange Commission on June 1,
2001 to register approximately 4.5 million shares of our common stock acquired
by the investors in the financing. The registration statement became effective
on July 6, 2001. Additionally, in connection with our March 2001 preferred stock
financing, we filed a registration statement on Form S-3 with the Securities and
Exchange Commission to register up to 6.8 million shares of our common stock
issued, or to be issued upon the conversion of our Series A preferred stock, to
the investors in the financing. And, in connection with our November 2001 common
stock financing, we filed a registration statement on Form S-3 with the
Securities and Exchange Commission to register approximately 4.5 million shares
of our common stock issued to the investors in the financing. Sale, or the
availability for sale, of substantial amounts of common stock by our existing
stockholders pursuant to an effective registration statement or under Rule 144,
through the exercise of registration rights or the issuance of shares of common
stock upon the exercise of stock options, or the conversion of our preferred
stock, or the perception that such sales or issuances could occur, could
adversely affect prevailing market prices for our common stock and could
materially impair our future ability to raise capital through an offering of
equity securities.



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We are subject to anti-takeover provisions and the terms and conditions of our
preferred stock financing that could delay or prevent an acquisition and could
adversely affect the price of our common stock.

Our Second Amended and Restated Certificate of Incorporation, as amended and
Amended and Restated Bylaws, certain provisions of Delaware law and the
certificate of designation governing the rights, preferences and privileges of
our preferred stock may make it difficult in some respects to cause a change in
control of our company and replace incumbent management. For example, our Second
Amended and Restated Certificate of Incorporation, as amended and Amended and
Restated Bylaws provide for a classified board of directors. With a classified
board of directors, at least two annual meetings of stockholders, instead of
one, will generally be required to effect a change in the majority of the board.
As a result, a provision relating to a classified board may discourage proxy
contests for the election of directors or purchases of a substantial block of
our common stock because its provisions could operate to prevent obtaining
control of the board in a relatively short period of time.

Separately, the holders of our preferred stock have the right to designate two
members of our board of directors, and they also have a number of voting rights
pursuant to the terms of the certificate of designation which could potentially
delay, defer or prevent a change of control. In particular, the holders of our
Series A preferred stock have the right to approve a number of actions by us,
including mergers, consolidations, acquisitions and similar transactions in
which the holders of Series A preferred stock and common stock do not receive at
least three times the then existing conversion price per share of the Series A
preferred stock. This right may create a potentially discouraging effect on,
among other things, any third partys interest in completing these types of
transactions with us. Consequently, the terms and conditions under which we
issued our preferred stock, coupled with the existence of other anti-takeover
provisions, may collectively have a negative impact on the price of our common
stock, may discourage third-party bidders from making a bid for our company or
may reduce any premiums paid to our stockholders for their common stock.

In addition, our board of directors has the authority to fix the rights and
preferences of, and to issue shares of, our preferred stock, which may have the
effect of delaying or preventing a change in control of our company without
action by holders of our common stock.



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ITEM 2. PROPERTIES

We currently lease three properties located in Corte Madera,
California, which are used as our headquarters. The first property in Corte
Madera consists of approximately 3,600 square feet of office space and
approximately 11,000 square feet of warehouse space. The lease expires on
December 31, 2003. The second and third properties in Corte Madera consist of
approximately 30,000 square feet of office space in total and the leases expire
on May 15, 2003.

We lease approximately 160,000 square feet of warehouse space in
Hayward, California, for use as our west coast distribution center. This lease
expires on July 31, 2004, with an option to extend for one additional five-year
term. We lease an additional 191,000 square feet of warehouse space in Tracy,
California, also for use as a distribution center. This lease expires on
September 1, 2003. We lease approximately 276,000 square feet of warehouse space
in Baltimore, Maryland, for use as our east coast distribution center. The lease
expires on September 30, 2006, with options to extend for two additional
three-year terms.

As of February 2, 2002, we leased approximately 1,187,000 gross square
feet for our 104 retail stores. Our retail stores lease terms range from 10 to
15 years. Most leases for our retail stores provide for a minimum rent,
typically including escalating rent increases, plus a percentage rent based upon
sales after certain minimum thresholds are achieved. The leases generally
require us to pay insurance, utilities, real estate taxes, and repair and
maintenance expenses.

Michaels leases two properties used for the manufacturing and storage
of furniture, in Sacramento, California. The main property consists of
approximately 100,000 square feet of manufacturing space and 7,000 square feet
of office space. The lease expires on February 28, 2008, with options to extend
the lease for two additional 5-year terms. The second property consists of
approximately 46,000 square feet of warehouse space which is used to house
finished upholstered goods. This lease expires on July 31, 2006.




ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings against us. We are,
however, involved in routine litigation arising in the ordinary course of our
business. We believe that the final outcome of such proceedings should not have
a material adverse effect on our consolidated financial condition or results of
operations. However, we cannot assure you that the result of any proceeding will
be in our favor.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS










No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this annual report other than a
request for approval by the holders of our Series A preferred stock in
connection with our November 6, 2001 common stock financing transaction. With
regard to this approval, we held, on November 5, 2001, a special meeting of
holders of our Series A preferred stock. As of the date of the special meeting,
we had 15,000 shares of our Series A preferred stock outstanding and entitled to
vote on the proposal presented at the special meeting, held by 17 stockholders
of record. Of these outstanding shares, 91.5% or 13,730 shares of Series A
preferred stock were represented at such meeting, which constituted a quorum.
The matter voted upon at the special meeting was the approval, pursuant to the
requirements of our certificate of designation, of a financing transaction in an
amount of not more than $17.5 million, which financing would be obtained by the
issuance of our common stock at a price per share between $3.75 and $3.90 and
which might involve a holder of 5% or greater of our outstanding shares of
common stock and common stock equivalents, a holder of our preferred stock or
their respective affiliates. The result of the voting as to such matter was as
follows:

|       |  |         |  |             |  |                 
|------ |  | ------- |  | ----------- |  | ----------------
|For    |  | Against |  | Abstentions |  | Broker Non-Votes
|       |  |         |  |             |  |                 
|13,730 |  | 0       |  | n/a         |  | n/a             






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PART II




ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

Our common stock is listed on The Nasdaq National Market under the
symbol RSTO. The closing price of our common stock on Nasdaq was $11.76 on
April 23, 2002.

STOCKHOLDERS

The number of our common stockholders of record as of April 23, 2002
was 206. This number excludes stockholders whose stock is held in nominee or
street name by brokers.

DIVIDEND POLICY

No dividends have been declared on our common stock since our 1998
initial public offering and it is not anticipated that we will pay any dividends
in the foreseeable future on our common stock.

STOCK PRICE INFORMATION

Set forth below are the high and low closing sale prices for shares of
our common stock for each quarter during the fiscal years ended February 2, 2002
and February 3, 2001 as reported by The Nasdaq National Market.

|                 |  |      |       |     |  |   |      | 
|---------------- |  | ---- | ----- | --- |  | - | ---- | 
|QUARTER ENDING   |  | HIGH |       | LOW
|                 |  |      |       |    
|January 29, 2000 |  | $    | 10.38 |     |  | $ | 5.13 | 
|April 29, 2000   |  |      | 7.00  |     |  |   | 3.72 | 
|July 29, 2000    |  |      | 6.44  |     |  |   | 4.06 | 
|October 28, 2000 |  |      | 6.00  |     |  |   | 2.50 | 
|February 3, 2001 |  |      | 2.94  |     |  |   | 0.53 | 
|May 5, 2001      |  |      | 6.12  |     |  |   | 1.38 | 
|August 4, 2001   |  |      | 7.25  |     |  |   | 4.77 | 
|November 3, 2001 |  |      | 4.83  |     |  |   | 2.30 | 
|February 2, 2002 |  |      | 10.50 |     |  |   | 3.96 | 



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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected, consolidated financial
information for operations for the years indicated. This information is
qualified by reference to and should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations, the
consolidated financial statements, related notes thereto and other financial
data included elsewhere in this annual report. The following results may not be
indicative of our future operating results.

|                                                                       |  |        |         |          |  |        |         |          |  |        |         |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------- |  | ------ | ------- | -------- |  | ------ | ------- | -------- |  | ------ | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                       |  | Fiscal |         | Fiscal   |  | Fiscal |         | Fiscal   |  | Fiscal
|                                                                       |  | 2001   |         | 2000 (2) |  | 1999   |         | 1998 (1) |  | 1997  
|                                                                       |  |        |         |          |  |        |         |          |  |       
|Results of
Operations (Dollars
in thousands except
per share amounts): |  |        |         |          |  |        |         |          |  |        |         |   |  |   |         |   |  |   |         |  
|Net sales                                                              |  | $      | 366,473 |          |  | $      | 366,236 |          |  | $      | 298,902 |   |  | $ | 211,347 |   |  | $ | 98,655  |  
|Earnings (loss) before
income taxes                                    |  |        | (43,615 | )        |  |        | (5,977  | )        |  |        | (4,773  | ) |  |   | 8,247   |   |  |   | 3,056   |  
|Net earnings (loss)                                                    |  |        | (33,867 | )        |  |        | (4,560  | )        |  |        | (3,040  | ) |  |   | 4,866   |   |  |   | 1,748   |  
|Net earnings (loss)
available to common
shareholders                   |  |        | (36,684 | )        |  |        | (4,560  | )        |  |        | (3,040  | ) |  |   | 3,867   |   |  |   | (5,285  | )
|Basic EPS                                                              |  |        | (1.57   | )        |  |        | (0.27   | )        |  |        | (0.18   | ) |  |   | 0.33    |   |  |   | (1.20   | )
|Diluted EPS                                                            |  |        | (1.57   | )        |  |        | (0.27   | )        |  |        | (0.18   | ) |  |   | 0.23    |   |  |   | (1.20   | )
|Financial Position:                                                    |  |        |         |          |  |        |         |          |  |        |         |   |  |   |         |   |  |   |         |  
|Working capital                                                        |  |        | 49,979  |          |  |        | 36,196  |          |  |        | 48,373  |   |  |   | 34,417  |   |  |   | 8,188   |  
|Total assets                                                           |  |        | 206,744 |          |  |        | 233,871 |          |  |        | 221,715 |   |  |   | 164,245 |   |  |   | 87,233  |  
|Long-term debt and other
liabilities                                   |  |        | 3,236   | (4)      |  |        | 39,470  |          |  |        | 37,145  |   |  |   | 470     |   |  |   | 10,678  |  
|Redeemable convertible
preferred stock                                 |  |        | 14,106  |          |  |        |        |          |  |        |        |   |  |   |        |   |  |   | 43,033  |  
|Stockholders equity                                                   |  |        | 88,144  |          |  |        | 78,875  |          |  |        | 82,882  |   |  |   | 83,755  |   |  |   | (11,748 | )
|Retail Stores:                                                         |  |        |         |          |  |        |         |          |  |        |         |   |  |   |         |   |  |   |         |  
|Store count                                                            |  |        | 104     |          |  |        | 106     |          |  |        | 93      |   |  |   | 65      |   |  |   | 41      |  
|Comparable store sales
growth (3)                                      |  |        | (4.6    | %)       |  |        | (1.0    | %)       |  |        | 0.8     | % |  |   | 12.3    | % |  |   | 11.1    | %
|Store selling sq. ft. at
year-end                                      |  |        | 682,936 |          |  |        | 701,628 |          |  |        | 614,343 |   |  |   | 418,025 |   |  |   | 250,622 |  



---

|(1) |  | The results of operations for 1998 include the results of Michaels from
the date of acquisition on March 20, 1998.                                                                                                                                                   
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Fiscal 2000 was a 53-week
year. For purposes of the calculation of comparable store growth, results were calculated to correspond with 52-week
fiscal year.                                                                                                          
|   
|   
|   
|   
|   
|(3) |  | Comparable store sales are defined as sales from stores whose gross
square feet did not change by more than 20% in the previous 12 months
and which have been open at least 12 full months. Stores generally
become comparable in their 14th full month of operation.
|   
|   
|   
|   
|   
|(4) |  | As of February 2, 2002,
we had no outstanding bank debt.                                                                                                                                                                                                             



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|        |  |                                                                                      
|------- |  | -------------------------------------------------------------------------------------
|ITEM 7. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Net Sales

Net sales consist of the following components:

|                        |  |                        |         |       |  |      |       |       |  |      |         |       |  |  |       |   |  |      |         |  |  |  |       |  
|----------------------- |  | ---------------------- | ------- | ----- |  | ---- | ----- | ----- |  | ---- | ------- | ----- |  |  | ----- | - |  | ---- | ------- |  |  |  | ----- | -
|                        |  |                        |         |       |  | % OF |       |       |  |      |         | % OF  |  |  |       |   |  | % OF
|                        |  | 2001                   |         | TOTAL |  | 2000 |       | TOTAL |  | 1999 |         | TOTAL
|                        |  |                        |         |       |  |      |       |       |  |      |         |      
|                        |  | (Dollars in thousands)
|Retail sales            |  | $                      | 332,783 |       |  |      | 90.8  | %     |  | $    | 342,687 |       |  |  | 93.5  | % |  | $    | 279,225 |  |  |  | 93.4  | %
|Direct-to-customer      |  |                        | 33,647  |       |  |      | 9.2   | %     |  |      | 22,554  |       |  |  | 6.2   | % |  |      | 12,785  |  |  |  | 4.3   | %
|Furniture manufacturing |  |                        | 43      |       |  |      |      |       |  |      | 995     |       |  |  | 0.3   | % |  |      | 6,892   |  |  |  | 2.3   | %
|                        |  |                        |         |       |  |      |       |       |  |      |         |       |  |  |       |   |  |      |         |  |  |  |       |  
|Total net sales         |  | $                      | 366,473 |       |  |      | 100.0 | %     |  | $    | 366,236 |       |  |  | 100.0 | % |  | $    | 298,902 |  |  |  | 100.0 | %
|                        |  |                        |         |       |  |      |       |       |  |      |         |       |  |  |       |   |  |      |         |  |  |  |       |  

Net sales for the 52 weeks ended February 2, 2002 (fiscal 2001),
increased $0.2 million or 0.1% over net sales for the 53 weeks ended February 3,
2001 (fiscal 2000). Net sales for fiscal 2000 increased $67.3 million, or
22.5%, over net sales for the 52 weeks ended January 29, 2000 (fiscal 1999).
The furniture manufacturing sales include only those sales to third
parties. Total net
sales include shipping fees of $7.1 million, $5.7 million and $4.0 million for
fiscal 2001, fiscal 2000, and fiscal 1999, respectively. As of February 2, 2002,
we operated 104 stores in 31 states, the District of Columbia and Canada.

Retail Sales

|                                      |  |                                                   |         |      |  |      |         |    |  |   |         |  
|------------------------------------- |  | ------------------------------------------------- | ------- | ---- |  | ---- | ------- | -- |  | - | ------- | -
|                                      |  | 2001                                              |         | 2000 |  | 1999
|                                      |  |                                                   |         |      |  |     
|                                      |  | (in thousands except percentages, sq. ft. amounts
|                                      |  | and retail stores data)                          
|Retail sales                          |  | $                                                 | 332,783 |      |  | $    | 342,687 |    |  | $ | 279,225 |  
|Retail growth percentage              |  |                                                   | (2.9    | %)   |  |      | 22.7    | %  |  |   | 45.0    | %
|Comparable store sales growth         |  |                                                   | (4.6    | %)   |  |      | (1.0    | %) |  |   | 0.8     | %
|Number of stores at beginning of year |  |                                                   | 106     |      |  |      | 93      |    |  |   | 65      |  
|Number of stores opened               |  |                                                   | 1       |      |  |      | 13      |    |  |   | 28      |  
|Number of stores closed               |  |                                                   | 3       |      |  |      | 0       |    |  |   | 0       |  
|Number of stores at year-end          |  |                                                   | 104     |      |  |      | 106     |    |  |   | 93      |  
|Store selling sq. ft. at year-end     |  |                                                   | 682,936 |      |  |      | 701,628 |    |  |   | 614,343 |  

Retail sales decreased 2.9% in fiscal 2001 as compared to the prior
year, primarily due to a 4.6% decrease in comparable store sales and the
closure of three underperforming stores. As further discussed in Liquidity and
Capital Resources, below, in the first and second quarters of fiscal 2001, we
received cash proceeds from a third party to cancel leases and close three
of our underperforming stores. The cash proceeds received of $5.3 million
approximated the net book value of the assets that were written off
as a part of the store closures.

Over the second half of fiscal 2001, as part of our repositioning
strategy, we reduced the number of items in our merchandise assortment by 30%,
from approximately 7,000 to approximately 5,000 items. In connection
with this process,
under-performing products were eliminated and new products were introduced,
resulting in the introduction of approximately 60% new product in the first quarter of fiscal 2002.

Retail sales in fiscal 2000 increased 22.7% as compared to the prior
year, primarily due to new store openings.




Comparable store sales are defined as sales from stores whose gross
square feet did not change by more than 20% in the previous 12 months and which
have been open at least 12 full months. Stores generally become comparable in
their 14th full month of operation. In any given period, the set of stores
comprising comparable stores may be different from the set of the comparable
stores in the previous period, depending on when stores were opened.




Direct-to-customer

Direct-to-customer sales consist of catalog and Internet sales. Net
direct-to-customer sales in fiscal 2001 increased $11.1 million or 49.2% as
compared to fiscal 2000. Total catalogs mailed in fiscal 2001 increased to 20.5
million, as compared to approximately 12 million catalogs in fiscal 2000.

Of the total catalogs
mailed in fiscal 2001, 12.2 million were mailed
into our retail trade areas, versus 4.9 million in the prior year. We believe
that the strategy of mailing catalogs into retail trade areas increases customer
traffic in



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our stores and enhances the overall brand image. In April 2002, in connection
with our repositioning strategy, we redesigned our catalog and launched a new
website to enhance the overall customer experience.

Net direct-to-customer sales in fiscal 2000 increased $9.8 million as
compared to fiscal 1999. Approximately half of the increase was from sales from
our website, which was launched in August 1999. Total catalogs mailed in fiscal
2000 increased to 12.2 million, from 7.2 million in fiscal 1999.

Furniture Manufacturing

We own a wholly-owned
furniture manufacturing company located
in Sacramento, California, The Michaels Furniture Company (Michaels). The large majority of furniture produced at Michaels
is sold through the Companys sales channels. Additionally, since we acquired
Michaels, there have been sales of Michaels furniture to third party customers.
Over the past 3 years, we have significantly reduced these sales to third
parties in order to increase production capacity for inter-segment sales.
Inter-segment sales to Restoration Hardware represented virtually all of
Michaels total sales during fiscal 2001, and this trend is expected to
continue.

COST OF SALES AND OCCUPANCY

In fiscal 2001, cost of sales and occupancy expenses expressed as a
percentage of net sales increased 9.4% to 78.7% from 69.3% in fiscal 2000.

In the fourth quarter of fiscal 2001 we had charges due to special
items totaling $17.5 million which accounted for 4.8% of the 9.4% increase in
the cost of sales expressed as a percentage of net sales. These charges included: a $5.3
million charge to reduce certain inventory being eliminated in our repositioning
strategy to its net realizable value, a $2.0 million accelerated depreciation
charge related to reduced lives of certain long-lived assets being replaced in
our Spring 2002 store remodel program, and a $10.2 million charge related to the
write-down of long-lived assets in eight under-performing stores. These charges
are further discussed below in the section Special Items.

Merchandise markdown and clearance activity associated with our
repositioning strategy resulted in a 5.2% deterioration in merchandise margins.
Partially offsetting these negative factors, the cost of sales component
which pertains to buying and distribution costs expressed as a
percent of sales improved 0.6% in
fiscal 2001 as compared to fiscal 2000, primarily as a result of lower freight
expense to our stores, and lower payroll in our distribution centers.

In fiscal 2000, cost of sales and occupancy expressed as a percentage
of sales remained unchanged at 69.3% compared to the fiscal 1999. Merchandise
margin improvements in fiscal 2000 as a result of better sourcing and product
flow were offset by higher occupancy costs.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses expressed as a percentage
of net sales increased 0.5% to 31.3% in fiscal 2001 from 30.8% in fiscal 2000.
The increase is largely due to increased marketing and fulfillment charges in
the direct-to-customer division, increased professional fees associated with our
repositioning strategy and increased health and benefit costs for our employees.
Selling, general and administrative expenses expressed as a percentage of net
sales decreased 1.0% to 30.8% in fiscal 2000 from 31.8% in fiscal 1999. The
decrease was primarily attributable to improvements store payroll and other
store controllable expenses.

INTEREST EXPENSE AND INTEREST INCOME

Interest expense includes interest related to the amortization of debt
issuance costs and interest on borrowings under our line of credit facility. In
fiscal 2001, such interest expense was $4.8 million as compared to $5.9 million
in fiscal 2000. After eliminating non-cash interest charges related to
amortization of debt issuance costs for both fiscal years, interest expense was
$3.1 million for fiscal 2001 as compared to $5.1 million for fiscal 2000, a
decrease of $2.0 million.



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The decrease resulted from the amendments of our credit facility to provide for
more favorable interest rates and a reduction in debt made possible by the $56.0
million (net of fees) raised in our preferred and common stock
financings in fiscal 2001, as discussed below.

We completed three financing transactions in fiscal 2001. In March
2001, we completed a preferred stock financing, appointed a new Chief Executive
Officer, and amended our credit facility. In May and November, we completed two
common stock financings. Combined net proceeds from our preferred stock and
common stock transactions of $56.0 million (net of fees) were used to pay down
our revolving line of credit and for other general corporate purposes. As a
result, average borrowings in fiscal 2001 decreased to $23.6 million from $48.4
million in fiscal 2000. The average interest rate during the same period
increased from 11.2% to 12.6%, primarily as a result of two high-interest term
loans that were part of the amendment of the credit facility in September 2000.
Until the anniversary of the amendment in September of fiscal 2001, the
existence of these term loans negatively impacted our average interest rate in
fiscal 2001 as compared to the prior year. The two term loans were paid off in
the second and fourth quarters of fiscal 2001.

In fiscal 2000, interest expense was $5.9 million as compared to $1.4
million in fiscal 1999, an increase of $4.5 million. During fiscal 2000 our
average borrowings outstanding increased to $48.4 million from $20.8 million in
fiscal 1999. Interest expense in fiscal 2000 included $0.7 million of
amortization of debt issuance costs.

Interest income, which consists of income from our short-term
investments and notes receivable, increased $0.2 million in fiscal 2001 as
compared to fiscal 2000. The majority of the increase was due to interest on a
$2.05 million loan we provided to Mr. Friedman in connection with his purchase
of common stock and preferred stock in March 2001. Interest income in fiscal
2000 increased $0.1 million as compared to fiscal 1999.

INCOME TAXES

The fiscal 2001 income tax benefit included a valuation allowance
charge of $7 million, as more further discussed in Critical Accounting
Policies below. After adjusting for this charge, our effective tax benefit rate
was 22.4% in fiscal 2001, as compared to a tax benefit rate of 37.4% in fiscal
2000 and a tax provision rate of 36.3% in fiscal 1999. These rates reflect the
effect of aggregate state tax rates based on a mix of retail sales and
direct-to-customer sales in the various states in which we have sales revenue or
conduct business.

SPECIAL ITEMS

Fiscal 2001 included special item charges of approximately $24.5
million. A discussion of these charges follows.

Inventory lower of cost or market reserve  In connection with the
elimination of approximately 30% of the items from our merchandise assortment,
we recorded a charge of $5.3 million to write down discontinued merchandise at
year-end to its estimated net realizable value.

Accelerated
depreciation  At the beginning of the fourth quarter 2001,
concurrent with our November, 2001 private placement of common stock,
we finalized our decision to remodel our stores in the first quarter
of fiscal 2002. As a result, we recorded an accelerated depreciation
charge of $2.0 million in order to reflect the shortened useful life of store
fixtures and leasehold assets which were scheduled to be replaced.

Asset impairment charge  In the course of performing our periodic cash
flow analysis of our mature stores, we determined that an asset impairment
charge of $10.2 million was required for eight underperforming locations. The
impairment charge was calculated as the difference between the net book value of
the stores long-lived assets and the present value of the
stores estimated future
cash flows over the remaining life of the lease.

Tax Valuation Allowance  In the course of analyzing our projected
taxable income, we determined that a valuation allowance of $7.0 million against
our deferred tax assets was appropriate. The valuation allowance reduced our
deferred tax assets to an amount that is more likely than not to be realized.



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LIQUIDITY AND CAPITAL RESOURCES

Operating Cash Flows:

In fiscal 2001, net cash provided by operating activities decreased
$15.1 million to $4.3 million, from $19.4 million in fiscal 2000. Cash decreased
largely because of the following factors: the increased net losses resulting
from a deterioration in merchandise margins due to increased cost of
sales associated with our repositioning strategy; increased
cash use in reducing accounts payable and other accrued expenses; and a reduction in
cash provided from deferred lease incentives. These factors were partially
offset by a reduction in the investment in inventory as a result of lower
inventory balances, and a reduction in accounts receivable.

In fiscal 2000, net cash provided by operating activities increased
$15.1 million, to $19.4 million from $4.3 million in fiscal 1999. Cash increased
largely because of a reduction during fiscal 2000 in the use of cash for
building merchandise inventories, and improved operating margins before
depreciation expense resulting from expense reductions. These factors were
partially offset by reductions in cash provided from deferred lease incentives,
and an increased use of cash in reducing accounts payable and other accrued
expenses.

Investing Cash Flows:

Net cash from investing activities increased $25.1 million, to a source
of cash of $1.5 million in fiscal 2001, from a use of cash of $23.6 million in
fiscal 2000. The majority of the change is due to a reduction in capital
expenditures as a result of opening only one store in fiscal 2001 as compared to
13 in fiscal 2000. Additionally, in fiscal 2001, we entered into agreements with
a third party to cancel leases and close three of our under-performing
locations, for which we received $5.3 million.

Net cash used in investing activities decreased $23.6 million, to $23.6
million in fiscal 2000 from $47.2 million in fiscal 1999, primarily due to a
decrease in the number of new stores. In fiscal 2000, 13 new stores were added
as compared to 28 stores in fiscal 1999.

In connection with our repositioning strategy, in the first quarter of
2002 we remodeled our stores and launched a new website. Capital expenditures
for these projects are expected to total approximately $15 million.

Financing Cash Flows:

Net cash provided by financing activities increased $11.6 million, to
$13.8 million in fiscal 2001 from $2.2 million in fiscal 2000. In March of 2001,
we completed a preferred stock financing, appointed a new Chief Executive
Officer and amended our credit facility. In May and November of 2001, we
completed two common stock financings with various institutional investors.
Combined net proceeds from our preferred stock financing and common stock
transactions were $56.0 million and were used primarily to pay down our line of
credit and for other general corporate purposes.

In fiscal 2000, net cash provided by financing activities decreased
$37.1 million to $2.2 million from $39.3 million in fiscal 1999, principally due
to reduced borrowings under our line of credit.

On March 21, 2001, we amended our existing credit facility. The
amendment reduced the overall commitment under the line of credit from $111
million to $89 million, increased the amounts available for letters of credit
from $10 million to $20 million and eliminated the minimum earnings before
interest, taxes, depreciation and amortization (EBITDA) requirement.
Additionally, the borrowing base calculation was modified to provide us with
more available borrowings due to the pledge of additional collateral, and the
interest rate was reduced by 0.25%, with possible additional reductions based on
achievement of future EBITDA. The amended credit facility contains minimum
availability requirements based on seasonality.

The amended credit facility included two high-interest term loans. The
first of these term loans was paid off in the second quarter of fiscal 2001. In
September



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2001, the credit facility was further amended to provide for more favorable
interest rates on the remaining term loan. This loan was paid off in January
2002.

As a result of the paydowns of the term loans, as of February 2, 2002
the maximum availability under the facility was $80.0 million, with amounts
available for letters of credit up to $20 million. Availability under the credit
facility is limited by reference to a borrowing base calculation, based upon
eligible inventory and accounts receivable. The amount available under the
credit facility is typically much less than the $80.0 million stated maximum
limit of the facility (as of February 2, 2002 the total borrowing base available
was approximately $30 million). The agreement contains restrictive covenants
including annual capital expenditure limits, minimum inventory levels,
limitations on store openings and closings, and prohibitions on dividends. As of
February 2, 2002, we had no loans outstanding, and $13.3 million in outstanding
letters of credit. Interest is paid monthly at the banks reference rate or
LIBOR plus a margin. The agreement expires on June 30, 2003.

In connection with an amendment to our line of credit in September
2000, we issued putable warrants for the purchase of 550,000 shares of our
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 our 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 expire on September 27,
2005. 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.

While we currently believe that our cash flow from operations, proceeds received
from our various equity financings in fiscal 2001 and funds available under our
credit facility will satisfy our capital requirements for at least the next 12
months, adverse developments concerning our sales performance or the
availability of credit under our credit facility due to covenant limitations or
other factors could limit the overall availability of funds to us. Moreover, we
may not have successfully anticipated our future capital needs and, should the
need arise, additional sources of financing may not be available or, if
available, may not be on terms favorable to us or our stockholders. For more
information, please see the section Factors That May Affect Our Future
Operating Results, above, in particular the sections We are dependent on
external funding sources which may not make available to us sufficient funds
when we need them, Because our business requires a substantial level of
liquidity, we are dependent upon a credit facility with numerous restrictive
covenants that limit our flexibility and We may be unable to raise additional
funds that we will need to remain competitive.



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Contractual Commitments:

The following table summarizes significant contractual obligations of the
Company as of February 2, 2002:

|                            |                                    |   |                                        |         |        |   |           |        |       |   |         |        |       |   |        |        |  |   |         |         | 
|--------------------------- | ---------------------------------- | - | -------------------------------------- | ------- | ------ | - | --------- | ------ | ----- | - | ------- | ------ | ----- | - | ------ | ------ |  | - | ------- | ------- | 
|                            |                                    |   | AMOUNT OF COMMITMENT EXPIRATION PERIOD
|                            |                                    |   |                                       
|                            |                                    |   |                                        |         |        |   | LESS THAN |        | 1 - 3 |   | 4 - 5   |        | AFTER
|                            |                                    |   | TOTAL                                  |         | 1 YEAR |   | YEARS     |        | YEARS |   | 5 YEARS
|                            |                                    |   |                                        |         |        |   |           |        |       |   |        
|CONTRACTUAL OBLIGATIONS     |                                    |   |                                        |         |        |   |           |        |       |   |         |        |       |   |        |        |  |   |         |        
|Long-term debt              |                                    | $ |                                       |         |        | $ |          |        |       | $ |        |        |       | $ |       |        |  | $ |        |        
|Operating leases            |                                    |   | 350,069                                |         |        |   | 36,327    |        |       |   | 71,148  |        |       |   | 67,382 |        |  |   | 175,212 |        
|Capital leases              |                                    |   | 464                                    |         |        |   | 278       |        |       |   | 186     |        |       |   |       |        |  |   |        |        
|Other long-term obligations |                                    |   | 3,236                                  |         |        |   | 3,236     |        |       |   |        |        |       |   |       |        |  |   |        |        
|                            |                                    |   |                                        |         |        |   |           |        |       |   |         |        |       |   |        |        |  |   |         |        
|                            | Total contractual cash
obligations |   | $                                      | 353,769 |        |   | $         | 39,841 |       |   | $       | 71,334 |       |   | $      | 67,382 |  |   | $       | 175,212 | 
|                            |                                    |   |                                        |         |        |   |           |        |       |   |         |        |       |   |        |        |  |   |         |        

|                             |                              |       |                                        |         |  |       |           |        |       |         |        |        |       |   |   |   |  |   |   |   | 
|---------------------------- | ---------------------------- | ----- | -------------------------------------- | ------- |  | ----- | --------- | ------ | ----- | ------- | ------ | ------ | ----- | - | - | - |  | - | - | - | 
|                             |                              |       | AMOUNT OF COMMITMENT EXPIRATION PERIOD
|                             |                              |       |                                       
|                             |                              |       |                                        |         |  |       | LESS THAN |        | 1 - 3 |         | 4 - 5  |        | AFTER
|OTHER COMMERCIAL COMMITMENTS |                              | TOTAL |                                        | 1 YEAR  |  | YEARS |           | YEARS  |       | 5 YEARS
|                             |                              |       |                                        |         |  |       |           |        |       |        
|Revolving credit facility    |                              |       | $80,000                                |         |  | $     |          |        |       | $       | 80,000 |        |       | $ |  |   |  | $ |  |  
|Standby letters of credit    |                              |       | 2,737                                  |         |  |       | 2,737     |        |       |         |       |        |       |   |  |   |  |   |  |  
|Trade letters of credit      |                              |       | 10,599                                 |         |  |       | 10,599    |        |       |         |       |        |       |   |  |   |  |   |  |  
|                             |                              |       |                                        |         |  |       |           |        |       |         |        |        |       |   |   |   |  |   |   |  
|                             | Total commercial commitments |       |                                        | $93,336 |  |       | $         | 13,336 |       |         | $      | 80,000 |       |   | $ |  |  |   | $ |  | 
|                             |                              |       |                                        |         |  |       |           |        |       |         |        |        |       |   |   |   |  |   |   |  

Revolving Credit Facility: As of February 2, 2002, the Company had no amounts
outstanding under its revolving credit facility

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to product returns, bad debts, inventories, goodwill, taxes on income,
financing operations, contingencies and litigation. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

Our management believes the following critical accounting policies
affect their more significant judgments and estimates used in the preparation of
our consolidated financial statements:



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Inventory  Our merchandise inventory is carried at the lower of cost or
market with cost determined on a weighted average cost method. In
connection with our merchandise repositioning, we recorded a charge of $5.3
million to write down discontinued merchandise at year-end to its estimated
net realizable value, bringing our total lower of cost or market reserve to
$6.5 million. If actual market conditions are less favorable than those
projected by our management, or if liquidation of the inventory is more
difficult than anticipated, additional inventory write-downs may be
required.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| | Long-lived Asset Impairment  We record a long-lived asset impairment
charge when events or changes in circumstances indicate that the carrying
amount of a long-lived asset may not be recoverable based on estimated
future cash flows. In the course of performing this analysis, we determined
that a long-lived asset impairment charge of $10.2 million was required for
eight under-performing stores. The impairment charge was calculated as the
difference between the net book value of the stores long-lived assets and
the projected present value of stores cash flows over the remaining life
of the lease. Should actual results differ materially from projected
results for these or other locations, additional impairment charges may be
required in the future.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Goodwill  We had goodwill in the amount of $4.6 million at February 2,
2002. As required by generally accepted accounting principles, we performed
an impairment test of goodwill which resulted in no impairment being
identified. However, the process of evaluating goodwill involves making
certain judgements and estimates in regards to company strategies and
future cash flows. To the extent additional information arises or our
strategies change, it is possible that our conclusion regarding goodwill
impairment could change and result in an impairment charge.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | Self-insurance costs  We record estimated liabilities for certain
self-insured workers compensation programs. Should a greater amount of
claims occur compared to what was estimated or the costs of the medical
profession increase beyond what were anticipated, reserves recorded may not
be sufficient and additional charges may be required.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | Income Taxes  We account for income taxes under Statement of Financial
Standards No. 109 (SFAS 109) Accounting for Income
Taxes. Accordingly, we record a valuation
allowance to reduce our deferred tax assets to the amount that is more
likely than not to be realized. An analysis of projected taxable income and
the corresponding utilization of these tax assets indicated that a
valuation allowance of $7.0 million was appropriate. While future taxable
income and ongoing prudent and feasible tax planning were considered in
determining the amount of the valuation allowance, this allowance is
subject to adjustment in the future. Specifically, in the event we were to
determine that we would be able to realize our deferred tax assets in the
future in excess of their net recorded amounts, an adjustment to the
deferred tax assets would increase income in the period such determination
was made. Likewise, should we determine that we would not be able to
realize all or part of our net deferred tax assets in the future, an
adjustment to the deferred tax assets would be charged to income in the
period such determination was made. Additionally, SFAS 109 does not allow
us to contemplate changes in tax laws or rates in our analysis of the
utilization of our deferred tax assets. We believe that the economic
stimulus bill that was enacted on March 9, 2002 may have a positive impact
on our analysis of our deferred tax assets, resulting in additional
deferred tax assets becoming more likely than not to be realized in the
first quarter of fiscal 2002.

The above listing is not intended to be a comprehensive list of all of
our accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by generally accepted accounting
principles, with no need for managements judgement in their application. There
are also areas in which managements judgement in selecting any available
alternative would not produce a materially different result. See our audited
consolidated financial statements and notes thereto which begin on page 31 of
this annual report, which contain accounting policies and other disclosures
required by generally accepted accounting principles.



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RECENT ACCOUNTING DEVELOPMENTS:




In the spring of 2002, we implemented the U.S. Securities and Exchange
Commissions Staff Accounting Bulletin No. 101, Revenue Recognition in
Financial Statements (SAB 101) effective January 30, 2000, which resulted in
a change in revenue recognition for furniture sales. Previously, revenue for
sales of furniture delivered to the customer was recognized when the furniture
was shipped to the customer. Upon implementation of SAB 101, our revenue now
reflects the recognition of revenue on furniture sales at the time of customer
receipt. The cumulative effect of the implementation of SAB 101 resulted in a
charge to income of $819,000 (net of income taxes of $570,000), or $0.05 per
basic and diluted share for the fiscal year ended January 30, 2000.




Effective February 4, 2001, we adopted Statement of Financial
Accounting Standards No. 133 (SFAS No. 133), Accounting for Derivative
Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, which establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133, as amended, requires the recognition of all derivative instruments
as either assets or liabilities in the statement of financial position measured
at fair value. The adoption of this standard had no material effect on our
financial condition or results of operations.

In June 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 141 (SFAS No.141), Business Combinations
(effective July 1, 2001) and Statement of Financial Accounting Standards No. 142
(SFAS No. 142), Goodwill and Other Intangible Assets (effective for the
Company on February 3, 2002). SFAS No. 141 prohibits pooling-of-interests
accounting for acquisitions. SFAS No. 142 specifies that goodwill and certain
intangible assets will no longer be amortized but instead will be subject to
periodic impairment testing. In accordance with the adoption of SFAS No. 142, as
of February 3, 2002, we stopped amortizing goodwill. Goodwill was $4.6 million
and $4.8 million as of February 2, 2002 and February 3, 2001, respectively.
Goodwill amortization was $0.2 million in each of fiscal years 2001, 2000 and
1999. In accordance with SFAS 142, we will test goodwill for impairment under
the new fair value approach.

In October 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144, (SFAS No. 144),
Accounting for the Impairment or Disposal of Long-Lived Assets. This statement
supercedes Statement of Financial Accounting Standards No. 121 (SFAS No. 121),
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, and the accounting and reporting provisions of APB Opinion No.
30, Reporting the Results of Operations  Reporting the Effects of Disposal of a
Segment of a Business and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business. SFAS No.
144 became effective for the Company on February 3, 2002. The adoption of this
standard is not expected to have a material effect on our financial condition or
results of operations.

RELATED PARTY TRANSACTIONS

Stephen Gordon is Chairman of our Board of Directors. We lease our
store in Eureka, California, from Mr. and Mrs. Gordon and a partnership of which
Mr. Gordon is a partner. Pursuant to the written lease, we pay rent annually to
Mr. and Mrs. Gordon and the partnership for use of the store. The aggregate
lease payments paid to Mr. and Mrs. Gordon and the partnership were $65,657,
65,657 and 64,222 for the fiscal years ended February 2, 2002, February 3, 2001
and January 29, 2000. The lease term expires on May 31, 2004 and there are no
renewal options. We believe that the lease arrangement with Mr. and Mrs. Gordon
and a partnership of which Mr. Gordon is a partner was made on terms no less
favorable to us than could have been obtained from unaffiliated third parties.

In connection with the Series A and B preferred stock financing
completed in March 2001, Mr. 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, we 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, we also made a loan to Mr.
Friedman in the amount of $2.05 million. All of the loan proceeds were used by
Mr. Friedman to purchase a portion of this stock. The loan is a full recourse
loan and is secured by shares of the common stock and preferred stock purchased
by Mr. Friedman. This loan is evidenced by a note, dated



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March 22, 2001. Pursuant to the terms of the note, the interest rate on the
outstanding principal amount of the loan is 8.5% per annum, payable on the
first, second and third anniversaries of the date of the note. The principal is
due on March 22, 2004 but the due date may be accelerated due to a number of
factors, including, failure to make payments due under the note, expiration of
the six-months period following the date Mr. Friedman ceases to be an employee
of our company as a result of termination by us for cause, or 90 days after the
closing of an acquisition of our company.

All transactions with officers, directors and principal stockholders
and their affiliates, including the loan arrangement with
Mr. Friedman, were approved, and all future such transactions
will continue to be, approved by a majority of our board of directors, including a
majority of the independent and disinterested directors of our board, and will
be on terms no less favorable to us than could be obtained from unaffiliated
third parties.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This annual report on Form 10-K contains forward-looking statements,
within the meaning of the Private Securities Litigation Reform Act of 1995, that
involve known and unknown risks. Such forward-looking statements include
statements as to the results of strategic initiatives, our working capital and
capital expenditure needs, the impact of competition and other statements
containing words such as believes, anticipates, estimates, expects,
may, intends, and words of similar import or statements of our managements
opinion. These forward-looking statements and assumptions involve known and
unknown risks, uncertainties and other factors that may cause our actual
results, market performance or achievements to differ materially from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Important factors that could cause such differences
include, but are not limited to, changes in economic or business conditions in
general, changes in product supply, fluctuations in comparable store sales,
limitations resulting from restrictive covenants in our credit facility, failure
of our management to anticipate changes in consumer trends, loss of key vendors,
changes in the competitive environment in which we operate, changes in our
management information needs, changes in management, failure to raise additional
funds when required, changes in customer needs and expectations, governmental
actions and consequences stemming from terrorist activities in or related to the
United States. We undertake no obligation to update any forward-looking
statements in order to reflect events or circumstances that may arise after the
date of this annual report.

QUARTERLY RESULTS OF OPERATIONS

|                                            |                     |   |                                               |      |         |   |         |      |         |   |         |      |   |   |         |      |  
|------------------------------------------- | ------------------- | - | --------------------------------------------- | ---- | ------- | - | ------- | ---- | ------- | - | ------- | ---- | - | - | ------- | ---- | -
|                                            |                     |   | 2001                                         
|                                            |                     |   |                                              
|                                            |                     |   | FIRST                                         |      | SECOND  |   | THIRD   |      | FOURTH 
|                                            |                     |   | QUARTER                                       |      | QUARTER |   | QUARTER |      | QUARTER
|                                            |                     |   |                                               |      |         |   |         |      |        
|                                            |                     |   | (dollars in thousands, except per share data)
|Statements of Consolidated
Operations Data: |                     |   |                                               |      |         |   |         |      |         |   |         |      |   |   |         |     
|Net sales(1)                                |                     | $ | 70,659                                        |      |         | $ | 75,912  |      |         | $ | 75,504  |      |   | $ | 144,398 |     
|Gross profit                                |                     |   | 15,544                                        |      |         |   | 15,886  |      |         |   | 15,375  |      |   |   | 31,331  |     
|                                            | As a % of net sales |   |                                               | 22.0 | %       |   |         | 20.9 | %       |   |         | 20,4 | % |   |         | 21.7 | %
|Income (loss) from operations               |                     |   | (8,631                                        | )    |         |   | (8,606  | )    |         |   | (12,503 | )    |   |   | (6,731  | )   
|Comparable store sales change               |                     |   | (11.4                                         | %)   |         |   | (5.4    | %)   |         |   | (10.8   | %)   |   |   | 3.0     | %   
|Net income (loss)                           |                     |   | (7,425                                        | )    |         |   | (5,779  | )    |         |   | (8,318  | )    |   |   | (12,345 | )   
|Net income (loss) per common share:         |                     |   |                                               |      |         |   |         |      |         |   |         |      |   |   |         |     
|                                            | Basic(2)            |   | $                                             | (.46 | )       |   | $       | (.30 | )       |   |         | (.36 | ) |   | $       | (.45 | )
|                                            | Diluted(3)          |   | $                                             | (.46 | )       |   |         | (.30 | )       |   |         | (.36 | ) |   |         | (.45 | )



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|                                                                             |                     |   |                                        |       |         |   |         |       |         |   |        |       |   |   |         |      |  
|---------------------------------------------------------------------------- | ------------------- | - | -------------------------------------- | ----- | ------- | - | ------- | ----- | ------- | - | ------ | ----- | - | - | ------- | ---- | -
|                                                                             |                     |   | 2000                                  
|                                                                             |                     |   |                                       
|                                                                             |                     |   | FIRST                                  |       | SECOND  |   | THIRD   |       | FOURTH 
|                                                                             |                     |   | QUARTER                                |       | QUARTER |   | QUARTER |       | QUARTER
|                                                                             |                     |   |                                        |       |         |   |         |       |        
|                                                                             |                     |   | (dollars in thousands, per share data)
|Statements of Consolidated
Operations Data:                                  |                     |   |                                        |       |         |   |         |       |         |   |        |       |   |   |         |     
|Net sales(1)                                                                 |                     | $ | 68,900                                 |       |         | $ | 72,427  |       |         | $ | 81,247 |       |   | $ | 143,662 |     
|Gross profit                                                                 |                     |   | 16,950                                 |       |         |   | 19,170  |       |         |   | 20,415 |       |   |   | 55,939  |     
|                                                                             | As a % of net sales |   |                                        | 24.6  | %       |   |         | 26.5  | %       |   |        | 25.1  | % |   |         | 38.9 | %
|Income (loss) from operations                                                |                     |   | (6,905                                 | )     |         |   | (4,493  | )     |         |   | (6,790 | )     |   |   | 18,015  |     
|Comparable store sales change                                                |                     |   | (14.4                                  | %)    |         |   | 0.8     | %     |         |   | (1.7   | %)    |   |   | 5.7     | %   
|Net
income (loss) before cumulative effect of change in accounting
principle |                     |   | (4,634                                 | )     |         |   | (3,320  | )     |         |   | (5,119 | )     |   |   | 9,332   |     
|Net income (loss) per common share:                                          |                     |   |                                        |       |         |   |         |       |         |   |        |       |   |   |         |     
|                                                                             | Basic(2)            |   | $                                      | (0.32 | )       |   | $       | (0.19 | )       |   | $      | (0.30 | ) |   | $       | 0.55 |  
|                                                                             | Diluted(3)          |   | $                                      | (0.32 | )       |   | $       | (0.19 | )       |   | $      | (0.30 | ) |   | $       | 0.54 |  



---

|(1) |  | Net sales amounts include shipping fees in accordance with EITF 00-10,
Accounting for Shipping and Handling Fees and Costs.                                                                                                                                                                                                                                                                                                                                                        
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Basic earnings per share is calculated for interim periods, including
the effect of stock options exercised in prior interim periods. Basic
earnings per share for the fiscal year is calculated using weighted
shares outstanding based on the date stock options were exercised.
Therefore, basic earnings per share for the cumulative four quarters
may not equal fiscal year basic earnings per share.                                                                        
|   
|   
|   
|   
|(3) |  | Diluted earnings per share for the fiscal year and for quarters with
net earnings are computed based on weighted average common stock
outstanding, convertible preferred stock and common stock equivalents
(stock options and warrants). Net loss per share for quarters with net
losses is computed based solely on weighted average common shares
outstanding. Therefore, the earnings (loss) per share for each quarter
do not sum up to the earnings for the full fiscal year.






|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

We are exposed to market risks, which include changes in interest rates
and, to a lesser extent, foreign exchange rates. We do not engage in financial
transactions for trading or speculative purposes.

The interest payable on our credit facility is based on variable
interest rates and is, therefore, affected by changes in market interest rates.
If interest rates on existing variable rate debt rose no more than 10% from the
banks reference rate, our results of operations and cash flows would not be
materially affected. In addition, we have fixed and variable income investments
consisting of cash equivalents and short-term investments, which are also
affected by changes in market interest rates.

We do enter into a significant amount of purchase obligations outside
of the United States which, to date, have been settled mostly in U.S. dollars
and, therefore, we have only minimal exposure at present to foreign currency
exchange risks. Historically, we have not hedged our currency risk and do not
currently anticipate doing so in the future. However, it is possible that in the
future a growing number of our purchases outside of the United States will be
made in currencies other than the U.S. dollar. Consequently, fluctuations in the
rates of exchange between the U.S. dollar and other currencies may subject us to
foreign currency exchange risks in the future.




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



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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 2, 2002 and
February 3, 2001, 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 2, 2002. 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 2, 2002 and February 3, 2001, and the
results of their operations and their cash flows for each of the three fiscal
years in the period ended February 2, 2002 in conformity with accounting
principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP
San Francisco, California
April 23, 2002 (September 13, 2002 as to Note 1)



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

|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |         |         |         | 
|--------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------- | ------- | ----------- | ------- | ----------- | ------- | ------- | ------- | 
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         | FEBRUARY 2, |         | FEBRUARY 3,
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         | 2002        |         | 2001       
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |            
|ASSETS                                                                      |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|Current assets                                                              |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            | Cash and cash equivalents                    |                                                                                                                                                                                                              | $                         | 22,285  |             |         | $           | 2,610   |        
|                                                                            | Accounts receivable                          |                                                                                                                                                                                                              |                           | 3,278   |             |         |             | 8,069   |        
|                                                                            | Merchandise inventories                      |                                                                                                                                                                                                              |                           | 62,070  |             |         |             | 85,067  |        
|                                                                            | Prepaid expense and other                    |                                                                                                                                                                                                              |                           | 13,800  |             |         |             | 8,975   |        
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            |                                              |                                                                                                                                                                                                              | Total current assets      |         |             | 101,433 |             |         |         | 104,721 | 
|                                                                            | Property and equipment, net                  |                                                                                                                                                                                                              |                           | 87,934  |             |         |             | 117,186 |        
|                                                                            | Goodwill                                     |                                                                                                                                                                                                              |                           | 4,560   |             |         |             | 4,776   |        
|                                                                            | Other assets                                 |                                                                                                                                                                                                              |                           | 12,817  |             |         |             | 7,188   |        
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            |                                              |                                                                                                                                                                                                              | Total assets              |         | $           | 206,744 |             |         | $       | 233,871 | 
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                           
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS EQUITY
|                                                                           
|Current liabilities                                                         |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            | Accounts payable and accrued expenses        |                                                                                                                                                                                                              | $                         | 34,909  |             |         | $           | 43,321  |        
|                                                                            | Revolving line of credit and short term debt |                                                                                                                                                                                                              |                           |        |             |         |             | 5,730   |        
|                                                                            | Current portion of deferred lease incentives |                                                                                                                                                                                                              |                           | 4,507   |             |         |             | 4,575   |        
|                                                                            | Deferred revenue                             |                                                                                                                                                                                                              |                           | 2,855   |             |         |             | 6,398   |        
|                                                                            | Other current liabilities                    |                                                                                                                                                                                                              |                           | 9,183   |             |         |             | 8,501   |        
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            |                                              |                                                                                                                                                                                                              | Total current liabilities |         |             | 51,454  |             |         |         | 68,525  | 
|Long-term debt                                                              |                                              |                                                                                                                                                                                                              |                          |         |             |         | 33,128      |        
|Long-term portion of deferred lease incentives                              |                                              |                                                                                                                                                                                                              | 37,101                    |         |             |         | 41,944      |        
|Deferred rent                                                               |                                              |                                                                                                                                                                                                              | 12,703                    |         |             |         | 10,787      |        
|Other long-term obligations                                                 |                                              |                                                                                                                                                                                                              | 3,236                     |         |             |         | 612         |        
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            | Total liabilities                            |                                                                                                                                                                                                              |                           | 104,494 |             |         |             | 154,996 |        
|Series A redeemable convertible preferred stock,                            |                                              |                                                                                                                                                                                                              | 14,106                    |         |             |         |            |        
|                                                                            |                                              | $.0001 par value, 28,037 shares designated on
March 21, 2001, 14,320 shares issued and
outstanding at February 2, 2002, aggregate
liquidation preference and redemption value
of $16,411 at February 2, 2002 |                           |         |             |         |             |         |         |        
|Common stock, $.0001 par value, 60,000,000 shares                           |                                              |                                                                                                                                                                                                              | 143,059                   |         |             |         | 94,901      |        
|                                                                            |                                              | authorized, 28,827,883 and 17,100,142 issued and
outstanding, respectively                                                                                                                                   |                           |         |             |         |             |         |         |        
|Stockholder loan                                                            |                                              |                                                                                                                                                                                                              | (2,050                    | )       |             |         |            |        
|Foreign currency translation adjustment                                     |                                              |                                                                                                                                                                                                              | (159                      | )       |             |         | (4          | )      
|Accumulated deficit                                                         |                                              |                                                                                                                                                                                                              | (52,706                   | )       |             |         | (16,022     | )      
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            | Total stockholders equity                   |                                                                                                                                                                                                              |                           | 88,144  |             |         |             | 78,875  |        
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        
|                                                                            |                                              | Total liabilities, redeemable convertible preferred
stock and stockholders equity                                                                                                                           |                           | $       | 206,744     |         |             | $       | 233,871 |        
|                                                                            |                                              |                                                                                                                                                                                                              |                           |         |             |         |             |        

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



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

|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |        |        |       |   | 
|----------------------------------------------------------------- | ------------------------------------------------------------------------------ | -------------------- | ------------------------------------------------------------------------------------ | ----------------------------- | ------- | ----------------- | ---------- | ----------- | ------- | ----------- | ---------- | ------ | ------ | ----- | - | 
|                                                                  |                                                                                |                      |                                                                                      |                               |         | Fiscal Year Ended
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                  
|                                                                  |                                                                                |                      |                                                                                      |                               |         | February 2,       |            | February 3, |         | January 29,
|                                                                  |                                                                                |                      |                                                                                      |                               |         | 2002              |            | 2001        |         | 2000       
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |            
|Net sales                                                         |                                                                                | $                    | 366,473                                                                              |                               |         | $                 | 366,236    |             |         | $           | 298,902    |       
|Cost of sales and occupancy                                       |                                                                                |                      | 288,337                                                                              |                               |         |                   | 253,762    |             |         |             | 207,225    |       
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|                                                                  |                                                                                | Gross profit         |                                                                                      |                               | 78,136  |                   |            |             | 112,474 |             |            |        | 91,677 |      
|Selling, general and administrative                               |                                                                                |                      | 114,607                                                                              |                               |         |                   | 112,647    |             |         |             | 95,031     |       
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|                                                                  |                                                                                | Loss from operations |                                                                                      |                               | (36,471 | )                 |            |             | (173    | )           |            |        | (3,354 | )    
|Interest expense                                                  |                                                                                |                      | 4,780                                                                                |                               |         |                   | 5,895      |             |         |             | 1,628      |       
|Interest income                                                   |                                                                                |                      | (313                                                                                 | )                             |         |                   | (91        | )           |         |             | (209       | )     
|Change in fair value of warrants                                  |                                                                                |                      | 2,677                                                                                |                               |         |                   |           |             |         |             |           |       
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|                                                                  |                                                                                | Pretax loss          |                                                                                      |                               | (43,615 | )                 |            |             | (5,977  | )           |            |        | (4,773 | )    
|Income tax benefit                                                |                                                                                |                      | 9,748                                                                                |                               |         |                   | 2,236      |             |         |             | 1,733      |       
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|(Loss) before cumulative effect
of change in accounting principle |                                                                                |                      | (33,867                                                                              | )                             |         |                   | (3,741     | )           |         |             | (3,040     | )     
|                                                                  | Cumulative effect of change in accounting principle,
net of tax effect of $570 |                      |                                                                                      |                              |         |                   |            | (819        | )       |             |            |       |       
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|                                                                  | Net (loss)                                                                     |                      |                                                                                      | (33,867                       | )       |                   |            | (4,560      | )       |             |            | (3,040 | )     
|Preferred shareholder return:                                     |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|                                                                  |                                                                                |                      |                                                                                      | Dividends                     |         |                   | (1,411     | )           |         |             |           |        |        |       |  | 
|                                                                  |                                                                                |                      |                                                                                      | Beneficial conversion charges |         |                   | (1,406     | )           |         |             |           |        |        |       |  | 
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|(Loss)
available to common stockholders                           |                                                                                | $                    | (36,684                                                                              | )                             |         | $                 | (4,560     | )           |         | $           | (3,040     | )     
|                                                                  |                                                                                |                      |                                                                                      |                               |         |                   |            |             |         |             |            |       
|                                                                  | Earnings (Loss) per common share  basic and diluted:                          |                      |                                                                                      |                               |         |                   |            |             |         |             |            |        |       
|                                                                  |                                                                                |                      | Earnings (Loss) per share before cumulative
effect of change in accounting principle |                               | $       | (1.57             | )          |             | $       | (0.22       | )          |        | $      | (0.18 | )
|                                                                  |                                                                                |                      | Cumulative effect of change in
accounting principle                                  |                               |         |                  |            |             |         | (0.05       | )          |        |        |      |  
|                                                                  |                                                                                |                      | Earnings (loss) per common share                                                     |                               |         | (1.57             | )          |             |         | (0.27       | )          |        |        | (0.18 | )
|Weighted average shares outstanding, basic and diluted            |                                                                                |                      | 23,395,750                                                                           |                               |         |                   | 17,042,052 |             |         |             | 16,697,668 |       

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



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RESTORATION HARDWARE, INC.
 
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLEPREFERRED STOCK AND STOCKHOLDERS EQUITY
(DOLLARS IN THOUSANDS)

|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |        |        |   |  |   |      |   |  |   |         |   |  |   |         |   |  |   |         |   | 
|---------------------------------------------------- | --------------- | ------ | --------------------- | ------ |  | -------- | ------ | ------------- | ----- | ------------ | ---------- | ------------- |  | ------- | ------- | ------ | ------------- | ------ | ------ | - |  | - | ---- | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | - | 
|                                                     |                 |        | RedeemableConvertible |        |  |          |        |               |       |              |            |               |  |         |         |        | Accumulated   |        |        |   |  |   |      |   |  |   | Total  
|                                                     | Preferred Stock |        | Common Stock          |        |  |          |        |               | Other |              |            |               |  |         | Total   |        | Comprehensive
|(Dollars in                                          |                 |        |                       |        |  | Unearned |        | Comprehensive |       | Accumulated  |            | Stockholders |  | Income 
|thousands)                                           |                 | Shares |                       | Amount |  | Shares   |        | Amount        |       | Compensation |            | Income/(Loss) |  | Deficit |         | Equity |               | (Loss)
|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |       
|BALANCE AT
JANUARY 30, 1999                          |                 |        |                      |        |  | $        |       |               |       |              | 16,246,260 |               |  | $       | 92,169  |        |               |        |       |   |  | $ | 8    |   |  | $ | (8,422  | ) |  | $ | 83,755  |   |  |   |        |  
|Issuance of common
stock                             |                 |        |                      |        |  |          |       |               |       |              | 655,078    |               |  |         | 2,149   |        |               |        |       |   |  |   |     |   |  |   |        |   |  |   | 2,149   |   |  |   |        |  
|Foreign currency translation
adjustment              |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   | 18   |   |  |   |        |   |  |   | 18      |   |  | $ | 18      |  
|Net loss                                             |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   |     |   |  |   | (3,040  | ) |  |   | (3,040  | ) |  |   | (3,040  | )
|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |        |        |   |  |   |      |   |  |   |         |   |  |   |         |   |  |   |         |  
|BALANCE AT
JANUARY 29, 2000                          |                 |        |                      |        |  |          |       |               |       |              | 16,901,338 |               |  |         | 94,318  |        |               |        |       |   |  |   | 26   |   |  |   | (11,462 | ) |  |   | 82,882  |   |  | $ | (3,022  | )
|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |        |        |   |  |   |      |   |  |   |         |   |  |   |         |   |  |   |         |  
|Issuance of
common stock                             |                 |        |                      |        |  |          |       |               |       |              | 198,804    |               |  |         | 583     |        |               |        |       |   |  |   |     |   |  |   |        |   |  |   | 583     |   |  |   |        |  
|Foreign currency
translation
adjustment              |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   | (30  | ) |  |   |        |   |  |   | (30     | ) |  | $ | (30     | )
|Net loss                                             |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        |        |   |  |   |     |   |  |   | (4,560  | ) |  |   | (4,560  | ) |  |   | (4,560  | )
|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |        |        |   |  |   |      |   |  |   |         |   |  |   |         |   |  |   |         |  
|BALANCE AT
FEBRUARY 3, 2001                          |                 |        |                      |        |  |          |       |               |       |              | 17,100,142 |               |  |         | 94,901  |        |               |        |       |   |  |   | (4   | ) |  |   | (16,022 | ) |  |   | 78,875  |   |  | $ | (4,590  | )
|Issuance of
preferred
stock  net                    |                 |        | 15,000                |        |  |          | 13,440 |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Beneficial
conversion
feature                        |                 |        |                      |        |  |          | (1,406 | )             |       |              |           |               |  |         | 1,406   |        |               |        |       |   |  |   |     |   |  |   |        |   |  |   | 1,406   |   |  |   |        |  
|Accretion of
cumulative
dividends of
preferred stock |                 |        |                      |        |  |          | 1,411  |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   |     |   |  |   | (1,411  | ) |  |   | (1,411  | ) |  |   |        |  
|Stock
Compensation                                   |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         | 1,580   |        |               | $      | (1,580 | ) |  |   |     |   |  |   |        |   |  |   |        |   |  |   |        |  
|Amortization of
unearned stock
compensation          |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        | 477    |   |  |   |     |   |  |   |        |   |  |   | 477     |   |  |   |        |  
|Beneficial
conversion
charge                         |                 |        |                       |        |  |          | 1,406  |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   |     |   |  |   | (1,406  | ) |  |   | (1,406  | ) |  |   |        |  
|Conversion of
preferred
stock to
common stock        |                 |        | (680                  | )      |  |          | (745   | )             |       |              | 340,000    |               |  |         | 745     |        |               |        |       |   |  |   |     |   |  |   |        |   |  |   | 745     |   |  |   |        |  
|Foreign currency
translation
adjustment              |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   | (155 | ) |  |   |        |   |  |   | (155    | ) |  | $ | (155    | )
|Net loss                                             |                 |        |                      |        |  |          |       |               |       |              |           |               |  |         |        |        |               |        |       |   |  |   |     |   |  |   | (33,867 | ) |  |   | (33,867 | ) |  |   | (33,867 | )
|Issuance
of common
stock  net                       |                 |        |                      |        |  |          |       |               |       |              | 11,387,741 |               |  |         | 43,480  |        |               |        |       |   |  |   |     |   |  |   |        |   |  |   | 43,480  |   |  |   |        |  
|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |        |        |   |  |   |      |   |  |   |         |   |  |   |         |   |  |   |         |  
|BALANCE AT
FEBRUARY 2, 2002                          |                 |        | 14,320                |        |  | $        | 14,106 |               |       |              | 28,827,883 |               |  | $       | 142,112 |        |               | $      | (1,103 | ) |  | $ | (159 | ) |  | $ | (52,706 | ) |  | $ | 88,144  |   |  | $ | (34,022 | )
|                                                     |                 |        |                       |        |  |          |        |               |       |              |            |               |  |         |         |        |               |        |        |   |  |   |      |   |  |   |         |   |  |   |         |   |  |   |         |  

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



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RESTORATION HARDWARE, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |         |         |         |       | 
|-------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ---------------------------------------------------- | --------------------------------------------------------- | ----------------------------------------- | ------ | ----------------- | ----- | ----------- | ------- | ----------- | ------ | ------- | ------- | ------- | ----- | 
|                                                               |                                                                                          |                                                      |                                                           |                                           |        | Fiscal Year Ended
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                  
|                                                               |                                                                                          |                                                      |                                                           |                                           |        | FEBRUARY 2,       |       | FEBRUARY 3, |         | JANUARY 29,
|                                                               |                                                                                          |                                                      |                                                           |                                           |        | 2002              |       | 2001        |         | 2000       
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |            
|Cash flows from operating activities:                          |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | Loss before cumulative effect of change in accounting principle                          |                                                      | $                                                         | (33,867                                   | )      |                   | $     | (3,741      | )       |             | $      | (3,040  | )      
|                                                               | Adjustments to reconcile net income (loss) to net cash provided by
operating activities: |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |         |        
|                                                               |                                                                                          | Change in fair value of warrants                     |                                                           |                                           | 2,677  |                   |       |             |        |             |        |         |        |        
|                                                               |                                                                                          | Depreciation and amortization                        |                                                           |                                           | 20,624 |                   |       |             | 15,915  |             |        |         | 10,788  |        
|                                                               |                                                                                          | Impairment of fixed assets                           |                                                           |                                           | 10,220 |                   |       |             |        |             |        |         |        |        
|                                                               |                                                                                          | Other                                                |                                                           |                                           | (142   | )                 |       |             |        |             |        |         |        |        
|                                                               |                                                                                          | Deferred income taxes                                |                                                           |                                           | (7,615 | )                 |       |             | (3,956  | )           |        |         | (3,791  | )      
|                                                               |                                                                                          | Changes in assets and liabilities:                   |                                                           |                                           |        |                   |       |             |         |             |        |         |         |        
|                                                               |                                                                                          |                                                      | Accounts receivable                                       |                                           |        | 4,791             |       |             |         | (1,518      | )      |         |         | (1,376  | )    
|                                                               |                                                                                          |                                                      | Merchandise inventories                                   |                                           |        | 21,782            |       |             |         | 2,618       |        |         |         | (20,504 | )    
|                                                               |                                                                                          |                                                      | Prepaid expenses and other assets                         |                                           |        | (697              | )     |             |         | (583        | )      |         |         | (1,720  | )    
|                                                               |                                                                                          |                                                      | Accounts payable and accrued expenses                     |                                           |        | (8,412            | )     |             |         | (2,054      | )      |         |         | 5,679   |      
|                                                               |                                                                                          |                                                      | Tax payable                                               |                                           |        |                  |       |             |         | 18          |        |         |         | (1,492  | )    
|                                                               |                                                                                          |                                                      | Deferred revenue                                          |                                           |        | (3,543            | )     |             |         | 6,398       |        |         |         |        |      
|                                                               |                                                                                          |                                                      | Other current liabilities                                 |                                           |        | 374               |       |             |         | (1,238      | )      |         |         | 2,164   |      
|                                                               |                                                                                          |                                                      | Deferred rent                                             |                                           |        | 2,187             |       |             |         | 2,718       |        |         |         | 3,788   |      
|                                                               |                                                                                          |                                                      | Deferred lease incentives and other long-term liabilities |                                           |        | (4,044            | )     |             |         | 4,792       |        |         |         | 13,802  |      
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               |                                                                                          |                                                      |                                                           | Net cash provided by operating activities |        |                   | 4,335 |             |         |             | 19,369 |         |         |         | 4,298 | 
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|Cash flows from investing activities:                          |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | Proceeds from store closing agreements                                                   |                                                      |                                                           | 5,325                                     |        |                   |       |            |         |             |        |        |        
|                                                               | Capital expenditures                                                                     |                                                      |                                                           | (3,798                                    | )      |                   |       | (23,506     | )       |             |        | (46,620 | )      
|                                                               | Purchase of The Michaels Furniture Co.                                                   |                                                      |                                                           |                                          |        |                   |       | (80         | )       |             |        | (592    | )      
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               |                                                                                          | Net
cash provided by (used in) investing activities  |                                                           |                                           | 1,527  |                   |       |             | (23,586 | )           |        |         | (47,212 | )      
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|Cash flows from financing activities:                          |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | Net proceeds from private placement of preferred stock                                   |                                                      |                                                           | 13,440                                    |        |                   |       |            |         |             |        |        |        
|                                                               | Net proceeds from private placements of common stock                                     |                                                      |                                                           | 42,616                                    |        |                   |       |            |         |             |        |        |        
|                                                               | Borrowings (repayments) under revolving line of credit  net                             |                                                      |                                                           | (41,581                                   | )      |                   |       | 1,429       |         |             |        | 37,447  |        
|                                                               | Debt issuance costs                                                                      |                                                      |                                                           | (1,426                                    | )      |                   |       |            |         |             |        |        |        
|                                                               | Borrowings (repayments)  other debt                                                     |                                                      |                                                           | (53                                       | )      |                   |       | 218         |         |             |        | (274    | )      
|                                                               | Issuance of common stock                                                                 |                                                      |                                                           | 849                                       |        |                   |       | 583         |         |             |        | 2,149   |        
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               |                                                                                          | Net cash provided by financing activities            |                                                           |                                           | 13,845 |                   |       |             | 2,230   |             |        |         | 39,322  |        
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|Effects of foreign currency exchange rate translation on cash: |                                                                                          |                                                      | (32                                                       | )                                         |        |                   | (30   | )           |         |             | 18     |        
|                                                               |                                                                                          | Net increase (decrease) in cash and cash equivalents |                                                           |                                           | 19,675 |                   |       |             | (2,017  | )           |        |         | (3,574  | )      
|Cash and cash equivalents:                                     |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | Beginning of period                                                                      |                                                      |                                                           | 2,610                                     |        |                   |       | 4,627       |         |             |        | 8,201   |        
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | End of period                                                                            |                                                      | $                                                         | 22,285                                    |        |                   | $     | 2,610       |         |             | $      | 4,627   |        
|                                                               |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|Additional cash flow information:                              |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | Cash paid during the year for interest (net of amount capitalized)                       |                                                      | $                                                         | 3,500                                     |        |                   | $     | 5,137       |         |             | $      | 1,333   |        
|                                                               | Cash (received) paid during the year for taxes                                           |                                                      | $                                                         | (2,370                                    | )      |                   | $     | 1,317       |         |             | $      | 4,145   |        
|Non-cash transactions:                                         |                                                                                          |                                                      |                                                           |                                           |        |                   |       |             |         |             |        |        
|                                                               | Stockholder loan                                                                         |                                                      | $                                                         | 2,050                                     |        |                   | $     |            |         |             | $      |        |        
|                                                               | Beneficial conversion feature  preferred stock                                          |                                                      | $                                                         | 1,406                                     |        |                   | $     |            |         |             | $      |        |        
|                                                               | Beneficial conversion charge  preferred stock                                           |                                                      | $                                                         | (1,406                                    | )      |                   | $     |            |         |             | $      |        |        
|                                                               | Dividends attributable to preferred stock                                                |                                                      | $                                                         | (1,411                                    | )      |                   | $     |            |         |             | $      |        |        

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



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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 2, 2002, the Company operated
a total of 104 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 included
53 weeks. All other years presented include 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 financial statements in conformity with generally
accepted accounting principles 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 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 reserves on inventory, expected future cash flows in the
review for impairment on long lived assets, the adequacy of self insurance
reserves, and realization of deferred tax assets, including the potential need
for valuation allowances on these tax assets. 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 of less to be cash equivalents.

Accounts Receivable

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

Merchandise Inventories

Retail inventories are stated at the lower of cost (determined under the
weighted average cost method) or market. Manufacturing inventories are stated at
the lower of cost (first-in, first-out) or market. 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 provision, when necessary,
has been made to reduce excess or obsolete inventory to its net realizable
value. As of February 2, 2002, the Company had lower of cost or market reserves
of $6.5 million, which included $5.3 million in reserves related to discontinued
merchandise.

Prepaid Catalog Expenses

Prepaid catalog expenses consist of the cost to produce, print and
distribute catalogs. Such costs are amortized over the expected sales volume of
each catalog. Typically, over 90% of the cost of a catalog is amortized in the



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first four months. At February 2, 2002 and February 3, 2001, the Company had
$1,015,000 and $1,044,000, respectively, recorded as current assets.

Property and Equipment

Furniture, fixtures 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 five to twelve years for equipment. The cost of
leasehold improvements is amortized over the useful life of the asset or the
applicable lease term, whichever is less. Computer hardware and software costs
are included in fixtures and equipment and are amortized over estimated useful
lives of three to five years. Fiscal 2001 depreciation expense includes a $2.0
million accelerated depreciation charge related to assets whose lives were
shortened due to their anticipated elimination in connection with our spring
2002 remodel project.

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 2, 2002, February 3, 2001 and January 29, 2000,
$15,000, $195,000 and $390,000, respectively, of interest was capitalized.

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
(Michaels). Goodwill is amortized on a straight-line
basis over 25 years (see New Accounting
Pronouncements ).

Capitalized Leases

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

Impairment of Long-Lived Assets

The Companys policy is to review long-lived assets and certain
identifiable intangibles, including goodwill, 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. Based on the Companys reviews for the years ended February 3, 2001
and January 29, 2000 no adjustments were recognized to the carrying value of
such assets. In the fiscal year ended February 2, 2002, the Company
recorded a $10.2 million impairment charge on the long-lived assets
of eight under-performing stores. The impairment charge was equal to
the difference between the net asset value of long-lived assets and
the present value of estimated future cash flows for these eight
stores.

Store Closures

The Company continually reviews the operating performance of its stores
and assesses its plans for certain store closures. For stores that are to be
closed, the Company records a liability for future minimum lease payments and
related ancillary costs from the date of closure to the end of the remaining
lease term, net of estimated cost recoveries that may be achieved through
favorable lease terminations. This liability is recorded at the time management
commits to closing the store. The operating costs, including depreciation, of
stores to be closed are expensed during the period they remain in use.

The Company closed
three of its underperforming stores in fiscal
2001, for which it received cash proceeds from a third party who
purchased the Company's lease rights. The cash
proceeds received of $5.3 million approximated the net book value of the assets
that were written off as a part of the store closures.

Accounts Payable

Accounts payable represents amounts owed to third parties at the end of
the period. Accounts payable includes outstanding checks of approximately $13.7
million and $10.0 million at February 2, 2002 and February 3, 2001,
respectively.



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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.

Deferred Rent and Deferred Lease Incentives

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. 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 which are taken from the store by the customer at the time of
purchase.

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

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 upon delivery of the furniture to the
customer.

Shipping and Handling: Emerging Issues Task Force (EITF) Issue 00-10,
Accounting for Shipping and Handling Fees and Costs, requires that all amounts
billed to a customer in a sale transaction related to shipping and handling, if
any, should be classified as revenue. 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 $7.1 million, $5.7 million and $4.0 million in fiscal
2001, 2000 and 1999, respectively. Costs of shipping and handling are included
in cost of sales and occupancy.

Returns: The Company provides an allowance for sales returns based upon
historical return rates.

Advertising Expense

Advertising costs are expensed as incurred. For the fiscal years ended
February 2, 2002, February 3, 2001, and January 29, 2000, advertising costs were
approximately $16.1 million, $14.9 million, and $11.2 million, respectively.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash and cash equivalents.
The Company places its cash with financial institutions. At times, such amounts



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may be in excess of FDIC insurance limits.

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 future tax
consequences of events that have been recognized in the Companys financial
statements or tax returns. In estimating future tax consequences, the company
generally considers all expected future events other than changes in the tax law
or rates. For the year ended February 2, 2002, a $7 million tax valuation
allowance was recorded against the Companys deferred tax assets to reduce such
assets to the amount that are more likely than not to be realized.

Stock-based Compensation

The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with APB No. 25, Accounting for Stock
Issued to Employees. The disclosure requirements of Statement of Financial
Accounting Standards No. 123 (SFAS No. 123), Accounting for Stock-Based
Compensation, are set forth in Note 6.

Estimated Fair Value of Financial Instruments

The following disclosure is made in accordance with the requirements of
SFAS No. 107, Disclosures about 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

Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings
Per Share (EPS), requires earnings per share to be computed and reported,
under the treasury stock method, as both Basic EPS and Diluted EPS. Basic 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 potential
dilutive effects of certain common stock equivalents have been excluded from
diluted earnings per share, because their inclusion would be anti-dilutive.
Included here are only those options and warrants for which the exercise price
is less than the average share price for the respective year.

|                                                                               |  |                  |           |                  |  |                  |         |  |  |  |         | 
|------------------------------------------------------------------------------ |  | ---------------- | --------- | ---------------- |  | ---------------- | ------- |  |  |  | ------- | 
|                                                                               |  | February 2, 2002 |           | February 3, 2001 |  | January 29, 2000
|                                                                               |  |                  |           |                  |  |                 
|Shares of common stock subject
to outstanding options                          |  |                  | 573,867   |                  |  |                  | 395,440 |  |  |  | 837,053 | 
|Shares of common stock subject
to outstanding warrants                         |  |                  | 405,226   |                  |  |                  |        |  |  |  |        | 
|Shares of common stock reserved
for conversion of the Series
A preferred stock |  |                  | 7,160,000 |                  |  |                  |        |  |  |  |        | 



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The following is a reconciliation of the number of shares (denominator)
used in the basic and diluted EPS computations (shares in thousands):




|                                         |  |        |        |           |  |        |       |           |  |        |        |           |  |   |       |   |  |  |        |  |  |   |       |  
|---------------------------------------- |  | ------ | ------ | --------- |  | ------ | ----- | --------- |  | ------ | ------ | --------- |  | - | ----- | - |  |  | ------ |  |  | - | ----- | -
|                                         |  | 2001   |        | 2000      |  | 1999  
|                                         |  |        |        |           |  |       
|                                         |  | Shares |        | Per Share |  | Shares |       | Per Share |  | Shares |        | Per Share
|                                         |  |        |        |           |  |        |       |           |  |        |        |          
|Basic earnings (loss) per
common share   |  |        | 23,396 |           |  | $      | (1.57 | )         |  |        | 17,042 |           |  | $ | (0.27 | ) |  |  | 16,698 |  |  | $ | (0.18 | )
|Effect of dilutive securities(1)         |  |        |       |           |  |        |      |           |  |        |       |           |  |   |      |   |  |  |       |  |  |   |      |  
|Diluted earnings (loss) per
common share |  |        | 23,396 |           |  | $      | (1.57 | )         |  |        | 17,042 |           |  | $ | (0.27 | ) |  |  | 16,698 |  |  | $ | (0.18 | )






---

|(1) |  | Potentially dilutive preferred stock, options and warrants were excluded
because their inclusion would be anti-dilutive (their inclusion would decrease
the loss per share)
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 changes in stockholders equity.

Foreign Currency Translation

In the preparation of consolidated financial statements, the assets and
liabilities of the Companys subsidiary denominated in Canadian
dollars are 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 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.

New Accounting Pronouncements

Effective February 4, 2001, we adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS No. 133), as amended by SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities, which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. SFAS No.
133, as amended, requires the recognition of all derivative instruments as
either assets or liabilities in the statement of financial position measured at
fair value. The adoption of this standard had no material effect on our financial
condition or results of operations.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 141, Business Combinations (effective July 1,



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2001), (SFAS No. 141), and SFAS No. 142, Goodwill and Other Intangible
Assets (effective for the Company on February 3, 2002). SFAS No. 141 prohibits
pooling-of-interests accounting for acquisitions. SFAS No. 142 specifies that
goodwill and certain intangible assets will no longer be amortized but instead
will be subject to periodic impairment testing. In accordance with the adoption
of SFAS No. 142, as of February 3, 2002, the Company no longer amortizes
goodwill. Goodwill was $4.6 million and $4.8 million as of February 2, 2002 and
February 3, 2001, respectively. Goodwill amortization was $0.2 million in each
of fiscal years 2001, 2000 and 1999. The adoption of this new accounting
standard will result in the elimination of approximately $0.2 million of
goodwill amortization each year. Instead, the Company will evaluate the fair
value of goodwill versus the carrying amount on its balance sheet. The
Company has not yet determined the impact the new approach to valuing goodwill
will have on its financial position.




As required by SFAS No. 142, prior year results have not been restated
to reflect the non-amortization provision. A reconciliation of net loss
available to stockholders and loss per common share as if SFAS No. 142 had been
adopted is presented below for the 2001, 2000 and 1999 fiscal years:

|                                                   |  |                           |        |      |  |      |       |  |  |   |       | 
|-------------------------------------------------- |  | ------------------------- | ------ | ---- |  | ---- | ----- |  |  | - | ----- | 
|                                                   |  | 2001                      |        | 2000 |  | 1999
|                                                   |  |                           |        |      |  |     
|                                                   |  | (Dollars in thousands,   
|                                                   |  | except per share amounts)
|Net loss available to common stockholders:         |  |                           |        |      |  |      |       |  |  |   |       | 
|Reported net loss available to common stockholders |  | $                         | 36,684 |      |  | $    | 4,560 |  |  | $ | 3,040 | 
|Goodwill amortization, net of tax effect           |  |                           | 83     |      |  |      | 83    |  |  |   | 75    | 
|                                                   |  |                           |        |      |  |      |       |  |  |   |       | 
|Adjusted net loss available to common stockholders |  | $                         | 36,601 |      |  | $    | 4,476 |  |  | $ | 2,965 | 
|Basic and diluted loss per common share:           |  |                           |        |      |  |      |       |  |  |   |       | 
|Reported loss per share                            |  | $                         | 1.57   |      |  | $    | 0.27  |  |  | $ | 0.18  | 
|Goodwill amortization, net of tax effect           |  |                           | 0.01   |      |  |      | 0.01  |  |  |   |      | 
|                                                   |  |                           |        |      |  |      |       |  |  |   |       | 
|Adjusted loss per common share                     |  | $                         | 1.56   |      |  | $    | 0.26  |  |  | $ | 0.18  | 




In October 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS No. 144). This statement supercedes SFAS
No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, and the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of a business.
SFAS No. 144 became effective for the Company on February 3, 2002. The adoption
of this standard is not expected to have a material effect on the Companys
financial position or results of operations.

Reclassifications

Certain prior year balance sheet amounts have been reclassified to conform
with the fiscal year ended February 2, 2002 presentation.

(2) PROPERTY AND EQUIPMENT

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

|                                               |  |                  |  |                  |  |   |         |   |  |   |         |  
|---------------------------------------------- |  | ---------------- |  | ---------------- |  | - | ------- | - |  | - | ------- | -
|                                               |  |                  |  |                 
|                                               |  | FEBRUARY 2, 2002 |  | FEBRUARY 3, 2001
|                                               |  |                  |  |                 
|Leasehold improvements                         |  |                  |  |                  |  | $ | 101,487 |   |  | $ | 115,527 |  
|Furniture, fixtures and equipment              |  |                  |  |                  |  |   | 40,725  |   |  |   | 38,572  |  
|Equipment under capital leases                 |  |                  |  |                  |  |   | 1,035   |   |  |   | 1,447   |  
|                                               |  |                  |  |                  |  |   |         |   |  |   |         |  
|Total                                          |  |                  |  |                  |  |   | 143,247 |   |  |   | 155,546 |  
|Less accumulated depreciation and amortization |  |                  |  |                  |  |   | (55,313 | ) |  |   | (38,360 | )
|                                               |  |                  |  |                  |  |   |         |   |  |   |         |  
|Property and equipment, net                    |  |                  |  |                  |  | $ | 87,934  |   |  | $ | 117,186 |  
|                                               |  |                  |  |                  |  |   |         |   |  |   |         |  

(3) 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.



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The aggregate future minimum rental payments under leases in effect at February
2, 2002 are as follows (in thousands):

|                                           |  |         |      |           |  |       |         |  |  |   |         | 
|------------------------------------------ |  | ------- | ---- | --------- |  | ----- | ------- |  |  | - | ------- | 
|                                           |  | CAPITAL |      | OPERATING |  |       |         | 
|YEAR ENDING                                |  | LEASES  |      | LEASES    |  | TOTAL
|                                           |  |         |      |           |  |      
|2003 (FY 2002)                             |  | $       | 278  |           |  | $     | 36,327  |  |  | $ | 36,605  | 
|2004                                       |  |         | 186  |           |  |       | 36,100  |  |  |   | 36,286  | 
|2005                                       |  |         |     |           |  |       | 35,048  |  |  |   | 35,048  | 
|2006                                       |  |         |     |           |  |       | 34,903  |  |  |   | 34,903  | 
|2007                                       |  |         |     |           |  |       | 32,479  |  |  |   | 32,479  | 
|Thereafter                                 |  |         |     |           |  |       | 175,212 |  |  |   | 175,212 | 
|                                           |  |         |      |           |  |       |         |  |  |   |         | 
|Minimum lease commitments                  |  | $       | 464  |           |  | $     | 350,069 |  |  | $ | 350,533 | 
|                                           |  |         |      |           |  |       |         |  |  |   |         | 
|Less amount representing interest          |  |         | (47  | )         |  |       |         |  |  |   |         | 
|                                           |  |         |      |           |  |       |         |  |  |   |         | 
|Present value of capital lease obligations |  |         | 417  |           |  |       |         |  |  |   |         | 
|Less current portion                       |  |         | (243 | )         |  |       |         |  |  |   |         | 
|                                           |  |         |      |           |  |       |         |  |  |   |         | 
|Long-term portion                          |  | $       | 174  |           |  |       |         |  |  |   |         | 

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 ENDED
|                          |       |   |                  
|                          |       |   | FEBRUARY 2, 2002  |        | FEBRUARY 3, 2001 |   | JANUARY 29, 2000
|                          |       |   |                   |        |                  |   |                 
|Operating leases:         |       |   |                   |        |                  |   |                  |        |  |   |        |       
|Minimum rental expense    |       | $ | 36,078            |        |                  | $ | 34,965           |        |  | $ | 25,316 |       
|Contingent rental expense |       |   | 555               |        |                  |   | 838              |        |  |   | 621    |       
|                          |       |   |                   |        |                  |   |                  |        |  |   |        |       
|                          | Total |   | $                 | 36,633 |                  |   | $                | 35,803 |  |   | $      | 25,937 | 
|                          |       |   |                   |        |                  |   |                  |        |  |   |        |       

(4) REVOLVING LINE OF CREDIT AND DEBT

On March 21, 2001, the Company amended its existing credit facility. The
amendment reduced the overall commitment under the line of credit from $111
million to $89 million, increased the amounts available for letters of credit
from $10 million to $20 million and eliminated the minimum earnings before
interest, taxes, depreciation and amortization (EBITDA) requirement.
Additionally, the borrowing base calculation was modified to provide the Company
with more liquidity due to the pledge of additional collateral, and the interest
rate was reduced by 0.25%, with possible additional reductions based on
achievement of future EBITDA.

The amended credit facility included two high-interest term loans. The
first of these term loans was paid off in the second quarter of fiscal 2001. In
August of fiscal 2001, the credit facility was further amended to provide for
more favorable interest rates on the remaining term loan. This loan was paid off
in January 2002.

As a result of the paydowns of the term loans, as of February 2, 2002,
maximum availability under the facility was $80.0 million, with amounts
available for letters of credit up to $20 million. Availability under the credit
facility is limited by reference to a borrowing base calculation, based upon
eligible inventory and accounts receivable. The amount available under the
credit facility is typically much less than the $80.0 million stated maximum
limit of the facility (as of February 2, 2002, the total borrowing base
available was approximately $30.0 million). The agreement contains restrictive
covenants, including annual capital expenditure limits, minimum inventory
levels, limitations on store openings and closings and prohibitions on
dividends. As of February 2, 2002, the Company had no loans outstanding, and
$13.3 million in outstanding letters of credit. Interest is paid monthly at the
banks reference rate or LIBOR plus a margin. As of February 2, 2002, the banks
reference rate was 6.0% and the LIBOR plus margin rate was 5.3%. The agreement
expires on June 30, 2003.

In connection with an amendment to the Companys line of credit in
September 2000, putable warrants were issued to purchase 550,000 shares of
common stock, at an exercise price of $3.75 per share, subject to antidilution
protection. The credit facility was amended in March of 2001 and the exercise
price for 200,000 of the 550,000 warrants was decreased from $3.75 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



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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 the 2001 fiscal year, the revaluation of the warrants
resulted in an expense of $2.7 million. The warrants expire on September 27,
2005. As of February 2, 2002, warrants for the purchase of approximately 405,000
shares of common stock were outstanding. During the first quarter of fiscal 2002, all remaining
outstanding warrants were exercised.

(5) INCOME TAXES

The income tax expense (benefit) for the year ended February 2, 2002 consisted
of (in thousands):

|                           |         |                       |        |                   |        |             |        |             |        |   |        |        |        |  
|-------------------------- | ------- | --------------------- | ------ | ----------------- | ------ | ----------- | ------ | ----------- | ------ | - | ------ | ------ | ------ | -
|                           |         |                       |        | FISCAL YEAR ENDED
|                           |         |                       |        |                  
|                           |         |                       |        | FEBRUARY 2,       |        | FEBRUARY 3, |        | JANUARY 29,
|                           |         |                       |        | 2002              |        | 2001        |        | 2000       
|                           |         |                       |        |                   |        |             |        |            
|Current:                   |         |                       |        |                   |        |             |        |             |        |   |        |       
|                           | Federal |                       | $      | (1,979            | )      |             | $      | 1,394       |        |   | $      | 1,692  |       
|                           | State   |                       |        | (152              | )      |             |        | 326         |        |   |        | 366    |       
|                           | Foreign |                       |        | (2                | )      |             |        |            |        |   |        |       |       
|                           |         |                       |        |                   |        |             |        |             |        |   |        |       
|                           |         | Total current payable |        |                   | (2,133 | )           |        |             | 1,720  |   |        |        | 2,058  |  
|                           |         |                       |        |                   |        |             |        |             |        |   |        |       
|Deferred:                  |         |                       |        |                   |        |             |        |             |        |   |        |       
|                           | Federal |                       | $      | (4,166            | )      |             |        | (3,169      | )      |   |        | (3,106 | )     
|                           | State   |                       |        | (2,734            | )      |             |        | (787        | )      |   |        | (685   | )     
|                           | Foreign |                       |        | (715              | )      |             |        |             |        |   |        |        |       
|                           |         |                       |        |                   |        |             |        |             |        |   |        |       
|                           |         | Total deferred        |        |                   | (7,615 | )           |        |             | (3,956 | ) |        |        | (3,791 | )
|                           |         |                       |        |                   |        |             |        |             |        |   |        |       
|Provision for income taxes |         | $                     | (9,748 | )                 |        | $           | (2,236 | )           |        | $ | (1,733 | )     
|                           |         |                       |        |                   |        |             |        |             |        |   |        |       

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

|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |        |       |  
|------------------------------------------------------ | ---------------------------------------------------- | ------------------------------------------ | ------ | ----------- | ------ | ----------- | ----- | ----------- | ----- | - | ----- | ------ | ----- | -
|                                                       |                                                      |                                            |        | FEBRUARY 2, |        | FEBRUARY 3, |       | JANUARY 29,
|                                                       |                                                      |                                            |        | 2002        |        | 2001        |       | 2000       
|                                                       |                                                      |                                            |        |             |        |             |       |            
|Current deferred tax asset
(liability)
Accrued expense |                                                      | $                                          | 1,656  |             |        | $           | 827   |             |       | $ | 425   |       
|                                                       | State tax benefit                                    |                                            |        | (1,453      | )      |             |       | (444        | )     |   |       | (198   | )    
|                                                       | Inventory                                            |                                            |        | 3,485       |        |             |       | 1,059       |       |   |       | 843    |      
|                                                       | Deferred Revenue                                     |                                            |        | 655         |        |             |       | 446         |       |   |       |        |      
|                                                       | Other                                                |                                            |        | (615        | )      |             |       | (1,041      | )     |   |       | (1,221 | )    
|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |       
|                                                       |                                                      | Net current deferred tax
asset (liability) |        |             | 3,728  |             |       |             | 847   |   |       |        | (151  | )
|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |       
|Long-term deferred tax asset (liability):              |                                                      |                                            |        |             |        |             |       |             |       |   |       |       
|                                                       | Derivative warrant liability                         |                                            |        | 1,121       |        |             |       |            |       |   |       |       |      
|                                                       | Deferred lease credits                               |                                            |        | (758        | )      |             |       | 355         |       |   |       | 966    |      
|                                                       | Property and equipment                               |                                            |        | 8,833       |        |             |       | 6,560       |       |   |       | 3,230  |      
|                                                       | Net operating loss carryforwards                     |                                            |        | 9,251       |        |             |       | 239         |       |   |       |       |      
|                                                       | AMT Credit                                           |                                            |        | 441         |        |             |       |            |       |   |       |       |      
|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |       
|                                                       |                                                      | Net long-term deferred tax
asset           |        |             | 18,888 |             |       |             | 7,154 |   |       |        | 4,196 |  
|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |       
|                                                       | Total deferred tax assets before
valuation allowance |                                            |        | 22,616      |        |             |       | 8,001       |       |   |       | 4,045  |      
|                                                       | Valuation Allowance                                  |                                            |        | (7,000      | )      |             |       |            |       |   |       |       |      
|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |       
|Net deferred tax asset                                 |                                                      | $                                          | 15,616 |             |        | $           | 8,001 |             |       | $ | 4,045 |       
|                                                       |                                                      |                                            |        |             |        |             |       |             |       |   |       |       



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A reconciliation of the federal statutory tax rate to our effective state rate
is as follows:

|                                               |  |                   |       |             |  |             |       |    |  |  |       |   
|---------------------------------------------- |  | ----------------- | ----- | ----------- |  | ----------- | ----- | -- |  |  | ----- | --
|                                               |  | FISCAL YEAR ENDED
|                                               |  |                  
|                                               |  | FEBRUARY 2,       |       | FEBRUARY 3, |  | JANUARY 29,
|                                               |  | 2002              |       | 2001        |  | 2000       
|                                               |  |                   |       |             |  |            
|Provision at statutory tax rate                |  |                   | (34.0 | %)          |  |             | (34.0 | %) |  |  | (34.0 | %)
|State income taxes, net of federal tax
benefit |  |                   | (4.4  | %)          |  |             | (5.1  | %) |  |  | (4.4  | %)
|Other                                          |  |                   | 0.0   | %           |  |             | 1.7   | %  |  |  | 2.1   | % 
|Valuation allowance                            |  |                   | 16.0  | %           |  |             | 0.0   | %  |  |  | 0.0   | % 
|                                               |  |                   |       |             |  |             |       |    |  |  |       |   
|Total                                          |  |                   | (22.4 | %)          |  |             | (37.4 | %) |  |  | (36.3 | %)
|                                               |  |                   |       |             |  |             |       |    |  |  |       |   

As of February 2, 2002, the Company had federal, state and foreign net
operating loss carryovers of approximately $19.7 million, $20.1 million and
$950,000, respectively. These net operating loss carryovers will expire between
2006 and 2021. As of February 2, 2002, the Company also had a federal
alternative minimum tax credit of approximately $441,000. Using its best
estimates, the Company has established a valuation allowance of $7.0 million at
February 2, 2002, on certain of its federal and state deferred tax assets. The
Company believes the remaining deferred tax assets are more likely than not to
be realized. As is required by SFAS No. 109, the Company did not consider the
impact of tax laws or changes in tax rates that had not been enacted by February
2, 2002, including the economic stimulus bill that was enacted subsequent to
year-end on March 9, 2002.

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.

(6) REDEEMABLE CONVERTIBLE PREFERRED STOCK

On March 21, 2001, the Company completed a sale of the preferred stock
with aggregate proceeds to the Company of approximately $15 million. The initial
sale on March 21, 2001 included the sale of 6,820 shares of Series A and 8,180
shares of Series B, 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 on July 11, 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 Series A in accordance with the terms of the
Certificate of Designation of the Series A and Series B (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 of completion of the
preferred stock equity financing (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 on March 21, 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.



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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 the exercise of the Companys
redemption rights and the redemption rights of the holders of Series A in
connection with the Companys conversion rights described above and in the
Certificate of Designation and the determining of the liquidation preferences
of the holders of the Series A. 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.

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 represented
on all committees of the 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, 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.



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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.

(7) STOCKHOLDERS EQUITY

In June 1998, the Company reincorporated in Delaware and adopted a
Restated Certificate of Incorporation, Amended Bylaws and a Stockholder Rights
Agreement. In October 2001, the Company amended its Restated Certificate of
Incorporation to increase the number of authorized shares of the Company. The
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.

At February 2, 2002, the Company has reserved the following shares of
common stock for issuance in connection with:

|                              |                                                            |  |                                     |  |                                     |  |           |  |  |  |            | 
|----------------------------- | ---------------------------------------------------------- |  | ----------------------------------- |  | ----------------------------------- |  | --------- |  |  |  | ---------- | 
|                              | Issuable uponconversion orexercise ofoutstandingsecurities |  | Available
forfuture salesand grants |  | Total shares
ofcommon stockreserved
|Series A preferred stock      |                                                            |  | 7,160,000                           |  |                                     |  | 6,707,500 |  |  |  | 13,867,500 | 
|Stock warrants                |                                                            |  | 405,226                             |  |                                     |  |          |  |  |  | 405,226    | 
|Stock
options                 |                                                            |  | 3,836,778                           |  |                                     |  | 2,454,491 |  |  |  | 6,291,269  | 
|Employee
stock purchase plans |                                                            |  |                                    |  |                                     |  | 172,367   |  |  |  | 172,367    | 
|Total                         |                                                            |  | 11,402,004                          |  |                                     |  | 9,334,358 |  |  |  | 20,736,362 | 

EQUITY TRANSACTIONS

On March 21, 2001, the Company entered into a stock purchase agreement
with its 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 33 1/3% 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 shares vest at the rate
of 33-1/3% 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 is 8.5% per annum, which interest is payable on the first, second
and third anniversaries of the date of the note. The principal is due on March
22, 2004 but the due date may 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 ceases 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 is a full recourse
loan and is secured by shares of the common stock and preferred stock purchased
by Mr. Friedman.

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.

November financing  On November 6, 2001, the Company completed a private
placement sale with various institutional investors of 4,487,178 shares of our
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.



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STOCK OPTION GRANT AND COMMON STOCK PURCHASE
 
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, 2002, January 2, 2001 and January 3, 2000, the
Company added 853,670 shares, 512,668 shares and 506,993 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 1998 Plan, the vesting, exercise prices
and other terms of the options are fixed by the Compensation Committee or
Secondary



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Committee, as applicable. Options are granted at prices not less than the fair
market value on the date of grant for incentive stock options and not less than
85% of the fair market value for non-statutory stock options. These options
generally expire ten years from the date of grant and vest ratably over a
three-year period. If any options are exercised before becoming vested, the
holder can not 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.

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 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. 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. 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:

|                                               |                                                                                     |  |           |            |          |   |          |       | 
|---------------------------------------------- | ----------------------------------------------------------------------------------- |  | --------- | ---------- | -------- | - | -------- | ----- | 
|                                               |                                                                                     |  |           |            |          |   | WEIGHTED
|                                               |                                                                                     |  |           |            |          |   | AVERAGE 
|                                               |                                                                                     |  | NUMBER OF |            | EXERCISE
|                                               |                                                                                     |  | SHARES    |            | PRICE   
|                                               |                                                                                     |  |           |            |         
|Outstanding and exercisable, January 30, 1999  |                                                                                     |  | 2,254,001 |            |          | $ | 8.75     |      
|                                               | Granted with exercise price at fair value (weighted average fair value of $4.98)    |  |           | 1,000,126  |          |   |          | 9.06  | 
|                                               | Exercised                                                                           |  |           | (561,337   | )        |   |          | 1.27  | 
|                                               | Canceled                                                                            |  |           | (282,992   | )        |   |          | 14.32 | 
|                                               |                                                                                     |  |           |            |          |   |          |      
|Outstanding and exercisable, January 29, 2000  |                                                                                     |  | 2,409,798 |            |          |   | 11.00    |      
|                                               | Granted
with exercise price at fair value (weighted average fair value of $2.25)    |  |           | 1,235,316  |          |   |          | 4.17  | 
|                                               | Exercised                                                                           |  |           | (78,252    | )        |   |          | 1.54  | 
|                                               | Canceled                                                                            |  |           | (623,902   | )        |   |          | 12.18 | 
|                                               |                                                                                     |  |           |            |          |   |          |      
|Outstanding and exercisable, February 3, 2001  |                                                                                     |  | 2,942,960 |            |          |   | 8.06     |      
|                                               | Granted
with exercise price at fair value
(weighted average fair value of $1.99)    |  |           | 1,723,597  |          |   |          | 4.40  | 
|                                               | Granted
with exercise price above fair value (weighted average fair value of
$0.06) |  |           | 205,000    |          |   |          | 6.00  | 
|                                               | Granted
with exercise price below fair value
(weighted average fair value of $1.57) |  |           | 1,460,000  |          |   |          | 1.79  | 
|                                               | Exercised                                                                           |  |           | (1,612,076 | )        |   |          | 1.68  | 
|                                               | Canceled                                                                            |  |           | (882,703   | )        |   |          | 8.39  | 
|                                               |                                                                                     |  |           |            |          |   |          |      
|Outstanding and exercisable, February 2, 2002  |                                                                                     |  | 3,836,778 |            |          | $ | 6.52     |      
|                                               |                                                                                     |  |           |            |          |   |          |      
|Vested at February 2, 2002                     |                                                                                     |  | 1,543,582 |            |          |   |          |      
|                                               |                                                                                     |  |           |            |          |   |          |      
|Available for future grant at February 2, 2002 |                                                                                     |  | 2,454,491 |            |          |   |          |      
|                                               |                                                                                     |  |           |            |          |   |          |      



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Additional information regarding options outstanding as of February 2, 2002 is
as follows:

|                |  |             |           |              |  |           |      |          |  |          |       |  |  |          |           |  |  |   |       | 
|--------------- |  | ----------- | --------- | ------------ |  | --------- | ---- | -------- |  | -------- | ----- |  |  | -------- | --------- |  |  | - | ----- | 
|                |  |             |           |              |  | WEIGHTED  |      |          |  |          |       |  |  |          |           |  |  |  
|                |  |             |           |              |  | AVERAGE   |      | WEIGHTED |  |          |       |  |  | WEIGHTED
|                |  |             |           |              |  | REMAINING |      | AVERAGE  |  |          |       |  |  | AVERAGE 
|RANGE OF        |  | NUMBER      |           | CONTRACTUAL  |  | EXERCISE  |      | NUMBER   |  | EXERCISE
|EXERCISE PRICES |  | OUTSTANDING |           | LIFE (YEARS) |  | PRICE     |      | VESTED   |  | PRICE   
|                |  |             |           |              |  |           |      |          |  |         
|$  0.00 - 0.33  |  |             | 20,000    |              |  |           | 8.92 |          |  | $        | 0.32  |  |  |          | 20,000    |  |  | $ | 0.32  | 
|$  0.66 - 1.72  |  |             | 309,001   |              |  |           | 6.65 |          |  | $        | 1.30  |  |  |          | 209,438   |  |  | $ | 1.10  | 
|$  2.00
- 2.94  |  |             | 585,414   |              |  |           | 9.08 |          |  | $        | 2.36  |  |  |          | 107,297   |  |  | $ | 2.66  | 
|$  3.05

- 4.65 |  |             | 1,003,864 |              |  |           | 9.04 |          |  | $        | 4.25  |  |  |          | 139,167   |  |  | $ | 4.17  | 
|$  5.00
- 7.25  |  |             | 1,009,307 |              |  |           | 9.26 |          |  | $        | 5.87  |  |  |          | 270,654   |  |  | $ | 5.89  | 
|$  7.67 - 11.94 |  |             | 498,745   |              |  |           | 6.79 |          |  | $        | 10.42 |  |  |          | 409,846   |  |  | $ | 10.45 | 
|$12.38 - 14.50  |  |             | 53,456    |              |  |           | 7.28 |          |  | $        | 13.94 |  |  |          | 30,189    |  |  | $ | 14.50 | 
|$19.00 - 22.00  |  |             | 356,991   |              |  |           | 6.48 |          |  | $        | 19.86 |  |  |          | 356,991   |  |  | $ | 19.86 | 
|                |  |             |           |              |  |           |      |          |  |          |       |  |  |          |           |  |  |   |       | 
|$0.66 - $30.38  |  |             | 3,836,778 |              |  |           | 8.36 |          |  | $        | 6.52  |  |  |          | 1,543,582 |  |  | $ | 9.39  | 
|                |  |             |           |              |  |           |      |          |  |          |       |  |  |          |           |  |  |   |       | 

Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123), requires the disclosure of pro forma net
income had the Company adopted the fair value method as of the beginning of
fiscal 1995. Under SFAS 123, the fair value of stock-based awards to employees
is calculated through the use of option pricing models, even though such models
were developed to estimate the fair value of freely traded, fully transferable
options without vesting restrictions, which significantly differ from the
Companys stock option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise which
greatly affect the calculated values. The Companys calculations were made using
the Black-Scholes option pricing model with the following weighted average
assumptions: expected life 54 months in all three years; stock volatility
considered to be 50% in 2001, 21% in 2000, and 50% in 1999; risk free interest
rates of 2.28% in 2001, 4.90% in 2000, and 6.50% in 1999, and no dividends
during the expected term. The Companys calculations are based on a multiple
option valuation approach and forfeitures are recognized as they occur. If the
computed fair values of the awards had been amortized to expense over the
vesting period of the awards, pro forma net income and per share amounts would
have been as follows (dollars in thousands, except per share data):

|                                                   |                                |   |                   |       |             |   |             |       |   |   |        |       |  
|-------------------------------------------------- | ------------------------------ | - | ----------------- | ----- | ----------- | - | ----------- | ----- | - | - | ------ | ----- | -
|                                                   |                                |   | FISCAL YEAR ENDED
|                                                   |                                |   |                  
|                                                   |                                |   | FEBRUARY 2,       |       | FEBRUARY 3, |   | JANUARY 29,
|                                                   |                                |   | 2002              |       | 2001        |   | 2000       
|                                                   |                                |   |                   |       |             |   |            
|Net income (loss) available to
common stockholders |                                |   |                   |       |             |   |             |       |   |   |        |      
|As reported                                        |                                | $ | (36,684           | )     |             | $ | (4,560      | )     |   | $ | (3,040 | )    
|Pro-forma                                          |                                |   | (37,855           | )     |             |   | (5,924      | )     |   |   | (5.547 | )    
|Net Income (loss) per share:                       |                                |   |                   |       |             |   |             |       |   |   |        |      
|                                                   | Basic
and diluted, as reported |   |                   | (1.57 | )           |   |             | (0.27 | ) |   |        | (0.18 | )
|                                                   | Basic
and diluted, proforma    |   |                   | (1.62 | )           |   |             | (0.35 | ) |   |        | (0.33 | )

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 2001, 2000 and 1999, employees purchased approximately 116,191
shares,89,856 shares and 96,592 shares, respectively, of the Companys common
stock under the Purchase Plan at weighted average per-share prices of $1.33,
$4.89 and $11.10, respectively. Through February 2, 2002, approximately 302,639
shares had been issued under the Purchase Plan and 172,361 shares remained
available for future issuance.



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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.

(7) 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 $10,000 and qualify for favorable tax treatment under Section
401(k) of the Internal Revenue Code. In November 1997, the Company began
matching 10% of the employees contribution up to a maximum of 4% of their base
salary. The Company contributed $264,576, $221,977 and $56,827 in the years
ended February 2, 2002, February 3, 2001, and January 29, 2000, respectively.

(8) 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 the fiscal
years ended February 2, 2002, February 3, 2001, and January 29, 2001, rents of
$65,657, $65,657, and $64,222 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.

In connection with the preferred stock financing completed in March 2001,
Mr. Friedman purchased 455 shares of the Series A 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, we 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, we also made a loan to Mr. Friedman
in the amount of $2.05 million. All of the loan proceeds were used by Mr.
Friedman to purchase a portion of this stock. The loan is a full recourse loan
and is secured by shares of the common stock and preferred stock purchased by
Mr. Friedman. This loan is 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 is 8.5% per annum, payable on the first, second and third
anniversaries of the date of the note. The principal is due on March 22, 2004
but the due date may 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.

(9) 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.

(10) 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 expense associated with the 104 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 expense associated with our wholly-owned furniture manufacturer, The
Michaels Furniture Co. 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.



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

|                                           |                                     |   |                   |         |             |   |             |         |   |   |         |         |  
|------------------------------------------ | ----------------------------------- | - | ----------------- | ------- | ----------- | - | ----------- | ------- | - | - | ------- | ------- | -
|                                           |                                     |   | FISCAL YEAR ENDED
|                                           |                                     |   |                  
|                                           |                                     |   | FEBRUARY 2,       |         | FEBRUARY 3, |   | JANUARY 29,
|                                           |                                     |   | 2002              |         | 2001        |   | 2000       
|                                           |                                     |   |                   |         |             |   |            
|Net sales                                  |                                     |   |                   |         |             |   |             |         |   |   |         |        
|                                           | Retail                              |   | $                 | 332,783 |             |   | $           | 342,687 |   |   | $       | 279,225 |  
|                                           | Direct-to-customer                  |   |                   | 33,647  |             |   |             | 22,554  |   |   |         | 12,785  |  
|                                           | Furniture manufacturing             |   |                   | 16,001  |             |   |             | 19,980  |   |   |         | 26,376  |  
|                                           | Intersegment furniture sales        |   |                   | (15,958 | )           |   |             | (18,985 | ) |   |         | (19,484 | )
|                                           |                                     |   |                   |         |             |   |             |         |   |   |         |        
|Consolidated net sales                     |                                     | $ | 366,473           |         |             | $ | 366,236     |         |   | $ | 298,902 |        
|                                           |                                     |   |                   |         |             |   |             |         |   |   |         |        
|Income from operations                     |                                     |   |                   |         |             |   |             |         |   |   |         |        
|                                           | Retail                              |   |                   | 5,413   |             |   |             | 42,735  |   |   |         | 26,837  |  
|                                           | Direct-to-customer                  |   |                   | 1,751   |             |   |             | 278     |   |   |         | (257    | )
|                                           | Furniture manufacturing             |   |                   | (963    | )           |   |             | (1,799  | ) |   |         | 2,494   |  
|                                           | Unallocated                         |   |                   | (40,278 | )           |   |             | (40,449 | ) |   |         | (29,505 | )
|                                           | Intersegment income from
operations |   |                   | (2,394  | )           |   |             | (938    | ) |   |         | (2,923  | )
|                                           |                                     |   |                   |         |             |   |             |         |   |   |         |        
|Consolidated income (loss) from operations |                                     |   | (36,471           | )       |             | $ | (173        | )       |   | $ | (3,354  | )      
|                                           |                                     |   |                   |         |             |   |             |         |   |   |         |        

(11) 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. For each of the years ended February 2, 2002, February 3, 2001 and
January 29, 2000, rental payments of $346,560 were paid to Mr. Vermillion in
each year.






|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------

None.




PART III

Certain information required by Part III is omitted from this annual
report in that we will have filed our definitive proxy statement pursuant to
Regulation 14A no later than 120 days after the end of the fiscal year covered
by this annual report and certain information is incorporated herein by
reference.




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information relating to our executive officers and directors will be set
forth in the sections with the captions Executive Officers and Directors and
Compliance with Section 16(a) of the Securities



47



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##### Table of Contents



Exchange Act in our definitive proxy statement in connection with the annual
meeting of stockholders to be held in July 2002. This information is
incorporated herein by reference.







ITEM 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION




Information relating to executive compensation will be set forth in the
section with the caption Executive Compensation and Other Information in our
definitive proxy statement. This information is incorporated herein by
reference.







ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT




Information relating to the security ownership of our common stock by our
management and other beneficial owners will be set forth in the section with the
caption Security Ownership of Certain Beneficial Owners and Management in our
definitive proxy statement. This information is incorporated herein by
reference.







ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information relating to certain relationships and related transactions
between our company and directors, executive officers and stockholders owning
greater than five percent of any class of voting securities will be set forth in
the sections with the captions Employment Contracts, Termination of Employment
and Change in Control Arrangements and Certain Relationships and Related
Transactions in our definitive proxy statement. This information is
incorporated herein by reference.







PART IV







ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K






| | (a) |    | The following are filed as a part of this annual report on Form
10-K.                                                                                                       
| | --- | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     | 1. | Index to Financial Statements                                                                                                                                               
| |     |    | Consolidated Balance
Sheet                                                                                                                                                  
| |     |    | Consolidated Statements
of Operations                                                                                                                                       
| |     |    | Consolidated Statements
of Stockholders Equity                                                                                                                             
| |     |    | Consolidated Statements
of Cash Flows                                                                                                                                       
|
| |     | 2. | Financial Statement Schedule                                                                                                                                                
|
| |     |    | Schedule II  Valuation and Qualifying Accounts                                                                                                                             
|
| |     | 3. | Exhibits                                                                                                                                                                    
|
|
| |     |    | The exhibits filed as part of this
Form 10-K/A are listed in the
Exhibit Index immediately preceding such exhibits, which Exhibit
Index is incorporated herein by reference.
|

(b)  Reports on Form 8-K:

| |                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) The Company filed an amendment to a Form 8-K on January 18, 2002,
announcing that it had completed an equity financing in November 2001 for
an aggregate consideration to the Company of approximately $17.5 million.                                                       
| | (b) The Company filed a Form 8-K on January 15, 2002, announcing the
Companys holiday comparable store sales results.                                                                                                                                                          
| | (c) The Company filed a Form 8-K on
November 21, 2001, announcing the Companys third quarter
results.                                                                                                                                                                          
| | (d) The Company filed a Form 8-K on
November 20, 2001, announcing the appointment of Kevin Shahan as the
Companys new Chief Financial Officer.                                                                                                                                 
| | (e) The Company filed a Form 8-K on
November 8, 2001, announcing the Companys third quarter sales
results.                                                                                                                                                                     
| | (f) The Company filed a Form 8-K on
November 7, 2001, announcing that it entered into a stock purchase
agreement with a number of investors for the sale of its common stock
for an aggregate consideration of approximately $17.5 million.                                     
| | (g) The Company filed a Form 8-K on
November 6, 2001, announcing the incorporation by reference of the
full text of the section titled Risk Factors that was
included in the Companys Amendment No. 1 to its registration
statement on Form S-3 (Registration No. 333-70624).



48



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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, in the City
of Corte Madera, State of California on this 17th day of
September, 2002.




| |                                                                                      |                     
| | ------------------------------------------------------------------------------------ | --------------------
| | RESTORATION HARDWARE, INC.                                                          
|
| | By:                                                                                  | /s/ GARY G. FRIEDMAN
| |                                                                                     
| | Gary G. Friedman
President and Chief Executive Officer
(Principal Executive Officer)
|
| | Date: September 17, 2002                                                            

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Amendment No. 1 to the report 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                                                                                           |  | September __, 2002
|                                      
|/s/ GARY G. FRIEDMAN

Gary G. Friedman |  | President, Chief Executive
Officer and Director                                                    |  | September 17, 2002
|                                      
|/s/ KEVIN W. SHAHAN

Kevin W. Shahan   |  | Vice President,
Chief Financial Officer and
Secretary
(Principal Financial and Accounting Officer) |  | September 17, 2002
|                                      
|Thomas M. Bazzone                      |  | Executive Vice President,
Chief Operating Officer,
Assistant Secretary and Director                |  | September __, 2002
|                                      
|Damon H. Ball                          |  | Director                                                                                           |  | September __, 2002
|                                      
|Robert E. Camp                         |  | Director                                                                                           |  | September __, 2002
|                                      
|Raymond C. Hemmig                      |  | Director                                                                                           |  | September __, 2002
|                                      
|Glenn J. Krevlin                       |  | Director                                                                                           |  | September __, 2002
|                                      
|Mark J. Schwartz                       |  | Director                                                                                           |  | September __, 2002
|                                      



49



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##### Table of Contents






RESTORATION HARDWARE, INC.

CERTIFICATION

I, Gary G. Friedman, certify that:



|1. |  | I have reviewed this Amendment No. 1 to the annual report on Form 10-K of
Restoration Hardware, Inc.;                                                                                                                                                                                                                                                                     
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this Amendment No. 1 to the annual report does not
contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this Amendment No. 1 to the annual
report; and
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this Amendment No. 1 to the annual report, fairly
present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods
presented in this Amendment No. 1 to the annual report.                       

Date: September 17, 2002

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

RESTORATION HARDWARE, INC.

CERTIFICATION

I, Kevin W. Shahan, certify that:



|1. |  | I have reviewed this Amendment No. 1 to the annual report on Form 10-K of
Restoration Hardware, Inc.;                                                                                                                                                                                                                                                                     
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this Amendment No. 1 to the annual report does not
contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this Amendment No. 1 to the annual
report; and
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this Amendment No. 1 to the annual report, fairly
present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods
presented in this Amendment No. 1 to the annual report.                       

Date: September 17, 2002

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




SCHEDULE II
 
VALUATION AND QUALIFYING ACCOUNTS
 
AS OF AND FOR THE FISCAL YEARS ENDED FEBRUARY
2, 2002, FEBRUARY 3, 2001 AND JANUARY 29, 2000
(Dollars in Thousands)

|                                                  |                                                  |           |             |          |            |          |            |            |  |        |   |   |             |  |   |        |   |  |   |       | 
|------------------------------------------------- | ------------------------------------------------ | --------- | ----------- | -------- | ---------- | -------- | ---------- | ---------- |  | ------ | - | - | ----------- |  | - | ------ | - |  | - | ----- | 
|Column A                                          |                                                  | Column B  |             | Column C |            | Column D |            | Column E  
|                                                  |                                                  |           |             |          |            |          |            |           
|                                                  |                                                  |           |             |          |            |          | Additions  |            |  |        |   |   |             |  |   |        |   |  |  
|                                                  |                                                  |           | Balances at |          | Charged to |          | Charged to |            |  |        |   |   | Balances at
|                                                  |                                                  |           | Beginning   |          | Costs and  |          | Other      |            |  |        |   |   | End of     
|Description                                       |                                                  | of Period |             | Expenses |            | Accounts |            | Deductions |  | Period
|                                                  |                                                  |           |             |          |            |          |            |            |  |       
|AMOUNTS DEDUCTED FROM ASSETS TO WHICH
THEY APPLY: |                                                  |           |             |          |            |          |            |            |  |        |   |   |             |  |   |        |   |  |   |      
|                                                  | Year
ended January 29, 2000Inventory
reserves(1) |           | $           | 130      |            |          | $          | 4,115      |  |        | $ |  |             |  | $ | (4,125 | ) |  | $ | 120   | 
|                                                  | Year
ended February 3, 2001Inventory reserves(1) |           |             | 120      |            |          |            | 4,149      |  |        |   |  |             |  |   | (3,062 | ) |  |   | 1,207 | 
|                                                  | Year
ended February 2, 2002Inventory reserves(1) |           |             | 1,207    |            |          |            | 9,425      |  |        |   |  |             |  |   | (4,131 | ) |  |   | 6,501 | 

|    |  |                                                                                                                                    
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------
|(1) |  | Amounts include reserves for shortages,
damaged goods, and reductions in inventory to record inventory at its
net realizable value.



50



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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)                                                                                                                                                                             
|              
|4.1            |  | Reference is made to Exhibit 3.1                                                                                                                                                                          
|              
|4.2            |  | Reference is made to Exhibit 3.3                                                                                                                                                                          
|              
|4.3            |  | Specimen Common Stock Certificate(3)                                                                                                                                                                      
|              
|4.4            |  | Specimen Series A Preferred Stock Certificate(4)                                                                                                                                                          
|              
|4.5            |  | Specimen Series B Preferred Stock Certificate(4)                                                                                                                                                          
|              
|4.6            |  | Certificate of Designation of Series A and Series B Preferred
Stock(4)                                                                                                                                    
|              
|4.7            |  | Consent and Waiver Regarding Additional Financing(5)                                                                                                                                                      
|              
|4.8            |  | Amended and Restated Letter Agreement, dated as of March 21,
2001, by and among certain holders of Series A preferred
stock(6)                                                                            
|              
|+10.1          |  | Form of 1995 Stock Option Plan(3)                                                                                                                                                                         
|              
|+10.2          |  | Form of 1998 Stock Incentive Plan(3)                                                                                                                                                                      
|              
|+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)                                                                                                                             
|              
|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(7)                                                                                                                         



51



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|               |  |                                                                                                                                                                                           
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT NUMBER |  | DOCUMENT DESCRIPTION                                                                                                                                                                      
|               |  |                                                                                                                                                                                           
|              
|10.15          |  | First Amendment to the Fifth Amended and Restated Loan and
Security Agreement, dated March 31, 2000(8)                                                                                    
|              
|10.16          |  | Sixth Amended and Restated Loan and Security Agreement, dated
September 27, 2000(9)                                                                                                       
|              
|10.17          |  | Warrant Agreement, dated as of September 27, 2000, by and
among Restoration Hardware, Inc., Goldman Sachs & Co., and
Enhanced Retail Funding, LLC(10)                                     
|              
|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(4)                       
|              
|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(4)
|              
|10.20          |  | Third Amendment to the Sixth Amended and Restated Loan and
Security Agreement, dated as of March 21, 2001(4)                                                                              
|              
|10.30          |  | Offer of Employment Letter for Mr. Gary G. Friedman dated as
of March 15, 2001(4)                                                                                                         
|              
|10.31          |  | Compensation and Severance Agreement between Restoration
Hardware, Inc. and Gary G. Friedman, effective as of March 21,
2001(4)                                                           
|              
|10.32          |  | Stock Pledge Agreement between Restoration Hardware, Inc. and
Gary G. Friedman, dated as of March 22, 2001(4)                                                                             
|              
|10.33          |  | Stock Purchase Agreement between Restoration Hardware, Inc.
and Gary G. Friedman, dated as of March 18, 2001(4)                                                                           
|              
|10.34          |  | Early Exercise Stock Purchase Agreement between Restoration
Hardware, Inc. and Gary G. Friedman, dated as of March 18,
2001(4)                                                            
|              
|10.35          |  | Note Secured by Stock between Restoration Hardware, Inc. and
Gary G. Friedman, dated as of March 22, 2001(4)                                                                              
|              
|10.36          |  | Notice of Grant of Stock Option for Gary G. Friedman(4)                                                                                                                                   
|              
|10.37          |  | Stock Option Agreement between Restoration Hardware, Inc. and
Gary G. Friedman, dated as of March 18, 2001(4)                                                                             
|              
|10.38          |  | Separation Agreement and Release between Restoration Hardware,
Inc. and Thomas Christopher, dated as of March 20, 2001(11)                                                                
|              
|10.39          |  | Amended and Restated Promissory Note by and among Restoration
Hardware, Inc., Thomas Christopher and Barbara Christopher,
dated as of May 1, 2001(11)                                     
|              
|10.40          |  | Severance Agreement between Restoration Hardware, Inc. and
Stephen J. Gordon, effective as of March 21, 2001(11)                                                                          
|              
|10.41          |  | Stock Purchase Agreement, dated as of May 17, 2001, by and
among Restoration Hardware, Inc. and certain investors named
therein(12)                                                       
|              
|10.42          |  | Offer Letter, dated June 26, 2001, from Restoration Hardware,
Inc. to Tom Bazzone(13)                                                                                                     
|              
|10.43          |  | Fourth Amendment to the Fourth Amended and Restated Loan and
Security Agreement, dated October 15, 1999(14)                                                                               
|              
|+10.44         |  | Amended and Restated 1998 Stock Incentive Plan(15)                                                                                                                                        
|              
|+10.45         |  | Form of Non-Plan Notice of Grant of Stock Option and Stock
Option Agreement(16)                                                                                                           
|              
|10.46          |  | Stock Purchase Agreement, dated as of November 6, 2001, by and
among Restoration Hardware, Inc. and certain investors named
therein(17)                                                   
|              
|*10.47         |  | Employment Offer Letter between Restoration Hardware, Inc. and
Kevin Shahan, dated November 4, 2001                                                                                       
|              
|*10.48         |  | Option Agreement between Restoration Hardware, Inc. and Kevin
Shahan, dated December 3, 2001                                                                                              
|              
|*10.49         |  | Option Agreement between Restoration Hardware, Inc. and Tom
Bazzone, dated July 16, 2001                                                                                                  
|              
|*10.50         |  | Fourth Amendment to the Sixth Amended and Restated Loan and
Security Agreement, dated September 27, 2001                                                                                  
|              
|21             |  | List of Subsidiaries(8)                                                                                                                                                                   
|              
|              
|**23.1         |  | Consent of Independent Auditors                                                                                                                                                           
|              



---

|(1) |  | Incorporated by reference to the exhibit with the exhibit number 3.1 filed
with the registrants Form 8-K filed with the Securities and Exchange
Commission on October 24, 2001.                                                            
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Incorporated by reference to the exhibit with the same number filed with
the Companys Quarterly Report on Form 10-Q for the quarterly period ended
October 31, 1998 filed with the Securities and Exchange Commission on
December 15, 1998.



52



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##### Table of Contents



|(3)  |  | Incorporated by reference to the exhibit with the same number filed with
the Companys Registration Statement on Form S-1 (File No. 333-51027)
filed with the Securities and Exchange Commission on June 17, 1998.                                       
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|    
|    
|    
|(4)  |  | Incorporated by reference to the exhibit with the same number filed with
the Companys Report on Form 8-K filed with the Securities and Exchange
Commission on April 2, 2001.                                                                            
|    
|    
|    
|    
|(5)  |  | Incorporated by reference to the exhibit with the exhibit number 10.2
filed with the registrants Form 8-K filed with the Securities and
Exchange Commission on May 23, 2001.                                                                            
|    
|    
|    
|    
|(6)  |  | Incorporated by reference to the exhibit with the exhibit number 4.9 filed
with the registrants Registration Statement on Form S-3 with the
Securities and Exchange Commission on January 4, 2002.                                                      
|    
|    
|    
|    
|(7)  |  | Incorporated by reference to the exhibit with the exhibit number 10.12
filed with the registrants Annual Report on Form 10-K for the year ended
January 29, 2000 filed with the Securities and Exchange Commission on
April 27, 2000.                   
|    
|    
|    
|    
|(8)  |  | Incorporated by reference to the exhibit with the exhibit number 10.12
filed with the registrants Annual Report on Form 10-K for the year ended
January 29, 2000 filed with the Securities and Exchange Commission on
April 27, 2000.                   
|    
|    
|    
|    
|(9)  |  | Incorporated by reference to the exhibit with the exhibit number 10.12
filed with the registrants Quarterly Report on Form 10-Q for the
quarterly period ended October 28, 2000 filed with the Securities and
Exchange Commission on December 12, 2000. 
|    
|    
|    
|    
|(10) |  | Incorporated by reference to the exhibit with the exhibit number 10.14
filed with the registrants Quarterly Report on Form 10-Q for the
quarterly period ended October 28, 2000 filed with the Securities and
Exchange Commission on December 12, 2000. 
|    
|    
|    
|    
|(11) |  | Incorporated by reference to the exhibit with the same number filed with
the Companys Annual Report on Form 10-K for the year ended February 3,
2001 filed with the Securities and Exchange Commission on May 4, 2001.                                  
|    
|    
|    
|    
|(12) |  | Incorporated by reference to the exhibit with the exhibit number 10.1
filed with the registrants Form 8-K filed with the Securities and
Exchange Commission on May 23, 2001.                                                                            
|    
|    
|    
|    
|(13) |  | Incorporated by reference to the exhibit with the exhibit number 10.2
filed with the registrants Quarterly Report on Form 10-Q for the
quarterly period ended August 4, 2001, filed with the Securities and
Exchange Commission on September 18, 2001.  
|    
|    
|    
|    
|(14) |  | Incorporated by reference to the exhibit with the exhibit number 10.18
filed with the registrants Quarterly Report on Form 10-Q for the
quarterly period ended October 30, 1999, filed with the Securities and
Exchange Commission on December 14, 1999.
|    
|    
|    
|    
|(15) |  | Incorporated by reference to the exhibit with the exhibit number 99.1
filed with the registrants registration statement on S-8 filed with the
Securities and Exchange Commission on October 26, 2001.                                                   
|    
|    
|    
|    
|(16) |  | Incorporated by reference to the exhibit with the exhibit number 10.42
filed with the registrants Quarterly Report on Form 10-Q for the
quarterly period ended November 3, 2001, filed with the Securities and
Exchange Commission on December 18, 2001.
|    
|    
|    
|    
|(17) |  | Incorporated by reference to the exhibit with the exhibit number 10.1
filed with the registrants Form 8-K filed with the Securities and
Exchange Commission on January 18, 2002.                                                                        
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|+    |  | Management contract, compensatory plan or arrangement.                                                                                                                                                                                                   
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|*    |  | Previously filed.                                                                                                                                                                                                                                        
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|**   |  | Filed herewith.                                                                                                                                                                                                                                          
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