Restoration Hardware 2012 Annual Report Download - page 79

supplied defective merchandise will not be able to refund the purchase price to us or pay us any penalties or
damages associated with any defects.
In addition, our vendors may not adhere to our quality control standards, and we might not identify a quality
deficiency before merchandise ships to our stores or customers. Our vendors’ failure to manufacture or import
quality merchandise in a timely and effective manner could damage our reputation and brand image, and could
lead to an increase in product returns or exchanges or customer litigation against us and a corresponding increase
in our routine and non-routine litigation costs. Further, any merchandise that does not meet our quality standards
or other government requirements could become subject to a recall, which could damage our reputation and
brand image and harm our business.
Our former Chairman and Co-Chief Executive Officer, Gary Friedman, resigned from these positions and as
a director of the Company last year. There can be no assurance that these developments will not have an
adverse impact on us.
Our former Chairman and Co-Chief Executive Officer, Gary Friedman, resigned from these positions and as
a director of the Company, effective October 20, 2012, following an investigation by a special committee of non-
management directors of the board assisted by independent counsel prompted by disclosure that Mr. Friedman
and a Company employee were engaged in a personal relationship, described by the parties as consensual. The
investigation concluded that Mr. Friedman engaged in activities that were inconsistent with the board of
directors’ expectations for executive conduct as previously communicated by the board of directors and failed to
comply with certain Company policies. We incurred $4.8 million of expenses related to the investigation. There
can be no assurance that we will not incur expenses or claims in the future related to the conduct that was the
subject of the investigation or similar conduct that has occurred in the past or, given Mr. Friedman’s continued
involvement with the Company in his new roles, may occur in the future.
In connection with his resignation as Chairman, Co-Chief Executive Officer and a director, Mr. Friedman
and the Company entered into an advisory services agreement that provides for Mr. Friedman to advise the
Company in a role described as the Creator and Curator with respect to product development, merchandising and
other creative matters. In addition, in connection with our initial public offering, Home Holdings agreed to invest
$5 million, consisting of $2.5 million in an initial tranche and $2.5 million in one or more additional tranches,
directly or indirectly, in Hierarchy, LLC (“Hierarchy”), a recently formed entity in which Mr. Friedman has a
controlling interest. If requested by Home Holdings and agreed to by us, we may make such subsequent tranche
investments. We will have the right to acquire all or a portion of Home Holdings’ interest in Hierarchy between
the second and third anniversaries of our initial public offering, at the greater of the then fair market value and
the price paid by Home Holdings. Further, Home Holdings has assigned to us its right of first offer and co-sale
right over the sale by Mr. Friedman of his interests in Hierarchy, its right of first offer over the sale of Hierarchy
or any of its lines of business and its preemptive rights on issuances of additional interests in Hierarchy. Unless
otherwise agreed by Home Holdings, for two years from the date of the Hierarchy operating agreement,
Hierarchy’s lines of business will be limited to apparel and apparel related businesses. In addition, Hierarchy will
be permanently prohibited from entering into lines of business in which we are engaged and certain lines of
business in which we may become engaged (other than luggage, which Hierarchy may enter into after such two
year period). The agreements among Hierarchy, Home Holdings, Mr. Friedman and the Company contemplate
that we will enter into an agreement to provide Hierarchy with back office, logistics, supply chain and
administrative support, with pricing determined based on the fair market value of such services. We also
transferred to Hierarchy our minimal apparel-related assets at fair market value. Mr. Friedman is also a
significant stockholder in the Company and will continue to advise the board of directors in an observer capacity,
with the honorary title of Chairman Emeritus.
Mr. Friedman’s leadership and creative talents were important contributors to the Company’s performance
during his tenure as our Chairman and Co-Chief Executive Officer. While we believe that Mr. Alberini, the
current sole Chief Executive Officer, and the other management team members can continue to effectively lead
the Company, and we expect to continue to benefit from Mr. Friedman’s contributions as the Company’s Creator
and Curator on an advisory basis, and as Chairman Emeritus, there can be no assurance that the absence of
Mr. Friedman in his former roles will not have an adverse impact on us.
23
Form 10-K