UNITED STATES
FORM 10-Q
Commission file number 001-14077
WILLIAMS-SONOMA, INC.
Registrant’s Telephone Number, Including Area Code (415) 421-7900
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check [X] 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. Yes [X] No [ ]
Indicate by check [X] whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of December 12, 2002, 116,349,193 shares of the Registrant’s Common Stock were outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
WILLIAMS-SONOMA, INC. AND SUBSIDIARIES
See Notes to Condensed Consolidated Financial Statements.
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NOTE A. FINANCIAL STATEMENTS — BASIS OF PRESENTATION
The condensed consolidated balance sheets as of November 3, 2002 and October 28, 2001, the condensed consolidated statements of earnings for the thirteen and thirty-nine week periods ended November 3, 2002 and October 28, 2001, and the condensed consolidated statements of cash flows for the thirty-nine week periods ended November 3, 2002 and October 28, 2001 have been prepared by Williams-Sonoma, Inc., without audit. In the opinion of management, the financial statements include all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at the balance sheet dates and the results of operations for the thirteen and thirty-nine week periods then ended. These financial statements include Williams-Sonoma, Inc., and its wholly-owned subsidiaries (the “Company”). Significant intercompany transactions and accounts have been eliminated. The balance sheet at February 3, 2002, presented herein, has been derived from the audited balance sheet of the Company included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2002.
Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2002.
Certain reclassifications have been made to the prior period financial statements to conform to the presentation used in the current period.
The results of operations for the thirteen and thirty-nine weeks ended November 3, 2002 are not necessarily indicative of the operating results of the full year.
NOTE B. NEW ACCOUNTING PRONOUNCEMENT
In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144. The Company is required to adopt the provisions of SFAS No. 146 for exit or disposal activities, if any, initiated after December 31, 2002. Management does not believe the adoption of SFAS No. 146 will have an impact on the consolidated financial position or results of operation of the Company.
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NOTE C. BORROWING ARRANGEMENTS
The Company’s line of credit facility provides for a $200,000,000 unsecured revolving credit facility and contains certain restrictive loan covenants, including minimum tangible net worth, maximum leverage ratio, minimum fixed charge coverage ratio, and maximum annual capital expenditures. The line of credit facility was renewed by an amended and restated agreement dated October 22, 2002. The amended agreement expires on October 22, 2005. Through April 22, 2005, the Company may, upon notice to the lenders, request an increase in the facility up to $250,000,000. The Company may elect interest rates calculated by reference to the agent’s internal reference rate or LIBOR plus a margin based on the Company’s leverage ratio. As of November 3, 2002, the Company had no borrowings outstanding under the line of credit facility.
As of November 3, 2002, the Company had issued and outstanding standby letters of credit under the line of credit facility in an aggregate amount of $9,964,000. The standby letters of credit were issued to replace surety bonds that support workers’ compensation and other insurance programs.
In July 2002, the Company entered into three new unsecured commercial letter of credit reimbursement agreements for an aggregate of $100,000,000. These agreements expire on July 2, 2003. The latest expiration for the letters of credit issued under the agreements is November 29, 2003. Per the new agreements, the Company is permitted to have issued and outstanding up to $120,000,000 under both the new letter of credit agreements and the prior letter of credit agreement. As of November 3, 2002, $1,037,000 was outstanding under the prior letter of credit agreement, and $75,892,000 was outstanding under the new letter of credit agreements. Such letters of credit represent only a future commitment to fund inventory purchases to which the Company had not taken legal title as of November 3, 2002.
NOTE D. COMPREHENSIVE INCOME
Comprehensive income for the thirteen and thirty-nine weeks ended November 3, 2002 and October 28, 2001 was as follows:
NOTE E. EARNINGS PER SHARE
Basic earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options.
The following is a reconciliation of net earnings and the number of shares used in the basic and diluted earnings per share computations:
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Options with an exercise price greater than the average market price of common shares were 63,000 and 268,000 for the thirteen weeks and 46,000 and 213,000 for the thirty-nine weeks ended November 3, 2002 and October 28, 2001, respectively, and were not included in the computation of diluted earnings per share.
NOTE F. STOCK-BASED COMPENSATION
In fiscal 2001, the Company entered into an employment agreement (the “Agreement”), effective April 2, 2001, with Dale Hilpert to serve as the Company’s Chief Executive Officer and as a Director. Under the Agreement, the Company agreed to issue Mr. Hilpert 500,000 restricted shares of the Company’s common stock. Such restricted shares will vest on March 31, 2004 based upon Mr. Hilpert’s continued employment through such date. Accordingly, total compensation expense (based upon the fair market value of $15.45 on the issue date) of $7,725,000 is being recognized ratably through March 31, 2004. In both the thirteen weeks ended November 3, 2002 and October 28, 2001, the Company recognized $624,000, and in the thirty-nine weeks ended November 3, 2002 and October 28, 2001, recognized $1,872,000 and $1,696,000, respectively, of compensation expense related to these restricted shares, with a remaining $3,533,000 of deferred compensation included in shareholders’ equity at November 3, 2002.
The Company entered into other employment agreements with executive officers during fiscal 2001. The Company has recognized $303,000 in both the thirteen weeks ended November 3, 2002 and October 28, 2001, and $909,000 and $624,000 in the thirty-nine weeks ended November 3, 2002 and October 28, 2001, respectively, of stock-based compensation expense related to these other employment agreements. At November 3, 2002, $1,227,000 of deferred compensation related to these agreements was included in shareholders’ equity.
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NOTE G. SEGMENT REPORTING
The Company has two reportable segments, retail and direct-to-customer. The retail segment sells products for the home through its four retail concepts (Williams-Sonoma, Pottery Barn, Pottery Barn Kids and Hold Everything). The four retail concepts are operating segments which have been aggregated into one reportable segment, retail. The direct-to-customer segment sells similar products through its seven direct-mail catalogs (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Bed + Bath, Hold Everything, West Elm and Chambers) and four e-commerce websites (wsweddings.com, williams-sonoma.com, potterybarn.com and potterybarnkids.com).
These reportable segments are strategic business units that offer similar home-centered products. They are managed separately because the business units utilize two distinct distribution and marketing strategies. Management’s expectation is that the overall economics of each of the Company’s major concepts within each reportable segment will be similar over time.
The accounting policies of the segments, where applicable, are the same as those described in the summary of significant accounting policies included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2002. The Company uses earnings before unallocated corporate overhead, interest and taxes to evaluate segment profitability. Unallocated assets include corporate cash and equivalents, the net book value of corporate facilities and related information systems, deferred tax amounts and other corporate long-lived assets.
Segment Information
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements and Risk Factors
The plans, projections and other forward-looking statements included in Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Quarterly Report on Form 10-Q with respect to the financial condition, results of operations and business of Williams-Sonoma, Inc. and its subsidiaries (the “Company”) are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in such statements. These risks and uncertainties include, without limitation, the following and should be read in conjunction with the Risk Factors portion of Management’s Discussion and Analysis section of the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2002:
The Company has not undertaken, nor is it required, to publicly update or revise any of its forward-looking statements, even if experience or future events make it clear that the results set forth in such statements will not be realized.
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Business
The Company is a specialty retailer of products for the home. The retail segment sells its products through its four retail concepts (Williams-Sonoma, Pottery Barn, Pottery Barn Kids and Hold Everything). The direct-to-customer segment sells similar products through its seven direct-mail catalogs (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Bed + Bath, Hold Everything, West Elm and Chambers) and four e-commerce websites (wsweddings.com, williams-sonoma.com, potterybarn.com and potterybarnkids.com). The principal concepts in retail and direct-to-customer are: Williams-Sonoma, which sells cookware essentials; Pottery Barn, which sells contemporary tableware and home furnishings; and Pottery Barn Kids, which sells stylish children’s furnishings. The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with the Company’s condensed consolidated financial statements and the notes thereto.
Net Revenues
Net revenues consist of retail sales, direct-to-customer sales and shipping fees. Direct-to-customer sales include catalog and Internet sales. Shipping fees consist of revenue received from customers for delivery of merchandise.
The following table summarizes the Company’s net revenues for the thirteen and thirty-nine weeks ended November 3, 2002 and October 28, 2001.
Net revenues for the thirteen weeks ended November 3, 2002 (Third Quarter of 2002) were $527,894,000, an increase of $65,798,000 or 14.2% over net revenues for the thirteen weeks ended October 28, 2001 (Third Quarter of 2001). Net revenues for the thirty-nine week period ended November 3, 2002 (Year-to-Date 2002) were $1,501,866,000, an increase of $193,204,000 or 14.8% from the thirty-nine week period ended October 28, 2001 (Year-to-Date 2001). The reasons for these increases are discussed in the segment analyses below.
During the Third Quarter of 2002, the Company launched a private label credit card program in both the retail and direct-to-customer channels of the Pottery Barn and Pottery Barn Kids brands. A third party credit provider administers the program, and the Company bears no credit risk. To support the launch of the card, the Company offered introductory discounts and a loyalty rewards program to customers who used the card. The cost of these programs is accounted for as a reduction of net revenues and negatively impacted quarter-over-quarter and year-over-year top line sales growth.
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Retail Revenues
Retail revenues for the Third Quarter of 2002 increased $48,452,000 or 18.7% over retail revenues for the Third Quarter of 2001 primarily due to a net increase of 65 stores and a 2.8% increase in comparable store sales, partially offset by sales discounts to customers utilizing the Company’s private label credit card. Pottery Barn and Pottery Barn Kids brands accounted for 49 of the 65 net increase of stores and 67.5% of the growth in retail revenues from Third Quarter of 2001 to Third Quarter of 2002.
Total retail revenues for Year-to-Date 2002 grew $134,731,000 or 18.5% over the same period of the prior year, primarily due to new store openings. Retail sales for the Third Quarter of 2001 were negatively impacted by the economic aftermath of the events of September 11th. The Pottery Barn and the Pottery Barn Kids brands accounted for 77.7% of the growth in retail revenues from Year-to-Date 2001 to Year-to-Date 2002.
Comparable Store Sales
Comparable stores are defined as those whose gross square feet did not change by more than 20% in the previous 12 months and which have been open for at least 12 months without closure for seven or more consecutive days. Comparable store sales of merchandise are computed monthly for purposes of this analysis.
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Comparable store sales in the Pottery Barn Kids concept have and are expected to continue to fluctuate due to the rapid growth of the retail store base in fiscal 2002 and fiscal 2001 and the initial impact of new store openings on existing comparable stores; strong first year sales in new stores due to grand opening events; and inventory management challenges that resulted from aggressive store opening calendars and better than expected merchandise successes in a new retail concept. At the end of the Third Quarter of 2002, Pottery Barn Kids operated 54 retail stores versus 23 stores at the end of the Third Quarter of 2001. For the comparable store sales base calculation, 20 stores were included in the Third Quarter of 2002 and only three stores were included in the Third Quarter of 2001.
Direct-to-Customer Revenues
Direct-to-customer revenues of $220,081,000 in the Third Quarter of 2002 increased $17,346,000 or 8.6% over direct-to-customer revenues in the Third Quarter of 2001. For Year-to-Date 2002, direct-to-customer revenues increased $58,473,000 or 10.1% to $637,150,000 from Year-to-Date 2001. These increases were primarily due to strong growth in the Pottery Barn, Williams-Sonoma and Pottery Barn Kids brands and incremental revenues from the West Elm catalog launched in April 2002, partially offset by an expected decrease in the Hold Everything brand and introductory sales discounts to customers utilizing the Company’s private label credit card.
Direct-to-customer growth was driven primarily by the Internet, which increased sales during the Third Quarter of 2002 by $12,548,000 or 35.4% to $48,042,000 from the Third Quarter of 2001. Direct-to-customer sales for the Third Quarter of 2001 were negatively impacted by the economic aftermath of the events of September 11th. For Year-to-Date 2002, Internet sales increased $46,789,000 or 55.6% to $130,872,000 from Year-to-Date 2001. The Company estimates that approximately 40% to 50% of non-bridal e-commerce sales are incremental to the direct-to-customer channels and approximately 50% to 60% are from mail order customers who would have potentially placed an order via the catalog call center. Catalog sales were affected by the continuing trend in customer preference to place orders via the internet rather than by phone, and by initial purchase and loyalty program discounts on private label credit card catalog sales.
Cost of Goods Sold
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Cost of goods and occupancy expenses increased $27,646,000 to $293,338,000 in the Third Quarter of 2002 from $265,692,000 in the Third Quarter of 2001. Cost of goods and occupancy expenses expressed as a percentage of net revenues for the Third Quarter of 2002 decreased 190 basis points to 55.6% from 57.5% in the Third Quarter of 2001. For Year-to-Date 2002, cost of goods and occupancy expenses increased $77,239,000 to $840,759,000 from $763,520,000 from Year-to-Date 2001. Cost of goods and occupancy expenses expressed as a percentage of net revenues for Year-to-Date 2002 decreased 230 basis points to 56.0% from 58.3% for Year-to-Date 2001. These decreases were primarily driven by several operational improvements including (1) an increase in net shipping profitability; (2) a substantial reduction in customer returns and replacements from improved merchandise quality, changes in the Company’s return policy for furniture in the Pottery Barn brands, and new processes for handling returns in the call centers; (3) a substantial reduction in retail inventory shrinkage due to better than expected mid-year physical inventory results; (4) lower cost of merchandise due to improved sourcing; and (5) lower freight costs from the distribution center to the stores.
Shipping costs consist of third-party delivery services and shipping materials. Shipping costs decreased to $28,367,000 in the Third Quarter of 2002 from $30,432,000 in the Third Quarter of 2001. As a percentage of shipping fees, shipping costs have decreased to 83.0% in the Third Quarter of 2002 from 107.7% in the Third Quarter of 2001. For Year-to-Date 2002, shipping costs increased to $87,646,000 from $86,033,000 for Year-to-Date 2001. As a percentage of shipping fees, shipping costs have decreased to 88.2% for Year-to-Date 2002 from 105.7% for Year-to-Date 2001. Shipping costs as a percentage of shipping fees decreased due to an increase in shipping fees from the modification of the Company’s shipping rates and surcharge tables. In addition, shipping costs decreased due to improved logistics.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $23,495,000 or 14.9% to $181,469,000 in the Third Quarter of 2002 from $157,974,000 in the Third Quarter of 2001. Selling, general and administrative expenses expressed as a percent of net revenues increased by 20 basis points to 34.4% in the Third Quarter of 2002 from 34.2% in the Third Quarter of 2001. As a percentage of net revenues, this increase in selling, general and administrative expenses was primarily due to an increase in employment costs offset by significant leverage in administrative expenses and lower advertising. The employment cost increase as a percentage of net revenues was primarily due to an increase in incentive compensation based upon improved profitability, higher retail employment due to a year-over-year increase in new store openings and higher employment costs to support information technology initiatives. The significant leverage in administrative expenses was primarily due to a reduction in credit card exchange fees due to the customer shifting from major credit cards to the Company’s private label credit card during the Third Quarter of 2002; a reduction in bad debt expense due to the implementation of check authorization in the fourth quarter of 2001; and ongoing reductions in other general operating expenses.
For Year-to-Date 2002, selling, general and administrative expenses increased $55,339,000 or 12.4% to $500,305,000 from $444,966,000 for Year-to-Date 2001. Selling, general and administrative expenses expressed as a percentage of net revenues decreased by 70 basis points to 33.3% for Year-to-Date 2002 from 34.0% for Year-to-Date 2001. As a percentage of net revenues, this decrease in selling, general and administrative expense was primarily due to a significant leverage in catalog advertising costs and other operating expenses, partially offset by higher employment costs. The reduced catalog advertising costs as a percentage of net revenues was primarily due to an overall reduction in the percentage of total net revenues being generated by direct-to-customer channel, higher catalog productivity, and lower catalog production costs. The employment cost increase as a percentage of net revenues was primarily due to an increase in incentive compensation based upon improved year-over-year profitability.
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Interest Expense — Net
Net interest expense decreased $1,627,000 to $106,000 in the Third Quarter of 2002 from $1,733,000 in the Third Quarter of 2001. For Year-to-Date 2002, net interest expense decreased $4,295,000 to $585,000 from $4,880,000 for Year-to-Date 2001. These decreases were primarily due to no borrowings under the revolving line of credit facility during fiscal 2002.
Income Taxes
The Company’s effective tax rate was 38.5% for Year-to-Date 2002 and Year-to-Date 2001.
Liquidity and Capital Resources
For Year-to-Date 2002, net cash provided by operating activities was $72,079,000 as compared to cash used by operating activities of $50,554,000 in Year-to-Date 2001. This improvement in operating cash is primarily attributable to higher net earnings and a significant increase in accounts payable partially offset by an increase in merchandise inventories.
Net cash used in investing activities was $117,482,000 for Year-to-Date 2002 as compared to net cash used in investing activities of $118,289,000 for the same period of fiscal 2001. Year-to-Date 2002 purchases of property and equipment include approximately $88,146,000 for stores, $25,770,000 for systems development projects and $3,566,000 for distribution and facility infrastructure projects.
Year-to-Date 2001 purchases of property and equipment include approximately $74,584,000 for stores, $30,067,000 for systems development projects, $12,527,000 for the buildout of corporate facilities and $1,461,000 for distribution capacity expansion.
Based on the Company’s current plans, gross capital expenditures in fiscal 2002 are projected to be approximately $160,000,000, including $114,000,000 for stores, $40,000,000 for systems development and approximately $6,000,000 for distribution and facility infrastructure projects. In addition to these projected expenditures, on March 4, 2002, the Company’s Board of Directors authorized management to obtain information, conduct negotiations and enter into appropriate agreements with the intent to pursue potential acquisitions of two distribution facilities currently leased from certain related parties prior to the end of fiscal 2002.
For Year-to-Date 2002, cash provided by financing activities was $8,448,000, comprised primarily of $15,918,000 in proceeds from the exercise of stock options, partially offset by the repayment of long-term obligations of $6,959,000 including the repayment of capital lease and long-term debt obligations.
For Year-to-Date 2001, cash provided by financing activities was $156,036,000, comprised primarily of net line of credit borrowings of $155,250,000 and $12,937,000 in proceeds from the exercise of stock options, partially offset by the repayment of long-term obligations of $12,151,000 including the repayment of a mortgage agreement and long-term debt obligations.
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The Company regularly reviews and evaluates its liquidity and capital needs. As the Company continues to grow, the Company may experience peak periods for its cash needs during the course of its fiscal year. The Company believes it would have access to additional debt and/or capital market funding as such needs are required. The Company currently believes that its available cash, cash equivalents, cash flow from operations and cash available under its existing credit facilities will be sufficient to finance the Company’s operations and capital requirements for at least the next twelve months.
Impact of Inflation
The impact of inflation on results of operations has not been significant.
Seasonality
The Company’s business is subject to substantial seasonal variations in demand. Historically, a significant portion of the Company’s revenues and net earnings have been realized during the period from October through December, and levels of net revenues and net earnings have generally been significantly lower during the period from January through September. The Company believes this is the general pattern associated with the direct-to-customer and retail industries. In anticipation of its peak season, the Company hires a substantial number of additional employees in its retail stores and direct-to-customer processing and distribution areas, and incurs significant fixed catalog production and mailing costs.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks, which include changes in U.S. interest rates and foreign exchange rates. The Company does not engage in financial transactions for trading or speculative purposes.
Interest Rate RiskThe interest payable on the Company’s bank line of credit is based on variable interest rates and therefore affected by changes in market interest rates. If interest rates on existing variable rate debt rose 26 basis points (a 10% change in the associated debt’s variable rate as of November 3, 2002), the Company’s results from operations and cash flows would not be materially affected. In addition, the Company has fixed and variable income investments consisting of cash equivalents and short-term investments, which are also affected by changes in market interest rates.
The Company has an interest rate cap contract at 5.88% with a notional amount of $13,083,000 which extends through February 2005 related to an operating lease. The contract has not been designated as a hedge and is accounted for by adjusting the carrying amount of the contract to market. A loss of approximately $19,000 and $88,000 was recorded in selling, general and administrative expenses for the thirteen and thirty-nine weeks ended November 3, 2002, respectively, and nil in the thirteen and thirty-nine weeks ended October 28, 2001.
Foreign Currency RisksThe Company enters into a significant amount of purchases outside of the U.S. that are primarily U.S. dollar transactions. A small percentage of the Company’s international purchase transactions are in currencies other than the U.S dollar. Any currency risks related to these transactions are immaterial to the Company as a whole. As of November 3, 2002, the Company has eight retail stores in Toronto, Canada and expects to open one or more additional Canadian stores in fiscal 2003 which exposes the Company to market risk associated with foreign currency exchange rate fluctuations.
During fiscal 2002, due to the Company’s new operations in Canada and the volatility of the Canadian dollar, 30-day forward contracts have been purchased in order to limit the currency exposure associated with intercompany asset and liability accounts that are denominated in Canadian dollars. The Company continues to monitor currency exposure, which has been immaterial during fiscal 2002 to date, and will continue to take steps toward limiting foreign currency risk.
ITEM 4. CONTROLS AND PROCEDURES
As of November 3, 2002, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and the Senior Vice President, Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of November 3, 2002. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to November 3, 2002.
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ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings against the Company. The Company is, however, involved in routine litigation arising in the ordinary course of its business, and, while the results of the proceedings cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a material adverse effect on the Company’s consolidated financial statements taken as a whole.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
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CERTIFICATION
I, Dale W. Hilpert, Chief Executive Officer, certify that:
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I, Sharon L. McCollam, Senior Vice President and Chief Financial Officer, certify that:
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