Attached files

file filename
EX-32.2 - EX-32.2 - WILLIAMS SONOMA INCd563678dex322.htm
EX-32.1 - EX-32.1 - WILLIAMS SONOMA INCd563678dex321.htm
EX-31.2 - EX-31.2 - WILLIAMS SONOMA INCd563678dex312.htm
EX-31.1 - EX-31.1 - WILLIAMS SONOMA INCd563678dex311.htm
EX-10.3 - EX-10.3 - WILLIAMS SONOMA INCd563678dex103.htm
EX-10.2 - EX-10.2 - WILLIAMS SONOMA INCd563678dex102.htm
EX-10.1 - EX-10.1 - WILLIAMS SONOMA INCd563678dex101.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 28, 2018.

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission File Number: 001-14077

 

 

WILLIAMS-SONOMA, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-2203880

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3250 Van Ness Avenue, San Francisco, CA   94109
(Address of principal executive offices)   (Zip Code)

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 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.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
Emerging growth company       

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 25, 2018, 80,155,276 shares of the registrant’s Common Stock were outstanding.

 

 

 


Table of Contents

WILLIAMS-SONOMA, INC.

REPORT ON FORM 10-Q

FOR THE QUARTER ENDED OCTOBER 28, 2018

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

 

          PAGE  

Item 1.

  

Financial Statements

     1  

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     15  

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     22  

Item 4.

  

Controls and Procedures

     22  
     PART II. OTHER INFORMATION       

Item 1.

  

Legal Proceedings

     22  

Item 1A.

  

Risk Factors

     23  

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     23  

Item 3.

  

Defaults Upon Senior Securities

     23  

Item 4.

  

Mine Safety Disclosures

     23  

Item 5.

  

Other Information

     23  

Item 6.

  

Exhibits

     24  


Table of Contents

ITEM 1. FINANCIAL STATEMENTS

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

     Thirteen
Weeks Ended
     Thirty-nine
Weeks Ended
 
In thousands, except per share amounts   

October 28,

2018

    

October 29,

2017

    

October 28,

2018

    

October 29,

2017

 

E-commerce net revenues

   $ 746,716      $ 690,045      $ 2,079,838      $ 1,901,348  

Retail net revenues

     610,267        609,291        1,755,319        1,711,101  

Net revenues

     1,356,983        1,299,336        3,835,157        3,612,449  

Cost of goods sold

     861,999        832,269        2,444,067        2,326,911  

Gross profit

     494,984        467,067        1,391,090        1,285,538  

Selling, general and administrative expenses

     400,600        356,254        1,155,990        1,030,667  

Operating income

     94,384        110,813        235,100        254,871  

Interest (income) expense, net

     2,288        594        5,073        974  

Earnings before income taxes

     92,096        110,219        230,027        253,897  

Income taxes

     10,631        38,906        51,681        90,112  

Net earnings

   $ 81,465      $ 71,313      $ 178,346      $ 163,785  

Basic earnings per share

   $ 1.01      $ 0.84      $ 2.17      $ 1.90  

Diluted earnings per share

   $ 1.00      $ 0.84      $ 2.15      $ 1.89  

Shares used in calculation of earnings per share:

           

Basic

     80,475        84,940        82,070        86,111  

Diluted

     81,641        85,384        82,951        86,582  

See Notes to Condensed Consolidated Financial Statements.

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     Thirteen
Weeks Ended
    Thirty-nine
Weeks Ended
 
In thousands   

October 28,

2018

   

October 29,

2017

   

October 28,

2018

   

October 29,

2017

 

Net earnings

   $ 81,465     $ 71,313     $ 178,346     $ 163,785  

Other comprehensive income (loss):

        

Foreign currency translation adjustments

     (1,830     40       (5,968     1,864  

Change in fair value of derivative financial instruments, net of tax (tax benefit) of $(23), $133, $378 and $(52)

     (65     373       1,064       (138

Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax (tax benefit) of $43, $45, $19 and $48

     (120     (128     (71     (137

Comprehensive income

   $ 79,450     $ 71,598     $ 173,371     $ 165,374  

See Notes to Condensed Consolidated Financial Statements.

 

1


Table of Contents

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

In thousands, except per share amounts   

October 28,

2018

   

January 28,

2018

   

October 29,

2017

 

ASSETS

      

Current assets

      

Cash and cash equivalents

   $ 164,414     $ 390,136     $ 90,779  

Accounts receivable, net

     113,582       90,119       92,282  

Merchandise inventories, net

     1,197,554       1,061,593       1,176,941  

Prepaid catalog expenses

     —         20,517       19,051  

Prepaid expenses

     94,071       62,204       69,267  

Other current assets

     21,805       11,876       12,141  

Total current assets

     1,591,426       1,636,445       1,460,461  

Property and equipment, net

     931,361       932,283       931,131  

Deferred income taxes, net

     45,999       67,306       131,793  

Goodwill

     85,649       18,838       18,769  

Other long-term assets, net

     64,324       130,877       38,230  

Total assets

   $ 2,718,759     $ 2,785,749     $ 2,580,384  

LIABILITIES AND STOCKHOLDERS’ EQUITY

      

Current liabilities

      

Accounts payable

   $ 487,733     $ 457,144     $ 468,566  

Accrued expenses

     132,398       134,207       101,434  

Gift card and other deferred revenue

     275,567       300,607       299,031  

Borrowings under revolving line of credit

     60,000       —         170,000  

Income taxes payable

     9,903       56,783       48,865  

Other current liabilities

     71,119       59,082       49,655  

Total current liabilities

     1,036,720       1,007,823       1,137,551  

Deferred rent and lease incentives

     205,143       202,134       195,220  

Long-term debt

     299,571       299,422       —    

Other long-term liabilities

     85,388       72,804       75,439  

Total liabilities

     1,626,822       1,582,183       1,408,210  

Commitments and contingencies – See Note F

      

Stockholders’ equity

      

Preferred stock: $.01 par value; 7,500 shares authorized; none issued

     —         —         —    

Common stock: $.01 par value; 253,125 shares authorized; 80,282, 83,726 and 84,478 shares issued and outstanding at October 28, 2018, January 28, 2018 and October 29, 2017, respectively

     803       837       845  

Additional paid-in capital

     570,924       562,814       557,198  

Retained earnings

     532,172       647,422       623,170  

Accumulated other comprehensive loss

     (11,757     (6,782     (8,314

Treasury stock, at cost: 2, 11 and 11 shares as of October 28, 2018, January 28, 2018 and October 29, 2017, respectively

     (205     (725     (725

Total stockholders’ equity

     1,091,937       1,203,566       1,172,174  

Total liabilities and stockholders’ equity

   $ 2,718,759     $ 2,785,749     $ 2,580,384  

See Notes to Condensed Consolidated Financial Statements.

 

2


Table of Contents

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Thirty-nine
Weeks Ended
 
In thousands   

October 28,

2018

   

October 29,

2017

 

Cash flows from operating activities:

    

Net earnings

   $ 178,346     $ 163,785  

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     141,167       135,473  

Loss on disposal/impairment of assets

     5,290       1,299  

Amortization of deferred lease incentives

     (19,728     (18,987

Deferred income taxes

     12,170       (11,884

Tax benefit related to stock-based awards

     10,361       15,439  

Stock-based compensation expense

     40,953       30,164  

Other

     (389     (416

Changes in:

    

Accounts receivable

     (21,851     (2,341

Merchandise inventories

     (143,723     (197,757

Prepaid catalog expenses

     —         447  

Prepaid expenses and other assets

     (50,171     (19,814

Accounts payable

     8,689       7,728  

Accrued expenses and other liabilities

     19,002       (28,775

Gift card and other deferred revenue

     24,048       (4,108

Deferred rent and lease incentives

     23,695       17,000  

Income taxes payable

     (48,358     25,677  

Net cash provided by operating activities

     179,501       112,930  

Cash flows from investing activities:

    

Purchases of property and equipment

     (128,326     (135,821

Other

     1,804       458  

Net cash used in investing activities

     (126,522     (135,363

Cash flows from financing activities:

    

Repurchases of common stock

     (220,221     (154,321

Payment of dividends

     (105,654     (101,928

Borrowings under revolving line of credit

     60,000       170,000  

Tax withholdings related to stock-based awards

     (13,906     (14,836

Other

     —         (20

Net cash used in financing activities

     (279,781     (101,105

Effect of exchange rates on cash and cash equivalents

     1,080       604  

Net decrease in cash and cash equivalents

     (225,722     (122,934

Cash and cash equivalents at beginning of period

     390,136       213,713  

Cash and cash equivalents at end of period

   $ 164,414     $ 90,779  

See Notes to Condensed Consolidated Financial Statements.

 

3


Table of Contents

WILLIAMS-SONOMA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE A. FINANCIAL STATEMENTS - BASIS OF PRESENTATION

These financial statements include Williams-Sonoma, Inc. and its wholly owned subsidiaries (“we,” “us” or “our”). The Condensed Consolidated Balance Sheets as of October 28, 2018 and October 29, 2017, the Condensed Consolidated Statements of Earnings, the Condensed Consolidated Statements of Comprehensive Income for the thirteen and thirty-nine weeks then ended, and the Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks then ended, have been prepared by us, without audit. In our opinion, 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 weeks then ended. Intercompany transactions and accounts have been eliminated. The balance sheet as of January 28, 2018, presented herein, has been derived from our audited Consolidated Balance Sheet included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2018.

The results of operations for the thirteen and thirty-nine weeks ended October 28, 2018 are not necessarily indicative of the operating results of the full year.

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 (“U.S. GAAP”) have been omitted. These financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2018.

Reclassifications

Certain amounts reported in our Condensed Consolidated Balance Sheets as of January 28, 2018 and October 29, 2017 and our Condensed Consolidated Statement of Cash Flows for the thirty-nine weeks ended October 29, 2017 have been reclassified in order to conform to the current period presentation. These reclassifications impacted prepaid catalog expenses, prepaid expenses, goodwill, other long-term assets, accounts payable, accrued expenses, gift card and other deferred revenue and other current liabilities. There was no change to total current assets, total assets, total current liabilities, or cash flows as a result of these reclassifications.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. We adopted the ASU on a modified retrospective basis in the first quarter of fiscal 2018 and applied the guidance therein to all applicable contracts that were not complete as of the date of application. As a result, we recorded an increase to opening retained earnings as of January 29, 2018 of approximately $17,862,000, net of tax, for the cumulative effect adjustments of adopting the ASU. These adjustments primarily related to the acceleration in the timing of recognizing breakage income related to our unredeemed stored-value cards, the acceleration in the timing of revenue recognition for certain merchandise shipped to our customers, and prepaid catalog advertising costs, which were capitalized and amortized over their expected period of future benefit prior to adoption, and are now expensed as incurred. Prior period balances were not retrospectively adjusted as a result of adopting the ASU. See Note L for further discussion related to the impact of the adoption of the ASU on our Condensed Consolidated Financial Statements.

In February 2016, the FASB issued ASU 2016-02, Leases, which will require lessees to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than short-term leases). This ASU, as amended, is effective for us beginning in the first quarter of fiscal 2019. We plan to apply the provisions of this ASU at the adoption date, instead of to the earliest comparative period presented in the financial statements, with a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We are currently assessing the impact of this ASU on our Consolidated Financial Statements, but expect that it will result in a substantial increase in our long-term assets and liabilities, however, we do not expect it to materially impact our Consolidated Statement of Earnings.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities (Topic 815), which expands and refines hedge accounting for both non-financial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The guidance also makes certain targeted improvements to simplify the application of hedge accounting guidance and ease the administrative burden of hedge documentation requirements and assessing hedge effectiveness. This ASU is effective for us in the first quarter of fiscal 2019. Entities should apply the guidance to existing cash flow and net investment hedge relationships using a modified retrospective approach with a cumulative effect adjustment recorded to opening retained earnings on the date of adoption. The guidance also provides transition relief to make it easier for entities to apply certain amendments to existing hedges where the hedge documentation needs to be modified. We do not expect the adoption of this ASU to have a material impact on our financial condition, results of operations or cash flows.

 

4


Table of Contents

NOTE B. BORROWING ARRANGEMENTS

Credit Facility

We have a credit facility which provides for a $500,000,000 unsecured revolving line of credit (“revolver”) and a $300,000,000 unsecured term loan facility (“term loan”). The revolver may be used to borrow revolving loans or request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders to increase the revolver by up to $250,000,000, at such lenders’ option, to provide for a total of $750,000,000 of unsecured revolving credit. The revolver matures on January 8, 2023, at which time all outstanding borrowings must be repaid and all outstanding letters of credit must be cash collateralized. We may, prior to the first and second anniversaries of the closing date of the amendment of the credit facility, elect to extend the maturity date for an additional year, subject to lender approval.

During the third quarter and for year-to-date fiscal 2018, we had borrowings of $60,000,000 under the revolver (at a weighted average interest rate of 3.28%). During the third quarter of fiscal 2017, we had borrowings of $55,000,000 under the revolver. For year-to-date fiscal 2017, we borrowed $170,000,000 (at a weighted average interest rate of 2.25%), all of which was outstanding as of October 29, 2017. Additionally, as of October 28, 2018, $11,728,000 in issued but undrawn standby letters of credit were outstanding under the credit facility. The standby letters of credit were issued to secure the liabilities associated with workers’ compensation and other insurance programs.

As of October 28, 2018, we had $300,000,000 outstanding under our term loan (at a weighted average interest rate of 3.10%). The term loan matures on January 8, 2021, at which time all outstanding principal and any accrued interest must be repaid.

The interest rates under the credit facility are variable, and may be elected by us as: (i) the London Interbank Offer Rate plus an applicable margin based on our leverage ratio ranging from 0.91% to 1.775% for revolver borrowings, and 1.0% to 2.0% for the term loan; or (ii) a base rate as defined in the credit facility plus an applicable margin ranging from 0% to 0.775% for revolver borrowings, and 0% to 1.0% for the term loan.

As of October 28, 2018, we were in compliance with our financial covenants under the credit facility and, based on current projections, we expect to remain in compliance throughout the next 12 months.

Letter of Credit Facilities     

We have three unsecured letter of credit reimbursement facilities for a total of $70,000,000, each of which matures on August 24, 2019. The letter of credit facilities contains covenants that are consistent with our credit facility. Interest on unreimbursed amounts under the letter of credit facilities accrues at a base rate as defined in the credit facility plus an applicable margin based on our leverage ratio. As of October 28, 2018, an aggregate of $6,330,000 was outstanding under the letter of credit facilities, which represents only a future commitment to fund inventory purchases to which we had not taken legal title. The latest expiration possible for any future letters of credit issued under the facilities is January 21, 2020.

NOTE C. STOCK-BASED COMPENSATION

Equity Award Programs

Our Amended and Restated 2001 Long-Term Incentive Plan (the “Plan”) provides for grants of incentive stock options, nonqualified stock options, stock-settled stock appreciation rights (collectively, “option awards”), restricted stock awards, restricted stock units (including those that are performance-based), deferred stock awards (collectively, “stock awards”) and dividend equivalents up to an aggregate of 36,570,000 shares. As of October 28, 2018, there were approximately 7,465,000 shares available for future grant. Awards may be granted under the Plan to our officers, employees and non-employee members of the board of directors of the company (the “Board”) or any parent or subsidiary. Shares issued as a result of award exercises or releases are primarily funded with the issuance of new shares.

Option Awards

Annual grants of option awards are limited to 1,000,000 shares on a per person basis and have a maximum term of seven years. The exercise price of these option awards is not less than 100% of the closing price of our stock on the day prior to the grant date. Option awards granted to employees generally vest evenly over a period of four years for service-based awards. Certain option awards contain vesting acceleration clauses resulting from events including, but not limited to, retirement, merger or a similar corporate event.

 

5


Table of Contents

Stock Awards

Annual grants of stock awards are limited to 1,000,000 shares on a per person basis and have a maximum term of seven years. Stock awards granted to employees generally vest evenly over a period of four years for service-based awards. Certain performance-based awards, which have variable payout conditions based on predetermined financial targets, vest three years from the date of grant. Certain stock awards and other agreements contain vesting acceleration clauses resulting from events including, but not limited to, retirement, merger or a similar corporate event. Stock awards granted to non-employee Board members generally vest in one year. Non-employee Board members automatically receive stock awards on the date of their initial election to the Board and annually thereafter on the date of the annual meeting of stockholders (so long as they continue to serve as a non-employee Board member).

Stock-Based Compensation Expense

During the thirteen and thirty-nine weeks ended October 28, 2018, we recognized total stock-based compensation expense, as a component of selling, general and administrative expenses, of $14,427,000 and $40,953,000, respectively. During the thirteen and thirty-nine weeks ended October 29, 2017, we recognized total stock-based compensation expense, as a component of selling, general and administrative expenses, of $7,335,000 and $30,164,000, respectively.

Stock-Settled Stock Appreciation Rights

A stock-settled stock appreciation right is an award that allows the recipient to receive common stock equal to the appreciation in the fair market value of our common stock between the grant date and the conversion date for the number of shares converted.

The following table summarizes our stock-settled stock appreciation right activity during the thirty-nine weeks ended October 28, 2018:

 

      Shares  

Balance at January 28, 2018 (100% vested)

     167,737  

Granted

     —    

Converted into common stock

     (165,847

Cancelled

     (1,290

Balance at October 28, 2018 (100% vested)

     600  

Restricted Stock Units

The following table summarizes our restricted stock unit activity during the thirty-nine weeks ended October 28, 2018:

 

      Shares  

Balance at January 28, 2018

     2,358,137  

Granted

     1,387,023  

Granted, with vesting subject to performance conditions

     256,350  

Released

     (647,617

Cancelled

     (327,035

Balance at October 28, 2018

     3,026,858  

Vested plus expected to vest at October 28, 2018

     2,342,164  

NOTE D. 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 is computed as net earnings divided by the weighted average number of common shares outstanding and common stock equivalents outstanding for the period. Common stock equivalents consist of shares subject to stock-based awards with exercise prices less than or equal to the average market price of our common stock for the period, to the extent their inclusion would be dilutive.

 

6


Table of Contents

The following is a reconciliation of net earnings and the number of shares used in the basic and diluted earnings per share computations:

 

In thousands, except per share amounts    Net Earnings     

Weighted

Average Shares

    

Earnings

Per Share

 

Thirteen weeks ended October 28, 2018

        

Basic

   $ 81,465        80,475      $ 1.01  

Effect of dilutive stock-based awards

        1,166     

Diluted

   $ 81,465        81,641      $ 1.00  

Thirteen weeks ended October 29, 2017

        

Basic

   $ 71,313        84,940      $ 0.84  

Effect of dilutive stock-based awards

        444     

Diluted

   $ 71,313        85,384      $ 0.84  

Thirty-nine weeks ended October 28, 2018

        

Basic

   $ 178,346        82,070      $ 2.17  

Effect of dilutive stock-based awards

        881     

Diluted

   $ 178,346        82,951      $ 2.15  

Thirty-nine weeks ended October 29, 2017

        

Basic

   $ 163,785        86,111      $ 1.90  

Effect of dilutive stock-based awards

        471     

Diluted

   $ 163,785        86,582      $ 1.89  

Stock-based awards of 6,000 and 16,000 were excluded from the computation of diluted earnings per share for the thirteen and thirty-nine weeks ended October 28, 2018 as their inclusion would be anti-dilutive. Stock-based awards of 994,000 and 1,052,000 were excluded from the computation of diluted earnings per share for the thirteen and thirty-nine weeks ended October 29, 2017, respectively, as their inclusion would be anti-dilutive.

NOTE E. SEGMENT REPORTING

We have two reportable segments, e-commerce and retail. The e-commerce segment has the following merchandise strategies: Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, PBteen, Williams Sonoma Home, Rejuvenation and Mark and Graham, which sell our products through our e-commerce websites and direct-mail catalogs. Our e-commerce merchandise strategies are operating segments, which have been aggregated into one reportable segment, e-commerce. The retail segment, which includes our franchise operations, has the following merchandise strategies: Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation, which sell our products through our retail stores. Our retail merchandise strategies are operating segments, which have been aggregated into one reportable segment, retail. Management’s expectation is that the overall economic characteristics of each of our operating segments will be similar over time based on management’s judgment that the operating segments have had similar historical economic characteristics and are expected to have similar long-term financial performance in the future.

These reportable segments are strategic business units that offer similar products for the home. They are managed separately because the business units utilize two distinct distribution and marketing strategies. Based on management’s best estimate, our operating segments include allocations of certain expenses, including advertising and employment costs, to the extent they have been determined to benefit both channels. These operating segments are aggregated at the channel level for reporting purposes since our brands are interdependent for economies of scale and we do not maintain fully allocated income statements at the brand level. As a result, material financial decisions related to the brands are made at the channel level. Furthermore, it is not practicable for us to report revenue by product group.

We use operating income to evaluate segment profitability. Operating income is defined as earnings (loss) before net interest income (expense) and income taxes. Unallocated costs before interest and income taxes include corporate employee-related costs, occupancy expenses (including depreciation expense), administrative costs and third-party service costs, primarily in our corporate administrative and systems departments. Unallocated assets include corporate cash and cash equivalents, prepaid expenses, the net book value of corporate facilities and related information systems, deferred income taxes and other corporate long-lived assets.

Income taxes are calculated at an entity level and are not allocated to our reportable segments.

 

7


Table of Contents

Segment Information

 

In thousands    E-commerce      Retail      Unallocated     Total  

Thirteen weeks ended October 28, 2018

          

Net revenues1

   $ 746,716      $ 610,267      $ —       $ 1,356,983  

Depreciation and amortization expense

     9,877        21,574        15,907       47,358  

Operating income (loss)2

     152,204        45,052        (102,872     94,384  

Capital expenditures

     12,068        20,038        16,199       48,305  

Thirteen weeks ended October 29, 2017

          

Net revenues1

   $ 690,045      $ 609,291      $ —       $ 1,299,336  

Depreciation and amortization expense

     6,870        22,555        16,000       45,425  

Operating income (loss)2

     142,865        42,804        (74,856     110,813  

Capital expenditures

     13,184        22,066        17,844       53,094  

Thirty-nine weeks ended October 28, 2018

          

Net revenues1

   $ 2,079,838      $ 1,755,319      $ —       $ 3,835,157  

Depreciation and amortization expense

     26,874        67,067        47,226       141,167  

Operating income (loss)2

     432,245        101,035        (298,180     235,100  

Assets3

     874,259        1,156,075        688,425       2,718,759  

Capital expenditures

     26,820        55,728        45,778       128,326  

Thirty-nine weeks ended October 29, 2017

          

Net revenues1

   $ 1,901,348      $ 1,711,101      $ —       $ 3,612,449  

Depreciation and amortization expense

     20,625        67,282        47,566       135,473  

Operating income (loss)2

     410,008        99,110        (254,247     254,871  

Assets3

     732,842        1,156,117        691,425       2,580,384  

Capital expenditures

     24,173        61,851        49,797       135,821  
1 

Includes net revenues related to our international operations (including our operations in Canada, Australia, the United Kingdom and our franchise businesses) of approximately $79.0 million and $84.1 million for the thirteen weeks ended October 28, 2018 and October 29, 2017, respectively, and $239.1 million and $234.1 million for the thirty-nine weeks ended October 28, 2018 and October 29, 2017, respectively.

2 

The thirteen and thirty-nine weeks ended October 28, 2018 includes: $6.0 million and $17.9 million of expense, respectively, related to our acquisition of Outward, Inc., (primarily acquisition-related compensation costs, the amortization of intangible assets acquired, and the operations of the Outward business), of which $4.6 million and $13.7 million, respectively, is recorded in the e-commerce segment and $1.4 million and $4.2 million, respectively, is recorded in the unallocated segment; $1.9 million and $5.4 million, respectively, of employment-related expense associated with a one-time special equity grant, which is recorded within the unallocated segment, as well as $1.1 million and $6.4 million of expense related to impairment and early lease termination charges which is primarily recorded in the retail segment. The thirty-nine weeks ended October 29, 2017 includes $5.7 million of severance-related charges in our corporate functions, which is recorded within the unallocated segment.

3 

Includes long-term assets related to our international operations of approximately $51.0 million and $58.5 million as of October 28, 2018 and October 29, 2017, respectively.

NOTE F. COMMITMENTS AND CONTINGENCIES

We are involved in lawsuits, claims and proceedings incident to the ordinary course of our business. These disputes, which are not currently material, are increasing in number as our business expands and our company grows. We review the need for any loss contingency reserves and establish reserves when, in the opinion of management, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. In view of the inherent difficulty of predicting the outcome of these matters, it may not be possible to determine whether any loss is probable or to reasonably estimate the amount of the loss until the case is close to resolution, in which case no reserve is established until that time. Any claims against us, whether meritorious or not, could result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits, claims and proceedings cannot be predicted with certainty. However, we believe that the ultimate resolution of these current matters will not have a material adverse effect on our Consolidated Financial Statements taken as a whole.

NOTE G. STOCK REPURCHASE PROGRAM AND DIVIDENDS

Stock Repurchase Program

During the thirteen weeks ended October 28, 2018, we repurchased 742,508 shares of our common stock at an average cost of $61.15 per share for a total cost of approximately $45,403,000. During the thirty-nine weeks ended October 28, 2018, we repurchased 3,883,875 shares of our common stock at an average cost of $56.70 per share for a total cost of approximately $220,221,000. As of October 28, 2018, there was $298,898,000 remaining under our current stock repurchase program. In addition, as of October 28, 2018, we held treasury stock in the amount of $205,000, which represents the cost of shares available for issuance to satisfy future stock-based award settlements in certain foreign jurisdictions.

 

8


Table of Contents

During the thirteen weeks ended October 29, 2017, we repurchased 1,301,373 shares of our common stock at an average cost of $46.84 per share for a total cost of approximately $60,960,000. During the thirty-nine weeks ended October 29, 2017, we repurchased 3,226,297 shares of our common stock at an average cost of $47.83 per share for a total cost of approximately $154,321,000. As of October 29, 2017, we held treasury stock in the amount of $725,000.

Stock repurchases under our program may be made through open market and privately negotiated transactions at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability and other market conditions.

Dividends

We declared cash dividends of $0.43 and $0.39 per common share during the thirteen weeks ended October 28, 2018 and October 29, 2017, respectively. We declared cash dividends of $1.29 and $1.17 per common share during the thirty-nine weeks ended October 28, 2018 and October 29, 2017, respectively. Our quarterly cash dividend may be limited or terminated at any time.

NOTE H. DERIVATIVE FINANCIAL INSTRUMENTS

We have retail and e-commerce businesses in Canada, Australia and the United Kingdom, and operations throughout Asia and Europe, which expose us to market risk associated with foreign currency exchange rate fluctuations. Substantially all of our purchases and sales are denominated in U.S. dollars, which limits our exposure to this risk. However, some of our foreign operations have a functional currency other than the U.S. dollar. To mitigate this risk, we hedge a portion of our foreign currency exposure with foreign currency forward contracts in accordance with our risk management policies. We do not enter into such contracts for speculative purposes. The assets or liabilities associated with these derivative financial instruments are measured at fair value and recorded in either other current or long-term assets or other current or long-term liabilities. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on whether the derivative financial instrument is designated as a hedge and qualifies for hedge accounting in accordance with Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging.

Cash Flow Hedges

We enter into foreign currency forward contracts designated as cash flow hedges (to sell Canadian dollars and purchase U.S. dollars) for forecasted inventory purchases in U.S. dollars by our Canadian subsidiary. These hedges have terms of up to 18 months. All hedging relationships are formally documented, and the forward contracts are designed to mitigate foreign currency exchange risk on hedged transactions. We record the effective portion of changes in the fair value of our cash flow hedges in other comprehensive income (“OCI”) until the earlier of when the hedged forecasted inventory purchase occurs or when the respective contract reaches maturity. Subsequently, as the inventory is sold to the customer, we reclassify amounts previously recorded in OCI to cost of goods sold. Changes in the fair value of the forward contract related to interest charges (or forward points) are excluded from the assessment and measurement of hedge effectiveness and are recorded immediately in selling, general and administrative expenses. Based on the rates in effect as of October 28, 2018, we expect to reclassify a net pre-tax gain of approximately $595,000 from OCI to cost of goods sold over the next 12 months.

We also enter into non-designated foreign currency forward contracts (to sell Australian dollars and British pounds and purchase U.S. dollars) to reduce the exchange risk associated with our assets and liabilities denominated in a foreign currency. Any foreign exchange gains or losses related to these contracts are recognized in selling, general and administrative expenses.

As of October 28, 2018 and October 29, 2017, we had foreign currency forward contracts outstanding (in U.S. dollars) with notional values as follows:

 

In thousands    October 28, 2018      October 29, 2017  

Contracts designated as cash flow hedges

   $ 13,300      $ 23,000  

Contracts not designated as cash flow hedges

   $ 5,200      $ 48,000  

Hedge effectiveness is evaluated prospectively at inception, on an ongoing basis, as well as retrospectively using regression analysis. Any measurable ineffectiveness of the hedge is recorded in selling, general and administrative expenses. No gain or loss was recognized for cash flow hedges due to hedge ineffectiveness and all hedges were deemed effective for assessment purposes for the thirteen and thirty-nine weeks ended October 28, 2018 and October 29, 2017.

 

9


Table of Contents

The effect of derivative instruments in our Condensed Consolidated Financial Statements during the thirteen and thirty-nine weeks ended October 28, 2018 and October 29, 2017, pre-tax, was as follows:

 

In thousands   

Thirteen

Weeks Ended

October 28, 2018

   

Thirteen

Weeks Ended

October 29, 2017

    

Thirty-nine

Weeks Ended

October 28, 2018

    

Thirty-nine

Weeks Ended

October 29, 2017

 

Net gain (loss) recognized in OCI

   $ (88   $ 506      $ 1,442      $ (190

Net gain (loss) reclassified from OCI into cost of goods sold

   $ 163     $ 173      $ 90      $ 185  

Net foreign exchange gain (loss) recognized in selling, general and administrative expenses:

          

Instruments designated as cash flow hedges1

   $ 16     $ 20      $ 49      $ 75  

Instruments not designated or de-designated

   $ 105     $ 1,752      $ 4,048      $ (1,096
1

Changes in fair value of the forward contract related to interest charges (or forward points).

The fair values of our derivative financial instruments are presented below according to their classification in our Condensed Consolidated Balance Sheets. All fair values were measured using Level 2 inputs as defined by the fair value hierarchy described in Note I.

 

In thousands    October 28, 2018      October 29, 2017  

Derivatives designated as cash flow hedges:

     

Other current assets

   $ 504      $ 161  

Other long-term assets

   $ —        $ 25  

Other current liabilities

   $ —        $ (131

Other long-term liabilities

   $ —        $ (11

Derivatives not designated as hedging instruments:

                                     

Other current assets

   $ 118      $ 209  

We record all derivative assets and liabilities on a gross basis. They do not meet the balance sheet netting criteria as discussed in ASC 210, Balance Sheet, because we do not have master netting agreements established with our derivative counterparties that would allow for net settlement.

NOTE I. FAIR VALUE MEASUREMENTS

Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

We determine the fair value of financial and non-financial assets and liabilities using the fair value hierarchy established by ASC 820, Fair Value Measurement, which defines three levels of inputs that may be used to measure fair value, as follows:

 

   

Level 1: inputs which include quoted prices in active markets for identical assets or liabilities;

 

   

Level 2: inputs which include observable inputs other than Level 1 inputs, such as quoted prices in active markets for similar assets or liabilities; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability; and

 

   

Level 3: inputs which include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the underlying asset or liability.

The fair values of our cash and cash equivalents are based on Level 1 inputs, which include quoted prices in active markets for identical assets.

Long-term Debt

As of October 28, 2018, the fair value of our long-term debt approximates its carrying value and is based on observable Level 2 inputs, primarily market interest rates for instruments with similar maturities.

 

10


Table of Contents

Foreign Currency Derivatives and Hedging Instruments

We use the income approach to value our derivatives using observable Level 2 market data at the measurement date and standard valuation techniques to convert future amounts to a single present value amount, assuming that participants are motivated but not compelled to transact. Level 2 inputs are limited to quoted prices that are observable for the assets and liabilities, which include interest rates and credit risk ratings. We use mid-market pricing as a practical expedient for fair value measurements. Key inputs for foreign currency derivatives are the spot rates, forward rates, interest rates and credit derivative market rates.

The counterparties associated with our foreign currency forward contracts are large credit-worthy financial institutions, and the derivatives transacted with these entities are relatively short in duration, therefore, we do not consider counterparty concentration and non-performance to be material risks at this time. Both we and our counterparties are expected to perform under the contractual terms of the instruments. None of the derivative contracts that we have entered into are subject to credit risk-related contingent features or collateral requirements.

Property and Equipment

We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We measure these assets at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy. The fair value is based on the present value of estimated future cash flows using a discount rate that approximates our weighted average cost of capital.

There were no transfers between Level 1, 2 or 3 categories during the thirteen and thirty-nine weeks ended October 28, 2018 or October 29, 2017.

 

11


Table of Contents

NOTE J. ACCUMULATED OTHER COMPREHENSIVE INCOME

Changes in accumulated other comprehensive income (loss) by component, net of tax, are as follows:

 

In thousands   

Foreign Currency

Translation

   

Cash Flow

Hedges

   

Accumulated Other

Comprehensive

Income (Loss)

 

Balance at January 28, 2018

   $ (6,227   $ (555   $ (6,782

Foreign currency translation adjustments

     (1,145     —         (1,145

Change in fair value of derivative financial instruments

     —         1,123       1,123  

Reclassification adjustment for realized (gain) loss on derivative financial instruments 1

     —         49       49  

Other comprehensive income (loss)

     (1,145     1,172       27  

Balance at April 29, 2018

     (7,372     617       (6,755

Foreign currency translation adjustments

     (2,993     —         (2,993

Change in fair value of derivative financial instruments

     —         6       6  

Reclassification adjustment for realized (gain) loss on derivative financial instruments 1

     —         —         —    

Other comprehensive income (loss)

     (2,993     6       (2,987

Balance at July 29, 2018

     (10,365     623       (9,742

Foreign currency translation adjustments

     (1,830     —         (1,830

Change in fair value of derivative financial instruments

     —         (65     (65

Reclassification adjustment for realized (gain) loss on derivative financial instruments 1

     —         (120     (120

Other comprehensive income (loss)

     (1,830     (185     (2,015

Balance at October 28, 2018

   $ (12,195   $ 438     $ (11,757

Balance at January 29, 2017

   $ (9,957   $ 54     $ (9,903

Foreign currency translation adjustments

     (1,566     —         (1,566

Change in fair value of derivative financial instruments

     —         655       655  

Reclassification adjustment for realized (gain) loss on derivative financial instruments 1

     —         (16     (16

Other comprehensive income (loss)

     (1,566     639       (927

Balance at April 30, 2017

     (11,523     693       (10,830

Foreign currency translation adjustments

     3,390       —         3,390  

Change in fair value of derivative financial instruments

     —         (1,166     (1,166

Reclassification adjustment for realized (gain) loss on derivative financial instruments 1

     —         7       7  

Other comprehensive income (loss)

     3,390       (1,159     2,231  

Balance at July 30, 2017

     (8,133     (466     (8,599

Foreign currency translation adjustments

     40       —         40  

Change in fair value of derivative financial instruments

     —         373       373  

Reclassification adjustment for realized (gain) loss on derivative financial instruments 1

     —         (128     (128

Other comprehensive income (loss)

     40       245       285  

Balance at October 29, 2017

   $ (8,093   $ (221   $ (8,314
1 

Refer to Note H for additional disclosures about reclassifications out of accumulated other comprehensive income and their corresponding effects on the respective line items in the Condensed Consolidated Statements of Earnings.

NOTE K. ACQUISITION OF OUTWARD, INC.

On December 1, 2017, we acquired Outward, Inc. (“Outward”), a 3-D imaging and augmented reality platform for the home furnishings and décor industry. Outward’s technology enables applications in product visualization, digital room design and augmented and virtual reality. Of the $112,000,000 contractual purchase price, approximately $80,812,000 was deemed to be purchase consideration, $26,690,000 is payable to former stockholders of Outward over a period of four years from the acquisition date, contingent upon their continued service during that time, and $4,498,000 primarily represents settlement of pre-existing obligations of Outward with third parties on the acquisition date. Certain key employees of Outward may also collectively earn up to an additional $20,000,000, contingent upon achievement of certain financial performance targets, and subject to their continued service over the performance period. Both of these contingent amounts will be recognized as post-combination compensation expense as they are earned.

 

12


Table of Contents

The purchase consideration has been allocated based on estimates of the fair value of identifiable assets acquired and liabilities assumed, as set forth in the table below.

 

In thousands        

Working capital and other assets

   $ 718,000  

Property and equipment, net

     2,049,000  

Intangible assets

     18,300,000  

Liabilities

     (7,160,000

Total identifiable net assets acquired

   $ 13,907,000  

Goodwill

     66,905,000  

Total purchase consideration

   $ 80,812,000  

During the second quarter of fiscal 2018, we finalized the valuation of intangible assets acquired, which primarily represent 3-D imaging data and core intellectual property which are being amortized over a useful life of four years. Goodwill is primarily attributable to expected synergies as a result of the acquisition, which include the leverage of acquired technology and talent to drive improved conversion, cost savings and operating efficiencies. None of the goodwill will be deductible for income tax purposes.

Outward is a wholly-owned subsidiary of Williams-Sonoma, Inc. Results of operations for Outward have been included in our Condensed Consolidated Financial Statements from the acquisition date. Pro forma results of Outward have not been presented as the results are insignificant to our Condensed Consolidated Financial Statements for all periods presented and would not have been significant had the acquisition occurred at the beginning of fiscal 2017.

NOTE L. REVENUE

The majority of our revenues are generated from sales of merchandise to our customers, either in our retail stores or through our e-commerce channel (websites or direct-mail catalogs) and include shipping fees received from customers for delivery of merchandise to their homes. The remainder of our revenues are primarily generated from sales to our franchisees and other wholesale transactions, breakage income related to stored-value cards, and incentives received from credit card issuers in connection with our private label and co-branded credit cards.

We recognize revenue as control of promised goods or services are transferred to our customers. We record a liability at each period end where we have an obligation to transfer goods or services for which we have received consideration or have a right to consideration. We exclude from revenue any taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and are concurrent with revenue-generating activities. Our payment terms are primarily at the point of sale for merchandise sales and for most services.

See Note E, for disaggregation of our net revenues by reportable segment.

Merchandise Sales

Revenues from the sale of our merchandise through our e-commerce channel, at our retail stores, as well as to our franchisees and wholesale customers are, in each case, recognized at a point in time when control of merchandise is transferred to the customer. Merchandise can either be picked up in our stores, or delivered to the customer. For merchandise picked up in the store, control is transferred at the time of the sale to the end customer. For merchandise delivered to the customer, control is transferred when either delivery has been completed, or we have a present right to payment which, for certain merchandise, occurs upon conveyance of the merchandise to the carrier for delivery. We have elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation.

Revenue from the sale of merchandise is reported net of sales returns. We estimate future returns based on historical return trends together with current product sales performance. As of October 28, 2018, we recorded a liability for expected sales returns of approximately $25,555,000 within other current liabilities and a corresponding asset for the expected net realizable value of the merchandise inventory to be returned of approximately $9,567,000 within other current assets in our Condensed Consolidated Balance Sheet.

 

13


Table of Contents

Stored-value Cards

We issue stored-value cards that may be redeemed on future merchandise purchases at our stores or through our e-commerce channel. Our stored-value cards have no expiration dates. Revenue from stored-value cards is recognized at a point in time upon redemption of the card and as control of the merchandise is transferred to the customer. Revenue from estimated unredeemed stored-value cards (breakage) is recognized in a manner consistent with our historical redemption patterns over the estimated period of redemption of our cards of approximately four years, the majority of which is recognized within one year of the card issuance. Breakage revenue is not material to our Condensed Consolidated Financial Statements.

Credit Card Incentives

We enter into agreements with credit card issuers in connection with our private label and co-branded credit cards whereby we receive cash incentives in exchange for promised services, such as licensing our brand names and marketing the credit card program to end customers. Services promised under these agreements are interrelated and are thus considered a single performance obligation. Revenue is recognized over time as we transfer promised services throughout the contract term.

Customer Loyalty Programs

We have customer loyalty programs which allow members to earn points for each qualifying purchase. Points earned enable members to receive certificates that may be redeemed on future merchandise purchases at our stores or through our e-commerce channel. This customer option is a material right and, accordingly, represents a separate performance obligation to the customer. The allocated consideration for the points earned by our loyalty program members is deferred based on the standalone selling price of the points and recorded within gift card and other deferred revenue within our Condensed Consolidated Balance Sheet. The measurement of standalone selling prices takes into consideration the discount the customer would receive in a separate transaction for the delivered item, as well as our estimate of certificates expected to be redeemed, based on historical redemption patterns. This measurement is applied to our portfolio of performance obligations for points earned, as all obligations have similar economic characteristics. We believe the impact to our Condensed Consolidated Financial Statements would not be materially different if this measurement was applied to each individual performance obligation. Revenue is recognized for these performance obligations at a point in time when certificates are redeemed by the customer. These obligations relate to contracts with terms less than one year, as our certificates generally expire within 6 months from issuance.

Deferred Revenue

We defer revenue when cash payments are received in advance of satisfying performance obligations, primarily associated with our stored-value cards, merchandise sales, and incentives received from credit card issuers. As of October 28, 2018, we held $275,567,000 in gift card and other deferred revenue on our Consolidated Balance Sheet, substantially all of which will be recognized into revenue within the next 12 months.

Adoption of ASU 2014-09

The adoption of ASU 2014-09 most significantly impacted our Condensed Consolidated Financial Statements as follows:

 

   

the reclassification from selling, general and administrative expenses into net revenues for certain incentives received from credit card issuers,

 

   

the reclassification of breakage income related to our unredeemed stored-value cards from selling, general and administrative expenses into net revenues, as well as an acceleration in the timing of recognizing breakage income,

 

   

an acceleration in the timing of revenue recognition for certain merchandise shipped to our customers, and

 

   

the recording of a right of return asset for merchandise we expect to receive back from customers of $9,567,000.

 

14


Table of Contents

The following summarizes the impact of adopting ASU 2014-09 on our Condensed Consolidated Statement of Earnings for the thirteen and thirty-nine weeks ended October 28, 2018.

 

     Thirteen Weeks Ended October 28, 2018      Thirty-nine Weeks Ended October 28, 2018  
In thousands   

As

Reported

    

ASU 2014-09

Adjustment1

   

As

Adjusted

    

As

Reported

    

ASU 2014-09

Adjustment1

   

As

Adjusted

 

Net revenue

   $ 1,356,983      $ (17,390   $ 1,339,593      $ 3,835,157      $ (59,322   $ 3,775,835  

Cost of goods sold

     861,999        (2,775     859,224        2,444,067        (11,176     2,432,891  

Gross profit

     494,984        (14,615     480,369        1,391,090        (48,146     1,342,944  

Selling, general and administrative expenses

     400,600        (10,334     390,266        1,155,990        (33,504     1,122,486  

Operating income

   $ 94,384      $ (4,281   $ 90,103      $ 235,100      $ (14,642   $ 220,458  
1 

Net revenue adjustment is primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues due to the adoption of ASU 2014-09.

Other than the presentation of our sales returns liability and a right of return asset, which resulted in a reclassification of liabilities into other current assets of approximately $9,567,000, all other impacts to our Condensed Consolidated Balance Sheet from the adoption of this ASU were not material either individually or in the aggregate as of October 28, 2018. The adoption of this ASU had no net impact to our Condensed Consolidated Statement of Cash Flows for the thirty-nine weeks ended October 28, 2018.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they do not fully materialize or are proven incorrect, could cause our business and results of operations to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include statements related to: our strategic initiatives; our merchandise strategies; our growth strategies for our brands; our beliefs regarding the resolution of current lawsuits, claims and proceedings; our stock repurchase program; our expectations regarding our cash flow hedges and foreign currency risks; our planned use of cash; our future compliance with the financial covenants contained in our credit facilities; our belief that our cash on-hand, in addition to our available credit facilities, will provide adequate liquidity for our business operations over the next 12 months; our beliefs regarding our exposure to foreign currency exchange rate fluctuations; and our beliefs regarding seasonal patterns associated with our business, as well as statements of belief and statements of assumptions underlying any of the foregoing. You can identify these and other forward-looking statements by the use of words such as “may,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or the negative of such terms, or other comparable terminology. The risks, uncertainties and assumptions referred to above that could cause our results to differ materially from the results expressed or implied by such forward-looking statements include, but are not limited to, the potential impact of tariffs, including our ability to mitigate the potential impact, and those discussed under the heading “Risk Factors” in this document and our Annual Report on Form 10-K for the year ended January 28, 2018, and the risks, uncertainties and assumptions discussed from time to time in our other public filings and public announcements. All forward-looking statements included in this document are based on information available to us as of the date hereof, and we assume no obligation to update these forward-looking statements.

OVERVIEW

Williams-Sonoma, Inc. is a specialty retailer of high-quality products for the home. These products, representing distinct merchandise strategies – Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, PBteen, Williams Sonoma Home, Rejuvenation, and Mark and Graham – are marketed through e-commerce websites, direct-mail catalogs and 633 stores. These brands are also part of The Key Rewards, our free-to-join loyalty program that offers members exclusive benefits across the Williams-Sonoma family of brands. We operate in the U.S., Puerto Rico, Canada, Australia and the United Kingdom, offer international shipping to customers worldwide, and have unaffiliated franchisees that operate stores in the Middle East, the Philippines, Mexico and South Korea, as well as e-commerce websites in certain locations. In December 2017, we acquired Outward, Inc., a 3-D imaging and augmented reality platform for the home furnishings and décor industry.

The following discussion and analysis of financial condition, results of operations, and liquidity and capital resources for the thirteen weeks ended October 28, 2018 (“third quarter of fiscal 2018”), as compared to the thirteen weeks ended October 29, 2017 (“third quarter of fiscal 2017”) and the thirty-nine weeks ended October 28, 2018 (“year-to-date fiscal 2018”), as compared to the thirty-nine weeks ended October 29, 2017 (“year-to-date fiscal 2017”), should be read in conjunction with our Condensed Consolidated Financial Statements and the notes thereto.

All explanations of changes in operational results are discussed in order of their magnitude.

 

15


Table of Contents

Third quarter of Fiscal 2018 Financial Results

Net revenues in the third quarter of fiscal 2018 increased by $57,647,000, or 4.4%, compared to the third quarter of fiscal 2017, with comparable brand revenue growth of 3.1%. The increase in net revenues was driven by an 8.2% increase in our e-commerce net revenues primarily driven by West Elm, Pottery Barn and Williams Sonoma, with particular strength in furniture, and a 0.2% increase in retail net revenues primarily due to growth in West Elm partially offset by a decline in our franchise operations and Pottery Barn Kids and Teen. Total net revenue growth for the third quarter of fiscal 2018 also included a double-digit net revenue increase in our company-owned international operations, as well as the favorable impact of the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note L to our Condensed Consolidated Financial Statements). Net revenue growth was unfavorably impacted by an unexpected delay in product receipts from China, which impacted our ability to fill customer orders placed in the third quarter, as well as a higher than expected amount of drop-ship sales which take longer to fulfill.

In the third quarter of fiscal 2018, diluted earnings per share was $1.00 (which included a $0.13 benefit associated with U.S. tax legislation, a $0.06 impact related to Outward, a $0.02 impact related to employment-related expense associated with a one-time special equity grant, and a $0.01 impact primarily associated with impairment and early termination charges) versus $0.84 in the third quarter of fiscal 2017. We also returned $80,726,000 to our stockholders through stock repurchases and dividends.

In the third quarter of fiscal 2018, we also made progress on our four strategic priorities of digital leadership, product innovation, retail transformation and operational excellence.

In digital leadership, we continued to leverage the power of our multi-brand portfolio, launching two new cross-brand initiatives, the customer-facing version of our professional design tool, Design Crew Room Planner, as well as our cross-brand registry program that allows customers to create a registry across our brands all in one place. In addition to these initiatives, our cross-brand loyalty program, The Key, continued to gain momentum. We also expanded our cross-channel shopping capabilities with Buy Online Pick-up in Store in the Pottery Barn and West Elm brands.

In product innovation we expanded our partnership with the Harry Potter franchise and coordinated the releases of our One Home collection to all three Pottery Barn brands. We also introduced Design Crew Basics, a proprietary collection of low price, high quality essentials for the home. In addition, our incremental growth initiatives, such as PB Apartment and Modern Baby, continued to attract new customers. In Williams Sonoma, our customers continued to respond to unique innovations only available through our brand, and West Elm continued to see customers respond positively to the brand’s aesthetic, scale and price point.

Under our strategic priority of retail transformation, we continued to execute on our remodel strategy while selectively investing in new stores. In our global business we continued to expand our presence with the introduction of Pottery Barn Kids in three new shop-in-shop locations as well as e-commerce in the United Kingdom. We also entered into a new franchise partnership in India for entry in early 2020.

We also remain committed to operational excellence. During the third quarter, we continued to drive efficiency improvements and cost reductions throughout the supply chain. Production shipments from our domestic manufacturing facility increased during the quarter, and we further reduced company-wide damages. We made progress on our multi-year transition to One Inventory, which will allow us to re-engineer inventory flow processes, better allocate inventory cross-channel, optimize inventory levels, improve our distribution center efficiency and bring down costs in the supply chain. And, despite tightness in the labor market, we are ahead in our seasonal hiring compared to last year, helped by the recent increase in hourly wage and incentive pay in our distribution centers.

NET REVENUES

Net revenues consist of e-commerce net revenues and retail net revenues. E-commerce net revenues include sales of merchandise to customers through our e-commerce websites and our catalogs, as well as shipping fees. Retail net revenues include sales of merchandise to customers at our retail stores and to our franchisees, as well as shipping fees on any products shipped to our customers’ homes. Shipping fees consist of revenue received from customers for delivery of merchandise to their homes. Revenues are presented net of sales returns and other discounts.

 

     Thirteen Weeks Ended     Thirty-nine Weeks Ended  
In thousands   

October 28,

2018

     % Total    

October 29,

2017

     % Total    

October 28,

2018

     % Total    

October 29,

2017

     % Total  

E-commerce net revenues

   $ 746,716        55.0   $ 690,045        53.1   $ 2,079,838        54.2   $ 1,901,348        52.6

Retail net revenues

     610,267        45.0     609,291        46.9     1,755,319        45.8     1,711,101        47.4

Net revenues

   $ 1,356,983        100.0   $ 1,299,336        100.0   $ 3,835,157        100.0   $ 3,612,449        100.0

 

16


Table of Contents

Net revenues in the third quarter of fiscal 2018 increased by $57,647,000, or 4.4%, compared to the third quarter of fiscal 2017, with comparable brand revenue growth of 3.1%. The increase in net revenues was driven by an 8.2% increase in our e-commerce net revenues primarily driven by West Elm, Pottery Barn and Williams Sonoma, with particular strength in furniture, and a 0.2% increase in retail net revenues primarily due to growth in West Elm partially offset by a decline in our franchise operations and Pottery Barn Kids and Teen. Total net revenue growth for the third quarter of fiscal 2018 also included a double-digit net revenue increase in our company-owned international operations, as well as the favorable impact of the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note L to our Condensed Consolidated Financial Statements). Net revenue growth was unfavorably impacted by an unexpected delay in product receipts from China, which impacted our ability to fill customer orders placed in the third quarter, as well as a higher than expected amount of drop-ship sales which take longer to fulfill.

Net revenues for year-to-date fiscal 2018 increased by $222,708,000, or 6.2%, compared to year-to-date fiscal 2017, with comparable brand revenue growth of 4.4%. The increase in net revenues was driven by a 9.4% increase in our e-commerce net revenues with growth across all brands and a 2.6% increase in our retail net revenues primarily driven by West Elm and Pottery Barn, with particular strength in furniture. Net revenue growth also included a double-digit net revenue increase in our company-owned international operations, as well as the favorable impact of the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note L to our Condensed Consolidated Financial Statements). Net revenue growth was unfavorably impacted by an unexpected delay in product receipts from China, which impacted our ability to fill customer orders placed in the third quarter, as well as a higher than expected amount of drop-ship sales which take longer to fulfill.

Comparable Brand Revenue

Comparable brand revenue includes retail comparable store sales and e-commerce sales, as well as shipping fees, sales returns and other discounts associated with current period sales. Comparable stores are defined as permanent stores where gross square footage did not change by more than 20% in the previous 12 months and which have been open for at least 12 consecutive months without closure for seven or more consecutive days. Outlet comparable store net revenues are included in their respective brands. Sales to our international franchisees are excluded from comparable brand revenue as their stores and e-commerce websites are not operated by us. Sales from certain operations are also excluded until such time that we believe those sales are meaningful to evaluating their performance. Additionally, comparable brand revenue growth for newer concepts is not separately disclosed until such time that we believe those sales are meaningful to evaluating the performance of the brand.

 

     Thirteen
Weeks Ended
    Thirty-nine
Weeks Ended
 
Comparable brand revenue growth (decline)   

October 28,

2018

   

October 29,

2017

   

October 28,

2018

   

October 29,

2017

 

Pottery Barn

     1.4     (0.3 %)      2.0     (0.2 %) 

West Elm

     8.3     11.5     8.9     9.4

Williams Sonoma

     2.1     2.3     3.1     2.5

Pottery Barn Kids and Teen1

     0.0     0.9     3.4     (3.0 %) 

Total

     3.1     3.3     4.4     2.1
1 

The performance of the Pottery Barn Kids and PBteen brands are being reported on a combined basis as Pottery Barn Kids and Teen.

 

17


Table of Contents

STORE DATA

 

     Store Count      Average Leased Square
Footage Per Store
 
     

July 29,

2018

     Openings      Closings    

October 28,

2018

    

October 29,

2017

    

October 28,

2018

    

October 29,

2017

 

Williams Sonoma

     226        —          —         226        233        6,800        6,700  

Pottery Barn

     205        —          —         205        202        13,900        13,900  

West Elm

     109        3        —         112        105        13,200        13,100  

Pottery Barn Kids

     84        —          (2     82        88        7,500        7,400  

Rejuvenation

     8        —          —         8        8        8,800        8,800  

Total

     632        3        (2     633        636        10,300        10,200  

Store selling square footage at period-end

 

          4,084,000        4,031,000  

Store leased square footage at period-end

 

                      6,551,000        6,468,000  

COST OF GOODS SOLD

 

     Thirteen Weeks Ended     Thirty-nine Weeks Ended  
In thousands   

October 28,

2018

    

% Net

Revenues

   

October 29,

2017

    

% Net

Revenues

   

October 28,

2018

    

% Net

Revenues

   

October 29,

2017

    

% Net

Revenues

 

Cost of goods sold1

   $ 861,999        63.5   $ 832,269        64.1   $ 2,444,067        63.7   $ 2,326,911        64.4
1 

Includes total occupancy expenses of $177,261,000 and $171,161,000 for the third quarter of fiscal 2018 and the third quarter of fiscal 2017, respectively, and $521,544,000 and $507,013,000 for year-to-date fiscal 2018 and year-to-date fiscal 2017, respectively.

Cost of goods sold includes cost of goods, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight expenses, freight-to-store expenses and other inventory related costs such as shrinkage, damages and replacements. Occupancy expenses consist of rent, depreciation and other occupancy costs, including common area maintenance, property taxes and utilities. Shipping costs consist of third-party delivery services and shipping materials.

Our classification of expenses in cost of goods sold may not be comparable to other public companies, as we do not include non-occupancy related costs associated with our distribution network in cost of goods sold. These costs, which include distribution network employment, third-party warehouse management and other distribution related administrative expenses, are recorded in selling, general and administrative expenses.

Within our reportable segments, the e-commerce channel does not incur freight-to-store or store occupancy expenses, and typically operates with lower markdowns and inventory shrinkage than the retail channel. However, the e-commerce channel incurs higher customer shipping, damage and replacement costs than the retail channel.

Third quarter of Fiscal 2018 vs. Third quarter of Fiscal 2017

Cost of goods sold increased by $29,730,000, or 3.6%, in the third quarter of fiscal 2018 compared to the third quarter of fiscal 2017. Cost of goods sold as a percentage of net revenues decreased to 63.5% in the third quarter of fiscal 2018 from 64.1% in the third quarter of fiscal 2017. This decrease was primarily driven by higher selling margins and the leverage of occupancy costs, and includes the favorable impact from the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues.

In the e-commerce channel, cost of goods sold as a percentage of net revenues decreased in the third quarter of fiscal 2018 compared to the third quarter of fiscal 2017, primarily driven by higher selling margins.

In the retail channel, cost of goods sold as a percentage of net revenues increased in the third quarter of fiscal 2018 compared to the third quarter of fiscal 2017, primarily driven by occupancy expense deleverage, partially offset by higher selling margins.

Year-to-Date Fiscal 2018 vs. Year-to-Date Fiscal 2017

Cost of goods sold increased by $117,156,000, or 5.0%, for year-to-date fiscal 2018 compared to year-to-date fiscal 2017. Cost of goods sold as a percentage of net revenues decreased to 63.7% for year-to-date fiscal 2018 from 64.4% for year-to-date fiscal 2017. This decrease was primarily driven by the leverage of occupancy costs and higher selling margins and includes the favorable impact from the adoption of ASU 2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues.

 

 

18


Table of Contents

In the e-commerce channel, cost of goods sold as a percentage of net revenues decreased for year-to-date fiscal 2018 compared to year-to-date fiscal 2017, primarily driven by higher selling margins.

In the retail channel, cost of goods sold as a percentage of net revenues decreased for year-to-date fiscal 2018 compared to year-to-date fiscal 2017, primarily driven by higher selling margins and the leverage of occupancy costs.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

     Thirteen Weeks Ended     Thirty-nine Weeks Ended  
In thousands   

October 28,

2018

    

% Net

Revenues

   

October 29,

2017

    

% Net

Revenues

   

October 28,

2018

    

% Net

Revenues

   

October 29,

2017

    

% Net

Revenues

 

Selling, general and administrative expenses

   $ 400,600        29.5   $ 356,254        27.4   $ 1,155,990        30.1   $ 1,030,667        28.5

Selling, general and administrative expenses consist of non-occupancy related costs associated with our retail stores, distribution and manufacturing facilities, customer care centers, supply chain operations (buying, receiving and inspection) and corporate administrative functions. These costs include employment, advertising, third party credit card processing and other general expenses.

We experience differing employment and advertising costs as a percentage of net revenues within the retail and e-commerce channels due to their distinct distribution and marketing strategies. Employment costs represent a greater percentage of net revenues within the retail channel as compared to the e-commerce channel. However, advertising expenses are higher within the e-commerce channel than in the retail channel.

Third quarter of Fiscal 2018 vs. Third quarter of Fiscal 2017

Selling, general and administrative expenses increased by $44,346,000, or 12.4%, in the third quarter of fiscal 2018 compared to the third quarter of fiscal 2017. Selling, general and administrative expenses as a percentage of net revenues increased to 29.5% in the third quarter of fiscal 2018 from 27.4% in the third quarter of fiscal 2017. This increase as a percentage of net revenues was driven by lower incentive compensation costs last year from a reduction in performance-related compensation that was not earned, increased hourly wages from the reinvestment of tax savings, an increase in general expenses primarily from the reclassification of other income from selling, general and administrative expenses into net revenues due to the adoption of ASU 2014-09, and the impact from our acquisition of Outward in the fourth quarter of fiscal 2017. This was partially offset by the optimization of catalog advertising costs.

In the e-commerce channel, selling, general and administrative expenses as a percentage of net revenues increased in the third quarter of fiscal 2018 compared to the third quarter of fiscal 2017, primarily driven by an increase in general expenses primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues, and the impact from our acquisition of Outward, partially offset by the optimization of catalog advertising costs.

In the retail channel, selling, general and administrative expenses as a percentage of net revenues decreased in the third quarter of fiscal 2018 compared to the third quarter of fiscal 2017, primarily driven by the leverage of employment costs, partially offset by an increase in general expenses primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues.

Year-to-Date Fiscal 2018 vs. Year-to-Date Fiscal 2017

Selling, general and administrative expenses increased by $125,323,000, or 12.2%, for year-to-date fiscal 2018 compared to year-to-date fiscal 2017. Selling, general and administrative expenses as a percentage of net revenues increased to 30.1% for year-to-date fiscal 2018 from 28.5% for year-to-date fiscal 2017. This increase as a percentage of net revenues was driven by an increase in general expenses primarily from the reclassification of other income from selling, general and administrative expenses into net revenues due to the adoption of ASU 2014-09, lower incentive compensation costs last year from a reduction in performance-related compensation that was not earned, as well as increased hourly wages from the reinvestment of tax savings, the impact from our acquisition of Outward in the fourth quarter of fiscal 2017, and impairment and early lease termination charges related to underperforming retail stores. This was partially offset by the optimization of catalog advertising costs.

In the e-commerce channel, selling, general and administrative expenses as a percentage of net revenues increased for year-to-date fiscal 2018 compared to year-to-date fiscal 2017, primarily driven by an increase in general expenses primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues, the impact from our acquisition of Outward, and the increased hourly wages from the reinvestment of tax savings, partially offset by the optimization of catalog advertising costs.

 

19


Table of Contents

In the retail channel, selling, general and administrative expenses as a percentage of net revenues increased for year-to-date fiscal 2018 compared to year-to-date fiscal 2017, primarily driven by an increase in general expenses primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues and impairment and early lease termination charges related to underperforming retail stores.

INCOME TAXES

Staff Accounting Bulletin No. 118 (“SAB 118”) issued by the SEC in December 2017 provides us with up to one year to finalize our measurement of the income tax effects of the 2017 Tax Cuts and Jobs Act (“U.S. Tax Reform”) on our fiscal year ended January 28, 2018. As of January 28, 2018, we had made reasonable estimates of the income tax effects of U.S. Tax Reform, including the transition tax under Internal Revenue Code section 965.

As a result of the issuance of IRS Notice 2018-26, we recorded a measurement period adjustment in the first quarter of fiscal 2018 to increase the transition tax by approximately $2,871,000. In the second quarter of fiscal 2018, we finalized our valuation of intangible assets acquired in connection with the acquisition of Outward. As a result, we recorded an increase to tax expense of approximately $1,757,000 representing an adjustment to the re-measurement of our deferred tax liabilities. In the third quarter of fiscal 2018, we finalized our measurement of the income tax effect of U.S. Tax Reform for certain items, which resulted in an $11,677,000 tax benefit from the re-measurement of our deferred tax assets and a $2,909,000 tax benefit related to the transition tax.

We have historically elected not to provide for U.S. income taxes with respect to the undistributed earnings of our foreign subsidiaries as we intended to utilize those earnings in our foreign operations for an indefinite period of time. Under Internal Revenue Code section 965 of U.S. Tax Reform, we are deemed to have distributed all of the post-1986 accumulated earnings of our foreign subsidiaries to the U.S. as of December 31, 2017. In light of the transition tax under U.S. Tax Reform, we made a determination that any undistributed foreign earnings as of January 28, 2018 are no longer indefinitely reinvested, resulting in an accrual of approximately $2,507,000 of foreign withholding tax and additional U.S. income tax in the third quarter of fiscal 2018. We currently intend to utilize the undistributed earnings of our foreign subsidiaries subsequent to January 28, 2018 in our foreign operations and will only repatriate such earnings when it is tax effective to do so.

The effective tax rate was 22.5% for year-to-date fiscal 2018 and 35.5% for year-to-date fiscal 2017. The decrease in the effective tax rate was primarily due to the reduction of the U.S. corporate income tax rate from 35% to 21% as a result of U.S. Tax Reform, and the tax benefit from the remeasurement of our deferred tax assets.

In fiscal 2018, we are subject to several provisions of U.S. Tax Reform including a tax on global intangible low-taxed income (“GILTI”), the base erosion anti-abuse tax (“BEAT”) and a deduction for foreign-derived intangible income (“FDII”). We are accounting for GILTI as a periodic expense when the tax arises.

The ultimate impact of U.S. Tax Reform may differ from our provisional amounts due to changes in interpretations and assumptions and/or additional regulatory guidance that may be issued. We expect to revise our U.S. Tax Reform impact estimates as we refine our analysis of the new rules and as new guidance is issued. We expect to finalize accounting for the impact of U.S. Tax Reform under SAB 118 once our 2017 corporate income tax returns are filed in the fourth quarter of fiscal 2018.

LIQUIDITY AND CAPITAL RESOURCES

As of October 28, 2018, we held $164,414,000 in cash and cash equivalents, the majority of which was held in interest bearing demand deposit accounts and money market funds, and of which $104,614,000 was held by our foreign subsidiaries. As is consistent within our industry, our cash balances are seasonal in nature, with the fourth quarter historically representing a significantly higher level of cash than other periods.

In fiscal 2018, we plan to use our cash resources to fund our inventory and inventory related purchases, advertising and marketing initiatives, property and equipment purchases, stock repurchases and dividend payments. In addition to our cash balances on hand, we have a $500,000,000 unsecured revolving line of credit (“revolver”) under our credit facility. The revolver may be used to borrow revolving loans or request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders to increase the revolver by up to $250,000,000 at such lenders’ option, to provide for a total of $750,000,000 of unsecured revolving credit. For year-to-date fiscal 2018, we had borrowings of $60,000,000 under the revolver, all of which was outstanding as of October 28, 2018. For year-to-date fiscal 2017, we borrowed $170,000,000 under the revolver, all of which was outstanding as of October 29, 2017. As of October 28, 2018, we had $300,000,000 outstanding under our term loan. The term loan matures on January 8, 2021, at which point all outstanding principal and any accrued interest must be repaid. Additionally, as of October 28, 2018, a total of $11,728,000 in issued but undrawn standby letters of credit were outstanding under the credit facility. The standby letters of credit were issued to secure the liabilities associated with workers’ compensation and other insurance programs.

 

20


Table of Contents

As of October 28, 2018, we had three unsecured letter of credit reimbursement facilities for a total of $70,000,000, of which $6,330,000 was outstanding. These letter of credit facilities represent only a future commitment to fund inventory purchases to which we had not taken legal title.

We are currently in compliance with all of our financial covenants under the credit facility and, based on our current projections, we expect to remain in compliance throughout the next 12 months. We believe our cash on hand, in addition to our available credit facilities, will provide adequate liquidity for our business operations over the next 12 months.

Cash Flows from Operating Activities

For year-to-date fiscal 2018, net cash provided by operating activities was $179,501,000 compared to $112,930,000 for year-to-date fiscal 2017. For year-to-date fiscal 2018, net cash provided by operating activities was primarily attributable to net earnings adjusted for non-cash items and an increase in cash received for gift cards and other deferred revenue and deferred rent and lease incentives, partially offset by an increase in merchandise inventories, a decrease in income taxes payable, and an increase in prepaid expenses and other assets. Net cash provided by operating activities increased compared to year-to-date fiscal 2017, primarily due to lower merchandise inventory purchases and an increase in accrued expenses and other liabilities.

Cash Flows from Investing Activities

For year-to-date fiscal 2018, net cash used in investing activities was $126,522,000 compared to $135,363,000 for year-to-date fiscal 2017, and was primarily attributable to purchases of property and equipment. Net cash used in investing activities decreased compared to year-to-date fiscal 2017, primarily due to a decrease in purchases of property and equipment.

Cash Flows from Financing Activities

For year-to-date fiscal 2018, net cash used in financing activities was $279,781,000 compared to $101,105,000 for year-to-date fiscal 2017. For year-to-date fiscal 2018, net cash used in financing activities was primarily attributable to repurchases of common stock and the payment of dividends partially offset by borrowings under our revolver. Net cash used in financing activities increased compared to year-to-date fiscal 2017, primarily due to a decrease in borrowings under our revolver, as well as an increase in repurchases of common stock.

Stock Repurchase Program and Dividends

See Note G to our Condensed Consolidated Financial Statements, Stock Repurchase Program and Dividends, within Item 1 of this Quarterly Report on Form 10-Q for further information.

Critical Accounting Policies

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. These estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates. During the third quarter of fiscal 2018, other than those discussed in Note L to our Condensed Consolidated Financial Statements, there have been no significant changes to the critical accounting policies discussed in our Annual Report on Form 10-K for the year ended January 28, 2018.

Seasonality

Our business is subject to substantial seasonal variations in demand. Historically, a significant portion of our revenues and net earnings have been realized during the period from October through January, and levels of net revenues and net earnings have typically been lower during the period from February through September. We believe this is the general pattern associated with the retail industry. In preparation for and during our holiday selling season, we hire a substantial number of additional temporary employees, primarily in our retail stores, customer care centers and distribution facilities, and incur significant fixed catalog production and mailing costs.

 

21


Table of Contents

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risks, which include significant deterioration of the U.S. and foreign markets, changes in U.S. interest rates, foreign currency exchange rate fluctuations, and the effects of economic uncertainty which may affect the prices we pay our vendors in the foreign countries in which we do business. We do not engage in financial transactions for trading or speculative purposes.

Interest Rate Risk

Our revolver and our term loan each have a variable interest rate which, when drawn upon, subjects us to risks associated with changes in that interest rate. During the third quarter of fiscal 2018, we had $60,000,000 in borrowings under our revolver, all of which was outstanding as of October 28, 2018, and $300,000,000 outstanding under the term loan. A hypothetical increase or decrease of one percentage point on our existing variable rate debt instruments would not materially affect our results of operations or cash flows.

In addition, we have fixed and variable income investments consisting of short-term investments classified as cash and cash equivalents, which are also affected by changes in market interest rates. As of October 28, 2018, our investments, made primarily in interest bearing demand deposit accounts and money market funds, are stated at cost and approximate their fair values.

Foreign Currency Risks

We purchase a significant amount of inventory from vendors outside of the U.S. in transactions that are denominated in U.S. dollars. Approximately 1% of our international purchase transactions are in currencies other than the U.S. dollar, primarily the euro. Any foreign currency impact related to these international purchase transactions was not significant to us during the third quarter of fiscal 2018 or the third quarter of fiscal 2017. However, since we pay for the majority of our international purchases in U.S. dollars, a decline in the U.S. dollar relative to other foreign currencies would subject us to risks associated with increased purchasing costs from our vendors in their effort to offset any lost profits associated with any currency devaluation. We cannot predict with certainty the effect these increased costs may have on our financial statements or results of operations.

In addition, our retail and e-commerce businesses in Canada, Australia and the United Kingdom, and our operations throughout Asia and Europe, expose us to market risk associated with foreign currency exchange rate fluctuations. Substantially all of our purchases and sales are denominated in U.S. dollars, which limits our exposure to this risk. However, some of our foreign operations have a functional currency other than the U.S. dollar. While the impact of foreign currency exchange rate fluctuations was not material to us in the third quarter of fiscal 2018 or the third quarter of fiscal 2017, we have continued to see volatility in the exchange rates in the countries in which we do business. As we continue to expand globally, the foreign currency exchange risk related to our foreign operations may increase. To mitigate this risk, we hedge a portion of our foreign currency exposure with foreign currency forward contracts in accordance with our risk management policies (see Note H to our Condensed Consolidated Financial Statements).

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of October 28, 2018, an evaluation was performed by management, with the participation of our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures. Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow for timely discussions regarding required disclosures, and that such information is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Information required by this Item is contained in Note F to our Condensed Consolidated Financial Statements within Part I of this Form 10-Q.

 

22


Table of Contents

ITEM 1A. RISK FACTORS

See Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended January 28, 2018 for a description of the risks and uncertainties associated with our business. We are providing the following information regarding changes that have occurred to the previously disclosed risk factors in our Form 10-K. Except for such additional information, we believe there have been no material changes from the risk factors previously disclosed in our Form 10-K.

Recent tariffs could result in increased prices and/or costs of goods or delays in product received from our vendors and could adversely affect our results of operations.

Recently, the U.S. administration has enacted certain tariffs and proposed additional tariffs on many items sourced from China, including certain furniture, accessories, furniture parts, and raw materials for domestic furniture manufacturing products imported into the U.S. While we expect there to be minimal financial impact on our fiscal 2018 results of operations, we may not be able to fully or substantially mitigate the impact of these tariffs, pass price increases on to our customers, or secure adequate alternative sources of products or materials. The tariffs, along with any additional tariffs or retaliatory trade restrictions implemented by other countries, could adversely affect customer sales, including potential delays in product received from our vendors, our cost of goods sold and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information as of October 28, 2018 with respect to shares of common stock we repurchased during the third quarter of fiscal 2018 under our $500,000,000 stock repurchase program. For additional information, please see Note G to our Condensed Consolidated Financial Statements within Part I of this Form 10-Q.

 

Fiscal period   

Total Number

of Shares

Purchased1

    

Average Price

Paid Per Share

    

Total Number of

Shares Purchased as

Part of a Publicly

Announced Program1

    

Maximum Dollar Value

of Shares That May

Yet Be Purchased

Under the Program

 

July 30, 2018 – August 26, 2018

     433,272      $ 58.70        433,272      $ 318,869,000  

August 27, 2018 – September 23, 2018

     124,278      $ 68.79        124,278      $ 310,320,000  

September 24, 2018 – October 28, 2018

     184,958      $ 61.75        184,958      $ 298,898,000  

Total

     742,508      $ 61.15        742,508      $ 298,898,000  
1 

Excludes shares withheld for employee taxes upon vesting of stock-based awards.

Stock repurchases under our program may be made through open market and privately negotiated transactions at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability and other market conditions. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

 

23


Table of Contents

ITEM 6. EXHIBITS

(a) Exhibits

 

Exhibit

Number

  

Exhibit Description

10.1*    Fifth Amendment to Reimbursement Agreement between Williams-Sonoma, Inc., Williams-Sonoma Singapore Pte. Ltd., and Bank of America, N.A., dated as of August 24, 2018
10.2*    Fifth Amendment to Reimbursement Agreement between Williams-Sonoma, Inc., Williams-Sonoma Singapore Pte. Ltd., and Wells Fargo Bank, N.A., dated as of August 24, 2018
10.3*    Fifth Amendment to Reimbursement Agreement between Williams-Sonoma, Inc., Williams-Sonoma Singapore Pte. Ltd., and U.S. Bank National Association, dated as of August 24, 2018
31.1*    Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
31.2*    Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
32.1**    Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**    Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document

 

*

Filed herewith.

**

Furnished, not filed.

 

24


Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

WILLIAMS-SONOMA, INC.
By:  

/s/ Julie Whalen

  Julie Whalen
  Duly Authorized Officer and Chief Financial Officer

Date: December 7, 2018

 

 

25