10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended August 3, 2014.

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

As of August 31, 2014, 93,299,192 shares of the registrant’s Common Stock were outstanding.

 

 

 


Table of Contents

WILLIAMS-SONOMA, INC.

REPORT ON FORM 10-Q

FOR THE QUARTER ENDED AUGUST 3, 2014

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

 

         PAGE  

Item 1.

  Financial Statements      2   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      12   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      19   

Item 4.

  Controls and Procedures      20   
  PART II. OTHER INFORMATION   

Item 1.

  Legal Proceedings      20   

Item 1A.

  Risk Factors      20   

Item 2.

  Unregistered Sales of Equity Securities And Use of Proceeds      20   

Item 3.

  Defaults Upon Senior Securities      21   

Item 4.

  Mine Safety Disclosures      21   

Item 5.

  Other Information      21   

Item 6.

  Exhibits      21   

 

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ITEM 1. FINANCIAL STATEMENTS

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

     Thirteen Weeks Ended      Twenty-Six Weeks Ended  
Dollars and shares in thousands, except per share amounts    August 3,
2014
     August 4,
2013
     August 3,
2014
    August 4,
2013
 

Net revenues

   $   1,039,102       $   982,209       $ 2,013,432      $ 1,870,017   

Cost of goods sold

     657,004         613,285         1,262,926        1,166,908   

Gross profit

     382,098         368,924         750,506        703,109   

Selling, general and administrative expenses

     296,762         290,838         590,844        561,240   

Operating income

     85,336         78,086         159,662        141,869   

Interest expense (income), net

     40         (125      (29     (314

Earnings before income taxes

     85,296         78,211         159,691        142,183   

Income taxes

     34,549         29,292         62,782        53,798   

Net earnings

   $ 50,747       $ 48,919       $ 96,909      $ 88,385   

Basic earnings per share

   $ 0.54       $ 0.50       $ 1.03      $ 0.91   

Diluted earnings per share

   $ 0.53       $ 0.49       $ 1.01      $ 0.89   

Shares used in calculation of earnings per share:

          

Basic

     93,979         96,892         94,010        97,470   

Diluted

     95,839         98,957         95,714        99,365   

See Notes to Condensed Consolidated Financial Statements.

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     Thirteen Weeks Ended      Twenty-Six Weeks Ended  
Dollars in thousands    August 3,
2014
    August 4,
2013
     August 3,
2014
    August 4,
2013
 

Net earnings

   $ 50,747      $ 48,919         $  96,909        $  88,385   

Other comprehensive income (loss):

         

Foreign currency translation adjustments

     545        (3,148      1,943        (4,496

Changes in fair value of derivative financial instruments, net of tax

     91        292         (207     123   

Reclassification adjustment for realized gains on derivative financial instruments

     (287     0         (520     0   

Comprehensive income

   $ 51,096      $ 46,063         $  98,125        $  84,012   

See Notes to Condensed Consolidated Financial Statements.

 

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WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

Dollars and shares in thousands, except per share amounts    August 3,
2014
    February 2,
2014
    August 4,
2013
 

ASSETS

      

Current assets

      

Cash and cash equivalents

   $ 70,574      $ 330,121      $ 205,364   

Restricted cash

     0        14,289        16,967   

Accounts receivable, net

     69,653        60,330        62,808   

Merchandise inventories, net

     894,860        813,160        736,871   

Prepaid catalog expenses

     39,072        33,556        37,266   

Prepaid expenses

     55,892        35,309        61,725   

Deferred income taxes, net

     121,527        121,486        99,699   

Other assets

     9,772        10,852        11,029   

Total current assets

       1,261,350          1,419,103          1,231,729   

Property and equipment, net

     849,255        849,293        829,951   

Non-current deferred income taxes, net

     856        13,824        7,509   

Other assets, net

     52,087        54,514        54,989   

Total assets

   $ 2,163,548      $ 2,336,734      $ 2,124,178   

LIABILITIES AND STOCKHOLDERS’ EQUITY

      

Current liabilities

      

Accounts payable

   $ 336,470      $ 404,791      $ 318,532   

Accrued salaries, benefits and other

     101,818        138,181        95,762   

Customer deposits

     251,146        228,193        225,822   

Income taxes payable

     14,604        49,365        2,955   

Current portion of long-term debt

     1,968        1,785        1,817   

Other liabilities

     44,713        38,781        35,531   

Total current liabilities

     750,719        861,096        680,419   

Deferred rent and lease incentives

     171,193        157,856        170,817   

Long-term debt

     0        1,968        1,968   

Other long-term obligations

     63,227        59,812        51,599   

Total liabilities

     985,139        1,080,732        904,803   

Commitments and contingencies

      

Stockholders’ equity

      

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

     0        0        0   

Common stock: $.01 par value; 253,125 shares authorized; 93,414, 94,049 and 95,839 shares issued and outstanding at August 3, 2014, February 2, 2014 and August 4, 2013, respectively

     934        941        959   

Additional paid-in capital

     514,464        522,595        513,246   

Retained earnings

     657,721        729,043        699,012   

Accumulated other comprehensive income

     7,741        6,524        9,260   

Treasury stock, at cost

     (2,451     (3,101     (3,102

Total stockholders’ equity

     1,178,409        1,256,002        1,219,375   

Total liabilities and stockholders’ equity

   $ 2,163,548      $ 2,336,734      $ 2,124,178   

See Notes to Condensed Consolidated Financial Statements.

 

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WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

         Twenty-Six Weeks Ended      
Dollars in thousands   

August 3,

2014

   

August 4,

2013

 

Cash flows from operating activities:

    

Net earnings

   $ 96,909      $ 88,385   

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

    

Depreciation and amortization

     79,332        73,832   

Loss on sale/disposal/impairment of assets

     952        1,233   

Amortization of deferred lease incentives

     (12,483     (12,621

Deferred income taxes

     (8,326     (6,937

Tax benefit related to stock-based awards

     46,174        11,733   

Excess tax benefit related to stock-based awards

     (22,911     (5,173

Stock-based compensation expense

     22,191        18,472   

Other

     305        0   

Changes in:

    

Accounts receivable

     (4,227     (1,284

Merchandise inventories

     (80,158     (97,653

Prepaid catalog expenses

     (5,516     (35

Prepaid expenses and other assets

     (18,043     (40,191

Accounts payable

     (60,527     52,336   

Accrued salaries, benefits and other current and long-term liabilities

     (28,981     (10,677

Customer deposits

     22,767        18,710   

Deferred rent and lease incentives

     17,516        12,823   

Income taxes payable

     (34,757     (38,890

Net cash provided by operating activities

     10,217        64,063   

Cash flows from investing activities:

    

Purchases of property and equipment

     (83,519     (97,777

Restricted cash receipts (deposits)

     14,289        (912

Other

     282        1,274   

Net cash used in investing activities

     (68,948     (97,415

Cash flows from financing activities:

    

Repurchase of common stock

     (112,054     (131,006

Payment of dividends

     (63,996     (52,196

Tax withholdings related to stock-based awards

     (49,434     (11,135

Excess tax benefit related to stock-based awards

     22,911        5,173   

Net proceeds related to stock-based awards

     3,471        6,541   

Repayments of long-term obligations

     (1,785     (1,692

Other

     (6     0   

Net cash used in financing activities

     (200,893     (184,315

Effect of exchange rates on cash and cash equivalents

     77        (1,524

Net decrease in cash and cash equivalents

     (259,547     (219,191

Cash and cash equivalents at beginning of period

     330,121        424,555   

Cash and cash equivalents at end of period

   $ 70,574      $ 205,364   

See Notes to Condensed Consolidated Financial Statements.

 

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WILLIAMS-SONOMA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Twenty-Six Weeks Ended August 3, 2014 and August 4, 2013

(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 August 3, 2014 and August 4, 2013, the Condensed Consolidated Statements of Earnings and the Condensed Consolidated Statements of Comprehensive Income for the thirteen and twenty-six weeks then ended, and the Condensed Consolidated Statements of Cash Flows for the twenty-six 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 twenty-six weeks then ended. Intercompany transactions and accounts have been eliminated. The balance sheet as of February 2, 2014, 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 February 2, 2014.

The results of operations for the thirteen and twenty-six weeks ended August 3, 2014 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 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 February 2, 2014.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) 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. This ASU is effective retrospectively for fiscal years and interim periods within those years beginning after December 15, 2016. We are currently assessing the potential impact of this ASU on our Condensed Consolidated Financial Statements.

NOTE B. 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 25,760,000 shares. As of August 3, 2014, there were approximately 4,437,000 shares available for future grant. Awards may be granted under the Plan to officers, employees and non-employee members of the board of directors of the company (the “Board”) or any parent or subsidiary. Annual grants are limited to 1,000,000 shares covered by option awards and 400,000 shares covered by stock awards on a per person basis. All grants of option awards made under the Plan 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 and stock-awards granted to employees generally vest over a period of four years for service-based awards, and three years for certain performance-based awards. Certain option awards, stock awards and other agreements contain vesting acceleration clauses resulting from events including, but not limited to, retirement, merger or a similar corporate event. Option and stock awards granted to non-employee Board members generally vest in one year.

 

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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). Shares issued as a result of award exercises or releases are primarily funded with the issuance of new shares.

Stock-Based Compensation Expense

We measure and record stock-based compensation expense for all employee stock-based awards using a fair value method. During the thirteen and twenty-six weeks ended August 3, 2014, we recognized total stock-based compensation expense, as a component of selling, general and administrative expenses, of $9,823,000 and $22,191,000, respectively. During the thirteen and twenty-six weeks ended August 4, 2013, we recognized total stock-based compensation expense of $9,481,000 and $18,472,000, respectively.

Stock Options

The following table summarizes our stock option activity during the twenty-six weeks ended August 3, 2014:

 

      Shares  

Balance at February 2, 2014

     222,488   

Granted

     0   

Exercised

     (100,988

Cancelled

     0   

Balance at August 3, 2014 (100% vested)

     121,500   

Stock-Settled Stock Appreciation Rights

The following table summarizes our stock-settled stock appreciation right activity during the twenty-six weeks ended August 3, 2014:

 

      Shares  

Balance at February 2, 2014

     1,859,762   

Granted

     0   

Converted into common stock

     (504,087

Cancelled

     (17,566

Balance at August 3, 2014

     1,338,109   

Vested at August 3, 2014

     1,041,455   

Vested plus expected to vest at August 3, 2014

     1,217,066   

Restricted Stock Units

The following table summarizes our restricted stock unit activity during the twenty-six weeks ended August 3, 2014:

 

      Shares  

Balance at February 2, 2014

     3,079,651   

Granted

     872,177   

Released

     (1,414,406

Cancelled

     (123,562

Balance at August 3, 2014

     2,413,860   

Vested plus expected to vest at August 3, 2014

     1,570,053   

 

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NOTE C. 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 for the period plus common stock equivalents. Common stock equivalents consist of shares subject to option awards with exercise prices less than or equal to the average market price of our common stock for the period, as well as restricted stock units, to the extent their inclusion would be dilutive.

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

 

Dollars and amounts in thousands, except per share amounts    Net Earnings      Weighted
Average Shares
     Earnings
Per Share
 

Thirteen weeks ended August 3, 2014

        

Basic

   $ 50,747         93,979       $ 0.54   

Effect of dilutive stock-based awards

              1,860            

Diluted

   $ 50,747         95,839       $ 0.53   

Thirteen weeks ended August 4, 2013

        

Basic

   $ 48,919         96,892       $ 0.50   

Effect of dilutive stock-based awards

              2,065            

Diluted

   $ 48,919         98,957       $ 0.49   

Twenty-six weeks ended August 3, 2014

        

Basic

   $ 96,909         94,010       $ 1.03   

Effect of dilutive stock-based awards

              1,704            

Diluted

   $ 96,909         95,714       $ 1.01   

Twenty-six weeks ended August 4, 2013

        

Basic

   $ 88,385         97,470       $ 0.91   

Effect of dilutive stock-based awards

              1,895            

Diluted

   $ 88,385         99,365       $ 0.89   

There were no stock-based awards excluded from the computation of diluted earnings per share for the thirteen weeks ended August 3, 2014 and August 4, 2013 and the twenty-six weeks ended August 3, 2014. Stock-based awards of 133,000 for the twenty-six weeks ended August 4, 2013, were excluded from the computation of diluted earnings per share, as their inclusion would be anti-dilutive.

NOTE D. SEGMENT REPORTING

We have two reportable segments, direct-to-customer and retail. The direct-to-customer segment has seven merchandising concepts (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, PBteen, Rejuvenation and Mark and Graham) which sell our products through our e-commerce websites and direct-mail catalogs. Our direct-to-customer merchandising concepts are operating segments, which have been aggregated into one reportable segment, direct-to-customer. The retail segment has five merchandising concepts (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation) which sell our products through our retail stores. Our retail merchandising concepts 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 home-centered products. 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

 

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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 due to the fact that 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 or 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, deferred income taxes, the net book value of corporate facilities and related information systems, and other corporate long-lived assets.

Income tax information by reportable segment has not been included as income taxes are calculated at a company-wide level and are not allocated to each reportable segment.

Segment Information

 

Dollars in thousands    Direct-to-
Customer
     Retail      Unallocated     Total  

Thirteen weeks ended August 3, 2014

          

Net revenues1

   $ 522,589       $   516,513       $ 0      $ 1,039,102   

Depreciation and amortization expense

     7,730         20,358         12,614        40,702   

Operating income (loss)

     120,612         37,058         (72,334     85,336   

Capital expenditures

     13,398         19,548         12,454        45,400   

Thirteen weeks ended August 4, 2013

          

Net revenues1

   $ 477,657       $ 504,552       $ 0      $ 982,209   

Depreciation and amortization expense

     6,096         19,535         11,592        37,223   

Operating income (loss)

     114,491         34,609         (71,014     78,086   

Capital expenditures

     9,993         24,428         15,912        50,333   

Twenty-six weeks ended August 3, 2014

          

Net revenues1

   $ 1,013,878       $ 999,554       $ 0      $ 2,013,432   

Depreciation and amortization expense

     15,137         39,718         24,477        79,332   

Operating income (loss)

     241,748         67,254         (149,340     159,662   

Assets2

     588,234         974,474         600,840        2,163,548   

Capital expenditures

     22,875         34,248         26,396        83,519   

Twenty-six weeks ended August 4, 2013

          

Net revenues1

   $ 896,741       $ 973,276       $ 0      $ 1,870,017   

Depreciation and amortization expense

     12,922         38,752         22,158        73,832   

Operating income (loss)

     210,432         68,625         (137,188     141,869   

Assets2

     470,792         937,720         715,666        2,124,178   

Capital expenditures

     19,699         45,150         32,928        97,777   
1  Includes net revenues of approximately $55.4 million and $50.4 million for the thirteen weeks ended August 3, 2014 and August 4, 2013, respectively, and $106.5 million and $98.5 million for the twenty-six weeks ended August 3, 2014 and August 4, 2013, respectively, related to our foreign operations.
2 Includes approximately $62.2 million and $55.5 million of long-term assets as of August 3, 2014 and August 4, 2013, respectively, related to our foreign operations.

NOTE E. 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

 

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grows larger. Litigation is inherently unpredictable. Any claims against us, whether meritorious or not, could be time consuming, 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 F. STOCK REPURCHASE PROGRAM AND DIVIDEND

Stock Repurchase Program

During the thirteen weeks ended August 3, 2014, we repurchased 847,946 shares of our common stock at an average cost of $69.28 per share for a total cost of approximately $58,745,000. During the twenty-six weeks ended August 3, 2014, we repurchased 1,688,707 shares of our common stock at an average cost of $66.35 per share for a total cost of approximately $112,054,000. As of August 3, 2014, we held treasury stock of $2,451,000 which represents the cost of shares available for issuance in certain foreign jurisdictions as a result of future stock award exercises or releases.

During the thirteen weeks ended August 4, 2013, we repurchased 1,613,943 shares of our common stock at an average cost of $55.66 per share for a total cost of $89,832,000. During the twenty-six weeks ended August 4, 2013, we repurchased 2,414,825 shares of our common stock at an average cost of $54.25 per share for a total cost of $131,006,000.

Stock repurchases under this 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. This stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice.

Dividend

We declared cash dividends of $0.33 and $0.31 per common share for the thirteen weeks ended August 3, 2014 and August 4, 2013, respectively. We declared cash dividends of $0.66 and $0.62 per common share for the twenty-six weeks ended August 3, 2014 and August 4, 2013, respectively.

NOTE G. DERIVATIVE FINANCIAL INSTRUMENTS

Substantially all of our purchases and sales are denominated in U.S. dollars, which limits our exposure to foreign currency exchange rate fluctuations. However, we are exposed to foreign currency exchange risk related to the transactions of our foreign subsidiaries. While the impact of foreign currency exchange rate fluctuations was not significant in the second quarter of fiscal 2014, as we continue to expand globally, the foreign currency exchange risk related to the transactions of our foreign subsidiaries will 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. We do not enter into such contracts for speculative purposes.

The assets or liabilities associated with the derivative instruments are measured at fair value and recorded in either other current assets or other current liabilities. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on whether the derivative instrument is designated as a hedge and qualifies for hedge accounting in accordance with the Financial Accounting Standards Board Accounting Standard Codification (“ASC”) 815, Derivatives and Hedging.

 

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Cash Flow Hedges

We enter into foreign currency forward contracts designated as cash flow hedges for forecasted inventory purchases in U.S. dollars by our foreign subsidiaries. These hedges generally have terms of up to 12 months. The hedges are designed to offset changes to future cash flows 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 either the hedged forecasted inventory purchase occurs or the respective contracts reach maturity. Subsequently, as the inventory is sold to the customer, we reclassify the 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 other income (expense), net. Based on the rates in effect as of August 3, 2014, we expect to reclassify a net gain of approximately $19,000 from OCI to cost of goods sold over the next 12 months.

We also enter into non-designated foreign currency contracts to reduce the exchange risk associated with our assets and liabilities denominated in a foreign currency. Any foreign exchange gains (losses) related to these contracts are recognized in other income (expense), net.

As of August 3, 2014, and August 4, 2013, we had foreign currency forward contracts outstanding (in U.S. dollars) as follows:

 

Dollars in thousands    August 3, 2014      August 4, 2013  

Contracts to sell Canadian dollars and buy U.S. dollars

     

Contracts designated as cash flow hedges

   $ 24,400       $ 19,400   

Contracts not designated as cash flow hedges 1

   $ 0       $ 3,800   

Contracts to sell Australian dollars and buy U.S. dollars

     

Contracts not designated as cash flow hedges

   $ 10,410       $ 5,000   
                   
1 These contracts are no longer designated as cash flow hedges as the related inventory purchases have occurred.

Hedge effectiveness is evaluated prospectively at inception, on an ongoing basis, as well as retrospectively using regression analysis. Any measureable ineffectiveness of the hedge is recorded in other income (expense), net. 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 twenty-six weeks ended August 3, 2014 and August 4, 2013.

The effect of derivative instruments in our Condensed Consolidated Financial Statements, pre-tax, was as follows:

 

Dollars in thousands   

Thirteen

Weeks Ended

August 3, 2014

   

Thirteen

Weeks Ended

August 4, 2013

   

Twenty-Six

Weeks Ended
August 3, 2014

   

Twenty-Six

Weeks Ended
August 4, 2013

 

Net gain (loss) recognized in OCI

   $ 22      $ 292      $ (202   $ 123   

Net gain reclassified from OCI into cost of goods sold

     287        0        520        0   

Net foreign exchange gain (loss) recognized in other income (expense):

        

Instruments designated as cash flow hedges 1

     (53     (29     (87     (42

Instruments not designated or de-designated during the period 2

     36        222        620        222   
                                  
1  Changes in fair value of the forward contract related to interest charges or “forward points.”
2 Changes in fair value subsequent to de-designation for instruments no longer designated as cash flow hedges, and changes in fair value related to instruments not designated as cash flow hedges.

The fair values of our derivative financial instruments are presented below. All fair values for these derivatives were measured using Level 2 inputs as defined by the fair value hierarchy described in Note H.

 

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Dollars in thousands    Balance sheet location    August 3, 2014     August 4, 2013  

Derivatives designated as hedging instruments:

       

Cash flow hedge foreign currency forward contracts

   Other current assets    $ 150      $ 107   

Cash flow hedge foreign currency forward contracts

   Other current liabilities      (198     (48
                       

Total

      $ (48   $ 59   
                       

Derivatives not designated as hedging instruments:

       

Foreign currency forward contracts

   Other current assets    $ 0      $ 204   

Foreign currency forward contracts

   Other current liabilities      (16     0   
                       

Total

      $ (16   $ 204   
                       

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.

Amounts recorded within accumulated other comprehensive income (“AOCI”) associated with our derivative instruments were as follows:

 

Dollars in thousands   

Thirteen

Weeks Ended

August 3, 2014

   

Thirteen

Weeks Ended

August 4, 2013

   

Twenty-Six

Weeks Ended

August 3, 2014

   

Twenty-Six

Weeks Ended

August 4, 2013

 

AOCI beginning balance amount of gain (loss)

   $ 284      $ (169   $ 741      $ 0   

Amounts recognized in OCI before reclassifications

     22        292        (202     123   

Amounts reclassified from OCI into cost of goods sold

     (287     0        (520     0   
                                  

AOCI ending balance amount of gain

   $ 19      $ 123      $ 19      $ 123   
                                  

NOTE H. 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.

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

 

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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 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 entered into are subject to credit risk-related contingent features or collateral requirements. Our policy is to present the fair value of our foreign currency derivatives on a gross basis in our Balance Sheet as these instruments are not subject to legal right of offset or other netting arrangements with our counterparties.

There were no transfers between Level 1 and Level 2 categories during the thirteen and twenty-six weeks ended August 3, 2014.

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 beliefs regarding the resolution of current lawsuits, claims and proceedings; our three year stock repurchase program; our expectations regarding our cash flow hedges and foreign currency risks; our planned use of cash; our compliance with our financial covenants; 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 plans to expand our operations globally; 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, those discussed under the heading “Risk Factors” in this document and our Annual Report on Form 10-K for the year ended February 2, 2014, 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 eight 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 589 stores. Williams-Sonoma, Inc. currently operates in the United States, Canada, Australia and the United Kingdom, offers international shipping to customers worldwide, and has unaffiliated franchisees that operate stores in the Middle East and the Philippines.

The following discussion and analysis of financial condition, results of operations, and liquidity and capital resources for the thirteen weeks ended August 3, 2014 (“second quarter of fiscal 2014”), as compared to the thirteen weeks ended August 4, 2013 (“second quarter of fiscal 2013”) and the twenty-six weeks ended August 3, 2014 (“year-to-date 2014”), as compared to the twenty-six weeks ended August 4, 2013 (“year-to-date 2013”), should be read in conjunction with our Condensed Consolidated Financial Statements and the notes thereto.

 

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

Second Quarter of Fiscal 2014 Financial Results

In the second quarter of fiscal 2014, our net revenues increased 5.8% to $1,039,102,000, compared to $982,209,000 in the second quarter of fiscal 2013, with comparable brand revenue growth of 5.7%. Diluted earnings per share in the second quarter of fiscal 2014 increased to $0.53, versus $0.49 in the second quarter of fiscal 2013, and we returned $89,850,000 to our stockholders through stock repurchases and dividends.

Direct-to-customer net revenues in the second quarter of fiscal 2014 increased $44,932,000, or 9.4%, compared to the second quarter of fiscal 2013, primarily driven by West Elm, Pottery Barn, Williams-Sonoma, and Pottery Barn Kids. Direct-to-customer net revenues generated 50% of our total company net revenues in the second quarter of fiscal 2014 compared to 49% in the second quarter of fiscal 2013.

Retail net revenues in the second quarter of fiscal 2014 increased $11,961,000, or 2.4%, compared to the second quarter of fiscal 2013, primarily driven by West Elm and Pottery Barn, partially offset by a decrease in Williams-Sonoma.

In Pottery Barn, our largest brand, comparable brand revenues increased 4.4% in the second quarter of fiscal 2014 on top of an increase of 9.9% in the second quarter of fiscal 2013, driven by furniture with strong performance across our upholstery and outdoor furniture collections. In the Williams-Sonoma brand, comparable brand revenues increased 3.4% in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013, with strong performance in the cutlery, tabletop, electrics, cookware and food product categories. In West Elm, comparable brand revenues increased 16.7% in the second quarter of fiscal 2014 on top of 16.5% in the second quarter of fiscal 2013. Brand growth continued to be broad-based across many categories. In Pottery Barn Kids, comparable brand revenues increased 5.6% in the second quarter of fiscal 2014 on top of 8.2% in the second quarter of fiscal 2013. The introduction of new furniture collections was a key contributor to this growth. In PBteen, comparable brand revenues decreased 1.0% in the second quarter of fiscal 2014 on top of an increase of 16.3% in the second quarter of fiscal 2013. Although furniture demand remained strong, our net revenues were primarily impacted by increased backorders in furniture due to the recent political unrest in Vietnam, as well as a decrease in net revenues in our dorm and gear product categories.

Results of Operations

NET REVENUES

Net revenues consist of direct-to-customer net revenues and retail net revenues. Direct-to-customer 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, 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.

 

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The following table summarizes our net revenues for the second quarter of fiscal 2014 and fiscal 2013, and year-to-date 2014 and 2013:

 

     Thirteen Weeks Ended     Twenty-Six Weeks Ended  
Dollars in thousands    August 3,
2014
     % Total     August 4,
2013
     % Total     August 3,
2014
     % Total     August 4,
2013
     % Total  

Direct-to-customer net revenues

   $ 522,589         50.3   $ 477,657         48.6   $ 1,013,878         50.4   $ 896,741         48.0

Retail net revenues

     516,513         49.7     504,552         51.4     999,554         49.6     973,276         52.0
                                                                      

Net revenues

   $ 1,039,102         100.0   $ 982,209         100.0   $ 2,013,432         100.0   $ 1,870,017         100.0
                                                                      

Net revenues in the second quarter of fiscal 2014 increased by $56,893,000, or 5.8%, compared to the second quarter of fiscal 2013, with comparable brand revenue growth of 5.7%. This increase was primarily driven by the West Elm and Pottery Barn brands.

Net revenues for year-to-date 2014 increased by $143,415,000, or 7.7%, compared to year-to-date 2013, with comparable brand revenue growth of 7.8%. This increase was primarily driven by the Pottery Barn and West Elm brands.

Comparable Brand Revenue Growth

Comparable brand revenues include retail comparable store sales and direct-to-customer sales, as well as shipping fees, sales returns and other discounts associated with current period sales. Outlet comparable store net revenues are included in their respective brands. Sales related to our international franchised stores have been excluded as these stores are not operated by us. Comparable stores are defined as permanent stores in which 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.

Percentages represent changes in comparable brand revenues compared to the same period in the prior year.

 

     Thirteen Weeks Ended     Twenty-Six Weeks Ended  
Comparable brand revenue growth (decline)    August 3,
2014
    August 4,
2013
    August 3,
2014
   

August 4,

2013

 

Pottery Barn

     4.4     9.9     7.0     8.8

Williams-Sonoma

     3.4     (0.4 %)      4.7     0.7

Pottery Barn Kids

     5.6     8.2     6.8     7.6

West Elm

     16.7     16.5     17.7     14.2

PBteen

     (1.0 %)      16.3     4.2     16.2
                                  

Williams-Sonoma, Inc.

     5.7     8.4     7.8     7.8
                                  

DIRECT-TO-CUSTOMER NET REVENUES

 

     Thirteen Weeks Ended     Twenty-Six Weeks Ended  
Dollars in thousands    August 3,
2014
    August 4,
2013
    August 3,
2014
    August 4,
2013
 

Direct-to-customer net revenues

   $ 522,589      $ 477,657      $ 1,013,878      $ 896,741   

Direct-to-customer net revenue growth

     9.4     15.3     13.1     13.7
                                  

Direct-to-customer net revenues in the second quarter of fiscal 2014 increased $44,932,000, or 9.4%, compared to the second quarter of fiscal 2013, primarily driven by West Elm, Pottery Barn, Williams-Sonoma, and Pottery Barn Kids. Direct-to-customer net revenues generated 50% of our total company net revenues in the second quarter of fiscal 2014 compared to 49% in the second quarter of fiscal 2013.

Direct-to-customer net revenues for year-to-date 2014 increased $117,137,000, or 13.1%, compared to year-to-date 2013, with increases across all brands. This growth was primarily led by Pottery Barn, West Elm, Williams-Sonoma, and Pottery Barn Kids.

 

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RETAIL NET REVENUES AND OTHER DATA

 

     Thirteen Weeks Ended     Twenty-Six Weeks Ended  
Dollars in thousands    August 3,
2014
    August 4,
2013
    August 3,
2014
    August 4,
2013
 

Retail net revenues

   $ 516,513      $ 504,552      $ 999,554      $ 973,276   

Retail net revenue growth

     2.4     9.7     2.7     7.8

Store count - beginning of period

     589        587        585        581   

Store openings

     2        5        9        16   

Store closings

     (2     (2     (5     (7

Store count - end of period1, 2

     589        590        589        590   

Store selling square footage at period-end

     3,598,000        3,600,000        3,598,000        3,600,000   

Store leased square footage (“LSF”) at period-end

     5,843,000        5,863,000        5,843,000        5,863,000   
                                  
1  Included in the fiscal 2014 numbers above are 5 stores in Australia and 1 West Elm store in the United Kingdom.
2  Included in the fiscal 2013 numbers above are 4 stores in Australia.

 

     Store Count      Avg. LSF Per Store  
     

May 4,

2014

     Openings      Closings    

August 3,

2014

     August 4,
2013
     August 3,
2014
    

August 4,

2013

 

Williams-Sonoma

     248                 (1     247         253         6,600         6,600   

Pottery Barn

     195                        195         196         13,700         13,800   

Pottery Barn Kids

     84         1         (1     84         86         7,700         8,000   

West Elm

     58         1                59         51         14,000         14,600   

Rejuvenation

     4                        4         4         13,200         13,200   
                                                               

Total

     589         2         (2     589         590         9,900         9,900   
                                                               

Retail net revenues in the second quarter of fiscal 2014 increased $11,961,000, or 2.4%, compared to the second quarter of fiscal 2013, primarily driven by West Elm and Pottery Barn, partially offset by a decrease in Williams-Sonoma.

Retail net revenues for year-to-date 2014 increased $26,278,000, or 2.7%, compared to year-to-date 2013, primarily driven by West Elm and Pottery Barn, partially offset by a decrease in our international franchise operations and Williams-Sonoma.

COST OF GOODS SOLD

 

     Thirteen Weeks Ended     Twenty-Six Weeks Ended  
Dollars in thousands    August 3,
2014
     % Net
Revenues
    August 4,
2013
     % Net
Revenues
    August 3,
2014
     % Net
Revenues
    August 4,
2013
     % Net
Revenues
 

Cost of goods sold1

   $ 657,004         63.2   $ 613,285         62.4   $ 1,262,926         62.7   $ 1,166,908         62.4
                                                                      
1 Includes total occupancy expenses of $148,142,000 and $138,068,000 for the second quarter of fiscal 2014 and second quarter of fiscal 2013, respectively, and $294,581,000 and $271,072,000 for year-to-date 2014 and year-to-date 2013, 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.

 

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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 direct-to-customer 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 direct-to-customer channel incurs higher customer shipping, damage and replacement costs than the retail channel.

Second Quarter of Fiscal 2014 vs. Second Quarter of Fiscal 2013

Cost of goods sold increased by $43,719,000, or 7.1%, in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013. Cost of goods sold as a percentage of net revenues increased to 63.2% in the second quarter of fiscal 2014 from 62.4% in the second quarter of fiscal 2013. This increase was primarily driven by lower selling margins and occupancy deleverage.

In the direct-to-customer channel, cost of goods sold as a percentage of net revenues increased in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013 primarily driven by lower selling margins and occupancy deleverage.

In the retail channel, cost of goods sold as a percentage of net revenues increased in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013 primarily driven by occupancy deleverage.

Year-to-Date 2014 vs. Year-to-Date 2013

Cost of goods sold for year-to-date 2014 increased by $96,018,000, or 8.2%, compared to year-to-date 2013. Cost of goods sold as a percentage of net revenues increased to 62.7% for year-to-date 2014 from 62.4% for year-to-date 2013. This increase was primarily driven by lower selling margins and occupancy deleverage.

In the direct-to-customer channel, cost of goods sold as a percentage of net revenues increased for year-to-date 2014 compared to year-to-date 2013 primarily driven by lower selling margins and occupancy deleverage.

In the retail channel, cost of goods sold as a percentage of net revenues increased for year-to-date 2014 compared to year-to-date 2013 primarily driven by occupancy deleverage, partially offset by higher selling margins.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

     Thirteen Weeks Ended     Twenty-Six Weeks Ended  
Dollars in thousands    August 3,
2014
     % Net
Revenues
    August 4,
2013
     % Net
Revenues
    August 3,
2014
     % Net
Revenues
    August 4,
2013
     % Net
Revenues
 

Selling, general and administrative expenses

   $ 296,762         28.6   $ 290,838         29.6   $ 590,844         29.3   $ 561,240         30.0
                                                                      

Selling, general and administrative expenses consist of non-occupancy related costs associated with our retail stores, distribution warehouses, 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.

 

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

Second Quarter of Fiscal 2014 vs. Second Quarter of Fiscal 2013

Selling, general and administrative expenses increased by $5,924,000, or 2.0%, in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013. Selling, general and administrative expenses as a percentage of net revenues decreased to 28.6% in the second quarter of fiscal 2014 from 29.6% in the second quarter of fiscal 2013. This decrease as a percentage of net revenues was primarily driven by lower general expenses and advertising efficiency.

In the direct-to-customer channel, selling, general and administrative expenses as a percentage of net revenues decreased in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013 primarily driven by advertising efficiency, partially offset by the deleverage of employment costs.

In the retail channel, selling, general and administrative expenses as a percentage of net revenues decreased in the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013 primarily driven by lower general expenses, partially offset by the deleverage of employment costs.

Year-to-Date 2014 vs. Year-to-Date 2013

Selling, general and administrative expenses for year-to-date 2014 increased by $29,604,000, or 5.3%, compared to year-to-date 2013. Selling, general and administrative expenses as a percentage of net revenues decreased to 29.3% for year-to-date 2014 from 30.0% for year-to-date 2013. This decrease was primarily driven by advertising efficiency and the leverage of general expenses.

In the direct-to-customer channel, selling, general and administrative expenses as a percentage of net revenues decreased for year-to-date 2014 compared to year-to-date 2013 primarily driven by advertising efficiency.

In the retail channel, selling, general and administrative expenses as a percentage of net revenues increased for year-to-date 2014 compared to year-to-date 2013 primarily driven by the deleverage of employment costs, partially offset by the leverage of general expenses.

INCOME TAXES

Our effective tax rate was 39.3% for year-to-date 2014 compared to 37.8% for year-to-date 2013, reflecting certain unfavorable income tax matters.

LIQUIDITY AND CAPITAL RESOURCES

As of August 3, 2014, we held $70,574,000 in cash and cash equivalent funds, the majority of which is held in demand deposit accounts, including $60,937,000 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.

Throughout the fiscal year, we utilize our cash balances to build our inventory levels in preparation for our fourth quarter holiday sales. In fiscal 2014, we plan to use our cash resources to fund our inventory and inventory related purchases, advertising and marketing initiatives, stock repurchases and dividend payments and purchases of property and equipment. In addition to our cash balances on hand, we have a $300,000,000 unsecured revolving line of credit (“credit facility”) that may be used for loans or letters of credit. Prior to December 22, 2016, we

 

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may, upon notice to the lenders, request an increase in the credit facility of up to $200,000,000 to provide for a total of $500,000,000 of unsecured revolving credit. During the thirteen and twenty-six weeks ended August 3, 2014 and August 4, 2013, we had no borrowings under the credit facility, and no amounts were outstanding as of August 3, 2014 or August 4, 2013. During the quarter, we redeemed restricted cash deposits of $14,289,000 previously held under collateralized trust agreements. These deposits, which secured potential liabilities associated with our workers’ compensation and other insurance programs, were replaced with standby letters of credit upon redemption. As of August 3, 2014, a total of $17,440,000 in issued but undrawn standby letters of credit was outstanding under the credit facility. Additionally, as of August 3, 2014, we had three unsecured letter of credit reimbursement facilities for a total of $70,000,000, of which an aggregate of $9,065,000 was outstanding. On August 29, 2014, we renewed all three of our letter of credit facilities for an aggregate of $70,000,000, and each of these facilities now matures on August 28, 2015. 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 and, based on our current projections, we expect to remain in compliance throughout fiscal 2014. 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 2014, net cash provided by operating activities was $10,217,000 compared to $64,063,000 for year-to-date 2013. For year-to-date 2014, net cash provided by operating activities was primarily attributable to net earnings adjusted for non-cash items, partially offset by an increase in merchandise inventories as well as a decrease in accounts payable, income taxes payable, and accrued liabilities, due to the timing of payments. This represents a decrease in net cash provided by operating activities, compared to year-to-date 2013, primarily due to a decrease in both accounts payable and accrued liabilities resulting from the timing of payments, partially offset by an increase in net earnings adjusted for non-cash items.

Cash Flows from Investing Activities

For year-to-date 2014, net cash used in investing activities was $68,948,000 compared to $97,415,000 for year-to-date 2013, and was primarily attributable to purchases of property and equipment, partially offset by the redemption of restricted cash deposits we previously held under collateralized trust agreements. Net cash used compared to year-to-date 2013 decreased primarily due to the redemption of restricted cash and a decrease in purchases of property and equipment.

Cash Flows from Financing Activities

For year-to-date 2014, net cash used in financing activities was $200,893,000 compared to $184,315,000 for year-to-date 2013. For year-to-date 2014, net cash used in financing activities was primarily attributable to repurchases of common stock, the payment of dividends and tax withholding payments related to stock-based awards. Net cash used compared to year-to-date 2013 increased primarily due to an increase in tax withholding payments related to stock-based awards.

Stock Repurchase Program and Dividend

See Note F to our Condensed Consolidated Financial Statements, Stock Repurchase Program and Dividend, 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 accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and

 

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expenses and related disclosures of contingent assets and liabilities. The 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 may differ significantly from these estimates. During the second quarter of fiscal 2014, there have been no significant changes to the critical accounting policies discussed in our Annual Report on Form 10-K for the year ended February 2, 2014.

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 anticipation of our holiday selling season, we hire a substantial number of additional temporary employees in our retail stores, customer care centers and distribution centers, and incur significant fixed catalog production and mailing costs.

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 rates, including the devaluation of the U.S. dollar, and the effects of uncertain economic forces 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 line of credit facility is the only instrument we hold with a variable interest rate which could, if drawn upon, subject us to risks associated with changes in that interest rate. As of August 3, 2014, there were no amounts outstanding under our credit facility.

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 August 3, 2014, our investments, made primarily in demand deposit accounts 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 2% of our international purchase transactions are in currencies other than the U.S. dollar, primarily the euro. Any currency risks related to these international purchase transactions were not significant to us during the second quarter of fiscal 2014 or the second quarter of fiscal 2013. Since we pay for the majority of our international purchases in U.S. dollars, however, 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 stores in Canada, Australia and the United Kingdom, and 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. While the impact of foreign currency exchange rate fluctuations was not significant in the second quarter of fiscal 2014, as we continue to expand globally, the foreign currency exchange risk related to the transactions of our foreign subsidiaries will 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 G to our Condensed Consolidated Financial Statements).

 

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of August 3, 2014, 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 SEC.

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 E to our Condensed Consolidated Financial Statements within Part I of this Form 10-Q.

ITEM 1A. RISK FACTORS

See Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended February 2, 2014 for a description of the risks and uncertainties associated with our business. There were no material changes to such risk factors in the current quarterly reporting period.

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

The following table provides information as of August 3, 2014 with respect to shares of common stock we repurchased during the second quarter of fiscal 2014. For additional information, please see Note F 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 Program
     Maximum Dollar Value
of Shares That May Yet
Be Purchased Under the
Program
 

May 5, 2014 to June 1, 2014

     115,830         64.57         115,830         450,434,000   

June 2, 2014 to June 29, 2014

     451,953         69.33         451,953         419,101,000   

June 30, 2014 to August 3, 2014

     280,163         71.15         280,163         399,168,000   
                                     

Total

     847,946         69.28         847,946         399,168,000   
                                     

 

1 In March 2013, our Board of Directors announced a $750,000,000 stock repurchase program. Stock repurchases under this 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. This stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice.

 

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM  5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

(a) Exhibits

 

Exhibit
Number

  

Exhibit Description

  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

 

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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 P. Whalen

  Julie P. Whalen
  Chief Financial Officer

Date: September 12, 2014

 

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