filings.toolsItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Williams-Sonoma, Inc.
Consolidated Statements of Earnings
| In thousands, except per share amounts | Fiscal 2019 (52 weeks) | Fiscal 2018 (53 weeks) | Fiscal 2017 (52 weeks) | |||||||||
| Net revenues | $ | 5,898,008 | $ | 5,671,593 | $ | 5,292,359 | ||||||
| Cost of goods sold | 3,758,916 | 3,570,580 | 3,360,648 | |||||||||
| Gross profit | 2,139,092 | 2,101,013 | 1,931,711 | |||||||||
| Selling, general and administrative expenses | 1,673,218 | 1,665,060 | 1,477,900 | |||||||||
| Operating income | 465,874 | 435,953 | 453,811 | |||||||||
| Interest (income) expense, net | 8,853 | 6,706 | 1,372 | |||||||||
| Earnings before income taxes | 457,021 | 429,247 | 452,439 | |||||||||
| Income taxes | 100,959 | 95,563 | 192,894 | |||||||||
| Net earnings | $ | 356,062 | $ | 333,684 | $ | 259,545 | ||||||
| Basic earnings per share | $ | 4.56 | $ | 4.10 | $ | 3.03 | ||||||
| Diluted earnings per share | $ | 4.49 | $ | 4.05 | $ | 3.02 | ||||||
| Shares used in calculation of earnings per share: | ||||||||||||
| Basic | 78,108 | 81,420 | 85,592 | |||||||||
| Diluted | 79,225 | 82,340 | 86,080 |
See Notes to Consolidated Financial Statements.
Williams-Sonoma, Inc.
Consolidated Statements of Comprehensive Income
| In thousands | Fiscal 2019 (52 weeks) | Fiscal 2018 (53 weeks) | Fiscal 2017 (52 weeks) | |||||||||
| Net earnings | $ | 356,062 | $ | 333,684 | $ | 259,545 | ||||||
| Other comprehensive income (loss): | ||||||||||||
| Foreign currency translation adjustments | (3,334 | ) | (5,032 | ) | 3,730 | |||||||
| Change in fair value of derivative financial instruments, net of tax (tax benefit) of $195, $390 and $(259) | 163 | 1,098 | (715 | ) | ||||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax (tax benefit) of $261, $122 and $(38) | (343 | ) | (357 | ) | 106 | |||||||
| Comprehensive income | $ | 352,548 | $ | 329,393 | $ | 262,666 |
See Notes to Consolidated Financial Statements.
Williams-Sonoma, Inc.
Consolidated Balance Sheets
| In thousands, except per share amounts | Feb. 2, 2020 | Feb. 3, 2019 | ||||||
| ASSETS | ||||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | 432,162 | $ | 338,954 | ||||
| Accounts receivable, net | 111,737 | 107,102 | ||||||
| Merchandise inventories, net | 1,100,544 | 1,124,992 | ||||||
| Prepaid expenses | 90,426 | 101,356 | ||||||
| Other current assets | 20,766 | 21,939 | ||||||
| Total current assets | 1,755,635 | 1,694,343 | ||||||
| Property and equipment, net | 929,038 | 929,635 | ||||||
| Operating lease right-of-use assets | 1,166,383 | — | ||||||
| Deferred income taxes, net | 47,977 | 44,055 | ||||||
| Goodwill | 85,343 | 85,382 | ||||||
| Other long-term assets, net | 69,666 | 59,429 | ||||||
| Total assets | $ | 4,054,042 | $ | 2,812,844 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities | ||||||||
| Accounts payable | $ | 521,235 | $ | 526,702 | ||||
| Accrued expenses | 175,003 | 163,559 | ||||||
| Gift card and other deferred revenue | 289,613 | 290,445 | ||||||
| Income taxes payable | 22,501 | 21,461 | ||||||
| Current debt | 299,818 | — | ||||||
| Operating lease liabilities | 227,923 | — | ||||||
| Other current liabilities | 73,462 | 72,645 | ||||||
| Total current liabilities | 1,609,555 | 1,074,812 | ||||||
| Deferred rent and lease incentives | 27,659 | 201,374 | ||||||
| Long-term debt | — | 299,620 | ||||||
| Long-term operating lease liabilities | 1,094,579 | — | ||||||
| Other long-term liabilities | 86,389 | 81,324 | ||||||
| Total liabilities | 2,818,182 | 1,657,130 | ||||||
| Commitments and contingencies – See Note I | ||||||||
| Stockholders’ equity | ||||||||
| Preferred stock: $.01 par value; 7,500 shares authorized; none issued | — | — | ||||||
| Common stock: $.01 par value; 253,125 shares authorized; 77,137 and 78,813 shares issued and outstanding at February 2, 2020 and February 3, 2019, respectively | 772 | 789 | ||||||
| Additional paid-in capital | 605,822 | 581,900 | ||||||
| Retained earnings | 644,794 | 584,333 | ||||||
| Accumulated other comprehensive loss | (14,587 | ) | (11,073 | ) | ||||
| Treasury stock – at cost: 14 and 2 shares as of February 2, 2020 and February 3, 2019, respectively | (941 | ) | (235 | ) | ||||
| Total stockholders’ equity | 1,235,860 | 1,155,714 | ||||||
| Total liabilities and stockholders’ equity | $ | 4,054,042 | $ | 2,812,844 |
See Notes to Consolidated Financial Statements.
Williams-Sonoma, Inc.
Consolidated Statements of Stockholders’ Equity
| Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Total Stockholders’ Equity | |||||||||||||||||||||||
| In thousands | Shares | Amount | ||||||||||||||||||||||||||
| Balance at January 29, 2017 | 87,325 | $ | 873 | $ | 556,928 | $ | 701,702 | $ | (9,903 | ) | $ | (1,380 | ) | $ | 1,248,220 | |||||||||||||
| Net earnings | — | — | — | 259,545 | — | — | 259,545 | |||||||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | 3,730 | — | 3,730 | |||||||||||||||||||||
| Change in fair value of derivative financial instruments, net of tax | — | — | — | — | (715 | ) | — | (715 | ) | |||||||||||||||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax | — | — | — | — | 106 | — | 106 | |||||||||||||||||||||
| Conversion/release of stock-based awards 1 | 452 | 5 | (17,810 | ) | — | — | (325 | ) | (18,130 | ) | ||||||||||||||||||
| Repurchases of common stock | (4,051 | ) | (41 | ) | (18,518 | ) | (177,620 | ) | — | — | (196,179 | ) | ||||||||||||||||
| Reissuance of treasury stock under stock-based compensation plans 1 | — | — | (554 | ) | (426 | ) | — | 980 | — | |||||||||||||||||||
| Stock-based compensation expense | — | — | 42,768 | — | — | — | 42,768 | |||||||||||||||||||||
| Dividends declared | — | — | — | (135,779 | ) | — | — | (135,779 | ) | |||||||||||||||||||
| Balance at January 28, 2018 | 83,726 | 837 | 562,814 | 647,422 | (6,782 | ) | (725 | ) | 1,203,566 | |||||||||||||||||||
| Net earnings | — | — | — | 333,684 | — | — | 333,684 | |||||||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | (5,032 | ) | — | (5,032 | ) | |||||||||||||||||||
| Change in fair value of derivative financial instruments, net of tax | — | — | — | — | 1,098 | — | 1,098 | |||||||||||||||||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax | — | — | — | — | (357 | ) | — | (357 | ) | |||||||||||||||||||
| Conversion/release of stock-based awards 1 | 460 | 5 | (14,149 | ) | — | — | (291 | ) | (14,435 | ) | ||||||||||||||||||
| Repurchases of common stock | (5,373 | ) | (53 | ) | (25,775 | ) | (269,476 | ) | — | — | (295,304 | ) | ||||||||||||||||
| Reissuance of treasury stock under stock-based compensation plans 1 | — | — | (418 | ) | (363 | ) | — | 781 | — | |||||||||||||||||||
| Stock-based compensation expense | — | — | 59,428 | — | — | — | 59,428 | |||||||||||||||||||||
| Dividends declared | — | — | — | (144,609 | ) | — | — | (144,609 | ) | |||||||||||||||||||
| Adoption of accounting pronouncements 2 | — | — | — | 17,675 | — | — | 17,675 | |||||||||||||||||||||
| Balance at February 3, 2019 | 78,813 | 789 | 581,900 | 584,333 | (11,073 | ) | (235 | ) | 1,155,714 | |||||||||||||||||||
| Net earnings | — | — | — | 356,062 | — | — | 356,062 | |||||||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | (3,334 | ) | — | (3,334 | ) | |||||||||||||||||||
| Change in fair value of derivative financial instruments, net of tax | — | — | — | — | 163 | — | 163 | |||||||||||||||||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax | — | — | — | — | (343 | ) | — | (343 | ) | |||||||||||||||||||
| Conversion/release of stock-based awards 1 | 649 | 6 | (27,624 | ) | — | — | (134 | ) | (27,752 | ) | ||||||||||||||||||
| Repurchases of common stock | (2,325 | ) | (23 | ) | (11,658 | ) | (136,195 | ) | — | (958 | ) | (148,834 | ) | |||||||||||||||
| Reissuance of treasury stock under stock-based compensation plans 1 | — | — | (386 | ) | — | — | 386 | — | ||||||||||||||||||||
| Stock-based compensation expense | — | — | 63,590 | — | — | — | 63,590 | |||||||||||||||||||||
| Dividends declared | — | — | — | (156,103 | ) | — | — | (156,103 | ) | |||||||||||||||||||
| Adoption of accounting pronouncements 3 | — | — | — | (3,303 | ) | — | — | (3,303 | ) | |||||||||||||||||||
| Balance at February 2, 2020 | 77,137 | $ | 772 | $ | 605,822 | $ | 644,794 | $ | (14,587 | ) | $ | (941 | ) | $ | 1,235,860 |
| 1 | Amounts are shown net of shares withheld for employee taxes. |
|---|
| 2 | Primarily relates to our adoption of ASU 2014-09, Revenue from Contracts with Customers, in fiscal 2018. See Note A. |
|---|
| 3 | Relates to our adoption of ASU 2016-02, Leases, in fiscal 2019. See Note A. |
|---|
See Notes to Consolidated Financial Statements.
Williams-Sonoma, Inc.
Consolidated Statements of Cash Flows
| In thousands | Fiscal 2019 (52 Weeks) | Fiscal 2018 (53 Weeks) | Fiscal 2017 (52 Weeks) | |||||||||
| Cash flows from operating activities: | ||||||||||||
| Net earnings | $ | 356,062 | $ | 333,684 | $ | 259,545 | ||||||
| Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: | ||||||||||||
| Depreciation and amortization | 187,759 | 188,808 | 183,077 | |||||||||
| Loss on disposal/impairment of assets | 1,755 | 10,209 | 1,889 | |||||||||
| Amortization of deferred lease incentives | (7,714 | ) | (26,199 | ) | (25,372 | ) | ||||||
| Non-cash lease expense | 215,810 | — | — | |||||||||
| Deferred income taxes | (2,557 | ) | 23,639 | 63,381 | ||||||||
| Stock-based compensation expense | 64,163 | 59,802 | 42,988 | |||||||||
| Other | (26 | ) | (579 | ) | (135 | ) | ||||||
| Changes in: | ||||||||||||
| Accounts receivable | (5,034 | ) | (15,329 | ) | 149 | |||||||
| Merchandise inventories | 24,219 | (70,331 | ) | (80,235 | ) | |||||||
| Prepaid catalog expenses | — | — | (1,019 | ) | ||||||||
| Prepaid expenses and other assets | (3,189 | ) | (54,691 | ) | (15,475 | ) | ||||||
| Accounts payable | (11,051 | ) | 62,377 | 2,549 | ||||||||
| Accrued expenses and other liabilities | 13,259 | 45,976 | 9,597 | |||||||||
| Gift card and other deferred revenue | (640 | ) | 38,899 | (3,002 | ) | |||||||
| Deferred rent and lease incentives | — | 24,929 | 28,226 | |||||||||
| Operating lease liabilities | (226,257 | ) | — | — | ||||||||
| Income taxes payable | 735 | (35,208 | ) | 33,541 | ||||||||
| Net cash provided by operating activities | 607,294 | 585,986 | 499,704 | |||||||||
| Cash flows from investing activities: | ||||||||||||
| Purchases of property and equipment | (186,276 | ) | (190,102 | ) | (189,712 | ) | ||||||
| Acquisition of Outward, Inc., net of cash received | — | — | (80,528 | ) | ||||||||
| Other | 728 | 2,203 | 480 | |||||||||
| Net cash used in investing activities | (185,548 | ) | (187,899 | ) | (269,760 | ) | ||||||
| Cash flows from financing activities: | ||||||||||||
| Payment of dividends | (150,640 | ) | (140,325 | ) | (135,010 | ) | ||||||
| Repurchases of common stock | (148,834 | ) | (295,304 | ) | (196,179 | ) | ||||||
| Borrowings under revolving line of credit | 100,000 | 60,000 | 170,000 | |||||||||
| Repayments of borrowings under revolving line of credit | (100,000 | ) | (60,000 | ) | (170,000 | ) | ||||||
| Tax withholdings related to stock-based awards | (27,752 | ) | (14,437 | ) | (18,130 | ) | ||||||
| Proceeds from issuance of long-term debt | — | — | 300,000 | |||||||||
| Debt issuance costs | — | — | (1,191 | ) | ||||||||
| Other | — | — | (1,197 | ) | ||||||||
| Net cash used in financing activities | (327,226 | ) | (450,066 | ) | (51,707 | ) | ||||||
| Effect of exchange rates on cash and cash equivalents | (1,312 | ) | 797 | (1,814 | ) | |||||||
| Net increase (decrease) in cash and cash equivalents | 93,208 | (51,182 | ) | 176,423 | ||||||||
| Cash and cash equivalents at beginning of year | 338,954 | 390,136 | 213,713 | |||||||||
| Cash and cash equivalents at end of year | $ | 432,162 | $ | 338,954 | $ | 390,136 | ||||||
| Supplemental disclosure of cash flow information: | ||||||||||||
| Cash paid during the year for interest | $ | 12,682 | $ | 11,424 | $ | 2,915 | ||||||
| Cash paid during the year for income taxes, net of refunds | $ | 113,344 | $ | 107,951 | $ | 99,062 | ||||||
| Non-cash investing activities: | ||||||||||||
| Purchases of property and equipment not yet paid for at end of year | $ | 2,386 | $ | 2,773 | $ | 1,257 |
See Notes to Consolidated Financial Statements.
Williams-Sonoma, Inc.
Notes to Consolidated Financial Statements
Note A: Summary of Significant Accounting Policies
We are 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, Pottery Barn Teen, Williams Sonoma Home, Rejuvenation, and Mark and Graham — are marketed through
e-commerce
websites, direct-mail catalogs and 614 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 2017, we acquired Outward, Inc., a
3-D
imaging and augmented reality platform for the home furnishings and décor industry.
Consolidation
The Consolidated Financial Statements include the accounts of Williams-Sonoma, Inc. and its subsidiaries. All intercompany transactions and balances have been eliminated.
Fiscal Year
Our fiscal year ends on the Sunday closest to January 31, based on a 52 or
53-week
year. Fiscal 2019, a
52-week
year, ended on February 2, 2020; Fiscal 2018, a
53-week
year, ended on February 3, 2019; and Fiscal 2017, a
52-week
year, ended on January 28, 2018.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America 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 from these estimates.
Cash Equivalents
Cash equivalents include highly liquid investments with an original maturity of three months or less. As of February 2, 2020, we were invested primarily in interest-bearing demand deposit accounts and money market funds. Book cash overdrafts issued, but not yet presented to the bank for payment, are reclassified to accounts payable.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are stated at their carrying values, net of an allowance for doubtful accounts. Accounts receivable consist primarily of credit card, franchisee and landlord receivables for which collectability is reasonably assured. Receivables are evaluated for collectability on a regular basis and an allowance for doubtful accounts is recorded, if necessary. Our allowance for doubtful accounts was not material to our financial statements as of February 2, 2020 and February 3, 2019.
Merchandise Inventories
Merchandise inventories, net of an allowance for shrinkage and obsolescence, are stated at the lower of cost (weighted average method) or market. To determine if the value of our inventory should be reduced below cost, we consider current and anticipated demand, customer preferences and age of the merchandise. The significant estimates used in inventory valuation are obsolescence (including excess and slow-moving inventory and lower of cost or market reserves) and estimates of inventory shrinkage. We reserve for obsolescence based on historical trends of inventory sold below cost and specific identification.
Reserves for shrinkage are estimated and recorded throughout the year as a
percentage
of net sales based on historical shrinkage results, cycle count results within our distribution centers, expectations of future shrinkage and current inventory levels. Actual shrinkage is recorded at
year-end
based on the results of our cycle counts and physical inventory counts and can vary from our estimates due to such factors as changes in operations, the mix of our inventory (which ranges from large furniture to small tabletop items) and execution against loss prevention initiatives in our stores, distribution facilities,
off-site
storage locations, and with our third-party warehouse and transportation providers. Accordingly, there is no shrinkage reserve at
year-end,
with the exception of a cycle count reserve based on the historical cycle count results in our distribution centers. This reserve was not material to our Consolidated Financial Statements as of February 2, 2020. Historically, actual shrinkage has not differed materially from our estimates.
Our obsolescence and shrinkage reserve calculations contain estimates that require management to make assumptions and to apply judgment regarding a number of factors, including market conditions, the selling environment, historical results and current inventory trends. If actual obsolescence or shrinkage estimates change from our original estimate, we will adjust our reserves accordingly throughout the year. We made no material changes to our assumptions included in the calculations of the obsolescence and shrinkage reserves throughout the year. As of February 2, 2020, and February 3, 2019, our inventory obsolescence reserves were $13,424,000 and $13,580,000, respectively.
Long-lived Assets
Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives of the assets:
| Leasehold improvements | Shorter of estimated useful life or lease term (generally 5 – 22 years) | |
| Fixtures and equipment | 2 – 20 years | |
| Buildings and building improvements | 10 – 40 years | |
| Capitalized software | 2 – 10 years |
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 or asset group may not be recoverable. Our impairment analyses determine whether projected cash flows from operations are sufficient to recover the carrying value of these assets. The asset group is comprised of both property and equipment and operating lease
right-of-use
assets. Impairment may result when the carrying value of the asset or asset group exceeds the estimated undiscounted future cash flows over its remaining useful life. For store asset impairment, our estimate of undiscounted future cash flows over the store lease term is based upon our experience, the historical operations of the stores and estimates of future store profitability and economic conditions. The estimates of future store profitability and economic conditions require estimating such factors as sales growth, gross margin, employment costs, lease escalations, inflation and the overall economics of the retail industry, and are therefore subject to variability and difficult to predict. For
right-of-use
assets, we determine the fair value of the assets by using estimated market rental rates. These estimates can be affected by factors such as future store results, real estate demand, store closure plans, and economic conditions that can be difficult to predict. Actual future results may differ from those estimates. If a long-lived asset is found to be impaired, the amount recognized for impairment is equal to the excess of the asset or asset group’s net carrying value over its estimated fair value. We measure property and equipment at fair
value
on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy (see Note M to our Consolidated Financial Statements). We measure
right-of-use
assets at fair value on a nonrecurring basis using Level 2 inputs, primarily market rental rates, that are corroborated by market data. Where Level 2 inputs are not readily available, we use Level 3 inputs. Fair value of these long-lived assets is based on the present value of estimated future cash flows using a discount rate commensurate with the risk.
During fiscal 2019, we recorded an approximate
$
3,303,000
, net of tax, reduction to the opening balance of retained earnings resulting from the impairment of certain long-lived assets upon adoption of Accounting
Standards Update (“ASU”)
2016-02,
Leases
. During fiscal 2018, we recorded asset impairment charges of
approximately
$
9,639,000
,
related to our retail stores, which is recorded within selling, general and administrative expenses. During fiscal 2017, we did not record any asset impairment charges.
Leases
We lease store locations, distribution and manufacturing facilities, corporate facilities, customer care
centers
and certain equipment for our U.S. and foreign operations with initial terms generally ranging from 2 to 22 years. We determine whether an arrangement is or contains a lease at inception by evaluating potential lease agreements including services and operating agreements to determine whether an identified asset exists that we control over the term of the arrangement. Lease commencement is determined to be when the lessor provides us access to, and the right to control, the identified asset.
The rental payments for our leases are typically structured as either fixed or variable payments. Our fixed rent payments include: stated minimum rent and stated minimum rent with stated increases. We consider lease payments that cannot be predicted with reasonable certainty upon lease commencement to be variable lease payments, which are recorded as incurred each period and are excluded from our calculation of lease liabilities. Our variable rent payments include: rent increases based on a future index; rent based on a percentage of store sales; payments made for pass-through costs for property taxes, insurance, utilities and common area maintenance; and rent based on a percentage of store sales if a specified store sales threshold or contractual obligation of the landlord has not been met.
Upon lease commencement, we recognize a
right-of
use asset and a corresponding lease liability measured at the present value of the fixed future minimum lease payments. We have elected the practical expedient to not separate lease and
non-lease
components. Therefore, lease payments included in the measurement of the lease liability include all fixed payments in the lease arrangement. We record a
right-of-use
asset for an amount equal to the lease liability, increased for any prepaid lease costs and initial direct costs and reduced by any lease incentives. We remeasure the lease liability and
right-of-use
asset when a remeasurement event occurs. Many of our leases contain renewal and early termination options. The option periods are generally not included in the lease term used to measure our lease liabilities and
right-of-use
assets upon commencement, as we do not believe the exercise of these options to be reasonably certain. We remeasure the lease liability and
right-of-use
asset once we are reasonably certain to exercise a renewal or an early termination option.
Our leases generally do not provide information about the rate implicit in the lease. Therefore, we utilized an incremental borrowing rate to calculate the present value of our future lease obligations. The incremental borrowing rate represents the rate of interest we would have to pay on a collateralized borrowing, for an amount equal to the lease payments, over a similar term and in a similar economic environment. We use judgment in determining our incremental borrowing rate, which is applied to each lease based on the lease term. An increase or decrease in the incremental borrowing rate applied would impact the value of our
right-of-use
assets and lease liabilities.
We use judgment in determining lease classification, including our determination of the economic life and the fair market value of the identified asset. The fair market value of the identified asset is generally estimated based on comparable market data provided by third-party sources. All of our leases are currently classified as operating leases.
Goodwill
Goodwill is initially recorded as of the acquisition date, and is measured as any excess of the purchase price over the estimated fair value of the identifiable net assets acquired. Goodwill is not amortized, but rather is subject to impairment testing annually (on the first day of the fourth quarter), or between annual tests whenever events or changes in circumstances indicate that the fair value of a reporting unit may be below its carrying amount. We first perform a qualitative assessment to evaluate goodwill for potential impairment. If based on that assessment it is more likely than not that the fair value of the reporting unit is below its carrying value, a quantitative impairment test is necessary. The quantitative impairment test requires determining the fair value of the reporting unit. We use the income approach, whereby we calculate the fair value based on the present value of estimated
future cash flows, using a discount rate that approximates our weighted average cost of capital. The process of evaluating the potential impairment of goodwill is subjective and requires significant estimates and assumptions about the future such as sales growth, gross margins, employment costs, capital expenditures, inflation and future economic and market conditions. Actual future results may differ from those estimates. If the carrying value of the reporting unit’s assets and liabilities, including goodwill, exceeds its fair value, impairment is recorded for the excess, not to exceed the total amount of goodwill allocated to the reporting unit
.
As of February 2, 2020 and February 3, 2019, we had goodwill of $85,343,000 and $85,382,000, respectively, primarily related to our fiscal 2017 acquisition of Outward (see Note O) and to our fiscal 2011 acquisition of Rejuvenation, Inc. In fiscal 2019, fiscal 2018 and fiscal 2017, we performed a qualitative assessment of potential goodwill impairment and determined it was more likely than not that the fair value of each of our reporting units exceeded its carrying value. Accordingly, no further impairment testing of goodwill was performed. We did not recognize any goodwill impairment in fiscal 2019, fiscal 2018 or fiscal 2017.
Self-Insured Liabilities
We are primarily self-insured for workers’ compensation, employee health benefits, product and other general liability claims. We record self-insurance liability reserves based on claims filed, including the development of those claims, and an estimate of claims incurred but not yet reported, based on an actuarial analysis of historical claims data. Factors affecting these estimates include future inflation rates, changes in severity, benefit level changes, medical costs and claim settlement patterns. Should a different number of claims occur compared to what was estimated, or costs of the claims increase or decrease beyond what was anticipated, reserves may need to be adjusted accordingly. Self-insurance reserves for workers’ compensation, employee health benefits, product and other general liability claims were $27,000,000 and $28,542,000 as of February 2, 2020 and February 3, 2019, respectively.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, accounts receivable, accounts payable and debt approximate their estimated fair values. We use derivative financial instruments to hedge against foreign currency exchange rate fluctuations. The assets or liabilities associated with our derivative financial instruments are recorded at fair value in either other current or long-term assets or other current or long-term liabilities. The fair value of our foreign currency derivative instruments is measured using the income approach
,
whereby we use observable market data at the measurement date and standard valuation techniques to convert future amounts to a single present value amount. These observable inputs include spot rates, forward rates, interest rates and credit derivative market rates (see Notes L and M for additional information).
Revenue
from 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 customer. For merchandise delivered to the customer, control is transferred either when delivery has been completed, or when we have a present right to payment which, for certain merchandise, occurs upon conveyance of the merchandise to the carrier for delivery. 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. 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 February 2, 2020 and February 3, 2019, we recorded a liability for expected sales returns of approximately
$
25,456,000 and $26,276,000
within other current liabilities and a corresponding asset for the expected net realizable value of the merchandise inventory to be returned of approximately
$
9,941,000
and $
10,030,000
within other current assets in our Consolidated Balance Sheet.
Gift Card and Other 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, customer loyalty programs, and incentives received from credit card issuers.
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
s
issuance. Breakage revenue is not material to our Consolidated Financial Statements.
For merchandise sales, we record a liability at each period end where we have not fulfilled our obligation to transfer goods or services to the customer, but for which we have already received consideration or have a right to consideration.
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 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 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. 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 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.
As of February 2, 2020
and February 3, 2019
, we had recorded $292,550,000
and $298,435,000
for gift card and other deferred revenue in our Consolidated Balance Sheet, substantially all of which
is typically
recognized into revenue within the next 12 months.
Vendor Allowances
We receive allowances or credits from certain vendors for volume rebates. We treat such volume rebates as an offset to the cost of the product or services provided at the time the expense is recorded. These allowances and credits received are recorded in both cost of goods sold and in selling, general and administrative expenses.
Cost of Goods Sold
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.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of
non-occupancy-related
costs associated with our retail stores, distribution 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.
Stock-Based Compensation
We account for stock-based compensation arrangements by measuring and recognizing compensation expense for all stock-based awards using a fair value based method. Restricted stock units are valued using the closing price of our stock on the date prior to the date of grant. The fair value of each stock-based award is amortized over the requisite service period.
Advertising Expenses
Advertising expenses consist of media and production costs related to digital advertising, catalog mailings and other direct marketing activities. All advertising costs are expensed as incurred, or upon the release of the initial advertisement. Prior to the adoption of ASU
2014-09
in fiscal 2018, prepaid advertising costs were capitalized and amortized over their expected period of future benefit of approximately three months.
Total advertising expenses (including digital advertising, catalog advertising and other advertising costs) were approximately $388,194,000, $390,115,000 and $382,206,000 in fiscal 2019, fiscal 2018 and fiscal 2017, respectively.
Foreign Currency Translation
Some of our foreign operations have a functional currency other than the U.S. dollar. A
s
sets and liabilities are translated into U.S. dollars using the current exchange rates in effect at the balance sheet date, while revenues and expenses are translated at the average exchange rates during the period. The resulting translation adjustments are recorded as other comprehensive income within stockholders’ equity. Foreign currency exchange gains and losses are recorded in selling, general and administrative expenses, except for those discussed in Note L.
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 plus common stock equivalents 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.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under this method, deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in our Consolidated Financial Statements. We record reserves for our estimates of the additional income tax liability that is more likely than not to result from the ultimate resolution of foreign and domestic tax examinations. At any one time, many tax years are subject to examination by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. We review and update the estimates used in the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax examination, upon expiration of statutes of limitation, or upon occurrence of other events.
In order to compute income tax on an interim basis, we estimate what our effective tax rate will be for the full fiscal year and adjust these estimates throughout the year as necessary. Adjustments to our income tax provision due to changes in our estimated effective tax rate are recorded in the interim period in which the change occurs. The tax expense (or benefit) related to items other than ordinary income is individually computed and recognized when the items occur. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of our earnings in various taxing jurisdictions or changes in tax law.
New Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU
2016-02,
Leases
, which requires lessees to recognize a
right-of-use
asset and an operating lease liability for virtually all leases.
We adopted the ASU, as amended, as of February 4, 2019, the first day of fiscal year 2019. We have elected to apply the provisions of this ASU at the adoption date, instead of to the earliest comparative period presented in the financial statements. We have elected the package of practical expedients upon adoption, which permits us not to reassess whether existing contracts are or contain leases, the lease classification of existing leases, or initial direct costs for existing leases. We have elected not to separate lease and
non-lease
components for all of our leases and not to recognize a
right-of-use
asset and a lease liability for all short-term leases.
The adoption of this ASU resulted in an increase in total long-term assets and total liabilities of approximately $1.2 billion, which includes an increase in liabilities for lease obligations of approximately $1.4 billion, a decrease in deferred rent and deferred lease incentives of approximately $0.2 billion, and an increase in
right-of-use
assets of approximately $1.2 billion on the first day of fiscal 2019. We also recorded an approximate $3,300,000
reduction
, net of tax, to the opening balance of retained earnings resulting from the impairment of certain long-lived assets upon adoption of this ASU. The adoption of this ASU did not 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. 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. This ASU was effective for us in the first quarter of fiscal 2019. The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.
In August 2018, the FASB issued ASU
2018-15,
Intangibles—Goodwill and
Other—Internal-Use
Software
(Subtopic
350-40):
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain
internal-use
software. Accordingly, the amendments require an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic
350-40
to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. This ASU is effective for us in the first quarter of fiscal 2020. We do not expect the adoption of this ASU to have a material impact on our financial condition, results of operations or cash flows.
In December 2019, the FASB issued ASU
2019-12,
Simplifying the Accounting for Income Taxes
(Topic 740). This standard simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in Accounting Standards Codification (“ASC”) 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The standard also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a
step-up
in the tax basis of goodwill. The standard is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021, and early adoption is permitted. We do not expect the adoption of this ASU to have a material impact on our financial condition, results of operations or cash flow.
In June 2016, the FASB issued ASU
2016-13,
Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This standard is intended to introduce a revised approach to the recognition and measurement of credit losses, emphasizing an updated model based on expected losses rather than incurred losses. This standard is effective for annual reporting periods, and interim reporting periods contained therein, beginning after December 15, 2019. We do not expect the adoption of this ASU to have a material impact on our financial condition, results of operations or cash flows.
Note B: Property and Equipment
Property and equipment consists of the following:
| In thousands | Feb. 2, 2020 | Feb. 3, 2019 | ||||||
| Leasehold improvements | $ | 946,880 | $ | 950,259 | ||||
| Fixtures and equipment | 830,650 | 836,400 | ||||||
| Capitalized software | 788,635 | 733,941 | ||||||
| Land and buildings | 177,088 | 175,181 | ||||||
| Corporate systems projects in progress | 62,059 | 39,416 | ||||||
| Construction in progress 1 | 7,076 | 7,205 | ||||||
| Total | 2,812,388 | 2,742,402 | ||||||
| Accumulated depreciation | (1,883,350 | ) | (1,812,767 | ) | ||||
| Property and equipment, net | $ | 929,038 | $ | 929,635 |
| 1 | Construction in progress primarily consists of leasehold improvements and furniture and fixtures related to new, expanded or remodeled retail stores where construction had not been completed as of year-end. |
|---|
Note C: 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
, at such lenders’ option,
to increase the revolver by up to $250,000,000 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
.
See Note P
.
During fiscal
2019
, we had borrowings of $
100,000
,
under the revolver (at a weighte
d average interest rate of
3.04
%), all of which were repaid in the fourth quarter of fiscal
2019
, and
no
amounts were outstanding as of February
,
2020
. During fiscal
2018
, we had borrowings of $
60,000
,
under the revolver (at a weighted average interest rate of
3.20
%), all of which were repaid in the fourth quarter of fiscal
2018
, and
no
amounts were outstanding as of February
,
2019
. Additionally, as of February
,
2020
, $
12,187,000
in issued but undrawn standby letters of credit were outstanding under the revolver. The standby letters of credit were issued to secure the liabilities associated with workers’ compensation and other insurance programs.
As of February 2, 2020, we had $300,000,000 outstanding under our term loan (at a weighted average interest rate of 3.32%). The term loan matures on January 8, 2021, at which time all outstanding principal and any accrued interest must be repaid. Costs incurred in connection with the issuance of the term loan are presented as a reduction to the carrying value of the debt in our Consolidated Balance Sheet.
Prior to maturity in fiscal 2020, we intend to renew and extend our $300,000,000 term loan.
The interest rate under the credit facility is variable, and may be elected by us as: (i) the London Interbank Offer Rate (“LIBOR”) plus an applicable margin based on our leverage ratio ranging from 0.91% to 1.775% for a revolver borrowing, 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 a revolver borrowing, and 0% to 1.0% for the term loan. See Risk Factors in Item 1A.
As of February 2, 2020, we were in compliance with our covenants under the credit facility
. See “Risk Factors” in Item 1A
and
Note P: Subsequent Events
.
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 23, 2020. The letter of credit facilities contain 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 February 2, 2020, an aggregate of $6,462,000 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, 2021.
Note D: Income Taxes
The components of earnings before income taxes, by tax jurisdiction, are as follows:
| Dollars in thousands | Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | |||||||||
| United States | $ | 353,215 | $ | 333,594 | $ | 379,000 | ||||||
| Foreign | 103,806 | 95,653 | 73,439 | |||||||||
| Total | $ | 457,021 | $ | 429,247 | $ | 452,439 |
The provision for income taxes consists of the following:
| Dollars in thousands | Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | |||||||||
| Current | ||||||||||||
| Federal | $ | 76,873 | $ | 43,745 | $ | 97,202 | ||||||
| State | 14,205 | 15,357 | 19,552 | |||||||||
| Foreign | 12,438 | 12,822 | 12,759 | |||||||||
| Total Current | $ | 103,516 | $ | 71,924 | $ | 129,513 | ||||||
| Deferred | ||||||||||||
| Federal | $ | (606 | ) | $ | 23,507 | $ | 62,893 | |||||
| State | (870 | ) | 1,562 | 460 | ||||||||
| Foreign | (1,081 | ) | (1,430 | ) | 28 | |||||||
| Total Deferred | $ | (2,557 | ) | $ | 23,639 | $ | 63,381 | |||||
| Total provision | $ | 100,959 | $ | 95,563 | $ | 192,894 |
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 the post-1986 accumulated earnings of our foreign subsidiaries to the U.S. as of December 31, 2017. In light of the U.S. Tax Cuts and Jobs Act, the Company
re-evaluated
its permanent reinvestment assertion with respect to unremitted foreign earnings. As a result, we are now permanently reinvested with respect to our foreign earnings in Canada beginning in fiscal 2018.
A reconciliation of income taxes at the federal statutory corporate rate to the effective rate is as follows:
| Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | ||||||||||
| Federal income taxes at the statutory rate | 21.0% | 21.0% | 33.9% | |||||||||
| Re-measurement of deferred tax assets and liabilities | — | (2.2% | ) | 6.7% | ||||||||
| Transition tax | — | (0.6% | ) | 2.9% | ||||||||
| State income tax rate | 2.9% | 3.8% | 2.5% | |||||||||
| Officer’s compensation under Sec.162(m) | 1.0% | — | — | |||||||||
| Deferred true up | (1.3% | ) | — | — | ||||||||
| Change in uncertain tax positions | 0.5% | 4.1% | (1.6% | ) | ||||||||
| Rate differential | (1.8% | ) | (2.3% | ) | (2.9% | ) | ||||||
| Research and development credits | (0.7% | ) | (2.1% | ) | — | |||||||
| Other | 0.5% | 0.6% | 1.1% | |||||||||
| Total | 22.1% | 22.3% | 42.6% |
Significant components of our deferred income tax accounts are as follows:
| Deferred tax asset (liabilities), Dollars in thousands | Fiscal 2019 | Fiscal 2018 | ||||||
| Operating lease liabilities | $ | 347,693 | $ | — | ||||
| Merchandise inventories | 22,311 | 18,703 | ||||||
| Customer deposits | 19,520 | 14,345 | ||||||
| Compensation | 14,350 | 11,251 | ||||||
| Stock-based compensation | 9,860 | 14,281 | ||||||
| Accrued liabilities | 8,440 | 13,470 | ||||||
| State taxes | 7,546 | 7,435 | ||||||
| Executive deferred compensation | 7,543 | 5,739 | ||||||
| Federal and state net operating loss | 3,443 | 4,223 | ||||||
| Deferred rent | — | 18,942 | ||||||
| Operating lease right-of-use assets | (309,801 | ) | — | |||||
| Deferred lease incentives | (46,701 | ) | (26,032 | ) | ||||
| Property and equipment | (37,309 | ) | (31,557 | ) | ||||
| Prepaid catalog expenses | (394 | ) | (936 | ) | ||||
| Other | 2,369 | (4,797 | ) | |||||
| Valuation allowance | (3,648 | ) | (3,542 | ) | ||||
| Total deferred tax assets, net | $ | 45,222 | $ | 41,525 |
As a result of the acquisition of Outward, Inc., we had net state operating loss carry-forwards as of February 2, 2020. A valuation allowance has been provided against certain state net operating carry-forwards, as we do not expect to fully utilize the losses in future years.
The following table summarizes the activity related to our gross unrecognized tax benefits:
| Dollars in thousands | Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | |||||||||
| Beginning Balance | $ | 35,209 | $ | 18,051 | $ | 25,864 | ||||||
| Increases related to current year tax positions | 3,438 | 4,694 | 3,345 | |||||||||
| Increases for tax positions for prior years | 1,405 | 14,905 | 808 | |||||||||
| Decrease for tax positions for prior years | (308 | ) | (1,279 | ) | (10,610 | ) | ||||||
| Settlements | — | (376 | ) | — | ||||||||
| Lapse in statute of limitations | (3,106 | ) | (786 | ) | (1,356 | ) | ||||||
| Ending Balance | $ | 36,638 | $ | 35,209 | $ | 18,051 |
As of February 2, 2020, we had $36,638,000 of gross unrecognized tax benefits, of which $32,421,000 would, if recognized, affect the effective tax rate.
We accrue interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of February 2, 2020 and February 3, 2019, our accruals for the payment of interest and penalties totaled $7,251,000 and $5,437,000 respectively.
Due to the potential resolution of tax issues, it is reasonably possible that the balance of our gross unrecognized tax benefits could decrease within the next twelve months by a range of $0 to $11,757,000.
We file income tax returns in the U.S. and foreign jurisdictions. We are subject to examination by the tax authorities in these jurisdictions. Our U.S. federal taxable years for which the statute of limitations has not expired are fiscal years 2016 to 2019. Substantially all material states, local and foreign jurisdictions’ statutes of limitations are closed for taxable years prior to 2016.
Note
E
:
Leases
The components of
our lease costs
are as follows:
| I n thousands | Fiscal 2019 (52 Weeks) | |||
| Operating lease costs | $ | 267,883 | ||
| Variable lease costs | 129,018 | |||
| Total lease costs | $ | 396,901 |
Sublease income and short-term lease costs were not material to us for
fiscal
Supplemental cash flow information related to our leases are as follows:
| In thousands | Fiscal 2019 (52 Weeks) | |||
| Cash paid for amounts included in the measurement of operating lease liabilities | $ | 285,678 | ||
| Net additions to right-of-use assets | $ | 150,401 | ||
As of February 2, 2020, additional information related to our leases is as follows:
| Weighted average remaining lease term (years) | 7.3 | |||
| Weighted average incremental borrowing rate | 3.8 | % | ||
As of February 2, 2020, the future minimum lease payments under our operating lease liabilities are as follows:
| In thousands | ||||
| Fiscal 2020 | $ | 281,995 | ||
| Fiscal 2021 | 246,588 | |||
| Fiscal 2022 | 212,629 | |||
| Fiscal 2023 | 178,650 | |||
| Fiscal 2024 | 154,594 | |||
| Fiscal 2025 and thereafter | 463,280 | |||
| Total lease payments | 1,537,736 | |||
| Less interest | (215,234 | ) | ||
| Total operating lease liabilities | 1,322,502 | |||
| Less current operating lease liabilities | (227,923 | ) | ||
| Total non-current operating lease liabilities | $ | 1,094,579 |
As previously disclosed in our 2018 Annual Report on Form
10-K
and under the previous lease accounting standard, future minimum lease payments under
non-cancellable
operating leases as of February 3, 2019 were as follows:
| In thousands | ||||
| Fiscal 2019 | $ | 292,387 | ||
| Fiscal 2020 | 262,429 | |||
| Fiscal 2021 | 225,755 | |||
| Fiscal 2022 | 190,263 | |||
| Fiscal 2023 | 160,308 | |||
| Thereafter | 559,802 | |||
| Total | $ | 1,690,944 |
Memphis-Based Distribution Facility
In fiscal 2015, we entered into an agreement with a partnership comprised of the estate of W. Howard Lester, our former Chairman of the Board and Chief Executive Officer, and the estate of James A. McMahan, a former Director Emeritus and significant stockholder and two unrelated parties to lease a distribution facility in Memphis, Tennessee through July 2017. In fiscal 2017, we amended the lease to further extend the term through July 2020. The amended lease provides for two additional
one-year
renewal options. We made annual rental payments of approximately $1,765,000, $1,689,000, and $1,629,000 plus applicable taxes, insurance and maintenance expenses in fiscal 2019, fiscal 2018 and fiscal 2017, respectively.
Note F: 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.
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 | |||||||||
| Fiscal 2019 (52 Weeks) | ||||||||||||
| Basic | $ | 356,062 | 78,108 | $ | 4.56 | |||||||
| Effect of dilutive stock-based awards | 1,117 | |||||||||||
| Diluted | $ | 356,062 | 79,225 | $ | 4.49 | |||||||
| Fiscal 2018 (53 Weeks) | ||||||||||||
| Basic | $ | 333,684 | 81,420 | $ | 4.10 | |||||||
| Effect of dilutive stock-based awards | 920 | |||||||||||
| Diluted | $ | 333,684 | 82,340 | $ | 4.05 | |||||||
| Fiscal 2017 (52 Weeks) | ||||||||||||
| Basic | $ | 259,545 | 85,592 | $ | 3.03 | |||||||
| Effect of dilutive stock-based awards | 488 | |||||||||||
| Diluted | $ | 259,545 | 86,080 | $ | 3.02 |
Stock-based awards of 46,000, 31,000, and 577,000 were excluded from the computation of diluted earnings per share in fiscal 2019, fiscal 2018 and fiscal 2017, respectively, as their inclusion would be anti-dilutive.
Note G: 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 approximately 36,570,000 shares. As of February 2, 2020, there were approximately 5,430,000 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. 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
must
not
be
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.
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,
generally
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, disability, death, 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 fiscal 2019, fiscal 2018 and fiscal 2017, we recognized total stock-based compensation expense, as a component of selling, general and administrative expenses, of $64,163,000, $59,802,000 and $42,988,000, respectively. As of February 2, 2020, there was $83,444,000 of unrecognized stock-based compensation expense (net of estimated forfeitures), which we expect to recognize on a straight-line basis over a weighted average remaining service period of approximately two years. At each reporting period, all compensation expense attributable to vested awards has been fully recognized.
Restricted Stock Units
The following table summarizes our restricted stock unit activity during fiscal 2019:
| Shares | Weighted Average Grant Date Fair Value | Weighted Average Contractual Term Remaining (Years) | Intrinsic Value 1 | |||||||||||||
| Balance at February 3, 2019 | 3,012,923 | $ | 52.88 | |||||||||||||
| Granted | 1,066,337 | 58.27 | ||||||||||||||
| Granted, with vesting subject to performance conditions | 240,515 | 57.77 | ||||||||||||||
| Released 2 | (1,029,288 | ) | 55.94 | |||||||||||||
| Cancelled | (406,293 | ) | 53.89 | |||||||||||||
| Balance at February 2, 2020 | 2,884,194 | $ | 54.09 | 3.00 | $ | 202,124,000 | ||||||||||
| Vested plus expected to vest at February 2, 2020 | 2,335,826 | $ | 54.04 | 3.16 | $ | 163,695,000 |
| 1 | Intrinsic value for outstanding and unvested restricted stock units is based on the market value of our common stock on the last business day of the fiscal year (or $70.08). |
|---|
| 2 | Excludes 105,436 incremental shares released due to achievement of performance conditions above target. |
|---|
The following table summarizes additional information about restricted stock units:
| Fiscal 2019 (52 weeks) | Fiscal 2018 (53 weeks) | Fiscal 2017 (52 weeks) | ||||||||||
| Weighted average grant date fair value per share of awards granted | $ | 58.18 | $ | 49.57 | $ | 52.76 | ||||||
| Intrinsic value of awards released 1 | $ | 65,403,000 | $ | 34,213,000 | $ | 35,508,000 |
| 1 | Intrinsic value for releases is based on the market value on the date of release. |
|---|
Tax Benefit
We record excess tax benefits and deficiencies resulting from the settlement of stock-based awards as a benefit or expense within income taxes in the period in which they occur. During fiscal 2019, fiscal 2018, and fiscal 2017, the current tax benefit related to stock-based awards totaled $13,793,000, $9,927,000, and $16,066,000, respectively.
Note H: Williams-Sonoma, Inc. 401(k) Plan and Other Employee Benefits
We have a defined contribution retirement plan, the Williams-Sonoma, Inc. 401(k) Plan (the “401(k) Plan”), which is intended to be qualified under Internal Revenue Code sections 401(a), 401(k), 401(m) and 4975(e)(7). The 401(k) Plan permits eligible employees to make salary deferral contributions up to 75% of their eligible compensation each pay period (7%
for highly-compensated employees prior to February 3, 2020). Employees designate the funds in which their contributions are invested. Each participant may choose to have his or her salary deferral contributions and earnings thereon invested in one or more investment funds, including our company stock fund.
Our matching contribution is equal to 50% of each participant’s salary deferral contribution, taking into account only those contributions that do not exceed 6% of the participant’s eligible pay for the pay period. Each participant’s matching contribution is earned on a semi-annual basis with respect to eligible salary deferrals for those participants that are employed with the company on June 30th or December 31st of the year in which the deferrals are made. Each associate must complete one year of service prior to receiving company matching contributions. For the first five years of the participant’s employment, all matching contributions vest at the rate of 20% per year of service, measuring service from the participant’s hire date. Thereafter, all matching contributions vest immediately. Our contributions to the plan were $9,544,000, $9,036,000 and $8,224,000 in fiscal 2019, fiscal 2018 and fiscal 2017, respectively.
The 401(k) Plan consists of two parts: a profit sharing plan portion and a stock bonus plan/employee stock ownership plan (the “ESOP”). The ESOP portion is the portion that is invested in the Williams-Sonoma, Inc. Stock Fund. The profit sharing and ESOP components of the 401(k) Plan are considered a single plan under Internal Revenue Code section 414(l).
We also have a nonqualified executive deferred compensation plan that provides supplemental retirement income benefits for a select group of management. This plan permits eligible employees to make salary and bonus deferrals that are 100% vested. We have an unsecured obligation to pay in the future the value of the deferred compensation adjusted to reflect the performance, whether positive or negative, of selected investment measurement options chosen by each participant during the deferral period. As of February 2, 2020 and February 3, 2019, $30,534,000 and $23,319,000, respectively, is included in other long-term liabilities related to these deferred compensation obligations. Additionally, we have purchased life insurance policies on certain participants to potentially offset these unsecured obligations. The cash surrender value of these policies was $31,886,000 and $25,390,000 as of February 2, 2020 and February 3, 2019, respectively, and is included in other long-term assets, net.
Note I: 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 J: Stock Repurchase Program and Dividends
During fiscal 2019, we repurchased 2,341,931 shares of our common stock
, of which 16,368 shares were designated as treasury stock,
at an average cost of $63.55 per share and a total cost of approximately $148,834,000 under our stock repurchase program. As of February 2, 2020, there was approximately $574,982,000 remaining under our current stock repurchase program. As of February 2, 2020, we held treasury stock of $941,000 that represents the cost of shares available for issuance intended to satisfy future stock-based award settlements in certain foreign jurisdictions.
During fiscal 2018, we repurchased
5,373,047
shares of our common stock at an
average
cost of $
54.96
per share and a total cost
of
approximately $
295,304
,000. During fiscal 2017, we repurchased
4,050,697
shares of our common stock at an average cost of $
48.43
per share and a total cost of approximately $
196,179
,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.
Total cash dividends declared in fiscal 2019, fiscal 2018 and fiscal 2017, were approximately $
156,103
,000, or $
1.92
per common share, $
144,609
,000, or $
1.72
per common share and $
135,779
,000, or $
1.56
per common share, respectively.
Note K: Segment Reporting
We identify our operating segments according to how our business activities are managed and evaluated.
Prior to fiscal 2019, we managed
e-commerce
merchandise strategies, which included the results of Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, Pottery Barn Teen, Williams Sonoma Home, Rejuvenation and Mark and Graham, separately from our retail business. Because these merchandising strategies shared similar economic and other qualitative characteristics, they had been aggregated into the
e-commerce
reportable segment. Also, prior to fiscal 2019, we managed retail merchandise strategies, which included the results of our retail stores for Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation, separately from our
e-commerce
business. Because these merchandising strategies shared similar economic and other qualitative characteristics, they had been aggregated into the retail reportable segment.
Beginning in fiscal 2019, due to the convergence of our
e-commerce
and retail businesses and to better align with how we manage our
omni
-channel business, we have combined the results of our
e-commerce
and retail merchandise strategies at the overall brand level. Each of our brands are operating segments. Because they share similar economic and other qualitative characteristics, we have aggregated our operating segments into a single reportable segment.
The following table summarizes our net revenues by brand for fiscal 2019
, fiscal 2018
and fiscal 2017. We have updated fiscal 2018
and fiscal 2017
results to conform with the current year presentation.
| In thousands | Fiscal 2019 (52 weeks) | Fiscal 2018 (53 weeks) | Fiscal 2017 (52 weeks) | |||||||||
| Pottery Barn | $ | 2,214,397 | $ | 2,177,344 | $ | 2,066,302 | ||||||
| West Elm | 1,466,537 | 1,292,928 | 1,114,339 | |||||||||
| Williams Sonoma | 1,032,368 | 1,056,125 | 1,022,434 | |||||||||
| Pottery Barn Kids and Teen | 908,561 | 895,762 | 860,468 | |||||||||
| Other 1 | 276,145 | 249,434 | 228,816 | |||||||||
| Total 2 | $ | 5,898,008 | $ | 5,671,593 | $ | 5,292,359 |
| 1 | Primarily consists of net revenues from our international franchise operations, Rejuvenation and Mark and Graham. |
|---|
| 2 | Includes net revenues related to our international operations (including our operations in Canada, Australia, the United Kingdom and our franchise businesses) of approximately $365.6 million , $346.8 million and $328.2 million for fiscal 2019, fiscal 2018 and fiscal 2017, respectively . |
|---|
Long-lived assets by geographic location are as follows:
| In thousands | Feb. 2, 2020 1 | Feb. 3, 2019 1 | ||||||
| U.S. | $ | 2,132,635 | $ | 1,068,196 | ||||
| International | 165,772 | 50,305 | ||||||
| Total | $ | 2,298,407 | $ | 1,118,501 |
| 1 In fiscal 2019, we adopted Accounting Standards Update (“ASU”) 2016-02, Leases, as of the adoption date. Amounts reported for fiscal 2018 and prior years have not been adjusted, and continue to be reported in accordance with previous lease accounting guidance. See Note A to the Consolidated Financial Statements. |
|---|
Note L: 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 the 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 the 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 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
in cost of goods sold
. Based on the rates in effect as of February 2, 2020, we expect to reclassify a net
pre-tax
gain of approximately $
7,000
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 February 2, 2020, and February 3, 2019, we had foreign currency forward contracts outstanding (in U.S. dollars) with notional values as follows:
| In thousands | Feb. 2, 2020 | Feb. 3, 2019 | ||||||
| Contracts designated as cash flow hedges | $ | 17,200 | $ | 16,600 | ||||
| Contracts not designated as cash flow hedges | $ | — | $ | 5,300 |
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 fiscal 2019, fiscal 2018 and fiscal 2017.
The effect of derivative instruments in our Consolidated Financial Statements,
pre-tax,
was as follows:
| Fiscal 2019 | Fiscal 2018 | Fiscal 2017 | ||||||||||||||||||||||
| In thousands | Cost of goods sold | Selling, general and administrative expenses | Cost of goods sold | Selling, general and administrative expenses | Cost of goods sold | Selling, general and administrative expenses | ||||||||||||||||||
| Line items presented in the Condensed Consolidated Statement of Earnings in which the effects of derivatives are recorded | $ | 3,758,916 | $ | 1,673,218 | $ | 3,570,580 | $ | 1,665,060 | $ | 3,360,648 | $ | 1,477,900 | ||||||||||||
| Gain (loss) recognized in income | ||||||||||||||||||||||||
| Derivatives designated as cash flow hedges | $ | 604 | $ | — | $ | 478 | $ | 57 | $ | (144 | ) | $ | 88 | |||||||||||
| Derivatives not designated as hedging instruments | $ | — | $ | 28 | $ | — | $ | 3,967 | $ | — | $ | (3,286 | ) |
The fair values of our derivative financial instruments are presented below according to their classification in our Consolidated Balance Sheets. All fair values were measured using Level 2 inputs as defined by the fair value hierarchy described in Note M.
| In thousands | Fiscal 2019 | Fiscal 2018 | ||||||
| Derivatives designated as cash flow hedges: | ||||||||
| Other current assets | $ | 138 | $ | 358 | ||||
| Derivatives not designated as hedging instruments: | ||||||||
| Other current assets | $ | — | $ | 4 |
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 M: 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
inputs, which include quoted prices in active markets for identical assets.
Current debt
As of February 2, 2020, the fair value of our current debt, which consists of outstanding borrowings under our term loan, approximates its carrying value, as the instrument is relatively short-term in nature and the interest rate under the term loan is based on observable Level 2 inputs, primarily quoted market interest rates for instruments with similar maturities.
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 entered into are subject to credit risk-related contingent features or collateral requirements.
Long-lived Assets
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 property and equipment at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy. We measure
right-of-use
assets on a nonrecurring basis using Level 2 inputs that are corroborated by market data. Where Level 2 inputs are not readily available, we use Level 3 inputs. Fair value of these long-lived assets is based on the present value of estimated future cash flows using a discount rate commensurate with the risk.
There were no transfers between Level 1, 2 or 3 categories during fiscal 2019 or fiscal 2018.
Note N: Accumulated Other Comprehensive Income (
L
oss)
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 29, 2017 | $ | (9,957 | ) | $ | 54 | $ | (9,903 | ) | ||||
| Foreign currency translation adjustments | 3,730 | — | 3,730 | |||||||||
| Change in fair value of derivative financial instruments | — | (715 | ) | (715 | ) | |||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments 1 | — | 106 | 106 | |||||||||
| Other comprehensive income (loss) | 3,730 | (609 | ) | 3,121 | ||||||||
| Balance at January 28, 2018 | (6,227 | ) | (555 | ) | (6,782 | ) | ||||||
| Foreign currency translation adjustments | (5,032 | ) | — | (5,032 | ) | |||||||
| Change in fair value of derivative financial instruments | — | 1,098 | 1,098 | |||||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments 1 | — | (357 | ) | (357 | ) | |||||||
| Other comprehensive income (loss) | (5,032 | ) | 741 | (4,291 | ) | |||||||
| Balance at February 3, 2019 | (11,259 | ) | 186 | (11,073 | ) | |||||||
| Foreign currency translation adjustments | (3,334 | ) | — | (3,334 | ) | |||||||
| Change in fair value of derivative financial instruments | — | 163 | 163 | |||||||||
| Reclassification adjustment for realized (gain) loss on derivative financial instruments 1 | — | (343 | ) | (343 | ) | |||||||
| Other comprehensive income (loss) | (3,334 | ) | (180 | ) | (3,514 | ) | ||||||
| Balance at February 2, 2020 | $ | (14,593 | ) | $ | 6 | $ | (14,587 | ) |
| 1 | Refer to Note L for additional disclosures about reclassifications out of accumulated other comprehensive income and their corresponding effects on the respective line items in the Consolidated Statements of Earnings. |
|---|
Note O: Acquisition of Outward, Inc.
On December 1, 2017, we acquired Outward, Inc., 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.
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 | ||
| Property and equipment, net | 2,049 | |||
| Intangible assets | 18,300 | |||
| Liabilities | (6,886 | ) | ||
| Total identifiable net assets acquired | $ | 14,181 | ||
| Goodwill | 66,631 | |||
| Total purchase consideration | $ | 80,812 |
Intangible assets acquired 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, Inc. 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.
Note P: Subsequent Events
On March 11, 2020, the World Health Organization declared the novel strain of coronavirus
(COVID-19)
a global pandemic and recommended containment and mitigation measures worldwide. On March 17, 2020, we announced the temporary closures of our retail store operations in the United States and Canada to protect our employees, customers and the communities in which we operate and to help contain the
COVID-19
coronavirus outbreak. Our retail stores are expected to remain closed until at least April 2, 2020 depending upon how the
COVID-19
outbreak evolves. Our retail store revenue comprises approximately 44% of our net revenues. At this time, we continue to operate our
e-commerce
sites and distribution centers and continue to deliver products to our customers. As of the date of this filing, we cannot reasonably estimate the impact on our business from this pandemic, but we currently anticipate a material impact on our consolidated statements of earnings, consolidated balance sheet, consolidated cash flows and liquidity in fiscal 2020.
On March 23, 2020, as a precautionary measure to maximize our liquidity and to increase our available cash on hand in the event of a protracted
COVID-19
outbreak, we drew down $488,000,000 on our revolving line of credit, for an outstanding balance on our revolver of $500,000,000.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Williams-Sonoma, Inc.:
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Williams-Sonoma, Inc. and subsidiaries (the “Company”) as of February 2, 2020 and February 3, 2019, the related consolidated statements of earnings, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended February 2, 2020, and the related notes (collectively referred to as the “financial statements”). We also have audited the Company’s internal control over financial reporting as of February 2, 2020, based on criteria established in
Internal Control — Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of February 2, 2020 and February 3, 2019, and the results of its operations and its cash flows for each of the three years in the period ended February 2, 2020, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 2, 2020, based on criteria established in
Internal Control — Integrated Framework (2013)
issued by COSO.
Change in Accounting Principle
As discussed in Note A to the financial statements, effective February 4, 2019, the Company adopted FASB Accounting Standards Update 2016-02,
Leases,
(“ASC 842”), using the modified retrospective approach. This change in accounting principle is also communicated as a critical audit matter below.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures
in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Property and Equipment — Refer to Note A and M to the financial statements
.
Critical Audit Matter Description
The Company performs an analysis of the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the long-lived assets may not be recoverable. Events that result in an impairment review may include a significant decrease in the operating performance of the
long-lived
asset, or the decision to close a store, corporate facility, or distribution center. The majority of the Company’s evaluation of long-lived asset is at the individual store level and involves the comparison of a store’s estimated future undiscounted cash flows over its remaining useful life to its carrying value. As of February 2, 2020, the Company had $830.6 million in fixtures and equipment, $946.9 million in leasehold improvements, and $1.2 billion in lease right-of-use assets, the majority of which relates to the Company’s stores. Impairment may result when the carrying value of a store’s assets exceeds the store’s estimated undiscounted future cash flows.
We identified this as a critical audit matter because the Company’s estimate of future store cash flows involves significant estimates and assumptions related to revenue growth rates and gross margin. Additionally, the measurement of any impairment loss also includes estimation of the fair value of the Company’s lease right-of-use asset included within the asset group, which includes estimates of market rental rates. Changes in these assumptions could have a significant impact on management’s conclusion on whether a store could be impaired and the impairment loss that is recorded.
Performing audit procedures to evaluate the appropriateness of the Company’s judgments used in these significant assumptions therefore involved a high degree of subjectivity and complexity.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s judgments regarding the forecasts of revenue growth and gross margin, as well as the fair value of the lease right-of-use asset, included the following, among others:
| • | We tested the operating effectiveness of controls over management’s forecasts of future revenue growth, gross margin, and market rental rates. |
|---|
| • | We evaluated management’s ability to accurately forecast future sales and gross margin growth by comparing actual results to management’s historical forecasts. |
|---|
| • | We evaluated the reasonableness of management’s revenue and operating forecast by comparing the forecasts to (1) historical revenues and gross margins, (2) internal communications to management and the Board of Directors, (3) external communications made by management to analysts and investors, and (4) trends in the industry and geographical region. |
|---|
| • | Evaluated the methods and inputs used by management to determine the fair value of the lease right-of-use asset, including assessing comparable market rents and broker quotes. |
|---|
Leases — Refer to Notes A and E to the financial statements (also see ASC 842 adoption explanatory paragraph above)
Critical Audit Matter Description
The Company adopted ASU 2016-02,
Leases
, which requires lessees to recognize a right-of-use asset and lease liability for virtually all leases. The adoption of this new accounting standard resulted in an increase in total
long-term
assets and total liabilities of approximately $1.2 billion, which included an increase in liabilities for lease obligations of approximately $1.4 billion, a decrease in deferred rent and deferred lease incentives of approximately $0.2 billion, and an increase in right-of-use assets of approximately $1.2 billion on the first day of fiscal 2019.
In order to determine the fair value of the lease liability at lease commencement, an incremental borrowing rate (IBR) was used to discount and determine the fair value of its lease payments. The determination of an IBR requires management to use significant estimates and assumptions as to its credit ratings, credit spreads, lease tenors, and adjustments for the effects of collateral.
Given the significant estimates management makes to determine the IBR to apply to each lease, as well as the large population of leases that were discounted during the initial adoption of ASU 2016-02, performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to the IBR requires a high degree of auditor judgment and necessitates the involvement of a fair value specialist.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the determination of the rate included the following, among others:
| • | We tested the operating effectiveness of management’s controls over the determination and appropriateness of the IBR |
|---|
| • | With the assistance of our fair value specialists, we: |
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| o | Evaluated that the methodology used by management was reasonable to approximate the Company’s incremental borrowing rate |
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| o | Assessed the reasonableness of the credit rating, base rate, spreads and adjustments for the effects of collateral applied in determining the IBR by comparing to Company specific benchmarks, comparable companies, and other market information. |
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| o | Evaluated the accuracy of the models and calculations used to estimate the IBR, including validating the inputs used. |
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/s/ Deloitte & Touche LLP
San Francisco, California
March 27, 2020
We have served as the Company’s auditor since 1980.
Quarterly Financial Information
(Unaudited)
| In thousands, except per share amounts | ||||||||||||||||||||
| Fiscal 2019 (52 Weeks) | First Quarter | Second Quarter | Third Quarter | Fourth Quarter 1 | Full Year | |||||||||||||||
| Net revenues | $ | 1,241,132 | $ | 1,370,814 | $ | 1,442,472 | $ | 1,843,590 | $ | 5,898,008 | ||||||||||
| Gross profit | 444,331 | 483,861 | 518,172 | 692,728 | 2,139,092 | |||||||||||||||
| Operating income ,2,3 | 74,132 | 86,165 | 101,891 | 203,686 | 465,874 | |||||||||||||||
| Net earnings 6 | 52,656 | 62,648 | 74,713 | 166,045 | 356,062 | |||||||||||||||
| Basic earnings per share 7 | $ | 0.67 | $ | 0.80 | $ | 0.96 | $ | 2.15 | $ | 4.56 | ||||||||||
| Diluted earnings per share 7 | $ | 0.66 | $ | 0.79 | $ | 0.94 | $ | 2.10 | $ | 4.49 | ||||||||||
| Fiscal 2018 (53 Weeks) | First Quarter | Second Quarter | Third Quarter | Fourth Quarter 1 | Full Year | |||||||||||||||
| Net revenues | $ | 1,203,000 | $ | 1,275,174 | $ | 1,356,983 | $ | 1,836,436 | $ | 5,671,593 | ||||||||||
| Gross profit | 432,164 | 463,942 | 494,984 | 709,923 | 2,101,013 | |||||||||||||||
| Operating income ,2,3,4 | 66,550 | 74,166 | 94,384 | 200,853 | 435,953 | |||||||||||||||
| Net earnings 5,6 | 45,168 | 51,713 | 81,465 | 155,338 | 333,684 | |||||||||||||||
| Basic earnings per share 7 | $ | 0.54 | $ | 0.63 | $ | 1.01 | $ | 1.95 | $ | 4.10 | ||||||||||
| Diluted earnings per share 7 | $ | 0.54 | $ | 0.62 | $ | 1.00 | $ | 1.93 | $ | 4.05 | ||||||||||
| 1 | Our fourth quarter of fiscal 2018 included 14 weeks as compared to 13 weeks in fiscal 2019 . |
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| 2 | Fiscal 2019 includes approximately $6.4 million in the first quarter, $7.2 million in the second quarter, $7.4 million in the third quarter and $9.1 million in the fourth quarter of expenses related to the acquisition of Outward and its ongoing operations. Fiscal 2018 includes approximately $6.9 million in the first quarter, $5.0 million in the second quarter, $6.0 million in the third quarter and $7.2 million in the fourth quarter of expenses related to the acquisition of Outward and its ongoing operations. |
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| 3 | Fiscal 2019 includes approximately $6.5 million in the first quarter for employment-related expenses. Fiscal 2018 includes approximately $1.7 million in the first quarter, $1.9 million in the second quarter, $1.9 million in the third quarter and $2.5 million in the fourth quarter for employment-related expenses. |
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| 4 | Includes $5.3 million in the second quarter, $1.1 million in the third quarter and $6.8 million in the fourth quarter of fiscal 2018 associated with impairment and early lease termination charges. |
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| 5 | Includes tax expense of approximately $1.1 million in the first quarter of fiscal 2018 associated with the adoption of new accounting rules related to stock-based compensation. |
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| 6 | Fiscal 2019 includes a tax e xpense of $0.1 million in the third quarter resulting from t ax legislation changes, and a t ax benefit of $ 6.0 million in the fourth quarter resulting from a deferred tax liability adjustment . Fiscal 2018 includes tax expense of $3.3 million in the first quarter, tax expense of $2.9 million in the second quarter, a tax benefit of $10.6 million in the third quarter and tax expense of $0.3 million in the fourth quarter, resulting from the enactment of the Tax Cuts and Jobs Act. |
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| 7 | Due to differences between quarterly and full year weighted average share count calculations, and the effect of quarterly rounding to the nearest cent per share, full year earnings per share may not equal the sum of the quarters. |
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