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Williams-Sonoma (NYSE: WSM)
Analyst Report
Anjana RadhakrishnanStudent Managed Fund
MBA 2004
Date: 6 December 2003 Sector: Consumer Discretionary Industry: Retail
Williams-Sonoma Inc.(New York Stock Exchange)
3250 Van Ness AvenueSan Francisco
California -94109
http://www.williams-sonoma.com
NYSE: WSMP/E 26.9
Employees 6,000Common Stock 116.76
millionMarket Cap $ 4.1 billion
Business Summary
Williams-Sonoma, Inc. is a specialty retailer of products for the home. The retail segment of its business sells its products through its four retail store concepts: Williams-Sonoma, Pottery Barn, Pottery Barn Kids and Hold Everything. The direct-to-customer segment of its business sells similar products through its eight direct-mail catalogs: Williams-Sonoma, Pottery Barn, PBteen, Pottery Barn Kids, Pottery Barn Bed + Bath, Hold Everything, West Elm and Chambers, and four e-commerce Websites: wsweddings.com, williams-sonoma.com, potterybarn.com and potterybarnkids.com. Its principal concepts in both retail and direct-to-customer are Williams-Sonoma, which sells cookware essentials; Pottery Barn, which sells contemporary tableware and home furnishings, and Pottery Barn Kids, which sells stylish children's furnishings.
Share PerformancePrice ($): 34.25 52 Week High: 37.29 Currency: USDVolume (millions): 0.5 52 Week Low: 19.90
Financial SummaryFor the 39 weeks ended 11/2/03, net sales rose 17% to $1.75 billion. Net income rose 23% to $55.1 million. Revenues reflect higher retail sales from 62 new stores opened. Net income reflects favorable leveraging of fixed occupancy expenses..
Value lineBeta 1.40
Timeliness 2Safety 3
Technical 3Financial Strength
B++
Industry Ranking
18 of 98
Analyst RatingZack’s Moderate
BuyMoneycentral Moderate
BuyWSJ Moderate
BuyMerril Lynch Buy
Prudential NeutralDeutsche
BankHold
Bear Stern Peer Perform
RECOMMENDATION:
BUY# of shares: 400Share Price: $ 34.25Stop Loss: $ 27.40
Company Overview
Williams-Sonoma. (referred to as ‘WSM’ henceforth) was founded in 1956 by Charles E
Williams who opened the first store in Sonoma, California. WSM is a specialty retailer of home
products. WSM has three different channels of sale for their products. First, they sell their
products through four retail store concepts – Williams Sonoma, Pottery Barn, Pottery Barn kids
and Hold Everything. The second channel is the direct –to –customer segment which includes
seven direct mail catalogues - Williams Sonoma, Pottery Barn, Pottery Barn kids and Hold
Everything, Bed + Bath , West Elm and Chambers. The third channel is the e-commerce
websites – wsweddings.com, Williams-sonoma.com, potterybarn.com and potterybarnkids.com
Williams-Sonoma branch of WSM deals with the cookware essentials, pottery barn sells
contemporary tableware and pottery barn kids’ deals primarily with the concept of stylish
children’s furniture. The direct-to-customer channel in the business was started in 1972 and
today it accounts for 39.3% of their revenues. WSM acquired Pottery Barn in 1986.
WSM went public in the year 1982.As of February 2003, WSM had 478 retail stores
across 48 states. The company intends to increase the leased footage area by 9 – 11% by the end
of fiscal year 2003.
RETAIL STORES
Williams Sonoma Pottery Barn Pottery Barn Kids Hold Everything
DIRECT - TO -CUSTOMER
Williams Sonoma Pottery Barn Pottery Barn Kids Hold Everything Bed + Bath West Elm Chambers
E-COMMERCE
Wsweddings.com Potterybarnkids.com Williamssonoma.com Potterybarn.com
WSM purchases most of its supplies/products from foreign and domestic manufacturers
and importers. The largest supplier accounted for 4% of their supplies in 2002. Approximately
58% of their merchandise was foreign sourced in 2002.
Competition and Competitors
The specialty retail business is highly competitive. WSM’s retail stores, mail order
catalogs and websites compete with other department stores, discount stores and specialty stores.
The business is also subject to fluctuating seasonal demands. Historically, a large portion of their
income is generated during the period between October and December. But this is a general
pattern seen in retail industry. The key competitors for WSM are as follows:
Ashley Furniture
Bed Bath and Beyond
Bombay Company
Euromarket Designs
Decorize
Hanover Direct
Pier 1 Imports
IKEA
For the purpose of analysis, the performance of WSM was compared with Hanover Direct
(HNV) and Pier 1 Imports (PIR).
PAST PERFOMANCE
The year 2002 has been a historic year for WSM. In 2002, WSM achieved a pre-tax operating
margin of 8.6%, the highest in the history of the company. The company achieved $ 2.3 billion
in net revenue and increased their diluted earning per share by 60%.
Growth TrendsRevenues and Net Income
Revenue Grow th (5 year)
-10-5
05
1015
2025
WSM HNV PIR Industry S & P 500
Revenue Gorwth (%)
Revenues and Net Income
0
500
1000
1500
2000
2500
1998 1999 2000 2001 2002
c
Net Profit Margin
Net Profit Margin (%)
-6
-4
-2
0
2
4
6
8
WSM HNV PIR Industry S & P 500
Net Profit Margin (%)
0%
1%
2%
3%
4%
5%
6%
1998 1999 2000 2001 2002
The declining trend in the Net Profit Margin from 1998 to 2000 could be attributed to the
expenses WSM had to incur (and investment) to build new facilities, improve infrastructure and
The revenues and net income of WSM has
been on an upward trend from 1998 to 2002.
The revenues for WSM consist of retail sales,
direct-to-customer sales and shipping fees. The
increase in sales in 2001 and 2002 were
primarily from 63 new stores (2002) and 31
new stores (2001) of Williams Sonoma,
Pottery Barn and Pottery Barn kids. The 5-year
average sales growth of the company has been
higher than the industry average and its
competitors.
to reorganize management structure to create more synergy between sales channels. The net
profit margin has been on a rebound phase since 2000. This measure for the company is higher
than the industry average and S & P 500.
Earnings per Share (EPS)
EPS (5-year average)
-20
-10
0
10
20
30
WSM HNV PIR Industry S & P 500
EPS
0
0.2
0.4
0.6
0.8
1
1.2
1998 1999 2000 2001 2002
spending declined in 2001; the company could not make up for the huge investments it had made
for the holiday season. The lesson learnt from this mistake is reflected in its cautious outlook for
2003.
Free Cash Flow
The EPS of WSM is much higher than
the competitors and the industry
average. The decline in EPS in the year
2000 could be attributed to the extra
expenses incurred (as mentioned above)
and the rough economic /market
conditions in that particular year. Prior
to 2002, the company had achieved
exemplary rates of growth and therefore
the management projected its future
performance on the basis of the high
growth rates. When the consumer
Free Cash Flow
-100
-50
0
50
100
150
200
1998 1999 2000 2001 2002
Barn “ brand increased by 50% in the year 2001. The Pottery Barn online wedding and gift
registry was launched the same year.
Dividends
Williams-Sonoma have not paid any dividneds to its shareholders.
Financial Health
Debt/Equity ratio
Debt/Equity Ratio
00.20.40.60.8
11.21.4
WSM HNV PIR Industry S & P 500
Interest Coverage
WSM’s debt to equity ratio is much lower than
that of its competitors and industry average.
According to Harry Domash of
www.winninginvesting.com, a debt-equity
ratio of less than 0.4 is a sign of “bullet proof”
stock. The debt-equity ratio of WSM is 0.02.
Free cah flow is the measure of cash that is
available from WSM’s business operations
after the payment of interest and tax, for
distribution of dividends or for reinvestment
in business. The proceeds of disposals and
acquisitions are excluded from this
calculation. The sales for the brand “Pottery
The interest coverage ratio of WSM is 21.8x. This ratio reiterates the low debt burden on the
company.
Management Performance
Return on Equity (ROE)
ROE
0
5
10
15
20
25
WSM HNV PIR Industry S & P 500
.
Return on Assets (ROA)
ROE = Income/shareholder equity
ALV’s ROE is much greater than the industry
average and equal to its competitor Pier 1 Imports.
From company’s stand point, the ROE has been
increasing from year 2000. ROE has increased from
13.3% in 2000 to 19.3% in 2002 reflecting that the
management has been very effectively investing the
resources provided by the shareholders.
Return on Invested Capital (ROIC)
According to www.global.factiva.com, the return on invested capital for the
past year for WSM is 18.7%. The five year average ROIC for the company is
15.5%. The high ROIC shows that the company has made good use of its
debt and capital.
Economic Value Added
In the year ending 2002, the invested capital for WSM was $662,049,000
(http://global.factiva.com). The weighted average cost of capital (WACC) from
www.bloomberg.com is 10.43%.
Economic Value Added = (ROIC – WACC) x Invested Capital
= (18.7 -10.43) x $662,049,000 = $54,751,452.3
Market Multiples
P/E Ratio
WSM PIR HNV Industry S & P 500
P/E ratio 30.3 18.2 21.3 34.3 31.1
ROA = Net Income / Total Assets
WSM’s ROA is higher than the industry
average indicating that the company has used
its assets very efficiently. This is often a good
sign of management.
ROA
-20
-15
-10
-5
0
5
10
15
WSM HNV PIR Industry S & P 500
ROA (%)
The P/E ratio for WSM is lower than that of the industry average. This suggests that stock of
WSM might be undervalued and its attainable price target is high. The view is also reflected in
the “Moderate Buy” and “Overweight” recommendations of various analysts.
PEG
The PEG ratio for WSM is 1.3, which is lower than the industry average of
1.8 indicating that the stock is undervalued. This could be an indicator that
the investors expect the EPS growth to be much higher than the street
consensus number.
Stock Valuation
Capital Structure
99.53% of WSM’s capital is from shareholders and the remaining 0.47% is funded through short
term and long term debt. WSM has no preferred stock. This means that the company is not as
risky since they do not owe any money.
Equity Capital Structure Debt Capital Structure
Market Capitalization =
$4124.95 MShort-term debt = $ 7.74 M
Preferred equity = 0 Long-term debt = $11.91 M
Common Weight = 99.53% Short Debt Weight = 0.19%
Preferred Weight = 0% Long Debt Weight = 0.29%
Cost of Capital
The Weighted Average Cost of Capital for ALV is calculated under the following assumptions
(based on Bloomberg):
Rf = risk-free rate = 5 year treasury bond rate = 4.23%
Rm - Rf = historical long term equity risk premium = 6.23%
Beta = volatility of the company = 1.22
Long-term growth rate = 19.41% Country Premium = 5.12%
Note rate = 1.87% Bond rate = 4.32%
Debt adjustment factor = 1.38 Tax rate = 38.50%
DebtCommon
Equity
Preferred
EquityWACC
Weight (%) 0.47 99.53 0
Cost (%) 2.80 10.47 0
Wtd. Avg. 0.0001316 0.10420791 0 10.43%
Intrinsic Value Calculation
An intrinsic value/share is a hypothetical value of the company based on the sum of its future
earnings. This value can be compared to a stock’s current price to determine if it is overvalued or
undervalued. The Intrinsic Value for WSM is calculated under the following assumptions:
R = initial earnings = $ 134,900,000.00
n = length of the first stage = 10yrs
E1 = first stage earnings growth rate = 18.7% (www.moneycentral.com)
E2 = second stage earnings growth rate = 6.0% (www.quicken.com)
D1 = first stage discount rate = 15%
D2 = second stage discount rate = 15%
www.quicken.com
05
1015202530354045
Intrinsic Value Current Stock Price
The above calculations show that stock of WSM is undervalued. One must note that for a
company like WSM with new products, new stores and new markets, the growth may be above
the predicted norms on one hand and may also be lower than expected due to sudden market
changes.
Risk Analysis
Insider Trading
From www.wsj.com:
# shares outstanding 117 M
% owned by insiders 5 %
# sold in the past 6
months
130,720 = 0.3% of insider
shares
Discounted Value $1.61B
Continuing Value $3.27 B
Long-term Debt $11.91 M
# shares outstanding 117 M
Intrinsic Stock
Price$41.67
Current Stock
Price$ 34.20
# purchased by insider 0
As seen from the above table, around 0.3% of insider shares were traded (sold) over the last six
month period.
The Board of Directors
Name Occupation Independent
Charles E Williams Founder No
W Howard LesterDirector
Director – Harold Department Stores Yes
Edward E MuellerDirector
President and CEO of AmeritechYes
Adrian BellamyDirector
Chairman – Body Shop InternationalYes
Patrick J ConnolyDirector
Vice-President – Mail Order (WSM)No
Jeanne JacksonDirector
President and CEO of WalmartYes
Micheal R LynchDirector
Director – Goldman SachsYes
James A McMahan
Director
Chairman – McMahan Furniture Stores Yes
Heather M Reisman
Director
Chairman and CEO of Indigo Books and Music Yes
Richard T Robertson Director
Director – Warner Bros Domestic Television
Distribution
Yes
8 out of 10 directors on the board are independent.
Valuation Models
CAPM model
Risk-free rate (Rf) = 4.25% (based on 10-year T-bond rate on 11/17/2003)
Market Return (Rm) = 7.25% (Expected return on S & P 500 for the five year horizon)
Beta = 1.40 (www.valueline.com)
Formula CAPM:
CAPM = Rf + (Rm - Rf ) = 0.0425 +1.40 (0.075 – 0.0425) = 0.099375 = 8.8%
The expected return on WSM based on its risk and the prevalent market and risk free rate is
8.8%.
AVERAGE ANNUAL GROWTH RATE
ROE (5 year average) 16.4%
Retention ratio 100%
Annual growth rate = retention ratio x return on equity:100% x 18.7% = 16.4%
Growth Rate in Earnings
Earning per share (1998) $ 0.48
Earning per share (2002) $ 1.07
PV = 0.48; FV = 1.07; N =5; PMT = 0
Therefore g = 17.4%
The average of both the growth rate is assumed to be the growth rate for further analysis. The
average growth rate is 16.89%.
No Growth Model
Vo = Current EPS / K
= 1.07 /0.088 = $ 12.16
The current market price is $ 34.20, therefore ($ 34.20 - $ 12.16) = $ 22.04 is the value of the
growth. This means that 64% of the value of the company comes form growth and hence it is a
“buy”.
P/E Model
Average P/E for past five years (1998 – 2002)
= (29.8 +34.5+ 29.2 +25.2 + 24.6) / 5 = $ 28.66
The expected EPS in 2003 = $ 1.28
Based on this data, the expected price in the year 2004 = Avg. P/E x Exp. EPS
= $ 28.66 x $ 1.28 = $ 36.7
Based on this model the value of growth opportunities in terms of stock price appreciation is
limited.
Valuepro.net Stock Valuation
This proprietary valuation model is based on observed historical data and growth rate estimates.
According to that analysis the value of the stock is $39.2, which indicates that the stock is
undervalued. The growth rate assumed in this model is 20 %.
Intrinsic Value Growth Rate$ 39.2 20%
Economic Value Added
$54,751,452.3 / 0.1043 = $ 524,942,016.3 + 4,100,000,000 = 4,624,942,016 – 11,910,000
= $ 4,613,032,016
$ 4,613,032,016 / 116,760,000 = $ 39.51
These valuation models indicate that at current price, WSM is undervalued.
Risk Factors
WSM must successfully anticipate changing consumer preferences and buying trends,
and manage our inventory commensurate with customer demand.
WSM’s success depends upon their ability to anticipate and respond to changing merchandise
trends and customer demands in a timely manner. Consumer preferences cannot be predicted
with certainty and may change between sales seasons. If they misjudge either the market for their
merchandise or our customers’ purchasing habits, their sales may decline significantly and they
may be required to mark down certain products to sell the resulting excess inventory or sell such
inventory through their outlet stores at prices which are significantly lower than their retail
prices, each of which would harm their business and operating results.
In addition, they must manage their inventory effectively and commensurate with customer
demand. Much of their inventory is sourced from vendors located outside the United States.
Thus, they usually must order merchandise, and enter into contracts for the purchase and
manufacture of such merchandise, well in advance of the applicable selling season and
frequently before trends are known. The extended lead times for many of their purchases may
make it difficult for them to respond rapidly to new or changing trends. In addition, the seasonal
nature of the specialty home products business requires them to carry a significant amount of
inventory prior to peak selling season. As a result, they are vulnerable to demand and pricing
shifts and to misjudgments in the selection and timing of merchandise purchases. If they do not
accurately predict their customers’ preferences and acceptance levels of their products, their
inventory levels will not be appropriate and their business and operating results may be
negatively impacted.
WSM’s business depends, in part, on factors affecting consumer spending that are out of
their control.
Their business depends on consumer demand for their products and, consequently, is sensitive to
a number of factors that influence consumer spending, including general economic conditions,
disposable consumer income, recession and fears of recession, war and fears of war, inclement
weather, consumer debt, interest rates, sales tax rates and rate increases, consumer confidence in
future economic conditions and political conditions, and consumer perceptions of personal well-
being and security generally. Adverse changes in factors affecting discretionary consumer
spending could reduce consumer demand for their products, thus reducing their sales and
harming their business and operating results.
The growth of WSM’s sales and profits depends, in large part, on their ability to
successfully open new stores.
In each of the past three fiscal years, their retail stores have generated approximately 60% of
their net revenues. They plan a net increase of approximately 34 new retail stores in fiscal 2003
as part of their growth strategy. There is no assurance that this strategy will be successful. Their
ability to open additional stores successfully will depend upon a number of factors, including:
o identification and availability of suitable store locations;
o success in negotiating leases on acceptable terms
o ability to secure required governmental permits and approvals
o hiring and training of skilled store operating personnel, especially management
o timely development of new stores, including the availability of construction
materials and labor and the absence of significant construction and other delays in
store openings
Many of these factors are beyond their control. For example, for the purpose of identifying
suitable store locations, they rely, in part, on demographics surveys regarding location of
consumers in their target market segments. While they believe that the surveys and other relevant
information are helpful indicators of suitable store locations, we recognize that the information
sources cannot predict future consumer preferences and buying trends with complete accuracy.
In addition, time frames for lease negotiations and store development vary from location to
location and can be subject to unforeseen delays. Construction and other delays in store openings
could have a negative impact on their business and operating results. There can be no assurance
that they will be able to open new stores or that, if opened, those stores will be operated
profitably.
WSM faces intense competition from companies with brands or products similar to ours.
The specialty retail and direct-to-customer business is highly competitive. Their specialty retail
stores, mail order catalogs and Internet websites compete with other retail stores, other mail
order catalogs and other e-commerce websites that market lines of merchandise similar to theirs.
They compete with national, regional and local businesses utilizing a similar retail store strategy,
as well as traditional furniture stores, department stores and specialty stores. The substantial
sales growth in the direct-to-customer industry within the last decade has encouraged the entry of
many new competitors and an increase in competition from established companies.
The competitive challenges facing us include, without limitation:
o anticipating and quickly responding to changing consumer demands better
than their competitors
o effectively marketing and competitively pricing their products to
consumers in several diverse market segments
o developing innovative, high-quality products in colors and styles that
appeal to consumers of varying age groups and tastes, and in ways that
favorably distinguish us from their competitors.
In light of the many competitive challenges facing them, there can be no assurance that they will
be able to compete successfully. Increased competition could adversely affect their sales,
operating results and business.
We depend on key domestic and foreign vendors for timely and effective sourcing of their
merchandise, and we are subject to various risks and uncertainties that might affect their
vendors’ ability to produce quality merchandise.
Their performance depends on their ability to purchase their merchandise in sufficient quantities
at competitive prices. They purchase their merchandise from numerous foreign and domestic
manufacturers and importers. They have no contractual assurances of continued supply, pricing
or access to new products, and any vendor could discontinue selling to us at any time. There can
be no assurance that they will be able to acquire desired merchandise in sufficient quantities on
terms acceptable to them in the future. Any inability to acquire suitable merchandise or the loss
of one or more key vendors could have a negative effect on their business and operating results
because we would be missing products that they felt were important to their assortment, unless
and until alternative supply arrangements are secured. They may not be able to develop
relationships with new vendors, and products from alternative sources, if any, may be of a lesser
quality and/or more expensive than those we currently purchase.
In addition, they are subject to certain risks, including availability of raw materials, labor
disputes, union organizing activity, inclement weather, natural disasters, and general economic
and political conditions, that might limit their vendors’ ability to provide us with quality
merchandise on a timely basis. For these or other reasons, one or more of their vendors might not
adhere to their quality control standards, and we might not identify the deficiency before
merchandise ships to their stores or customers. Their vendors’ failure to manufacture or import
quality merchandise in a timely and effective manner could damage their reputation and brands,
and could lead to an increase in customer litigation against us and attendant increase in their
routine litigation costs.
WSM’s dependence on foreign vendors subjects us to a variety of risks and uncertainties.
They source their products from manufacturers in over 34 countries. Specifically, in fiscal 2002,
approximately 58% of their merchandise purchases were foreign sourced, primarily from Asia
and Europe.
Their dependence on foreign vendors means, in part, that we may be affected by declines in the
relative value of the U.S. dollar to other foreign currencies. Although substantially all of their
foreign purchases of merchandise are negotiated and paid for in U.S. dollars, declines in foreign
currencies and currency exchange rates might negatively affect the profitability and business
prospects of one or more of their foreign vendors. This, in turn, might cause such foreign
vendors to demand higher prices for merchandise, hold up merchandise shipments to us, or
discontinue selling to us, any of which could ultimately reduce their sales or increase their costs.
They are also subject to other risks and uncertainties associated with changing economic and
political conditions in foreign countries. These risks and uncertainties include import duties and
quotas, work stoppages, economic uncertainties (including inflation), foreign government
regulations, wars and fears of war, political unrest and trade restrictions. They cannot predict
whether any of the countries in which their products are currently manufactured or may be
manufactured in the future will be subject to trade restrictions imposed by the U.S. or foreign
governments or the likelihood, type or effect of any such restrictions. Any event causing a
disruption or delay of imports from foreign vendors, including the imposition of additional
import restrictions, restrictions on the transfer of funds and/or increased tariffs or quotas, or both,
against home-centered items could increase the cost or reduce the supply of merchandise
available to us and adversely affect their business, financial condition and operating results.
Furthermore, some or all of their foreign vendors’ operations may be adversely affected by
political and financial instability resulting in the disruption of trade from exporting countries,
restrictions on the transfer of funds and/or other trade disruptions.
WSM must timely and effectively deliver merchandise to their stores and customers.
They cannot control all of the various factors that might affect their fulfillment rates in direct-to-
customer sales and/or timely and effective merchandise delivery to their stores. They rely upon
third party carriers for their merchandise shipments, including shipments to their customers and
to and from all of their stores. Accordingly, they are subject to the risks, including labor disputes
(e.g., west coast port strike of 2002), union organizing activity, inclement weather, natural
disasters, and possible acts of terrorism associated with such carriers’ ability to provide delivery
services to meet their shipping needs. Failure to deliver merchandise in a timely and effective
manner could damage their reputation and brands. In addition, they are seeing fuel costs increase
substantially and airline companies struggle to operate profitably, which could lead to increased
fulfillment expenses and negatively affect their business and operating results by increasing costs
and negatively affecting the efficiency of their shipments.
Their failure to successfully manage their order-taking and fulfillment operations might
have a negative impact on their business.
The operation of their direct-to-customer business depends on their ability to maintain the
efficient and uninterrupted operation of their order-taking and fulfillment operations and our e-
commerce websites. Disruptions or slowdowns in these areas could result from disruptions in
telephone service or power outages, inadequate system capacity, human error, natural disasters
or adverse weather conditions. These problems could result in a reduction in sales as well as
increased selling, general and administrative expenses.
WSM may experience fluctuations in their comparable store sales.
WSM’s success depends, in part, upon their ability to increase sales at theexisting stores. Various
factors affect comparable store sales, including the number of stores they open, close and expand
in any period, the general retail sales environment, changes in sales mix between distribution
channels, their ability to efficiently source and distribute products, changes in their merchandise
mix, competition, current economic conditions, the timing of release of new merchandise and
promotional events, the success of marketing programs, and cannibalization of existing store
sales by new stores. Among other things, weather conditions can affect comparable store sales,
because inclement weather can require us to close certain stores temporarily and thus reduce
store traffic. Even if stores are not closed, many customers may decide to avoid going to stores in
bad weather. These factors may cause our comparable store sales results to differ materially from
prior periods and from earnings guidance we have provided.
Our failure to successfully manage the costs and performance of our catalog mailings
might have a negative impact on our business.
Postal rate increases and paper and printing costs affect the cost of their catalog mailings. They
rely on discounts from the basic postal rate structure, such as discounts for bulk mailings and
sorting by zip code and carrier routes. The ur cost of paper has fluctuated significantly during the
past three fiscal years, and their paper costs may increase in the future.
WSM must successfully manage our Internet business.
The success of their e-commerce business depends, in part, on factors over which they have
limited control. In addition to changing consumer preferences and buying trends relating to
Internet usage, they are vulnerable to certain additional risks and uncertainties associated with
the Internet, including changes in required technology interfaces, website downtime and other
technical failures, changes in applicable federal and state regulation, security breaches, and
consumer privacy concerns. Their failure to successfully respond to these risks and uncertainties
might adversely affect the sales through their e-commerce business, as well as damage their
reputation and brands.
WSM must successfully manage the complexities associated with a multi-channel and
multi-brand business.
During the past few years, with the launch and expansion of their e-commerce business, new
brands and brand expansions, their overall business has become substantially more complex. The
changes in their business have forced us to develop new expertise and face new challenges, risks
and uncertainties. For example, they face the risk that their e-commerce business might
cannibalize a significant portion of their retail and catalog businesses. While they recognize that
their e-commerce sales cannot be entirely incremental to sales through their retail and catalog
channels, they seek to attract as many new customers as possible to their websites. They
continually analyze the business results of their three channels and the relationships among the
channels, in an effort to find opportunities to build incremental sales. However, they cannot
ensure that, as their e-commerce business grows, it will not cannibalize a portion of their retail
and catalog businesses.
They have recently introduced a new brand, West Elm, and may introduce additional new brands
and brand extensions in the future. Their introduction of new brands and brand extensions poses
another set of risks. If they devote time and resourrces to new brands and brand extensions, and
those businesses are not as successful as they planned, then they risk damaging their overall
business results. Alternatively, if their new brands and brand extensions prove to be very
successful, they risk hurting their existing brands through the migration of customers to the new
businesses. There can be no assurance that they can and will introduce new brands and brand
extensions that improve their overall business and operating results.
WSM’s inability to obtain commercial insurance at acceptable prices might have a
negative impact on our business.
During fiscal 2002, there was a substantial increase in the costs of insurance, partly in response
to the terrorist attacks of September 11, 2001, and financial irregularities and other fraud at
publicly-traded companies. They believe that extensive commercial insurance coverage is
prudent for risk management and anticipate that their insurance costs will increase substantially.
In addition, for certain types or levels of risk (e.g., risks associated with earthquakes or terrorist
attacks), they might determine that they cannot obtain commercial insurance at acceptable prices.
Therefore, they might choose to forego or limit their purchase of relevant commercial insurance,
choosing instead to self-insure one or more types or levels of risks. If they suffer a substantial
loss that is not covered by commercial insurance, the loss and attendant expenses could have a
material adverse effect on their business and operating results.
WSM’s inability or failure to protect our intellectual property would have a negative
impact on our business.
Our trademarks, service marks, copyrights, patents, trade dress rights, trade secrets, domain
names and other intellectual property are valuable assets that are critical to our success. The
unauthorized reproduction or other misappropriation of our intellectual property could diminish
the value of our brands or goodwill and cause a decline in our sales. There can be no assurance
that we will be able to adequately protect our intellectual property or that the costs of defending
our intellectual property will not adversely affect our operating results.