Wsm

Williams-Sonoma (NYSE: WSM)

Analyst Report

Anjana Radhakrishnan Student Managed Fund MBA 2004

Date: 6 December 2003 Industry: Retail

Sector: Consumer Discretionary

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 Performance Price ($): 34.25 52 Week High: 37.29 Currency: USD Volume (millions): 0.5 52 Week Low: 19.90

Financial Summary For 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..

Williams-Sonoma Inc. (New York Stock Exchange) 3250 Van Ness Avenue San Francisco California -94109 http://www.williamssonoma.com NYSE: WSM P/E 26.9 Employees 6,000 Common Stock 116.76 million Market Cap $ 4.1 billion Value line Beta 1.40 Timeliness 2 Safety 3 Technical 3 Financial B++ Strength Industry 18 of 98 Ranking Analyst Rating Zack’s Moderate Buy Moneycentral Moderate Buy WSJ Moderate Buy Merril Lynch Buy Prudential Neutral Deutsche Hold Bank Bear Stern Peer Perform RECOMMENDATION:

BUY # of shares: 400 Share Price: $ 34.25 Stop 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

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

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.

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 Trends Revenues and Net Income Revenue Grow th (5 year)

The revenues and net income of WSM has been

25 20 15 10 5 0 -5 -10

on an upward trend from 1998 to 2002. The revenues for WSM consist of retail sales, directWSM

HNV

PIR

Industry

S & P 500

Revenue Gorw th (%)

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.

Revenues and Net Incom e 2500 2000 1500

c

1000 500 0 1998

1999

2000

2001

2002

Net Profit Margin

Net Profit Margin (%)

Net Profit Margin (%)

8

6%

6

5%

4

4%

2

3%

0 -2 -4 -6

WSM

HNV

PIR

Industry

S & P 500

2% 1% 0% 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 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)

The EPS of WSM is much higher than the

30

competitors and the industry average. The

20

decline in EPS in the year 2000 could be

10

attributed to the extra expenses incurred (as

0 -10

WSM

HNV

PIR

Industry

S & P 500

-20

mentioned above) and the rough economic /market conditions in that particular year. Prior to 2002, the company had achieved

EPS

exemplary rates of growth and therefore the

1.2

management projected its future

1 0.8

performance on the basis of the high

0.6 0.4

growth rates. When the consumer

0.2 0 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

Free cah flow is the measure of cash that is

Free Cash Flow

available from WSM’s business operations after

200 150

the payment of interest and tax, for distribution

100

of dividends or for reinvestment in business.

50

The proceeds of disposals and acquisitions are

0 -50

1998

1999

2000

2001

2002

-100

excluded from this calculation. The sales for the brand “Pottery

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

WSM’s debt to equity ratio is much lower than 1.4 1.2 1 0.8 0.6 0.4 0.2 0

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 WSM

HNV

Interest Coverage

PIR

Industry

S & P 500

debt-equity ratio of WSM is 0.02.

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 = Income/shareholder equity

ROE 25

ALV’s ROE is much greater than the industry average

20

and equal to its competitor Pier 1 Imports. From

15

company’s stand point, the ROE has been increasing

10

from year 2000. ROE has increased from 13.3% in 2000

5

to 19.3% in 2002 reflecting that the management has

0 WSM

HNV

PIR

.

Return on Assets (ROA)

Industry

S & P 500

been very effectively investing the resources provided by the shareholders.

ROA 15

ROA = Net Income / Total Assets

10 5

WSM’s ROA is higher than the industry

0 -5

WSM

HNV

PIR

Industry

average indicating that the company has used

S & P 500

-10

its assets very efficiently. This is often a

-15 -20

good sign of management.

ROA (%)

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,

(http://global.factiva.com).

The

the

invested

weighted

capital

average

for

cost

WSM of

was

capital

$662,049,000

(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 P/E ratio

WSM 30.3

PIR 18.2

HNV 21.3

Industry 34.3

S & P 500 31.1

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 Market Capitalization =

Debt Capital Structure Short-term debt = $ 7.74 M

$4124.95 M Preferred equity = 0 Common Weight = 99.53% Preferred Weight = 0%

Long-term debt = $11.91 M Short Debt Weight = 0.19% 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%

Debt

Common

Preferred Equity 0

Weight (%)

0.47

Equity 99.53

Cost (%)

2.80

10.47

0

Wtd. Avg.

0.0001316

0.10420791

0

WACC

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

Discounted Value Continuing Value Long-term Debt # shares outstanding Intrinsic Stock Price Current Stock Price

$1.61B $3.27 B $11.91 M 117 M $41.67 $ 34.20

45 40 35 30 25 20 15 10 5 0 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 % owned by insiders # sold in the past 6

117 M 5% 130,720 = 0.3% of insider

months

shares

# 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 Lester Edward E Mueller Adrian Bellamy Patrick J Connoly Jeanne Jackson Micheal R Lynch

James A McMahan

Director Director – Harold Department Stores Director President and CEO of Ameritech Director Chairman – Body Shop International Director Vice-President – Mail Order (WSM) Director President and CEO of Walmart Director Director – Goldman Sachs Director Chairman – McMahan Furniture Stores

Yes Yes Yes No Yes Yes

Yes

Director Heather M Reisman

Chairman and CEO of Indigo Books and Music

Yes

Director Richard T Robertson

Director – Warner Bros Domestic Television Distribution

8 out of 10 directors on the board are independent.

Yes

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 + β(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 Intrinsic Value $ 39.2

Growth Rate 20%

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 %. 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 wellbeing 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-tocustomer 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 ecommerce 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.