WILLIAMS-SONOMA, INC. The following discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 52 weeks endedJanuary 31, 2021 ("fiscal 2020"), and the 52 weeks endedFebruary 2, 2020 ("fiscal 2019") should be read in conjunction with our Consolidated Financial Statements and notes thereto. All explanations of changes in operational results are discussed in order of magnitude. A discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 52 weeks endedFebruary 2, 2020 ("fiscal 2019"), compared to the 53 weeks endedFebruary 3, 2019 ("fiscal 2018"), can be found under Item 7 in our Annual Report on Form 10-K for fiscal 2019, filed with theSEC onMarch 27, 2020 , which is available on theSEC's website at www.sec.gov and under the Financial Reports section of our Investor Relations website. OVERVIEWWilliams-Sonoma, Inc. is a specialty retailer of high-quality sustainable products for the home. Our products, representing distinct merchandise strategies - Williams Sonoma,Pottery Barn ,Pottery Barn Kids ,Pottery Barn Teen, West Elm,Williams Sonoma Home , Rejuvenation, and Mark and Graham - are marketed through e-commerce websites, direct-mail catalogs and retail 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 theU.S. ,Puerto Rico ,Canada ,Australia and theUnited Kingdom , offer international shipping to customers worldwide, and have unaffiliated franchisees that operate stores in theMiddle East ,the Philippines ,Mexico ,South Korea andIndia , as well as e-commerce websites in certain locations. We are also proud to lead the industry with our ESG efforts. COVID-19 OnMarch 11, 2020 , theWorld Health Organization declared COVID-19 to be a global pandemic and recommended containment and mitigation measures worldwide. InMarch 2020 , we announced the temporary closures of all of our retail store operations to protect our employees, customers and the communities in which we operate and to help contain the COVID-19 pandemic. As ofJanuary 31, 2021 , the majority of our retail stores have reopened for in-person shopping. However, given the continued uncertainty around COVID-19 due to high rates of infections in certain areas, state and local officials in certain geographies have extended closures or restrictions on retail capacity, which may continue to impact our store traffic and retail revenues, and may result in future store impairments. Throughout fiscal 2020, we have continued to operate our e-commerce sites and distribution centers and continued to deliver products to our customers. However, governmental mandates, illness, or the absence of a substantial number of distribution center employees may require in the future that we temporarily close one or more of our distribution centers, or may prohibit or significantly limit us, or our third-party logistics providers from delivering packages to our customers and our stores, which could complicate or prevent us from fulfilling e-commerce orders and supplying merchandise to our stores. Fiscal 2020 Financial Results Net revenues in fiscal 2020 increased by$885,181,000 , or 15.0%, compared to fiscal 2019, with comparable brand revenue growth of 17.0% and double-digit comparable brand revenue growth across all our brands. This was primarily driven by an increase of approximately 44% in e-commerce revenues, due to both an increase in demand for our product as well as a larger portion of our net revenues being driven by furniture, which has a higher average selling price, partially offset by a decrease in retail revenues driven by limited capacity in stores and reduced customer store traffic due to COVID-19. During fiscal 2020, we delivered double-digit comparable brand revenue growth across all our brands. The Williams Sonoma brand delivered comparable brand revenue growth of 23.8% as we implemented a content-driven marketing strategy that featured exclusive products and relevant lifestyle stories over promotions. We also 34 -------------------------------------------------------------------------------- Table of Contents grew our exclusive products to 70% of our total business, consistent with one of our key strategic initiatives to increase the mix of product that is only available at Williams Sonoma. In ourPottery Barn Kids and Teen business, we delivered 16.6% comparable brand revenue growth, as we continue to amplify our leadership in design and sustainability in the children's home furnishings business. In addition to strong core introductions in furniture, we have added a new modern aesthetic that is driving growth and attracting new customers to our brands. The Pottery Barn brand delivered comparable brand revenue growth of 15.2% and our multi-year work to improve our value proposition is paying off. Our value-engineered products are attracting new customers and we believe our multi-step finish, high-quality furniture pieces are the best value in the market. In West Elm, we delivered strong comparable brand revenue growth of 15.2% on top of 14.4% last year. We continue to build this business with original design and by filling white space in underdeveloped categories. And, our emerging brands, Rejuvenation and Mark and Graham, combined delivered another year of double-digit comparable brand revenue growth. We ended the year with a cash balance of$1,200,337,000 , compared to$432,162,000 last year, which reflects our strong financial performance as well as operating cash flow, which was more than double last year. In addition to our strong cash balance, we also ended the year with no amount outstanding under our line of credit. This strong liquidity position allowed us to fund the operations of the business, and to provide shareholder returns of approximately$307,645,000 through dividends and share repurchases. In fiscal 2020, diluted earnings per share was$8.61 (which included a$0.26 impact related to store asset impairments, a$0.13 impact from acquisition-related expenses ofOutward, Inc. , an$0.11 impact related to inventory write-offs, and a$0.06 benefit related to the adjustment of certain deferred tax assets and liabilities) versus$4.49 in fiscal 2019 (which included a$0.30 impact from acquisition-related expenses and the operations ofOutward, Inc. , an$0.11 impact related to certain employment-related expenses, and an$0.08 benefit related to the adjustment of a deferred tax liability). Throughout fiscal 2020, our three key differentiators were instrumental to our strong financial performance. They are: our in-house design, our digital-first channel strategy, and our values. Our in-house teams design our own products, create original aesthetics, and work with our talented vendors to bring quality, sustainable products to market. The majority of our products cannot be found elsewhere and the design, quality, and value that we offer is strong. Throughout fiscal 2020, we were very deliberate in reducing promotions in all of our brands, resulting in product margin expansion compared to fiscal 2019. Our second differentiator is our digital-first channel strategy. One of the key reasons for our results over the past year was because our e-commerce platform was able to serve our customers at scale. In our digital channels, we have been acquiring a significant number of new customers all year, and our customer retention metrics continue to improve among new customers. We are digital-first but not digital only. Our stores are a competitive advantage that support our online business, for customers who want to experience our products in person, as well as for those who prefer the convenience of our omni-channel fulfillment services, including buy online pick up in store and ship from store. Our third differentiator is our values. We care deeply about sustainability, equity action and supporting our associates and the communities where we work. We believe our commitment to sustainability is one of the main reasons our customers choose us over our competitors and diversity, equity and inclusion is central to who we are as a company. We continued to support our associates and customers throughout fiscal 2020 by continuing to pay our associates during the initial months of COVID-19 while our stores and offices were closed, providing pandemic bonuses and hourly wage increases to our frontline workers, as well as providing personal protective gear and COVID-19 testing to our store and supply chain associates. Looking Ahead to 2021 As we look forward to the year ahead, we will continue to focus on our three key differentiators to drive net revenue and operating margin growth. In our retail stores, we plan to further optimize our store footprint with fewer, better stores that serve as design centers and omni-channel fulfillment hubs. We believe our digital-first channel strategy will continue to accelerate, with our future growth driven predominantly by e-commerce. In our 35 -------------------------------------------------------------------------------- Table of Contents supply chain, we expect to expand ourU.S. manufacturing and fulfillment capacity by over 20%-30% next year, including adding close to two million square feet of distribution space to our delivery network. We also plan to deepen our sustainability commitments including our goal to reach 100% responsibly-sourced cotton and 50% responsibly-sourced wood. In fiscal 2021, we believe operating margin expansion will predominantly be driven by overall sales leverage from higher sales levels, a continued shift to our more efficient and profitable e-commerce business, as well as reduced occupancy costs, continued strength in our product margins, and overall strong financial discipline. However, we have experienced and may continue to experience delays in inventory receipts due to COVID-19-related slowdowns, inclement weather, port congestion, and shipping container shortages, and we have incurred and may continue to incur higher shipping charges as we deliver goods to our customers. In addition, given the continued uncertainty around COVID-19 and extended closures or restrictions on retail capacity by state and local officials in certain geographies, we have experienced and may continue to experience reduced store traffic. Overall, the long-term impact of COVID-19 on our business, results of operations and financial condition still remains uncertain. A prolonged pandemic could further interrupt our operations, our vendors' operations, the economy and overall consumer spending, which could have a material impact on our revenues, results of operations, and cash flows. For more information on risks associated with COVID-19, please see "Risk Factors" in Part I, Item 1A. 36
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Table of Contents
Results of Operations
NET REVENUES
Net revenues consist of sales of merchandise to our customers through our
e-commerce
websites, direct-mail catalogs, and at our retail stores and include shipping
fees received from customers for delivery of merchandise to their homes. Our
revenues also include sales to our franchisees and wholesale customers, breakage
income related to our stored-value cards, and incentives received from credit
card issuers in connection with our private label and
co-branded
credit cards.
Net revenues in fiscal 2020 increased by $885,181,000 , or 15.0%, compared to
fiscal 2019, with comparable brand revenue growth of 17.0% and double-digit
comparable brand revenue growth across all our brands. This was primarily driven
by an increase of approximately 44% in e-commerce revenues, due to both an
increase in demand for our product as well as a larger portion of our net
revenues being driven by furniture, which has a higher average selling price,
partially offset by a decrease in retail revenues driven by limited capacity in
stores and reduced customer store traffic due to
COVID-19.
The following table summarizes our net revenues by brand for fiscal 2020 and
fiscal 2019:
In thousands Fiscal 2020 Fiscal 2019
Pottery Barn $ 2,526,241 $ 2,214,397
West Elm 1,682,254 1,466,537
Williams Sonoma 1,242,271 1,032,368
Pottery Barn Kids and Teen 1,042,531 908,561
Other
1 289,892 276,145
Total $ 6,783,189 $ 5,898,008 1 Primarily consists of net revenues from our international franchise
operations, Rejuvenation and Mark and Graham.
Comparable Brand Revenue
Comparable brand revenue includes comparable store sales and
e-commerce
sales, including through our direct-mail catalog, as well as shipping fees,
sales returns and other discounts associated with current period sales.
Comparable stores are defined as permanent stores where gross square footage did
not change by more than 20% in the previous 12 months and which have been open
for at least 12 consecutive months without closure for seven or more consecutive
days. Comparable stores that were temporarily closed during the year due to
COVID-19
were not excluded from the comparable stores calculation. Outlet comparable
store net revenues are included in their respective brands. Sales to our
international franchisees are excluded from comparable brand revenue as their
stores and
e-commerce
websites are not operated by us. Sales from certain operations are also excluded
until such time that we believe those sales are meaningful to evaluating their
performance. Additionally, comparable brand revenue growth for newer concepts is
not separately disclosed until such time that we believe those sales are
meaningful to evaluating the performance of the brand.
Comparable brand revenue growth Fiscal 2020 Fiscal 2019
Pottery Barn 15.2 % 4.1 %
West Elm 15.2 14.4
Williams Sonoma 23.8 0.4
Pottery Barn Kids and Teen 16.6 4.5
Total
1 17.0 % 6.0 %
1 Total comparable brand revenue growth includes the results of Rejuvenation and
Mark and Graham.
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Table of Contents
RETAIL STORE DATA
1
Fiscal 2020 Fiscal 2019
Store count - beginning of year 614 625
Store openings 10 14
Store closings (43 ) (25 )
Store count - end of year 581 614
Store selling square footage at
year-end 3,975,000 4,129,000
Store leased square footage ("LSF") at
year-end 6,301,000 6,558,000
1 Store count at the end of the year for fiscal 2020 includes stores temporarily
closed due
to COVID-19.
Store count data excludes temporary closures
and re-openings
of our stores due
to COVID-19.
Fiscal 2020 Fiscal 2019
Store Avg. LSF Store Avg. LSF
Count Per Store Count Per Store
Williams Sonoma 198 6,800 211 6,900
Pottery Barn 195 14,600 201 14,400
West Elm 121 13,100 118 13,100
Pottery Barn Kids 57 7,800 74 7,700
Rejuvenation 10 8,500 10 8,500
Total 581 10,800 614 10,700
COST OF GOODS SOLD
% Net % Net
In thousands Fiscal 2020 Revenues Fiscal 2019 Revenues
Cost of goods sold
1 $ 4,146,920 61.1% $ 3,758,916 63.7%
1 Includes occupancy expenses of
and fiscal 2019, respectively.
Cost of goods sold includes cost of goods, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight expenses, freight-to-store expenses and other inventory related costs such as replacements, damages, obsolescence and shrinkage. Occupancy expenses consist of rent, depreciation and other occupancy costs, including common area maintenance, property taxes and utilities. Shipping costs consist of third-party delivery services and shipping materials. Our classification of expenses in cost of goods sold may not be comparable to other public companies, as we do not include non-occupancy-related costs associated with our distribution network in cost of goods sold. These costs, which include distribution network employment, third-party warehouse management and other distribution-related administrative expenses, are recorded in selling, general and administrative expenses. Fiscal 2020 vs. Fiscal 2019 Cost of goods sold increased by$388,004,000 , or 10.3%, in fiscal 2020 compared to fiscal 2019. Cost of goods sold as a percentage of net revenues decreased to 61.1% in fiscal 2020 from 63.7% in fiscal 2019. This rate decrease was primarily driven by higher merchandise margins from reduced promotional activity in fiscal 2020 and the leverage of occupancy expenses resulting from higher sales and reduced occupancy costs year-over-year due to our efforts to renegotiate rent and close less profitable stores. This decrease was partially offset by higher shipping costs due to a significantly greater portion of our total net revenues being generated from e-commerce and surcharges from our third-party shippers, as well as inventory write-offs of approximately$11,378,000 resulting from the closure of our outlet stores due to COVID-19 in the first quarter of fiscal 2020. 38 -------------------------------------------------------------------------------- Table of Contents SELLING, GENERAL AND ADMINISTRATIVE EXPENSES % Net % Net In thousands Fiscal 2020 Revenues Fiscal 2019 Revenues Selling, general and administrative expenses$ 1,725,572 25.4%$ 1,673,218 28.4% Selling, general and administrative expenses consist of non-occupancy-related costs associated with our retail stores, distribution and manufacturing facilities, customer care centers, supply chain operations (buying, receiving and inspection) and corporate administrative functions. These costs include employment, advertising, third-party credit card processing and other general expenses. Fiscal 2020 vs. Fiscal 2019 Selling, general and administrative expenses increased by$52,354,000 , or 3.1%, for fiscal 2020, compared to fiscal 2019. Selling, general and administrative expenses as a percentage of net revenues decreased to 25.4% for fiscal 2020 from 28.4% for fiscal 2019. This rate decrease was primarily driven by lower advertising costs as we further optimized our digital spend on those initiatives that drove higher returns in traffic and conversion, and the leverage of employment costs from higher sales and lower variable store payroll. This decrease was partially offset by store asset impairment charges of approximately$27,069,000 for fiscal 2020 due in part to the impact of COVID-19 on our retail stores. INCOME TAXES The effective income tax rate was 23.9% for fiscal 2020 and 22.1% for fiscal 2019. The increase in the effective tax rate in fiscal 2020 is primarily due to the tax effect of the change in the mix and level of our earnings. LIQUIDITY AND CAPITAL RESOURCES As ofJanuary 31, 2021 , we held$1,200,337,000 in cash and cash equivalents, the majority of which was held in interest-bearing demand deposit accounts and money market funds, and of which$147,464,000 was held by our international subsidiaries. As is consistent within our industry, our cash balances are seasonal in nature, with the fourth quarter historically representing a significantly higher level of cash than other periods. Throughout the fiscal year, we utilize our cash resources to build our inventory levels in preparation for our fourth quarter holiday sales. In fiscal 2021, we plan to use our cash resources to fund our inventory and inventory-related purchases, advertising and marketing initiatives, stock repurchases and dividend payments, early repayment of our term loan and property and equipment purchases. In addition to our cash balances on hand, 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 to request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders to increase the revolver by up to$250,000,000 , at such lenders' option, to provide for a total of$750,000,000 of unsecured revolving credit. During fiscal 2020, we had borrowings of$487,823,000 under our revolver, all of which were repaid prior to the end of the fiscal year. No amounts were outstanding as ofJanuary 31, 2021 . Additionally, as ofJanuary 31, 2021 , a total of$12,609,000 in issued but undrawn standby letters of credit were outstanding under our revolver. The standby letters of credit were primarily issued to secure the liabilities associated with workers' compensation and other insurance programs. InMay 2020 , we entered into an amendment to our credit facility, which, among other changes, extends the maturity date and amends the interest rate of the term loan, modifies covenants under the credit facility, and maintains the maturity date and interest rate of the revolver. As ofJanuary 31, 2021 , we had$300,000,000 outstanding under our term loan. InFebruary 2021 , prior to maturity, we repaid the full outstanding balance on the term loan. 39 -------------------------------------------------------------------------------- Table of Contents In addition to the Credit Facility Amendment, during the second quarter of fiscal 2020 we entered into a new agreement (the "364-Day Credit Agreement") for an additional$200,000,000 unsecured revolving line of credit. During fiscal 2020, we had no borrowings under the 364-Day Credit Agreement. We do not expect to renew the 364-Day Credit Agreement upon its maturity inMay 2021 . The Credit Facility Amendment and the 364-Day Credit Agreement contain certain restrictive loan covenants, including, among others, a financial covenant requiring a maximum leverage ratio (funded debt adjusted for lease and rent expense to earnings before interest, income tax, depreciation, amortization and rent expense), and covenants limiting our ability to incur indebtedness, grant liens, make acquisitions, merge or consolidate, and dispose of assets. As ofJanuary 31, 2021 , we were in compliance with our financial covenants under our credit facilities and, based on our current projections, we expect to remain in compliance throughout the next 12 months. We believe our cash on hand, in addition to our available credit facilities, will provide adequate liquidity for our business operations over the next 12 months. Letter of Credit Facilities We have three unsecured letter of credit reimbursement facilities for a total of$35,000,000 , each of which matures onAugust 22, 2021 . 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 ofJanuary 31, 2021 , an aggregate of$3,843,000 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 date possible for any future letters of credit issued under the facilities isJanuary 19, 2022 . Cash Flows from Operating Activities For fiscal 2020, net cash provided by operating activities was$1,274,848,000 compared to$607,294,000 in fiscal 2019. For fiscal 2020, net cash provided by operating activities was primarily attributable to net earnings adjusted for non-cash items, an increase in accrued expenses and other liabilities, a decrease in merchandise inventories and an increase in gift card and other deferred revenue. Net cash provided by operating activities compared to fiscal 2019 increased primarily due to an increase in net earnings, an increase in accrued expenses and other liabilities, an increase in gift card and other deferred revenue and a decrease in merchandise inventories. Cash Flows from Investing Activities For fiscal 2020, net cash used in investing activities was$168,884,000 compared to$185,548,000 in fiscal 2019 and was primarily attributable to purchases of property and equipment. Cash Flows from Financing Activities For fiscal 2020, net cash used in financing activities was$343,019,000 compared to$327,226,000 in fiscal 2019 and was primarily attributable to the payment of dividends and repurchases of common stock. Net cash used in financing activities compared to fiscal 2019 increased primarily due to an increase in the payment of dividends. Dividends In fiscal 2020 and fiscal 2019, total cash dividends declared were approximately$163,316,000 , or$2.02 per common share, and$156,103,000 , or$1.92 per common share, respectively. InMarch 2021 , our Board of Directors authorized a$0.06 , or 11.3%, increase in our quarterly cash dividend, from$0.53 to$0.59 per common share, subject to capital availability. Our quarterly cash dividend may be limited or terminated at any time. Stock Repurchase Program See section titled "Stock Repurchase Program" within Part II, Item 5 of this Annual Report on Form 10-K for further information. 40
-------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table provides summary information concerning our future contractual obligations as ofJanuary 31, 2021 : Payments Due by Period 1 Fiscal 2022 Fiscal 2025 In thousands Fiscal 2021 to Fiscal 2024 to Fiscal 2026 Thereafter Total Current debt 2$ 300,000 $ - $ - $ -$ 300,000 Interest 542 - - - 542 Operating leases 3 267,760 605,121 263,192 291,356 1,427,429 Purchase obligations 4 1,350,121 22,456 - - 1,372,577 Total$ 1,918,423 $ 627,577 $ 263,192 $ 291,356 $ 3,100,548
1 This table excludes
associated with uncertain tax positions as we are not able to reasonably
estimate when and if cash payments for these liabilities will occur. This
amount, however, has been recorded as a liability in our accompanying
Consolidated Balance Sheet as of
2 Current debt consists of term loan borrowings under our credit facility, all
of which was repaid in full, prior to maturity, in
to our Consolidated Financial Statements for discussion of our borrowing
arrangements.
3 Projected undiscounted payments include only those amounts that are fixed and
determinable as of the reporting date. See Note E to our Consolidated
Financial Statements for discussion of our operating leases.
4 Represents estimated commitments at
year-end
to purchase inventory and other goods and services in the normal course of
business to meet operational requirements.
Other Contractual Obligations We have other liabilities reflected in our Consolidated Balance Sheet. The payment obligations associated with these liabilities are not reflected in the table above due to the absence of scheduled maturities. The timing of these payments cannot be determined, except for amounts estimated to be payable in fiscal 2021, which are included in our current liabilities as ofJanuary 31, 2021 . In connection with our acquisition ofOutward Inc. , we have agreed to pay certain additional amounts to former stockholders of Outward, contingent upon their continued service or the achievement of certain financial performance targets. These contingent obligations are not reflected in the table above. We are party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to commercial matters, operating leases, trademarks, intellectual property and financial matters. Under these contracts, we may provide certain routine indemnification relating to representations and warranties or personal injury matters. The terms of these indemnifications range in duration and may not be explicitly defined. Historically, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any of these matters, the loss would not have a material effect on our financial condition or results of operations. Commercial Commitments The following table provides summary information concerning our outstanding commercial commitments as ofJanuary 31, 2021 : Amount of
Outstanding Commitment Expiration by Period
1
Fiscal 2022 Fiscal 2025
In thousands Fiscal 2021 to Fiscal 2024 to Fiscal 2026 Thereafter Total
Standby letters of credit $ 12,609 $ - $ - $ - $ 12,609
Letter of credit facilities 3,843 - - - 3,843
Total $ 16,452 $ - $ - $ - $ 16,452 1 See Note C to our Consolidated Financial Statements for discussion of our
borrowing arrangements.
41-------------------------------------------------------------------------------- Table of Contents IMPACT OF INFLATION The impact of inflation (or deflation) on our results of operations for the past three fiscal years has not been significant. However, we cannot be certain of the effect inflation (or deflation) may have on our results of operations in the future. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations is based on our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America . The preparation of these Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. These estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ from these estimates. We believe the following critical accounting policies used in the preparation of our Consolidated Financial Statements include the significant estimates and assumptions that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. See Note A to our Consolidated Financial Statements for further discussion of each policy. 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 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 year end 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 and off-site storage locations, and with our third-party warehouse and transportation providers. Accordingly, there is no shrinkage reserve at year-end. 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 have made no material changes to our assumptions included in the calculations of the obsolescence and shrinkage reserves throughout the year. In addition, we do not believe a 10% change in our inventory reserves would have a material effect on our net earnings. As ofJanuary 31, 2021 andFebruary 2, 2020 , our inventory obsolescence reserves were$9,827,000 and$13,424,000 , respectively. Long-lived Assets Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the 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 or asset group may not be recoverable. Our impairment analyses determine whether projected cash flows from operations are sufficient 42 -------------------------------------------------------------------------------- Table of Contents 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 supply and 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. Given the material reductions in our retail store revenues and operating income during fiscal 2020 as a result of the COVID-19 pandemic, we evaluated our estimates and assumptions related to our stores' future sales and cash flows, and performed a comprehensive review of our stores' long-lived assets for impairment, including both property and equipment and operating lease right-of-use assets, at an individual store level. Our assumptions account for the estimated impact on future cash flows from the recent temporary store closures and capacity restrictions, including reduced store traffic and longer recovery times in those stores we have re-opened, as well as the reinstatement of closures or restrictions on retail capacity in certain areas. These events and changes in circumstances, including a more prolonged and/or severe COVID-19 pandemic and the reinstatement of closures or restrictions on retail capacity, may lead to increased impairment risk in the future; therefore, we will continue to monitor events and changes in circumstances that may indicate the need to test our long-lived assets, including goodwill, for potential impairment. During fiscal 2020, we recognized asset impairment charges of approximately$19,204,000 related to property and equipment and$7,865,000 related to right-of use assets for our retail stores, which is recognized within selling, general and administrative expenses. During fiscal 2019, we recognized 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 . Leases We lease store locations, distribution and manufacturing facilities, corporate facilities, customer care centers and certain equipment for ourU.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 service 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. 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 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 when we are reasonably certain to exercise a renewal or an early termination option. 43 -------------------------------------------------------------------------------- Table of Contents Our leases generally do not provide information about the rate implicit in the lease. Therefore, we utilize 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. 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. 44
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