WILLIAMS SONOMA INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
---------------------

FORM 10-K

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended February 3, 2002.

OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission file number 001-14077

WILLIAMS-SONOMA, INC.
(Exact Name of Registrant as Specified in Its Charter)

CALIFORNIA 94-2203880
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

3250 VAN NESS AVENUE, SAN FRANCISCO, CA 94109
(Address of principal executive offices) (Zip Code)

Registrant's Telephone Number, Including Area Code (415) 421-7900

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $.01 par value New York Stock Exchange, Inc.
(Title of Class) (Name of Each Exchange on which Registered)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by checkmark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by checkmark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of April 2, 2002, the approximate aggregate market value of voting stock
held by non-affiliates of the Registrant was $2,055,055,643 using the closing
sales price on this day of $44.94. It is assumed for purposes of this
computation an affiliate includes all persons registered as Registrant insiders
with the Securities and Exchange Commission, as well as the Registrant's
Associate Stock Incentive Plan.

As of April 15, 2002, 57,428,301 shares of the Registrant's Common Stock
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the 2002 Annual Meeting
(the "Proxy Statement") in Part III have been incorporated herein by reference.

FORWARD-LOOKING STATEMENTS AND RISK FACTORS

The plans, projections and other forward-looking statements included in
Management's Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in the Annual Report on Form 10-K with respect to the
financial condition, results of operations and business of the Company are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those set forth in such statements. These risks and
uncertainties include, without limitation, the following:

- The Company's ability to anticipate consumer preferences and buying
trends

- Dependence on timely introduction and customer acceptance of its
merchandise

- Construction and other delays in store openings

- Competition from companies with concepts or products similar to those of
the Company

- Timely and effective sourcing of its merchandise from its foreign and
domestic vendors and delivery of merchandise through its supply chain to
its stores and customers

- Effective inventory management commensurate with customer demand

- Successful catalog management, including timing, sizing and merchandising

- Uncertainties in Internet marketing, infrastructure and regulation

- Changes in consumer spending based on weather, economic, competitive and
other conditions beyond the Company's control

- Multichannel and multibrand complexities

- Dependence on external funding sources for operating funds

- The Company's ability to control employment, occupancy and other
operating costs

- The Company's ability to improve and control its systems and processes

- General economic and market conditions and events

- Other risks and uncertainties contained in the Company's public
announcements, reports to stockholders and SEC filings, including but not
limited to Reports on Forms 10-K, 8-K and 10-Q.

The Company has not undertaken, nor is it required, to publicly update or
revise any of its forward-looking statements, even if experience or future
events make it clear that the results set forth in such statements will not be
realized.

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WILLIAMS-SONOMA, INC.
FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED FEBRUARY 3, 2002

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

Williams-Sonoma, Inc. and its subsidiaries (the "Company") are specialty
retailers of products for the home. The retail segment sells its products
through its four retail concepts -- Williams-Sonoma, Pottery Barn, Pottery Barn
Kids and Hold Everything. The direct-to-customer segment sells similar products
through its six direct-mail catalogs -- Williams-Sonoma, Pottery Barn, Pottery
Barn Kids, Pottery Barn Bed + Bath, Hold Everything and Chambers -- and four
e-commerce websites. Based on net revenues in fiscal 2001, retail accounted for
59.3% of the business and direct-to-customer accounted for 40.7%. The principal
concepts in retail are Williams-Sonoma which sells cookware essentials and
Pottery Barn which sells contemporary tableware and home furnishings. The
principal concepts in direct-to-customer are Williams-Sonoma, Pottery Barn and
Pottery Barn Kids which sells stylish children's furnishings.

The Company was founded in 1956 with the opening of its first store in
Sonoma, California by Charles E. Williams, currently Vice Chairman and a
director of the Company. Today, the Williams-Sonoma stores offer a wide
selection of culinary and serving equipment, including cookware, cookbooks,
cutlery, informal dinnerware, glassware, table linens, specialty foods and
cooking ingredients. The Company's direct-to-customer business began in 1972
when it introduced its flagship catalog, "A Catalog for Cooks," which markets
the Williams-Sonoma brand.

In 1983, the Company internally developed the Hold Everything catalog to
offer innovative solutions for household storage needs by providing efficient
organization solutions for every room in the house. The first Hold Everything
store was opened in 1985.

In 1986, the Company acquired Pottery Barn, a retailer and
direct-to-customer merchandiser featuring a large assortment of items in casual
home furnishings, flatware and table accessories from around the world that are
designed internally to be combined to create a dynamic look in the home.

In 1989, the Company developed Chambers, a mail order merchandiser of high
quality linens, towels, robes, soaps and accessories for the bed and bath.

In 1999, the Company launched both its Williams-Sonoma Internet wedding and
gift registry website and its Williams-Sonoma e-commerce site. In addition, the
Company launched the Pottery Barn Kids catalog which offers well-made and
stylish children's furnishings and in 2000, the Company opened its first Pottery
Barn Kids stores across the United States.

In 2000, the Company also introduced its Pottery Barn website and created
Pottery Barn Bed + Bath, a catalog dedicated to bed and bath products.

In 2001, the Company launched its Pottery Barn Kids website, Pottery Barn
online gift and bridal registry, and Pottery Barn Kids online gift registry.
Additionally, in 2001, the Company opened five new retail stores (two
Williams-Sonoma, two Pottery Barn and one Pottery Barn Kids retail stores) in
Toronto, Canada.

In 2002, the Company plans to test a new catalog called West Elm. The new
brand targets young, design conscious consumers looking to furnish and
accessorize their apartments, lofts or first homes with quality product at
accessible price points. West Elm product categories include furniture,
decorative accessories, table top items and an extensive textile collection. The
brand is scheduled to launch nationally with its summer 2002 catalog. If the
test is successful, the Company will consider expanding the concept at retail in
2003.

RETAIL STORES

The retail segment has four merchandising concepts -- Williams-Sonoma,
Pottery Barn, Pottery Barn Kids and Hold Everything. As of February 3, 2002, the
Company operated 415 retail stores, located in 41 states, Washington DC and
Toronto, Canada. This represents 214 Williams-Sonoma, 145 Pottery Barn, 27
Pottery Barn Kids, 15 Hold Everything, and 14 Outlet stores. In fiscal 2002, the
Company plans to increase retail leased square footage by approximately 14% to
15%. The average square footage for new and expanded

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stores in fiscal 2002 will be approximately 10,600 leased square feet for
Pottery Barn, 7,700 leased square feet for Pottery Barn Kids and 5,800 leased
square feet for Williams-Sonoma.

DIRECT-TO-CUSTOMER OPERATIONS

The direct-to-customer segment has six merchandising concepts and sells
products through its six direct-mail catalogs (Williams-Sonoma, Pottery Barn,
Pottery Barn Kids, Pottery Barn Bed + Bath, Hold Everything and Chambers) and
four e-commerce websites (wsweddings.com, williams-sonoma.com, potterybarn.com
and potterybarnkids.com). Of these six merchandising concepts, the Pottery Barn
brand and its extensions have been the major source of sales growth in the
direct-to-customer segment for the last several years. Management believes that
the success of the Pottery Barn brand and its extensions reflects the Company's
continuing investment in product design and quality and the consumer recognition
achieved through its Pottery Barn and Pottery Barn Kids catalogs, websites and
stores.

The Company estimates that approximately 40% to 50% of non-bridal
e-commerce sales are incremental to the direct-to-customer channels and
approximately 50% to 60% are from catalog customers who would have potentially
placed an order via the catalog call center.

The Company sends its catalogs to addresses from its proprietary customer
list, as well as to names from lists which the Company receives in exchange or
rents from other mail order merchandisers, magazines and other companies. In
accordance with prevailing industry practice, the Company rents its list to
other merchandisers. The Company's customer list is continually updated to
include new prospects and eliminate non-responders.

The direct-to-customer business complements the retail business by building
customer awareness of a brand and acting as an effective advertising vehicle. In
addition, the Company believes that the mail order catalogs and the Internet act
as a cost efficient means of testing market acceptance of new products.

SUPPLIERS

The Company purchases its merchandise from numerous foreign and domestic
manufacturers and importers, none of which accounted for more than 4% of
purchases during fiscal 2001. Approximately 55% of the Company's payments for
merchandise in fiscal 2001 were to foreign vendors, most of which are located in
Europe and Asia. Substantially all of the Company's foreign purchases of
merchandise are negotiated and paid for in U.S. dollars.

The Company cannot predict whether any of the countries in which its
products are currently manufactured or may be manufactured in the future will be
subject to trade restrictions imposed by the U.S. government, including the
likelihood, type or effect of any such restrictions. Any event causing a sudden
disruption of imports from foreign vendors, including the imposition of
additional import restrictions, as well as increased tariffs or quotas, or both,
against home-centered items could increase the cost or reduce the supply of
merchandise available to the Company and adversely affect the Company's
business, financial condition and results of operations. The Company's sourcing
strategy includes relationships with manufacturers in over 40 countries. These
sourcing operations may be adversely affected by political and financial
instability resulting in the disruption of trade from exporting countries,
significant fluctuation in the value of the U.S. dollar against foreign
currencies, restrictions on the transfer of funds and/or other trade
disruptions.

COMPETITION AND SEASONALITY

The specialty retail business is highly competitive. The Company's
specialty retail stores, mail order catalogs and the Internet compete with other
retail stores, including specialty stores and department stores, other mail
order catalogs and other e-commerce websites. 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 Company competes on the basis of the quality of its merchandise,
service to its customers and its proprietary customer list.

4

The Company's business is subject to substantial seasonal variations in
demand. Historically, a significant portion of the Company's revenues and net
earnings have been realized during the period from October through December, and
levels of net revenues and net earnings have generally been significantly lower
during the period from January through September. The Company believes this is
the general pattern associated with the direct-to-customer and retail
industries. In anticipation of its peak season, the Company hires a substantial
number of additional employees in its retail stores and direct-to-customer
processing and distribution areas, and incurs significant fixed catalog
production and mailing costs.

PATENTS, TRADEMARKS, COPYRIGHTS AND DOMAIN NAMES

Williams-Sonoma, Inc. owns and/or has applied to register over one hundred
trademarks and service marks in the United States, Canada and in approximately
35 additional countries throughout the world. Exclusive rights to the trademarks
and service marks are held by Williams-Sonoma, Inc. and are used by its
subsidiaries under license. These marks include brand names for products as well
as house marks for the subsidiaries and their signature publications and web
sites. The house marks in particular, including "Williams-Sonoma," the
Williams-Sonoma Grand Cuisine logo, "Pottery Barn," "Hold Everything,"
"Chambers," "Pottery Barn Kids," and "West Elm," are of material importance to
the Company. Trademarks are generally valid as long as they are in use and/or
their registrations are properly maintained, and they have not been found to
have become generic. Trademark registrations can generally be renewed
indefinitely so long as the marks are in use. Williams-Sonoma, Inc. also owns
numerous copyrights and exclusive trade dress rights for Company products,
product packaging, catalogs, books, house publications and web site designs,
among other things, which are also used by its subsidiaries under license.
Williams-Sonoma, Inc. also holds patents on certain product functions and
product designs. In addition, Williams-Sonoma, Inc. has registered and maintains
numerous Internet domain names, including "williams-sonoma.com,"
"wsweddings.com," "potterybarn.com," and "potterybarnkids.com." Collectively,
the copyrights, trade dress rights, patents and domain names currently held by
Williams-Sonoma, Inc. are of material importance to the Company.

EMPLOYEES

At February 3, 2002, the Company employed approximately 27,000 persons,
approximately 6,000 of whom were full-time employees. During the fiscal 2001
peak season the Company hired approximately 11,000 temporary employees in its
stores and in its direct-to-customer processing and distribution areas.

ITEM 2. PROPERTIES

The Company's gross leasable area, at February 3, 2002, totaled
approximately 3,179,000 square feet of lease space for 415 stores compared to
approximately 2,753,000 square feet for 382 stores at the end of the prior year.
All of the existing stores are leased by the Company with original terms ranging
generally from 3 to 23 years. Certain leases contain renewal options for periods
of up to 20 years. Store leases typically provide for minimum rental payments
and additional rent based upon a percentage of store sales if a specified store
sales target is exceeded. Such contingent rental expense is accrued each
reporting period if achievement of a store sales target is considered probable.
(See Note E to the Company's Consolidated Financial Statements.)

The Company leases distribution facilities in the following locations:

Location Square Footage (Approximate)
- ------------------------------------------------------------------------------------------
Olive Branch, Mississippi 2,152,000 square feet
Memphis, Tennessee 1,515,000 square feet
- ------------------------------------------------------------------------------------------

Two of the Company's distribution facilities in Memphis, Tennessee are
leased from two partnerships whose partners include directors, executive
officers and/or significant shareholders of the Company. (See Note F to the
Company's Consolidated Financial Statements.)

5

The Company leases call centers in the following locations:

Location Square Footage (Approximate)
- ------------------------------------------------------------------------------------------
Las Vegas, Nevada 36,000 square feet
Oklahoma City, Oklahoma 36,000 square feet
Camp Hill, Pennsylvania 38,000 square feet
- ------------------------------------------------------------------------------------------

The Company's corporate facilities are located in San Francisco,
California. The Company's primary headquarters, consisting of 122,000 square
feet, was purchased in 1993. In February 2000, the Company purchased a 204,000
square foot facility in San Francisco, California for the purpose of
consolidating certain headquarters staff and to provide for future growth.

The Company also leases office, warehouse, design/photo studio and data
center space in the following locations:

Location Square Footage (Approximate)
- ------------------------------------------------------------------------------------------
San Francisco, California 150,000 square feet
New York City, New York 19,000 square feet
Rocklin, California 14,000 square feet
Jupiter, Florida 2,000 square feet
- ------------------------------------------------------------------------------------------

As of February 3, 2002, approximately 38,000 square feet of the Company's
San Francisco leased properties were sublet and approximately 33,000 square feet
of the Company's owned properties were leased. The lease agreement relating to
the Company's owned properties expires in April 2002.

ITEM 3. LEGAL PROCEEDINGS

There are no material pending legal proceedings against the Company. The
Company is, however, involved in routine litigation arising in the ordinary
course of its business, and, while the results of the proceedings cannot be
predicted with certainty, the Company believes that the ultimate resolution of
such matters will not have a material adverse effect on the Company's
consolidated financial statements taken as a whole.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the
fourth quarter of the 2001 fiscal year.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

MARKET INFORMATION

Williams-Sonoma's common stock is traded on the New York Stock Exchange
(NYSE) under the symbol WSM. The following table sets forth the high and low
closing prices on the NYSE for the periods indicated.

- ----------------------------------------------------------------------------------
Fiscal 2001 High Low
- ----------------------------------------------------------------------------------
1st Quarter $29.51 $23.00
2nd Quarter $38.91 $30.00
3rd Quarter $39.04 $21.73
4th Quarter $46.00 $25.30
- ----------------------------------------------------------------------------------
Fiscal 2000 High Low
- ----------------------------------------------------------------------------------
1st Quarter $34.63 $18.94
2nd Quarter $40.44 $26.00
3rd Quarter $44.75 $18.19
4th Quarter $27.63 $16.19
- ----------------------------------------------------------------------------------

The closing sales price of the Company's common stock on the NYSE on April
2, 2002 was $44.94.

SHAREHOLDERS

The number of shareholders of record as of April 2, 2002 was approximately
519. This number excludes shareholders whose stock is held in nominee or street
name by brokers.

DIVIDEND POLICY

The Company has never declared or paid a cash dividend on its common stock.
In addition, the Company is prohibited from doing so by certain covenants in its
bank line of credit. (See Note C to the Company's Consolidated Financial
Statements.)

STOCK SPLIT

On April 15, 2002, the Company's Board of Directors declared a two-for-one
stock split to be effected by issuing one additional share of common stock for
each share of the Company's common stock outstanding. The distribution will be
made on May 9, 2002 to shareholders of record on April 29, 2002. (See Note M to
the Company's Consolidated Financial Statements.) All amounts shown in this
Annual Report on Form 10-K reflect a pre-stock split basis, except for certain
pro forma earnings per share information as noted.

7

ITEM 6. SELECTED FINANCIAL DATA

FIVE-YEAR SELECTED FINANCIAL DATA

The information set forth above is not necessarily indicative of future
operations, and should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and notes thereto in this Annual Report on Form 10-K.

(1)The fiscal year ended February 3, 2002 includes 53 weeks.
(2)Per share amounts have been restated to reflect the 2-for-1 stock split in
May 1998.
(3)Operating margin is defined as earnings before interest, income taxes and
gain on sale of Gardeners Eden.
(4)Earnings per share restated to reflect the 2-for-1 stock split declared in
April 2002.

8

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

BUSINESS

Williams-Sonoma, Inc. and its subsidiaries (the "Company") are specialty
retailers of products for the home. The retail segment sells its products
through its four retail concepts -- Williams-Sonoma, Pottery Barn, Pottery Barn
Kids and Hold Everything. The direct-to-customer segment sells similar products
through its six direct-mail catalogs -- Williams-Sonoma, Pottery Barn, Pottery
Barn Kids, Pottery Barn Bed + Bath, Hold Everything and Chambers -- and four
e-commerce websites. The principal concepts in retail are Williams-Sonoma which
sells cookware essentials and Pottery Barn which sells contemporary tableware
and home furnishings. The principal concepts in direct-to-customer are
Williams-Sonoma, Pottery Barn and Pottery Barn Kids which sells stylish
children's furnishings. The following discussion and analysis of financial
condition, results of operations, liquidity and capital resources should be read
in conjunction with the Company's audited consolidated financial statements and
the notes thereto.

RISK FACTORS

The following information describes certain significant risks inherent in
the Company's business. You should carefully consider such risks, together with
the other information contained in this Annual Report on Form 10-K. If any of
the following risks and uncertainties actually occur, our business, financial
condition or operating results could be harmed substantially. This could cause
the trading price of our common stock to decline, perhaps significantly.

The Company must successfully anticipate changing consumer preferences and
buying trends to succeed.

The Company is a specialty retailer of products for the home, including
cookware, cooking accessories, home furnishings and table accessories. The
Company's success depends upon its ability to anticipate and respond to changing
merchandise trends and customer demands in a timely manner. Shifts in consumer
preferences away from the Company's major product lines could have a negative
impact on the Company's business and operating results. Consumer preferences
cannot be predicted with certainty and may change between sales seasons. If the
Company misjudges either the market for its merchandise or its customers'
purchasing habits, its sales may decline significantly and it may be required to
markdown certain products to sell the resulting excess inventory, each of which
would harm the Company's business and operating results.

The Company's ability to manage its inventory effectively and commensurate
with customer demand depends on fluctuations in consumer preferences. The
Company 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 evidenced by customer purchases.
The extended lead times for many of the Company's purchases may make it
difficult for the Company to respond rapidly to new or changing trends. In
addition, the seasonal nature of the specialty home products business requires
the Company to carry a significant amount of inventory prior to peak selling
season. As a result, the Company is vulnerable to demand and pricing shifts and
to misjudgments in the selection and timing of merchandise purchases. If the
Company does not accurately predict its customers' preferences and acceptance
levels of its products, its business and operating results may be negatively
impacted.

The Company's success also depends on maintaining favorable brand
recognition. If any of the Company's vendors, manufacturers or stores does not
adhere to the Company's quality control or service procedures or otherwise fail
to ensure the satisfactory quality of its products, the Company could lose
customer goodwill, which could negatively affect the Company's business and
operating results.

The Company's growth in sales and profits depends on its ability to successfully
open new stores.

In each of the past three fiscal years, the Company's retail stores have
generated nearly 60% of its net revenues. The Company plans a net increase of
approximately 56 new retail stores in fiscal 2002 as part of its

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growth strategy. There is no assurance that this strategy will be successful.
The Company's ability to open additional stores will depend upon a number of
factors, including:

- the identification and availability of suitable locations;

- the Company's success in negotiating leases on acceptable terms;

- the Company's ability to secure required governmental permits and
approvals,

- the hiring and training of skilled operating personnel, especially
management;

- the timely development of new stores, including the availability of
construction materials and labor;

- the availability of financing on acceptable terms (if at all); and

- general economic conditions.

Many of these factors are beyond the Company's control. 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 the Company's business and operating results.
There can be no assurance that the Company will be able to open new stores or
that, if opened, those stores will be operated profitably.

The Company faces intense competition.

The specialty retail business is highly competitive. The Company faces a
variety of competitive challenges, including:

- anticipating and quickly responding to changing consumer demands;

- maintaining favorable brand recognition and effectively marketing its
products to consumers in several diverse market segments;

- developing innovative, high-quality products in colors and styles that
appeal to consumers of varying age groups and tastes;

- competitively pricing our products and achieving customer perception of
value; and

- providing strong and effective marketing support.

The Company's 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 those of the
Company. The Company competes 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. There is no assurance that the Company will be able to compete
successfully.

The Company's business is dependent on factors affecting consumer spending.

The Company's business is dependent on consumer demand for its products
and, consequently, is sensitive to a number of factors that influence consumer
spending, including general economic conditions, disposable consumer income,
fears of recession, consumer debt, interest rates and consumer confidence in
future economic conditions. Adverse changes in factors affecting discretionary
consumer spending could reduce customer demand for the Company's products, thus
imposing practical limits on pricing and harming its operating results.

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The Company depends on key domestic and foreign vendors for timely and effective
sourcing of its merchandise.

The Company's performance depends on its ability to purchase its
merchandise in sufficient quantities at competitive prices. The Company
purchases its merchandise from numerous foreign and domestic manufacturers and
importers. The Company has no contractual assurances of continued supply,
pricing or access to new products and any vendor or distributor could
discontinue selling to the Company at any time. There can be no assurance that
the Company will be able to acquire desired merchandise in sufficient quantities
on terms acceptable to the Company in the future. Any inability to acquire
suitable merchandise or the loss of one or more key vendors could have a
negative effect on the Company's business and operating results unless and until
alternative supply arrangements are secured. The Company 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 the Company
currently purchases.

The Company's sourcing strategy includes relationships with manufacturers
in over 40 countries. Approximately 55% of the Company's payments for
merchandise in fiscal 2001 were to foreign vendors, most of which are located in
Europe and Asia. Substantially all of the Company's foreign purchases of
merchandise are negotiated and paid for in U.S. dollars. The Company's sourcing
operations and arrangements with foreign vendors are subject to a variety of
risks, including import duties and quotas, fluctuations in currency exchange
rates, work stoppages, economic uncertainties (including inflation), foreign
government regulations, political unrest and trade restrictions. In addition,
the Company competes with other companies for production facilities and import
quota capacity. The Company cannot predict whether any of the countries in which
its 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
sudden 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 the
Company and adversely affect the Company's business and operating results.

The Company must timely and effectively deliver merchandise to its stores and
customers.

The Company relies upon third party carriers for its product shipments,
including shipments to its customers and to and from all of its stores, and
accordingly is subject to the risks, including employee strikes and inclement
weather, associated with such carriers' ability to provide delivery services to
meet the Company's shipping needs. Failure to deliver products to customers in a
timely manner could damage the Company's reputation and brands.

The Company experiences fluctuations in its comparable store sales.

The Company's success depends, in part, upon its ability to improve sales
at its stores. Various factors affect comparable store sales, including the
general retail sales environment, changes in sales mix between distribution
channels, the Company's ability to efficiently source and distribute products,
changes in the Company's merchandise mix, competition, current economic
conditions, the timing of release of new merchandise and promotional events, the
success of marketing programs and weather conditions. These factors may cause
the Company's comparable store sales results to differ materially from prior
periods and from expectations. The Company's comparable store sales have
fluctuated significantly in the past on an annual, quarterly and monthly basis,
and the Company expects that it will continue to fluctuate in the future. The
Company's comparable store net sales increases for fiscal years 2001, 2000 and
1999 were 1.7%, 5.5% and 6.4%, respectively. Past comparable store sales are no
indication of future results, and there can be no assurance that the Company's
comparable store sales will not decrease in the future. The Company's ability to
maintain and improve its comparable store sales results depends in large part on
maintaining and improving its forecasting of customer demand and buying trends,
selecting effective marketing techniques, providing an appropriate mix of
merchandise for its broad and diverse customer base and using more effective
pricing strategies. Any failure to meet the comparable store sales expectations
of investors and security analysts in one or more future periods could reduce
the market price of the Company's common stock.
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The failure to successfully manage the Company's catalog mailings and
fulfillment may have a negative impact on the Company's business.

Postal rate increases and paper and printing costs affect the cost of the
Company's catalog mailings. The Company relies on discounts from the basic
postal rate structure, such as discounts for bulk mailings and sorting by zip
code and carrier routes. The Company's cost of paper has fluctuated
significantly during the past three fiscal years, and its future paper costs are
subject to supply and demand forces external to its business. There can be no
assurance that the Company will not be subject to an increase in paper costs.
Although the Company has entered into long-term contracts for the paper and
printing of its catalogs, these contracts offer no assurance that the Company's
catalog production costs will not substantially increase following expiration of
the contracts. Future increases in postal rates or paper or printing costs would
have a negative impact on the Company's operating results to the extent that the
Company is unable to pass such increases on directly to customers or offset such
increases by raising selling prices or by implementing more efficient printing,
mailing, delivery and order fulfillment systems.

Each catalog issue requires substantial investments in layout and design,
paper, printing, and inventory prior to mailing. As a result, the Company is not
able to adjust these costs for a particular mailing in response to the actual
performance of the catalog. The Company has historically experienced
fluctuations in customer response to its catalogs. Customer response to the
Company's catalogs is substantially dependent on merchandise assortment,
availability and creative presentation as well as the timing of delivery of the
catalogs. The lack of effective performance of any third parties with respect to
production and distribution of catalogs could affect the timing of delivery of
catalogs. Any delay could cause customers to forego or defer purchases from the
Company. If the Company is unable to achieve favorable customer response in the
future, its revenues could decline.

The operation of the Company's direct-to-customer business is also
dependent on the Company's ability to maintain the efficient and uninterrupted
operation of its order-taking and fulfillment operations and its 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 net revenues as well as increased administrative costs.

The Company's inability or failure to protect its intellectual property would
have a negative impact on the Company's business.

The Company's trademarks, service marks, copyrights, patents, trade dress
rights, trade secrets, domain names and similar intellectual property are
critical to its success. The unauthorized reproduction or other misappropriation
of the Company's trademarks or other intellectual property could diminish the
value of the Company's proprietary rights or goodwill. There can be no assurance
that effective trademark, service mark, copyright, trade secret and other
protection is or will be available.

The Company is planning certain system changes that may disrupt its supply
chain.

The Company's success depends on its ability to continue sourcing
merchandise efficiently. The Company continues to evaluate possible
modifications to its information technology systems supporting the product
pipeline, including design, sourcing, merchandise planning, forecasting and
purchase order, inventory, distribution, transportation and price management.
Modifications may involve updating or replacing legacy systems with successor
systems, if necessary. The Company is aware of inherent risks associated with
replacing these core systems, including supply chain disruptions, and believes
that it is taking appropriate action to mitigate the risks by staffing with
qualified technology and business professionals, insuring end-to-end business
ownership and staging implementation. The launch of these successor systems will
take place in a phased approach over several years. There can be no assurances
that the Company will successfully launch these new systems or that they will
occur without supply chain disruptions. Any resulting supply chain disruptions
could have a material adverse effect on the Company's business and operating
results.

12

CRITICAL ACCOUNTING POLICIES

Management's Discussion and Analysis of Financial Condition and Results of
Operations are based on the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosures of
contingent assets and liabilities. The estimates and assumptions are evaluated
on an on-going basis and are based on historical experience and other various
factors that are believed to be reasonable under the circumstances. Actual
results may differ from these estimates under different assumptions or
conditions.

The Company believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of the
consolidated financial statements.

Inventory Reserves
Merchandise inventories, net of an allowance for excess quantities and
obsolescence, are stated at the lower of cost (weighted-average method) or
market. The Company estimates a provision for damaged, obsolete, excess and
slow-moving inventory based on specific identification and inventory aging
reports.

Catalog Amortization
Prepaid catalog expenses consist of the third party incremental direct
costs including primarily creative design, paper, printing, postage and mailing
costs for all Company direct response catalogs. Such costs are capitalized as
prepaid catalog expenses and are amortized over their expected period of future
benefit. Such amortization is based upon the ratio of actual revenues to the
total of actual and estimated future revenues on an individual catalog basis.
Prepaid catalog expenses are evaluated for realizability at each reporting
period by comparing the carrying amount associated with each catalog to the
estimated probable remaining future net revenues (net sales less merchandise
cost of goods sold, selling expenses and catalog completion costs) associated
with that catalog. If the carrying amount is in excess of the estimated probable
remaining future net revenue, the excess is expensed in the reporting period.

Sales Return Reserve
The Company records a reserve for estimated product returns based on
historical return trends together with current product sales performance. If
actual returns are greater than those projected by management, additional sales
returns may be recorded in the future.

Self-Insured Liabilities
The Company is primarily self-insured for workers' compensation, employee
health benefits and product and general liability insurance. The Company records
its self-insurance liabilities based on claims filed and an estimate of claims
incurred but not yet reported. Should a greater amount of claims occur compared
to what was estimated or costs of the claims increase beyond what was
anticipated, reserves recorded may not be sufficient and additional accruals may
be required in future periods.

RESULTS OF OPERATIONS

NET REVENUES

Net revenues consist of retail sales, direct-to-customer sales and shipping
fees. Direct-to-customer sales include catalog and Internet sales. Shipping fees
consist of revenue received from customers for delivery of merchandise.

13

The following table summarizes the Company's net revenues for the 53 weeks
ended February 3, 2002 ("fiscal 2001") and each of the 52 weeks ended January
28, 2001 ("fiscal 2000") and January 30, 2000 ("fiscal 1999").

Net revenues for fiscal 2001 were $2,086,662,000 -- an increase of
$257,179,000 (14.1%) over net revenues for fiscal 2000. Net revenues for fiscal
2000 increased $369,483,000 (25.3%) over net revenues for fiscal 1999. The
increase in both years was primarily due to new stores and the growth of the
Williams-Sonoma, Pottery Barn and Pottery Barn Kids brands.

Revenue is recognized for retail sales at the point of sale in the store
and for direct-to-customer sales when the merchandise is delivered to the
customer. In the fourth quarter of fiscal 2001, the Company implemented the
recognition of revenue upon delivery for all merchandise delivered to the
customer. Previously, merchandise delivered to the customer was recognized upon
shipment. The impact was not material to the results of operations.

RETAIL REVENUES

Retail revenues for fiscal 2001 increased $191,214,000 (18.3%) over retail
revenues for fiscal 2000 primarily due to a net increase of 33 stores and a 1.7%
increase in comparable store sales. As of February 3, 2002, the Company operated
415 stores in 41 states, Washington DC and Toronto, Canada. During fiscal 2001,
the Company opened 57 stores (21 Williams-Sonoma, 15 Pottery Barn, 19 Pottery
Barn Kids and 2 Outlets) and closed 24 stores (7 Williams-Sonoma, 6 Pottery Barn
and 11 Hold Everything). Pottery Barn and Pottery Barn Kids accounted for 62.7%
of the growth in retail revenues from fiscal 2000 to fiscal 2001.

14

In fiscal 2001, the Company opened five new retail stores (two
Williams-Sonoma, two Pottery Barn and one Pottery Barn Kids retail stores) in
Toronto, Canada.

Retail revenues in fiscal 2000 increased $170,707,000 (19.5%) over retail
revenues in fiscal 1999, principally due to a net increase of 38 stores and a
5.5% increase in comparable store sales. Pottery Barn accounted for 53.6% of the
growth in retail revenues from fiscal 1999 to fiscal 2000.

Comparable stores are defined as those whose gross square feet did not
change by more than 20% in the previous 12 months and which have been open for
at least 12 months without closure for seven or more consecutive days.
Comparable store sales are computed monthly for purposes of this analysis. In
fiscal 2001, Williams-Sonoma and Pottery Barn Kids comparable store sales were
4.2% and 10.4%, respectively. Pottery Barn comparable store sales were negative
0.1% in fiscal 2001 while Hold Everything comparable store sales were negative
8.5% due to the transitional impact of the Company's brand realignment strategy.
In fiscal 2000, Williams-Sonoma and Pottery Barn comparable stores sales were
5.6% and 4.8%, respectively. Hold Everything comparable stores sales were 3.1%.

In fiscal 2002, the Company's current business plan is to increase retail
leased square footage by approximately 14% to 15% or a net increase of
approximately 56 new retail stores. The net increase in fiscal 2002 of 56 stores
includes 25 Pottery Barn Kids stores, 18 Williams-Sonoma stores, 14 Pottery Barn
stores and two Outlet stores. Hold Everything will decrease by three stores in
fiscal 2002. Also included in new stores in fiscal 2002 are three additional
stores in Toronto, Canada, one in each of the Williams-Sonoma, Pottery Barn and
Pottery Barn Kids concepts.

DIRECT-TO-CUSTOMER REVENUES

Direct-to-customer revenues in fiscal 2001 increased $65,965,000 or 8.4%
over direct-to-customer revenues in fiscal 2000. This increase was primarily due
to the growth in the Pottery Barn, Pottery Barn Kids and Williams-Sonoma brands
which was partially offset by lower sales in Hold Everything due to a planned
reduction in catalog circulation.

In fiscal 2001, the Company unveiled its Pottery Barn Kids website and
launched its Pottery Barn online gift and bridal registry and Pottery Barn Kids
online gift registry. In fiscal 2000, the Company launched its Pottery Barn
e-commerce website and in fiscal 1999, the Company introduced its
Williams-Sonoma Internet wedding website and its Williams-Sonoma website.
Combined revenues from these websites were $153,889,000 in fiscal 2001, an
increase of $89,442,000 or 138.8% from $64,447,000 in fiscal 2000. The Company
estimates that approximately 40% to 50% of non-bridal e-commerce sales are
incremental to the direct-to-customer channels and approximately 50% to 60% are
from mail order customers who would have potentially placed an order via the
catalog call center.

Direct-to-customer revenues in fiscal 2000 increased $198,776,000 or 34.0%
over direct-to-customer revenues in fiscal 1999 primarily due to strong growth
in the Pottery Barn brand and its extensions. Combined revenues from the Pottery
Barn, Pottery Barn Kids and Pottery Barn Bed + Bath catalogs and the Pottery
Barn e-commerce website grew 47.2% in fiscal 2000 over fiscal 1999. Net revenues
from the Pottery Barn Bed + Bath catalog, which launched in May 2000, and
Pottery Barn e-commerce website represented 29.7% of fiscal 2000
direct-to-customer revenue growth and 33.1% of fiscal 2000 total Pottery Barn
brands growth.

15

In 1999, the Company sold assets of the Gardeners Eden catalog to allow
greater focus on the Company's existing brands and Internet development. As a
result of the sale, the Company recognized a $3,962,000 pre-tax gain ($2,437,000
after tax).

COST OF GOODS SOLD

Cost of goods and occupancy expenses increased $141,349,000 to
$1,168,030,000 in fiscal 2001 from $1,026,681,000 in the fiscal 2000. Cost of
goods and occupancy expenses expressed as a percentage of net revenues for
fiscal 2001 decreased 0.1 percentage points to 56.0% from 56.1% in fiscal 2000.
The decrease was primarily due to fewer promotional markdowns, aggressive
inventory management, increased merchandise margins and lower freight costs in
the retail channels offset by increased occupancy costs. The increase in
occupancy costs was driven primarily by increased depreciation, a shift in the
percentage mix of net revenues generated through the retail channel, and
increased rent and utility costs.

Cost of goods and occupancy expenses increased $213,715,000 to
$1,026,681,000 in fiscal 2000 from $812,966,000 in fiscal 1999. Cost of goods
and occupancy expenses expressed as a percent of net revenues for fiscal 2000
increased 0.4 percentage points to 56.1% from 55.7% in fiscal 1999, principally
due to significant promotional markdown activity in the third and fourth
quarters and higher inventory shrinkage, damage and obsolescence costs.

Shipping costs consist of third-party delivery services and shipping
materials. Shipping costs increased to $124,643,000 in fiscal 2001 from
$109,174,000 in fiscal 2000 and $80,007,000 in fiscal 1999. As a percentage of
shipping fees, shipping costs have declined from 105.3% in fiscal 1999 to 104.0%
in fiscal 2000 to 102.9% in fiscal 2001 as cost control and service enhancement
programs have been implemented.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses increased $71,903,000 to
$666,015,000 in fiscal 2001 from $594,112,000 in fiscal 2000. Selling, general
and administrative expenses expressed as a percent of net revenues decreased by
0.6 percentage points to 31.9% in fiscal 2001 from 32.5% in fiscal 2000. The
decrease was primarily due to reduced catalog advertising costs as a percentage
of net revenues due to stronger consumer demand and higher catalog productivity
and an improvement in other general expenses, partially offset by higher
employment costs. The fiscal 2001 employment cost increase, as a percentage of
net revenues, was substantially driven by fiscal 2001 performance bonuses and
non-cash stock-based compensation charges. In fiscal 2000, no performance
bonuses or non-cash stock-based compensation charges were incurred.

Selling, general and administrative expenses increased $136,289,000 in
fiscal 2000 from $457,823,000 in fiscal 1999. Selling, general and
administrative expenses as a percent of net revenues increased 1.1 percentage
points in fiscal 2000 to 32.5% from 31.4% in fiscal 1999, primarily due to
increased catalog costs as a percentage of net revenues. The increased
percentage was primarily due to lower than anticipated direct-to-customer demand
in the second half of fiscal 2000 resulting from a weakening U.S. economy and a
corresponding slowdown in customer response to the Fall and Early Holiday
mailings.

INTEREST EXPENSE -- NET

Net interest expense decreased $1,319,000 from $7,187,000 in fiscal 2000 to
$5,868,000 in fiscal 2001, principally due to decreased borrowings under the
Company's line of credit and letter of credit facilities due to continued asset
management initiatives including aggressive inventory management programs as
well as lower

16

interest rates on the borrowings. Net interest expense in fiscal 2000 increased
$4,742,000 over net interest expense in fiscal 1999, principally due to
increased borrowings to finance the Company's purchase of new corporate
facilities.

INCOME TAXES

The Company's effective tax rate was 38.5% for fiscal 2001, fiscal 2000 and
fiscal 1999.

LIQUIDITY AND CAPITAL RESOURCES

In fiscal 2001, net cash provided by operating activities increased
$23,697,000 to $205,006,000 from $181,309,000 in fiscal 2000. This increase in
operating cash is primarily attributable to higher net earnings, reductions in
merchandise inventories and improved cash flow from accounts receivable offset
by increased cash used to reduce accounts payable. The decrease in accounts
payable was primarily due to substantially lower inventories and lower deferred
catalog expenses. The decrease in merchandise inventories is primarily due to
aggressive inventory management and improved inventory turns.

For fiscal 2000, net cash provided by operating activities increased
$73,347,000 to $181,309,000 from $107,962,000 in fiscal 1999. The fiscal 2000
increase in operating cash was primarily attributable to slower growth of
merchandise inventory and significant increases in accounts payable and accrued
expenses.

Net cash used in investing activities was $155,314,000 for fiscal 2001 as
compared to $233,360,000 in fiscal 2000. Fiscal 2001 purchases of property and
equipment were $155,987,000, which includes $91,636,000 for stores, $47,440,000
for systems development projects (including the Internet), $16,911,000 for
distribution and facility infrastructure projects.

Net cash used in investing activities increased $114,719,000 in fiscal 2000
to $233,360,000 from $118,641,000 in fiscal 1999. The fiscal 2000 expenditures
were primarily for stores, the upgrade of store systems and other systems
development projects (including the Internet), distribution capacity expansion,
corporate facilities and a new call center. Additionally, in February 2000, the
Company purchased a 204,000 square foot corporate office facility in San
Francisco, California, for the purpose of consolidating certain headquarters
staff and to provide for future growth. The total purchase price of the
corporate facility was approximately $73,300,000 plus a deposit of $7,500,000
paid in fiscal 1999.

Based on the Company's current plans, gross capital expenditures in fiscal
2002 are projected to be approximately $150,000,000 to $160,000,000, including
$97,500,000 to $104,000,000 for stores, $45,000,000 to $48,000,000 for systems
development (including the Internet) and approximately $7,500,000 to $8,000,000
for distribution and facility infrastructure projects. See Related Party Lease
Commitments below for additional potential acquisitions of certain distribution
facilities.

For fiscal 2001, cash provided by financing activities was $6,182,000,
comprised primarily of $18,689,000 proceeds from the exercise of stock options,
partially offset by the repayment of $6,154,000 under the mortgage agreement and
$5,714,000 repayment under the Senior Notes.

For fiscal 2000, cash used in financing activities was $21,062,000,
comprised primarily of repayment of long-term debt and Company repurchases of
825,200 shares of the Company's common stock for approximately $18,535,000,
partially offset by proceeds from stock option exercises.

17

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The following tables provide summary information concerning the Company's
future contractual obligations and commitments as of February 3, 2002.

Long-Term Debt
The unsecured Senior Notes are due in August 2005 with interest payable
semi-annually at 7.2%. Annual principal payments are $5,714,000. The Senior
Notes contain certain restrictive loan covenants, including minimum net-worth
requirements, fixed-charge coverage ratios and limitations on current and funded
debt.

Capital Leases
As of February 3, 2002, the Company has capital leases of $8,973,000 for
store equipment.

Operating Leases
The Company leases store locations, warehouses, corporate facilities, call
centers and certain equipment under operating and capital leases for original
terms ranging generally from 3 to 23 years. Certain leases contain renewal
options for periods up to 20 years. Stores leases typically provide for minimum
rental payments and additional rent based upon a percentage of store sales if a
specified store sales target is exceeded. Such contingent rental expense is
accrued each reporting period if achievement of a store sales target is
considered probable.

The Company has an operating lease for a 1,037,000 square foot retail
distribution facility located in Olive Branch, Mississippi. The lease has an
initial term covering 22.5 years, expiring January 2022, with two optional
five-year renewals. The lessor, an unrelated party, is a limited liability
company with operations separate from the leasing of this distribution facility
to the Company. The lessor financed the construction of the distribution
facility and expansion through the sale of $39,200,000 Taxable Industrial
Development Revenue Bonds, Series 1998 and 1999, issued by the Mississippi
Business Finance Corporation. The Bonds are secured by the distribution
facility. As of February 3, 2002, approximately $34,511,000 was outstanding on
the bonds. The Company is required to make annual rental payments of
approximately $3,763,000, plus applicable taxes, insurance and maintenance
expenses.

The Company has an operating lease for an additional 1,115,000 square foot
retail distribution facility located in Olive Branch, Mississippi. The lease has
an initial term covering 22.5 years, expiring January 2023, with two optional
five-year renewals. The lessor, an unrelated party, is a limited liability
company which has residual equity at risk of greater than 3%. The lessor
financed the construction of the distribution facility through the sale of
$42,500,000 Taxable Industrial Development Revenue Bonds, Series 1999, issued by
the Mississippi Business Finance Corporation. The Bonds are secured by the
distribution facility. As of February 3, 2002, approximately $37,346,000 was
outstanding on the bonds. The Company is required to make annual rental payments
of approximately $4,180,000, plus applicable taxes, insurance and maintenance
expenses.

Related Party Lease Commitments
The Company has an operating lease for a distribution facility in Memphis,
Tennessee with a term expiring August 2004. The lessor is a general partnership
("Partnership 1") comprised of W. Howard Lester,

18

Chairman of the Board of Directors and a significant shareholder of the Company
and James A. McMahan, a Director and significant shareholder of the Company.
Partnership 1 does not have operations separate from leasing of this
distribution facility to the Company and does not have lease agreements with any
unrelated third parties.

Partnership 1 financed the construction of this distribution facility
through the sale of a total of $9,200,000 of industrial development bonds in
1983 and 1985. Annual principal payments and monthly interest payments are
required through maturity in December 2010. The Partnership 1 Industrial
Development Bonds are secured by the distribution facility and the individual
partners guaranteed the bond repayments. As of February 3, 2002, $3,633,000 was
outstanding under the Partnership 1 Industrial Development Bonds.

The operating lease for this distribution facility requires the Company to
pay annual rent of $618,000 plus interest on the bonds calculated at a variable
rate determined monthly (2.75% at February 3, 2002), applicable taxes, insurance
and maintenance expenses. After August 2004, the Company is obligated to renew
the operating lease until these bonds are fully repaid.

The Company has an operating lease for another distribution facility in
Memphis, Tennessee with a term of 15 years expiring August 2006, with three
optional five-year renewal periods. The lessor is a general partnership
("Partnership 2") comprised of W. Howard Lester, James A. McMahan and two
unrelated parties. Partnership 2 does not have operations separate from leasing
this distribution facility to the Company and does not have lease agreements
with any unrelated third parties.

Partnership 2 financed the construction of this distribution facility and
related addition through the sale of a total of $24,000,000 of industrial
development bonds in 1990 and 1994. Quarterly principal and interest payments
are required through maturity in August 2015. The Partnership 2 Industrial
Development Bonds are secured by the distribution facility and require
maintenance of certain financial covenants by the Company. As of February 3,
2002, $16,809,000 was outstanding under the Partnership 2 Industrial Development
Bonds.

The operating lease for this distribution facility requires the Company to
pay annual rent of approximately $2,700,000, applicable taxes, insurance and
maintenance expenses. The Company is obligated to renew this operating lease
until these bonds are fully repaid.

On March 4, 2002, the Company's Board of Directors authorized management to
obtain information, conduct negotiations, and enter into appropriate agreements
with the intent to pursue potential acquisitions of the distribution facilities
currently leased from Partnerships 1 and 2 prior to the end of fiscal 2002. Any
such acquisitions will be subject to the approval of the Board of Directors.
There can be no assurance that any such acquisitions will be completed on
acceptable terms to the Company or at all.

Other Commercial Commitments:

Line of Credit
The Company's line of credit facility provides for a $200,000,000 unsecured
revolving credit facility and contains certain restrictive loan covenants,
including minimum tangible net worth, maximum leverage ratios, fixed charge
coverage requirements, restrictions on maximum capital expenditures and a
prohibition on payment of cash dividends. Through August 23, 2002, the Company
may request that the lenders under the credit facility increase the maximum
availability to $250,000,000. The Company may elect interest rates

19

calculated by reference to the agent's internal reference rate or LIBOR plus a
margin based on the Company's leverage ratio or, for advances under $10,000,000,
IBOR plus a margin based on the Company's leverage ratio. The agreement expires
on August 23, 2003. As of February 3, 2002, the Company had no borrowings
outstanding under the line of credit facility.

Letters of Credit
The Company has a $100,000,000 letter of credit facility which expires on
July 11, 2002. As of February 3, 2002, $55,854,000 was outstanding under this
letter of credit facility. Such letters of credit represent only a commitment to
fund inventory purchases to which the Company had not taken legal title as of
February 3, 2002. The Company expects to renew or replace its current letter of
credit agreement, on substantially similar terms, in order to meet increased
working capital needs associated with the Company's growth plans. Additionally,
as of February 3, 2002, the Company had $373,000 outstanding in standby letters
of credit.

The Company believes that its available cash, cash equivalents, cash flow
from operations and credit facilities will be sufficient to finance operations
and capital requirements for at least the next twelve months.

IMPACT OF INFLATION

The impact of inflation on results of operations has not been significant.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risks, which include changes in U.S.
interest rates and, to a lesser extent, foreign exchange rates. The Company does
not engage in financial transactions for trading or speculative purposes.

Interest Rate Risk
The interest payable on the Company's bank line of credit is based on
variable interest rates and therefore affected by changes in market interest
rates. If interest rates on existing variable rate debt rose 31 basis points (a
10% change in the associated debt's variable rate as of February 3, 2002), the
Company's results from operations and cash flows would not be materially
affected. In addition, the Company has fixed and variable income investments
consisting of cash equivalents and short-term investments, which are also
affected by changes in market interest rates.

During fiscal 2001, the Company entered into an interest rate cap contract
at 5.88% with a notional of $13,083,000 which extends through February 2005
related to an operating lease. The contract has not been designated as a hedge
and is accounted for by adjusting the carrying amount of the contract to market.
The fiscal 2001 loss, which was not significant, is recorded in selling, general
and administrative expenses.

Foreign Currency Risks
The Company enters into a significant amount of purchases outside of the
U.S. that are primarily U.S. dollar transactions. A small percentage of the
Company's international purchase transactions are in currencies other than the
U.S. dollar. Any currency risks related to these transactions are deemed to be
immaterial to the Company as a whole. In fiscal 2001, the Company opened five
new retail stores in Toronto, Canada and plans to open three additional retail
stores in fiscal 2002 which exposes the Company to market risk associated with
foreign currency exchange rate fluctuations.

During fiscal 2001, due to the Company's new operations in Canada and the
volatility of the Canadian dollar, 30-day forward contracts have been purchased
in order to limit the currency exposure associated with intercompany asset and
liability accounts that are denominated in Canadian dollars. The Company
continues to monitor possible currency exposure and will continue to take steps
toward limiting foreign currency risk.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

20

WILLIAMS-SONOMA, INC.
CONSOLIDATED STATEMENTS OF EARNINGS

See Notes to Consolidated Financial Statements.

21

WILLIAMS-SONOMA, INC.
CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

22

WILLIAMS-SONOMA, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

See Notes to Consolidated Financial Statements.

23

WILLIAMS-SONOMA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Consolidated Financial Statements.

24

WILLIAMS-SONOMA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Williams-Sonoma, Inc. and its subsidiaries (the "Company") are specialty
retailers of products for the home. The retail segment sells its products
through its four retail concepts -- Williams-Sonoma, Pottery Barn, Pottery Barn
Kids and Hold Everything. The direct-to-customer segment sells similar products
through its six direct-mail catalogs -- Williams-Sonoma, Pottery Barn, Pottery
Barn Kids, Pottery Barn Bed + Bath, Hold Everything and Chambers -- and four
e-commerce websites. The catalogs reach customers throughout the United States,
while the four retail businesses currently operate 415 stores in 41 states,
Washington DC and Toronto, Canada. Significant intercompany transactions and
accounts have been eliminated.

Fiscal Year The Company's fiscal year ends on the Sunday closest to January
31, based on a 52/53-week year. Fiscal years 2001, 2000 and 1999 ended on
February 3, 2002 (53 weeks), January 28, 2001 (52 weeks) and January 30, 2000
(52 weeks), respectively.

Cash Equivalents Cash equivalents include highly liquid investments with an
original maturity of three months or less. The Company's policy is to invest in
high-quality, short-term instruments to achieve maximum yield while maintaining
a level of liquidity consistent with the Company's needs.

Allowance for Doubtful Accounts A summary of activity in the allowance for
doubtful accounts is as follows:

Merchandise Inventories Merchandise inventories, net of an allowance for
excess quantities and obsolescence, are stated at the lower of cost
(weighted-average method) or market. The Company estimates a provision for
damaged, obsolete, excess and slow-moving inventory based on specific
identification and inventory aging reports. Approximately 55%, 52% and 48% of
the Company's payments for merchandise in fiscal 2001, fiscal 2000 and fiscal
1999, respectively, were to foreign vendors, most of which are located in Europe
and Asia.

Prepaid Catalog Expenses Prepaid catalog expenses consist of the third
party incremental direct costs including primarily creative design, paper,
printing, postage and mailing costs for all Company direct response catalogs.
Such costs are capitalized as prepaid catalog expenses and are amortized over
their expected period of future benefit. Such amortization is based upon the
ratio of actual revenues to the total of actual and estimated future revenues on
an individual catalog basis. Each catalog is generally fully amortized within
six months. Prepaid catalog expenses are evaluated for realizability at each
reporting period by comparing the carrying amount associated with each catalog
to the estimated probable remaining future net revenues (net sales less
merchandise cost of goods sold, selling expenses and catalog completion costs)
associated with that catalog. If the carrying amount is in excess of the
estimated probable remaining future net revenue, the excess is expensed in the
reporting period. Catalog advertising expenses were $191,080,000, $180,659,000
and $132,326,000 in fiscal 2001, fiscal 2000 and fiscal 1999, respectively.

25

Property and Equipment Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets as follows:

- ---------------------------------------------------------------------------------------------
Buildings and building improvements 12 - 40 years
- ---------------------------------------------------------------------------------------------
Leasehold improvements Shorter of estimated useful life or lease term
(generally 2 - 15 years)
- ---------------------------------------------------------------------------------------------
Fixtures and equipment 3 - 15 years
- ---------------------------------------------------------------------------------------------
Capitalized software 2 - 8 years
- ---------------------------------------------------------------------------------------------

Internally developed software costs are capitalized in accordance with
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." Interest costs related to assets under
construction are capitalized during the construction period. Whenever events or
changes in circumstances indicate that the carrying amount of its assets might
not be recoverable, the Company, using its best estimates based on reasonable
and supportable assumptions and projections, reviews for impairment the carrying
value of long-lived assets.

Self-Insured Liabilities The Company is primarily self-insured for workers'
compensation, employee health benefits and product and general liability
insurance. The Company records its self-insurance liabilities based on claims
filed and an estimate of claims incurred but not yet reported.

Deferred Lease Incentives For leases which contain fixed escalations of the
minimum annual lease payment during the original term of the lease, the Company
recognizes rental expense on a straight-line basis and records the difference
between rent expense and the amount currently payable as deferred lease
incentives. Deferred lease incentives also include construction allowances
received from landlords, which are amortized on a straight-line basis over the
initial lease term.

Fair Value of Financial Instruments The carrying value of cash and cash
equivalents, accounts receivable, investments, interest rate cap contracts,
accounts payable and debt approximates their estimated fair values.

Revenue Recognition Revenue is recognized for retail sales at the point of
sale in the store and for direct-to-customer sales when the merchandise is
delivered to the customer. The Company records a reserve for estimated product
returns in each reporting period. Shipping fees are included in net revenues and
shipping costs are included in cost of goods sold.

Foreign Currency Translation The functional currency of the Company's
Canadian subsidiary is the Canadian dollar. Assets and liabilities are
translated into U.S. dollars using the current exchange rates in effect at the
balance sheet date, while revenues and expenses are translated at the average
exchange rates during the period. The resulting translation adjustments are
recorded as a component of other comprehensive earnings within shareholders'
equity. Gains and losses resulting from foreign currency transactions have not
been significant and are included in selling, general and administrative
expenses.

Financial Instruments The Company utilizes 30-day Canadian foreign currency
contracts to minimize its market risk exposure in this foreign market. These
contracts have not been designated as a hedge and are accounted for by adjusting
the carrying amount of the contract to market and recognizing any gain or loss
in selling, general and administrative expenses in each reporting period.

During fiscal 2001, the Company entered into an interest rate cap contract
at 5.88% with a notional of $13,083,000 which extends through February 2005
related to an operating lease. The contract has not been designated as a hedge
and is accounted for by adjusting the carrying amount of the contract to market.
The fiscal 2001 loss, which was not significant, is recorded in selling, general
and administrative expenses.

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 the consolidated financial statements.

26

Earnings Per Share Basic earnings per share is computed as net earnings
divided by the weighted average number of common shares outstanding for the
period. Diluted net earnings per share is computed based on the weighted average
number of common shares outstanding for the period, plus common stock
equivalents consisting of shares subject to stock options.

Stock Option Accounting The Company accounts for stock options granted to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Accordingly, no compensation expense has been recognized in the consolidated
financial statements.

New Accounting Pronouncement In June 2001, Statement of Financial
Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142,
"Goodwill and Other Intangible Assets" were issued. SFAS No. 141 requires that
all business combinations initiated after June 30, 2001 be accounted for under
the purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets subsequent to their acquisition. SFAS No. 142 provides
that intangible assets with finite useful lives be amortized and that goodwill
and intangible assets with indefinite lives will not be amortized, but will
rather be tested at least annually for impairment. The Company is required to
adopt SFAS No. 142 as of February 4, 2002 and there will be no impact on the
consolidated financial position or results of operations.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No.
144 addresses financial accounting and reporting for the impairment or disposal
of long-lived assets. The Company is required to adopt SFAS No. 144 as of
February 4, 2002. Management does not expect the adoption of SFAS No. 144 to
have a significant impact on the consolidated financial position or results of
operations.

Use of Estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.

Reclassifications Certain items in the fiscal 2000 and fiscal 1999
consolidated financial statements have been reclassified to conform to the
fiscal 2001 presentation.

NOTE B: PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

(1)Construction in progress is primarily comprised of leasehold improvement
costs, furniture and fixtures related to new, unopened retail stores and
corporate systems and other infrastructure projects yet to be placed in
service.

27

NOTE C: BORROWING ARRANGEMENTS

Long-term debt consists of the following:

The unsecured Senior Notes are due in August 2005 with interest payable
semi-annually at 7.2%. Annual principal payments are $5,714,000. The Senior
Notes contain certain restrictive loan covenants, including minimum net-worth
requirements, fixed-charge coverage ratios and limitations on current and funded
debt.

As of February 3, 2002, the Company has capital leases of $8,973,000 for
store equipment.

The aggregate maturities of long-term debt at February 3, 2002 were as
follows:

The Company's line of credit facility provides for a $200,000,000 unsecured
revolving credit facility and contains certain restrictive loan covenants,
including minimum tangible net worth, maximum leverage ratios, fixed charge
coverage requirements, restrictions on maximum capital expenditures and a
prohibition on payment of cash dividends. Through August 23, 2002, the Company
may request that the lenders under the credit facility increase the maximum
availability to $250,000,000. The Company may elect interest rates calculated by
reference to the agent's internal reference rate or LIBOR plus a margin based on
the Company's leverage ratio or, for advances under $10,000,000, IBOR plus a
margin based on the Company's leverage ratio. The agreement expires on August
23, 2003. As of February 3, 2002, the Company had no borrowings outstanding
under the line of credit facility.

The Company has a $100,000,000 letter of credit facility which expires on
July 11, 2002. As of February 3, 2002, $55,854,000 was outstanding under this
letter of credit facility. Such letters of credit represent only a commitment to
fund inventory purchases to which the Company had not taken legal title as of
February 3, 2002. The Company expects to renew or replace its current letter of
credit agreement, on substantially similar terms, in order to meet increased
working capital needs associated with the Company's growth plans. Additionally,
as of February 3, 2002, the Company had $373,000 outstanding in standby letters
of credit.

Interest expense was $6,199,000 (net of capitalized interest of $691,000),
$8,254,000 (net of capitalized interest of $2,335,000), and $4,221,000 for
fiscal 2001, fiscal 2000 and fiscal 1999, respectively.

Accounts payable at February 3, 2002 and January 28, 2001, includes cash
overdrafts of $18,499,000 and $19,425,000, respectively, for checks issued and
not yet presented to the bank for payment.

28

NOTE D: INCOME TAXES

The provision for income taxes consists of the following:

A reconciliation of income taxes at the federal statutory corporate rate to
the effective rate is as follows:

Significant components of the Company's deferred tax accounts are as
follows:

29

NOTE E: LEASES

The Company leases store locations, warehouses, corporate facilities, call
centers and certain equipment under operating and capital leases for original
terms ranging generally from 3 to 23 years. Certain leases contain renewal
options for periods up to 20 years. Stores leases typically provide for minimum
rental payments and additional rent based upon a percentage of store sales if a
specified store sales target is exceeded. Such contingent rental expense is
accrued each reporting period if achievement of a store sales target is
considered probable.

The Company has an operating lease for a 1,037,000 square foot retail
distribution facility located in Olive Branch, Mississippi. The lease has an
initial term covering 22.5 years, expiring January 2022, with two optional
five-year renewals. The lessor, an unrelated party, is a limited liability
company with operations separate from the leasing of this distribution facility
to the Company. The lessor financed the construction of the distribution
facility and expansion through the sale of $39,200,000 Taxable Industrial
Development Revenue Bonds, Series 1998 and 1999, issued by the Mississippi
Business Finance Corporation. The Bonds are secured by the distribution
facility. As of February 3, 2002, approximately $34,511,000 was outstanding on
the bonds. The Company is required to make annual rental payments of
approximately $3,763,000, plus applicable taxes, insurance and maintenance
expenses.

The Company has an operating lease for an additional 1,115,000 square foot
retail distribution facility located in Olive Branch, Mississippi. The lease has
an initial term covering 22.5 years, expiring January 2023, with two optional
five-year renewals. The lessor, an unrelated party, is a limited liability
company which has residual equity at risk of greater than 3%. The lessor
financed the construction of the distribution facility through the sale of
$42,500,000 Taxable Industrial Development Revenue Bonds, Series 1999, issued by
the Mississippi Business Finance Corporation. The Bonds are secured by the
distribution facility. As of February 3, 2002, approximately $37,346,000 was
outstanding on the bonds. The Company is required to make annual rental payments
of approximately $4,180,000, plus applicable taxes, insurance and maintenance
expenses.

Total rental expense for all operating leases (including the related party
leases described in Note F) was as follows:

The aggregate minimum annual rental payments under noncancelable operating
leases in effect at February 3, 2002 were as follows:

30

NOTE F: RELATED PARTY LEASE TRANSACTIONS

The Company has an operating lease for a distribution facility in Memphis,
Tennessee with a term expiring August 2004. The lessor is a general partnership
("Partnership 1") comprised of W. Howard Lester, Chairman of the Board of
Directors and a significant shareholder of the Company and James A. McMahan, a
Director and significant shareholder of the Company. Partnership 1 does not have
operations separate from leasing of this distribution facility to the Company
and does not have lease agreements with any unrelated third parties.

Partnership 1 financed the construction of this distribution facility
through the sale of a total of $9,200,000 of industrial development bonds in
1983 and 1985. Annual principal payments and monthly interest payments are
required through maturity in December 2010. The Partnership 1 Industrial
Development Bonds are secured by the distribution facility and the individual
partners guaranteed the bond repayments. As of February 3, 2002, $3,633,000 was
outstanding under the Partnership 1 Industrial Development Bonds.

The operating lease for this distribution facility requires the Company to
pay annual rent of $618,000 plus interest on the bonds calculated at a variable
rate determined monthly (2.75% at February 3, 2002), applicable taxes, insurance
and maintenance expenses. After August 2004, the Company is obligated to renew
the operating lease until these bonds are fully repaid.

The Company has an operating lease for another distribution facility in
Memphis, Tennessee with a term of 15 years expiring August 2006, with three
optional five-year renewal periods. The lessor is a general partnership
("Partnership 2") comprised of W. Howard Lester, James A. McMahan and two
unrelated parties. Partnership 2 does not have operations separate from leasing
this distribution facility to the Company and does not have lease agreements
with any unrelated third parties.

Partnership 2 financed the construction of this distribution facility and
related addition through the sale of a total of $24,000,000 of industrial
development bonds in 1990 and 1994. Quarterly principal and interest payments
are required through maturity in August 2015. The Partnership 2 Industrial
Development Bonds are secured by the distribution facility and require
maintenance of certain financial covenants by the Company. As of February 3,
2002, $16,809,000 was outstanding under the Partnership 2 Industrial Development
Bonds.

The operating lease for this distribution facility requires the Company to
pay annual rent of approximately $2,700,000, applicable taxes, insurance and
maintenance expenses. The Company is obligated to renew this operating lease
until these bonds are fully repaid.

On March 4, 2002, the Company's Board of Directors authorized management to
obtain information, conduct negotiations, and enter into appropriate agreements
with the intent to pursue potential acquisitions of the distribution facilities
currently leased from Partnerships 1 and 2 prior to the end of fiscal 2002. Any
such acquisitions will be subject to the approval of the Board of Directors.
There can be no assurance that any such acquisitions will be completed on
acceptable terms to the Company or at all.

31

NOTE G: EARNINGS PER SHARE

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

Options with an exercise price greater than the average market price of
common shares for the period were 63,000 in fiscal 2001, 1,295,000 in fiscal
2000 and 170,000 in fiscal 1999 and were not included in the computation of
diluted earnings per share.

NOTE H: STOCK-BASED COMPENSATION

In February 2001, the Company entered into an employment agreement (the
"Agreement"), effective April 2, 2001, with Dale Hilpert to serve as the Chief
Executive Officer and as a director. Under the Agreement, the Company agreed to
issue Mr. Hilpert 250,000 restricted shares of the Company's common stock. Such
restricted shares will vest on March 31, 2004 based upon Mr. Hilpert's continued
employment through such date. Accordingly, total compensation expense (based
upon the fair market value of $30.90 on the issue date) of $7,725,000 will be
recognized ratably through March 31, 2004. In fiscal 2001, the Company
recognized approximately $2,320,000 of compensation expense related to these
restricted shares with a remaining $5,405,000 of deferred compensation included
in shareholders' equity.

The Company has entered into other employment agreements during fiscal
2001. The Company has recognized approximately $927,000 of stock-based
compensation expense related to these other employment agreements in fiscal
2001. At February 3, 2002, deferred compensation related to these agreements was
$2,136,000.

NOTE I: STOCK OPTIONS

The Company's 1993 Stock Option Plan (the 1993 Plan), as amended, provides
for grants of incentive and non-qualified stock options up to an aggregate of
8,500,000 shares. All incentive stock option grants made under the 1993 Plan
have a maximum term of ten years, except those issued to 10% shareholders which
have a term of five years. The exercise price of all incentive stock options is
100% of the fair market value of the stock at the option grant date or 110% for
a 10% shareholder. Options generally vest over five years.

The Company's 2000 Stock Option Plan (the 2000 Plan), provides for grants
of non-qualified stock options up to an aggregate of 1,500,000 shares. All
non-qualified stock option grants under the 2000 Plan have a maximum term of ten
years with an exercise price of 100% of the fair value of the stock at the
option grant date. Options generally vest over five years.

The Company's 2001 Stock Option Plan (the 2001 Plan), provides for grants
of incentive and non-qualified stock options up to an aggregate of 2,500,000
shares. All incentive stock option grants made under
32

the 2001 Plan have a maximum term of ten years, except those issued to 10%
shareholders which have a term of five years. The exercise price of all
incentive stock options will be no less than 100% of the fair market value of
the stock at the option grant date or will be no less than 110% for a 10%
shareholder. Options generally vest over five years.

The following table reflects the aggregate activity under the Company's
stock option plans:

Options to purchase 2,635,117 shares were available for grant at February
3, 2002.

The following table summarizes information about stock options outstanding
at February 3, 2002:

SFAS No. 123, "Accounting for Stock Based Compensation," requires the
disclosure of pro forma net earnings and earnings per share as if the Company
had adopted the fair value method. Under SFAS No. 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values.

33

The Company's calculations are based on a single option valuation approach
and forfeitures are recognized as they occur. Had compensation cost been
determined consistent with SFAS No. 123, the Company's net earnings and earnings
per share would have been changed to the pro forma amounts indicated below:

The fair value of each option grant was estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions:

NOTE J: ASSOCIATE STOCK-INCENTIVE PLAN AND OTHER EMPLOYEE BENEFITS

The Company has a defined contribution retirement plan, the
"Williams-Sonoma, Inc. Associate Stock-Incentive Plan" (the Plan), for eligible
employees, which is intended to be qualified under Internal Revenue Code
Sections 401(a) and 401(k). The Plan permits eligible employees to make salary
deferral contributions in accordance with Internal Revenue Code Section 401(k).
Each participant may choose to have his/her salary deferral contributions and
earnings thereon invested in one or more of a money market reserve fund, a
balanced mutual fund, or a fund investing in stock of the Company. All amounts
contributed by the Company are invested in common stock of the Company. The
Company's matching contribution is 100% of the first 6% of a participant's pay
(4% for highly-compensated individuals) which the participant elects to
contribute as salary deferral contributions and which the participant elects to
have invested in the Company stock fund. The Company's contributions were
$3,893,000 in fiscal 2001, $3,392,000 in fiscal 2000 and $2,822,000 in fiscal
1999.

The Company has a nonqualified executive deferred compensation plan which
provides supplemental retirement income benefits for a select group of
management and other certain highly compensated employees of the Company. This
plan permits eligible employees to make salary and bonus deferrals which are
100% vested. This is an unsecured obligation of the Company to pay in the future
the value of the deferred compensation adjusted to reflect the performance,
whether positive or negative, of selected investment measurement options, chosen
by each participant, during the deferral period. At February 3, 2002, $4,682,000
is included in other long-term obligations. The Company has purchased life
insurance policies on these participants. The cash surrender value of these
policies is $3,898,000 at February 3, 2002 and is included in other assets.

34

NOTE K: COMMITMENTS AND CONTINGENCIES

The Company is party to various legal proceedings arising from normal
business activities. Management believes that the ultimate resolution of these
matters will not have a material adverse effect on the Company's consolidated
financial statements taken as a whole.

NOTE L: SEGMENT REPORTING

Williams-Sonoma, Inc. has two reportable segments -- retail and
direct-to-customer. The retail segment sells products for the home through its
four retail concepts -- Williams-Sonoma, Pottery Barn, Pottery Barn Kids and
Hold Everything. The four retail concepts are operating segments which have been
aggregated into one reportable segment, retail. The direct-to-customer segment
sells similar products through its six direct-mail catalogs -- Williams-Sonoma,
Pottery Barn, Pottery Barn Kids, Pottery Barn Bed + Bath, Hold Everything and
Chambers -- and four e-commerce websites.

These reportable segments are strategic business units that offer similar
home-centered products. They are managed separately because the business units
utilize two distinct distribution and marketing strategies. Management's
expectation is that the overall economics of each of the Company's major
concepts within each reportable segment will be similar over time.

The accounting policies of the segments, where applicable, are the same as
those described in the summary of significant accounting policies. The Company
uses earnings before unallocated corporate overhead, interest and taxes to
evaluate segment profitability. Unallocated assets include corporate cash and
equivalents, the net book value of corporate facilities and related information
systems, deferred tax amounts and other corporate long-lived assets.

SEGMENT INFORMATION

35

NOTE M: SUBSEQUENT EVENT -- STOCK SPLIT

On April 15, 2002, the Company's Board of Directors declared a two-for-one
stock split to be effected by issuing one additional share of common stock for
each share of the Company's common stock outstanding. The distribution will be
made on May 9, 2002 to shareholders of record on April 29, 2002. Pro forma
earnings per-share on a post stock split basis are presented in the accompanying
consolidated statements of earnings.

36

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and the Shareholders of Williams-Sonoma, Inc.:

We have audited the accompanying consolidated balance sheets of
Williams-Sonoma, Inc. and subsidiaries (the Company) as of February 3, 2002 and
January 28, 2001, and the related consolidated statements of earnings,
shareholders' equity and cash flows for each of the three fiscal years in the
period ended February 3, 2002. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Williams-Sonoma, Inc. and
subsidiaries as of February 3, 2002 and January 28, 2001, and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended February 3, 2002, in conformity with accounting principles
generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

San Francisco, California
March 22, 2002 (April 15, 2002 as to Note M)

37

QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)

Dollars in thousands, except per share
amounts
- ----------------------------------------------------------------------------------------------------
First Second Third Fourth(1) Full
Fiscal 2001(1) Quarter Quarter Quarter Quarter Year
- ----------------------------------------------------------------------------------------------------
Net revenues $417,572 $428,994 $462,096 $ 778,000 $2,086,662
Gross margin 146,966 146,171 165,972 334,880 793,989
Earnings before income taxes 800 2,198 6,265 112,843 122,106
Net earnings 492 1,352 3,853 69,399 75,096
Basic earnings per share(2) $ .01 $ .02 $ .07 $ 1.22 $ 1.34(2)
Diluted earnings per share(2) $ .01 $ .02 $ .07 $ 1.18 $ 1.30(2)
- ----------------------------------------------------------------------------------------------------
Pro forma earnings per share -- post
stock split basis(3)
Basic earnings per share $ .00 $ .01 $ .03 $ .61 $ .67
Diluted earnings per share $ .00 $ .01 $ .03 $ .59 $ .65
- ----------------------------------------------------------------------------------------------------

First Second Third Fourth(1) Full
Fiscal 2000(1) Quarter Quarter Quarter Quarter Year
- ----------------------------------------------------------------------------------------------------
Net revenues $365,259 $366,484 $424,572 $ 673,168 $1,829,483
Gross margin 133,380 131,252 158,223 270,773 693,628
Earnings before income taxes 7,866 8,233 3,804 72,426 92,329
Net earnings 4,838 5,063 2,340 44,541 56,782
Basic earnings per share(2) $ .09 $ .09 $ .04 $ .80 $ 1.02(2)
Diluted earnings per share(2) $ .08 $ .09 $ .04 $ .79 $ .99(2)
- ----------------------------------------------------------------------------------------------------
Pro forma earnings per share -- post
stock split basis(3)
Basic earnings per share $ .04 $ .05 $ .02 $ .40 $ .51
Diluted earnings per share $ .04 $ .04 $ .02 $ .39 $ .49
- ----------------------------------------------------------------------------------------------------

(1)Fiscal 2001 is a 53-week year versus a 52-week year in fiscal 2000. In fiscal
2001, the fourth quarter includes 14 weeks versus 13 weeks in the fourth
quarter of fiscal 2000.

(2)Per SFAS 128, the sum of the quarterly net earnings per share amounts will
not necessarily equal the annual net earnings per share as each quarter is
calculated independently.

(3)Earnings per share restated to reflect the 2-for-1 stock split declared in
April 2002.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not Applicable.

38

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by this Item is incorporated by reference herein to
the Company's definitive Proxy Statement, which was filed with the Securities
and Exchange Commission on April 29, 2002.

Information with respect to the Executive Officers of the Registrant, as of
April 2, 2002 is set forth below:

Dale W. Hilpert, age 59, has served as Chief Executive Officer since April
2001. Mr. Hilpert previously served as Chairman and Chief Executive Officer of
Venator Group from 2000 to 2001, as President and Chief Executive Officer of
Venator Group from 1999 to 2000 and as President and Chief Operating Officer of
Venator Group from 1995 to 1999. He also served as Chairman and Chief Executive
Officer of Payless Shoe Source Division of The May Department Stores Company
from 1985 to 1995.

W. Howard Lester, age 66, has served as Chairman since 1986. Mr. Lester
previously served as Chief Executive Officer from 1979 to April 2001 and is a
member of the Nominations and Corporate Governance Committee. He also serves as
a director of Harold's Department Stores, Inc.

Charles E. Williams, age 86, is the founder and has served as Vice Chairman
since 1986.

Laura J. Alber, age 33, has served as President, Pottery Barn Brands since
February 2002. Ms. Alber previously served as Executive Vice President, Pottery
Barn Brand from 2000 to 2002, as Senior Vice President, Pottery Barn Catalog and
Pottery Barn Kids Retail from 1999 to 2000, as Divisional Vice President,
Pottery Barn Catalog from 1997 to 1999 and as Director, Pottery Barn Catalog
from 1996 to 1997.

James E. Boike, age 55, has served as Executive Vice President and Chief
Operating Officer since 2001. Mr. Boike previously served as Executive Vice
President, Premium Brands from 2000 to 2001, as Executive Vice President, Stores
and Operations from 1997 to 2000, as Senior Vice President, Stores from 1995 to
1997, as Vice President, Stores from 1994 to 1995 and as Vice President,
Merchandise Operations from 1993 to 1994.

John S. Bronson, age 54, has served as Senior Vice President, Human
Resources since 1999. Mr. Bronson previously worked at Pepsi Cola Worldwide from
1979 to 1999 and served as Executive Vice President of Human Resources of Pepsi
Cola Worldwide from 1997 to 1999.

James A. Brownell, age 44, has served as Senior Vice President, Chief
Information Officer since 2001. Mr. Brownell previously served as Vice President
of Information Technology of Toys R Us.com in 2000. He also served as Vice
President of Distribution Systems and Supply Chain of The Gap, Inc. from 1979 to
2000.

Patrick J. Connolly, age 55, has served as Executive Vice President and
Chief Marketing Officer since 2000. Mr. Connolly previously served as Executive
Vice President, General Manager, Catalog from 1995 to

39

2000, as Senior Vice President, Mail Order from 1991 to 1995 and as Vice
President, Mail Order from 1979 to 1990.

Patrick Cowell, age 52, has served as President, Williams-Sonoma Brand
since March 2002. Mr. Cowell serves as President of Cowell Development from 1999
to present. He previously served as President and Chief Executive Officer of
Airport Group International from 1996 to 1999 and as President, Americas and
Caribbean, Sun International Hotels and Resorts from 1994 to 1996. He also
worked at Hyatt Hotels Corporation from 1972 to 1994 and served as Divisional
Vice President of the Western Division for Hyatt Hotels Corporation from 1993 to
1994.

Donna H. Isralsky, age 46, has served as Senior Vice President, Product
Supply Chain and International Operations since 1999. Ms. Isralsky previously
served as Vice President, Product Supply Chain from 1996 to 1999. She also
served as Vice President, Operations, Production and Sourcing of Reebok
International Ltd. from 1994 to 1996.

Ronald M. Loeb, age 69, has served as Senior Vice President, General
Counsel since 1999. Mr. Loeb previously served as Senior Partner of Irell &
Manella from 1972 to 1997.

Sharon L. McCollam, age 39, has served as Senior Vice President, Chief
Financial Officer since 2000. Ms. McCollam previously served as Vice President
of Finance in 2000. She also served as Chief Financial Officer of Dole Fresh
Vegetables, Inc. from 1996 to 2000.

ITEM 11. EXECUTIVE COMPENSATION

Information required by this Item is incorporated by reference herein to
the Company's definitive Proxy Statement, which was filed with the Securities
and Exchange Commission on April 29, 2002.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required by this Item is incorporated by reference herein to
the Company's definitive Proxy Statement, which was filed with the Securities
and Exchange Commission on April 29, 2002.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required by this Item is incorporated by reference herein to
the Company's definitive Proxy Statement, which was filed with the Securities
and Exchange Commission on April 29, 2002.

40

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) Financial Statements

The following consolidated financial statements of Williams-Sonoma, Inc.
and subsidiaries and the related notes are filed as part of this report pursuant
to Item 8:

Consolidated Statements of Earnings for the fiscal years ended February 3,
2002, January 28, 2001 and January 30, 2000

Consolidated Balance Sheets as of February 3, 2002 and January 28, 2001

Consolidated Statements of Shareholders' Equity for the fiscal years ended
February 3, 2002, January 28, 2001 and January 30, 2000

Consolidated Statements of Cash Flows for the fiscal years ended February
3, 2002, January 28, 2001 and January 30, 2000

Notes to Consolidated Financial Statements

Independent Auditors' Report

Quarterly Financial Information

(a)(2) Financial Statement Schedules

Schedules have been omitted because they are not required or are not
applicable.

(b) Reports on Form 8-K: No Form 8-K filings were made during the last
quarter of the fiscal year ended February 3, 2002.

(c) Exhibits: See Exhibit Index on pages 44 through 50.

41

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly authorized.

WILLIAMS-SONOMA, INC.

Date: April 29, 2002 By /s/ DALE W. HILPERT
------------------------------------
Chief Executive Officer
Director

Pursuant to the requirements of Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.

Date: April 29, 2002 /s/ DALE W. HILPERT
------------------------------------------------------------
Dale W. Hilpert
Chief Executive Officer
Director (principal executive officer)

Date: April 29, 2002 /s/ W. HOWARD LESTER
------------------------------------------------------------
W. Howard Lester
Chairman of the Board and Director

Date: April 29, 2002 /s/ SHARON L. MCCOLLAM
------------------------------------------------------------
Sharon L. McCollam
Senior Vice President
Chief Financial Officer (principal financial officer and
principal accounting officer)

Date: April 29, 2002 /s/ CHARLES E. WILLIAMS
------------------------------------------------------------
Charles E. Williams
Founder, Vice-Chairman and Director

Date: April 29, 2002 /s/ PATRICK J. CONNOLLY
------------------------------------------------------------
Patrick J. Connolly
Executive Vice President
Chief Marketing Officer
Assistant Secretary and Director

Date: April 29, 2002 /s/ ADRIAN D.P. BELLAMY
------------------------------------------------------------
Adrian D.P. Bellamy
Director

Date: April 29, 2002 /s/ MICHAEL R. LYNCH
------------------------------------------------------------
Michael R. Lynch
Director

Date: April 29, 2002 /s/ JAMES A. MCMAHAN
------------------------------------------------------------
James A. McMahan
Director

42

Date: April 29, 2002 /s/ JOHN E. MARTIN
------------------------------------------------------------
John E. Martin
Director

Date: April 29, 2002 /s/ EDWARD A. MUELLER
------------------------------------------------------------
Edward A. Mueller
Director

Date: April 29, 2002 /s/ HEATHER M. REISMAN
------------------------------------------------------------
Heather M. Reisman
Director

Date: April 29, 2002 /s/ RICHARD T. ROBERTSON
------------------------------------------------------------
Richard T. Robertson
Director

43

EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE
FISCAL YEAR ENDED FEBRUARY 3, 2002

* Filed herewith.

50