Pottery Barn 2005 Annual Report Download - page 45

may provide certain routine indemnifications relating to representations and warranties or personal injury
matters. The terms of these indemnifications range in duration and may not be explicitly defined. Historically, we
have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any
of these matters, the loss would not have a material effect on our financial condition or results of operations.
CONSOLIDATION OF MEMPHIS-BASED DISTRIBUTION FACILITIES
Our Memphis-based distribution facilities include an operating lease entered into in July 1983 for a distribution
facility in Memphis, Tennessee. The lessor is a general partnership (“Partnership 1”) comprised of W. Howard
Lester, Chairman of the Board of Directors and a significant shareholder, and James A. McMahan, a Director
Emeritus and a significant shareholder. Partnership 1 does not have operations separate from the leasing of this
distribution facility 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 collateralized
by the distribution facility and the individual partners guarantee the bond repayments. As of January 29, 2006,
$1,887,000 was outstanding under the Partnership 1 industrial development bonds.
During fiscal 2005, we made annual rental payments of approximately $618,000 plus interest on the bonds
calculated at a variable rate determined monthly (3.5% in January 2006), applicable taxes, insurance and
maintenance expenses. Although the current term of the lease expires in August 2006, we are obligated to renew
the operating lease on an annual basis until these bonds are fully repaid.
Our other Memphis-based distribution facility includes an operating lease entered into in August 1990 for
another distribution facility that is adjoined to the Partnership 1 facility in Memphis, Tennessee. 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 the leasing of this distribution facility 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 interest and annual principal
payments are required through maturity in August 2015. The Partnership 2 industrial development bonds are
collateralized by the distribution facility and require us to maintain certain financial covenants. As of January 29,
2006, $13,809,000 was outstanding under the Partnership 2 industrial development bonds.
During fiscal 2005, we made annual rental payments of approximately $2,600,000, plus applicable taxes,
insurance and maintenance expenses. This operating lease has an original term of 15 years expiring in August
2006, with three optional five-year renewal periods. We are, however, obligated to renew the operating lease on
an annual basis until these bonds are fully repaid.
As of February 1, 2004, the Company adopted FIN 46R, which requires existing unconsolidated variable interest
entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among
parties involved. The two partnerships described above qualify as variable interest entities under FIN 46R due to
their related party relationship and our obligation to renew the leases until the bonds are fully repaid.
Accordingly, the two related party variable interest entity partnerships from which we lease our Memphis-based
distribution facilities were consolidated by us as of February 1, 2004. As of January 29, 2006, the consolidation
resulted in increases to our consolidated balance sheet of $18,250,000 in assets (primarily buildings),
$15,696,000 in debt, and $2,554,000 in other long-term liabilities. Consolidation of these partnerships did not
have an impact on our net income. However, the interest expense associated with the partnerships’ debt, shown
as occupancy expense in fiscal 2003, is now recorded as interest expense. In fiscal 2005 and fiscal 2004, this
interest expense approximated $1,462,000 and $1,525,000, respectively.
IMPACT OF INFLATION
The impact of inflation on our results of operations for the past three fiscal years has not been significant.
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Form 10-K