Williams-Sonoma Inc (WSM) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma, Incorporated fourth quarter 2002 earnings and 2003 guidance conference call.

At this time all participants are in a listen-only mode.

We will conduct a question and answer session after the presentation.

As a reminder this conference is being recorded.

I would now like to turn the call over to Ronald Loeb, Senior Vice President and General Counsel at Williams-Sonoma, Incorporated to discuss forward-looking statements.

Please you go ahead Mr. Loeb.

This is actually Bryn Argov.

Good morning everyone.

The forward-looking statements in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements address the financial condition results of operation and business of the company and are subject to certain risks and uncertainties that could cause actual results to differ materially.

Please refer to the company's current press releases and S.E.C. filings including but not limited reports on forms 10-K, 8-K and 10-Q for the full text of the forward-looking statements.

The company takes no obligation to update for events or circumstances that may arise after the date of this call.

I will turn the call over to Howard Lester, Chairman.

Good morning and thank you for joining us.

With me today is Ed Mueller our CEO, Pat Connolly, our Executive Vice President and Chief Marketing Officer, Laura Alber, our President of the Pottery Barn Brands, Patrick Cowell, our President of the Williams-Sonoma Brand and Sharon McCollam our Senior Vice President and Chief Financial Officer.

Edward Mueller joined our team as CEO in January and is rapidly assuming the leadership role in the company. he’s an outstanding complement to our existing management team and has seamlessly assimilated into our corporate culture.

I'll turn the call over to Ed to highlight our fourth quarter and fiscal year 2002 results and then Ed and I will be available for questions during the Q&A at the end of today's call.

Thank you, Howard and I would like to state I'm delighted to be here today.

Having served on the board for four years, I’ve observed the company's unwavering commitment to customer service, operational excellence and shareholder value, all of which are fundamental to my vision of a world class company.

I feel privileged to have the opportunity to lead this great organization, to new level of performance and to have Howard as my partner in this effort.

We will now begin our conference call.

The purpose of today's call is to discuss our fourth quarter and fiscal year 2002 business results and provide guidance for fiscal year 2003.

Fiscal 2002 was the year of many achievements for the company, not the least of which was delivering the highest pretax operating margin and diluted earnings per share in the history of the company.

We also substantially strengthened our balance sheet by improving our cash flow from operations and we met or exceeded the earnings guidance we provided to our shareholders in every quarter of the year.

Despite a very difficult retail environment, we delivered a pretax operating margin increase of 46%, a diluted earnings per share increase of 60%, and an increase in cash flow from operations of 51%.

Consistent with our strategic initiative to drive top line sales growth, we increased revenues by 15% including low double digit sales growth in Williams-Sonoma and Pottery Barn, and a 51% increase in the Pottery Barn Kids.

To achieve this growth, we increased our comparable store sales by 2.7%, our store base by 15%, our retail leased square footage by 17%, our catalog circulation by 14%, our electronic direct marketing messages by 196%, and our gift registries by 32%.

We also launched a new concept, West Elm.

Introduced our first private label credit card and loyalty rewards program, and finalized our reposition strategy in Hold Everything.

Consistent with our strategic initiative to improve profitability in our core businesses, we increased our pretax operating margin by 290 basis points to 8.6%.

The highest ever in the company's history.

This substantial improvement was driven by the successful integration of fundamental financial and operational disciplines throughout the organization, and superb execution on our supply chain.

The key drivers of this improvement included a substantial improvement in net shipping profitability for merchandise delivered to customers in the Pottery Barn and Pottery Barn Kids brands, a year-over-year increase in merchandise gross margin, driven by significant level of full-priced selling in the first half of the year and a highly disciplined mark-down strategy.

And a reduction in merchandise cost of goods sold, due to improved sourcing.

A significant reduction in customer returns, replacements and damages due to better merchandise quality, improved order fulfillment accuracy in the distribution center and new furniture return procedures in the call centers.

A substantial reduction in inventory shrinkage due to significantly improved inventory management and newly implemented controls in the freight-to-stores delivery process.

A continued improvement in distribution and transportation management performance, including labor productivity, inbound and outbound freight cost and overhead expense reduction initiatives.

In 2002, total distribution center operating cost decreased 4% versus the prior year, despite a 15% year over year increase in sales growth.

As a majority of these improvements were driven by fundamental changes in the way we operate our business, we believe that the financial and operational discipline is integrated into our business process and will be sustainable going forward.

In the information technology area, we made solid progress on our five-year strategic plan.

In 2002, we implemented the first two phases of our new transportation management system, substantially completed the implementation of the first phase of our new warehouse management system and began the development of our new direct-to-customer order management and inventory management systems.

These multi-phased, multiyear technology initiatives will be at the heart of our long term efforts to drive sales and reduce costs through productivity improvement.

As we reflect on 2002 we do so with pride.

It was a tremendous year for our company.

Despite the consistent unpredictability of the economic environment, the management team remained relentlessly committed to delivering the growth in earnings guidance they had promised to their shareholders.

The result was outstanding.

The team delivered the best year in the history of the company.

Howard and I are very proud of this company wide effort and believe the organization clearly demonstrated its ability to once again aggressively manage the business in difficult economic times.

Howard and I also believe that this management team has built a foundation for sustainable operational discipline that will benefit the company for years to come.

I will now turn the call over to Sharon McCollam for more details on fourth quarter and fiscal year 2002 financial results.

Thank you, Ed.

Good morning.

I'd like to start by outlining the agenda for the remaining of this morning's call.

First, we will review our fourth quarter and fiscal year 2002 earnings results.

Next, Ed will discuss our 2003 guidance.

Then, Patrick Cowell will provide you with a business update for the Williams-Sonoma brand.

After Pat's update, Laura Alber will provide you with a business update for the Pottery Barn, Pottery Barn Kids and PB Teen brands and then open the call for questions.

I'd now like to discuss our fourth quarter results.

In our last call we made several fourth quarter commitments to our shareholders.

We committed to drive top line sales growth in a difficult retail environment, we committed to increase operational efficiency and manage controllable costs, and we committed to deliver our earnings per share guidance.

We are very pleased today to be able to report that we met and exceeded all of these commitments.

In the fourth quarter, Williams-Sonoma delivered diluted earnings per share of 67 cents which was 2 cents above the guidance range provided in our holiday press release and 8 cents or 13.6% above last year.

As we have previously discussed, fourth quarter 2002 was a 13-week quarter versus 14 weeks in fourth quarter of 2001.

We estimated last year that the additional week in 2001 generated an incremental 38m in revenue and 2 cents in diluted earnings per share.

Therefore on a comparable 13 to 13 week basis, the fourth quarter 2002 year-over-year diluted earnings per share increase was 10 cents or 17.5%.

Net revenues for the 13 week fourth quarter of fiscal 2002 increased 10.4% to 859m versus the 14-week fourth quarter of fiscal 2002.

On a 13 to 13 week basis net revenues increased 16.5%.

Retail sales for the 13-week fourth quarter of 2002 increased 10.4% to 557.1m versus the 14 week fourth quarter of fiscal 2001.

On a 13 to 13 week basis, retail sales increased 15.7%.

This increase was driven by a year-over-year net increase of 63 stores and comparable store sales increases of 2.4%.

At the end of the fourth quarter of 2002 the company operated 478 stores, versus 415 stores at the end of 2001.

Store opening and closing information by retail concept are included in the financial schedules in this morning's press release.

Direct to customer sales for the 13-week fourth quarter of fiscal year 2002 increased 9.3% to 255.2m versus the 14 week fourth quarter of fiscal 2001.

On a 13 to 13 week basis, direct to customer net sales increased 16.8%, with all brands delivering positive growth during the quarter.

Internet sales contributed 27.2% of total direct to customer sales during the fourth quarter, versus 20.8% into the fourth quarter of 2001.

Net sales in the Williams-Sonoma brand in the 13-week fourth quarter of 2002 increased 14.2% on the 13 to 13 week basis, versus the fourth quarter of 2001.

Comparable store sales increased 5.3% versus 7.5% increase in 2001, and the direct to customer business delivered solid growth.

Net sales in the Pottery Barn brand in the 13-week fourth quarter of 2002 increased 11.6% on a 13 to 13 week basis versus the fourth quarter of 2001.

Pottery Barn finished the fourth quarter of 2002 with an expected 0.8% comparable sales store increase versus a 6% increase in 2001.

This decrease was primarily driven by a slower year-over-year consumer response to the post holiday floor set and lower than expected inventory levels.

At the end of the fourth quarter of 2002, retail inventory per leased square foot in Pottery Barn was near its lowest five year level.

The inventory management teams are aggressively working on improving the in-stock positions on core merchandise but due to sourcing lead times the in-stock positions will not be reaching targeted levels until the second quarter of 2003.

Net sales in the Pottery Barn Kids brand in the 13 week fourth quarter of 2002 increased 53.8% on a 13 to 13 week basis versus the fourth quarter of 2001.

Comparable store sales decreased an expected 1.6% primarily due to the initial impact of new store openings on existing comparable stores, lower than expected inventory levels and a slower year-over-year customer response to the post holiday retail floor sets.

The inventory situation at the end of the fourth quarter of 2002 in Pottery Barn Kids was very similar to the situation in Pottery Barn.

Pottery Barn Kids will also not reach targeted inventory levels until the end of the second quarter of 2003.

Gross margin in the fourth quarter of 2002 reported at 44.0% of net revenues increased 100 basis points versus the fourth quarter of 2001.

This increase was primarily driven by a significant improvement in shipping profitability for merchandise delivered to customers, a decrease in customer returns, replacements and damages, a reduction in inventory shrinkage and decrease in merchandise cost of goods sold.

This increase was partially offset by higher transportation costs from the distribution center to the stores due to substantially increasing the store replenishment schedule during the fourth quarter.

Selling and general administrative expenses were 249m or 29% of net revenues in the fourth quarter of fiscal year 2002, an increase of 60 basis points.

This year-over-year increase as a percentage of net revenues was primarily driven by higher incentive compensation based on the achievement of corporate profitability goals an approximate 4.0m expense associated with the departure of the company's previous CEO and increased employment costs to support information technology initiatives.

Lower credit card fees due to the launch of the private label credit card and an overall reduction in discretionary expenses drove the improvement in other general expenses as a percentage of net revenues.

Net interest expense in the fourth quarter of 2002 decreased 1.6m versus the fourth quarter of 2001, due to significantly improved earnings and the corresponding cash flow aggressive inventory management and higher interest capitalization on long term capital projects.

Depreciation and amortization expense in the fourth quarter of 2002 was 23.5m versus 22.2m in the fourth quarter of 2001.

The fourth quarter of 2002 deferred lease amortization credit was 4.3m versus 3.5m in the fourth quarter 2001.

And capital spending for the fourth quarter of 2002 was 38.7m versus 37.3m in the fourth quarter of 2001.

I will now discuss fiscal year 2002 earnings results.

Diluted earnings per share for the 52-week fiscal year of 2002 increased 60% to $1.04 versus 65 cents per diluted share for the 53 week fiscal year of 2001.

Consistent with our discussion on the fourth quarter, we estimate that the additional 53rd he week in 2001 generated an incremental 2 cents in diluted earnings per share that did not recur in fiscal 2002.

Therefore on a comparable 52 to 52 week basis the fiscal year 2002 year-over-year delight earnings per share increase was 65.1%.

Net revenues for fiscal year 2002, a 52 week year, increased 13.1% to 2.36b versus fiscal year 2001, a 53-week year.

On a 52 to 52 week basis, net revenues increased 15.3%.

Retail net sales for fiscal 2002 increased 15.2% to 1.41b versus fiscal 2001 a 53-week year.

On a 52 to 52 week, basis net retail sales increased 16.8%, total comparable store sales increased 2.7% versus a 1.8% increase in fiscal year 2001.

Total leased square footage, approximately 3.7m at year end increased 17.2% in fiscal 2002, versus 15.5% in fiscal 2001.

Total selling square footage, approximately 2.4m at year end increased 17.1% in fiscal 2002, versus 14.1% in fiscal 2001.

Average leased square footage per store at the end of fiscal 2002 by concept is as follows.

Williams-Sonoma, approximately 5,200 square feet, Pottery Barn, approximately 11,600 square feet, Pottery Barn Kids approximately 7,600 square foot, Hold Everything approximately 3,800 square feet, and clearance centers, approximately 13,100 square feet.

Direct to customer net sales for the 52-week fiscal year 2002 increased 8.5% to 798.2m versus the 53-week fiscal year of 2001.

On a 52 to 52 week basis direct to customer net sales increased 11.4%.

This year-over-year increase was primarily driven by net sales generated in the Pottery Barn, Pottery Barn Kids and Williams-Sonoma brands in addition to incremental sales from the West Elm catalog.

These increases were partially offset by a planned sales reduction in the Hold Everything brand.

Internet sales were 200.4m in the 52 weeks of fiscal year 2002 an increase of 50.9% versus 132.8m in the 52 weeks of fiscal 2001.

On a 52 to 52 week basis Internet sales increased 53.3%.

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

Catalogs mailed in the fiscal year 2002 totaled 279.7m, an increase in approximately 14.1% versus a 5.2% increase in the 53 week year of 2001.

Gross margin for the year reported at 40.3% of net revenues improved 220 basis points versus fiscal 2001.

This increase, as a percentage of net revenues, was primarily driven by a significant improvement in shipping profitability for merchandise delivered to customers, an increase in full price merchandise sales, fewer markdowns, a decrease in cost of merchandise due to sourcing efforts, a decrease in customer returns and associated costs, a decrease in inventory shrinkage and lower freight costs from the distribution center to our stores.

Selling, general and administrative expenses were 749.3m, or 31.7% of net revenues in fiscal 2002, an improvement of 20 base points versus fiscal year 2001.

This decrease as a percentage of net revenues was primarily driven by a reduction in other general expenses and lower catalog advertising costs.

Offset by higher employment costs.

Higher employment costs as a percentage of net revenues were primarily driven by increased incentive compensation based on the achievement of corporate profitability targets, an approximate $4m expense associated with the departure of the company's previous Chief Executive Officer, and higher employment cost to support information technology initiatives.

Net interest expense in fiscal year 2002 decreased 5.9m versus fiscal year 2001, due to significantly improved earnings in the corresponding cash flow, aggressive inventory management and higher interest capitalization on long term capital projects.

Depreciation and amortization expense for fiscal 2002 was approximately 91.1m versus 81.2m in fiscal 2001.

The fiscal 2002 deferred lease incentive amortization credit was approximately 16m versus 12.9m in fiscal 2001.

I would now like to discuss 2002 cash flow and significant year-over-year balance sheet variances.

Cash and cash equivalents increased 118.1m in fiscal 2002.

This $118.1m increase was primarily driven by 310.2m in net cash provided by operating activities in addition to 19.5m in proceeds from the exercise of stock options.

These cash flows were partially offset by capital spending of 156.2m, repurchases of common stock totaling 48.4m and repayments of long term debt obligations of 7.4m.

Capital spending for fiscal 2002 was approximately 156.2m.

This includes 107.2m for stores, 44.7m for systems and Internet development, and 4.3m for distribution and facility infrastructure projects.

Merchandise inventories at the end of fiscal 2002 were 321.2m versus 249.2 at the end of fiscal year 2001, a year over year increase of 72m or 28.9%.

This increase was due to a strategic management decision to improve the in-stock position on core merchandise in the Williams-Sonoma, Pottery Barn and Pottery Barn Kids brands.

This decision was based on unfavorable trends in customer service metrics including fulfillment rates in the direct to customer business and retail service levels in the stores.

Of the [72]m merchandise inventory increase at the end of fiscal year 2002, approximately 80% was in the retail channel, Williams-Sonoma, Pottery Barn Kids and Pottery Barn contributed approximately 62%, 23% and 6% respectively of the year-over-year increase in the retail channel.

The remaining 20% of the year-over-year inventory increase was in the direct to customer channel primarily Pottery Barn.

Prepaid catalog expenses at the end of fiscal year 2002 were 35.2m up 5.6m versus fiscal 2001.

This increase was primarily due to the timing of expenditures for the Pottery Barn and Pottery Barn Kids catalogs, an increase in catalog paper inventories and additional costs associated with increased circulation in the Hold Everything brand due to the initial implementation of the 2002 brand realignment strategy.

Prepaid expenses at the end of fiscal year 2002 were 21.3m, up 4.7m versus 2001.

This increase was primarily due to increases in prepaid rents, prepaid insurance, and prepaid occupancy costs.

Accounts payable at the end of fiscal year 2002 was 166.1m up 67.2m versus fiscal 2001.

This increase was primarily due to higher inventory payables due to increased inventory levels and higher freight payables due to a change in freight payment processors.

Accrued expenses at the end of fiscal year 2002 were 82m up 21.6m versus fiscal year 2001.

This increase is primarily due to higher accrual balances in incentive compensation, employee salaries and benefits and rent and occupancy related expenses.

Customer deposits at the end of fiscal year 2002 were 93.1m, up 12.6m versus fiscal year 2001.

This increase was primarily due to strong growth in both individual and corporate gift certificate sales, the year-over-year impact of recognizing revenue on a delivered basis, and a new liability in 2002 related to the loyalty rewards certificates issued in conjunction with the private label credit card program.

I would now like to turn the call over to Ed Mueller discuss our fiscal 2003 guidance.

Thank you, Sharon.

As we enter 2003, we are extremely excited by the opportunities that lie ahead for the company, include the launch of our newest concept PB Teen and the continued expansion of West Elm.

While we are cautious in our outlook given the current uncertainty in the economic environment, the strength of our brands and our management team's proven track record in driving the business in difficult economic time provides us with a strong confidence in our ability to deliver the fiscal year 2003 guidance we've provided today.

In 2003, the management team will focus on the company's three long-term strategic initiatives, driving top line sales growth, improving pretax operating margin and most importantly, enhancing shareholder value.

Consistent with our strategic initiative to drive top-line sales growth in 2003, we are projecting to increase total revenues by 12% to 16%, including west almost and PB Teen.

To achieve this growth we are projecting a comparable store sales increase of 1% to 3%, a 7% net increase in new stores, a 9% to 11% increase in retail leased square footage, and a 12% to 16% increase in catalog circulation.

Given the uncertainties in the current economic environment, we believe the current guidance for retail store growth and catalog circulation is appropriately conservative.

We will, however, accelerate our plans if the economic horizon improves.

To further support our ability to achieve our revenue growth in 2003, we are projecting to increase our merchandise inventories by 15% to 20%.

As discussed in this morning's press release, we believe this increase is fundamental to serving our customers and driving our business.

Our declining inventory levels in the first half of 2002 contributed to lost retail and direct to customer sales and customer disappointments.

By the end of 2002, we had been able to substantially improve our inventory levels in Williams-Sonoma, but due to longer lead times, Pottery Barn and Pottery Barn Kids will not reach targeted levels until the second quarter of 2003.

Additionally, across all brands and channels, we will be continuing to build our brand authority in the gift registry business, enhancing our assortments in key product categories for core and seasonal merchandise, expanding our electronic direct marketing initiatives, and improving our customer acquisition and retention efforts.

Consistent with our second strategic initiative to improve profitability in our core businesses, we are projecting to increase our 2003 pretax operating margin in the range of 30 to 50 basis points.

This will result in a second consecutive year of record pretax operating margins.

The key drivers of the pretax operating margin improvement will include improving supply chain execution in the areas of transportation, customer returns, merchandise cost of goods sold, and inventory management.

And leveraging general overhead expenses as we continue our efforts to reduce the company's fixed and variable cost structure.

Our final strategic initiative for 2003 is to enhance shareholder value.

The company is committed to continuing to profitably invest in key initiatives that support the long term growth of the company, and then increase the pretax operating margin as a percent of revenue.

Our current guidance is to increase the pretax operating margin as a percentage of revenues to 9% to 11% over the next three years.

Our management team is committed to execute this goal and delivering consistent and predictable earnings to our shareholders.

I will now turn the call over to Patrick Cowell to discuss the Williams-Sonoma brand.

Thank you, Ed.

Good morning. 2002 was an exceptional year for the Williams-Sonoma brand, in both the retail and direct to customer channels.

Despite a difficult retail environment we are proud to say that the brand delivered record earnings and strong sales growth.

Net sales for the year increased 11.9%, and comparable store sales increased 3.3%.

These results were fueled by extraordinary performance in the fourth quarter.

During the fourth quarter, Williams-Sonoma delivered a robust 5.3 comparable store sales increase on top of a 7.5% increase in 2001.

We also saw strong growth in the direct to customer channel, driven by our e-commerce businesses.

Traffic on the Williams-Sonoma Website increased approximately 92%, and conversion continues to exceed industry norms.

The consumer response to our new holiday merchandise in seasonal food including holiday confections and cooking spices performed well above our expectations.

Even more encouraging however was the outstanding performance all year of the core merchandise assortment.

A renewed merchandising focus on core categories grow substantial increases in cookware, cook’s tools, soaps and lotions, bake wear and high-end electrics.

In addition to better than expected sales growth during the year, the Williams-Sonoma brand also delivered record level earnings.

This financial performance was primarily driven by reduced catalog advertising costs, efficiencies in supply chain and leveraging general overhead expenses.

We believe the successful execution of our brand alignment strategy provided a consistent focus between our three channels and provided a platform for maximizing brand performance during the year.

As we look forward to 2003, we will focus on the following key initiatives.

Our first key initiative is to drive top line sales growth by enhancing our seasonal and core merchandise assortments, increasing our marking efforts through the expansion of strategic Internet partnerships, expanding our electronic direct marketing efforts to drive increased traffic to both our retail and the direct to customer businesses, improving customer acquisition and retention, and testing two new marketing programs including the introduction of a new summer catalog and a development of an extended, expanded corporate sales program.

Our new summer catalog involves shifting circulation from our spring and fall catalogs into a new summer version.

The introduction of this catalog will allow us to strategically align our summer offering in all three channels, and provide a fresh product assortment during a time that has historically been limited in its new product offerings.

Our expansion of our corporate sales program has been designed to develop a significantly larger presence in the corporate sales arena.

Today, Williams-Sonoma has not capitalized on its brand potential in this market segment and we believe that there may be significant opportunity to leverage the success of the Williams-Sonoma brand with that customer.

Our second key initiative is to continue to build brand authority in the bridal registry business by formulating cross channel promotional strategies and developing targeted communication plans for registrants and gift givers and thirdly improving the customer experience in both the retail stores and on our Website.

Our third key initiative is to continue to improve brand profitability.

We do this by implementing strong disciplines to ensure that the customer service levels in the retail stores are consistently maintained.

We reduce the cost of the merchandise and we are leveraging our general overhead expenses.

In summary these initiatives will continue to expand the reach of the brand and leverage the strength of the brand's authority as the destination for high quality cooking accessories, gift giving ideas and home entertaining essentials.

I would now like to turn the call over to Laura Alber.

Thank you, Pat.

Good morning.

This morning I will talk about our strong performance in the Pottery Barn and Pottery barn Kids brands and then expand on this morning’s announcement on the launch of Pottery Barn Teen.

2002 was a very strong year for the Pottery Barn brand.

Although the economic environment was challenging, particularly in the back half of the year, we are proud to report that the brand delivered record level earnings.

Net sales for the year increased 11.8%.

Retail comparable sales increased 2.6% and the e-commerce continued to drive strong growth in the direct to customer channel.

The consumer response to on line bridal and gift registry continued to be very positive.

We increased our registries 54% and significantly expanded our electronic direct marketing to drive e-commerce sales.

We are very pleased with the success of our private label credit card program.

We see this as a long term marketing vehicle to drive incremental merchandise sales and enhance customer loyalty with our better customers.

We are also pleased with the new customer acquisition aspects of this program because 37% of the card holders are new to the house file.

The overall consumer response to our key merchandising strategy throughout the year was also positive.

Our strategy to increase our gift business through assortment planning and presentation was powerful as was the three channel emphasis on seasonal holidays.

Consistent with our plans, furniture was one of our key growth strategies in 2002 in addition to growth in [textiles] and lighting.

Coupling top line growth was operating strength.

The Pottery Barn brand delivered a solid 11.8% sales increase in 2002, but also delivered exceptional year over year earnings growth.

This record financial performance was primarily driven by extraordinary sales growth in the first part of the year combined with a successful execution of brand profitability initiatives in every quarter.

These initiatives included a substantial improvement in shipping profitability for merchandise delivered to customers a reduction in customer returns and the related costs, efficiencies in supply chain, and leverage in general overhead expenses.

As we look forward to 2003, we will focus on the following key initiatives.

Our first key initiative is to drive top line sales growth by enhancing our assortments in key product categories for both core and seasonal merchandise.

Improving our inventory management process to maximize our in stock position and leverage cross channel opportunities.

Expanding our electronic direct marketing opportunities to drive increased traffic to both our retail and direct to customer businesses, improving customer acquisition and retention and delivering improved quality and a superior customer experience.

Our second key initiative is to continue to build brand authority in the wedding and gift registry business by improving core product assortment, formulating cross channel promotional strategies, developing targeted communication plans for both registrants and gift givers and improving the experience in our retail stores and our Website.

Our third key initiative is to continue to improve brand profitability by balancing inventory turn initiatives against customer service levels to maximize retail and direct to customer sales conversion and continuing to drive supply chain efficiencies.

I would now like to talk about Pottery Barn Kids. 2002 was an exceptional year for the Pottery Barn Kids brand both from a financial and operational perspective.

In a difficult economic environment net sales in the brand increased by over 51% and earnings increased by more than 57%.

In its fourth full year of operation, Pottery Barn Kids generated revenues of over 293m.

Our primary objective in Pottery Barn Kids for 2002 was to enhance customer access to the brand by increasing our retail presence and expanding the reach of our direct to customer channel.

We not only achieved this objective, but we were able to do so while substantially improving brand profitability.

The first highlight in the Pottery Barn Kids business in 2002 was the exceptional execution in the retail channel.

In 2002 we opened 29 new stores which more than doubled the 2001 store base of 27 stores and we expanded into ten new markets.

The rapid growth of new stores however put significant pressure on the existing comparable stores. 15 of the 29 stores opened were in the brand's top comparable store markets.

Although comparable store sales in single store markets were positive 6.5% in 2002 the impact of rapid store growth drove the overall comparable stores comparison for the year to a negative .3%.

We believe this comparable store sales performance however would be expected during this aggressive store growth phase of the brand, especially for a multi-channel retailer.

To test this premise we benchmarked the pottery store kids retail stores today to the performance of the Pottery Design Studio Store at the beginning of its rapid retail expansion in 1995.

The analysis was very encouraging.

The analysis showed that the comparable store sales performance in the Pottery Barn Kids brand in both single store and multi-store markets are outperforming the Pottery Barn stores at a similar point in their growth curve.

Another significant highlight in the Pottery Barn Kids business was the ongoing success of e-commerce.

Significant growth in baby and gift registry sales were the primary drivers of this e-commerce increase.

The consumer response to online baby and gift registry continued to be positive with over 300% increase in new registries created in 2002.

We also dramatically expanded our electronic direct marketing initiatives by delivering to our customers over 17m messages a 249% increase over the prior year.

Also during the year the brand saw significant improvement in brand profitability.

This financial performance was primarily driven by significant sales growth combined with the successful execution of brand profitability initiatives.

These initiatives included a substantial improvement in shipping profitability for merchandise delivered to customers, a reduction in customer returns and the related cost and leverage in catalog advertising.

As we look forward to 2003, we will focus on the following strategic priorities.

Our first strategic priority is to drive top line sales growth by continuing our aggressive retail expansion strategy.

Extending the reach of the direct to consumer channel by increase prospecting and electronic direct marketing initiatives and expanding successful Internet partnerships.

Expanding our assortment by building on the strength of core product categories including gift giving and nursery.

Improving our inventory management process to maximize our in stock positions and leverage cross channel opportunities and delivering improved quality and a superior customer experience.

Our second strategic priority is to continue to build brand authority in the baby and gift registry business by focusing on an improved product assortment to support year round gift giving.

Increase inventory availability on key core products, developing targeted communication plans for registrants and gift givers and improving the customer experience in both the retail stores and on our website.

Our third strategic priority is to continue to improve brand profitable by continuing to segment our catalog mailings to maximize mail order productivity, balancing inventory turn initiatives against customer service levels to maximize retail and direct to consumer sales conversion and continuing to drive supply chain efficiency.

In summary we are excited about our merchandising and marketing plans and confident in our ability to drive the Pottery Barn and Pottery Barn Kids businesses in 2003.

Our continued focus on retail execution, product design, creative merchandising and operational execution has laid the foundation for continued profitable growth in both brands and we are committed to delivering our results.

I would now like to talk about the newest addition to the Pottery Barn brand, Pottery Barn Teens, a concept that has been in development for over two years.

Based on customer feedback and an assessment of our kids house file we saw a clear need in the market for well designed high quality home furnishings for older children.

Upon further market analysis we validated the business opportunity for a fully developed concept.

PB Teen is a lifestyle offering within the Pottery Barn brand specifically meets this market need.

In analyzing the potential for this concept we determined that the teen market was a significant subset of the overall home furnishings market.

Further with roughly 40m children between 10 and 19 in the U.S. who influence over 200b in household spending annually, we believe this large and underserved demographic represents a meaningful business opportunity.

We are in a unique position to leverage this business opportunity based on the strength of our house file and ability to segment and mail to customers who we believe will have an affinity to this concept.

We have also been able to leverage the creative strength and process of our product design, merchandising and catalog and creative teams to develop unique products and new ways to show them that will appeal to teens and their parents.

PB Teen will allow teens reflect who they are when designing their personal space.

The concept will offer exclusively designed lifestyle collections for bedrooms, studies and lounge areas, with the same high quality excellent customer service that our Pottery Barn customers and Pottery Barn Kids customers have come to expect.

We are excited about PB Teen and its potential contribution to our life stage marketing strategy in the Pottery Barn brand.

The initial catalog will be mailed the week of April 21st.

I would now like to open the call for questions.

If you would like to ask a question today, please press the star key and then one.

Please allow the mute button to remain off.

Press the star key followed by the digit 1.

We go first to Lauren Leviton with S. G. Cowen.

Good morning, Sharon, could you help us reconcile some of the comments you made on inventory, help us reconcile the comments about inventory being so lean at Pottery Barn and Pottery Barn Kids in particular, relative to the absolute increase we’re seeing in inventory, in terms of either markdown or full-price selling and then I also had a question related to that with respect to the Q1 guidance.

How much of that is related to expenses for Pottery Barn Teen and other initiatives and maybe give us a sense of what the gross margin implications are as well in the first quarter guidance.

Thank you very much.

Good morning, Lauren.

Let me take your first question which is related to the inventory increase.

If you go back, the last two years, what you had seen was a consistent reduction in our inventory levels despite a substantial increase in our leased square footage in the retail side of our business.

So when you looked at 2001, our inventories were at their lowest point in the history of our company on an inventory per leased square foot basis.

What we have done this year is come back and look at that and based on the fact that I think every quarter last year, we said that we believed that we were losing sales because of our inventory levels.

And we clearly, in Q4, as we started to get back into stock, I think you will recall that we talked about testing some stores and feeding some stores, and giving them inventory, and looking at the change in the comps, et cetera.

And as a result of that, it was clear to us, without question, that the levels of inventory that we had in our stores, in core merchandise, we're talking core merchandise, was deflating our comparable store sales and our overall retail sales.

So we allowed our open to buy to be expanded, and what we saw, the first place we could really accomplish that, was in Williams-Sonoma.

In Williams-Sonoma, they were able to get back into stock in late Q3, and if you recall, Williams-Sonoma delivered over a four comp in Q3, which was better than all our other concepts and then of course they came into Q4, and they delivered again a substantial mid single digit comp.

And in the Pottery Barn and the Pottery Barn Kids businesses because of the lead times, they were not in of course our focus on quality, if we try to hurry the inventory in Pottery Barn and Pottery Barn Kids we risk quality.

Our focus was to get them back into stock and it's going to take us into the end of the second quarter to do that.

But the point we were trying to make to give some confidence and you can refer back in detail to the press release, is that of this increase, 80% of it is in the retail channel.

And of that 80%, 63% of it is in Williams-Sonoma.

So I think that that should given you a high level of confidence, Williams-Sonoma is very much dedicated to core merchandise.

The inventory is good merchandise, it's not seasonal.

Actually, we don't have anything left from holiday.

So I think that we feel really positive about the inventory levels.

It's going to be a balancing act for us going forward.

But we think that we're carrying, we think the decision was absolutely right and we have proved it with the comps.

Does the comment you made about post-holiday response to some of the merchandise being a little lower than expected, is that reflected in the inventory guidance?

In the inventory guidance, yes.

I mean, that would be -- in the guidance for Q1?

And so has that weakness continued or can you comment on to what extent that the weakness was felt in those post-holiday assortments?

This is in Pottery Barn and in Pottery Barn Kids, we discussed the fact that their comparable store sales in Q4 were lower, and negative, because we believe that the consumer response was less than it was in the prior year.

And Lauren, that related to the comps that Pottery Barn ran last year.

I don't want you to take something too serious away from that comment, from the standpoint that last year, Pottery Barn and Pottery Barn Kids, when we came out of holiday, had some of the strongest merchandise that we had seen.

Actually, I think the Aloha, I'll let Laura opine on that, one of our big programs last year, was one of our very strong programs.

We comped, if you remember going into Q1, in double digits.

So I think it is softer than last year because that is clearly not where our comp store sales guidance is for the first quarter.

Okay.

And the incremental responses for Teen related in the Q1 guidance?

I'm sorry, Lauren, could you repeat that?

Impact associated with the PBT launch, can you comment on the impact that has on your Q1 guidance particularly for SG&A?

We're not breaking that out separately, Lauren.

We think it is highly competitive.

So we will not be breaking that out.

We have three initiatives really in Q1.

We have the West Elm expansion, we have Pottery Barn Teen and we have the brand realignment strategy being executed in Hold Everything.

So we are investing in our growth.

And we think that it's appropriate.

Okay.

One last question for Laura if I could.

Laura, could you talk about Pottery Barn Teen in terms of whether or not you're targeting the parent or teenager or both and separate marketing strategies to reach those.

And if you have reached -- in the research that you've done, can you give us a sense of what the teen perception and reaction to the Pottery Barn brand is currently?

Thank you.

Sure, thank you for the question.

It was -- it's been a big topic for us to discuss because we know that while the teen is the one of the key decision makers in the purchase, it's the parent who makes the purchase because of the high ticket nature of furniture and related furnishings for the bedroom.

So we need to appeal to both and we've been very conscious of that.

And when you see the catalog, I think you'll clearly, that's the easiest way to see what I'm talking about.

We have really spoken to teen in a voice that’s appropriate to them.

But we are cognizant of how the parent perceives their world and what is appropriate for the parent.

As we've shown both groups the catalog we've had tremendous response in our ability to do that simultaneously.

And then also your question about the Pottery Barn, this age group’s reaction to Pottery Barn in general.

It is very, very positive and we've seen that.

However, they -- we haven't given them anything specifically for their rooms, and there's a lot of functions in a teenager's room or in a Tween's room that we don't serve today.

It is both design and function that's very important to us.

Great, thank you very much.

In the interest of time please limit yourself to one question.

We go next to Mark Friedman with Merrill Lynch.

Good morning, everyone, great job on the fourth quarter.

I guess my one question is about square footage.

Could you just give us an update?

It seems like part of it, the guidance includes closing temporarily nine or ten stores that reopen now.

Are the plans are, how many of those stores actually reopen this years, or are there adjustments being made on the square footage relative to original plan?

And just a follow-up question on Laura's, on the SG&A for the first quarter, Sharon, are you implying that the guidance for SG&A in the first quarter that's up about 200 basis points, give or take, is reflective of these initiatives?

Or are there other things that are influencing the increase in SG&A in the first quarter?

Thank you.

Okay.

Let me start, Mark, with responding to your question about the remodeled stores.

We do close stores to remodel them, and then we reopen them.

In this particular year, that will happen within the same fiscal year.

So what you're seeing in the guidance reflects both the closing and the reopening of the store.

But it's treated in the table, in the press release, it has to be treated as a closing, and as an opening, even though it's the same store.

And then the second question that you had is referring to the SG&A in the first quarter.

And there are significant drivers to the SG&A in the first quarter.

But it is primarily ad cost.

And of course the increase in ad cost is partially a result of the launch of these additional -- the additional catalog, the expansion of West Elm.

In addition to that, we are seeing an increase in the Hold Everything circulation in Q1.

So we have a different number of catalogs in Q1 than we had last year.

Also, our catalog in Q1 of last year-- last year, Q1, Mark, you'll remember, it was a phenomenal quarter for both our retail businesses and our catalog and Internet businesses.

And as a result of that, the leverage on the catalog ad cost was significant.

So we're also seeing a slight difference year-over-year in productivity, and a slight increase in paper costs.

Okay, great, thanks.

And just a clarification on the stores, Sharon, again, I understand the opening and closings of the remodels.

But have you made any adjustments up or down of plans for new stores for '03 to where you'd maybe were thinking six months ago?

I'm going to let Howard respond to that question.

Have we made any changes in our strategy toward real estate because of the current economic environment.

Mark, I think -- I think we probably have dropped about -- we've cut our estimate by about four or five stores, I think, from where we were six months ago.

We've gotten -- we've kind of raised our standard for what we're looking for in a real estate transaction or a location, and factored in kind of the conservatism we see in the economy, and so we are a little bit more conservative.

And I believe we have probably five more stores, four or five more stores in the plan six months ago than we now have in the plan.

Great, thank you.

We go next to Alan Rifkin with Lehman Brothers.

Couple of questions.

I understand, Sharon, the growth drivers that you've articulated as it relates to both SG&A improvement and gross margin improvement.

But could you maybe provide a little more color with respect to your guidance for both the third and fourth quarter, specifically where you see the earnings gains coming from of plus 20% even with, let's say, a 1% comp which is both at the low end of what you're talking about?

Let me -- let me stay the first question which has to do with the SG&A in Q3 and Q4.

In Q3 and Q4, as we look at the business and we look at what happened, in this fiscal year, we saw some significant expenses.

Obviously, you need to take into account, Alan, that the fourth quarter includes the charge that we had to take for the departure of our previous Chief Executive Officer.

So first before you even get started you need to modify that which of course is in SG&A.

We had some other unusual events going on in the third and fourth quarter.

We had obviously the port strike situation, which of course was in the gross margin.

We did do a substantial amount of air freighting, which of course hit the margin between really that was mostly affecting us in the fourth quarter.

But there was a lot of logistics of course that had to go along with that many too.

So the other issue that we had was the low inventory levels.

And that was problematic.

We rushed a lot of merchandise.

We said in the call this morning that our freight to stores for the first time in eight quarters was actually negative in Q4, and the reason for that was our need to accelerate and expedite inventories into our stores.

So there was a magnitude of issues in Q3 and Q4 that are nonrecurring that we believe are of course not going to repeat next year.

We go next to Peter Benedict with CIBC World Markets.

Good morning peter.

Mr. Benedict, your line is open.

I'm sorry, can you hear me now?

We can hear you.

Hi, Sharon.

Sorry, how are you?

I'm great thanks.

A follow-up question on the store growth.

I think Howard just mentioned that you guys thought that maybe four to five stores had fallen out of the plan.

How quickly can you, you know, return to that plan, and even maybe get beyond that plan for 2003?

And I'm just trying to get an idea of, you know, whether or not kind of a 10% stores/square footage growth plan is what you would plan to go into 2004 as well, thanks.

Well, the stores that we took out of the plan probably are out for 2003.

So I think our plan is pretty well set at this time.

We might have some unusual situation come up that one or two store opportunities would come up in time for us to open stores.

But you know, this is now effectively the 1st of April and we don't want to open stores after October, if we can help it.

So I think the plan's pretty much what it is.

And we just push those opportunities into '04.

We take our final question today from Anne-Marie Peterson with Thomas Weisel.

Good morning.

I had a couple of quick questions.

Laura, if you could address, if you how you're balancing newness at the Pottery Barn and Pottery Barn Kids brand, while trying to keep the assortment focused and trying to make sure your margins are intact particularly in the seasonal items, also do you plan to increase SKUs in 2003 either retail or direct and then also if you could address the Pottery Barn core versus the non-core, the fashion forward or seasonal items from a sales and margin standpoint, that would be very helpful.

Thank you.

Thanks, Anne Marie.

We continue to drive healthy merchandise margins by taking in season markdowns on slow movers.

And we are really committed to bringing in fresh new merchandise.

And while we've taken more markdowns than what we did last year at this time, our stores see improvements and continued on markdown strategy have allowed us to continue to drive strong merchandise margins despite a softer retail environment.

The increase, we continue as well as to look at our balance between core and fashion, and really refine that strategy as we go forward which we believe will continue to accelerate our market position in the home furnishings market and really bringing to market the best of class in each one of our product categories.

We are not taking a SKU increase or reduction strategy this year.

We are looking instead what the consumer wants from us and make sure we maintain a very strong and focused visual presentation.

So it's not so much about counting SKUs as it is in making very powerful statements to the customer.

I hope that answers your questions, Anne Marie.

That concludes today's question-and-answer session.

I'd like to turn the call back over to the speakers for any additional closing comments.

Welt, thank you all for joining us and we look forward to talking to you at the end of next quarter.

Good morning.

That concludes today's conference call.

Thank you for your participation.

You may now disconnect.