Williams-Sonoma Inc (WSM) 2004 Q4 法說會逐字稿

Welcome to the Williams-Sonoma, Incorporated fourth quarter and fiscal year 2004 earnings and fiscal 2005 guidance call.

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

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

As a reminder, this conference is being recorded.

At this time, I'd like turn the call over Mr. Steve Nelson, Director of Investor Relations at Williams-Sonoma, to discuss forward-looking statements.

Please go ahead, Mr. Nelson.

Good morning, the forward-looking statements included 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 operations, business and initiatives of the Company in 2005 and beyond, and are subject to certain risks and uncertainties that would cause actual results to differ materially from such forward-looking statements.

Please refer to the Company's current press releases and SEC filings, including but not limited to, reports on Forms 10-K, 10-Q and 8-K for more information on the risks and uncertainties that could cause actual results to differ materially from these forward-looking statements.

The Company under takes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.

This call contains certain non-GAAP financial measures as defined in Regulation G. For a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and explanation of why these non-GAAP financial measures are useful and how they are used by management, please see our press releases issued this morning and filed with the SEC on Forms 8-K.

I will now turn the conference call over to Mr. Ed Mueller, our Chief Executive Officer.

Good morning, and thank you for joining us.

With us today is Howard Lester, our Chairman;

Laura Alber, our President of the Pottery Barn brands;

Pat Connolly, our Executive Vice President and Chief Marketing Officer; and Sharon McCollam, our Executive Vice President and Chief Financial Officer.

I would like to begin our call today by discussing our 2004 financial results.

We are very pleased to be here today to deliver our shareholders another year of record financial performance.

In 2004, we once again delivered the highest pre-tax operating margin and diluted earnings per share in the history of the Company and met or exceeded the earnings guidance we provided to our shareholders in every quarter, excluding the impact of the lease accounting charge that we had to record in the fourth quarter as described in this morning's press release.

On revenue growth of 13.9 percent, we increased our earnings per share by 14.4 percent including this 1-time charge, and 21.2 percent excluding the charge.

We are very proud of these results, and believe they reflect the power of our multi-channel strategy, the ongoing strength of our core brands, the momentum we are creating in our emerging brands, and the competitive advantages that we have developed within our supply chain operations.

The first highlight of our 2004 operating results was our success in driving top-line sales growth of 13.9 percent.

This was a key strategic initiative in 2004, and we are extremely pleased to have been able to deliver these results, despite a significantly weaker than expected consumer response to the holiday merchandising strategies in the Pottery Barn brand in the fourth quarter.

In our core brands, net sales increased 12.2 percent in 2004, primarily driven by mid-teen net sales increases in both the Pottery Barn and Pottery Barn Kids' brands and a mid-single-digit net sales increase in the William-Sonoma brand.

In our emerging brands, including PBteen, West Elm, Hold Everything, and William Sonoma Home, net sales increased 38 percent, driven by strong performance in the PBteen and West Elm brands.

Net sales in 2004 in the PBteen brand increased 97.8 percent, significantly above our expectations.

This increase was primarily driven by incremental sales from the e-commerce website that was launched in October 2003 and a 55 percent increase in catalogue circulation.

Although we continue to believe that it is too early to predict the ultimate growth potential of PBteen, the strong consumer response to this brand leads us to believe that we have identified another under-served market segments in the home, similar to Pottery Barn Kids, that can provide a significant long-term growth opportunity for the future.

Net sales in the West Elm brand increased 75.9 percent, also above our expectations.

This increase was driven by significant growth in the e-commerce channel and extremely successful retail launch.

In late 2004, we opened 3 new prototype stores in the West Elm brand, all of which currently rank in the top volume producing stores in the Company.

Net sales in 2004 in the Hold Everything brand, excluding the negative impact of 2003 store closings, increased 8.9 percent, consistent with our expectations.

Within the brand, 2004 was a year of significant transition in both the merchandising strategy and the lifestyle positioning of the brand.

During 2004, we added significant management resources and infrastructure to support the future growth of the brand.

In the direct-to-customer channel, we increased catalogue prospecting to revitalize the customer database and launched the first Hold Everything e-commerce website in December.

We also opened 3 new prototype stores in late November.

All though the overall growth in the Hold Everything brand in 2004 met our expectations for 2004, its growth potential was limited by the breadth of the current merchandise assortment.

We are currently in the process of developing substantially expanded assortments for 2005 and 2006.

Our newest brand, William Sonoma Home was launched in the third quarter of 2004.

On a circulation of over 10 million catalogues, net sales in the brand were in line with the low end of our expectations.

What we found especially encouraging about the initial consumer response to the overall merchandise assortment was the stronger-than-expected demand for custom upholstered furniture, which we believe speaks to the long-term competitive advantage that we can create in this brand by leveraging the strength of our supply chain organization.

The second highlight of our 2004 operating results was a continued improvement in our pre-tax operating margin, increasing from 9.28 percent in 2003 to a record 9.33 percent in 2004.

Excluding the 2004 lease accounting charge, our pre-tax operating margin in 2004 increased 61 basis points to a record 9.89 percent.

This increase in the pre-tax operating margin, excluding the impact of the lease accounting charge in 2004, was the result of several successful operational initiatives, including a reduction in shipping cost as a percentage of net revenues driven by the ongoing consolidation of freight providers; the in-sourcing of line haul management in the furniture delivery network, and the strategic positioning of our coastal distribution centers in the proximity of our customer base; a reduction in workers' compensation costs, primarily due to a 72 percent reduction in work-related accidents in the Company's distribution operations; a reduction in telecommunications expenses, driven by the renegotiation of our Company-wide vendor agreements; and a reduction in corporate overhead expenses as a percentage of net revenues, due to strong expense-management initiatives, primarily in employment and employment-related expenses.

As a majority of these improvements were driven by fundamental changes in the way we operate our business, both in our supply chain and our corporate infrastructure, we believe that the operating of the financial disciplines necessary to sustain these improvements going forward are in place.

The third highlight of our 2004 operating results was the significant progress we made in building our infrastructure to support the growth of our core and emerging brands.

In the information technology area, we made important progress on our 5-year strategic plan.

During 2004 we entered into 2 strategic vendor partnerships with IBM, 1 to host and manage our data center and 1 to host our e-commerce websites.

These agreements were entered into in order to more cost effectively manage our information technology infrastructure, while at the same time, enhancing the functionality of our e-commerce websites.

We also continued to invest in our new direct-to-customer order management and inventory management systems, which are currently in beta testing in our Hold Everything brand.

These multi-phase, multi-year technology initiatives are at the heart of our long-term efforts to drive increased sales and reduce costs through productivity and operational efficiency.

In the area of inventory management and distribution operations, we increased our distribution center lease square footage by 25 percent, including opening our first East Coast distribution center in Cranbury, New Jersey.

We also made substantial progress on our weeks of supply inventory management initiative, which resulted in substantial reduction in the base levels of our inventory due to more efficiently flowing merchandise through the supply chain.

The full benefit of this initiative, however, will not be realized until we implement our new merchandising systems in 2006.

Our successful execution of all these initiatives in 2004, combined with the strength and depth of the management team responsible for this success have left us well-positioned to drive the business in 2005 and beyond.

I will now turn the call over to Sharon McCollam for more details on the fourth quarter and fiscal year 2004 financial results.

Thank you, Ed.

Good morning.

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

First we will discuss the lease accounting issues that affected our 2004 results.

Then we will review our fourth quarter and fiscal year 2004 financial performance.

Next, Ed will discuss the operating strategies that support our 2005 guidance.

Following Ed, Howard Lester will provide you with a business update on the Williams-Sonoma brand.

Then, Laura Alber will provide you with a business update on the Pottery Barn brands.

And finally, we will open the call for questions.

Before I begin discussing our fourth quarter and fiscal year 2004 earnings results, I would like to take a few moments to discuss the $0.09 per diluted share non-recurring lease accounting charge that we recorded in the fourth quarter.

On February 7, 2005, the SEC issued a letter to the American Institute of Certified Public Accountants to clarify its position on certain accounting issues relating to operating leases.

Specifically, the SEC staff expressed its views on the appropriate accounting for the amortization of leasehold improvements, the accounting for landlord and tenant incentives, and the recognition of rent when an operating lease contains free or reduced rents, commonly referred to as a rent holiday.

In response to this letter, we performed a comprehensive review of our leases and our lease accounting policies.

Based on this review, we determined that the only area in which our current method of accounting was not consistent with the SEC staff position was in the area of rent holidays.

Prior to the SEC's letter we did not recognize rent expense during the time that we were under construction, which is considered a rent holiday.

We followed a practice prevalent across the retail industry in which we recognized rent on a straight line basis beginning generally on the rent commencement date.

This practice had the effect of excluding the construction period from the time frame over which we expensed rents.

Based on the SEC's letter, however, we are now recording rent expense when we take control of a leased facility, which includes this construction period and often begins 2 to 4 months before the rent commencement date.

The cumulative financial impact of correcting our accounting for rent holidays through fiscal year 2004 was an increase to rent expense of approximately $17.4 million before tax, $10.7 million after tax, and $0.09 per diluted share after tax.

The amount of the after-tax adjustment that related to fiscal years 2004, 2003, and 2002 was approximately $1 million, $1.9 million, and $1.7 million, respectively.

The amount that related to fiscal years 2001 and prior was $6.1 million after tax, which related to leases that were entered into as early as 1991.

As the adjustment was not material to any prior period financial statements, the full lease accounting adjustment was recorded as a non-recurring charge in the fourth quarter of fiscal year 2004 with no corrections being made to prior periods.

The cumulative impact of this adjustment was recorded as occupancy expense, negatively impacting fourth quarter and fiscal year 2004 cost of goods sold in occupancy expenses, gross margins, earnings from operations, earnings before tax, pre-tax operating margins, net earnings, and earnings per share.

This adjustment does not impact our historical or future cash flows, nor the timing or amount of our lease payments, as it is solely related to a non-cash correction in accounting treatment.

Furthermore, it is not expected to have any material impact on future earnings.

For the remainder of our call today, we will refer to this adjustment as the lease accounting adjustment to simplify our discussion.

We will also provide comparisons excluding the adjustment in order to show meaningful year-over-year in -- variances.

I would now like to talk about our fourth-quarter earnings results.

We are extremely pleased to deliver to our shareholders another consecutive quarter of strong earnings performance, despite lower-than-expected top-line sales growth.

As we discussed in our holiday press release, the majority net revenue softness that we saw during the quarter was due to a weak consumer response to our holiday merchandising strategies in the Pottery Barn brand.

Throughout the quarter, however, we remained intently focused on our operational execution, including well-planned mark down strategies, strong distribution in transportation management, and disciplined cost containment initiatives.

Based on the success in all of these areas, we were once again able to deliver another record quarter.

And for the 18th consecutive quarter, excluding the impact of the lease accounting adjustment, we have met or exceeded the earnings-per-share guidance we have provided to our shareholders.

In the fourth quarter of 2004 we delivered earnings-per-share of $0.86.

Excluding the impact of the lease accounting adjustment we delivered earnings-per-share of $0.95, which was $0.10, or 11.8 percent, higher than the $0.85 we reported for the fourth quarter of 2003.

Net revenues in the fourth quarter of 2004 increased 7.9 percent, to $1.084 billion.

Retail sales in the fourth quarter increased 8.8 percent to 680.3 million.

This increase was primarily driven by a 11.4 percent increase in retail leaseware footage and a comparable store sales increase of 1.5 percent.

Net sales generated in the Williams-Sonoma and Pottery Barn Kids brands were the primary contributors to this year-over-year increase.

Direct-to-customer sales in the fourth quarter of 2004 increased 7.1 percent to $344.9 million.

This increase was primarily driven by net sales generated in the Pottery Barn, Pottery Barn Teen, Pottery Barn Kids, and Williams-Sonoma brands.

All of the brands in the direct-to-customer channel delivered positive growth during the fourth quarter.

Internet sales during the fourth quarter increased 26.2 percent to $152.6 million, contributing 44.2 percent of total direct to customer sales, versus 37.5 percent in the fourth quarter of 2003.

We estimate, however, that approximately 60 percent of our non-bridal internet sales are catalogue driven.

Gross margin as expressed as a percentage of net revenues in the fourth quarter of fiscal year 2004 was 43.2 percent.

Gross margin in the fourth quarter expressed as a percentage of net revenues excluding the impact of the lease accounting adjustment was 44.8 percent, versus 44.1 percent in the fourth quarter of fiscal year 2003.

This 70 basis point increase was primarily driven by a reduction in shipping cost, partially offset by a rate increase in occupancy expenses.

The improvement in shipping cost was primarily driven by expense reductions associated with the in-sourcing of line haul management in the furniture delivery network; reductions in furniture delivery cost; driven by efficiencies gained from the new East Coast distribution center; and a favorable product mix.

Higher occupancy costs as a percentage of net revenues were primarily driven by the deleveraging impact of negative comparable store sales in the Pottery Barn brand and increased costs associated with current year distribution infrastructure investments, including a 25 percent increase in distribution lease square footage.

Selling, general, and administrative expenses were 301 million, or 27.8 percent, of net revenues in the fourth quarter of fiscal year 2004, versus $276.7 million, or 27.5 percent, of net revenues in the fourth quarter of fiscal year 2003.

This 30 point basis point increase as a percentage net revenues was primarily driven by increased employment costs to support the growth of the emerging brands and higher employee benefit costs.

These increases were partially offset by a year-over-year reduction in incentive compensation expense and workers' compensation costs.

I will now discuss fiscal year 2004 earnings results.

In fiscal year 2004, we delivered earnings-per-share of $1.51.

Excluding the impact of the lease accounting adjustment, we delivered earnings per share of $1.60 which was $0.28, or 21.4 percent, higher than the 30 -- $1.32 we reported in fiscal year 2003.

Net revenues in fiscal year 2004, increased 13.9 percent to 3.137 billion.

Retail net sales increased 11.6 percent to $1.803 billion in fiscal year 2004.

This increase was primarily driven by a year-over-year increase in retail lease square footage and a comparable store sales increase of 3.5 percent.

Net sales generated in the Pottery Barn, Williams-Sonoma, and Pottery Barns Kids brands were the primarily contributors to the year-over-year sales increase, partially offset by the transitional impact of our Hold Everything brand realignment strategy.

Direct-to-customer net sales increased 17.5 percent to 1.135 billion in fiscal year 2004.

This year-over-year increase was primarily driven by net sales generated in the Pottery Barn, Pottery Barn Teen, Pottery Barn Kids, and West Elm brands.

All of the brands in the direct-to-customer channels delivered positive growth during fiscal year, with the exception of the Chambers brand, which was retired in the second quarter of 2004 in anticipation of the launch of the Williams-Sonoma Home brand.

Internet sales increased 43.4 percent to 477.5 million in fiscal year 2004, including the incremental net sales generated by the November launch of the Hold Everything website.

Catalogues mailed during fiscal year 2004 totaled approximately 368.2 million, an increase of approximately 12.1 percent versus 17.4 percent in fiscal year 2003.

Page circulation increased 19.5 percent in fiscal year 2004, versus 16.8 percent in fiscal year 2003.

Gross margin as expressed as a percentage of net revenues in fiscal year 2004 was 40 percent.

Gross margin in fiscal year 2004 expressed as a percentage of net revenues, excluding the impact of the lease accounting adjustment was 40.5 percent, versus 40.3 percent in fiscal year 2003.

This 20 basis point increase was primarily driven by a rate reduction in occupancy and shipping costs, partially offset by a rate increase in cost of goods sold.

The rate reduction in occupancy expenses was primarily due to a greater percentage of total Company net revenues being generated in the direct-to-customer channel, which does not incur store occupancy expenses.

The rate reduction in shipping costs was primarily due to a full year of expense reductions in 2004, associated with the mid-2003 consolidation of freight providers, the in-sourcing of line haul management in the furniture delivery network, and reductions in furniture delivery costs driven by efficiencies gained from the new East Coast distribution center.

The rate increase in cost of goods sold was primarily due to a higher percentage of total Company net revenues being driven by furniture, which generates a lower-than-average gross margin in addition to higher returns, replacements and damages.

Selling, general, and administrative expenses in fiscal year 2004 were $961.2 million, or 30.6 percent of net revenues, versus 855.8 million, or 31.1 percent of net revenues of fiscal year 2003.

This 50 basis point improvement was primarily due to a rate reduction in year-over-year employment expenses.

Contributing to the employment rate decrease were year-over-year reductions in workers' compensation and other employee-related costs.

I would now like to discuss fiscal year 2004 significant year-over-year balance sheet variances.

Cash and cash equivalents at the end of fiscal year 2004 were $239.2 million, the highest year-end balance in the history of the Company versus $163.9 million at the end of fiscal year 2003.

Our fiscal year 2004 consolidated statements of cash flow are included in this morning's press release.

Accounts receivable at the end of fiscal year 2004 were 42.5 million, an increase of 10.9 million versus the end of fiscal year 2003.

This increase was primarily due to a year-over-year increase in credit card receivables.

Merchandise inventories at the end of fiscal year 2004 were 452.4 million, an increase of 48.3 million, or 12 percent.

This year-over-year inventory growth rate is slightly below our current rate of revenue growth, primarily due to the ongoing success of our recently implemented weeks of supply inventory management initiatives and the continuing than lower-than-planned in-stock position on key furniture collections.

Pre-paid catalogue expenses at the end of fiscal year 2004 were 53.5 million, an increase of 15.1 million versus the end of fiscal year 2003.

This increase was primarily due to increased circulation and the timing of expenditures for the Pottery Barn and Pottery Barn Kids catalogues in addition to incremental costs associated with the Williams-Sonoma Home catalogue, which was not launched until September 2004.

Prepaid expenses at the end of fiscal year 2004 were 38 million, up 13.2 million versus the end of fiscal year 2003.

This increase was primarily due to pre-paying a portion of the Company's 2005 data center hosting fees in 2004.

Deferred income taxes at the end of fiscal year 2004 were $39 million, up 18.5 million versus the end of fiscal year 2003.

A change in the timing of revenue recognition for tax purposes on gift certificates and gift cards drove this increase.

Customer deposits at end of fiscal year 2004 were 148.5 million, up 32.4 million versus the end of fiscal year of 2003.

This increase was driven by substantial year-over-year growth in unredeemed gift certificates and gift cards.

As I turn the call over to Ed to discuss the strategy supporting our fiscal year 2005 guidance, I would like to remind everyone that the guidance we announced in this morning's press release excludes the impact from the implementation of accounting for share-based payments, which we expect to implement in the third quarter of fiscal year 2005.

We are currently assessing the necessary changes in our accounting and our employee benefit system to accurately forecast the expense associated with this new accounting pronouncement.

The implementation of this new standard will have the effect of increasing selling, general, and administrative expenses and reducing our net income and diluted earnings-per-share in the future.

I would also like to point out that our fiscal year 2005 guidance falls within the ranges of growth, both in revenue and diluted earnings-per-share, that we have previously provided to our shareholders.

Our previous guidance for revenue growth was in the range of low-double-digits to mid-teens, and we guided today in the range of 12 to 14 percent.

Our previous guidance for diluted earnings-per-share growth was in the range of mid-teens to high teens and we guided today in the range of 14 to 17 percent, if you exclude the lease accounting adjustment from our 2004 results.

It is important to note, however, that the future impact of the change in lease accounting is currently projected to increase our 2005 expenses by approximately $0.01 per diluted share, or 1 percent of 2005 earnings.

I would now like to turn the call over to Ed to discuss 2005.

Thank you, Sharon.

As we enter 2005, we are encouraged by the momentum we are seeing in both our core and emerging brands, and are excited about the opportunities that lie ahead for the balance of the year.

During 2005 we will open our first retail stores in Williams-Sonoma Home and expand the marketing reach of the PBteen, West Elm, and Hold Everything.

While we are remaining cautious in our outlook, the strength of our brands and our proven track record in driving our business provide us with a strong confidence in our ability to deliver the fiscal 2005 guidance that we have provided today.

In 2005 we will continue to focus on the Company's 3 long-term strategic initiatives -- driving profitable top-line sales growth, increasing pre-tax operating margin, and enhancing shareholder value including consistently delivering on the commitments that we make to our shareholders.

Consistent with our initiative to drive profitable top-line sales growth, we are projecting total revenues in 2005 to increase in the range of 12 to 14 percent.

To achieve this growth we are projecting an 8 to 9 percent increase in retail lease square footage, a 3 to 5 percent increase in comparable store sales, and a 5 to 7 percent increase in catalogue circulation, with a corresponding 11 to 13 percent increase in paid circulation growth.

Of our total projected revenue growth of 12 to 14 percent in 2005, we estimate that approximately 2 to 3 percent will be driven by the following growth initiative -- strategies in our new and emerging brands.

In PBteen in 2005, we will increase catalogue circulation and expand our extremely successful online marketing initiatives.

We will also drive aggressive name capture programs to expand our teen affinity database.

In West Elm, we will increase catalogue circulation and open 7 new retail stores.

We will also focus on growing our customer database through aggressive name capture and catalogue prospecting initiatives.

We continue to believe that West Elm has the potential to be our largest brand if we can successfully evolve the merchandising strategy, broaden the overall consumer appeal, and capture the mind share of the large consumer segment that West Elm targets.

In Williams-Sonoma Home in 2005, we will increase catalogue circulation, add catalogue ordering functionality to the current e-catalogue website, and open 3 prototype stores in the third quarter.

We believe that the retail launch in Williams-Sonoma Home is strategic to expanding the multi-channel reach of the brand due to the customer's desire to interact with the product and fully experience the design authority of the brand.

In Hold Everything, we'll significantly refine our catalogue circulation strategy, expand our online marketing initiatives, and open 2 additional prototype stores.

We will also introduce new merchandise assortments throughout the year that will reflect the lifestyle transition of the brand, including a significantly enhanced assortment in furniture, casual upholstery, textiles, lighting, and table top.

Consistent with our second strategic initiative to improve profitability in our core businesses, we are projecting to increase our 2005 pre-tax operating margin by 70 to 80 basis points, including the lease accounting charge in 2004, and 10 to 20 basis points excluding the charge.

The key drivers of this pre-tax operating margin improvement are expected to include -- improving the supply chain cost structure in the areas of customer returns, replacements, and damages; transportation and inventory management; and leveraging general overhead expenses as we continue our efforts to reduce our fixed and variable cost structure.

Operationally, key initiatives for the year include -- implementing operational disciplines throughout the supply chain to reduce, returns, replacements, and damages, particularly in furniture; improving our furniture sourcing and inventory management disciplines by implementing a long-term capacity and production planning process with key strategic vendors; and in-sourcing the management of a primary furniture hub to develop a new gold standard for customer service and to improve the overall operational efficiency of the furniture supply chain process.

In addition to the operational initiatives mentioned above, we're also planning to test, on a national basis, a new store replenishment program.

During 2005, we'll begin replenishing our retail store inventories on a daily basis, with UPS providing the transportation services.

The long-term benefits of this new replenishment program are to improve customer service by reducing out-of-stocks in the store, to reduce inventories in the backrooms of our stores and in local off-site storage locations, and to reduce inventory damages and shrinkage due to less handling of the merchandise.

In the short term, however, we are expecting to incur additional costs to implement this test, which we estimate at approximately $0.01 per share in 2005.

Consistent with our strategic initiative to enhance shareholder value, we are remaining committed to delivering on the commitments we have made to our shareholders, and are confident in our ability to deliver the 2005 guidance we have provided to our shareholders today.

As we look beyond 2005, over a 3-year planning horizon, we are currently projecting low-double-digit to mid-teen revenue growth, mid-teen to high-teen diluted earnings per share growth, and pre-tax operating margin expansion into the range of 9.9 to 11 percent, advancing gradually and incrementally over time.

I will now turn the call over to Howard Lester, our Chairman, to discuss the Williams-Sonoma brand.

Thanks, Ed.

I'd like to share with you this morning my perspectives on the performance of the Williams-Sonoma brand in 2004, and to update you on several new initiatives that we began implementing in the fourth quarter, which are having a significant positive effect on the brand as we enter 2005.

Net sales in '04 in the Williams-Sonoma brand increased 5.3 percent, driven primarily by new and expanded stores, strong internet growth, and a 0.5 percent comparable store sales increase.

Although our growth was below our expectations for the year, due to a weaker-than-planned performance in the second and third quarters, we were very encouraged by the renewed momentum that we saw in the fourth quarter.

A positive consumer response to both our holiday and core merchandise assortments drove this better-than-expected performance.

In the retail channel, we were pleased to end the year with a strong recovery in the fourth quarter, although comparable store sales growth was only a positive 05 (ph) for the year, comparable store sales growth in the fourth quarter increased 2.1 percent on top of a 4.8 percent increase in the fourth quarter of 2003.

In the direct-to-customer channel, we also saw sins of recovery in the fourth quarter, but our e-commerce business was strong all year.

Traffic on the website increased 38 percent, and we continue to benefit from above average conversion rates.

We also saw strong results from our online marketing efforts and continued growth in wedding registries, both of which are significant marketing opportunities for the brand, long term.

Another highlight of 2004 was the national broadcast exposure we received on the CBS Early Show.

The Thanksgiving series taped at our Columbus Circle flagship store provided significant brand recognition during a key holiday shopping period and demonstrated the brand's authority in premium home cooking and entertaining.

Based on the success of this series, CBS has partnered with us to develop a new cooking school segment that will begin airing on the Early Show in mid-April.

As we enter 2005, we're very encouraged by the momentum that's being generated by our new initiatives.

During the fourth quarter we began a major effort to refocus the way we merchandised our stores and our catalogues.

Our vision was to bring cooking and entertaining ideas to our customers, and then incorporate our products into the vision.

Each page in our catalogue and floor set in our stores was designed to create an inspirational message that would resonate with our customers.

Our redesigned catalogue that was mailed in January showed immediate positive results and also provided a rejuvenated effect in the stores.

The catalogue showed greater clarity around cooking and entertaining ideas with an additive assortment that was merchandised to our core strengths.

The contents included more recipes, more appealing food photography, and improved organization.

Based on the positive results of all these initiatives, we're planning to continue to enhance our merchandising and visual strategies going forward.

A similar strategy to the catalogue redesign is currently being tested for roll-out in our stores.

What we found in our evaluation of our stores over the past -- over the last several months, is that our small and mid-size stores have become somewhat over-assorted and the visual presentation is too cluttered to bring clear ideas to the customer.

In our first test store after editing the assortment and changing the visual merchandising, the store performance has substantially improved, as demonstrated by comparable store sales increases on an average of over 30 percent, which is substantially over the brand's current performance.

Based on these promising initial results, the roll-out to additional stores is being planned over the next 6 to 9 months.

In addition to these new merchandising strategies, we're also planning to significantly expand our cooking and entertaining classes, increased book signing and bridal registry events in '05.

We believe that all these in-store activities allow us to enhance our lifestyle marketing and build long-term relationships with our customers.

In summary we believe that executing against these initiatives in 2005 will allow us to continue to expand the reach of the brand and leverage the strength of the brand's authority as a destination for high-quality cooking accessories, gift giving ideas, and home entertaining essentials.

Let me now turn the call over to Laura Alber.

Thank you, Howard.

Good morning.

First, I'll start with the Pottery Barn brand.

We are very pleased with the performance of the Pottery Barn brand in 2004.

Net sales for the year increased 14.6 percent, which is the brand's strongest annual growth rate in 4 years, despite a disappointing holiday season.

Although the consumer response to our holiday merchandise offering did not meet our expectations, we were encouraged by the continued strong in our core merchandise assortments during that time frame.

Retail comparable store sales increased 4.6 percent in 2004, with especially strong performance in the first half of the year.

This increase was primarily driven by a strong consumer response to a significantly upgraded merchandise assortment and an overall improvement in our in-stock position on core merchandise inventories.

The direct-to-consumer channel also delivered strong growth, driven primarily by the success of our DTC-only merchandising initiatives and momentum in our e-commerce business.

We significantly expanded our electronic direct marketing efforts, and saw better-than-expected results from our online advertising initiatives.

Traffic on our website increased 43 percent, while conversion rates continued to exceed industry norms.

The consumer response to our key merchandising strategies throughout the year was also very positive, with the exception of the holiday assortment.

In both the retail and direct-to-consumer channels we continued to see strong growth in furniture in every quarter, despite high back orders in the back half of the year, in addition to positive growth across all major merchandising categories.

Another driver of strong sales performance was the ongoing success of our wedding and gift registry business, which we continue see as a key driver of new customers to the brand.

As we enter 2005 we are encouraged by the initial consumer response to our post-holiday assortments and are aggressively addressing the opportunities that we believe we missed in 2004.

In 2005 we will focus on the following brand building initiatives -- 1, improving our in-stock position on furniture to reduce lost sales and reestablish the service levels expected by our customers; 2, marketing our upgraded furniture quality and time to delivery as a key competitive advantage; 3, expanding the retail-only assortment in our larger format stores to better serve the higher-end Pottery Barn customer and maximize our sales-per-square-foot; 4, introducing new merchandising strategies that focus on solving the home-centered needs of our customers at relevant times during the year, including additional floor sets; 5, improving the 2005 holiday assortment by refocusing the design effort on more inspirational assortments and gift-giving strategies; and finally, expanding our catalogue and electronic direct marketing efforts to drive increased traffic to both our retail and direct-to-consumer businesses, including leveraging our brand authority with style tips and design ideas.

While we are excited about all these initiatives, we are cognizant of last year's very strong first half, when we delivered comparable store sales growth of over 10 percent and direct-to-consumer growth of over 25 percent.

Despite these difficult compares, however, we are confident in our ability to execute against the initiatives we have set for ourselves, and believe that we can capitalize on the strategic growth opportunities that we have identified throughout the year.

I would now like to talk about Pottery Barn Kids.

We are pleased to report today that 2004 net sales in the Pottery Barn Kids brand increased 16.1 percent, driving net revenues for the year to over $450 million.

This strong performance was driven by a positive consumer response to key merchandising strategies throughout the year, with particularly impressive growth in furniture and textiles, despite higher-than-expected back orders.

In the retail channel, we opened 9 new stores in 7 new markets and increased leased square footage by 12 percent.

What was extremely encouraging about our retail performance in 2004 was our success in driving a 4.1 percent comparable store sales increase, even with the ongoing pressure within multi-store markets.

We also saw strong performance in the direct-to-consumer channel driven primarily by our DTC-only merchandising initiatives, including personalization and the ongoing success of our e-commerce channel.

We significantly expanded our electronic direct marketing efforts, and saw better-than-expected results from our online advertising initiatives.

Traffic on our website increased 45 percent, and like Pottery Barn, conversion rates continued to exceed industry norms.

Another strong driver of sales performance during the year was the ongoing success of our baby and gift registry business, which we believe is a strategic driver of new customers to the brand.

In 2004, baby and gift registry sales increased over 32 percent.

As we enter 2005, we are encouraged by the momentum that we are seeing in both the retail and direct-to-consumer channels.

As we progress throughout the year, we'll focus on the following brand-building initiatives -- first, improving our in-stock position on furniture to reduce lost sales and reestablish the service levels expected by our customers; second, maximizing comparable store sales by expanding merchandise assortments that generate repeat customer traffic; third, expanding our family events program to develop further ties to the community and enhance the long-term relationship with our customers and their children; fourth, introducing new color palettes that will offer bolder and brighter classic fashions to our customer; fifth, increasing marketing support to drive additional baby and gift registries; and finally, expanding our catalogue and electronic direct marketing efforts to drive increased traffic to both our retail and direct-to-consumer businesses.

We believe that the successful execution of these brand-building initiatives will allow Pottery Barn Kids to further establish its market position as the authority in children's home furnishings.

I would now like to talk about the strong results that we have seen in PBteen.

PBteen has continued to far exceed our expectations since its debut in April 2003.

The consumer response to the overall merchandise assortment, including textiles, furniture, and decorative accessories has been extremely positive, and we are very encouraged by the success of our customer acquisition efforts.

We are also very encouraged by the tremendous similarities between PBteen and Pottery Barn Kids, both generating approximately a hundred million in revenue in their second year of operations.

Building upon the successful catalogue launch of 2003, we increased PBteen catalogue circulation by over 50 percent in 2004 to more than 28 million catalogues.

The e-commerce site has also developed into an exciting way to interact with the brand's target audience.

It has driven substantial brand affinity, and has rapidly become a shopping destination for teen customers.

Another great accomplishment of the PBteen brand is the significant mind share that has been built in less than 2 years, as evidenced by our recent Piper Jaffray survey, in which teenagers were asked to name their favorite store or catalogue for their own room furnitures and accessories.

This survey ranked PBteen second with respect to teenage mind share in the marketplace.

PBteen achieved this impressive ranking by introducing an exciting an exciting new product offering to under-served market, developing a highly effective catalogue and internet customer contact strategy, and leveraging the success of the brand with coordination with teen media, including magazines, television, and movies.

As we look forward to 2005, we will continue to drive profitable top-line sales growth by expanding our core merchandise assortment, introducing new merchandise categories, and aggressively pursuing the significant opportunity we identified during the holiday season in our gift giving assortment.

We'll also increase our catalogue and page circulation, in addition to our electronic direct marking, as we continue to leverage our database to identify new customers for the brand.

To maintain a growing teen awareness for the brand, we'll also remain very active in building our media and internet partnerships.

New, on-trend marketing initiatives, including contests, surveys, and media tie-ins will increase interactions with teens and further enhance their affinity for the brand.

Fulfilling its role in our life-stage marketing in the Pottery Barn brand we remain very confident in the long-term growth potential of PBteen.

I would now like to open the call for questions.

Thank you, our question-and-answer is conducted electronically.

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Our first question will come from Alan Rifkin at Lehman Brothers.

Good morning, Alan.

Sir, your line's open, sir.

Mr. Rifkin, please check, we're not hearing you.

Please check your mute button.

Mr. Rifkin?

I think you're going to re-signal.

I'm going to go ahead and go to Neely Tamminga at Piper Jaffray.

Great.

Thank you, so much.

Can you hear me?

Good morning, Neely.

How are you?

Good morning.

Very good.

Thank you, very much.

Very thorough call.

Thank you, so much for the run down.

Do have a couple follow-up questions.

Maybe if Howard could give us a sense of how of the Williams-Sonoma edited stores look.

What are you editing, in terms of categories, maybe, or is it just pure across-the-board style reduction?

And then also respect to floor sets, Laura mentioned adding more floor sets for the Pottery Barn brand in '05.

Can you give us a sense of how many you'll be moving towards?

What was in '04, and what will it will be in '05?

Thank you, so much.

First, on the Williams-Sonoma work that we're doing.

As we reviewed the stores this fall, you know, we began doing the Grand Cuisine stores in 1994.

And so those stores, when we initially built them, were from 4,500 feet to 6,000 feet, or something in that order, and we have close to 200 of those.

And then we built the balance of the stores larger, up to the size of our flagships.

And so much of our creative work has gone into the new stores, I think we've -- have not done a good job of looking back on the older stores and reviewing the assortments and reviewing the adjacencies in the store, and the space that we're giving different categories, and the way that we're presenting them.

So we just -- it hit us very strongly that we had a lot of opportunity there.

And, of course, those 200 stores are most important to us.

I mean, they are very profitable and they are our, really, our core business in the retail sector so -- for Sonoma.

So what we did was really with -- we tried to do it with a reasonable amount of money so we could afford to roll it out.

And into one store that we did the work in, we improved the cookware assortment by bringing in more specialty items that we hadn't had before in these smaller stores.

We added a -- gave a lot more space to some of the cookware lines that we had.

We improved the signage, added 2 or 3 bays to it.

And just basically improved the whole authority of the cookware.

We tripled the size of cutlery.

We put in a new gadget board.

We improved the bakeware assortment.

We gave a lot more space to electrics by breaking out all the coffee equipment from the basic electrics.

We didn't have nearly enough space to show them correctly.

We cut back a couple of food bays, and then, we actually cut back 4 cook bay -- food bays in this store, added 3 back on end caps.

So it just made the whole food assortment surround you better.

And by the same time, we gave some space in that area to books that we didn't have before.

So we put in a new fixture for our linens, which we're testing, which I think is very dramatic in showing the placemats and napkins where they've been hidden before.

We, of course, put in our new -- we're in the process of putting in our new strategy on dinnerware in that store.

We cut back on the glassware and eliminated a lot of the fashion glassware.

And we're in the process of improving the core assortment of glassware.

We put in 3 bays -- 4 bays of entertaining in this store, which we didn't have.

And we improved housewares' presentation.

So we did a lot of work for a small amount of money.

Our team did an incredible job.

We cut about 400 SKUs out of the store's assortment, so which is a little more than 10 percent.

You don't notice them.

And as I said, the results are very satisfying, and we're about, I think, 80 percent there.

We've still got some work to do in the table top area, because we don't have the all the new merchandise yet, but we'll now -- we'll roll it out to an additional group of stores.

And if it continues to perform, then we'll get very aggressive with it next year.

Hi, Neely, it's Laura.

We are adding several new floor sets to Pottery Barn.

I don't feel that comfortable going through the specifics for competitive reasons, but I will say that we think that it's going to be significant.

We're adding floors sets at times of the year to be more relevant to what our customers are thinking about at those key times.

So we do believe it represents a significant opportunity for us.

We'll now go to Keith DeVore at American Express.

Yes, 2 questions on your internet business.

Wondering what are industry norms for conversion on websites?

And then, secondly, just wondering as you look to '05 guidance, how fast you see your internet sales growing?

I'm going to let Pat Connolly speak to the industry norms on conversion, and then we can talk about the internet assumptions in our '05 guidance.

Keith, on -- industry norms very widely, based on the kind of marking that's done to attract people to the site.

But they're in the range of 1 to 2.5 and 3 percent.

Ours significant are usually well above that.

And then, Keith, as we think about 2005 and internet growth, we expect it to be very similar to 2004, plus the incremental revenue that we expect to receive from our Hold Everything site, which we launched late in the year this year so we're expecting '05 to continue to see very strong growth.

As you can tell in the guidance, when you look at the catalogue circulation compared to the DTC growth, we're seeing strong growth in internet.

We'll go to Lauren Levitan at SG Cowen.

Good morning, Lauren.

Thanks.

Good morning.

A couple questions for you.

I was hoping you could elaborate on that circulation plan, Sharon, and the implications between your expectations for core growth and circulation versus in the emerging brand.

And then related to that, I was wondering if you could give us some sense as to the longer-term square footage potential, or store-based potential by brand.

Certainly, with we've seen it come down a little -- your square footage growth in Pottery Barn Kids come down slightly, and just curious if within those core brands, if you have some longer-term targets for what you think the store base might look like?

Thank you.

Okay.

Pat, I'm going to let you take the question regarding circulation for next year.

And then, Lauren, I will take the question on the square footage.

So, Pat, go ahead.

Okay.

Great.

Lauren, on circulation we're looking at about a 5 to 7 percent range in circulation growth overall.

That will -- that will, obviously, vary by brand, West Elm and Williams-Sonoma Home will have -- and PBteen will have the largest percentage increases.

We continue to see opportunities to increase page count in our biggest brands and to our best customers.

And so we've started to give some guidance on page count increases because of that.

In Williams-Sonoma, as Howard talked about the performance of the catalogue, we actually were able to reduce page count about 10 to 12 percent and retain productivity.

So we had about a 10 to 12 percent improvement in productivity for book -- per book.

So even though we're reducing page count in that catalogue, we're still retaining the productivity per book in Williams-Sonoma.

And that's affecting the page count increase a little bit.

But just to elaborate on that, Lauren, when you look at the guidance that we gave on page count circulation increases, they were in the range of 11 point -- 11 to 13 percent this year.

And as it relates to the emerging brand circulation growth, we're expecting emerging brands growth to grow at the same rate year-over-year that it grew in 2004.

As we think about lease square footage and the potential of the core brands, we have consistently said that we believe that in the Williams-Sonoma brand that we can have between 275 to 300 stores.

And in Pottery Barn in the range of 225 stores.

And in the range of Pottery Barn Kids, we have said 100 -- approximately 100 to possibly 125 stores over time.

So our expectations of lease square footage growth have not changed as it relates to the core brands.

We are still sizing the emerging brands, and we will give numbers on those going forward.

So we -- we're not prepared at this point in the young stages of their retail growth to give those numbers today.

We'll now go to Dana Telsey at Bear Stearns.

Good morning, everybody.

Good morning, Dana.

Hi.

Good morning, Dana.

Can you talk a little bit about fashion versus core?

In each of the businesses, certainly at Williams-Sonoma table top going to cores, how you're mixing it in Pottery Barn fashion versus core?

Laura, you spoke about the new strategies for home needs of Pottery Barn.

Can you tell us a little bit more about that?

And then, Sharon, CapEx seems to be coming down a little bit, or maybe a little lower than originally expected.

Anything changing in terms of the spend on the infrastructure initiatives?

And how -- ?

Okay.

I'm going -- Dana, I'm going to let Howard speak to the Williams-Sonoma brand regarding fashion versus core, then Laura will talk about the fashion versus core and the strategy on the home needs.

And then I will discuss CapEx.

Thank you.

Okay.

Howard?

Dana, you know, in Williams-Sonoma, it's -- I think it's more about, I've always said it's all more about our merchandising than it is the merchandise, you know, because we're constantly creating ideas for the customer on how to cook or entertain or serve or what have you.

And so we make old things new again, you know, with those ideas.

Really, the place that we did have what I would characterize as some fashion goods was in 2 areas.

Seasonal, you know, around Easter or Christmas or Thanksgiving.

And, of course, we'll continue to do that.

We're not cutting back on that at all.

Our food content, which is maybe not as visible in the front of the stores, the seasonal food is there.

Our sales have not diminished there.

We're just showing it to the customer in a different way than we did before and giving more room to other things that are more on brand for us.

In the table top area, we are taking out some of the fashion dinnerware and glassware.

But we're replacing that with, I think, more relevant merchandise for our customer, which you can characterize as core, if you want to.

And it's probably more appropriate to think of it that way.

So finally, it's not -- it's not a huge fashion business for us.

It never has been.

I think we've overdone some of these fashion kinds of categories in the past, and we've just eliminated those.

Hi.

And in Pottery Barn, we believe that our stores and catalogues look the best when our fashion assortments really augment the core and reflect the way our customers are really living.

So in our core, for example, in Pottery Barn, you know, we're very focused on being in stock.

We're focused on driving quality statements in our key dominant categories.

And a good example in table top for Pottery Barn is our white dinnerware, our Great White Dinnerware, which we have continued to expand into new shapes.

We layer on fashion, because we believe that our customers, a lot of them, whether they buy our Great White, or they own Great White, everyone owns white dinnerware.

So our fashion layer -- and when we're the best, really makes that white dinnerware sparkle.

So for example, it would be the linens, the place card holder that you put on the table, the napkin rings, the centerpiece.

And those are the items that we believe our customer does change seasonally.

So it's really very much in meeting their needs and being realistic about how they live.

In kids, it's the same strategy, different business though, of course.

A good example of where we made significant improvement is our core bedding wall in our stores, which is in our design studio in the middle of the stores.

And you can see that we've really improved our mix-and-match strategy there, in that we offer the customer a lot of key basics, expanded gingham colors, solids, and then also some small prints that work very well with all of our fashion statements, you know, whether it be, you know, a sweet floral or a tie-dye or a surf theme, if you go through the store and you carry around the core, you can see that it intermixes very well with the rest of the bedding.

And, again, that's the way people decorate.

They own sheets in their closet that they pull out and use over and over.

But they want something to refresh the bed for their childrens' rooms.

And that is the way we approach both core and fashion in our stores.

And we believe we have continued opportunity to refine that and make it more inspiring for our customers.

And, Dana, as it relates to the capital spending guidance, there's a couple changes in that going it into '05.

First, our lease square footage growth this year was over 11 percent, and we're currently projecting 8 to 9 percent.

So we have less capital spending in store construction.

Secondly, this year we increased our distribution square footage by over 25 percent.

And the capital investment that goes along with doing that, of course, will be significantly lower in 2005.

And then, in addition, on systems, we've made some significant investments, as you know, in systems.

And as we get closer to the roll-outs of those systems, the investments are coming down.

So those are the 3 key areas that are driving the differences in the capital spending.

We'll now go to Michael Novak at Frontier Capital.

Hi.

I heard you mention something about in-sourcing of furniture hub.

Can we get some clarity on what that is?

Is it cost-cutting move or is it strategic?

And then, maybe, if you could talk about the opportunity, longer term, for a single delivery of multiple pieces of furniture?

Yes.

Mike, as it relates to the in-sourcing of our furniture hub, we believe that we have an opportunity to take our service in furniture delivery to a new level by managing the contact with the customer up until the point that the truck actually arrives at the customer's home.

So in other words, we will manage all customer contact up until the point that it actually gets delivered.

We will not, obviously, be delivering furniture.

And we are doing this with 1 of our largest East Coast hubs.

This is where we're testing it, which is in Keesbee (ph) on the East Coast.

And we think it's a big opportunity.

We'll evaluate, going forward, the cost.

We are putting the associates necessary to run it, the infrastructure, obviously, on our payroll.

But, historically, we've been paying someone else to do that.

So we are hoping that long term, that it could result in cost reduction.

But more importantly, what we're very focused on as we continue to expand the furniture businesses is that service level with the customer.

So that's where we are.

Your next question is, are we going to be able to get to the point, and I know why you're asking this.

Thank you for your order, Mike.

The consolidation of the items that a customer orders when they get their delivery, and we are continuing to work on that.

Where we are challenged with that is that some of the furniture items that we are currently selling are carried in our distribution centers.

And some of them, to reduce the handling on those items, we actually have them shipped directly from the vendor to the customer.

And those orders are going to be extremely difficult to consolidate because you would not have the volume in which to do it, and you would end up incurring a lot of costs to do so.

So we're continuing to re-engineer that.

I do not believe that you will see that in 2005 or 2006.

But as we go forward, we will definitely work on doing that.

We'll now go to Peter Benedict at CIBC World Markets.

Good morning, Peter.

Oh, hi, Sharon, how are you?

Quick -- quick question here.

Could you give some color upon the back order position right now, you know, when you expect to get it back to where you want it?

And related to that, have you seen any change in the order cancellation trends that, maybe, you were seeing late last year?

And then, lastly, how have the return rates looked recently versus planned, and where do you think you can bring that as we look towards 2005?

Thanks.

Since a significant piece of our back orders are in Pottery Barn, I'm going to let Laura address her current back order situation.

And then what I'd like to do is let Ed discuss returns, replacements, and damages.

Because this is a big initiative for us next year, which he is leading.

And so we'll let Ed just take that question.

Laura, could you quickly talk about your back order position?

Sure.

We have significantly reduced our back orders in Pottery Barn.

At the end of this quarter, we should be in -- we should be, what I consider, in good shape.

In Kids, we still have a little bit more work to do.

But, again, we're recovering.

And there's always going to be a few run aways.

But the overall level of our customer service has dramatically improved from where it was.

And we continue to work on making it even better.

Peter, this is Ed.

On the returns, replacement damages, you know, over the last several years, we've been working on this.

But now with taking over, as Sharon described, the Keesbee hub and visibility in our -- in our -- with our new system, we're going -- we're going to continue to improve.

I think over time, we've improved.

We're lumping them all together.

And we will really put a bullseye on what the customer's telling us, why it gets returned, replacements and damages.

And we are now, with our furniture improved quality last several years, we are really zeroing in on our Asian manufacturers, particularly.

And I think we'll have more to give you as time rolls on.

But I'm really comfortable that we're getting the right analysis, and we will do the right things this year to improve it.

And we have time for 1 more question.

That'll go to David Magee at SunTrust Robinson Humphrey.

Good morning.

Good morning, David.

Good quarter.

Good morning, David.

A couple of questions. 1, I was happy to see the comp got into 3 to 5.

And that seems to be strong, given the environments and everything else.

Can you give a little color as to, maybe, which of the concepts you expect to be at the higher end of that range, or providing the better part of the growth here, particularly in the first part of the year?

Dave, we don't give, as you know, comp guidance by brand.

But what I think I can say with confidence is that we are expecting to see strong performance in all of the brands.

Our in-stock positions are very good, as Howard described.

We're seeing momentum in the Williams-Sonoma brand.

Pottery Barn has the toughest comparison.

But they've got great strategies for the first half of the year and are aggressively looking at those issues.

So in Pottery Barn Kids, we've made great strides.

You saw the Q4 number.

So we're coming in with momentum.

So we feel that we're going to see it across the brands.

And that is all the time that we have for questions today.

I'd like to turn the call back to Mr. Mueller for closing comments.

Well, we'd really like to thank you for joining us today on the fourth-quarter earnings release and our 2005 guidance.

We've enjoyed sharing our results and vision with you this morning.

We're proud of our performance for 2004.

And we're very excited about the opportunities for 2005 and beyond.

And we really believe that we're well-positioned to execute against our guidance for 2005 and continue our track record of meeting our shareholder expectations.

With that, we'll conclude the call.

Thank you.

That does conclude our call.

We do thank you for your participation.

At this time, you may disconnect.

Thank you.