Williams-Sonoma Inc (WSM) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you again for standing by and welcome to the Williams-Sonoma Inc. first-quarter 2006 earnings release conference call.

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

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

And as a reminder, this conference is being recorded.

I would now like to turn the call over to Steve Nelson, Director of Investor Relations at Williams-Sonoma Inc., to discuss non-GAAP measures and the first-quarter 2006 press release and forward-looking statements.

Please go ahead, Mr. Nelson.

Good morning.

This morning's conference call should be considered in conjunction with the press release we issued earlier today.

I would first like to discuss the non-GAAP financial measures that are included in this morning's press release and in today's conference call.

In our press release this morning, we announced operating results for the first quarter of 2006 that included and excluded the diluted earnings per share impact of FAS 123R, Accounting for Share-Based Payments;

FSP FAS 13-1, Accounting for Rental Costs Incurred during a Construction Period; and the accounting charge associated with the holdeverything consolidation.

These charges totaled $0.06 per diluted share and were quantified and reconciled in today's press release to facilitate a meaningful comparison to our 2005 results.

In 2005, due to prospective implementation, there was no impact of FAS 123R or FSP FAS 13-1 and only a fourth-quarter charge of $0.07 per diluted share for the holdeverything consolidation.

For the remainder of today's call, we will be discussing our first-quarter 2006 results and our 2006 second-quarter and fiscal year financial guidance, excluding the impact of these charges, and will refer to these results as non-GAAP.

As excluding these charges creates non-GAAP financial measures as defined in Regulation G, a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful and how they are used by management are discussed in the press release issued this morning and furnished to the SEC on Form 8-K.

I would now like to discuss our forward-looking statements.

The forward-looking statements included in this morning's call 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 initiatives, guidance, growth plans and prospects of the Company in 2006 and beyond and are subject to certain risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the Company's current press releases and SEC filings, including Reports on Forms 10-K and 8-K, for more information on the risks and uncertainties that could cause actual results to differ materially from these forward-looking statements.

All forward-looking statements are based on information available to us as of the date of this call.

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

I will now turn the conference call over to Ed Miller, 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.

We are extremely pleased to deliver to our shareholders another consecutive quarter of strong financial results.

In the first quarter of 2006, on revenue growth of 10.2%, non-GAAP diluted earnings per share increased a better-than-expected 18.2% to $0.26 per share.

We are very proud of this performance and believe it reflects the competitive advantage that we have created with our multibrand, multichannel strategy and our Company-wide operational and financial disciplines.

In our core brands, net revenues in the first quarter of 2006 increased 7.9%.

Laura and Howard will discuss the performance of each of these brands later in this morning's call.

In our emerging brands, including west elm, Williams-Sonoma Home and PBteen, first-quarter net revenues increased 37.8%.

In the west elm brand, we continue to see strong year-over-year revenue growth, primarily driven by incremental sales from new stores, improved catalog response, and increased traffic in e-commerce, and ongoing improvements in our retail execution.

From a merchandising perspective during the first quarter, we saw continued strength in furniture and textiles, in addition to decorative accessories and lighting.

We are very pleased with the merchandising and operational progress that we are making in this brand as we accelerate the rollout.

In the Williams-Sonoma Home brand, growth in the first quarter was driven by incremental revenues from new stores.

During the quarter, we opened two new stores, one in Portland and one in Palo Alto, bringing our store count to five.

In the direct-to-customer channel, consumer demand was slightly below our expectations, partially driven by higher-than-expected backorders and cannibalization in our retail markets.

As we expand our retail presence, we clearly see an opportunity to capitalize on our multichannel capabilities, as many of our retail customers are also direct-to-customer shoppers.

Laura will discuss the performance of PBteen later in this morning's call.

On the consolidation of the holdeverything brand, we are making great progress.

During the first quarter, all of our retail stores were closed and the final holdeverything catalog was mailed on May 16.

The e-commerce website and our outlet stores will be used for the final clearance of inventory.

We are extremely pleased with the execution of this transition both operationally and financially, and expect to see a gradual expansion of the storage and organizational categories within our other brands beginning in the fall of 2006 and continuing throughout 2007.

From an operational perspective in the first quarter, we continued to make significant progress on our 2006 supply chain initiatives, including the refinement of our daily store replenishment program and the insourcing of our East Coast furniture hub operations.

We also began implementing several new warehouse management initiatives to address opportunities that we identified as part of our returns, replacements and damages improvement program.

As we look forward to the second quarter and the balance of the year, we are continuing to focus on the strategic initiatives that are fueling our success, driving profitable top-line revenue growth, increasing pretax operating margin and enhancing shareholder value.

Consistent with our strategic effort to drive profitable top-line revenue growth, we are continuing to invest in the growth opportunities we believe will provide the greatest returns in both our core and emerging brands.

In our core brands, between now and the end of the year, we are increasing retail leased square footage by opening 12 net new stores and expanding an additional 21 stores, increasing catalog circulation and electronic direct marketing, continuing to roll out visual merchandising upgrades in our small and midsize stores in the Williams-Sonoma brand, continuing to test new merchandising categories in the Pottery Barn Kids brand to generate repeat customer traffic, and implementing new gift card initiatives that we believe will drive increased sales and new customers to the brands.

In our emerging brands, we are focusing on initiatives that will expand the multichannel reach of the brands and build our customer databases.

In west elm, we are opening eight new stores through the balance of the year and will continue to increase our name capture, catalog circulation, electronic direct marketing and online customer acquisition efforts.

Capturing mind share is a key driver of the long-term marketing strategy for this brand.

We will also continue to broaden the appeal of the brand by expanding both the retail and direct-to-customer merchandise assortments and introducing new fabrics and finishes.

Although it is too early to predict the ultimate size of west elm, we believe that consumer response to date indicates that west elm could be one of our largest brands if we can successfully roll out our retail strategy, expand our customer database, evolve the merchandising strategy and broaden the consumer appeal.

In Williams-Sonoma Home, we are opening two new stores, one in Philadelphia and one in Coral Gables.

We continue to believe that expanding the retail presence of this brand is essential to our long-term growth strategy due to the customers' desire to see the product and fully experience the brand's design authority.

In the direct-to-customer channel, we will be launching an e-commerce website in the third quarter, which will allow our customers to see the full range of possibilities of our assortment.

We will also be focusing on improving our catalog merchandising and presentation to make it easier for customers to visualize how our assortment can be integrated in their homes.

In PBteen, we are increasing catalog circulation and page counts and expanding our online marketing initiatives.

Consistent with our second strategic initiative to improve profitability in our core businesses, we are projecting an increase in our non-GAAP 2006 pretax operating margin of 30 to 50 basis points.

Operationally, key initiatives for the remainder of the year include continuing to implement operational disciplines throughout the supply chain to reduce returns, replacements and damages, including a specific focus on product development, sourcing and supply chain customization for the west elm and Williams-Sonoma Home brands; continuing to test an extension of our daily store replenishment program in the New York metro area, where both customer delivery and store replenishment operations can be efficiently combined; expanding the insourcing of our East Coast furniture hub to further define the gold standard in customer service and improve the overall operational efficiency of the furniture delivery process.

In the first quarter of 2006, total furniture sales on a trailing 12-month basis increased to approximately 29% of net sales versus 27% in the first quarter of fiscal year 2005.

Consistent with our strategic initiative to enhance shareholder value, we remain committed to delivering on the commitments we have made to our shareholders, including delivering on the 2006 guidance we have provided today.

As we look forward to the second quarter and the balance of the year, we are doing so with a more cautious outlook than we had at that time of our last call due to the volatility in consumer demand that we began to see in mid-April.

We believe, however, that the strength of our brands and our operational flexibility leave us well-positioned to deliver against the commitments we have set for ourselves, despite a potentially softer macroeconomic environment.

Therefore, the only adjustments we are making to our 2006 non-GAAP diluted earnings per share guidance is in the second quarter, where we are reflecting a $0.02 per diluted share shift in earnings as a result of better-than-expected revenue recognition in the first quarter.

As this is only a shift in the quarterly recognition of earnings, we are pleased today to be able to reaffirm our full year non-GAAP diluted earnings per share guidance in the range of $2.15 to $2.19 per share.

This represents a 14.4% to 16.5% increase in non-GAAP diluted earnings per share on revenue growth of 9.4% to 11%.

I would now like to turn the call over to Sharon McCollam for more details on our first-quarter 2006 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 review our first-quarter 2006 financial results and our second-quarter and fiscal year 2006 earnings guidance.

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

Then Laura will provide you with an update on the Pottery Barn brand, and finally, we will open the call for questions.

I would now like to talk about our first-quarter 2006 earnings results.

As a reminder, in order to facilitate meaningful comparisons of our first-quarter and fiscal year 2005 results, all first-quarter and fiscal year 2006 financial references in my prepared remarks today will exclude the $0.06 per diluted share impact of FAS 123R, FSP FAS 13-1 and the holdeverything charge and will be identified as non-GAAP measures.

Year-over-year GAAP comparisons including these impacts were provided in this morning's press release.

In the first quarter of 2006, non-GAAP diluted earnings per share increased 18.2% to $0.26 versus $0.22 in the first quarter of 2005.

A positive consumer response to our key merchandising strategies combined with the benefits from a lower tax rate and higher interest income allowed us to deliver another quarter of better-than-expected financial performance.

And for the 23rd consecutive quarter, we met or exceeded the earnings per share guidance we provided to our shareholders.

Let's look at what drove these strong results in the first quarter.

Net revenues in the first quarter of 2006 increased 10.2% to 794 million.

Retail net revenues in the first quarter of 2006 increased 9.2% to 434 million.

This increase is primarily driven by an 8.7% increase in retail leased square footage and a comparable store sales increase of 1.3%.

Direct-to-customer net revenues in the first quarter of 2006 increased 11.4% to 360 million, with catalog circulation increasing approximately 2.2%, while page circulation increased 7.5%.

This circulation compares to catalog and page count circulation increases of 7.7% and 18%, respectively, in the first quarter of 2005.

Internet revenues during the first quarter of 2006 increased 31% to 201 million, contributing approximately 55% of our total direct-to-customer revenues.

Non-GAAP gross margin expressed as a percentage of net revenues in the first quarter of 2006 was 38.7% versus 39.5% in the first quarter of 2005.

This 80 basis point decrease was primarily driven by 2005 infrastructure investments that were not fully implemented until the second half of 2005, the negative impact of increased markdowns in the holdeverything brand, and higher energy costs.

Non-GAAP SG&A expenses were 261 million or 32.9% of net revenues in the first quarter of 2006 versus 241 million or 33.5% of net revenues in the first quarter of 2005.

This 60 basis point decrease was primarily driven by decreases in advertising and employee-related costs as a percentage of net revenues.

Interest income net of interest expense totaled 2.8 million, an increase of 2.2 million versus the first quarter of 2005, reflecting higher average cash balances and higher interest rates.

Our income tax rate in the first quarter of 2006 was 38.4% versus 41% in the first quarter of 2005.

This decrease was primarily due to the 2005 income tax rate being negatively impacted by an increase in tax audit reserves that did not recur in 2006.

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

All comparisons are versus quarter-end balances at the end of the first quarter of 2005, which are included in this morning's press release financial statements.

Cash and cash equivalents at the end of the first quarter of 2006 were $251 million.

This is the highest first-quarter balance in the history of the Company by $135 million, despite investing over 82 million in share repurchases over the last 12 month.

Our consolidated statements of cash flows are included in this morning's press release.

Merchandise inventories at the end of the first quarter of 2006 increased 4.9% to 548 million.

This below-sales-growth increase was primarily due to substantially reduced inventory levels in the holdeverything brand and the timing of receipts.

Prepaid catalog expenses at the end of the first quarter of 2006 increased 20% to $63 million.

This increase was primarily driven by higher page counts on catalogs circulated, increased paper inventory, higher postage and paper prices, and the timing of production and mailings of catalogs during the quarter.

Prepaid expenses at the end of the first quarter of 2006 were 32 million, down $7 million.

This decrease was primarily driven by reductions in prepaid information technology service and maintenance agreements.

Accounts payable at the end of the first quarter of 2006 increased 12.2% to 185 million.

This increase was primarily driven by our first-quarter declaration of a $0.10 per share or approximately $12 million dividend, which was not payable until the second quarter.

Customer deposits at the end of the first quarter of 2006 increased 25 million to 179 million.

This increase was primarily driven by a sales growth-related increase in unredeemed gift cards.

I would now like to briefly discuss our second-quarter and fiscal year 2006 earnings per share guidance.

As we look forward to the second quarter and the back half of the year, recognizing that approximately 80% of our full-year revenues and 88% of our full-year earnings will be generated in that timeframe, we are remaining cautious in our outlook, which we believe is prudent based on the volatility that we are currently seeing in consumer demand.

We are also mindful that during this time, we will be investing heavily in the growth of our emerging brands, which inherently creates a higher level of uncertainty in our forecast.

Despite our more cautious outlook, however, we are pleased today to be affirming our full-year non-GAAP diluted earnings per share guidance in the range of $2.15 to $2.19 per share.

This represents a year-over-year non-GAAP diluted earnings per share increase of 14.4% to 16.5% on a comparable basis to 2005.

We believe this guidance is appropriately conservative based on the current trends we are seeing and are confident in our ability to deliver against it, based on the ongoing strength of our brands, our proven track record in operational execution, and the consistency in which we have been able to deliver on our commitments.

We are, however, adjusting downward our second-quarter guidance range by approximately $8 million in revenue and $0.02 in diluted earnings per share to reflect the financial benefit that we saw in the first quarter from the better-than-expected timing of delivered orders and the earlier-than-expected sell-through of our remaining holdeverything inventory.

Our previous guidance assumed that these revenues and earnings would not be recognized until the second quarter.

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

Thank you, Sharon, and good morning, everyone.

We are pleased with the performance of the Williams-Sonoma brand in the first quarter.

Net revenues increased 5% and we saw continued improvement in the year-over-year gross margin due to successfully implementing several new merchandising and inventory management initiatives.

While the consumer response to our Easter assortment was very strong, we did see an overall softening of consumer demand in both the retail and direct-to-customer channels beginning in mid-April.

During the quarter, we continued to focus on retail execution by increasing the frequency of our in-store events, expanding our culinary expert program, enhancing the visual impact of our store features and continuing to roll out product information to our store associates.

In the retail channel, we delivered a 1.8% comparable store sales increased for the quarter.

Although this increase was slightly below our expectations, better-than-expected results in our new and expanded stores more than offset the lower comparable store sales performance.

In the direct-to-customer channel, successful online marketing initiatives drove impressive growth in e-commerce.

Traffic to the website increased 23% and we continued to see strong conversion rates as well as a higher average order size.

From a merchandising perspective during the first quarter, we saw particular strength in our high-end assortment, including cookware, electrics and cutlery.

This strength, however, was partially offset by the tabletop category, which, as we discussed in our last call, will not have a full assortment until the fall of '06.

As we look forward to the second quarter, we are pleased with our Mother's Day results and continue to be excited about our 2006 initiatives, especially our focus on bringing new cooking and entertaining ideas to our customers.

We are seeing great success with this initiative and believe it is a significant growth opportunity for the brand long term.

In the retail channel, we will continue to roll out the visual merchandising upgrades in our small and midsize stores.

An edited assortment combined with refixturing and increased signage will provide enhanced visibility to the products that we sell.

We will also be focusing on the execution of our year-round entertaining and gift-giving strategies, which are a significant opportunity in the second quarter due to Mother's Day, Memorial Day, Father's Day and the Fourth of July all occurring within the quarter.

In the direct-to-customer channel, we will continue to capitalize on the success of our burgeoning catalogs and will optimize the coordination of our catalog mailings with our summer holiday and our in-store events.

We will also continue to drive growth in the e-commerce channel by increasing electronic direct marketing and expanding our paid search initiatives.

I'd like to now turn the call over to Laura Alber to discuss the Pottery Barn brand.

Thank you, Howard.

Good morning.

First, I'll start with Pottery Barn.

We are pleased with the performance of the Pottery Barn brand in the first quarter as net revenues increased 6.9% on top of a 9.6% increase in the first quarter of last year.

A positive consumer response to both core and seasonal merchandise, particularly in furniture and decorative accessories, and a strong in-stock position drove this year-over-year increase across both channels.

Like Williams-Sonoma, however, Pottery Barn did see a softening in consumer demand beginning in mid-April.

In the retail channel, comparable store sales for the first quarter increased 1.1% on top of a 6.1% increase in the first quarter of 2005.

Although this increase was lower than expected due to the April softness, we did see a consistently positive consumer response to our overall merchandise assortment throughout the quarter.

In the direct-to-customer channel, successful catalog and Internet-only merchandising initiatives combined with strong momentum in e-commerce drove strong growth during the quarter.

We remain extremely pleased with the success of our two major marketing themes, including Big Ideas for Small Spaces and Summer Living Inside and Out.

During the quarter, traffic on our website increased 14% and we significantly expanded our online merchandising and electronic direct marketing efforts.

We also saw strong results from our online paid search initiative and we continue to believe that online marketing is a significant growth opportunity and a source of new customers for the brand long term.

As we look forward to the second quarter and balance of the year, we are encouraged by the initial response to our summer themes and outdoor merchandising strategy, including the recently launched outdoor test catalog.

Although it is still early, the consumer demand is trending positively to last year in both the retail and direct-to-consumer channels.

We are also extremely focused on the growth and operational initiatives that we believe are significant opportunities for the business as we progress throughout the year, marketing our design authority, upgraded furniture quality and time to delivery as key competitive advantages; strategically using online paid search to drive traffic to all channels; and maintaining our in-stock position to enhance customer service and minimize lost sales.

We are excited about all these initiatives and are confident in our ability to execute against them throughout 2006.

I would now like to talk about Pottery Barn Kids.

Having just surpassed the revenue milestone of over $0.5 billion in 2005, we could not be more pleased with the impressive growth that we saw in the Pottery Barn Kids brand in the first quarter of 2006.

First-quarter net revenues increased 14.7%, topping a 14.1% increase in the first quarter of 2005.

Positive growth across all major merchandising categories with particular strength in decorative accessories, furniture and textiles drove this better-than-expected year-over-year increase.

In the retail channel, comparable store sales for the first quarter increased 3.3% on top of a 10% comparable store sales increase in the first quarter of 2005.

Performance of new stores was also very strong, and during the quarter, we continued to build on the success of our in-store family event, baby and gift registry, and seasonally themed home centered floor sets.

The direct-to-customer channel also delivered strong growth during the quarter, driven by successful catalog and Internet-only merchandising strategies, including personalization and the ongoing success of e-commerce.

Increased electronic direct marketing and strong results from online paid search drove a better-than-expected e-commerce performance.

Traffic on our website increased over 29%, and we continued to see conversion rates that exceed industry norms.

As we look forward to the second quarter and the balance of the year, we are encouraged by the ongoing momentum in both the retail and direct-to-customer channels and by the early consumer response to both our core and summer merchandising strategies.

As we progress through the year, we will continue to focus on the following growth initiatives -- improving our in-stock position on textiles and furniture to reduce lost sales and re-establish service levels expected by our customers; expanding our nursery assortment in all three channels, including infant apparel and Series One for Nursery, to broaden our registry assortment and complete the customer experience; differentiating our gift assortment in all three channels to establish top-of-mind awareness of Pottery Barn Kids as the destination for gift-giving; and capitalizing on personalization trends through the expansion of our DTC assortment.

We believe that the successful execution of all 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 PBteen.

We are very pleased with the strong performance of PBteen during the first quarter.

Despite a slight year-over-year reduction in catalog circulation, the performance of the brand once again exceeded our expectations and delivered an impressive 15.1% year-over-year revenue increase.

What was particularly encouraging is that these better-than-expected results were driven by new product offerings and presentations, both of which were key initiatives for the brand as we entered the year.

From a merchandising perspective, we saw strong performance in all furniture categories.

A consistently on-brand presentation, in addition to increased newness, drove these better-than-expected results and indicate that we have attracted our core customer back to the brand.

As we look forward to the second quarter and the balance of the year, we are encouraged by the initial consumer response to our summer merchandise assortment and are confident that our focus on interpreting the Pottery Barn aesthetic with a teen point of view, which we identified as a significant opportunity in 2005, will draw many new customers to the brand.

During the remainder of the year, we will be substantially increasing year-over-year catalog circulation in Pottery Barn Teen, including page counts and significantly expanding our electronic direct marketing initiatives.

We continue to believe that electronic direct marketing represents a significant opportunity for this brand long term, as nearly 60% of its revenues are being generated in the e-commerce channel.

I would now like to open the call for questions.

(OPERATOR INSTRUCTIONS).

Mark Rowen, Prudential.

The slowness that you saw in late April -- I was wondering if you could tell us if furniture was more heavily impacted than your whole store in that -- were people pulling back particularly on big-ticket items?

And how is that trending into May?

I am going to let Laura speak to the furniture question and then we'll speak to the overall.

Laura, would you like to take that question?

Sure.

There have been a few shifts in the calendar, the retail calendar this year, that have impacted our ability to really assess our business in April.

And now that we are out of that, I'm very happy to report that our furniture business is strong, particularly in the areas of media, which is a very high-growth category for the Pottery Barn brand, and in the outdoor furniture category.

In Pottery Barn Kids, we continue to see very strong growth in our furniture collection in the bedroom, and we have expanded those collections to include desks that match the beds and bookcases, and that is working.

And in Teen, as I said in my prepared remarks, the furniture business continues to be a larger percent of total business and is driving year-over-year revenue increase in that brand as well.

Mark, just at a macro level and from a total Company point of view, we are continuing to see great performance or strong performance virtually across all of our merchandising categories.

We're just seeing a softness in demand, but it is across all categories.

So it is fairly equal and furniture isn't outsized as far as the softness in demand?

I actually would tell you that in some areas, it's actually greater in furniture and softer in some other areas.

And some other retailers have reported that after a weaker back half of April that things improved a little in May.

Are you seeing similar trends?

We are seeing similar trends.

We have been cautious in our outlook, but we are seeing similar trends, and it is volatile.

Colin McGranahan, Bernstein.

Can you comment a little bit more about the drivers of SG&A -- much better, obviously, than your original plan -- and just expand on the employee cost leverage and the advertising leverage and anything else.

Absolutely.

We saw a 60 basis point decrease in our SG&A, which was predominantly driven by advertising and employment costs as a percent of sales.

So the advertising rate decrease was driven by a year-over-year reduction in catalog advertising costs in the holdeverything brand and additionally, Colin, a greater percentage of our revenue is being generated in the e-commerce channel, which incurs advertising at a lower rate than the Company average.

So that was the big driver in the advertising category.

From an employment point of view, we saw favorable employment across the Company, including in our call centers, where when e-commerce shifts, you have lower -- a fewer number of people taking calls in the call center, and that benefits us on top of our normal cost containment initiatives throughout the Company.

So we were very pleased across the board with our employment results.

How does that advertising leverage -- how will that be affected by the rise in paper prices and potentially an increase in postage rates going forward?

We obviously planned for an increase in paper and in postage.

So you have to be more productive in the books and have offsets to those costs.

So those absolutely affect you because you're leveraging or trying to leverage a larger cost.

And those increases that you're seeing, especially in paper, are generally in line with what your forecast was?

Yes.

Armando Lopez, Morgan Stanley.

I guess just a quick question on the advertising costs again.

If you are looking at the guidance, it looks like the guidance for catalogs and page count has come in somewhat on a year-over-year growth basis.

I was wondering if you could just talk a little bit about what's driving that?

And is that across all brands?

Armando, could you please repeat -- I don't think I understand your question.

Could you repeat your question?

Yes, sure.

It looked like in the guidance that was provided on catalogs and page count, it looks like the year-over-year growth is a little bit lighter than the growth expectations that were provided in last quarter, the fourth quarter?

Yes, got it.

It's a slight decrease, about 0.5%.

And that's really a tweak.

And part of that is actually due to holdeverything.

We cut the circulation in holdeverything in the second quarter because our sell-through on the inventory was so much stronger in the first quarter, it was unnecessary for us to mail as many books in Q2 to liquidate the inventory.

So we saw a benefit from that.

And then we tweak our brands every quarter, but there's nothing significant to read into that tweak.

And then just one last -- in terms of capital spending, it looks like the CapEx guidance is a little bit higher than was expected.

What is driving that?

If you take a look at our store remodels into 2006, you will notice that we have eight additional expansions coming into the guidance -- if you see that in the store table in the press release.

So the majority of the capital that we increased was related to that.

In addition to that, we have some additional investments that we are making on the distribution side as a result of the success of the initiatives that Ed talked about on the insourcing of our furniture hub operations.

We are very encouraged by that and we are expecting to put some capital into that, in addition to some information technology investments that we are also making in order to improve productivity.

Adrianne Shapira, Goldman Sachs.

Sharon, could you just follow up on the expense line?

On the guidance, we are obviously hearing a little bit more moderation in terms of comp outlook, but keeping earnings guidance unchanged.

So it sounds like we should be expecting to see better leverage on a lower comp.

Could you just kind of give us some color on that and where you think the opportunity is?

Absolutely.

We are seeing, Adrianne, very good margins in our core businesses, which we are very encouraged by.

We also are seeing improvements in our operations -- many of these supply chain initiatives that we have implemented, we are very optimistic and have already seen results that are showing that we are going to see benefit from those over the balance of the year.

We continue to have extraordinary cost discipline throughout the organization.

So we are very confident in our guidance as it stands today.

We did tweak the second quarter just because of the shift in revenue recognition, but feel very -- and we tweaked that.

So basically, what we're doing is reiterating our guidance for the balance of the year with slightly lower revenue, but honestly, we feel extremely confident in our ability to deliver it.

So there's nothing doing -- we're only doing what we've always been doing.

And if you take a look at our history, you will see that we've consistently been able to deliver on the commitments we have made and have no reason to believe that we would not be able to do so.

What we are seeing right now is volatility.

And we don't want to make it bigger than it is.

We want to call it out.

But we don't want to make it bigger than it is at this point.

I appreciate that, Sharon.

Just following on the margin strength, could you maybe disaggregate -- obviously, we understand some pressure is hitting the gross margins, but perhaps discuss merchandise margins and the health of full-price selling in the quarter?

Are you talking about in the first quarter?

Yes, in the first quarter.

For the first quarter, absolutely.

When you think about the favorability that we saw in the first quarter, it was predominately driven by occupancy expenses.

But our guidance had already presumed a strong gross margin in our businesses.

The only pressure we saw in the first quarter on gross margin from a merchandise margin point of view in total was from the holdeverything brand.

Because those sales got accelerated into the first quarter, they were at obviously very low margins, especially when we liquidated the stores.

So that put pressure on the margin, but that was more than offset by improvements in the core brands.

So we did not see any impact on the merchandise margin in the first quarter.

And then given the fact that comps slowed down, inventory is in good shape?

You wouldn't expect some maybe accelerated markdowns heading into Q2 to clear some of the merchandise?

We don't.

I will let Laura speak to her inventories, and then I will let Howard speak to his.

Overall, as Sharon mentioned, our inventory is in very good shape in Pottery Barn.

Our seasonal merchandise has performed well, including outdoor.

And there are always going to be pockets of items where we take markdowns on slow movers, and we do that always at this time of year.

And there are pockets where we are still chasing inventory and where we know we have significant sales opportunities as we get back in stock.

And our second-quarter guidance reflects the markdown activities that we are planning.

And then Howard, can you address the Williams-Sonoma inventory?

Thanks, Sharon.

In Williams-Sonoma, we run really a quite substantial full-price business.

We are well into over 90% full-price sales in the summer brands.

So it's not a huge area for us anyway.

But I don't see any challenges for us in the second quarter.

Most of our product is core, and I don't think there will be any increase in markdowns that would be substantial at all.

And any markdowns we expected to take would be reflected in the guidance that we provided today.

David Strasser, Banc of America.

I wanted to talk a little bit more about the Williams-Sonoma Home on the direct side.

You mentioned cannibalization being a reason that I guess it was negative on the direct side.

Could you explore that a little bit more?

Because just thinking about it as going from two to four stores or adding just a couple of stores, it surprised me that it would have that big of an impact.

Dave, this is Pat Connolly.

We circulated substantial catalog quantities around the stores during the opening.

We did see a little more cannibalization during the opening than we had expected.

Over the longer term, we don't see it to be any different than our other brands.

What about outside of the areas around there -- what about just sort of outside of those markets?

Our performance was consistent with expectations, but slightly below -- but just very slightly below.

And as we said, we had some -- in the brand from the DTC point of view, we had backorders that we did not fill in the quarter that we expected to fill in the quarter, and that also impacted the direct-to-customer business during the quarter.

So should we see some of that starting to show up in second quarter incrementally?

We absolutely believe that we will be improving our fill rates.

I'm going to let Howard speak to that.

Well, not on the fill rates so much, but I'd just like to make a comment about the catalog.

It is work in progress.

If you look back at our history here, it takes a while to get our catalogs right and to really capture the consumer that we are trying to attract to the brand.

And we are learning.

And we are making progress, I think, all the while.

But we've got a long way to go.

And it will get better as we move forward.

We are conservative with our mailings today and feel the book has better response rates than it does today.

So we are very encouraged about the future of the book.

But we would be somewhat critical of some of the things that we're doing today.

[Chris Rapelgee], SunTrust Robinson Humphrey.

I am on the call for [David] this morning.

I just had one question about Pottery Barn Kids.

I was wondering if you could give some color on how the apparel that you have introduced there is doing?

You mentioned that one of your goals is to continue to expand that.

But just how are sales looking so far?

Thank you for the question.

We are very pleased with the performance of infant apparel.

And we believe it is strategic to the brand.

We have seen an increase -- a substantial increase in our gift registry sales.

We believe it is tied to offering a complete registry assortment to our customer.

And we believe that as the authority in the kids' business, both in home furnishings, but also in gift, it is a very significant opportunity for us and it furthers our initiative to maintain our dominance in the kids' category.

So very strong results.

You are going to see an increase in our page count substantially on infant apparel.

And we are going to continue to refine the assortment.

Although it performed well, I know that there's even more opportunity as we get better at it.

Joan Storms, Wedbush Morgan.

Sharon, I have a question with regards to some comments that were made about some improvements -- it looks like you're making some improvements in the returns, replacements and damages in particular at the west elm and Williams-Sonoma Home brand.

I was wondering if you could comment on that, and also on progress you anticipate to make for the rest of the year?

Absolutely.

The Williams-Sonoma Home and west elm brands operationally are not a cookie-cutter for the Pottery Barn brand.

In the west elm brand, we are selling ready-to-assemble furniture.

And in the case of Williams-Sonoma Home, we are selling the highest-end furniture we have, and we have a very discriminating customer.

And the sourcing for both of these brands is relatively young in the Company.

So as we mentioned last year, you will remember in our Q4 call, we talked about the fact that the returns in these brands were higher -- were running quite high compared to our other brands.

So we had put into place a significant number of initiatives in those brands, which we expect over time -- remember, sourcing is a long-term process.

What you have in inventory today, you are buying it six months to a year out.

So we are just continuing to make progress there and improve the processes around that.

We have learned a lot over the last 12 months in Williams-Sonoma Home.

And in west elm, several of the strategies Ed discussed are benefiting west elm in the retail side, including our New York store, which is doing substantial volume.

We have consolidated the in-home delivery for our customer with our daily store replenishment program.

And that has been very successful for us.

It is allowing them to have a warehousing-type back room, and we are very pleased with that and are looking to make changes similar to that in our other stores and expect to see a much more efficient retail execution as well.

So those are the things that we are working on.

And I expect the benefits from these to be gradual and incremental.

And then just quickly, I'm just curious on the comp at the outlets -- I don't recall ever seeing a negative comp and was wondering if you're having strong enough sell-through at the core brands, that maybe that was the reason.

That is absolutely the reason.

Jack Murphy, William Blair.

Sharon, I think in the past you have talked about the growth in the furniture as a percent of the mix being due in large part to the growth in emerging brands, or growth in brands that have furniture as opposed to the Williams-Sonoma brand not having furniture.

In this quarter within Pottery Barn and Pottery Barn Kids, did you see materially faster growth in furniture than the average in those brands?

When we look at our furniture sales and what we disclosed, Jack, is that in the quarter, 29% of our sales were driven by furniture.

That was versus 27% last year.

Pottery Barn had strong growth in furniture, Laura mentioned that.

But also, the growth of west elm and Williams-Sonoma Home are driving up our total Company percent.

So that is what is driving the furniture increase -- it is a combined growth in the core brands on top of incremental sales in the emerging brands.

Any sense of proportion on that?

Is it more the emerging brand growth or more in the core?

Well, in order for furniture to grow -- we have to keep in perspective the size of Pottery Barn versus the size of the emerging brands.

Mathematically, it would be impossible if Pottery Barn didn't have significant growth for us to move up 2 percentage points year over year just based on the emerging brands.

The second question, just related to emerging brands -- I know at the beginning of the year or in the fourth-quarter guidance, you'd indicated how much emerging brands should contribute to total revenue growth, 2006 total, with some changes in the revenue growth guidance.

Is there any change to that overall comment that you made in the fourth quarter?

No.

We still believe that the emerging brands will contribute a very similar level of the revenue growth during this year.

We've tweaked the revenue on all sides.

But basically, that's 180 to 210 basis points, including holdeverything, year over year, and then approximately 310 basis points if you take out holdeverything, does not change significantly.

We will update it if it changes materially.

Pauline Reader, Thomas Weisel.

Just a question on the insourcing of the furniture hub.

I think, Sharon, you had said that you were starting with the one in New Jersey and then you were going to roll it out to other hubs.

I was just wondering if you could give an update on if you've done that or if that is a plan for the future and what the results have been relative to your first test?

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

Ed, could you take that, please?

Sure.

On the East Coast, as you know, we are expanding -- we said this over the year -- we are expanding the insource to different ZIP codes and including more and pretty well-encompass the entire Northeast with particularly our big markets -- New Jersey, New York -- and reach up to Boston.

We will be expanding on the West Coast.

We have a distribution center in Ontario, California.

And so we will be reaching down and doing Southern California -- what makes sense.

But we are using our results in the first test up in the East Coast.

It is more than a test now because we see that it is really working.

But we will expand, and as we find those right areas to put a center in, we will keep doing that.

And so this is happening in the second half of the year, or kind of gradually throughout the year?

We will be doing the L.A. in the second half or first half of next year.

We are just taking this a step at a time.

We want to complete the East Coast first before we get that done.

Steve Soderberg, Wellington.

Just looking at the midpoint of your comp forecast for the rest of the year, obviously, the number for the first-quarter two-year run rate, 6.3, but as you look to the third and the fourth quarters, you are assuming quite an acceleration of 7.4, and then nearly 10 by the fourth quarter.

Can you maybe talk a little bit about why you'd be expecting an acceleration?

Steve, we are extremely confident in the merchandise assortment that we have coming forward for the second quarter.

We are very pleased with our response overall.

We're coming to fall and holiday and are very confident in our assortments.

What we are seeing right now is a softening -- we would call it volatility.

It is different than the way we forecasted it.

And we do not believe at this point that we are seeing what I would call a fundamental retail environment macro issue that we feel is sustaining.

It is clearly choppy, we could call it.

So as we look forward to the balance of the year, we have been slightly more conservative in our outlook, but extremely confident in our merchandising strategies.

And I will let Laura speak to Pottery Barn and Howard speak to Williams-Sonoma.

As Sharon said, for the balance of the year, I think we have one of our best assortments coming.

For fall, we have just completed the photography for our fall catalog.

And we have some strategies there, although confidentially, I will tell you that -- confidential to our competitors, that is, I will tell you that I think you are going to see some things happen in our fall catalogs that revolutionize what we have done in our direct business in Pottery Barn.

I'm very excited about that.

And the photography is just simply very beautiful.

And that is hard to measure and hard to quantify, but we know that that is a good thing.

For our retail strategies, last year during the gift-giving season in Pottery Barn, our comps weren't what we wanted them to be.

And we spent a lot of time working on that strategy.

And I believe we have a great holiday strategy.

We are building on the strengths of last year with our Thanksgiving decorating strategy, which you may recall -- our autumnal decorating was very well-received and was a blowout to our customers, and we have an opportunity to grow that business this year, as well as improve the timing of our Christmas flow and then offer our customer more gifts.

Similarly in kids', we've really taken a hard look at our gift-giving strategy there, and you are going to see us introduce new categories in the kids' business that, again, are substantial steps forward for the brand.

And again, I prefer not to really go into that in detail here.

But I will tell you that big introductions are coming in our kids' business for the fall season.

And in our teen business, we are going to continue to do what we have been saying we're going to do, and fall, holiday I think really completes the conversion out of the merchandise that we thought was too trendy last year into merchandise that really fits within the Pottery Barn family home.

So in total, as Sharon said, I am very confident about where we are going from a merchandising strategy.

And of course, our operations also augment these strategies and help us drive sales as we get better in-stock that helps our demand lines in the catalog and also helps us replenish our stores.

And all those things will help us drive sales.

So really, we are in good shape for the latter half of this year and very confident in Pottery Barn.

Steve, it is Howard.

With respect to the Williams-Sonoma brand, while I mentioned earlier the first quarter was less than we had expected, I think one of the issues that has already been commented on is that we've particularly had a difficult time I think forecasting the quarter and the shifts that we had in the various holidays.

It was an issue for us.

But when I think about the year, and we have spent a lot of time reviewing the balance of the year and how we feel about it and the forecast that we have within our division on retail comps, as an example, we have a lot of good things happening in the second half.

As I mentioned earlier, our [stonesdown] project that we started a year and a half ago -- we are going to touch 180 stores this year, is our plan, out of 250-odd.

So we are seeing improved comps from those stores when we do it.

The initiatives that we have been working on, we're rolling out, so they are starting to hit a lot more stores.

The culinary expert program is only in I think eight stores currently.

Our tabletop assortment hits the stores in the fall, this fall -- has not been there before -- it's only been about half of it there.

We just rolled out a new linen fixture in the stores -- I think it is in almost all the stores as of today.

We will have new tables in all the stores starting the first of September for our tabletop goods, which will improve the visual part and display in the back of the store.

Our cookware business, electrics business is accelerating, coffee business -- so we learned a lot last fall, I think, in the way that we are presenting goods on the floor for our gift business to drive that gift business.

So I am encouraged by that.

So we are forecasting, I think, fairly reasonable comparable store sales for the balance of the year.

I know that our team in the home division has some optimism that we will catch up from the first quarter and achieve our initial goal that we had for the year.

Time will tell, of course, whether we are able to do that.

Ladies and gentlemen, thank you very much for your participation in the question-and-answer session and in our conference call today.

We are out of time.

I would like now to turn things back over to Ed Mueller for closing remarks.

First, I would like to thank you for joining us for our first-quarter 2006 conference call.

As you can tell, we are extremely proud of the results that we reported today and are excited about the many opportunities that lie ahead for the Company for the remainder of 2006 and beyond.

I appreciate your time and look forward to speaking with you next quarter.

Have a great day.

Again, thank you all very much for joining us.

That will conclude the conference call.

Have a good day.