Williams-Sonoma Inc (WSM) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma Incorporated third 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.

As a reminder, this conference is being recorded.

I would now like to turn the call over to Stephen Nelson, Director of Investor Relations at Williams-Sonoma Incorporated.

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 nonGAAP financial measures that are included in this morning's press release and today's conference call.

In our press release, we announced operating results for the third quarter 2006, that included and excluded a $0.04 cent per diluted share net impact from new accounting pronouncements and unusual business events, in order to facilitate a meaningful comparison to our 2005 results.

Please see Exhibit 1 in the press release for a description of the effect of each of the new accounting pronouncements and unusual business events on our third quarter results.

For the remainder of today's call, we will be discussing our third quarter 2006 results, and our quarterly and fiscal year 2006 financial guidance excluding the impact of these items, and we will refer to these results as nonGAAP.

A reconciliation of these nonGAAP financial measures to the most directly comparable GAAP financial measures, and an explanation why these nonGAAP financial measures are useful, and how they are used by management, are discussed in Exhibit 1 of the press release.

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 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, 10-Q, and 8-K for more information on these risks and uncertainties.

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 Howard Lester, our Chairman and Chief Executive Officer.

Good morning and thank you for joining us.

With us today are Laura Alber, our President, Pat Connolly, our Chief Marketing Officer, Dave DeMattei, our Group Vice President for the Williams-Sonoma Home and West Elm brands, and Sharon McCollam, our Chief Operating and Chief Financial Officer.

While we are pleased to deliver our shareholders another quarter of solid earnings performance, our revenue growth was slightly below our expectations, due to further softening in the Pottery Barn brand, and increasing volatility in our other home furnishings brands.

In the third quarter in 2006 in revenue growth of 3%, nonGAAP diluted earnings per share deceased 6.5%, to $0.29 per share.

In our core brands, which includes Williams-Sonoma, Pottery Barn, and Pottery Barn Kids, net revenues in the third quarter increased 2.7%.

And in our emerging brand include West Elm, Williams-Sonoma Home, and PBteen, revenues increased 30.5%.

Although Laura and Dave will be discussing the performance of all of these brands later in this morning's call, from an overall perspective, our growth during the quarter was primarily driven by strong performance in the Williams-Sonoma, Pottery Barn Kids, and West Elm brands.

In our supply chain, the third quarter was an impressive quarter from both a financial and operational perspective.

In our newly in-sourced East coast furniture hub, our customer return rates were less than half of the return rates at our outsourced hubs.

And in our Memphis-based operations, we continue to make significant progress on our customer return inventory management initiatives.

As we look forward to the fourth quarter, we are focused on driving sales to both our channels, by continuing to execute against the initiatives that will drive increased traffic and consumer response.

The initiatives in the retail channel include, leveraging our strong in-stock position, maximizing conversion in our stores by maintaining a high level of customer service and visual merchandising, and opportunistically utilizing markdown strategies to drive increased traffic.

The growth initiatives in the direct-to-customer channel include, increasing catalog circulation by approximately 9% in fourth quarter, increasing electronic direct marketing and page search, and implementing gift card issuance and redemption in the Pottery Barn and Pottery Barn Kids brands.

We are also focused on executing against the following supply chain initiatives, generating further cost reduction and operational efficiencies in our daily store replenishment program, by combining store replenishment with local customer deliveries in the New York market, capitalizing on new technologies in our monogramming operations to reduce product damage, and improve labor productivity, and replicating the process improvements that we implemented in our in-source furniture hub to our 49 outsourced hubs.

This is an important initiative as furniture sales on a trailing 12-month basis, represent approximately 29% of total company sales.

And finally, we are focused on driving shareholder value by optimizing profitability, delivering on our financial commitments, and returning excess capital to our shareholders, through dividends and share repurchase.

Although we are confident in our ability to deliver against all these initiatives, we are continuing to see softness in our Pottery Barn brand, and increased volatility in the our other home furnishings brands.

Based on these trends, we are increasingly concerned about the home-related retail environment, as well as the competitive landscape, which is highly promotional.

Therefore we have reduced our fourth quarter guidance to reflect a significantly more cautious outlook.

In this guidance, we have lowered our revenue by $46 million, and our nonGAAP diluted share earnings per share by $0.16.

Including these revisions, we are projecting our fourth quarter net revenues in the range of 1.234 billion to 1.264 billion, and our nonGAAP diluted EPS in the range of $1.03 to $1.09.

I will now turn to call over to Sharon to further discuss our third quarter results and provide additional insight on our revised 2006 guidance.

Thank you Howard.

Good morning.

As a reminder, financial comparisons may be on a nonGAAP basis, as described earlier in the call by Steve.

In the third quarter of 2006, nonGAAP diluted earnings per share decreased 6.5% to $0.29, versus $0.31 in the third quarter of 2005.

Despite a softer than expected top line however, increased full price selling in the Williams-Sonoma brands, combined with successful expense control initiatives, allowed us to once again deliver the EPS guidance that we provided to our shareholders.

Net revenues in the third quarter of 2006 increased 3% to $853 million.

Excluding the negative impact of the shutdown of the Hold Everything brand, net revenues increased 5.2%, including a 7.1% increase retail channel, driven solely by increased retail lease square footage, and a 3% increase in the direct-to-customer channel, driven by an 18.5% increase in internet revenue.

Catalog circulation during the quarter, excluding Hold Everything decreased 1.9%, while page circulation increased 0.5%.

Gross margin as a percentage of net revenues on a nonGAAP basis decreased 110 basis points to 38.3% in the third quarter.

This decrease was primarily driven by the deleverage of fixed occupancy expenses in the retail channel, including the cost associated with the retail roll-out of our emerging brands, and a greater percentage of total company revenues being generated in the retail channel, which carries a substantially higher occupation cost than the direct-to-customer channel.

Selling general and administrative expenses as a percentage of net revenues on a nonGAAP basis increased 20 basis points to 32.4% in the third quarter, primarily driven by higher employment costs, partially offset by reductions in advertising and other general expenses.

Income tax expense as a percentage of pretax earnings in the third quarter decreased 340 basis points to 34.7%, due to certain income tax benefits under audit being favorably resolved during the quarter.

I would now to discuss significant third quarter 2006 year-over-year balance sheet variances.

All comparisons are versus quarter end balances at the end of the third quarter of 2005, which are included in today's press release.

Cash at the end of third quarter was $109 million, this is the highest third quarter balance in the history of the Company, despite returning more than $141 million to our shareholders through share repurchases and dividends over the past 12 months.

Merchandise inventories at the end of the third quarter increased 12.6% to $661 million.

This increase on a dollar basis was 1.7% above the high end of our previous guidance, primarily due to earlier than anticipated inventory receipts in the Williams-Sonoma brands.

Prepaid catalog expenses at end third quarter increased $11 million to $79 million, this increase was primarily driven by the timing of expenditures for paper and printing in the Pottery Barn brands, and the launch of the Pottery Barn gift book at the end of the quarter, this was partially offset by the elimination of Hold Everything circulation.

Customer deposits at the end of the third quarter increased 13 million to $182 million, this increase was primarily driven by a sales growth-related increase in unredeemed gift certificates, partially offset by a $12 million permanent reduction in the reserve at the end of the second quarter, relating to a change in the timing of income recognition on unredeemed gift certificates.

I would now like to discuss our fourth quarter guidance.

Based on the continued softness that we have seen in the our Pottery Barn brands, in addition to recent volatility in our other home furnishings brand, we believe that we have to approach the fourth quarter with a more cautious view.

Based on this view, we are reducing our fourth quarter revenue and earnings guidance, to reflect what we now believe is the most likely outcome, if we do not experience any deterioration in the home centered retail environment, or competitive landscape.

Our new guidance assumes a $46 million reduction in net revenues, to a range of $1.234 billion to $1.264 billion, and a corresponding $0.16 reduction in nonGAAP diluted EPS to a range of $1.03 to $1.09.

Although the majority of this reduction is in the Pottery Barn brand, we have also lowered our expectations in the other home furnishings brands, to reflect the volatility that we began to see in fourth quarter.

While our topline as reflected in our revised guidance is creating a significant challenge for us in the fourth quarter, we are aggressively modifying our marketing strategies to drive increased traffic in all of our channels, to ensure that we exit the year in a clean inventory position.

We are also staying intently focused on the aspects of our business that we can control, including customer service, operational execution, inventory management, and cost containment.

Although we are not optimistic that any of these initiatives will substantially alter the trends that are assumed in our guidance today, the strength of our brands and our proven track record in driving our business in difficult economic times, provide us with a high level of confidence in our ability to execute against these initiatives, and deliver the EPS guidance that we have provided you today.

I will now turn the call over to Dave DeMattei, to discuss the Williams-Sonoma, Williams-Sonoma Home, and West Elm brands.

Thank you Sharon.

Good morning.

I will begin by discussing the performance of the Williams-Sonoma brand in the third quarter.

We are very pleased with the performance of the Williams-Sonoma brands in the third quarter.

Net revenues increased a better-than-expected 5.9%, and the customer response to our cuisine around the world and fall merchandising themes was very strong.

Year-over-year merchandising margins were also above expectations due to increased full price selling and successful sourcing initiatives.

In the retail channel, comparable store sales increased 4.3%, which was a substantial acceleration from the first half of the year, which grew at 2.1%.

This increase was primarily driven by the success of our fall perimeter changes, higher catalog circulation in our retail store area, an increase in retail store events including cooking classes and book signings, and an improvement in store productivity due to the success of our small and mid sized store merchandising initiatives, and the direct-to-customer channel year-over-year revenue growth was driven by an 11% increase in our e-commerce traffic, and a higher catalog circulation.

Store value card redemption implemented in mid-September also drove incremental revenue in the quarter.

From a merchandising perspective, year-over-year sales were driven by continued strength in our high-end assortment, including Cookware and Cutlery, in addition to Cooks tools, Food, and Seasonal linens.

As we look forward to the fourth quarter, we are very encouraged by initial customer response to our Core and Seasonal merchandising strategies, including new product introductions in Cookware, Cutlery, and Electrics, that are exclusive to Williams-Sonoma.

In the retail channel, holiday entertaining and gift giving strategies will be our primary focus, including a significant increase in prewrapped gifts at a wide range of price points, stylish gift card boxes, and a new stocking stuffer feature.

Store productivity will also continue to be a significant opportunity, as we further leverage our third quarter investment in our small and mid size store merchandising initiative.

In the direct-to-customer channel, we are optimizing our catalog circulation, to reach 100% of our 12 month buyer file in the months of November and December.

We are also capitalizing on the traffic generating aspect of our Versions catalog, to optimize the coordination of our catalog mailings with key shopping dates in our retail channel.

Finally in the fourth quarter, we are launching new bridal advertising that will run in 3 major bridal publications.

This is the first campaign since 2001 that will promote bridal registry in the Williams-Sonoma brand through the use of national advertising.

Now I would like to talk about the performance of the Williams-Sonoma Home brand.

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

During the quarter, we opened 2 new stores, one in Pennsylvania, and one in the Florida.

We ended the quarter with 7 stores averaging approximately 14,500 square feet.

In the direct-to-customer channel, we continue to capitalize on our multi-channel strategy to our newly launched e-commerce website, which continued to gain momentum throughout the quarter, as customer awareness increased.

From a merchandising perspective, furniture continued to be a strong driver of sales growth, particularly Custom Upholstery and Case goods.

Looking forward to the fourth quarter, we will be focused on increasing traffic at all 3 channels and building brand awareness, including leveraging the marketing power of the Williams-Sonoma kitchen brand.

During the quarter, a link to our Williams-Sonoma Home website will be prominently featured on the Williams-Sonoma Kitchen website, and our classic dining tables will be featured at displays in our Williams-Sonoma Kitchen stores.

We have also expanded our decorative accessory and gift giving assortments, to attract a broader range of customers to the brand.

I would now like to talk about the third quarter performance of the West Elm brand.

In the West Elm brand, we continue to see strong year-over-year revenue growth, driven by incremental revenue from our new stores, improved catalog response, and increased traffic in e-commerce.

In the retail channel, we opened 6 new stores during the third quarter, bringing our store count to 20 stores, with an average square footage of appropriately 17,000 square feet.

In the direct-to-customer channel, growth was driven by increased catalog circulation and electronic direct marketing, in addition to successful e-mail capture initiatives in our retail stores, which supported a substantial increase in customer e-mail contacts.

From a merchandising perspective, we saw continued strength in Furniture, Textiles, and Decorative accessories.

Looking forward to the fourth quarter, we are encouraged by the initial response to new furniture initiatives, and addition to our expansion of our home office assortment that builds upon the Hold Everything legacy.

For the holiday season our larger gift assortment provides a destination for gift givers looking for modern design alternatives.

We also will continue our successful collaboration with the Savannah College of Art and Design, to offer work by young artists, to fulfill the decorating needs of the West Elm customers.

I would now like to turn the call over to Laura to discuss the Pottery Barn brand.

Good morning.

I would like to begin this morning, by updating you on the challenges we are continuing to face in the Pottery Barn brands.

The third quarter was a very difficult quarter for the Pottery Barn brand.

Net revenues decreased 1.2%, and the ongoing consumer response to our core merchandising strategy was weaker than expected.

The shortfall versus our guidance was primarily in the retail channel, which we believe was driven by further softening in the home-related retail environment, and unprecedented levels of competitive promotional activity.

From a merchandising perspective, during the quarter year-over-year sales were negative in all key product categories except Textiles.

As we look forward to the fourth quarter, we are doing so with an increasingly more cautious view of the home-related retail environment.

Based on this view and our expectation that the promotional activity that we saw in Q3 will continue into Q4.

We believe it is only prudent to further reduce our revenue and earnings guidance for the fourth quarter.

This reduction reflects what we believe could be additional downside risk, versus our previous guidance, that may result from a further softening in consumer demand, or increased competitive pressure.

Despite this lowering of or guidance however, there are initiatives in the brand that we are very excited about in the fourth quarter.

The first initiative is our expanded focus on gift giving.

On November 2nd, we launched our new holiday gift catalog.

This catalog showcases an expanded assortment of exclusive memorable personalized gifts, at a wide range of price points.

As the initial consumer response has been very positive, and more than half of the items will also be available in our retail stores, we believe this catalog will be an important retail traffic driver, and a source of new customers for the brand.

To support this gift giving strategy at retail, we are featuring a substantially larger selection of prewrapped gifts on the floor in our retail stores.

The second initiative is to capitalize on the success of our Pottery Barn Bed + Bath catalog, by expanding its reach into the retail channel.

Earlier this month, we opened our first two test stores in Orlando and New York City.

Later this month, we will open a third test store in Portland.

Although the first two stores have only been open for a short period of time, both are exceeding our expectations.

Also in the fourth quarter, we are expanding our partnership with CBS, by participating in a biweekly series of nationally broadcast decorating segments on the CBS Early Show.

These 5-minute segments entitled 'Easy Updates with Decorating' are being taped at our 67th & Broadway New York store, and are hosted by Julie Chen from CBS.

Susannah [Saltz] from 'House and Garden' magazine is the authoritative spokesperson.

We believe this series, like the 5-minute cooking school in Williams-Sonoma, will provide significant exposure for the Pottery Barn brand during the important holiday shopping period.

All of these initiatives represent potential long term growth opportunities for the Pottery Barn brand going forward.

I would like to talk about the strong performance of the Pottery Barn Kids brand.

We are very pleased with the performance of the Pottery Barn Kids brand in the third quarter as net revenues increased 9.8%, on top of a 12.3 increase last year.

From a merchandising perspective during the quarter, growth was positive in all key categories, with particular strength in Textiles and Decorative accessories.

In the retail channel, comparable store sales for the third quarter increased 2.3%, on top of a 3.8% increase in 2005, with all key merchandising categories delivering positive year-over-year results.

This increase was partially outset however, by lower than expected nursery sales, due to a vendor bankruptcy, that negatively impacted the flow of changing table and bassinet inventories.

As these product offerings are core pieces in larger collections, their impact was contagious to the overall nursery category.

We expect to continue to be challenged with this issue until the first quarter of 2007, when our new vendors will be able to replenish our in-stock position.

In the direct-to-customer channel, sales growth continued to be driven by the ongoing success of our direct-to-customer only merchandising initiatives, and the strength of our e-commerce business.

Traffic on our website increased 22.6%, and we continue to see impress conversion rates.

The nursery inventory issue also affected our DTC performance.

As we look forward to the fourth quarter, we are encouraged by the early consumer response to both our core and seasonal merchandise assortment, and are excited about our new merchandising strategies, including our enhanced focus on seasonal events and gift giving.

Classic Toys and expanded assortment of holiday decorative accessories, and new seasonal assortments in baby apparel, will provide our customers with a significantly greater level or holiday gift giving choices.

We are also encouraged by the excitement that was created by our first store opening in New York City on November 11th.

The consumer response was substantially better than we expected and the local publicity brought timely recognition to the brands during a key shopping period.

I would now like to talk about Pottery Barn Teen.

We are extremely pleased with the performance of the PBteen brand in the third quarter, delivering impressive year-over-year revenue growth of 14.1%, on top of a 28.1% increase last year.

From a merchandising perspective during the quarter, growth was positive in all key categories, with particular strength in Furniture.

As we look forward to the fourth quarter, we are extremely encouraged by the initial consumer response to our fall and holiday merchandise assortments.

Like our other Pottery Barn brands, gift giving is is a key focus, and we have significantly expanded our product offering to attract new customers to the brand.

We have also invested in the quality, design, and functionality of our core merchandise assortment, in addition to our visual aesthetic, to enhance the appeal of the PBteen brand with the high end consumer.

I would now like to open the call for questions .

Thank you. [OPERATOR INSTRUCTIONS] Our first question is from Lauren Levitan from Cowen and Company.

Thanks, good morning.

Good morning Lauren.

Good morning.

I was hoping you could to clarify some of the commentary around the environment, you said that you are seeing some of these issues affecting the other brands, but you were very upbeat in the commentary about Pottery Barn Kids, and teen, and Williams-Sonoma.

So if you could help us understand what you are seeing in the overall environment as it pertains to the brands beyond Pottery Barn, and then specific to Pottery Barn, we noticed that you stepped up promotions and the value proposition during the third quarter, and you said that you will do it more in the fourth quarter, can you talk about whether or not any of those initiatives had any impact in the third quarter, either in the retail or direct channels?

Thanks very much.

Lauren I am going to let Howard take the question on the environment, and then Laura will take your question on the Pottery Barn initiative.

Lauren thank you for the question.

It is one that we have spent a lot of time grappling with here.

As we have said, whatever is going on is affecting Pottery Barn, and not having that much effect on the other brands.

We are seeing some impact on our home furnishings aspect of our emerging businesses we think.

But it is hard to quantify what that is, because we don't have very many stores in the comp store base.

But we wanted call that out to you, because we are seeing some indication of that that's concerning us.

But we will follow that, and more to come.

With respect to the Pottery Barn versus the other brands and the economy, Williams-Sonoma is doing terrific, you heard the comps and they have been increasing each quarter, as we have implemented the initiatives that we have been talking about here for 2 years, and I would say that Williams-Sonoma is having as good a year as it's ever had since I have been here.

So if the economy is affecting us there, we are not seeing it.

Now the same thing is true with PBteen doing very well, and Kids is doing very well.

If we have any slip every in Kids, it is because we can see directly in some merchandise category that we were not in-stock in, or something that was executional on our part.

I think one of the differences with Pottery Barn, is that we have been copied so aggressively by so many people, who tend not to have any vision of their own for the merchandise, other than what we do at Pottery Barn.

And then they are very promotional with identical merchandise, as close as they can get to merchandise to look like ours, they are very promotional.

That coupled with the macro issue that is there to some extent, we don't know what is, has had a negative impact I think on Pottery Barn.

And we have suffered more there than we have in the others.

I have been out in the stores, as all of us have, a considerable amount of time in the last 30 days or so, and I have never seen the Pottery Barn stores looking better, frankly in 4 or 5 years than they do today.

So while we see things that we can correct and adjust to this, I think that is the reason that we are so, it's hard to describe this, because I think a couple of things are going on there.

Laura, would you like to take the question about the initiatives?

Sure.

Lauren, you asked me about promotions.

Promotions were up in Q3, and we expect that we are going to be taking further promotions in Q4.

As you have probably noticed, the market is, the competitive set is very promotional, moreso than we are on key core merchandising categories, and we have been cognizant of that, actually but we are more focused on being clean on our inventories than anything else.

And that's where we are talking markdowns in-season, as we always do, so that we will be clean as move into the next floor set.

If you look at our margin and guidance for Q4, just expanding on what Laura said, we are offsetting her promotions in the Williams-Sonoma brands, we are seeing significantly increased full price selling and substantially better margins, that will partially offset Laura's margin impact from her markdowns.

Let me just conclude on this Lauren, since it is such a key question.

As we go forward, we are not going to just accept this.

We are going to have initiatives that deal with what we think the problem is, you know everything from increased marketing so we remind people of the original and high quality nature of Pottery Barn, to work more on our assortment to get out in front whatever the competition is doing, to keep them to continuing to have to change what they are copying, and increased in our stores particularly, we are spending a lot of time on increased service and the executional pieces in our retail stores, so this too will pass, it's flattery, but it is something that we have to deal with.

Jack Murphy from William Blair.

I wonder if you could just dig into the furniture category a little bit, and give us a sense of how overall that did, relative to the overall growth of the the company the average revenue growth in the company, and when you look at the inventory growth is the composition of the inventory you have more heavily weighted towards the furniture?

Thanks.

Jack I will take the initial question.

Our furniture has trended very consistently with the total company growth, so that is where we are with furniture.

As far as getting into more detail regarding the furniture and the aspects of that, I am going turn it to Laura.

Thank you, Jack.

As Sharon said, the furniture category continues to be a strong one for us, however we have seen softness in some categories and some strength in others, where we have differentiated products, and a lot of that information is competitive because as Howard said, we are in such a competitive environment right now, so there are really some pockets where we are chasing inventory aggressively, and where we are seeing softness we are taking markdowns or cancelling orders, and as a results our inventories are in pretty good shape for furniture.

I wouldn't characterize it any heavier there or any lighter there than anywhere else, we have been aggressive on our inventory initiatives all year, and it's paying off.

I didn't mean to imply that furniture sales on furniture items were different materially than the rest of the categories.

Jack in case you thought that was what I was saying, I was talking about the whole brand.

As we grow, some of our emerging brands from PBteen to West Elm, furniture is a larger part of those brands, and so it could increase the total over time, so it's a complicated question to answer, because you are looking at emerging brands and then you are looking at Pottery Barn, a more mature brand, and so when you put it all together we are looking at a fairly similar percent of total sales as we have seen in the past.

Scot Ciccarelli from RBC Capital Markets.

Hi guys, how are you?

When I look at the guidance you guys provided, I would assume you are looking for a negative comp in the Pottery Barn brand, because obviously that brand is struggling a little bit in the environment, but when I look at the run rate of the business it looks like your 2 and 3 year trend rates are much easier.

If this is correct, it would basically suggest a substantial decline on a run rate basis even from third quarter levels, is that the the right way to look at it, or is there something else that might be distorting those numbers?

Scott we don't give guidance by brand, however obviously if we are coming in at a flat comp, and we have this extremely strong performance in Williams-Sonoma, in addition to an extra day before Christmas during the quarter, clearly we have the assumptions in this guidance that Pottery Barn will be running negative comps in Q4 .

Chris Horvers from Bear, Stearns.

Thank you.

Good morning.

Could you talk about relative weakness or relative category strength within the Pottery Barn brand, and just to dig in a little bit more on the inventory, if you're expecting inventories to be up in the 14 to 18% in fourth quarter, with sales being up about 3%, does this worry you at all going forward?

I am going the let Laura initially address the categories across Pottery Barn where she is seeing the volatility that we are talking about, and then I will address the inventory.

As I said in my comments Chris, we had negative growth in all categories, except Textiles where where we continued to see strength.

Beyond that we have varied success in some decorating ideas and some of or table top ideas however it's been volatile and those areas in total are negative to last year.

Beyond that, we have varied success in some of our decorating ideas and some of our table top ideas, however, it has been very volatile and those areas in total are negative to last year.

Beyond that, I really do think that the information is highly competitive to be sharing at this point.

Regarding the inventory, you have to remember that such a substantial amount of even the Pottery Barn brands inventory is go forward, and core merchandise.

And so where we are aggressive on markdowns is in our seasonal categories that have no life after Christmas.

That is where we are taking our markdowns.

In our core categories, we are carrying those forward, and we are also cutting inventories in future receipts going forward to make sure they don't get out of control.

As I said earlier, I feel that we are in good shape in Pottery Barn inventories at Pottery Barn brands, that is.

Chris as we think about that increase in inventory, as Laura said, we are planning to go into the 2007 with clean inventories.

Laura is taking the markdowns, they are aggressively moving through the inventory, but I think what is important to note is that in Q3, and when we expect to see in Q4 is not softness necessarily in our decorative accessories and seasonal assortment.

Our holiday assortments are strong, we have seen initial results that are very promising, and it's the overall business where we are seeing softness, it's not a fashion or holiday gift giving or a seasonal strategy that we think we are going to be challenged with.

Rex Henderson from Raymond James.

Good morning.

As I listen to you this morning I heard you talk a lot about some marketing initiatives, catalog circulation increases, some magazine advertising, and what I am wondering about is that investment in marketing and advertising.

Can you give me an idea about how much margin pressure that will put on the fourth quarter, and I know you haven't provided guidance for 2007 yet, but looking forward do you expect that cadence of advertising and marketing initiative to continue?

Rex let me try to take that at a guidance level, and then I will let Pat speak to the bridal advertising that we are doing, because that is really the new initiative that we have put on the table today.

From a guidance perspective, as it relates to ad costs, our challenge year-over-year with deleveraging ad cost is the productivity of the catalogs that we have mailed, and the softness in our direct-to-customer business.

These investments that we are making, we expect to have sales growth associated with them such as page search, et cetera.

We expect those to be actually enhancing to the margin, with the expectation obviously you won't have instant gratification from the bridal advertising.

Let me just follow-up, Good morning Rex, with a further comment on the catalog circulation increase, a lot of that, at least some of it is driven by the introduction of her new Pottery Barn gift catalog, which is off to a very good start, we are very pleased with it's performance, and it's a smaller book, so the page count is not going up as much as it has the circulation in that particular case.

We have been focusing on the on the bridal business, because we think it is a very significant opportunity, in fact we spent the last year to working with the stores to make sure that the experience the customer has, is the same in all 3 channels, particularly in assortment, the in-store experience, and the ability to satisfy that bridal customer with a number of different events, which we think are very differentiated, we believe will be launching in December the most outstanding advertising campaign that you will ever see in the Housewares market.

And that will be continuing throughout next year, we are very excited.

Janet Kloppenburg from JJK Research.

Good morning everybody.

Howard, what I am hearing is that the overall business was sluggish and there was some volatility in other brands late in October.

I am wondering if you have taken that volatility in other brands into your guidance, into account for guidance?

Janet, how are you, I haven't talked to you in a while.

I am good, Howard, thank you.

I have a couple of questions I just wanted to add on, but go ahead.

Okay.

Let me take this one first.

I wouldn't characterize our business as overall sluggish.

I would say that it is mixed, if Pottery Barn were performing at average rates, I think we would be very enthusiastic this morning about our business.

That is not to say that for 30 days or 60 days we don't have that the comps go down, we have issues, we have out-of-stock issues, or some classification didn't sell, or you always have that in our businesses, because we have several of them, and we never hit 100% on all the cylinders on all businesses at the same time, I wish we would one day.

So that's not the say that in the 30 days, or 30 days ago or something, we didn't have one of our other businesses, that aren't trending down.

But we think it is temporary when things like that happen, and we can relate to specific things that are causing that.

I would also reiterate for you, I didn't mean to characterize it as overall sluggish.

Williams-Sonoma is performing at a level I think better than they have in at least 10 or 15 years here.

The stores are crisp, the customers are responding, the margins are strong, the team is great, the customer service is terrific, and comps are increasing, so we are very pleased with that, and we know exactly why it is happening.

The second part of the question is, I think you asked have we considered all these other things in our forecast, and I can assure you that we have.

I hope not to a fault, or in one way too far.

But we have certainly considered them.

We have looked, this is a very difficult time for us, and we have looked very closely at all of our trends, and all of our numbers, and we want to be sure that we are conservative here going forward, so that is what we have attempted to do, but our major problem here is Pottery Barn is such a large portion of our business, and we are grappling with all the issues as we see them.

We spend a lot of time trying to understand it, and trying to move forward.

[OPERATOR INSTRUCTIONS] David Magee from SunTrust Robinson Humphrey.

Good morning.

Two part question I guess.

First, on the increased competition out there, are you speaking more of department stores, or of other specialty stores.

And the secondly, looking beyond this current environment, how do you see the growth dynamic for at least Williams-Sonoma corporate over the next several years, you say low teens topline, high teens bottom line, are you seeing enough coming from these newer concepts now that still gives you confidence in these numbers over time?

I am going the let Howard take the question about the competitive environment.

The competitive environment that I am talking about with Pottery Barn, I think it's everybody.

We have been 10 years ago we were truly unique in this area, with our assortment and what we were doing in our stores and everything, and I think we have created an area that's been highly successful, and highly copied and copies come from even Wal-Mart today a little bit, to Target, to Restoration, and Z Gallerie, of course if you look at their stores, and they have put a different name on the storefront, in some of their stores, you would think they were Pottery Barn stores until you go inside, and you realize it's not the same, but they are trying to be the same.

Then we are seeing pieces of our merchandise in a lot of places, it's very ubiquitous almost in so many different environments, department stores and others, but it is primarily from those people who are almost trying to duplicate our assortment, they are in our stores with cameras, that is what they do.

And we expect that, that's the nature of the business when you are the leader.

When they also get highly promotional, their quality in most cases, not in all, but in most cases aren't as good as ours, and they are lower priced.

They are promotional, that's clearly had probably some impact on us.

There are things that we can do to counteract that, we are going to do those things.

This will pass I believe, but that's what I am referring to.

The second part of the question on growth rate, we are only making forecasts where we are going, I would tell you, not from a forecasting standpoint, but from a desire standpoint, this is a Company that wants to grow in the low teens, and we have consistently said that, and we are working diligently always to try and drive top line growth.

I think that we have done, over the last 5 or 6 years, we have been made considerable progress with the operational aspects of our business, We are far better at controlling our costs, the processes that we have put in to place over the last 5 years in our supply chain, and really throughout our Company, have made significant improvements for us, and have been one of the driving forces clearly in the raising our operating margins here, so that's been a really good thing.

As we look forward, clearly, we need now to do two things, we need to continue with those operational processes, because there's a lot of improvement left, by no means are we finished.

Like I spoke in my opening comments about the in-sourcing, the results we have had, we have got a lot more of those to roll out.

It's just a lot of operational kinds of things that we are in the middle of, that we will continue to work on, that will both help us improve or customer's experience, and will also improve our operating margins, and make it easier for our people to perform.

We are not anywhere close to complete with that.

We do need to put more emphasis on growing the top line here, and we are focused on that.

We know that our comps need to improve if possible, we are focused on new business ideas, we don't want to do to a point so that we get in front of ourselves, but we would like to improve the rate of our top line growth over the next few years.

We will continue to stay in touch with you, and let you know how we are doing.

Marni Shapiro from Retail Tracker Research.

Hi guys how are you?

Fine thanks, how are you?

I am very good.

I really don't want to beat a dead horse, but on Pottery Barn a couple of questions, are you seeing the same inconsistencies in the catalog that you are seeing in stores, and then I guess importantly, over the last 18 months you have shifted the pendulum from what had become a faster fashion home environment at Pottery Barn, to what's a little bit more basic, and it has worked very well, has the pendulum maybe swung a little too far given the competitive environment, and I guess what is the thinking about where it needs to be?

You know the catalog versus stores question, they are both softer than we would like, however, where they are soft is sometimes different, and that's interesting to us, and it's volatile, it changes here and there.

Consistently we do see strength in Textiles, we have a lot of momentum there, and I think we are going to continue to see that, particularly with our new Bed + Bath stores which I said have met with great response from our customers.

Your second piece, I do agree that probably we have gone too far with not the basics but, because we have had so much competition and so many people ad through us, we need to stay ahead with differentiated products all the time.

In this environment where people are less likely to be moving or buying a second home, we need to inspire them to update their homes, and oftentimes that comes from something very new, so that's what we are looking at in our merchandising strategy, and we are very excited about it.

Alan Rifkin from Lehman Brothers.

Thank you.

Just a follow-up from an earlier question, Sharon, you said that you were expecting inventories to be pretty clean going in 2007, despite the total level being up anywhere from 14 to 18%, and revenues only up 2 to 4.

Can you maybe help us understand a little bit better, how it's such a higher level of inventories versus revenues you do expect to be clean heading into 2007, and as a follow up then should we expect the gross margin deterioration will not be as bad in the first half of '07, as what we have seen recently?

Thank you.

I believe on the inventory growth I will reiterate what Laura said, it is our plan to ensure that we exit our seasonal merchandise before the end of this fiscal year, that is our plan, and that is what is reflected in the guidance that we have given you.

Where we have seen a substantial increase in inventory is in core inventory in Pottery Barn, with these sales shortfalls, they have altered their buy plans, they have cancelled orders where is it appropriate, but this is core merchandise, and we also have another dynamic which is a good dynamic, that is taking our inventory up as well, which is in the Williams-Sonoma brand, we are seeing an increase in our inventory level not in our units, but in our inventory, because of the strength of our high-end assortments in that brand, so that has also driven an increase in our inventory.

The third contributor to the inventory increase, the biggest is Pottery Barn, but there are some others that follow, and the third is that we have seen some additional inventory, as a result of our new merchandising initiative, the small and mid size store initiatives, as we have added inventory in the different merchandising categories there, that I will let Dave just briefly speak to the small and mid size store initiatives.

Thank you Sharon.

What we have done with the small and mid size store project was really go after impacting categories and adjacencies in our mid-sized stores, and what we are doing is seeing that pay off, as you have heard from the comps.

What we are doing is going after the Cookware, the Cutlery, the Bakeware, and really trying to drive those businesses and impact them when the customer comes in, and we are pleased with the results of those.

That does conclude our question and answer session today, speakers, I will turn the conference back over to you.

Thank you for joining us.

We appreciate your time and your support, and we will talk to you next quarter.

That does conclude our conference call today.

Thank you all for your participation.