Williams-Sonoma Inc (WSM) 2006 Q4 法說會逐字稿

Welcome to the Williams-Sonoma, Inc., fourth quarter and fiscal year 2006 earnings and fiscal year 2007 guidance conference call. At this time all participants are in a listen-only mode. We will conduct a question and answer session after the presentation. As a reminder this conference is being recorded.

I would like to now turn the call over to Steve Nelson, Director of Investor Relations at Williams-Sonoma, Inc., to discuss the nonGAAP measures and the press releases issued this morning and forward-looking statements. Please go ahead, Mr. Nelson.

Good morning. This morning's conference call should be considered in conjunction with the press releases that we issued earlier today. I would first like to discuss the nonGAAP financial measures that are included in this morning's press releases and today's conference call.

In our earnings press release, we announced operating results for the fourth quarter that included and excluded a $0.02 per diluted share net impact from new accounting pronouncements in the fourth quarter of fiscal year 2006 and a $0.07 per diluted share net impact from unusual business events in the fourth quarter of fiscal year 2005. We also announced operating results that included and excluded an $0.11 per diluted share net impact from new accounting pronouncement and unusual business events during fiscal year 2006 and a $0.07 per diluted share net impact from unusual business events during fiscal year 2005. These nonGAAP financial measures are provided to facilitate meaningful year over year comparisons. Please see Exhibit 1 of the earnings press release for a description of the effect of each of the new accounting pronouncements and unusual business events on our fourth quarter and fiscal year results for 2006 and 2005.

In our guidance press release, we compared our fiscal year 2007 guidance to fiscal year 2006 operating results that included and excluded a $0.03 per diluted share net benefit from unusual business events. These nonGAAP financial measures are provided to facilitate meaningful year over year comparisons. Please see Exhibit 1 of the guidance press release for a description of the effect of each of the unusual business events on our fiscal year 2006 results. Within the 2007 guidance there are no unusual business events projected.

For the remainder of today's call we will be discussing our fourth quarter and fiscal year 2006 results and our quarterly and fiscal year 2007 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 of why these nonGAAP financial measures are useful and how they are used by management are discussed in Exhibit 1 of the press releases.

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 2007 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 Chief Executive Officer.

Thank you, Steve, and good morning and thank you for joining us. With me today is Laura Alber, our President, Pat Connolly, our Chief Marketing Officer, Dave DeMattei, our Group President for the Williams-Sonoma, Williams-Sonoma Home and West Elm brands, and Sharon McCollam, our Chief Operating and Chief Financial Officer.

I'd like to begin today by providing you with a high level overview of our fiscal 2006 results and our 2007 outlook. Then I will turn the call over to Sharon, Dave and Laura to discuss the financial and brand performance details.

Fiscal 2006 was a challenging year for us as our year over year growth rates, 5.3% in revenue and 1.1% in nonGAAP diluted earnings per share, fell well below the expectations that we had set for ourselves at the beginning of the year. But despite these lower growth rates we still delivered the highest nonGAAP diluted earnings per share in the history of our Company, and were able to return $220 million in cash to our shareholders through share repurchases and dividends. We believe these results once again demonstrate our ability to aggressively react to a rapidly changing business climate and illustrate our management team's commitment to optimize profitability even in difficult economic times.

Our key growth challenges during the year were really two-fold. First, like many home furnishing retailers, we were negatively impacted in the back half of the year by the significant softening in the home centered micro environment -- micro economic environment. As a result we saw lower direct-to-customer response rates, weaker retail traffic, and an unusually high level of competitive mark down pressure. This was particularly true at Pottery Barn, our largest brand, where revenues fell substantially short of our expectations. But there were also specific operational issues within the Pottery Barn brand, primarily in the areas of merchandising, marketing and retail execution, that contributed to the shortfall. As these issues were within our control, we assure you that a comprehensive recovery plan is underway but it's going to take some time. Our expectation is that we will see progressive improvement through -- throughout this year, 2007, leading to significantly improved performance by 2008.

Despite these challenges there were several operational advancements that we made during the year that we are very proud of. First, we successfully insourced our East Coast furniture hub operations which allowed us to substantially improve the furniture delivery experience for our customers and reduce our furniture return rates. We also implemented regional warehousing for our high volume East Coast stores, significantly expanding our capabilities in monogramming and personalization and reengineered our direct-to-customer returns processing operations. In information technology, we implemented new retail inventory management systems in our Williams-Sonoma and Pottery Barn Kids brands.

We believe that over time these new systems will allow us to optimize the flow of inventory from our vendors to our stores as well as improve our service levels to our customers. We also implemented new gift card insurance -- issuance and redemption functionality in our direct-to-customer channel. We believe that this functionality is critical to driving future growth as consumers increasingly show a preference for this convenient form of gift giving. All of these initiatives substantially enhanced our operational infrastructure and leave us well-positioned to support accelerated growth in the coming years.

In addition to our operational advancements there were also brand specific highlights that we were very proud of. In our Williams-Sonoma brand, for the second consecutive year, we reached a new milestone in brand profitability. This was also true in our West Elm brand as we gained momentum in the retail channel, and in our Pottery Barn Kids and PBteen brands, new product innovation and significantly improved brand marketing resulted in low double-digit and mid teen growth rates in a very challenging home furnishings environment.

As we enter 2007, we will focus on the key strategic initiatives that can transform the financial performance of the Company over the next few years including driving sustainable top line revenue growth, with a key focus on the revitalization of the Pottery Barn brand, which Laura will discuss in detail later in this morning's call; increasing our pretax operating margin by continuing to drive operational advancements and cost containment initiatives across the Company; and enhancing shareholder value by delivering on the commitments that we've made with respect to improving the overall performance of our current business.

To drive sustainable revenue growth in 2007, we expect to add 13 net new retail locations and expand the square footage of an additional 17 locations. We also expect to increase catalog circulation and electronic data direct marketing and will intensify the marketing support behind our fastest growing shopping channel, e-commerce. On the operational side of the business we expect to continue to improve efficiency in our supply chain by expanding our furniture hub insourcing initiative, capitalizing on the benefits of our daily store replenishment program and rolling out new sourcing and logistical strategies designed to reduce customer returns, replacements and damages. In our emerging brands, PBteen, West Elm and Williams-Sonoma Home, we will be focusing on building brand awareness and enhancing customer access to the brands. These initiatives will include adding seven new retail locations, five in West Elm and two in Williams-Sonoma Home, aggressively identifying new customers through retail name capture and database prospecting and expanding the use of electronic direct marketing.

To support all these brand building initiatives we will continue to invest in our long-term infrastructure, including implementing new supply chain and information technology initiatives that will support enhanced operational efficiency and long-term growth. Although these investments will have a short term impact on earnings results, we believe their impact will be more than offset over time by our continued ability to drive greater efficiencies in our existing supply chain operations and overhead cost structure.

Also in 2007, we remain committed to returning capital to our shareholders as reflected by the announcement today that our Board has increased our quarterly cash dividend by 15% to $0.115 per share and authorized an additional 5 million share stock repurchase program.

I will now turn the conference call over to Sharon to further discuss our fiscal 2006 results and provide additional details on our 2007 guidance. Sharon?

Thank you, Howard. Good morning. I'd like to begin by outlining the agenda for the remainder of this morning's call. First, I will briefly review our fourth quarter and fiscal year 2006 results. Then I will provide additional insight into our fiscal 2007 financial guidance. Then Dave and Laura will provide you with a business update on the Williams-Sonoma, Williams-Sonoma Home, West Elm and Pottery Barn brands and finally we will open the call for questions.

I would now like to briefly talk about our fourth quarter earnings results. As a reminder, financial comparisons may be on a nonGAAP basis as described by Steve earlier in today's call.

In the fourth quarter of 2006, nonGAAP diluted earnings per share decreased 0.9% to $1.08 versus $1.09 in the fourth quarter of 2005. Throughout the quarter we remained intently focused on operational execution and cost containment which allowed us to deliver results to our shareholders at the high-end of our guidance and $0.03 above the FirstCall estimate. Net revenues in the fourth quarter of 2006 increased 3.3% to approximately 1.25 billion. Excluding the negative impact of the shut down of Hold Everything, net revenues increased 4.9% including a 4.6% increase in the retail channel and a 5.4% increase in the direct-to-customer channel. Internet revenues increased 21.4%. Catalog circulation during the fourth quarter, excluding Hold Everything, increased 9.5% while paid circulation increased 8.8%.

Gross margin expressed as a percentage of net revenues on a nonGAAP basis decreased 80 basis points to 43.2% in the fourth quarter. This decrease was primarily driven by occupancy cost deleverage in the retail channel including costs associated with the retail roll-out of our emerging brands and increased mark downs in the Pottery Barn brands. These costs were partially offset, however, by the elimination of all cost of goods sold associated with the Hold Everything brand.

SG&A expenses as a percent of net revenues on a nonGAAP basis increased 30 basis points to 27.3% in the fourth quarter of 2006, primarily driven by higher information technology asset disposition costs, higher asset impairment charges related to retail stores and increased Pottery Barn advertising costs. These increases were partially offset by lower incentive compensation due to not achieving corporate bonus targets and the elimination of all SG&A expenses associated with the Hold Everything brand. The higher asset impairment charges relate to two mid-market Williams-Sonoma Home stores in which the estimated future cash flows were insufficient to cover the current net book value of the stores.

Now I will discuss our fiscal 2006 earnings results. In fiscal year 2006 we delivered nonGAAP diluted earnings per share of $1.90, an increase of $0.02 per diluted share or 1.1%. Net revenues in fiscal year 2006 increased 5.3% to approximately $3.7 billion. Excluding the negative impact of the shut down of the Hold Everything brand, net revenues increased 6.7% including a 6.7% increase in the retail channel driven by an 8.3% increase in retail lease square footage, and a 6.7% increase in the direct-to-customer channel driven by a 23.8% increase in internet revenues. Catalog circulation in 2006, excluding Hold Everything, increased 2.6% while paid circulation increased 5.8%.

Gross margin expressed as a percentage of net revenues on a nonGAAP basis decreased 70 basis points to 40% in fiscal year 2006. This decrease was primarily driven by occupancy costs deleverage in the retail channel including the costs associated with the retail roll-out of our emerging brands in addition to higher occupancy costs in our core brands and increased markdowns in the Pottery Barn brand. These costs were partially offset, however, by the elimination of all cost of goods sold associated with the Hold Everything brand.

SG&A expenses as a percentage of net revenues on a nonGAAP basis increased 10 basis points to 30.7% in fiscal year 2006, primarily driven by higher employment costs associated with the growth of our emerging brands, higher information technology asset disposition costs and higher asset impairment charges related to the Williams-Sonoma Home stores. This increase was partially offset by lower incentive compensation due to not achieving corporate bonus targets and the elimination of all SG&A expenses associated with the Hold Everything brand.

I would now like to discuss fiscal year 2006 significant year over year working capital balance sheet variances. All comparisons are versus year end balances at the end of fiscal year 2005 which are included in this morning's press release financial statement.

Cash and cash equivalents at the end of fiscal year 2006 were $275 million, after returning nearly $220 million to our shareholders through share repurchases and dividends through the year. This is the second highest year end cash balance in the history of our Company. Our consolidated statements of cash flows are included in this morning's press release.

Merchandise inventories at the end of fiscal year 2006 increased $90 million or 17.4% to $611 million on revenue growth of 5.3%. This above sales growth increase was primarily driven by increased inventories in the Pottery Barn and Williams-Sonoma brands. The Pottery Barn increase was primarily due to the significant shortfall in sales that the brand experienced in the back half of 2006. The Williams-Sonoma increase was primarily driven by a shift in product mix to support the 2006 small and mid-size store merchandising initiative in addition to higher overall average unit retail.

Customer deposits at the end of fiscal year 2006 increased $15 million to 188 million. This 9% increase was driven by year over year growth in unredeemed gift certificates and gift cards and customer deliveries in transit at year end, partially offset by a $12 million permanent reduction in the reserve at the end of the second quarter of 2006 relating to a change in the timing of income recognition on unredeemed gift cards.

I would now like to discuss the details of our fiscal year 2007 guidance. Before I begin, however, I would like to highlight three general comments about the guidance.

First, to provide meaningful book comparisons to fiscal year 2006, we are comparing 2007 guidance to 2006 actual results excluding unusual business events. As these are nonGAAP comparisons they should be interpreted in conjunction with this morning's press releases. Also fiscal year 2007 is a 53 week year for Williams-Sonoma, Inc., which adds approximately 200 to 210 basis points to the Company's projected annual revenue growth rate, and 280 to 400 basis points to the Company's projected diluted earnings per share growth rate. And finally, the loss of revenues from the Hold Everything brand shut down in fiscal year 2006 is negatively impacting the fiscal year 2007 year-over-year projected growth rate by approximately 70 basis points.

As we enter 2007 we are doing so with a very cautious outlook based on our ongoing concerns regarding the overall home centers macro economic environment and the challenges that we are facing with the Pottery Barn brand. Based on this conservative outlook, net revenues are expected to increase in the range of 5.7 to 8%, of which 200 to 240 basis points will be driven by the emerging brands. On a 53 week to 53 week basis, this represents a projected increase in the range of 3.7 to 5.9%. To achieve this growth, we are projecting a 5.5 to 6% increase in retail leased square footage, a negative to positive 1% change in comparable store sales, and a 6 to 7% increase in catalog circulation, excluding Hold Everything, with a corresponding 9 to 10% increase in page count.

NonGAAP gross margin as a percentage of net revenues in fiscal year 2007 is expected to decrease 20 to 40 basis points. This decrease is driven by increased costs associated with the revitalization initiative in the Pottery Barn brand, higher cost of goods sold associated with an expected continuation of the competitive mark-down pressure and higher depreciation expenses associated with the implementation of new information technology systems. NonGAAP SG&A as a percentage of net revenues in fiscal year 2007 is expected to increase 10 to 30 basis points. This increase is driven by higher incentive compensation and increased costs associated with the revitalization initiatives in the Pottery Barn brand, partially offset by lower catalog advertising and asset impairment charges.

Interest income in fiscal year 2007 is expected to decrease by 3.7 to 5.7 million due to cash being returned to shareholders through share repurchases and dividends. Income tax expense as a percentage of pretax earnings in fiscal year 2007 is expected to increase 40 to 70 basis points due to certain income tax benefits that were favorably resolved under audits in fiscal year 2006. Consistent with our strategic initiatives to enhance shareholder value, we remain committed to delivering on the commitments that we have made to our shareholders and are confident in our ability to deliver the 2007 guidance that we have provided today.

I will now turn the call over to Dave DeMattei to discuss the Williams-Sonoma brand.

Thank you, Sharon. Good morning. I'd like to first discuss the performance of the Williams-Sonoma brand.

In fiscal 2006, driven by strong execution, the Williams-Sonoma brand for the second consecutive year delivered the highest operating margin in its history. This is a tremendous accomplishment and a testament to the success of our new merchandising, catalog redesign and small and mid-size store strategies. Specifically, in 2006, net revenues increased 5.6% driven primarily by a comparable store sales increase of 3%, strong e-commerce growth and a better than expected performance in new and expanded stores. In the retail channel the 3% comparable store sales increase was primarily driven by the successful execution of new merchandising strategies, including exclusive new product introductions, holiday entertaining and gift giving and increased store productivity driven by our small and mid-size store remerchandising and refixturing initiatives.

In the direct-to-customer channel we delivered the best year in our history, particularly in e-commerce, as a result of strong merchandising, refined catalog circulation and successful electronic direct marketing initiatives. During the year we optimized our catalog circulation by expanding our customer specific versioning which allowed us to contact an additional 1 million customers at a neutral ad cost, traffic on the web site increased over 7%, and we continue to benefit from above average conversion rates. We also saw strong results from our on-line marketing efforts which, in addition to our on line bridal registry, continued to be significant future marketing opportunities for the brand.

As we enter 2007, we are doing so with a cautious outlook based on our concerns related to the home centered macro environment. We are, however, confident in our initiatives for 2007, including creating a more dominant presentation with our tabletop and entertaining assortments, introducing new ideas and techniques surrounding our cuisines around the world, continuing to leverage vendor -- key vendor partnerships to create unique and exclusive product, focusing on building our authority as a destination for entertaining, to complement our cooking expertise, and launching a national advertising campaign to grow our bridal registry business. Within the retail channel, based on our success in over 120 stores in 2006, we will continue to move forward with our initiative to remerchandise and refixture our small and mid-size stores. In 2007 we have approximately 30 stores remaining to convert.

In the DTC channel we are beginning the first phase of our e-commerce web site redesign. Leveraging off the success of the catalog redesign project in 2005, we will be focusing on enhancements that substantially improve the shopping experience for our customer and drive increased traffic, conversion and average order size. In addition, we are refining segmentation, targeting and relevance in our electronic direct marketing campaigns and increasing e-commerce marketing through paid search. In summary, we believe that executing against these initiatives in 2007 will allow us to continue to expand the reach of the brand and leverage the strength of the brand's authority as a destination for high quality cooking accessories, gift giving ideas and home entertaining essentials.

I would now like to talk about the Williams-Sonoma Home brand.

Fiscal 2006 was a challenging year in the Williams-Sonoma Home brand, particularly since it was the first year the brand began operating in all three shopping channels, retail, catalog and e-commerce. During the year the reach of the brand was extended by opening four new stores and successfully launching an e-commerce web site. But despite these growth initiatives, results for the year fell well below our expectations. Although the store impairment charges, that Sharon discussed earlier, impacted these results, there were other drivers including brand building operational issues that are taking longer to implement than initially planned.

Based on the significant opportunity that these issues represent, our top priority for 2007 is superior execution from product design to white glove furniture delivery. To ensure our success, we are modifying our brand roll-out strategy to coincide with the future development of the infrastructure necessary to accelerate the business. As such, our plan for 2007 is to open two additional stores, one in Dallas, one in St. Louis, and reduce catalog circulation until such time as we can improve the overall productivity of the direct-to-customer business.

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

In the West Elm we are pleased with our results from our efforts during 2006. Incremental revenue from both existing and new stores, improved catalog response and increased traffic in e-commerce drove year-over-year strong sales growth. As we grew the brand during 2006 we gained significant learnings, specifically, furniture is the dominant core business and continues to grow, our customer reacts positively to frequent change and looks to us for design direction, and the cash-and-carry model differentiates this brand.

In the retail channel we opened 10 stores in 2006 with 2 new stores during the fourth quarter, bringing our total store count to 22 stores with an average square footage of approximately 17,000 square feet. We also refined our retail model during 2006 to identify the ideal store configuration to maximize efficiencies. In our stores we rolled out a design lab with a web-based space planning tool that enables us to offer better design services to our customers.

In the direct-to-customer channel growth was driven by increased catalog circulation, electronic direct marketing, name capture in our stores and internet partnerships. In addition, we have improved the level of profitability as we made progress on our initiatives to increase catalog productivity through higher response rates and average order sizes. From a merchandising perspective, we saw continued strength in furniture, textile and decorative accessories as we increased overall SKU counts and densified the visual presentation at our stores.

Looking forward to 2007, we are encouraged by the momentum we have seen as our customer looks to us as a design resource for their home. We are delighted with our customers' initial response to our new spring merchandise, especially in the areas of furniture, flooring and lighting. We will round out our merchandise assortment in core categories such as upholstered furniture and expand to every room of the home.

In retail for 2007 we will open five new stores including our largest downtown location in Washington, D.C. We remain very excited about our retail expansion opportunity, and for 2008 we will look to be much more aggressive in our new store roll-out as we have the store development infrastructure in place.

In the direct-to-customer channel we will increase circulation and page count to support growth, implement initiatives to improve e-commerce conversion and test our value proposition within shipping costs. Overall, we are very pleased with the direction of our brand building efforts for West Elm and continue to be optimistic about our life style approach to contemporary style at an affordable price.

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

Thank you, Dave. Good morning. First I will start with the Pottery Barn brand.

We were very disappointed with the performance of the Pottery Barn brand in 2006, as net revenues increased only 1.8% versus a 12.3% compounded average growth rate for the preceding three years. The slow down in the brand's revenue growth was broad-based with a consistently declining trend in both channels. From a merchandising perspective, we experienced softness in most major merchandising categories, although furniture and textiles were somewhat more resilient than others. In the retail channel, comparable store sales decreased 2.1%, declining as the year progressed. Reflecting similar trends, the direct-to-customer channel also experienced progressively slowing growth during the year, although new product introductions, selective promotional activity and an increase in electronic direct marketing drove a modest increase in the fourth quarter.

Overall, our assessment on the year indicates that there are both internal and external factors that contributed to our weaker than expected performance. As Howard mentioned earlier, the home centered macro economic environment had a significant effect on top line growth in the Pottery Barn brand in 2006. However, there were some brand specific merchandising and operational issues that are within our control. In 2006 our brand positioning was not as differentiated as it had been in the past. The product assortment was too formal, we reduced a number of opening price point SKUs that we offered, and many of the new programs were redundant to past successes. We have ongoing consumer research and are well underway with our brand revitalization strategy to reposition ourselves as the leader in America's casual home furnishings market.

I would now like to share with you our revitalization strategy.

First and foremost, product. Our new product will be differentiated and relevant to our core customer. We are improving our speed to market so we can capture trends and bring them to our customer before the competition. We will also be improving our marketing and visual merchandising to create a more exciting customer experience.

Second, value. We are reinstating value as a key competitive advantage. In addition to improving our delivery experience, we are testing a number of shipping charge options. We are also reviewing our product offering to assure the right balance of quality and price.

Next, our in-store merchandising. Similar to Williams-Sonoma we are beginning an initiative to remerchandise our mid-size stores. By remixing the assortment and reallocating floor space amongst merchandise categories and improving our presentation we will be able to enhance the shopping experience for our customers.

Fourth. In our direct-to-customer business we are refining our contact strategies to reach more customers and to optimize our circulation strategy with customer specific versioning.

And, finally, to continue to build dominance in the market, we are testing and building upon the success of new concepts, such as our outdoor book and our bed and bath test stores. To date both of these concepts have met our expectations and we see them as viable growth opportunities. Earlier this year we began implementing parts of these initiatives in our winter catalog and on our web site and are encouraged by the initial results. We need more time to fully implement the entire strategy, but are confident in our ability to execute against our initiatives and successfully reposition the Pottery Barn brand.

Now I would like to talk about Pottery Barn Kids. We are extremely pleased to report today that in fiscal year 2006 Pottery Barn Kids achieved net revenue growth of 11.5%. Positive year-over-year sales growth in all major merchandising categories drove this strong performance. Particularly impressive was the growth in textiles and decorative accessories reflecting innovative product introductions. We were also able to improve order fulfillment throughout the year.

In the retail channel comparable store sales increased 3.3% following a strong 5.2% increase in 2005, and we continue to be pleased with the performance of new stores. Our bedding programs, in addition to bedroom furniture and key decorative accessory categories, drove these results. Traffic drivers during the year included our in-store events, baby and gift registry, exciting new floor sets and our consumable strategy.

The direct-to-customer channel also delivered strong growth, driven by an exceptional consumer response to our catalog and internet only merchandise strategies, including personalization and expanded furniture and the ongoing success of e-commerce. Increased and more relevant electronic direct marketing, on line advertising initiatives and improved creative on our web site drove this strong e-commerce performance. Traffic on our web site increased over 15% for the year and, like Pottery Barn, conversion rates continue to exceed industry norms. Our baby and gift registry business, which we believe is a strategic driver of new customers to the brand, continues to generate strong traffic in all channels.

As we enter 2007, we are encouraged by the opportunities in both the retail and direct-to-consumer channels. As the year progresses, we will continue to build dominance in the children's marketplace and attract new customers to the brand by focusing on the following growth initiatives -- continuing to be the innovative leader in developing new product introductions in key growth categories and bringing exciting new product categories to our customer; expanding infant apparel in all three channels to enhance our nursery and baby registry business and drive repeat traffic to our stores; increasing our gift assortment in all three channels to a stop -- established top of mind awareness of Pottery Barn Kids as the destination for gift giving for children at various ages and stages; and, expanding the seasonal holiday and themed party assortment to position ourselves as the destination to celebrate special milestones in children's lives. We believe that the successful execution of all of these brand building initiatives will enable Pottery Barn Kids to further establish its market position as the authority in children's home furnishings.

I would now like to talk about Pottery Barn Teen.

Net revenues in Pottery Barn Teen increased 14.5% in 2006 with strength throughout the year. We are particularly pleased with these results in that they were driven by revitalized catalog marketing and innovative product introductions, both of which are long-term success factors for the brand. From a merchandising perspective, we saw strong consumer response throughout the year to furniture and decorative accessories. In addition, holiday gift giving strategies were successful and provide future growth potential as we further expand brand awareness.

As we look forward to 2007 we will continue to capture marketing opportunities that appeal to families with teens by focusing on the following brand building initiatives -- building brand awareness through innovative marketing; substantially expanding our assortment; driving key categories through product innovation; refining our contact strategies to optimize response rates; improving our in-stock position to increase order fulfillment rates; and testing new product categories that we believe hold sizeable potential. We are very excited about our PBteen direct-to-customer opportunity and its role in our life stage marketing of the Pottery Barn family of brands.

I would now like to open the call for questions. Thank you.

Thank you. [OPERATOR INSTRUCTIONS] Lauren Levitan with Cowen and Company has our first question.

My question is for Laura, I was hoping you could elaborate on some of the revitalization initiatives you discussed, specifically maybe give us some sense of where you think you can get lead times and over what time period we should be watching for those improvements? Also your comments on value and the mid-size store initiative, if you can give us some time frame over which those initiatives will be rolling out? And then, if you could give us any sense of reaction to the shipping charge changes that you've had underway? Separately for Howard, I was wondering if you can give us an update on the management succession planning that you started with last summers announcement? And then lastly for Sharon, could you give us the drag on EPS for Williams-Sonoma Home in '06? And even if you can't quantify that number, would you expect that to shrink or grow in '07? Thanks very much.

Was that one question, Lauren?

If I didn't take a breath then it's one. [laughter]

There ought to be an award for that. Okay, Laura, would you please take Lauren's first question regarding the lead times associated with the revitalization strategy.

Sure, hi, Lauren.

Hi, Laura.

This year, everything I discussed you are going to see progressive improvement by quarter. So there are certain things we can do sooner than later. And so, with each of them, as I said, each quarter we are going to be testing and trying new things and reading our consumer response to those initiatives and then building on them. As I said earlier, we are well underway, particularly with the value initiatives in our direct business. And, one of the important parts of that was that we had significantly decreased our opening price points. And it's a very important part of our new customer acquisition strategy to have price points that appeal to our younger customer. And so will you see, as you go through the, even the spring catalog that is in home today, more opening price points than you've seen in the past, and as you go into Q2, Q3, Q4, you are going to see progressively more opening price points added where we have been able to engineer into those prices that we've been at before.

Regarding the shipping initiative, you saw, again, in the spring catalog changes in some of our shipping rate table levels. And what we did was, we really believe, and have always believed, that our shipping rates should be competitive. It's very important to us, and also to provide incredible service. And it's been a much more competitive environment on that front, as some people really do vary the cost of shipping in their retail prices, we break it out separately, and we've always been competitive on the total price, but for our customer the separate break out of the surcharges in the rate table has been an emotional and hot button for them, and we've heard that clearly through our sales and also through focus groups. And so, what you've seen is our first step in our spring catalog to rectify that situation and to understand where the demand will increase as you reduce shipping charges so that you get the optimal return on that strategy change. And we are pleased with what we are seeing and you will see continued adjustments in summer on that line.

In terms of product development lead times. And this is a very competitive issue as many people have adopted the Pottery Barn look as their strategy. People describe real estate as Pottery Barn and there are whole sections of furniture stores that people refer to as Pottery Barn. What's important is that we cut our lead time so that people have a harder time copying us. And that also we bring in new products that they haven't seen before. A really good example of that is, in our spring catalog we have our photographers lamps. And it's a very innovative product. You can't find it anywhere else and it's doing extremely well. And so we will continue to chase into products like that and drive innovation through all channels.

The initiative on our stores, I think you recall that Williams-Sonoma successfully remerchandised their mid-size stores last year and are seeing ongoing success through that initiative. And actually, we are, as we speak, working on remerchandising our mid-size stores. And it's early in the game to give you a lot of details on the strategy, but we know there are certain businesses that we should build and others that we should possibly shrink. And as we do that, and adjust the adjacencies and look at new ways to visually display our products, we feel strongly that we will be able to enhance our customer shopping experience.

So I hope that gives you more color, and I'm going to pass the question-- the next question to Howard about succession.

Lauren, with respect to our succession planning, I mean, we are kind of moving along on the schedule that we were on. I mean, as I said last year, the hope is is that within our team we've got the succession ability, and I believe that more than ever. Right now, though, we are all functioning as a team, trying to get our business turned in the right direction and we are having a lot of fun, and I am as well as I hope the others are. And we are just moving forward, and I hope everybody is learning, and we are moving towards a new generation of leadership here, but we don't have an announced timetable for that.

Then, Lauren, your question on the profitability or the losses of Williams-Sonoma Home, we don't disclose, as you know, brand profitability. So we are not going to begin doing that now. However, when we do file our 10(K) next week, the impairment charges that we took totaled about $5.2 million related to Williams-Sonoma Home and that will be in the K. So that at least gives you some sense of the magnitude of the impairment charges.

Great. Thank you very much and good luck.

Our next question will come from Adrianne Shapira of Goldman Sachs.

Thank you. Sharon, could you just kind of, on the shape of the inventory, qualitatively give us a sense of how much of that looks as if it's a seasonal overhang, how much of it is core inventory and then how we should expect that to be worked down throughout the year? And then, second question, just on the growth rate, it seems as if net unit openings across all brands seem to be coming down. Is it-- should we be thinking about sort of 5% square footage growth as a normalized run rate going forward?

Okay. Adrianne, I'm going to take your question on inventory and try to provide you with a little bit of color. The inventory was up $90 million, and approximately 1/3 of that is in the Pottery Barn brand. What I would like to do is let Laura just briefly speak to her Pottery Barn inventory, then she can give it back to me and I will speak to the balance of it. Laura, could you speak to your Pottery Barn inventory?

Sure. Just on the sales trends that we ended the year with, we have more inventory than we would like. But we were very aggressive with our seasonal markdowns at Christmas and have been very reactive to adjusting our on order. Our guidance for 2007 reflects the higher markdowns as a result of this inventory, and, but at the same time we are working very diligently to deliver better results above the guidance. In terms of seasonal versus core, a large part of the inventory that we have the excess is core. And so that's good news. And we continue to, as I said, take markdowns on seasonal, and you will continue to see that until we get our inventories back to where we would like them to be.

Then, Adrianne, on the balance of the inventory, of course you would have expected the inventory to grow because our sales did grow over 5% this year. So that's another 1/3 of the inventory. And the balance of it is spread across the brands, but it's predominantly in the Williams-Sonoma brand in the downtown remerchandising project, the stores have a deeper inventory investment than they did prior to the initiative. And they also have brought into the stores, which obviously based on their fourth quarter results, was very successful, a higher merchandise assortment, a higher end merchandise assortment. So that inventory, we have no issues with that inventory, it is just a mix of inventory that that they are currently carrying, along with a higher average unit retail and some cost increases we made across all brands. That's what we have in the inventory. So I don't think there is any big concerns. And as Laura pointed out in the guidance, that we have already taken into account any potential markdowns or what we believe would be the potential markdowns that could exist in the extra Pottery Barn inventory.

Then on the lease square footage growth, I am going to turn that question over to Howard.

There's no question that our store, our new store footprints have slowed. As our brands have matured from a real estate perspective. And we continue to believe that that strategy has been correct for us, and that we, we don't, we don't over build our store locations and create cannibalization and a lack of specialness about our brand. So that strategy won't change. It is more challenging.

On the other hand, West Elm, where we would be desirous of opening a large number of stores we continue to struggle with finding a real estate locations. We have zeroed in pretty much on what's going to work and what's not going to work. I think we are much closer to totally understanding the correct strategy for that from a standpoint of locations. But those locations are hard to come by. So we may experiment with smaller stores in order to find the correct number and get the expansion momentum that we'd like to have in West Elm. We may experiment with that over the next year or so. I wouldn't say that we should think in terms of 5% square footage growth ad infinitum, but that's where we forecast it for this year, so.

Howard, just following up on that, as you're zeroing in on what's the right location for West Elm does that change sort of the longer store potential?

Well, it does probably if we are going to stick to these 20,000 foot, 16 to 20,000 foot stores. But I think we have to adjust now to probably a smaller, to a smaller store format in order to get the number of stores in the coverage that we want. So, we are probably going to have to test that over the next year or so and we are prepared to do that. So I think it's, we are still in a learning process. The last West Elm store we opened appears to be next to Chelsea in New York, the best West Elm store that we've opened in terms of productivity. So we are learning. And the numbers are very satisfying for us. It's just a business in process, I think.

Thank you.

Armando Lopez of Morgan Stanley has our next question.

Hi. Thanks, good morning, everyone. Just a couple of quick questions. Just to follow up on that, Howard, as you zeroed in on like the ideal location for the West Elm stores, could you provide a little more color in terms of what those look like, either from a demographic perspective, income or household level, et cetera?

Well, generally, I think we can do that. Obviously our best stores are where the most customers are. And Chelsea, an area of Manhattan is of course our best store, everyone knows that. It's very exciting about the numbers that we take out of there. It's a younger, hipper, apartment, people living in smaller spaces, kind of customer who probably is buying furniture that is not going to last them for a lifetime but for a certain period in their lives before they move to the suburbs or do whatever they do. Miami, south Florida area, where we opened our most recent store in downtown Miami which was in-- we had opened the first one in Dade land area, outside the Dade land mall, it's been a big success, and then we opened recently in the kind of the redone area of downtown Miami where a big project is being built. And it draws from South Beach and downtown and that whole kind of area there, the aesthetics is great in Florida for us. And we are doing, frankly, amazing numbers there in both of those stores in Florida. Santa Monica is an example of, I think we were doing close to $1,000 a foot or something in Santa Monica, and it's a store that's been open, what, Dave, a year and a half now.

A year and a half.

About year and a half. Which is well above any business we have. We don't, I mean, we don't average anything like that. So that's very exciting for us. So those areas are clearly the best. But I think the most encouraging thing is in the areas like Mission Viejo in San Diego, now in Las Vegas, various places which you don't think of so much as associated with that core customer that I just described. Cordo Madero over in Marin County here in San Francisco, Oakbrook in Chicago, across the street from Oakbrook, those stores are performing quite well for us, and above our pro formas, on or above our pro formas. They are meeting our goals, our expectations, and in most cases exceeding them and we are very pleased with those and they will be the bread and butter. All of them aren't going to be the huge home runs. Dallas, Texas, over at SMU.

Portland, Oregon.

Portland, Oregon, is starting to pick up in the downtown, this refurbed area called the

Pearl district.

Pearl district in Portland, thank you, Dave. So we are seeing a diversity of areas around America where this thing works. The biggest problem is, as I mentioned before, it doesn't appear to work in shopping centers very often. Now, we do have one in Tysons Corner in Virginia just outside Washington, D.C., that is working quite well. And it's improving dramatically every month. We are getting a different growth curve in West Elm than we are in our other store roll-outs. That's the most encouraging thing to us.

The discouraging thing is it doesn't work in shopping center, so we can't go to a major shopping center owner and say, give us 40 locations tomorrow. Sharon just pointed out to me that we have 20 landlords out of our 22 stores, different landlords. Generally these are landlords that really don't care about what's next door, they just want their deal, their rent, and where a shopping center owner is more concerned about mix and it's a lot easier, you get some financing from them and other things.

This is a little bit more difficult roll-out, but I do think, as the brand gets stronger and we build more brand awareness it's going to have a lot more appeal, and we are going through San Juan, Puerto Rico with the brand early next year, which, as well as with Pottery Barn we are going down there. We will be going to Canada with West Elm. I think it will do terrific in Canada. So we are just getting more confidence all the time in what will work and so it make it easier for us to execute these transactions. But it takes a year or so lead time to get them done, and that's why I think we can accelerate this in '08.

Okay. All right. And then in terms of the Williams-Sonoma Home brand, I think, I forget who it was had mentioned some of the brand building operational issues, and looking at the charge for the two stores, I mean, what did you learn, what's different about those two stores?

Let me take that. When we started with Home, right or wrong, our strategic approach to the real estate was, let's do stores at both ends of what we thought the market could be. So we did, and we were trying to test, again, we're trying to develop a real estate strategy for Home, which is not clear, as we began, like our other businesses. It wasn't clear for Pottery Barn, by the way, in '87-- or '94, when we started these design stores, either. It's kind of part of what we do here. And we did the one in Beverly Boulevard in Los Angeles, which was on a street and it was in a design district in a very high-end market from a demographic point of view. And then we put two in shopping centers in the Midwest, which we thought was the lower end of the market. And we could that way understand what the market would be. We had our two largest landlords, each of them offered a site up to us for our Home store. The Simon Company in Indianapolis had general growth in Cincinnati. And we put those stores there, and we knew that was the smallest mall market probably that could sustain a Home store. The stores in Beverly has performed very, very well. We are extremely pleased with what's happened at Beverly. And in Indianapolis and Cincinnati we are clearly disappointed. Although we haven't given up, but we did feel that making the proper conservative forecast for those stores that the right thing to do was to impair them. So we did. And we learned from that. Now, I wish we didn't-- hadn't built them in order to learn, but that's kind of part of the process, and so that's why we did what we did.

Okay. Thank you.

And then, Dave, could you address the brand building initiatives, and the issues that the second part of Armando's question?

Sure, I think some of the learnings that we've had, we've been chasing product in the product development cycle since we are so new at the brand. In addition to launching the catalog we very quickly launched the stores which are about 15,000 square feet. If you break them both down, Laura talked about opening price points in her business. The good news and the bad news in our catalog was that furniture sells. So what we found is we were having very high-- high average orders and a lower response rate than we wanted. So in this year, besides from redesigning the book aesthetically to make it easier to shop, we have remixed the book offering much more decorative accessories and more textiles in the book to bring down the average order and increase our response rate. And from our initial reads of spring that is working.

In terms of the stores, what we found when we looked at the stores, we thought the stores looked very much like furniture storeroom-- furniture showrooms rather than shopable stores. Again, not because that's what we wanted, because we were chasing product to fill a 15,000 square foot store with a small staff. So what we did there, again, was increase the density of our stores, we densified them, filling them with more textiles, decorative accessories and tabletop. And again, from our initial reads on spring, which is our first delivery, we added tables to the stores, we made them much more shopable, if you've been in our store I think you would feel that, again, we are encouraged by the results we are beginning to see from that effort.

In addition we've been working on rebuilding our vendor structure. We just really bought back our [Central-X] office in Europe and are really working hard to establish the appropriate vendors to deliver the quality that we want in the Williams-Sonoma Home brand. I hope that kind of gives you a flavor of what we are trying to do.

Thank you. Rex Henderson of Raymond James and Associates has our next question.

Good morning and thanks for taking my call. I'd like to focus a little bit on the supply chain issues, Sharon probably can answer some of those. The hub expansion, the insourcing of furniture hubs, what's the opportunity, and what's the pace of that, what other markets can you do that in and how much of your total furniture deliveries can you cover with that?

I think that as, Rex, as we are talking about that, what I would like to do, this has so much to do with Pottery Barn, as you know, I'm going to let Laura respond to that at a high level, but we are not going to go into a lot of detail, as we think it's very competitive. But, I will let her give you sort of a very high level overview.

Hi.

Hi.

The most important thing for us is that we improve our delivery experience for our customers. And so, we are both working with our current vendors to do that, and are looking at really all the different touch point with the customer and saying, how can we be better, better than our competition, and provide more value to our customer in shipping. But also we are looking at where it makes sense, where we can do it ourselves. And we had a successful test last year. We were able to bring down return rates in that hub, and we are very, I'd say, care fully looking at where we should go next with this. But our overall strategy really is, first and foremost to improve the quality of the experience to the customer, and that's what you will continue to see us do throughout this year.

Have you determined that there are other markets where you can insource and do it efficiently?

Yes.

Okay. And can you give me any sense of how much of your-- of total market you can cover with that?

No, I think it's a little early to be that specific, and again, as Sharon said, it's a pretty competitive subject. So, I'd like to get some more time under our belts before we come out with that specific roll-out.

We probably ought to be talking to our vendors before we tell you on this call, about what we are going to do.

Thank you. Chris Horvers with Bear Stearns has our next question.

Thank you very much. As we think about where Williams-Sonoma, the Company, is in its growth cycle, can you talk a little bit about where you are in the CapEx curve and the SG&A investment curve? And then, as a follow up, do you think that there is more dividends coming, more buybacks coming, do you think it's time to maybe look at additional leverage?

Howard, would you like to take that question?

I will start it and we can do it. Where are we in our growth cycle? I mean, who knows, we've been at this for 50 years. So, I can just tell you that we are not at the end of our growth cycle. We continue to reinvent ourselves, and it's not as steady now because we are much larger as it used to be. But we will keep growing. We will keep innovating and being creative and thinking of things and improving our current businesses. I don't think we could quantify that for you any more than we try to do now a year ahead or two years ahead of time, which is what we try to do in these calls in our guidance for you. We are very fortunate that we've got a balance sheet with virtually no debt, and we are a generator of cash, and we have been now for a couple of years focused on trying to return, prudently, cash to our shareholders, and we've done that with stock buybacks which has been several hundred million dollars over the last couple three years, and a dividend that we initiated a little over a year ago. So, or just a year ago, I guess, which we just announced that we increased 15%.

To your question, should we create more leverage and get more aggressive with that? Perhaps. It's something that-- we look at all those alternatives constantly here, I think we study what our options might be. We are aware of what they are. We would like to have our businesses all working well and understand how they are doing so we've got more instances right now on Pottery Barn than we do on more increased, over and above than what we've announced, increased share buyback. We did announce, you heard, the extra 5 million shares, this morning. So, that's a possibility at some point in the future, I think right now for the next few months, you're going to see us focus primarily on hitting on all the cylinders here, and then that makes that-- that makes that kind of decision much easier to make and the result more profound.

Chris, as Howard always points out, our number one priority is growth. And one of the things, when you think about our growth in 2006, we grew over 5% and if you take out the impact of Hold Everything it was above that. And when you look at the home furnishings industry, where the numbers are starting to come out, it is clear that even in a year like this where Pottery Barn has been a little bit off track, we still are gaining share, and that is a big opportunity for us, and we would expect that our growth is going to come from several different areas. We've had a discussion this morning about lease square footage growth, and we are saying that when the locations are coming available we are taking the locations and in our emerging brands we would like to accelerate that. And the direct-to-customer channel we are making great strides on the e-commerce side of the business, and from the direct marketing side of the business, which as you know at your conference, Pat spoke articulately about some of the database things that we are currently doing in order to enhance our interactions with the customer. So those are very important growth initiatives, and those are going to be our first priority and then we can speak with what to do with the cash above and beyond that.

Too, I would like to add, I remember in 1990 and 1991, when we were doing 2 or $300 million in sales, I was answering these same questions. Where is the growth going to come from? You just got Williams-Sonoma, what's going to happen? Since then has come Pottery Barn and Pottery Barn Teen and Pottery Kids and West Elm and all of the other things. So now we are answering the questions again. There may come other things. So, time will tell. But I do believe that our core strength here is our creativity and our desire to build, continue to build a great company, so.

Chris, last question, the retail question, you asked about the capital spending and how you guys should model capital spending, and I would recommend in the ranges of 180 to $200 million, if you look over our history, that's where we've been. And I think that's a very comfortable number when you are working on your cash flows.

Our next question will come from Scot Ciccarelli with RBC Capital Markets.

Hey, guys, Scot Ciccarelli. Just wanted to verify, Sharon, your comments about the extra week, it lied about 5 to $0.08 for the fourth quarter, did I do that right?

Yes, but just simple math, yes.

Just making sure. Also, just in terms of the competitive environment, obviously you've brought up competition as something that has obviously impacted the whole business but particular in Pottery Barn. What changes that? It just seems to me you are kind of running uphill in terms of the macro environment. You've mentioned that it's very difficult. You've mentioned there's some things you can do internally. But what you can't control, at least the way I'm looking at it right now is, what all your competitors are doing. How do you really differentiate the brand at this point? Because it seems to me that the barrier entries or the barriers to change aren't dramatic in this business.

I am going to let Laura respond to that because obviously she's extremely passionate about this question.

Hi, Scot. I said the most important thing in a very competitive environment is to lead. And that is what we have always done is we have brought new ideas to market, we've brought new concepts and that has differentiated us, and that is what we will continued to. We recognize that there's a lot more competition, there's pricing pressure and we are very cognizant of all those things. But we are not-- the pricing game is not where you are going to lead. You are going to lead with new product innovations, great value and great service.

I just echo that. I think that is the difference. You've just got to keep in mind that all the competition we are getting is coming from people, which I've said before, that do nothing but copy what we are doing, and then try to do it at a cheaper price. So we have all the advantages. I mean we are, our strength, our multichannel strength is an example. We do $1 billion or something close to it on the web. We mail out-- we are the largest mailer of specialty catalogs in the world, I think, over 400 million. We have a database of 40 million households in America that we deal with. But more importantly, it's all the product innovation has come out of these buildings here, not these competitors that we refer to. Pretty much all they do is just copy what we do. So that's why Laura mentioned earlier, I mean we are going to be more innovative and we are going to make it more difficult for them to copy it, to copy what we are doing. And we are going to reposition our brands so that we don't make ourselves easy to look as though we are-- that our prices are the same. That our value is clear to the customer and differentiated. So that's what got us here. We kind of allowed them to slip up on us, I think, a little bit, and we recognize that and Laura and her team have worked hard. We are getting very good results out of the things that we are doing. And that's the way we will do it. I mean this leading is very important and that is our differentiation primarily.

Then, Scot, this year we have some very exciting things on the horizon as it relates to e-commerce. We are going to be launching a new e-mail platform that, I know you've spoken with Pat Connolly, that we are really excited about and is going to allow us to send much more relevant and targeted e-mails to our customers, which is going to give us an entirely new communication channel with our customer. So these are some big ideas on that side of our business and being one of the largest direct company's in the country it is very powerful. Okay.

Any other questions?

It appears that's all the time we have for questions today. I would like to turn the call over to Howard Lester for closing remarks.

Well, thank you for joining us. We appreciate it. We appreciate your support and the time that you give us today and we will talk to you next quarter and I hope everybody has a great day.

That does conclude our call today. We would like to thank everyone for their participation. Have a great day.