Williams-Sonoma Inc (WSM) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma Incorporated First Quarter 2007 Earnings Call.

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

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

(OPERATOR INSTRUCTIONS) 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 to discuss non-GAAP measures and forward-looking statements.

Good morning.

This mornings conference call should be considered in conjunction with the press release that we issued earlier today.

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

In our press release, we announced operating results for the first quarter of 2007 that included and excluded a $0.005 diluted earnings per share impact of the new accounting pronouncement FIN 48.

FASB Interpretation Number 48 accounting for uncertainty in income taxes.

The press release also contained comparison that included and excluded a $0.02 per diluted share net impact from unusual business events in the first quarter of fiscal year 2006.

In the guidance section of the press release, we included and excluded a projected $0.03 per diluted share impact of FIN 48 for fiscal year 2007 and a $0.006 per diluted share impact for the second quarter of 2007.

We also compared our fiscal year 2007 guidance to our fiscal year 2006 operating results that included and excluded a $0.03 per diluted share net benefit from unusual business events.

For the remainder of today's call, we will be discussing our first quarter 2007 results, our quarterly and fiscal year 2007 guidance, and our fiscal year 2006 results excluding the impact of these items and will refer to these results as non-GAAP.

These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparison.

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

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

The forward-looking statements included in this mornings 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 release 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 thanks for joining us.

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

I'll begin today with an overview of our first quarter 2007 business results and then a high level outlook for the balance of the year, Sharon, Dave, and Laura will then follow-up with the financial and brand level details.

Although the macro environment in the Home Furnishing sector in the first quarter continued to be very challenging , we aggressively drove our business and delivered year-over-year revenue growth of 5.2% excluding Hold Everything and non-GAAP diluted earnings per share of a better than expected $0.17.

We were particularly pleased with the performance of our merging brands and our progress to date on our strategic long-term initiatives.

In our core brands which include Williams-Sonoma, Pottery Barn And Pottery Barn Kids, net revenues for the first quarter increased 1.8% with positive growth in all brands.

In our emerging brands which include West Elm, Williams-Sonoma Home and PBteen, revenues increased a better than expected 38.9% despite the overall softness in the Home Centered retail environment.

During the quarter, we continue to make strategic advancements in our supply chain infrastructure.

In information technology, we successfully implemented a new retail inventory management system in our Pottery Barn brand.

This system was launched in the Williams-Sonoma and Pottery Barn Kids brands in 2006 and we're beginning to see early benefits from enhanced store level allocation and replenishment functionality that the system provides.

In the supply chain organization, we in sourced all of our European sourcing activities in order to establish greater control over vendor selection and product quality.

The third party agent previously managed those activities for us.

As we look forward to the second quarter and balance of the year, we're continuing to focus on the execution of two of our most important strategic initiative, driving top line revenue growth across all of our brands and optimizing our pre-tax operating margin through operational advancements and cost containment initiatives.

Within these initiatives, and our top priority is the revitalization of the Pottery Barn brand which Laura will update you on later in today's call.

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

In the retail channel we expect to add 11 net new retail locations in 2007, seven of which are in our emerging brands.

We're also expanding the square footage of 19 of our existing stores and remodeling three additional stores in place.

Additionally in the Pottery Barn brand, we're developing a new fixturing and modernization program for our first generation design studio stores that have been opened since 1995.

Similar to the Stonestown project in the Williams-Sonoma brand.

We anticipate that we will begin to rollout this program in late 2007 and through 2008.

In the direct to customer channel, we expect to increase catalog circulation in both our core and emerging brands, including an expansive rollout of the Pottery Barn Outdoor catalog in the second quarter.

We're also intensifying the marketing behind our fastest growing channel, E-commerce, including the launch of a new website in the Williams-Sonoma brand in the fourth quarter.

To support all these growth initiatives, we're continuing to invest in our supply chain infrastructure, including the second quarter expansion of our West Coast Furniture Distribution Center and Memphis Returns operation.

We're also intensifying our Company managed sourcing and quality control operations in Asia and expanding our in source Domestic Furniture delivery program as part of our ongoing effort to reduce furniture returns, replacements, and damages.

Although these initiatives put pressure on short-term earnings results, we believe that they will be more than offset over time by our continued ability to drive greater efficiencies in our supply chain operations and overhead cost structure.

As for our thoughts on the macro environment for the second quarter and the balance of the year, we believe an ongoing cautious outlook is appropriate.

We continue to see higher inventory levels among many of our competitors as their first quarter sales fell short of expectations and we're concerned about the ongoing pressure of industry wide markdowns and rising raw material costs.

Both of these factors could lead to further deterioration in the overall macro environment and lower gross margins.

Therefore, we're reducing our second quarter non-GAAP diluted EPS guidance by $0.02 to $0.14 to $0.18 to reflect where we believe there could be short-term risk.

We are; however, reiterating our full year non-GAAP diluted earnings per share guidance in the range of $1.76 to $1.84, based on our better than expected earnings results in the first quarter.

Let me now turn the conference call over to Sharon to further discuss our first quarter 2007 results and provide additional details on our 2007

Thank you, Howard.

Good morning.

I would like to start by discussing our first quarter earnings results.

As a reminder, financial comparison may be on a non-GAAP basis as described by Stephen earlier in today's call.

In the first quarter of 2007, non-GAAP diluted earnings per share decreased 19% to $0.17 versus $0.21 in the first quarter of 2006.

Throughout the quarter, we remained intently focused on operational execution and cost containment which allowed us to deliver results $0.02 above the high end of our guidance and $0.04 above the First Call estimate.

Net revenues in the first quarter of 2007 increased 2.7% to approximately $816 million.

Excluding the negative impact of the shut down of Hold Everything, net revenues increased 5.2% including a 5.6% increase in the retail channel and a 4.8% increase in the direct to customer channel.

Comparable store sales decreased 0.8% during the quarter.

Retail lead square footage increased 6.3% including 15 net new stores.

Catalog circulation during the first quarter excluding Hold Everything increased 3.4% while page circulation increased 9.6%.

This compares to catalog and paid circulation increases of 2.6% and 8.2% respectively in the first quarter of 2006.

Gross margin expressed as a percentage of net revenues in the first quarter was 37%, 170 basis point decrease on a non-GAAP basis from 38.7% in the first quarter of fiscal 2006.

This decrease was primarily driven by increased markdowns and cost of merchandise sold in our Pottery Barn and Pottery Barn Kids brands.

Increased liquidation activity in our outlet stores and increased occupancy costs.

The increased occupancy cost as a percentage of net revenues was primarily driven by the retail rollout of the emerging brands, fixed cost deleverage in our core brands due to negative comparable store sales growth and increased distribution capacity.

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 revenue in the first quarter were 33.5%, a 40 basis point decrease on a non-GAAP basis from 33.9% in the first quarter of fiscal 2006.

This 40 basis point decrease is a percentage of net revenues was primarily driven by reduced stock based compensation, increased income from unredeemed gift certificates and the elimination of all SG&A expenses associated with the Hold Everything brand.

This decrease was partially offset by increased employment costs associated with the growth of the emerging brands.

The effective income tax rate in the first quarter was 40.3% versus 38.4% in the first quarter of fiscal year 2006.

This increase was primarily driven by the implementation of FIN 48 accounting for uncertainty in income taxes which we implemented on January 29th.

The implementation of this accounting pronouncement resulted in a negative cumulative effective adjustment to retained earnings of $11.7 million and an approximate 200 basis point increase in the effective income tax rate in the first quarter of fiscal year 2007.

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

All comparison are versus quarter end balances at the end of the first quarter of 2006, which are included in this mornings press release.

Cash and cash equivalents at the end of the first quarter of 2007 were $117 million, after returning over $240 million to our shareholders through share repurchases and dividends over the past 12 months.

Our consolidated statements of cash flows are included in this mornings press release.

Merchandise inventories at the end of the first quarter of 2007 increased $92 million or 16.8% to $639 million, on revenue growth of 2.7%.

This above sales growth increase was primarily driven by increased inventory in the Pottery Barn and Williams-Sonoma brands.

The Pottery Barn increase was primarily driven by sales shortfalls in the fourth quarter of 2006 which resulted in midterm core inventory levels being significantly higher than prior years.

The Williams-Sonoma increase was primarily driven by a shift in product mix toward our higher end assortment particularly as a result of the 2006 small and mid size store re-merchandising initiative.

Customer deposits at the end of the first quarter of 2007 increased $13 million to $192 million.

This 7.3% increase was primarily driven by a year-over-year increase in customer orders in transit at the end of the first quarter.

Accounts payable at the end of the first quarter 2007 was $156 million, down 15.6% from last year.

This decrease was primarily driven by the timing of (inaudible) merchandise and catalog payables at the end of the first quarter.

I would now like to briefly discuss our second quarter and fiscal year 2007 guidance.

As a reminder, fiscal year 2007 is a 53 week year.

This 53rd week is expected to add approximately 200 to 210 basis points of revenue growth and 280 to 400 basis points of non-GAAP diluted earnings per share growth to our fiscal year 2007 results.

As we look forward to the second quarter and back half of the year, recognizing that approximately 80% of our full year revenues and 85% of our full year earnings will be generated in that time frame, we are remaining cautious in our outlook based on the softness that we are seeing in the Home Centered retail environment today.

Despite our cautious outlook; however, we are pleased to be reiterating our full year non-GAAP diluted earnings per share guidance in the range of $1.76 to $1.84.

We believe this guidance is appropriately conservative based on current trends and our better than expected earnings results for the first quarter.

We are; however, reducing our second quarter diluted earnings per share guidance by $0.02 from $0.16 to $0.20 per diluted share to $0.14 to $0.18.

This revision reflects the concerns that Howard discussed earlier including the ongoing pressure of industry wide markdowns and rising raw material costs.

As we believe these issues could result in increased promotional activity and higher cost of goods sold, we have accordingly reduced our second quarter gross margin guidance by 70 basis points.

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 would like to begin this morning by discussing the performance of the Williams-Sonoma brand.

The first quarter performance in the Williams-Sonoma brand as expected was negatively impacted by the top line pressure of a softer Home Centered retail environment, despite this pressure; however, first quarter net revenues increased 1.4% and selling gross margins reached record levels.

In the retail channel, revenue growth in new and remodeled stores more than offset a comparable store sales decrease of 0.6% and store productivity in the remerchandised small and mid sized stores out performed the brand average.

In the first quarter, we completed the remerchandising of our final 31 small and mid sized stores bringing our total converted stores to 152.

In the direct to customer channel, we delivered the highest first quarter operating margin in our history primarily driven by a strong consumer response to our seasonal merchandising strategies, the ongoing success of our version catalogs and continuing momentum in E-commerce.

Traffic on the website increased over 4% and conversion rates exceeded industry norms.

From a merchandising perspective during the quarter, we continued to see strong growth in Electrics and Cookware as well as Cooks' Tools.

These increases were partially offset, however, by softness in both core and seasonal food.

As we look toward the second quarter and the back half of the year, we are doing so with a sense of caution due to the softness we are seeing in the macro environment.

We are, however, confident in the strength of the Williams-Sonoma brand and our ability to execute against our 2007 initiatives.

These initiatives include, leveraging our key vendor partnerships to create unique and exclusive product, creating a more dominant presentation in table top and entertaining to drive increased sales per square foot and an improved bridal experience, launching the first phase of our website redesign to drive increased traffic conversion and average order size, and expanding our in store marketing activities including cooking classes, technique classes, and book signings to drive increased brand loyalty and enhance customer relationships.

We believe that all of these initiatives will enrich the shopping experience for our customers and advance the brands authority as a destination for high quality cooking accessories, gift giving ideas and Home Entertaining essentials.

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

When we entered 2007, our top priority in Williams-Sonoma Home was to drive superior execution from product design to world class furniture delivery.

To do this, we said we would modify our rollout strategy and invest our time in building the infrastructure necessary to support the long-term growth of this brand.

We are pleased to report this morning that during the first quarter, we made important progress on this initiative, including hiring a new general merchandise manager, accelerating our Product Development cycle, and taking our European sourcing in house.

We also made significant progress in rationalizing our catalog circulation strategy which resulted in a significant year-over-year improvement in direct to customer profitability.

In the retail channel, during the first quarter, we opened one new store in St.

Louis and densified the retail assortment in our existing seven stores.

In the back half of the year, we will open one additional store in the Dallas market.

In the direct to customer channel, we continued to gain brand awareness and build upon increased traffic and conversion rates that were driven by the redesign of our catalog in the first quarter of 2007 and the launch of the E-commerce website in the third quarter of 2006.

Based upon the successful execution of all of these brand building initiatives, Williams-Sonoma Home delivered significantly improved operating performance in the first quarter.

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

We are extremely pleased with the better than expected performance of the West Elm brand in the first quarter, on both the top and bottom lines.

In the retail channel, revenue growth was driven by incremental sales from new stores in addition to a positive consumer response to both our core and significantly expanded retail only assortment.

In the direct to customer channel, year-over-year revenue growth was primarily driven by the strength of E-commerce.

Traffic on our website increased 24%, a substantial increase in electronic direct ,marketing made possible by a successful e-mail capture initiatives in our retail stores and an increase in paid search over these better than expected results.

Operating contribution in the direct to customer channel was also a highlight during the quarter, as profitability as a percentage of net revenues reached its highest level since the inception of the brand.

From a merchandising perspective, we saw a strong consumer response to our Spring Merchandise assortment.

Furniture and decorative accessories including new product introductions continued to be key drivers of growth during the quarter.

As we look forward to the second quarter and the back half of the year, we are encouraged by the strong momentum, we are seeing performance of the brand over the last several quarters.

We are also encouraged by the ongoing consumer response to our new merchandising initiative.

For the balance of the year, we will be focusing on continuing to expand our merchandise assortment, improving product quality and introducing new customers to the brand, including the launch of our private label credit card in the fourth quarter.

In the retail channel we will open five new stores including our first flagship store in Washington D.C.

In the direct to customer channel, we will continue to increase catalog circulation and electronic Direct Marketing as well as test new shipping rate options to drive increased average order size and higher conversion rates.

All of these initiatives are strategic had our brand building efforts and we continue to be optimistic about the long term potential of the West Elm brand.

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

Thank you, Dave.

Good morning.

First I will start with the Pottery Barn brand.

Despite the ongoing pressure of a challenging Home Centered macro environment, net revenue growth in the Pottery Barn brand rebounded from negative low single-digit growth in the back half of 2006 to positive low single-digit growth or 1.2 % in the first quarter of 2007.

We believe that this reversal in trend in both channels was driven by early benefits from the Pottery Barn revitalization strategy, including a more rapid introduction of new and differentiated products, a reduction in shipping charges, a rebalancing of price points, and a significant increase in the circulation of the outdoor catalog.

As all of these initiatives were newly implemented in the first quarter, their sustainability over a longer period of time is still to be proven.

From a merchandising perspective during the quarter, year-over-year sales growth was driven by strength in Furniture and Home Furnishings.

These increases were substantially offset; however, by continued weakness in decorative accessories and table top.

From an operational point of view during the quarter, we continue to make progress on the five strategic initiatives behind our Pottery Barn revitalization strategy.

Our first initiative was to make our product more differentiated and relevant.

To accomplish this, we redesigned our product-- our process to reduce our overall product development cycle and are accelerating the rollout of new product introductions wherever possible.

Second, concerning value, we implemented a new shipping rate table and tested other shipping rate in furniture surcharge alternatives.

We also fully reviewed our current and future product offerings to rebalance our range of price points in future seasons as appropriate.

Third, to optimize the sales productivity of our mid sized stores similar to the Stonestown project in Williams-Sonoma brand , we completed the remerchandising of our first test store and are in the process of evaluating weekly results.

Fourth, to optimize our catalog circulation and customer contact strategies, we tested our first version Pottery Barn catalog.

The initial results were positive and we'll continue to expand the testing as we progress throughout the year.

And finally, to address the opportunity we have seen with new brand extensions, we significantly increased the year-over-year circulation of our outdoor catalog and expanded the merchandise assortment in our new Pottery Barn Bed and Bath stores.

Although it will take several quarters to fully implement all of these initiatives and additional time to determine the sustainable benefits, we remain confident in our ability to successfully reposition the Pottery Barn brand.

I'd now like to talk about Pottery Barn Kids.

Pottery Barn Kids had a difficult first quarter as increased pressure from the Home Centered macro environment negatively impacted top line sales growth in both channels.

Despite this pressure; however, net revenues increased 1.7% on top of a 14.7% increase in the first quarter of 2006.

Although this growth was substantially below our expectations, we did see positive growth in both channels and across all merchandising categories with the exception of textiles.

In the retail channel, comparable store sales decreased 3.8% but were more than offset by incremental revenues from new and remodeled stores.

Reflecting similar year-over-year sales trends to retail, the direct customer channel also experienced significantly slower growth during the quarter despite ongoing strength in E-commerce.

Traffic on our website increased 8% and conversion rates continued to exceed industry norms.

From a merchandising perspective during the quarter, year-over-year sales growth was driven by furniture, decorative accessories and infant apparel.

These increases were substantially offset, however, by softness in textiles and nursery.

The nursery softness, though, was driven by a vendor issue, not a consumer issue and will be resolved in the third quarter.

As we look forward to the balance of the year, we'll continue to be cautious in our outlook, but optimistic about the aspects of our business that we can control.

As the year progresses, we will continue to build on our successes and focus on attracting new customers to the brand through the following growth initiatives.

Introducing new, innovative product to expand the reach of the brand, expanding into apparel including testing two new 1,000 square foot standalone stores, enhancing our gift assortment to establish top of mind awareness of Pottery Barn Kids as the gift giving destination, and expanding our seasonal and themes party assortments to enable our customers to celebrate the milestones in their children's lives with the Pottery Barn Kids brand.

We believe that the successful execution of all of these brand building initiatives will enable Pottery Barn Kids to further its market position as the authority in Children's Home Furnishings despite the softer Home Furnishings retail environment.

I would now like to talk about Pottery Barn Teen.

We are extremely pleased with the performance of the Pottery Barn Teen brand in the first quarter delivering impressive year-over-year net revenue growth of 19.8% on top of a 15.1% increase in 2006.

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

A consistently on brand presentation in addition to increased newness drove these results and attracted new customers to the brand.

As we look forward to the second quarter and the balance of the year, we are encouraged by the initial consumer response to our Summer merchandise assortment and are excited about the ongoing strength of our new product offerings which we specifically designed to appeal to the Teen point of view.

I would now like to open the call

Thank you.

(OPERATOR INSTRUCTIONS) The question and answer session will be conducted electronically.

If you are on a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment and we'll pause for just a moment to assemble the roster.

We'll pause for just a moment to assemble our roster.

Our first question we'll hear from Lauren Levitan with Cowen & Co.

Thank you, good morning.

Good mornings, Lauren.

Sharon and Howard, I'm wondering if you could give us a little bit more sense of your perception of what's going on in the industry and how to compare that to your guidance specifically.

Are your expectations for the industry level discounting and inventory surplus worse now than you had thought at the beginning of the year and how much of the gross margin change is a function of the raw material cost that you called out versus your expectation that you need heavier discounting and versus maybe some of the shipping charges that you've been experimenting with and then I guess related to that one last thing.

What I'm curious what gives you confidence for the balance of the year that we don't see further deterioration in the macro environment or have you already incorporated that kind of deterioration in your assumptions?

Thanks very much.

Lauren, I'm going to have Howard give you our point of view on the macroenvironment, and then the majority of our margins guidance change is in the Pottery Barn brand and we're going to get Laura speak to that so Howard would you take the macro question?

Lauren, there's a lot of questions in your question.

But just in general, I think we have for the past year really become increasingly aware that things are going on in the economy and in our industry effecting our industry group that are detrimental to our business, and that has made it more challenging, and as we've watched other retailers in the Home Furnishings area report, they generally had a difficult year as well, as Sharon mentioned there's a lot of , or maybe I did, there's a lot of inventories out there.

We're concerned about that.

I think we're just cautious and I don't know that it's worse than it was.

It's not particularly better.

We see occasionally mini trends that make us give us hope, but we're not, it's not sustainable yet to the point that we could forecast it, so we're just, we've tried to say in the presentation today, we are just focusing on those things that we can control and we are making progress and we're seeing some results where we think our efforts were well executed.

So that's kind of the best answer I think I can give you.

Laura might like to give us a little more color on the margin because it is principally in Pottery

Sure.

Lauren, hi, good morning.

Short-term, we've seen increasing raw material increases in our prices and at the same time, our customer has required better quality, and we know that with the increased competition and a depressed Home Furnishings environment, we cannot raise prices like we used to, and this creates short-term margin pressure particularly in Pottery Barn and at retail as we transition our inventory and bring newness into that inventory.

Longer-term, we are beginning to see opportunities where our vendors have more open capacity to renegotiate prices and also as we go further throughout the year this year, we were able to engineer value into our product so that we made the right choice up front about where the customer cares a lot about quality and the subsequent price and where they may be less interested.

We also have our biggest opportunity as we come up against some more difficult numbers in the back half of the year to reduce our markdowns on a year-over-year basis.

Okay.

We'll move to our next question as a reminder please limit yourself to one question only.

Next we'll move to Chris Horvers with Bear Stearns.

Good morning, thank you.

It seems like in the emerging brands, West Elm and Williams-Sonoma Home, you made progress in the first quarter on the top line and from a profitability perspective.

Can you talk about how much pressure quantitatively or qualitatively these brands put on the total Company EBIT margin and has this progress changed your view on when these brands will become profitable on the fully loaded basis?

Howard, would you like to take that?

Yes.

Well let me just start, while we have not, I don't think commented on the profitability one way or the other, on these brands but they are certainly not operating at the profit level that the Company operates at.

And so in that sense, they do put pressure on our operating margins overall; however, we're very pleased with particularly West Elm as Dave mentioned.

We're getting real traction there.

We're moving forward at a pace that we're very happy with and have very high hopes about this brand both in terms of growth and in terms of rate of profitability as we move forward with it.

I think our progress to date is, I applaud it and I think we're doing quite well there and I'm very excited about it, particularly some of the new stores that I've seen open lately and the progress that we've made in the direct side.

Williams-Sonoma Home on the other hand is a much smaller business.

It's really not too impact full one way or the other in terms of the just absolute dollar amount, but we're going much slower there as we've announced.

We've only got eight stores open or eight stores open.

We're working on improving our direct side, improving our retail side.

We're making great progress year to year particularly in the stores and comps, that sort of thing, as Dave mentioned again we're quite pleased with it but we have a long way to go but it's still not large enough that it's that impact full on our overall margin rate in the Company.

And then, Laura, you might speak to PBteen and the emerging brands.

Well, Teen of course is a different issue.

Pottery Barn Teen is quite profitable.

Right.

And continues to exceed our expectations on both the top line and bottom line, so we're very excited about the future for Teen in the direct channel.

And would certainly not be detrimental to our overall operating margin.

And next we'll move to Joe Feldman, Chelsea Advisory Group.

Hi, guys.

First question I wanted to ask was furniture seems like it was strong across several of the brands and we were just kind of curious as to what you're seeing there because it does seem a little contrary to what we're seeing in the macro environment where a lot of the other retailers are calling out furniture being somewhat weak.

Let me say, Joe, let me just answer this question.

As a percentage of our sales, consistent on a trailing 12 month basis with last year, furniture was 29% of our total volume and I'm going to get Laura and Dave speak to furniture in the first Laura will speak to Pottery Barn and Dave will speak to the Williams-Sonoma Home in West Elm brands so Laura I'll turn it to you first and Dave you can follow Laura.

Thank you.

Furniture as I said in my prepared remarks has been the strongest piece of our business and I really believe it's because it is where we have the most differentiated product.

We have some beautiful finishes that you cannot find elsewhere in our stores and in our catalogs and also some very unique functions as well as strong marketing of course, but really, the customer continues to come to us for furniture and our new product offerings in categories such as media have been very very successful.

And we do know and we're quite aware that our competitors are not seeing the same success with their furniture that we are.

And in terms of, I have pretty much the same comparison to make as Pottery Barn.

In West Elm we put enormous amounts of effort into improving our quality, into our design of our product and we've made great progress there.

We've introduced a lot of new upholstery product over this past season and they've all been very successful for us so we continue to see strength in that area, and the same with Williams-Sonoma Home.

It is the strongest area of our business in the brand and I think it is a combination of the increased brand awareness for Home as we continue to circulate our market, our catalog in the marketplace and the launch of our website I think has also impacted the brand awareness and has helped to drive that product.

And Joe, I would say finally that when we look at this competitive space, we have always said that one of our greatest competitive advantages is our multi-channel strategy and our ability to present the furniture in the catalog and to have an equally high quality presentation on the website which many of these competitors that we get compared to don't have allow us to out compete them in this category consistently because it has been a consistent trend for us for the last couple of years.

And next we'll move to Adrianne Shapira with Goldman Sachs.

Thank you.

Just had two questions.

Just up until now, the comp shortfalls had been contained to Pottery Barn and Williams-Sonoma and PBKids have now turned negative as well.

In the past you've contributed about half of the PB softness to some of your own merchandising missteps.

I'm wondering give us a sense of how much of the softening at Williams-Sonoma PBKids is macro versus merchandising issues and then I have another question.

Dave I'll let you take the Williams-Sonoma Laura you may take Pottery Barn Kids.

It's best for me to comment on what we can control in our four walls.

We made significant progress with our mid size and small store strategy and we saw great execution there, all of the categories that we impacted through that remerchandising effort all out performed where we had not.

The weaknesses that we saw as I talked about in the prepared comments were in our food areas.

We de-emphasized our Valentine's Day offering due to margin liabilities and it did perform the way we de-emphasized it.

We also saw because we thought a particularly cold Spring in our drink categories some softness, so the food area was really particularly where we saw most of our softness.

And then on Pottery Barn Kids, we've introduced a lot of very successful strategies in Pottery Barn Kids, that compare on Pottery Barn Kids is very different than it is in Pottery Barn.

We had very high growth last year at this time and we are seeing softness, particularly in textiles and bedding, where the spend is more discretionary, probably in nature than it is in some of the more core categories, but we are very excited about our go forward strategy with kids and our customer and we've done some focus groups recently to just make sure that we're looking at everything possible.

Our customer continues to tell us how much they love the brand and how it continues to be the highest quality Children's Homes Furnishing brand in the market so we're not hearing any negative feedback nor have we changed our value proposition or design style in Pottery Barn Kids.

And Adrianne, I think it's important to note that if you go back to our last conference call, we had said that post- holiday, that we had started to see volatility and some of the trends that we have seen from a macro point of view in all of these brands, so if you look at our guidance for Q1, our revenues are right there in our range of guidance on an overall basis, we absolutely expected that we would see some additional softness across our other brands based on what we had seen post-holiday, so I would tell you that from our point of view, this is somewhat consistent.

I don't think that whether you call it by brand or not, I'm saying as an overall, our sense was that this macro would start trickling into these other brands.

It would make sense to us and our guidance was predicated on that as reason of being able to deliver our first quarter revenues.

So that's how we're thinking about that.

And next we'll move to Rex Henderson with Raymond James & Associates.

Good morning.

Thanks for taking my call.

A couple of questions.

First of all, just as a mechanical issue or detail on the SG&A, SG&A was down about 40 basis points year-over-year but versus your guidance it was down substantially more than that and I'm wondering if you could give a little bit of color on that of how much was unredeemed gift cards and remind us how the mechanics of the unredeemed gift cards flow through the income statement?

Basically when, if you recall last year, we had changed our accounting policy for unredeemed gift certificates and gift cards that after four years if they had not yet been redeemed they would be brought through income.

I actually saw a note this morning that said that it could be one-time income and Rex, that is not one-time income.

There is always a level, we have an actual report on this that of unredeemed gift card and gift certificates that will be coming into the P&L so the issue is that last year at this time on a regular, on an ongoing basis we had not yet changed our policy so you saw a little bit of year-over-year benefit but we really knew exactly what that number was going to be so that actually is not where we drove the better than expected versus our guidance SG&A rate.

Okay, can you give me some color on --

I'd be happy to.

That basically came from lower employment just across the Company and efficiencies in our distribution center.

Our DC is operating extremely effectively, we had a very mix of internet sales and our call center efficiency was very strong.

We also saw excellent management of store payroll despite some of the sales shortfalls in Williams-Sonoma so much better than we had in the past so we actually had positive things happening, in our prepared remarks we said the execution was really strong, so those are the key categories that we saw benefit and then in addition to that we actually saw benefit in AD comp, some of the things we're doing with this versioning are proving to be very interesting and we also saw some cost reductions on the catalog cost side that were included in those numbers, so it really is, I know you want one answer that simplifies it but it's doing everything a little bit better and then having great execution to stand behind it but our DC's are really doing an excellent job.

And we'll next move to Matt Nemer with Thomas Weisel Partners.

Good morning.

A couple of questions.

One, I'm wondering if the in sourcing the furniture hubs can provide some support to gross margins if the downward trend continues.

Secondly, have you seen any impact on your shipping expense related to the new postal rates that went into effect in the middle of May, and then lastly it sounds like you're seeing some success with paid search and direct e-mails at West Elm and I'm wondering how quickly you can transfer that to the other brands.

Thanks.

Okay.

As it relates to the in sourcing we absolutely believe that as we take on this West Coast initiative that there will be opportunity.

We're always cautious when you start up these new operations but there's no question that we would do this first and foremost to provide superior customer service.

That is the most important reason we are in sourcing these.

But we are seen cost benefit from doing that so we believe over time that that will happen.

As it relates to postal expenses, Pat, would you like to speak to the catalog postal costs?

Sure, Sharon.

Matt, our postal increases were much lower than the industry overall, primarily because our catalogs are larger and because of the way we enter them into the postal stream and the volumes that we mail.

We saw mid single-digit increases in that neighborhood which have been reflected in our guidance over the past several quarters.

And then Pat, also would you talk about paid search?

We're continuing to increase our paid search activities and seeing that there's good return there compared to some of the marginal catalog mailings we're doing and we think that remains an area of opportunity for us in the quarters ahead.

Next we'll move to Rob Wilson with Tiburon Research.

Yes, Sharon, we've heard a lot of commentary about better profitability in your direct to customer channels in Q1.

Could you speak to the profitability of the retail channel?

Thank you.

We'll speak to that, Rob, when we actually issue the 10-Q.

We haven't put that out there today, so our Q will be out shortly and you guys can take a look at that.

You're listening to it brand by brand.

We'll move on to Jack Murphy with William Blair.

Good morning.

Looking at the guidance going into the quarter versus where you came out just by channel, obviously retail was kind of high end a little bit better.

When you look at the direct to consumer channel as a group, was there anything, any kind of tactical change in circulation or anything or was there some reason just for lower than expected demand that kind of unified throughout the whole Company versus your guidance?

I think that within each of the brands they talked about their successes and the things that we believe drove our business.

I would say that Pat from a marketing point of view, why don't you just speak to the success that we're seeing in the targeting and the segmentation in circulation because I do think that that's an important aspect particularly currently in the Williams-Sonoma brand but where you're going with Pottery Barn.

I think they would like to hear about that.

Jack, we've implemented a new marketing system for all of our catalog mailings that is really allowing us to do a better job of targeting our customers particularly at the lower end of the more marginal catalogs we're mailing.

In addition we've implemented a new matching technology that will allow us to much better identify duplicates and really cut that to a very substantial amount than we've had in the past and we're seeing good results in that.

Williams-Sonoma Home as Dave mentioned we've had very significant progress there in terms of the productivity of our catalogs.

We're continuing to see that in West Elm as well, and we've had as Laura mentioned some very good success early reads on versioning and Pottery Barn which will be rolling that out to a greater level in the future so we're very encouraged by all of those things.

And next we'll move on to David McGee with SunTrust Robinson Humphrey.

Yes, hi.

Good morning.

A couple of questions, please.

First, on the shipping cost side with the move to lower the cost earlier this year, are you seeing or is it too early to say that you're seeing a percentage of increase in the velocity because of that factor alone and if that's not the case, would there be an opportunity to beef those up a bit?

Laura, would you like to speak to that?

The majority of that is happening currently in the Pottery Barn brand, so Laura could you speak to your shipping initiatives?

Sure.

We've been fortunate that we've had some improvements in our supply chain on the cost side, which have been great and allowed us to give back to our customer value in shipping and we are seeing a correlation between the reductions in shipping and increased velocity both on the shipping rate table change and also on reduced surcharges by item.

It's something that we look at constantly and that we're building the strategy based on the successes we're seeing now for the future.

And next we'll move to Neely Taminga with Piper Jaffrey.

Great.

Good morning.

Laura, could you talk a little bit about some of the earlier signs you're seeing in terms of speaking specifically with Pottery Barn Kids, the latest catalog that dropped I thought you did a great job featuring the kids birthday and kind of a green theme with these kids.

Have you seen good feedback on these categories particularly with the outdoor living?

Is that something that could turn even as quickly as Q2 within the stores or how should we be thinking about that and in terms of your opportunity in markdowns that you mentioned from last year, is that opportunity greater in Q3 or Q4?

Thanks.

Okay, let me just first talk about Pottery Barn Kids, Neely.

The customer is clearly very excited about our new businesses both our parties and also the organics that we've introduced, while they aren't huge volume, we're getting a lot of buzz and seeing activity on our registry from some of these organic towels and we're excited about that and think it's a very relevant future strategy although I will tell you that I don't believe it's volume in the very short-term.

Where we're seeing softness is in some of the core categories particularly bedding and textiles I said earlier, we're seeing strength continue in Pottery Barn Kids and Furniture but we had such incredible growth in some of those categories last year and it is just tougher out there and there is pressure on the price point in kids and we're doing everything that we can to make sure that we're providing superior customer service and a very innovative product line as we go forward, and so this is one I'll say that I'm cautious about what we have in store for us in the second quarter.

I'm extremely excited about our increased gift giving assortment that comes in for Christmas in the Pottery Barn Kids business and also getting back in stock as I said with our cribs, which continues to be difficult, because our quality standards are so high that we want to make sure that we don't ever ship anything to our customer that's sub standard and so we've been very careful in our furniture execution of cribs and introducing new ones into the market until they are perfect.

Our Fall catalogs for Pottery Barn Kids have a very strong back-to-school presentation as does our store and there's a lot of very new, inventive products there, so again, I think that the assortment is very strong and the consumer as I said earlier continues to tell us that they are very loyal to the business.

It's just that they are not spending the discretionary money that they were last year in some of the very important categories in our Kids business.

As it relates to markdowns I was really referring to Pottery Barn actually as I look at the back half of this year, we do have an opportunity particularly at retail, if we sell more at regular price.

And next we'll move to Brian Nagel with UBS.

Hi, good morning.

My question pertains to inventories.

For the past couple quarters we have seen inventories track well ahead of sales growth.

If you could comment, just kind of on the composition of those inventories and your view on how much potential markdown risk remains.

Thank you.

In our prepared remarks, we talked about the inventory.

The year-over-year increase in the inventory is predominantly driven by Pottery Barn and that of course has been brought in from year-end as we saw softer sales in the fourth quarter.

The second largest increase we have in the inventories in Williams-Sonoma as our assortment has moved toward our higher end assortment and then that was also supported by the Stonestown project our small and mid size store re-merchandising project.

That has given us higher average unit cost.

It is not a unit issue in Williams-Sonoma and then of course you've got the natural growth of the emerging brands.

We do have an increase in emerging brands but as we open more stores of course you have to not only put in your back shop but you have got to put in the store inventory so that's how we're thinking about it but it's really very similar to Q4 from a content point of view and Laura?

I just want to make one comment that I think is really kudos to the inventory team in Pottery Barn.

We've been very aggressive about reducing inventories on old merchandise, particularly in direct where we're starting to see real traction on our inventory levels and I think you'll be pleased to see the reduction going forward on inventories and Pottery Barn direct.

At retail I said because you have inventory in a lot more locations, it's harder to reduce it as quickly as we were able to in our direct business; however at retail, where we have overstock, it's in core, and in our guidance, it reflects the increased markdown activity that we foresee in Q2.

And that is all the time we have for questions.

I will turn the call back over to the speakers for any additional or closing remarks.

Well, thank you, everybody for joining our first quarter 2007 conference call today.

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

Have a great day.

And that will conclude today's call.

We thank you for your participation.