Williams-Sonoma Q4 Earnings Call Transcript

123jump.com Staff
07 Apr, 2009
New York City

William-Sonoma fourth quarter net revenue fell 27% to $1.01 billion while profit fell 90.2% to $12.2 million due 22.3% slump in comp store sales. Earnings per share were 12 cents as against $1.15 a year ago.

Williams-Sonoma, Inc. ((WSM))
Q4 2008 Earnings Call Transcript
March 24, 2009, 10:00 a.m. ET

Executives

Steve Nelson – Director of Investor Relations
Howard Lester – Chairman and Chief Executive Officer
Sharon McCollam – Chief Financial Officer, COO and Executive VP
Dave DeMattei – Group President of Williams-Sonoma, Williams-Sonoma Home and West Elm
Laura Alber – President
Pat Connolly -- Chief Marketing Officer

Analysts

Colin McGranahan – Sanford Bernstein
Alan Rifkin – Bank of America/Merrill Lynch
Matthew Fassler – Goldman Sachs
Budd Bugatch – Raymond James & Associates
Joe Feldman – Telsey Advisory Group
Matt Nemer – Thomas Weisel Partners
Michael Lasser – Barclays Capital
Scott Ciccarelli – RBC Capital Markets
Laura Champine – Cowen & Co
Marni Shapiro – The Retail Tracker

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Williams-Sonoma Incorporated fourth quarter and fiscal year 2008 earnings and fiscal year 2009 financial guidance call. At this time, all participants are in a listen-only mode. We’ll conduct a question-and-answer session after the presentation. This conference is being recorded. I would now like to turn the call over to Steve Nelson, Director of Investor Relations at Williams-Sonoma Incorporated to discuss non-GAAP measures and forward-looking statements. Please go ahead sir.

Steve Nelson – Director of Investor Relations

Good morning. This morning’s conference call should be considered in conjunction with the press releases that we issued earlier today. I’d first like to discuss the non-GAAP financial measures that are included in this morning’s press release and today’s conference call. Our press release contains non-GAAP financial measures that exclude the impact of unusual business events. For the remainder of today’s call we’ll be discussing our fourth quarter and fiscal year 2008 results excluding the impact of these items and we’ll refer to these results as non-GAAP. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons. 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 earnings press release. I’d 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 2009 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. As a reminder the fourth quarter of 2008 was a 13 week quarter versus 14 weeks in 2007 and fiscal year 2008 was a 52-week year versus 53 weeks in fiscal year 2007. All year-over-year revenue comparisons for the fourth quarter and fiscal year would be on comparable 13-to-13 week and 52-to-52 week basis respectively. The extra week in 2007 added approximately $70 million or 5% to our fourth quarter 2007 revenue growth and 4% or $0.05 to our diluted earnings per share. I’ll now turn the conference call over to Howard Lester, our Chairman and Chief Executive Officer.

Howard Lester – Chief Executive Officer

Thanks Steve. Good morning and thanks to everyone for joining us. With me today are Laura Alber, our President; Pat Connolly, our Chief Marketing Officer; Dave DeMattei, our Group President for the Williams-Sonoma and Williams-Sonoma Home, and West Elm brands and Sharon McCollam our Chief Operating and Chief Financial Officer. I’d like to begin today with an overview of our fourth quarter results and our 2009 outlook. Then I’ll turn the call over to Sharon, Dave and Laura for further details. Our fourth quarter results were better than expected due the increased promotional activity and tighter expense controls, our ability to drive increased traffic and conversion in this difficult economic environment, proved to be a significant challenge. As such we focused on aspects of the business that we could control and made significant progress on those initiatives that would strengthen the company’s financial position as we enter 2009. These initiatives included one, successfully amending our unsecured credit facilities and ending the year with significant cushions in our covenants, two, reducing our year end inventory levels by 17% or $121 million, three, initiating and implementing a $75 million infrastructure cost reduction program and four, optimizing profitability through aggressive expense management and highly controlled promotional activity. During the fourth quarter on a 22% decline in net revenues, we delivered non-GAAP diluted earnings per share of $0.31. We also increased our cash balance by $30 million to $149 million, after returning over $50 million to our shareholders through dividends during the year.

While these results in no way reflect a level of performance we were satisfied with, they do demonstrate the flexibility of our multi-channel business model and our organization’s ability to drive rapid change in a down trending economy. It is our ability to change, that allowed us to deliver the results we did in the fourth quarter of 2008. Our leaders abandoned business as usual early on and focused on what needed to be done in the short-term without ever losing sight of what was important, our customers and our brands. And while we were committed to driving revenue across all channels, an equal focus was placed on improving operational efficiency, driving down costs and lowering inventories. In our supply chains, we continued to make significant progress on our key initiatives including restructuring our Asia furniture sourcing network to establish in-country expertise and improved vendor performance, expanded our U.S upholstery furniture operations to provide shorter lead times, better quality, lower costs, and improving six of our largest local furniture delivery hubs to improve customer service and reduce returns, replacements and damages expense.

These initiatives combined with tightening of our customer return policies drove an 80 basis point reduction in our total company sales return rate and a 30 basis points reduction in returns, replacements and damages expense. We also reduced distribution capacity by 7% due to substantial improvements in inventory management. In information technology we continued the roll out of our direct to customer order management system. This is a phased implementation that is improving efficiency and functionality in an area that we believe still has significant cost and inventory planning opportunities. In the customer insight area, we have promoted a new functionality that is allowing us to significantly improve the relevancy of our marketing contacts and optimize our catalog response rates. In e-commerce we completed the migration of all of our websites to our next generation platform with the exception of West Elm which will be transitioned in ’09. We also began testing new functionality in the areas of click-to-call, product reviews and search. Infrastructure results are a key area of investment this year including the replacement of our company wide point of sale hardware and the roll out of electronic signature and thin debit functionality in our stores.

In addition to our supply chain and information technology advancements, there were also significant direct marketing and brand-specific highlights that were very important. In direct marketing, we reduced catalog advertising cost by $45 million based on the success of our catalog circulation optimization strategy. At the same time we continued to aggressively explore additional traffic drivers through paid and natural search, target-driven direct response, and affiliate programs. While we are still in the early stages of these roll outs all of these initiatives have driven increased traffic and incremental sales to the brand. In West Elm we opened 9 stores including our first stores in Canada and Puerto Rico. Across all brands in 2008, we opened 27 maintenance stores and increased leased square footage by 7.1%. While the timing of this additional leased square footage was unfortunate in this economic environment, the locations are all strategic and will be brand enhancing long-term.

In PBteens new product information and superior execution drove a 4% increase in year-over-year net revenues, which is impressive in these challenging times. And as we enter 2009, our focus is in three key areas, one, optimizing our brand positioning and marketing strategies in a reset economy, two, improving profitability and three, strengthening our balance sheet. To optimize our brand positioning we will continue to evolve our merchandize assortment and place a greater emphasis on opening price points and the value proposition. We will also continue to make superior customer service our top priority. We continue to believe that the strength of our brands, our multi-channel strategy and superior execution will allow us to gain market share as competitors fail or become less relevant and benchmark stores refocus on their core business.

To optimize our marketing strategies we are taking our catalog circulation optimization strategy to the next level and continuing to shift advertising dollars from catalog to e-commerce. E-commerce is our most profitable channel and we continue to identify new opportunities to build brand awareness and customer engagement through search, e-mail modeling, affiliate programs and enhanced functionality.

To improve profitability, our most significant initiative is the $75 million infrastructure cost reduction program we implemented in January. We’ll also be realizing increased productivity from catalog circulation optimization strategy which we expect will drive an additional 20 million in advertising cost reduction. In addition, we expect to realize a 50 to 100 basis points increase in our selling gross margin due to fewer markdowns and lower inventory levels as well as an additional $10 million to $15 million in savings from our furniture returns, replacements and damages initiatives.

To strengthen our balance sheet we will continue to optimize cash flow through aggressive inventory management and lower capital spending. In 2009, we expect to reduce merchandise inventories by $60 million to $90 million and gross capital spending by up to a $100 million. Based on this reduction, gross capital spending in 2009 is expected to be in the range of $90 million to $100 million but will be partially offset by store construction allowances of approximately $20 million. In ’09 we are only proceeding with new and remodeled stores that we are already committed to. Therefore net of store closings, retail leased square footage is only expected to increase approximately 1%. To the extent possible we will reduce this number further as we work with landlords to close underperforming stores. We believe all these initiatives will continue to improve our competitive positioning and allow us to emerge stronger when the economic headwinds we are currently facing subside. In 2009, we expect the net revenues to decline in the range of 12% to 17% and diluted earnings per share on non-GAAP basis to decline $0.30 to $0.50 to a range of -$0.15 to a positive $0.05.

This progress is based on a snapshot of how we believe 2009 will look if the top line trends we are seeing today continue and we deliver against the initiatives that I’ve just described. We are not intending to signal any type of insight into which direction the economy is headed but only that if our trends continue as they are today, this is how we’d expect the year to unfold. Also in 2009, we expect cash flow from operating activities net of capital spending to increase by at least $75 million. As such we announced this morning that we are maintaining our quarterly cash dividend at $0.12 per share for the balance of the year for a total annual payout of approximately $51 million. Assuming there is no significant changes to our business plan and our operating results are within the ranges of financial guidance we’ve provided today, net of the dividend we are targeting a cash balance of at least $200 million at the end of fiscal 2009. I’ll now turn the conference call over to Sharon for additional details on our 2008 performance and our 2009 guidance. Sharon?

Sharon McCollam – Chief Financial Officer

Thank you, Howard. Good morning. Before we discuss 2008 results, I want to mention that some financial comparisons maybe discussed on a non-GAAP basis as described by Steve earlier in today’s call. The two unusual business events excluded in this comparison are the $20 million or $0.12 per share asset impairment charge for underperforming retail stores and the $13 million or $0.08 a share charge associated with our infrastructure cost reduction program. Despite the unprecedented challenges facing the home furnishing sector in the fourth quarter, our results were better than expected as we collect our actions to adopt in a reset economy. The highlights are as follows. Fourth quarter non-GAAP diluted earnings per share decreased 73% to $0.31 versus the $1.15 in the fourth quarter of 2007. Net revenues in the fourth quarter decreased 22.2% to $1.8 billion. The decline was broad based with comparable store sales decreasing 22.3%. Direct to customer revenues declined by 25.5%. Circulation of catalog and catalog pages decreased 17% and 28.5% respectively, on a comparable 13 week-to-13 week basis. In our core brands net revenues decreased 23.1% compared to a 14.3% decrease in our emerging brands. Non-GAAP gross margin expressed as a percentage of net revenues decreased 770 basis points to 33.9% in the fourth quarter. This decrease was primarily driven by the impact of increased markdowns, with de-leverage of fixed occupancy expenses primarily due to declining sales and an increase in inventory related reserves, partially offset by favorable inventory shrinkage and replacement and damages expense.

Non-GAAP SG&A expenses as a percentage of net revenues in the fourth quarter increased a 150 basis points to 28.8%. This increase was primarily driven by the de-leverage of employment and total advertising costs primarily due to declining sales, partially offset by reductions in other general expenses.

Now, I’ll discuss our fiscal 2008 earnings highlights. Fiscal 2008 non-GAAP diluted earnings per share decreased $1.41 to $0.35 including the loss of the $0.05 per share diluted benefit from the extra week in 2007. Net revenues in fiscal year 2008 decreased 13.2% to $3.361 billion. Comparable store sales decreased 17.2% despite a 7.1% increase in retail leased square footage. Direct to customer revenues declined by 13.8%. Comparable week circulation of catalogs and catalog pages decreased 16.2% and 26.3% respectively reflecting implementation of our catalog circulation optimization strategy beginning in the second quarter. In our core brand net revenues decreased 15.2% compared to a 1.7% increase in our emerging brands. Gross margin expressed as a percentage of net revenues on a non-GAAP basis decreased 500 basis points to 33.9% in fiscal year 2008. This decrease was driven by the de-leverage of fixed occupancy expenses primarily due to declining sales, increased markdowns and an $11 million increase in inventory related reserves, partially offset by favorable replacement and damages expense.

SG&A expenses as a percentage of net revenues on a non-GAAP basis in fiscal year 2008 increased a 130 basis points to 32.3%. This increase was primarily driven by de-leverage of our employment and advertising costs due to declining sales, partially offset by reduction in other general expenses. The effective annual income tax rate for fiscal year 2008 was 28.4% versus 38.1% in 2007. This decrease was primarily driven by certain favorable income tax resolutions during 2008.

Significant year-over-year working capital balance sheet variances at the end of fiscal year 2008 were as follows. Cash and cash equivalents at the end of fiscal year 2008 were $149 million, an increase of $30 million over year end 2007 with no outstanding borrowings under our $300 million revolving line of credit, which was successfully amended in the fourth quarter. Our consolidated statements of cash flow are included in this morning’s press release. Merchandized inventory decreased $121 million or 17.4% to $573 million. The primary driver of this decrease was a reduction in units across all brands except PBteens including a $72 million reduction in the Pottery Barn core brands, a $34 million reduction in the emerging brands and a $35 million reduction in the Williams-Sonoma brand including costs and mix shift impact. These reductions were partially offset by a $20 million increase in new and remodeled stores across all brands.

Pre paid catalog expenses decreased $18 million or 34% to $36 million. This decrease was primarily driven by reduced catalog circulation partially offset by cost increases in paper and postage. Customer deposits decreased $10 million to $192 million. This 5% decline was driven by a year-over-year decrease in unredeemed gift cards reflecting this year’s lower level of customer demand in the third and fourth quarter. Accounts payable decreased $35 million or 18% to $162 million. This decrease was in alignment with our inventory reduction.

I’d now like to discuss the details of our fiscal year 2009 guidance. Before I begin however I’d like to point out that to provide meaningful full comparison to our 2009 guidance, we are excluding unusual business events from our 2008 results as I mentioned earlier. As these are non-GAAP comparison this should be interpreted in conjunction with exhibit 1 of this morning’s press release. We’ve approached our 2009 guidance by basing our planning on the assumption that the trends that we saw in the October, November time period will continue until they anniversary during the third quarter. This is consistent with our experience since that time with the exception of seasonally increased demand during holiday and the effect of promotional activities we undertook to take advantage of holiday and post holiday traffic to clear inventory. As we do not anticipate repeating the promotionally driven sales next fall, our guidance reflects negative revenue in all quarters. In line of our outlook net revenues in 2009 are projected to decrease in the range of 12% to 17% with comparable store sales projected to decline in the range of 12% to 16%. We are expecting an approximate 1% increase in retail leased square footage with 8 new stores, 7 remodeled expansion projects, and a minimum of 7 permanent closures scheduled. As we continue our catalog circulation optimization strategy we expect catalog circulation reduction in the range of 19% to 21% for the year.

Gross margin as a percentage of net revenues in fiscal year 2009 is expected to decrease 180 to 250 basis points on a non-GAAP basis. This decrease is primarily driven by the fixed cost de-leverage of occupancy associated with the mid teen decrease in net revenues partially offset by targeted improvements in cost of merchandize sold and replacement and damages. SG&A expenses as a percent of net revenues in fiscal year 2009 are expected to decrease 10 to 50 basis points on a non-GAAP basis. This decrease is primarily due to a reduction in advertising costs as well as the effect of our infrastructure cost reduction program and our ongoing efforts to flex our expense structure to this reset level of business. Income tax expense as a percentage of pre tax earnings in fiscal year 2009 is expected to be in the range of 35% to 41% versus 28.4% in fiscal year 2008 due to certain favorable income tax resolutions in fiscal year 2008 that are not anticipated to recur in fiscal year 2009, in addition to lower levels of earnings and markups.

Capital spending in fiscal year 2009 is expected to be in the range of $90 million to $100 million of which approximately 50% is for new and expanded stores, 25% for information technology and 25% for store maintenance, distribution centers and other facilities. Inventory at the end of fiscal year 2009 is expected to be in the range of $480 million to $510 million, a reduction of 11% to 16%. Consistent with our strategic initiatives to enhance shareholder values we remain committed to optimizing growth and profitability wherever possible in 2009 despite the challenges we face in the current macro economic climate. I’ll now turn the call over to Dave DeMattei to discuss the Williams-Sonoma, Williams-Sonoma Home and West Elm brands.

Dave DeMattei -- Group President of Williams-Sonoma, Williams-Sonoma Home and West Elm

Thank you, Sharon. Good morning. I’d like to begin with Williams-Sonoma. While the Williams-Sonoma brand was our top performing core brand in the fourth quarter, it too was negatively impacted by declines in mall traffic and increased promotional activity. During the quarter net revenues declined 14.2% with similar decreases in both channels. Selling gross margins also declined particularly in the retail channel as we introduced several traffic generating promotional events during the holiday period. The performance in the retail channel was primarily driven by a 16.8% decrease in comparable store sales partially offset by incremental revenues from new and expanded stores. From a merchandizing perspective we had negative growth in all key categories although bakeware, electrics and cookware were less pronounced. Exclusivity and perceived investment value continued to drive these categories as people are eating out less and entertaining at home more. As we enter 2009, we are doing so assuming that the revenue trends we have seen since the October and November 2008 will continue throughout the year. Therefore we are executing in this several key initiatives that we believe will resonate with our customer and drive our business in these more challenging times. These initiatives include partnering with key vendors to introduce innovative and exclusive products that are unique in the marketplace, enhancing our value proposition by offering more set pricing options and working with vendors to establish key price points in critical categories, taking the cooking authority that Williams-Sonoma has established over the years and expanding our developed foods to take advantage of the trend in home cooking and finally expanding our e-commerce marketing in the areas of paid and natural search, customize e-mail, product reviews and remarketing. We believe that despite the macro environment our strong merchandizing, concentrated marketing and superior customer service will continue to differentiate our brand as the destination of choice for the consumer.

In the Williams-Sonoma Home brand the fourth quarter continued to be very challenging as the October, November 2008 turn down in the high end retail sector continued to have a substantial impact on the brand’s performance. During the quarter, despite a substantial increase in promotional activity, brand net revenues declined significantly in all stores and in the direct to customer channel. While we are disappointed with these results, we believe that this customer has been particularly impacted by the macro environment and that these trends are likely to continue in the foreseeable future. Therefore, we are approaching 2009 as a year of transition in which we are going to aggressively implement strategies that will prioritize profitability over growth. These strategies include refining the product assortment to cater to our best customers including merchandizing at the store level, integrating buyer registry with the Williams-Sonoma Kitchen brand and take advantage of the buyer traffic, reinventing the direct to customer strategy with a significantly greater emphasis on e-commerce versus catalog and leveraging the new furniture sourcing network to lower inventories and reduce returns, replacements and damages expense. While these initiatives will improve profitability in 2009, there is still tremendous fixed cost pressure from underperforming retail stores that has to be addressed. Therefore in addition to these initiatives above, we are also working with our landlords on three potential store closings. All three of these stores have been fully impaired as of the end of 2008. Additionally we will continue to assess the brand’s overall market potential in this economic environment as we progress through the year.

And finally West Elm, while West Elm continued to be more resilient than our other home furnishings brand, net revenues during the fourth quarter did decline due to lower traffic and conversion. These declines were partially offset however by incremental sales from nine new stores. Selling gross margins also declined due to significant promotional activity during the quarter. West Elm ended the quarter with 36 stores including our first store in Puerto Rico and Canada. From a merchandizing perspective during the quarter, while we did see positive growth in table tops it was more than offset by declines in furniture and decorative accessories.

As we enter 2009, our focus in West Elm will be on continuing to expand the reach of the brand and improving profitability despite our expectation that comparable store sales will be negative. To expand the reach of the brand, we are opening four new stores in 2009, one in Emeryville, California, and one in Manhattan both of which have already opened as well as Scottsdale which is opening within the quarter and Austin later in the year. We are also developing a new opening price point merchandizing strategy and emphasizing our value proposition through our brand marketing. To improve profitability we are optimizing our vendor base through factory consolidation, improving packaging to further reduce returns, replacements and damages, refining our product mix such that a larger percentage of the mix is in the higher margin categories and lowering brand advertising costs by continuing to reduce and version catalog circulation while at the same time investing in higher productivity Internet opportunities. We believe our good design at great prices in West Elm will prove relevant in these trying times and provide a significant competitive advantage over the long-term. I’d now like to turn the call over to Laura to discuss the Pottery Barn brands.

Laura Alber – President

Thank you, Dave. Good morning. First I’ll start with the Pottery Barn brands. Fourth quarter year-over-year net revenues decreased 31.8% including a 250 basis point impact related to the catalog circulation optimization strategy. We saw comparable store sales decline 29%. Selling margins also declined due to aggressive markdowns related to inventory clearance and higher promotional activity in both the retail and direct to consumer channels. From a merchandizing perspective we saw significant decreases across all major categories including furniture. Our best categories while still negative were textiles and flooring that was driven by promotional initiative. From an operational perspective during the quarter, our returns, replacements and damage initiatives generated significant customer service and financial benefits as we continued to reduce our rates. We also successfully reduced our inventory levels in both units and dollars despite significant sales declines during the quarter. To provide grater value to our customers we introduced 12 months zero percent financing and enhanced our third party private label credit cards rewards program. These programs increased our card penetration and is correlated with an improvement in our furniture demand. In 2009, we recognized that the environment is difficult and as such have built our brand strategies to address profitable sales. These opportunities include clear and consistent merchandized strategies with improvement in every category. As part of this we are aggressively shifting our value proposition through competitive and cheaper prices, additional category promotions and our third party private label credit card program. We are also enhancing our value proposition through increased marketing, other grade opening price points and offers in all channels. Differentiated service is also a key component of our strategy. We are increasing our in-store design services to create retail and have added clienteling and new store events to improve the in-store customer experience.

We also recognize how important the Internet is to our future and we are focused on our selling effectiveness online and we have increased our Internet marketing to drive conversions and we are taking our catalog circulation optimization strategy to the next level. During 2009 we also remain intensely focused on our ability to successfully reduce inventory, tightly manage operating costs, and maximize profitability in order to keep in line with the changing trends of sales.

Now I’d like to talk about Pottery Barn Kids. Fourth quarter net revenue in Pottery Barn Kids declined 23.1% including 370 basis points impact related to the catalog circulation optimization strategy. Retail comparable store sales declined 24.9%. Selling margins also declined due to increased markdowns and significant inventory clearance. From an operational perspective during the quarter we continued to reduce inventory levels in tandem with our sales decline and made significant progress on our returns, replacement and damage initiative. We also achieved significant benefit from the catalog circulation optimization. As we look forward to 2009, we had the same theme with Pottery Barn, to deliver great products and a great value with continued focus on opportunities to maximize sales in the current environment while protecting our strong competitive presence. These initiatives include offering customers a wider range of opening price points by engineering value into key categories without sacrificing quality, marketing our private label credit card with its one year famous cash financing offer that is key for customers in need of children’s furniture as a life stage purchase. Starting our assortment and license program with premium brand names to create clear destinations for decorative teens, expanding our e-commerce marketing in the areas of pay and natural search, customize e-mail and remarketing and improving our four wall contribution in each and everyone of our stores including removing underperforming category such as baby apparel and party consumables.

Lastly we are closing our two tried test stores. Our Manhattan location will be used as a test showroom for PBteen merchandize and the other locations have been given back to the landlords. For both the Pottery Barn and Pottery Barn Kids brands our initiatives in 2009 will update our core assortments to reflect today’s economic environment and manage the aspects of the business that we can control, while at the same time protecting our brand image. By focusing on all these initiatives we believe that the Pottery Barn and Pottery Barn Kids brands will emerge from these challenging times with an even stronger competitive presence.

I’d now like to talk about Pottery Barn Teens. During the fourth quarter net revenues in the PBteen brands declined by 14.5% and while this decline was disappointing PBteen was still our best performing brand in the company during the quarter. And also a great part of the fact that PBteen was also the best performing brand for the year with 4% positive net revenue growth. As Howard said earlier in this environment that is impressive performance. From a merchandising perspective, like our other home furnishing brands, we did see sales declines in all categories. Textiles, however, was our best performing category. As we enter 2009, we will continue to focus on extending the reach of the brand and maintaining it’s positioning as the top of line destination for home furnishing for teens. These initiatives include expanding our merchandize assortments across a wider range of price points to serve a broader range of teens, creating a PBteen online community through select social networking sites, increasing e-commerce conversions through improved site usability merchandizing and customer interaction and testing PBteen merchandize at retail in a small showroom in New York and within the four walls of three Pottery Barn Kid stores. We continue to be excited about the long-term growth potential of PBteens as it solidifies it’s positioning in the Pottery Barn portfolio of brands. I’d now like to open the call for questions. Thank you.

Question-and-answer session

Operator

Thank you and if you’d like to ask a question today please do so by pressing the * key followed by the digit 1 on your touchtone telephone. If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment. Once again that’s “*1” on your touchtone telephone and we’ll pause for just a moment. We’ll go to our first question, Colin McGranahan with Bernstein.

Colin McGranahan – Sanford Bernstein

Hi good morning, couple of quick questions here. Just doing the calculation and the comp looks like maybe January given the holiday comp, January maybe was in the -16% to -17% range. Is that really driven is that sequential demand driven more by clearance activity? Was there any real demand improvement and to the degree that you are willing to given that you are almost through with March, what have you seen since then?

Sharon McCollam

Colin I’ll take that. Yes your January calculation is right in that range and it was driven by clearance. So, what we would say about the current environment is we believe we have stability and we are seeing the October, November trend, see our base line. We see it is volatile but that’s what we are seeing.

Operator

And our next question comes from Alan Rifkin with Bank of America/Merrill Lynch

Alan Rifkin – Bank of America/Merrill Lynch

Yes couple of questions if I may and I think I’ll list both of them upfront if you don’t mind. Your outlook for SG&A leverage was a -12% to-16% comp is quite admirable. So, can you maybe just provide a little bit color on how much of that reduction in SG&A is due specifically to the infrastructure reduction program and then on a more going forward basis, what do you think the opportunities are for SG&A leverage? That’s question number 1, and question number 2 is as you continue with the catalog circulation optimization program, can you just provide some color as to your opinion as to the returns of that program? Obviously you are giving up revenues but can you maybe just shed some color on your ROIC of that program? Thank you very much.

Sharon McCollam

Okay I’ll take the question on the SG&A and then Pat if you could take the question on the catalog circulation optimization strategy that would be great.

Pat Connolly

Okay.

Sharon McCollam

On the SG&A side Alan there are two primary drivers, on the infrastructure cost reduction program, year-over-year $16 million of that is in SG&A. So, when you do the math on the revenue base it is within the range of guidance we provided to you. That’s clearly driving a substantial piece of that number. In addition to that we also discussed the ad cost benefit. Howard mentioned the $20 million. We consider that as sort of fixed, semi-fixed. It is not having a major impact on the revenues but in addition because of the flexibility of business model, in this declining sales environment we are also reducing catalog circulation. So, the reduction program, infrastructure cost reduction program is the largest driver but you also have a substantial driver coming from catalog ad costs. Then which we didn’t call out in the infrastructure cost reduction program per se, throughout the company all year we have been reducing our SG&A in virtually every area. The other fixed expense, the other general expenses areas and that’s also driving, a portion of that and finally we have made some substantial progress in our labor scheduling modules in virtually every aspect of our variable labor starting with stores and then in the call centers and the DC. As a result of that we are seeing important leverage in everyone of the aspect of our business where we have variable labor. So, those are really the drivers of that. Then Pat could you please take the catalog circulation changes?

Pat Connolly

Sure, thank you Sharon. Alan we are seeing the books that we are eliminating as part of our optimization startaegy would have had ad costs in the 80% to 100% range. That means if we took 10 million out of costs we are looking at about between 10 million to 14 million in sales of the company there. We are using four techniques to do that. Outside data which helps us analyze marginal loans. We are extensively using versioning. We now have some brands that are up to 50% of our total circulation of version. We have right sized all of our pages transcribed, really focusing on signals per square inch productivity and we are adjusting the trim sizes of all of our catalogs to uniform size so that we can take maximum advantage of common opportunities. We are doing all of that in 2009.

Operator

We’ll now move on to Matthew Fassler with Goldman Sachs.

Matthew Fassler – Goldman Sachs

Thanks a lot and good morning to you. My question focuses on your discussion essentially emphasizing value. It seems that you alluded to that in the relation in your comments to acclimate to your new environment. Can you talk a little more detail about how you plan to do that, which brand you intend to focus on or your plans from across all brands and then also as you have tested your approach, how is consumer’s responded to promotions till our price points and I guess to value-oriented marketing, assuming that those are some of the options you have for pursuing that strategy.

Sharon McCollam

Laura, would you speak to Matt’s question please?

Laura Alber

Great. Thank you, Matt. Good morning.

Matthew Fassler – Goldman Sachs

Good morning.

Laura Alber

I wanted to reiterate that we are seeing the customer look for value in everything they buy. They are also very focused on still great quality design that will last and stand the test of time. And so we have looked at and this is in all of our brands, competitive pricing across every category and really researched our competition heavily to understand where they have moved down and potentially out marketing us or out pricing us and we, starting last year, started making necessary adjustment to continue in this new world of pricing and promotions and we are in this for long time and so you are going to see this year us introduce more opening price points and in the Pottery Barn brand, I’ll let Dave speak to West Elm and William-Sonoma, so we have actually reduced our actual opening price points and so there is more out there and of course the starting point is lower. We are also looking at 12-month calendar promotions monthly that are organized and in print to bring our customers into certain categories that will drive repeat purchases in the future. So, for example you saw Snow White sales, that was successful and we believe that the customers when they buy our towels they love them so much. They will come in and buy more towels later, and we’ve seen that occurring, seen that the financials actually get a pay back on margin dollars. So, we are looking at lower price points, more promotions on a regular basis and then of course our private label credit card I talked about and finally shipping value. We continue to look at ways to improve our costs so that we can pass along to our customers the savings and improve our shipping value where the price points are too high as a percent of the total sales. We are marketing all of these promotional, all these promotional activity and our value proposition more dominantly even then in the catalogs and in the stores in the back half of the year than you will see now. So, as you see the summer books and then subsequent fall books that come out and you will see very relevant ways that they are focused on value and understand the consumer’s mindset. So, we are really excited about this strategy. We think it is completely solid and it has been in the works for the last year. Dave, do you want to add?

Dave DeMattei

No, Matt as I said in my prepared comments for William-Sonoma, we have been really looking at, working on our set pricing. If you look in our stores right now, you’d see a roll back in our prices in our Apilco French Porcelain you’ll also see set pricing mix and match which we see working well. We went to set pricing in our Riedel glassware and in our selected products and in our Shun cutlery. We worked on with the vendors in getting better pricing and reducing our opening price points. We are making sure in our cookware that in our open stock that we have key price points that are under $100 and I think one of the bigger things that we see happening is the trend in our food and so we are continuing to develop our prepared foods. You’ve seen in the windows the Sloppy Joe Mixes, the new Bouchon programs, so we continue to work on that. Sooner we’ll be introducing new food programs for the remainder of the year which we are very excited about and finally in our seasonal goods there are exclusive to us that are developed by us, we are making sure that we price those appropriately, have compelling price points in our assortment where we control the complete assortment.

In West Elm, there is some little bit which Laura added. We now have been marketing in our stores, in our website, in our catalogs for three months now, good design at great prices. Affordability has been kind of the ethos of the brand. We are now playing up the marketing of that. We have developed like Pottery Barn brands monthly favorites that we are merchandizing into. We are using those as EDMs and as store events to drive traffic and conversion. We’ll be testing shipping in our direct channel as we continue to find the right equation on that and we are now syncing all of these promotions with the books as we move into the summer seasons and fall seasons. Where we were playing a little bit of catch up in the early part of the year, we are now thinking that we will be marking them and like Pottery Barn, West Elm has adopted the private label credit card, over a $100,000 purchase interest free and no payments for a year and that seems to be helping us with our furniture business.

Operator

We’ll now take our next question from Budd Bugatch with Raymond James.

Budd Bugatch – Raymond James & Associates

Hi good morning. This is actually T.J McCondle (ph) filling in for Budd. I had a couple of questions, just if I ask them both at the same time. First is on the private label credit card a little bit more detail there. First have we seen any types of push backs as far as approvals have gone maybe when things with your customer, I want to get your thoughts there and second, just how far can the penetration go on it and how much that’s baked into the 180 to 250 basis points reduction in gross margin?

Sharon McCollam

The question on whether or not we are seeing any decline in the approval rates on the part of the credit card, the answer is no. And then I am going to let Laura and Dave because their businesses are very different to speak to the penetration and how far they could take the card. So, Laura would you speak to Pottery Barn?

Laura Alber

Yeah I think the card is particularly relevant right now. So, it is hard to predict where it will go in the future. I think that largely depends on a lot of other factors outside of our control but in the Pottery Barn brand we have substantially increased the program differently. It is different than what Dave was talking about in West Elm where he had a pretty robust reward program. So, we are seeing quite an up-tick I’d say, four fold approximately from where we were previous to the program and as I said where that would go, I’d imagine it would stay in this range until the climate changes.

Dave Demattei

Sammy Laura alluded to West Elm, introduced the private label credit card over a year ago and when we introduced it we introduced it with design dollars. So, with every purchase you got a certain amount of design dollars because what we wanted to do and what we did see happen was for the customers to return and then now redeem those design dollars for a substantially higher purchase. So we continued to have them returning. We are still seeing and now it is has been a pretty robust program. It is understood by our store employees because it is used to sell furniture. We have still seen a pretty substantial up-tick in that program as we educate the customers to the benefits now. We have on going, we are evaluating the pros and cons of it and we will continue to refine it as we move forward.

Sharon McCollam

On the gross margin impact of the private label credit card there are two things to keep in mind. The first is that before we offered these programs like the 12 months famous cash the scene associated with the private label credit card, they were accounted for the SG&A. Of course when you do these programs, the way we are doing them, there is a cost associated with these. It is equivalent to a markdown and so that cost is treated as an offset to the selling price. So, it does have an impact on our gross margins because it is treated like a markdown. So, when you are thinking about where that goes that’s what we see.

Operator

Our next question will come from Joe Feldman with Telsey Advisor Group.

Joe Feldman – Telsey Advisory Group

Hi guys how are you? I wanted to ask about the lease negotiations. I know something that you guys has been focused on for sometime and you mentioned you are working towards some reductions in rents and also I’m just wondering kind of what kind of pushback you are seeing from the landlords and are you getting the reductions you are seeking? Are you getting concessions in cam charges? What are the gives and takes in that?

Sharon McCollam

Howard?

Howard Lester

Well we just continue to push. I can’t say that it is going as well as we’d like it to. You do have leases with landlords but on a selective basis we have made some progress. We’d like to make more. I think it is just a process that’s going to be a grind without leverage which means that you have expiring leases or you are opening new stores that you can put these landlords at the mall. It is a difficult situation to get in to just arbitrarily let you out this summer and we have been unwilling by and large to pay to get out. So, it is just a process. I’d say that with certain landlords we have had some real success and with others somewhat difficult but it continues.

Operator

It is “*1” to ask a question and if you find that your question has been answered you may remove yourself by pressing the pound key. Our next question comes from Matt Nemer with Thomas Weisel.

Matt Nemer – Thomas Weisel Partners

Hi good morning everyone. My question is can you comment on the potential for a higher number of store closings assuming that your discussions with landlords end up favorable? What is sort of the optimal number of stores or closings I guess, should everything go your way and then also secondly it sounds like you are closing the thread attached stores and a couple of William-Sonoma Home stores. What would be the profit impact if you decided to discontinue the William-Sonoma Home brand? Thank you.

Sharon McCollam

Howard would you like to comment on the number of stores that…the potential of store closing?

Howard Lester

Let me take the first part of that. I’d let Sharon take the second part, Sharon or Dave. With respect to the first part we have been fortunate that we’ve had a strong real estate portfolio and so we don’t have a large number of stores that we would close tomorrow if we had an option to do so. What we would rather do on the larger number is where we’ve had serious sales declines like we are seeing for last year or so and particularly since last fall, we’d like to have rent reductions probably for this period and I think that is probably preferable to the landlords, so that we can get through this period together but leave the store there because by and large there I don’t have a value type of store. I can’t really put a number on exactly how many we would close. I’d say that if we had our option it would be somewhere, it is not that many. It is probably somewhere around 5% of our stores today, we would close if we could and that would help us where we have made or opened stores in markets where we may have made some bad early decisions with West Elm, some of our kid stores. Say in Williams-Sonoma we are in pretty good shape, we are not having anything we would like to close in William-Sonoma and pottery Barn I think we are willing to try and maybe a few that we would like to close but it is a few and less so we would like to deal with rent reductions, so hard to put an exact number on closings.

Sharon McCollam

And Matt to your question about the impact of the direct stores or the closing of William-Sonoma homes we had said consistently that William-Sonoma is negatively impacting our earnings this year to the tune of somewhere in the neighborhood of well over $0.10 a share but I’ll say this, that Dave spoke to in his prepared remarks the focus in Home is profitability this year, it is not growth. They have been pushing to grow the business and they recognize that in this environment that it can be difficult to do. So, what we are focused on right now is profit optimization and I can tell you with great certainty that in 2009, we expect that to get substantially better. The exit costs of the William-Sonoma Home are pretty simple. The majority of their brand sales are coming from the stores their brand releases and they are large stores. So, you’d have the costs of vacating those facilities and then you have the cost of liquidating the inventory but we are really not at that point and it is not something that we are discussing at this point. So but those will be the implications of that. But yes the Home is pretty depressing, our operating constitution today it is going to get substantially better in 2009 and the actions we are taking in ’09 are actually going to be serious and I think it will be better in 2010. But that’s how we are progressing with Home.

Operator

Our next question comes from Michael Lasser with Barclays Capital.

Michael Lasser – Barclays Capital

Good morning. Thanks for taking my question. Two if I may, number 1 as we have calculated you are looking for roughly 20% revenue decline in the first half of this year and approximately 400 to 500 basis points of operating margin erosion. In the second half of the year you are looking for call it 10% revenue decline and an operating margin of flat to slightly up. Is there something that would change in the back half of the year to suggest that your margin is going to improve that much in spite of what we are seeing to be a challenging top line and then secondly can you talk about how the mix shift cue to William-Sonoma brand away from Pottery Barn has impacted your merchandize margin during 2008 and what’s your expectation for this trend during 2009? And I’m going to speak one more in there. Alan, can you talk a little bit more about the alternative rent agreement that you have in place? What is the penetration of those and how that impacted your profitability recently? Thanks.

Sharon McCollam

The question regarding the back half of the year is a really easy one. The inventory reduction that we had, we had substantial inventory clearance in the back half and quite frankly we wouldn’t even have the inventory. Now with our inventory at the site that they are even with the inventory, to run a program like that in 2009, so that margin change that you see in the back half is substantially coming from the mix of both price selling versus markdowns. As it relates from a shift from Pottery Barn to William-Sonoma those brands as you know will be down in 2009 and we don’t disclose brand profitability so we are going to let you go to the third question to Howard, which is to discussion of our brands and how that might work or benefit us in this type of an environment.

Howard Lester

Well that’s not something we talk a lot about publicly. We do have a variety of leases and one of those is a lease that you call as an alternative rent lease and that’s where the sale drop below some fixed, pre-fixed number and at that point your expense to the landlords charges change from a fixed rent to a gross rent, percentage of the gross which would include his rent and charges as a percent of sales, so, in trying to help us in a down period. Now that’s why we did them and we do that with a significant number of those. We won’t say exactly how many but it is a significant number of our leases which is less than 0.5% I think.

Operator

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

Scott Ciccarelli – RBC Capital Markets

Hi guys, Scott Ciccarelli. A few questions if I may, first of all I know it is not necessarily a practice but there is a lot of questions regarding regional discrepancies and sales trends. Any color on that would be very helpful, also, any kind of details regarding the declines that we are seeing in gross margins. Certainly we have a feel for what portion of that is the de-leveraging of occupancy and what is the actual reduction in merchandize margins?

Sharon McCollam

The question regarding regional discrepancy we are not seeing any material call out that you could take away and say if this got better in that region, then this clearly would help. The housing areas in the country, the areas that we all know about, those areas of course have been more challenged than the others but in general, there is nothing there that I’d say is something that you could take away from and you could really pull out and say this is where we are. As it relates to the question about the occupancy versus the cost of merge, as you know we don’t break out these two line items separately. However, in the fourth quarter and full year, this year, the inventory clearance was a substantial issue for us and they were both material to consider to the decline of 770 basis point decline. We are going into 2009 of course the selling margins, we talked in our prepared remarks where it is expected to improve by 50 to 100 basis points. That’s the selling margins. I want to make sure that we don’t use that as gross margins because you will also have occupancy de-leverage next year but we are ready within our numbers is giving us between a 100 basis improvement and we hope to see something better than that but it all depends on the promotional environment outside the company. But as far as having inventory to the type of inventory clearance we did in the third and fourth quarter we just don’t have that type of inventory.

Operator

Our next question comes from Laura Champine with Cowen & Co.

Laura Champine – Cowen & Co

Good morning. We are just trying to get a better sense of your leverage points with the big changes that you are making in your overall cost structure. Can you talk about what kind of a comp you’d need to have for higher operating margins and then if we can think about it this way, whatever incremental percentage of sales, what impact would that have on your overall operating margins?

Sharon McCollam

Laura I think for the conference call today I think that’s a difficult question because for our company because for most retailers they can take their fixed occupancy cost. They can answer that question but 40% of our business coming from direct and then we have improved visibility to where the sales are going to come from, it is a much more complex question and it is what quite frankly has allowed our performance to be of in a period we are doing it strong because we have flexibility to flex that direct business depending on what is happening in the environment, decisions will be made about catalog circulation. So, it is not a simple answer and I think for the benefit of time on this call this morning that’s something that is an interesting question for all of you. I’m sure perhaps we will discuss going forward in further and in this period of the talk today I don’t think we can give you a specific answer because there are too many scenarios we have to consider.

Operator

And we’ll now take our final question from Marni Shapiro with The Retail Tracker.

Marni Shapiro – The Retail Tracker

Hey guys thanks for getting me in there. I have two housekeeping questions in just one bigger picture. In case of your shrink reserve for ’09 if you plan that the economy is weaker because sometimes these things go hand-in-hand and if you can clarify on your circulation you guys are calling it down for ’09 I was curious if this was a part for all the brands and there were number of books or pages and then to the big picture question if you don’t mind. I appreciate that you guys are taking very strong defense, which is important right now but you’ve lost a lot of competition or a lot of your competitions are struggling at both the low end and the high end. So, I guess I just want to hear from you guys that at the same time that you are aggressively playing defense, that you are also aggressively playing offense, to secure your position in the market when we do eventually come out of this as the strongest player.

Sharon McCollam

Okay Marnie on your question about shrink in 2009, the answer to that is inherent in our guidance as an assumption that the shrink that we saw in 2008 would not recur in 2009 and there is definitely a level, a higher level of shrink in the 2009 number. I don’t want to turn that into something highly material but shrink as a material to our company in total but yes we are assuming that. On the catalog circulation question the answer is yes, that circulation is down in all brands and there is different degrees but we definitely will be down in our brands in the catalog circulation optimization strategy is more mature in some brands and in some areas and then we keep finding new ideas. So, that would take us through different phase. So, that’s our best answer to that one and then as far as this question about the offense versus taking the offense versus the defense Howard could you speak to the competitive environment, how we see ourselves playing in that?

Howard Lester

Yeah Marnie, while we have spent the last 6 to 12 months really working on resizing our cost structure, we have really throughout that whole process we have not lost touch with the customer and improving everything from our price points to our service, to our people, all the things that we do, I hope that we never do. I would say that now our major programs are in the area of improving the service in our stores and in the programs that we have in our stores for our customers. We fill in designer stores in Pottery Barn designer services I mean in Pottery Barn where we are reaching out to the customer and going into their homes which is a new program for us. We have driven about 14% of our sales in Pottery Barn I think it is with our clienteling which is personal book selling to three or four best customers for business to come in and asking them about, getting them back into the store to look at the merchandize. I’d say the merchandize run I mean we are spending a huge amount of time across the board in trying to improve every single category of goods in all of our brands and we have made some changes personnel wise to do that. We’ve got a very strong focus on that and that’s also true with our direct business I mean Internet. We prioritize the Internet. We are spending a lot more money and time on it. We have got a much more advanced vision probably than we had three years ago and we are starting to see some results now. So, across the board let me assure you that we are on off hands and we do think that we are gaining share as we see people drop along on the way. So, hello did that reach everyone?

Sharon McCollam

Okay.

Howard Lester

Well is that the last question?

Operator

That’s the last question.

Howard Lester

So let me thank all of you for joining us today and we appreciate your time and support and we’ll talk to you next quarter. Have a great day.

Operator

Thank you for your participation and have a great day.