Pottery Barn 2006 Annual Report Download - page 39

Our classification of expenses in cost of goods sold may not be comparable to other public companies, as we do
not include non-occupancy related costs associated with our distribution network in cost of goods sold. These
costs, which include distribution network employment, third party warehouse management and other
distribution-related administrative expenses, are recorded in selling, general and administrative expenses.
Within our reportable segments, the direct-to-customer channel does not incur freight-to-store or store occupancy
expenses, and typically operates with lower markdowns and inventory shrinkage than the retail channel.
However, the direct-to-customer channel incurs higher customer shipping, damage and replacement costs than
the retail channel.
Fiscal 2006 vs. Fiscal 2005
Cost of goods sold increased by $136,761,000, or 6.5%, in fiscal 2006 over fiscal 2005. Including expense of
approximately $5,000,000 associated with transitioning the merchandising strategies of our Hold Everything
brand into our other existing brands and the implementation of FASB Staff Position (“FSP”) FAS 13-1, cost of
goods sold as a percentage of net revenues increased to 60.1% in fiscal 2006 from 59.4% in fiscal 2005. This 70
basis point increase as a percentage of net revenues was primarily driven by retail occupancy expense deleverage
and increased markdowns in the Pottery Barn brand. The occupancy cost deleverage was primarily driven by the
retail rollout of our emerging brands, in addition to higher retail occupancy costs in our core brands. This
increase was further driven by the implementation of FSP FAS 13-1. These costs were partially offset, however,
by the elimination of fixed occupancy and all other cost of goods sold associated with the Hold Everything brand.
In the retail channel, cost of goods sold as a percentage of retail net revenues increased 130 basis points during
fiscal 2006 compared to fiscal 2005. This was driven by retail occupancy expense deleverage and increased
markdowns in the Pottery Barn brand. The occupancy cost deleverage was primarily driven by the retail rollout
of our emerging brands, in addition to higher retail occupancy costs in our core brands. This increase was further
driven by the implementation of FSP FAS 13-1. These costs were partially offset, however, by the elimination of
fixed occupancy and all other cost of goods sold associated with the Hold Everything brand.
In the direct-to-customer channel, cost of goods sold as a percentage of direct-to-customer net revenues
decreased by 30 basis points during fiscal 2006 compared to fiscal 2005. This was primarily due to an
improvement in cost of merchandise, partially offset by an increase in other occupancy expenses compared to
fiscal 2005 and higher direct-to-customer shipping costs.
Fiscal 2005 vs. Fiscal 2004
Cost of goods sold increased by $237,679,000, or 12.7%, in fiscal 2005 over fiscal 2004. Including an
approximate $4,500,000 charge associated with transitioning the merchandising strategies of our Hold
Everything brand into our other existing brands, cost of goods sold as a percentage of net revenues decreased 10
basis points in fiscal 2005 from fiscal 2004, primarily driven by rate reductions in shipping and occupancy costs,
partially offset by a rate increase in cost of goods. The rate reduction in shipping costs was primarily due to the
successful refining of our furniture delivery network, including the late 2004 in-sourcing of our line-haul
management and cost efficiencies gained from our east coast distribution center, partially offset by a year-over-
year increase in fuel surcharges. The rate reduction in occupancy expenses was primarily due to sales leverage in
the retail channel, partially offset by increased distribution leased square footage in the direct-to-customer
channel and lease termination costs associated with transitioning the merchandising strategies of our Hold
Everything brand into our other existing brands. The rate increase in cost of goods was primarily due to the costs
associated with the implementation of the daily store replenishment program in April and May of 2005 and a
higher percentage of total company net revenues being driven by furniture, which generates a lower than average
gross margin rate, as well as the write-down of impaired merchandise inventories associated with transitioning
the merchandising strategies of our Hold Everything brand into our other existing brands.
In the retail channel, cost of goods sold as a percentage of retail net revenues decreased 20 basis points during
fiscal 2005 compared to fiscal 2004. This was primarily due to sales leverage in fixed occupancy expenses,
despite the lease termination costs associated with the merchandising transition in the Hold Everything brand into
our other existing brands. Although cost of goods as a percentage of retail net revenues remained relatively flat
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Form 10-K