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Williams-Sonoma's Next Big Thing

NEW YORK ( TheStreet) - Williams-Sonoma (WSM - Get Report) reported better-than-expected second quarter earnings on Wednesday, but the real exciting part of the company's story how it's using West Elm - its largest growth brand -- as a platform for innovation.

Besides its flagship Williams-Sonoma brand, which sells kitchen gadgets, cookware and gourmet foods, it is the parent company to the ever-popular Pottery Barn group of brands and West Elm, both of which cater to upper middle-class homeowners and home decorating enthusiasts.

On top of that, the company has smaller extension brands such as Rejuvenation, which it acquired in 2011 and offers high-end lighting and hardware, Mark and Graham, its late 2012-launched personalization gift brand, among others.

By focusing on social media and creating partnerships that give the upscale home furnishings and gourmet kitchen gadget company more unique product offerings, the company may be on to something here for its West Elm brand.

"We believe that West Elm is at the forefront of a transformational change in retail, where consumer preferences are influenced by the opinions of other like-minded consumers and enthusiasts," CEO Laura Alber said on the earnings call yesterday. "From its award-winning blog, Front & Main, to its pioneering use of Pinterest, to collaborations with Etsy, West Elm is building its brand and driving profitable sales with a carefully orchestrated infusion of social media into its marketing mix."

The San Francisco-based Williams Sonoma said on Wednesday its profit rose 13% from a year-ago to $48.9 million, or 49 cents a share, beating analysts' estimates of 47 cents a share.

Shares on Thursday fell 0.19% to $56.86.

Also see: Williams-Sonoma Beats Earnings Estimates; Results Leaked

Also see: Nordstrom: Earnings Beat, Revenue Misses

Also see: 5 Crafty Entrepreneurs Jolly With Etsy Success

Company revenue rose 12.3% to $982.2 million in the second quarter beating estimates of $940 million, while overall company comparable store sales rose 8.4%, it said.

Of course one cannot ignore the fact that Williams-Sonoma is taking full advantage of the housing recovery as well as the fact that high-end consumers are faring better than low-income customers that shop at stores such as Wal-Mart (WMT).

It's worth noting that about half of Williams-Sonoma's revenue comes from its direct-to-consumer (its online channel, which also includes catalog business). The company said yesterday 49% of its total second-quarter revenue, or $478 million, comes from direct to consumer.

West Elm is the fastest-growing Williams Sonoma brand, generating 26% revenue growth, and comparable sales rising 16.5% last quarter. Still it's a small portion of the overall company, with just 58 of the company's overall 583 stores. West Elm accounted for $430 million, or 11%, of Williams-Sonoma's 2012 revenue, according to its annual report.

Williams-Sonoma believes that West Elm has the potential to be a $1-billion brand.

"West Elm is such an exciting growth story. And across the country, we are seeing strong response to the brand's high design, its authenticity and the craft that it brings to the customers," Alber said. "There's still room for margin expansion in that brand, and we continue to push, as I've said, on expansion and category, dimensional size and in authentic design."

Wedbush Securities analyst Joan Storms says the brand has the potential to rise to 15% to 20% of the company's overall revenue.

"It's a very different concept than the more traditional Pottery Barn brand," Storms says. "To me it's a little more hip, urban, a little more down to earth. It's a price point that has broader accessibility to a younger demographic and also sort of emphasizes value. And they've used social media to a big degree to attract that type of customer that cares about the local community."

"I think it has the potential definitely to be at least $1 billion," she adds.

Indeed the use of handmade furnishings by so-called Etsians (just look at any West Elm catalogue for instance) is an example of how more big retailers can partner with small businesses for maximum exposure, benefiting everyone, instead of placing an unfair competitive advantage of big vs. small.

In the case of selling Etsy products, West Elm is taking advantage of the exploding trend by consumers -- most identifiable through Etsy's success -- for more unique and handmade items.

"We are focused on growing our assortment of handmade products, which is a key differentiator in the marketplace. Customers love knowing how and where their products are made," Alber said on the call.

In contrast, Williams-Sonoma's traditional brand saw comparable sales fall 0.4% in the quarter, which the company blamed on soft sales for seasonal items.

The Williams-Sonoma brand will end the year with the most store closings. The company plans to close 15 Williams-Sonoma stores, while opening just seven, whereas it expects to open 11 West Elm stores in 2013 (with one closure).

Innovation-focused companies like Williams-Sonoma and Gap (GPS) are doing plenty to position themselves for the long haul. We don't see it happening at big dinosaurs like J.C. Penney (JCP) or Sears (SHLD).

-- Written by Laurie Kulikowski in New York.

To contact Laurie Kulikowski, send an email to: Laurie.Kulikowski@thestreet.com.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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