Williams-Sonoma Inc (WSM) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma incorporated second quarter 2002 earnings release conference call.

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

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

As a reminder, this conference is being recorded.

I would now like to turn the call over to Mr. Ron Lobe, Senior Vice President and General Counsel at Williams-Sonoma, Incorporated, to discuss forward-looking statements.

Mr. Lobe, please go ahead, sir.

Good morning.

The earnings guidance, company plan and other forward-looking statements included in this call constitute forward-looking statements within the meaning of the private securities and litigation reform act of 1995.

These statements address the financial condition, results of operations and business of the company and are subject to certain risks and uncertainties that could cause actual results to differ materially.

Please refer to the company's current press releases, website, and SEC filings including, but not limited to, reports on forms 10-k, 8-k and 10-q for the full text of the forward-looking statements warning.

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 over to Dale Hilpert, Chief Executive Officer.

Thanks, Ron.

Good morning.

Thank you for joining us.

With me today is W. Howard Lester, our Chairman, Pat Connelly, our Executive Vice President Chief Marketing Officer, Laura Alber, President of the Pottery Barn Brands, Pat Cowell, President of Williams Sonoma Brand, and Sharon McCollam our Senior Vice President and Chief Financial Officer.

The second quarter, 2002, was another quarter of many achievements for our company, not the least of which was delivering the strongest second quarter earnings performance in the history of the company.

As mentioned in this morning's press release, despite a difficult late quarter retail environment we reported second quarter 2002 diluted earnings per share of 12 cents, which was 4 cents above the first call consensus estimate and 11 cents above last year.

Even more encouraging is that, year to date basis, we have delivered diluted earnings per share of 25 cents per share, which is 23 cents per share above last year.

Consistent with our strategy to improve profitability in our core businesses these strong earnings and better than expected results were driven by on ongoing success in five key performance drivers.

The first driver was strong customer response to our new Pottery Barn and Pottery Barn Kids merchandising assortments.

The second key driver was significant year over year increases in merchandise gross margins.

Strong merchandise assortments, significant improvement in inventory and receive-flow management, and substantially fewer markdowns throughout the quarter drove a majority of the increase.

In addition, inventories at the end of the second quarter were down 7.4% versus the second quarter of 2001, despite a 16.9% increase in retail sales.

The third key driver was significant improvement in net shipping profitability of merchandise delivered to customers, primarily in our Pottery Barn and Pottery Barn Kids' brands.

The fourth key driver was distribution center and labor productivity and cost-reduction initiatives.

In the second quarter, 2002, packages shipped per man hour increased 12% versus the second quarter of 2001.

In addition, a total company net revenue increase of 15.5%, total distribution center operating costs decreased 1.3% in the second quarter of 2002 versus the same period last year.

The fifth key driver was the continued success of cost-management initiatives throughout the company.

Other operating achievements during the quarter included: the pilot launch of our private label credit card in Pottery Barn and Pottery Barn Kids, the successful launch of the next generation of e-commerce sites for the Williams-Sonoma brand, the elimination of 500,000 square feet of leased distribution space in Memphis drew a substantial improvement in inventory management and a positive customer response to the introduction of the West Elm catalogue.

On circulation 1.5 million catalogues the performance of West Dow exceeded our expectation in each of the three drops of the catalogue during the quarter.

In the third and fourth quarter we will mail approximately four million catalogues, assuming these mailings continue to perform well during the back half of the year we will substantially increase our catalogue circulation and launch an e-commerce site in 2003 and open retail stores in the fall of 2004.

We continue to be very optimistic about the strategic potential of this brand in the middle market segment.

As we look forward to the third and fourth quarter our diluted E.P.S. guidance remains unchanged.

We have been cautious all year and our economic expectations for the third and fourth quarter and we are confident, that even if the economy continues to be volatile, we will be able to deliver the E.P.S. guidance that we have provided to our shareholders.

We do plan, however, to remain flexible in our decisions, and we will be prepared to accelerate our business plans if the economic horizon improves.

I would like now to turn the call over to Sharon McCollam.

Thank you, Dale.

Good morning.

I would like to start by outlining the agenda for the remaining call -- first we will review our second quarter 2002 earnings results.

Next, we will briefly talk about our third and fourth quarter guidance.

And then Laura Alber will provide with you a business update for the Pottery Barn and Pottery Barn Kids brands.

After Laura's update, Pat Cowell will provide you with a business update on the Williams-Sonoma brands.

And finally, we will open the call for questions.

Our second quarter, 2002 earnings: In May, we reported the best first quarter financial performance in the history of the company.

We are pleased to report today that, despite consumer volatility in the second quarter, we were able to deliver our second consecutive quarter of record earnings, operating margins and diluted earnings per share.

Diluted earnings per share for the second quarter of 2002 were 12 cents, which was 4 cents above the first call consensus estimate and 11 cents above the second quarter of 2001.

Net revenues for the second quarter of 2002 increased 15.5% to $495.6 million versus $429 million in the second quarter of 2001.

Retail sales grew by 16.9% to $285.8 million versus $244.4 million in the second quarter of 2001.

Store counts at the end of the second quarter were above guidance by five stores, due to early store openings.

As in other aspects of the business, we are continuing to exceed expectations in the execution of the store development calendar.

We continue to be very encouraged by the strong momentum and related financial performance of our new stores.

Comparable store sales for the second quarter of 2002 were flat, versus positive 1% in the second quarter of 2001.

Through May and June, comparable store sales were trending positive in the low single digits.

In the first week of July, however, we saw a slowing trend in consumer demand that we believe to be particularly correlated to the turmoil in the financial markets.

In response to this trend, we briefly considered a reactive markdown strategy on core merchandise but, after assessing the quality of our inventory positions, determined that full-price selling and fewer markdowns would be a more brand appropriate and financially beneficial short-term strategy.

Although this decision impacted our comparable store sales for the quarter, we are very pleased with the gross margin and profitablity impact of our decisions.

Directed customer sales grew by 11.9% to 177.1 million versus 158.3 million in the second quarter of 2001.

Continued growth in the Pottery Barn Kids, Pottery Barn Chambers and Williams-Sonoma brands in addition to incremental sales from the 2002 launch of West Elm were partially offset by a planned increase in Hold Everything.

The Hold Everything brands increase was consistent with transitional impact of our brand realignment strategy.

Gross margin in the second quarter of 2002, reported at 37.4% of net revenues, improved 330 basis points versus the second quarter of 2001.

This improvement as a percentage of net revenues was driven by many factors, including the fewer markdowns in promotions, lower freight costs from the distribution center to the stores, a reduction in merchandise due to improved sourcing, lower replacements and improved shipping profitablity for merchandise delivered to customers.

SG&A in the second quarter of 2002 reported at 32.7% of net revenues, improved 50 basis points versus second quarter, 2001.

An approximate 70-basis point improvement in other general expenses, in addition to leverage and advertising costs were partially offset by higher employment costs.

The second quarter, 2002, employment cost increase as a percentage of net revenues was primarily driven to an increase in incentive compensation based on improved year over year profitablity in the first half of the year.

The leverage in that advertising cost was driven by higher catalogue productivity and lower catalogue production costs.

Interest expense in the second quarter of 2002 was 0.2 million versus 1.7 million in second quarter, 2001.

Significantly improved earnings and the corresponding cash flow, aggressive inventory management, and lower interest rates drove this year-over-year expense reduction.

Depreciation and amortization expense for the second quarter 2002 was 22.4 million, versus 19.4 million in second quarter of 2001.

The second quarter, 2002 credit for deferred lease incentive amortization was $3.8 million versus $3.1 million in the second quarter of 2001.

Capital spending for the second quarter of 2002 was $38.5 million versus $50.1 million in the second quarter of 2001.

I would now like to discuss year over year balance sheet variances.

Cash at the end of the second quarter of 2002 was $89.9 million, and the company had no obligations under its revolving line of credit.

This compares to $7.8 million in cash and $81.8 million of revolving debt at the end of the second quarter of 2001.

This represents a positive $164 million increase in the company's net position.

This substantial strengthening in the company's cash and debt position is primarily due to stronger earnings, aggressive inventory management, and a significantly enhanced asset management focus.

Merchandise inventories at the end of the second quarter of 2002 were $250.4 million versus $270.4 million in the second quarter of 2001.

This was a decrease of $20 million or 7.4%, versus the second quarter of 2001 and was driven by the ongoing improvement in inventory and receipts flow managements and a corresponding increase in inventory turnover.

Inventory turnover retail, on a 12-month rolling basis at the end of the second quarter increased 19%.

Prepaid catalogue expenses at the end of the second quarter 2002 were $28.4 million, up $10 million versus second quarter, 2001.

This increase was primarily due to the timing in the Pottery Barn and Pottery Barn Kids catalogue and an increase in paper inventories.

Prepaid expenses at the end of second quarter 2002 were $19 million, up $4.4 million versus second quarter 2001.

This increase was primarily due to prepaid store rents, up approximately $3.3 million, and prepaid information technology maintenance contract,s up $2.4 million, offset by prepaid insurance, which was down approximately $1.3 million.

Accrued expenses at the end of the quarter were $56.1 million, up $11.7 million, versus second quarter, 2001.

This increase is primarily due to the timing of [INAUDIBLE] accruals in 2002 for incentive compensation and higher accrual balances in customer returns, employee vacations, employee benefits, workers' compensation and other miscellaneous expenses.

Customer deposits at the end of the second quarter were $85.6 million, up $28.8 million versus second quarter, 2001.

This increase is primarily due to strong growth in both individual and corporate gift certificate sales, and the second quarter 2002 balance sheet impact of recognizing revenue on a delivered basis.

I would now like to briefly discuss our third and fourth quarters guidance.

Based on the strength of our retail business and our ability to secure prime retail locations, we have increased our third and fourth quarter store counts.

Retail stores, at the end of the third quarter, have increased from 454 stores to 470 stores.

Retail stores at the end of the fourth quarter have increased from 472 stores to 475 stores.

Our fiscal 2002 growth, in square footage based on these changes, will increase from a range of 15% to 16% to a range of 16% to 17%.

We have not changed our top-line revenue guidance for the third and fourth quarters, with the exception of the composition of our retail sales.

The composition of our retail sales has been adjusted to reflect the additional stores we are adding to our retail store base, with an offsetting adjustment to our comparable store sales estimates.

We lowered our comparable store sales estimate to conservatively anticipate the potential impact of ongoing volatility in retail sales trends and potential softness in the economy overall.

We have also not changed our third and fourth quarter diluted E.P.S. guidance.

Since February of this year we have told our shareholders that we believe that conservative guidance that we provided for the back half of the year was prudent, based on the uncertainties facing the U.S. economy.

Clearly, we have seen some of these uncertainties become realities in the last several months.

Since our third and fourth quarter guidance has consistently reflected the possibility of a softening in the economy, we remain confident today in our ability to deliver the earnings per share guidance that we have previously provided.

We are optimistic, however, that our new fall holiday assortments and strong execution will enable us to drive the business despite a potentially weak economy.

We will be flexible in our decisions and remain focused on the three dey initiatives we committed to at the beginning of the year: driving top sales growth, improving operating margin and percent of sales, and enhancing shareholder value.

I would now like to turn the call over to Laura Alber.

Thank you, Sharon.

Good morning, everyone.

This morning I will be providing you with an update on both Pottery Barn and Pottery Barn Kids brand, [INAUDIBLE].

We are pleased with the performance of Pottery Barn in the second quarter.

Both sales and gross margin continued on a strong growth trend with net sales in the second quarter growing 13% versus last year.

Sales strength continues to be driven by positive consumer response to our revitalized core products and our seasonal assortment.

Lighting, furniture, textiles represent several of the core categories that continue to contribute to the net sales strength.

Additionally, sales in the Aloha Collections for summer and big bets within our Modern Country assortment for fall have exceeded our expectations, particularly within the furniture and textiles category.

However, given the recent volatility in consumer spending levels, we are more focused than ever on reordering hot-selling merchandise for the holiday season and taking markdowns within season where necessary on slow movers.

The retail and the direct consumer channels both contributed to the net sales growth for the quarter.

Retail was the primary driver of sales growth in the second quarter fueled in part, by 15 new stores opened since Q2 last year.

Over all, comp store sales for the quarter grew by 1.3% and were impacted by the faster than expected sellthrough of summer products in advancement of our late July floor set and increased sales activity versus last year.

Additionally, we are pleased with the results we are achieving from our cross-channeling marketing efforts, in particular our e-mail campaigns and our wedding and gift registry.

In addition -- excuse me, in addition to strong sales growth, gross margins were significantly better than expected, due to lower cost of merchandise, fewer than expected markdowns, strategic inventory management, and continued improvement in the cost of freight from the distribution center to our stores.

Additionally, we continue to see improvement in our customer shipping model, which resulted in a net contribution to income in the second quarter.

I would now like to give you an update on the strategic initiatives for 2002.

As we said on our May conference call, we have four key initiatives for this year: grow top-line sales, build our registry businesses, improve brand profitability, and launch the Pottery Barn private label credit card in the third quarter of this year.

In Q2, our sales were strong in all three channels.

Additionally, we have seen a 75% increase in new wedding an gift registries created for the brand versus last year.

The brand's profitability improved dramatically, as a result of very strong gross margins and continued cost controls.

And, finally, we are looking forward to the launch of the Pottery Barn credit card, which will be introduced in all channels across the brand this week.

We are excited about this new business initiative, and we believe that it will help us to develop increased loyalty with our customers.

Now for Pottery Barn Kids.

The Pottery Barn Kids brand in the second quarter continued its strong performance.

Net sales recorded increased over 60%, due to our retail expansion and strong sales on the e-commerce website and a considerable increase in gift registry.

In the second quarter, Pottery Barn Kids opened 11new retail stores, ending the quarter with 47 stores versus 15 stores at end of second quarter, 2001.

In our retail stores, we moved our fall floor sets up into the second quarter, due to faster sellthrough on spring merchandise.

Initial consumer response to our fall assortment has been positive, especially in the bedding and our expanded nursery selection, and reorders are already taking place.

In the second quarter, stronger sales were accompanied by improvements in gross margin and SG&A. [INAUDIBLE] the costs in merchandise, and improving inventory control helped considerably to improve our gross margins.

The [INAUDIBLE] increase in Q2 for Pottery Barn Kids was 2.6%.

And we continue to be very pleased with our new store performance.

I'd like to you note that, at this point, we have a limited amount of comp stores.

In the second quarter, we continue to be pleased with our progress towards achieving our initiatives for 2002.

First, we continue to increase customer access to the brands through our new store openings and increased catalogue circulation.

Second -- we drove top-line sales through strong growth in our gift business, and a significant increase in gift registries.

Third -- we increased our operating margins through improvements in gross margins, enhanced our shipping model, which resulted in a net contribution to income, and continued our cost control initiatives.

Last, as we look forward, we are pleased to be launching our Pottery Barn Kids private label credit card this week in conjunction with the Pottery Barn credit card, which we mentioned earlier.

As we look toward the third quarter for the Pottery Barn and Pottery Barn Kids, we are optimistic about our fall holiday costume assortments and we are excited about our seasonal merchandise retail, especially for both Halloween and Christmas, and look forward to the introduction of our new holiday line.

As I have said before, our continued strategic focus on retail execution, product design, creative merchandising, product assortment, and operational execution has laid the foundation for our continued profitable growth in fiscal 2002, and will be the platform for future success.

Now I'd like to turn the call over to Pat Cowell to discuss the Williams-Sonoma brand.

Good morning.

Thanks, Laura.

I would like to now give you an update on the Williams-Sonoma brand.

The Williams-Sonoma brand experienced net sales growth of 8.3% in the second quarter over the same period last year.

The sales growth was strong for both the retail and direct to customer business.

Our traditionally strong core products, particularly cookware, bakeware, cutlary and housewares, all experienced solid growth in all channels.

We also continued to experience success with our new products, the second quarter launch of the Frontera food line, in partnership with chef Rick Bayless, has been very successful.

Our new cook's tools, and our new cookware and cutlery are exceeding our expectations.

Although the comp sales were down 1.7% in the second quarter we believe this was consistent with the softness in the retail sector.

This also reflects our deliberate decision to resist excessive markdowns on our core merchandise, which we believe is inconsistent with our brand strategy.

As we look to the second half of the year, we are very optimistic about our new assortments in both core and seasonal products.

The new products will be introduced for the fall and holiday periods in our key merchandise categories, including foods, linens, cookware, tabletop, and bakeware items.

As we continue to focus on increasing profitability in our core business we have achieved further reductions in SG&A expenses as a percent of sales, through increased leverage of catalogue advertising and reduced controllable expenses.

Notably, our inventory turns have continued to improve for both the retail and the direct to customer channels.

I would now like to give you an update on strategic initiatives for 2002.

As we said in our May conference call, we are focused on three initiatives for the Williams-Sonoma brand.

The first of these initiatives is to drive top-line sales by focusing on seasonable merchandising.

The positive response that we had to Mother's Day, Father's Day, 4th of July merchandise contributed greatly to our second quarter success.

Our strong Mother's Day performance was driven by the bakeware and seasonal food categories and sales of merchandise in our exclusive new color glacier.

This year marks the first time that we have promoted Father's Day.

We had a very special Father's Day gift wrap and strongly promoted gift-giving ideas.

Our customers responded positively to this message.

Accordingly, our 2002 Father's Day results were similar in success to the traditionally strong Mother's Day results.

For the Fourth of July, we experienced strong sales results with our focus on ice cream mixes, molds, and machines, and we are very excited about our fall and Halloween new product launches in the third quarter.

We continue to see excellent results for our second initiative, which is to continue to build the e-commerce and on-line bridal registry businesses.

Williams-Sonoma e-commerce sales experienced 13% growth.

The bridal sales grew 17% over last year.

We have combined our two websites, the Williams-Sonoma e-commerce site and the wedding registry site into one, and it added enhanced functionality to bring more convenience to the customers.

For example, the site will now allow the user to buy multiple gifts and something for themselves in the same transaction and have each item shipped to a separate address, if they wish.

Another enhancement is that brides will now be able to purchase the registry items that they did not receive as gifts on line.

Formerly, this option was only offered through our stores and care centers.

The third initiative -- improving operating margin as a percent of sales--is meeting with continued success.

We have driven down the cost of merchandise, and we've also been able to reduce freight costs between the distribution center and the stores, due to an increase in proportion of direct store deliveries.

Williams-Sonoma brands is poised for continued strong growth across all channels.

We are the premiere destination for high-quality products for cooking, entertaining homes and for gift-giving, and for gift-giving and we remain focused on leveraging the strength of the brand to drive profitable sales growth on increasing operating margin as percent of sales.

With that, we would like to open the call to questions.

Thank you, sir.

Our question and answer session will be conducted electronically.

If you would like to ask a question, please firmly press the star key followed by the digit 1 on your touch-tone telephone.

We will come to you in the order that you signal.

And if you find that your question has been asked and answered before you can ask it and you would like to be removed from the roster, please firmly press the pound key.

Again, if you would like to ask a question press the star key followed by the digit 1.

And for our first question we go to Lauren Levingham with SG Capital.

Good morning, thank you.

With respect to the [INAUDIBLE] Cap guidance I'm curious, Sharon, if you could elaborate maybe on how you are planning out the season and, particularly, at Williams-Sonoma, where Thanksgiving is, really, your big holiday,given we have got a short period between Thanksgiving and Christmas, maybe you can give us some sense of what you are doing in terms of timing on catalogue drops and timing on events in the stores to try and overcome the challenges that the shift counter presents.

And maybe you could even give us an some detail on what catalogue shipping cut-off dates might look like and maybe even give us a historical perspective on what has happened in the past when you had that compressed holiday shopping season.

Thanks very much.

Good.

Lauren, I'll have Sharon take on the first part of that and then have Pat really talk about preparedness for the fall.

Go ahead.

Lauren, as we take a look at the guidance for the back half of the year, since the first of the year, we've been talking about the fact that we are -- we have been very focused on analyzing, not only the change in the calendar, obviously, that you mentioned, but also the impacts of the events after September 11th and how we think those are going to play out.

So we have done a significant amount of analysis on that issue.

And, as we said in the press release this morning we believe that, as we go forward, we had gone out in February with the conservative guidance for the back half of the year in anticipation of the potential softness in the economy, which we thought was possible.

And we do believe that it's alive; we did see [INAUDIBLE] were discussing the softness and when you think about it, it is an instant replay of what happened in July of last year because, even before the September 11th events, we were seeing this kind of volatility in the consumer in July.

Then we saw what happened to the consumer after that.

As the consumer adjusts and the shareholders and people investing in the market adjust to the new levels of the market, just like they did last year, we think that the customer is going to -- they will see the rebound that we saw.

And we are very confident in our assortment.

So, as we look at the guidance, clearly, some of the conservatism we had in the guidance has been taken out by our realities of a weaker economy.

But we still feel very confident in the numbers we have out there for the third and fourth quarter.

I am now going to let Pat talk about what they are doing to plan to address the Thanksgiving holiday and talk about the back half of the year in Williams-Sonoma.

Thank you.

I think a couple of things are very important.

First of all, we have a great fall catalogue with new products going in the homes the first week of September.

We had a campaign this year, fall in Paris.

You will see a different assortment.

The precursor of that has come in in August.

And we've had great stale sales on some of the first items there, so I'm very excited about that coming in in September.

A lot of new assortments.

I think you'll love that.

The customer will love that.

We also have a lot more increased gift wrap issues for the Christmas period of time and, as you know, at Thanksgiving, Thanksgiving is a week late this year so it is a huge holiday for us.

We have an excellent cooperative program that I will have Pat Connelly talk about, which is something new for us, that we get into an additional four million magazine circulation opportunity, so we'll talk about that in a second.

But I think in the Christmas season, the product that we have, we built on some of the stuff that was extremely strong last year, and we are very focused on executing this.

We have a tremendous focus on the stores taking anything off of their plate with regard to issues that don't focus on the sales.

So in summary, we've got a great fall catalogue coming out that premieres the merchandise that we are going to have in the store, which is new.

Secondly, a very focused Halloween program.

A week longer for Thanksgiving and a cooperative marketing agreement that would allow us to take advantage of the Thanksgiving season.

And then a huge product opportunity in December that we're very focused on, increased gift wrap, new assortments, retail execution.

We know that the assortments were bought well.

So we are looking for an excellent opportunity over the next four months so, with that, let me have Pat chat regarding the catalogue and the cooperative marketing arrangement that we've had.

We've been very pleased with the performance of the Williams-Sonoma catalogue on a year basis.

We've put a new person in charge of it in a creative direction over last year.

And at the fall booking, we put out press releases and we're very, very excited about that.

As Pat mentioned, we have a very significant cooperative program that will be launched in mid October with a major credit card provider that will, essentially, we will have four-page inserts in five major magazines throughout the country focusing on Thanksgiving as well as special promotions to over three million customers.

Additionally, for the holiday period when you asked about the difference between Thanksgiving and Christmas, we are very optimistic about the potential for gift-giving at Williams-Sonoma this year compared to last year.

Last year, Christmas was on a Tuesday and so we had to cut off taking orders the previous Friday.

This year, because Christmas is on a Wednesday and because we are two miles from the Fed-Ex warehouse in Memphis, we are taking orders through late Monday, so they will still be delivered by Tuesday, the day before Christmas.

So it gives us two to three days of increased selling over last year.

We've timed the catalogues accordingly to take that into account.

We've been in this for 20-something years, [INAUDIBLE], and so we're pretty--we know what to do here in the short selling season, so we're optimistic about what we can achieve there.

Lauren, just one--this is Dale--just one last comment.

We're going to put a catalogue in the mail for Sonoma on the 19th, that will allow customers for late shopping.

We've tooled up the distribution center to ship all the way through Monday.

And we've pre-planned that.

In addition, we're finding enormous response to personalization, both monogramming and engraving.

And we've redone the distribution center to be much more responsive to that last-minute gift that people want and personalization and engraving.

And the last thing is, we have significantly increased our gift-wrap capability and how we monitor that to provide that very special gift to the customer.

We spent a lot of time pre-planning.

We do think the four versus five weeks is an issue, and we're out in front of that.

I think the merchandise is right.

But also on the executional side we are spending a lot of time to make sure that we capture every dollar sale.

Thanks very much.

For our next question we go to Dana Selsky, with Bear Stearns.

Good morning.

Hi Dana.

Hi.

I would was wondering if you could just on floor, if you could comment a little bit on Modern Country, how that's doing, anything--any furniture--any of the other items that we should be focusing more on, or what you're seeing there.

And then Sharon, could you give us an update on some of the systems initiatives.

I know that reducing customer returns this year by 25 basis points was one of the goals.

Where are you with some of those initiatives, whether it is transportation, distribution, or items like that?

Thank you very up much.

Thanks, Dana.

We will let Laura answer the first question.

And I'll take the systems question.

Go ahead.

Great.

Thanks, Dana.

We are pleased with our reception to Modern Country, specifically, in a few key categories.

You know, it's hard for me to comment specifically because A lot of the merchandise is also planned for later in the season.

And people right now are really on our tails copying what we do.

But I will say the suede division has really proven to be a great success for us and will be something we can ride for a while.

While it was under the heading of Modern Country what we find is that when we put together a strong seasonal assortment we are also able to find merchandise that becomes core that we can count on for a longer period of time.

So that's really good news.

Also, we are still continuing to see strong response to our furniture collections in all channels.

It's been a strategic focus for us to own the furniture market , both from a service and products perspective, and at the same time, we really increase our profitability on furniture.

And I really feel strongly that we are becoming a dominant player in that category.

And you will continue to see even more exciting things come from us, both on the operational side and the product side through the back half of the year.

If you look at systems support, you really have to break that down into two categories.

We're spending an enormous amount of time on things that can drive the business this year.

Part of that is with the new mms system, which is a complicated way to say significant support to our circulation strategy and our catalogues.

That system was put in last year.

The impact of that--the first impact of that will be this fall.

When you mail as many catalogues as we do the preciseness with which we circulate those catalogues is very important and has a tremendous impact on sales.

As we've talked about earlier, private label credit cards is a very big deal for us at Pottery Barn and Pottery Barn Kids.

We have tested that here in the San Francisco area.

We are bringing it up this morning in our -- in our care centers throughout the country, and we've trained over 1,000 people, in addition to bringing the system forward.

We are very confident that we are able to do that.

A complicated systems issue, but something very special to driving business in the fall.

Our transportation management system we just put in to Memphis continues to leverage our capability.

We spend $200 million a year in transportation costs world-wide.

This is an effort to do that.

We were almost 60 basis points favorable in the second quarter in transportation alone and we will continue to leverage that as we move ahead.

We are adding a major product, a retail inventory management system, a [INAUDIBLE] project, which is a longer-term project and will not have the benefits this year, but we're spending time to prepare ourselves for the future in an effort to get more quick hits or quick response to our inventory management, we've set up teams in both Sonoma and both Pottery Barn and Pottery Barn Kids to address the gap when retail will be done and today.

Those teams have already had significant impact in our furniture area.

We are starting to see some impact in in other Pottery Barns.

We've started that initiative in Sonoma.

And I think in the fall season we can do some things.

What it means is we will probably have some throw-away work after two years.

But we are addressing the issues very quickly to be even better at managing our inventories throughout our system.

We are continuing to work on an upgrade in our financial system.

Our Laussen Financial System will be upgraded this fall, as many of you know.

With the new accounting requirements we need to support Sharon in a lot of those ways.

We are very pleased that we've got a lot of our systems initiatives going.

The focus here, is how do you drive business in the short-term--how do we make sure we support business every way we can and still prepare for the future?

So we've got to do both.

And I think we are making a good balance of that right now.

Thank you very much.

For our next question we go to Mark Rowen with Prudential Securities.

Thank you.

Good morning.

A couple of questions.

One, can you give us a little bit more insight into the slowdown in July?

Was it primarily traffic, conversion of the traffic or the average ticket that caused the slowdown in sales?

And then related to that, are you seeing the same trends in August, or have things uhm, gotten any better or deteriorated from there?

And then related to that, you mentioned that you looked at your inventory position and decided to keep your margins intact and sell the merchandise at the full price.

If the consumer continues to be weak, or weakens from here, would that continue to be your strategy?

Or do you think you would have to start cutting prices to drive volumes?

Thank you.

Well, those are a complicated series of questions.

Let me see if I can be helpful.

First of all, what we see in August is consistent with our current guidance through the street.

We feel that our third-quarter sales will come in where we've guided the street and we have some upside potential.

So we're kind of on course, on stream in that regard.

In terms of inventory management, I think we feel that, throughout the system, we had a tremendous first quarter in Pottery Barn and we're scrambling to get back into key items.

I think we did some of that in the second quarter.

Third quarter I think we've done a good job of preparing key items, not only what we see with Modern Country, but also holiday.

I think Sonoma, as you I'm sure know, we have tremendous receipts coming in in the third quarter to support the holiday business, which is very important to them.

So, in general, I think you'll see our inventories start to rise a bit in response to what we think is the potential for third and fourth quarter business.

But we are being cautious because we think that we don't know enough about the September 11th response and the short selling period at Christmas.

We're not going to overdo it, but we're going to be in stock on key items and focus on newness for our customers.

Sharon, you want to add anything to that?

You know, Mark, we don't give guidance on average ticket and we don't have traffic counters, as you know in our stores.

But what we would say is we thought it was very much a volatile month the entire month all five weeks.

We had different things happening in different weeks of the month but, over all, it was significantly a change in consumer behavior in comparison to what we had seen in May and June.

Ok, thank you.

And one detailed question, if I could.

In the direct business, what portion of that was internet sales, if you're breaking that out?

And then what was the circulation growth?

I'll tell you we will get to the direct -- the catalogue versus internet.

Remember, they are almost both promoted simultaneously.

Catalogue circulation was actually down 3% in the quarter total versus last year.

It's going to be up in the range of 15% to 20% in the third quarter versus last year.

In the third and fourth quarter, you said, Pat?

Third and fourth quarter for the year were up about 11.

We're adding about 30 million books to our circulation.

Third and fourth quarter circulations will be up 15% to 20% and a little between 6% and 10% in the fourth quarter.

Mark, your question on internet revenue for the quarter they, were $44.7 million.

Great.

Thank you very much.

For our next question we go to Mark Friedman from Merrill lynch.

Good morning, Mark.

Good morning, thanks guys.

Congratulations.

Could you talk about what plans you have going forward?

You and Sharon mentioned that, in July, because of the strength of the business early, you didn't feel it necessary to have to put in any promotions.

With these trends, what are you guys think big now?

As you talked about July being volatile, is there anything to call out on the Pottery Barn side between price points, higher price points performance and furniture, etc., versus lower price points?

One last question for Laura.

Laura, it's been over a year since really the big improvements in Pottery Barn.

Are there any big categories that you feel you weren't able to touch over the last year that we'll see a big improvement in for fall and holiday in this year?

Thanks, guys.

Okay, Mark, just let me make a basic comment about the markout strategy in the third and fourth quarter.

One of the things we didn't have to do coming out of the second quarter was mark down overstock, where we got ourselves into a position we had to clear goods to make room for fall receipts.

As we move into the third quarter, though, I think there's, uh, you know, we are going to keep a rule around here, and that is take in-season markdowns to keep our inventories clean.

So you'll see markdown activity in the stores.

But the most important thing is to continue to keep our inventories clean and make sure that we take any markdowns we need in season.

As we look to the third quarter, our margin guidance--our margin rate guidance--is [INAUDIBLE] is about 150 to 250 basis points improved.

So we think that by carefully managing inventories, and making sure we take in-season markdowns, that we don't need to get ourselves in a position where we have to take a very significant markdown to clear overstocks to make room for pricey new products.

One of the things we know very clearly, is the customer is responding to new products.

We see that at both Sonoma and Pottery Barn.

So managing that process of making sure we have fresh receipts coming through all the time through our stores is an incredibly important part of our we will drive the fall season.

Laura?

Sure.

You know, we are always looking for opportunity.

While we've had success this year, we continue to see even more opportunities to drive the business throughout the back half of this year and into the next three to five years as well.

The--in particular, in the third and fourth quarter, we have, uhm, really improved our Halloween assortments, as I mentioned earlier, and also are addressing Thanksgiving in Pottery Barn for the first time ever.

We are really focusing on being timely with our customers and addressing their needs when they have them.

In addition, our holiday assortment has never been stronger.

We've always been a destination for seasonal decorating in your own house.

But we've really taken a hard look at gift-giving opportunities.

As I've said many times we have increased our gift wrap but, also, the product assortment is just great.

So we have a lot of opportunities in our seasonal merchandising throughout the back half of the year.

And we are also working on upgrading all of our core merchandise substantially through the back half and into next year, to not only drive our wedding and gift registry businesses but, also, to make sure that we have that firm foundation in all categories.

So I'd say that all categories have opportunities for improvement continually and, also, we've put a lot of process improvements in place this year that allow us to be much more nimble than ever.

So by having better execution, we can change our strategy as needed based on customer response.

The last thing that I wanted to mention that we are extremely excited about is our private label credit card.

We think that it couldn't be more timely.

We've really studied and tested it.

We know how to do it.

The initial response from the customers have been very positive, and we believe that this will be a very important sales generating strategy, as well as a strategy that will allow us to understand our customers better and build our loyalty with them.

That's great.

Thank you, guys.

Thanks, Mark.

For our next question we go to Brent Ricestrom with U.S.

Bank Corp, Piper Jaffray.

Good morning.

Two quick questions.

Your comps--excuse me--your occupancy leveraging point.

At what level do comps need to be for you to have favorable leverage of occupancy?

Well, let me let Sharon just comment on that.

We don't give specific guidance as it relates to our occupancy but, as can you see from the growth margins that we had this period, in this particular quarter we did not see any deliverage in our occupancy, even with the flat comp.

And that gets in the operational improvements we were continuing to introduce in the company.

But we have not given specific guidance beyond that as it relates to the specifics of occupancy.

Okay.

One quick other question -- you had mentioned that West Elm had done very well relative to your expectations.

Is there part of West Elm that surprised you coming out of it, that you would like to change or that you are changing on a go forward basis?

I think the answer to that question is yes, there are some things surprised us, and they were positive.

The thing that's been very encouraging about the West Elm catalogue is the fact that the merchandise throughout the catalogue has been strong.

We've been impressed with the fact that, as we look at the catalogue we see that--when you drop a new catalogue, of course, there are things that very strong.

And then there could be things that you weren't as excited about and the overall consumer response to that catalogue has been very positive.

And that gives us a lot of confidence as we go forward with the introduction of expanded lines and as we think about doing retail in 2004 we really seem to have hit the consumer right on.

Thank you.

We go next to Michael Baker with Deutsch Bank.

Hi, thanks.

I have two questions.

One, just in terms of your different divisions and the possibility for a weaker economy in the second half of the year.

Which of your divisions do you think are more impacted by slowing consumer trends?

Would that be Pottery Barn or Williams-Sonoma?

And then the second question is on the inventory.

As I've calculated you've announced five strategic quarters of inventory down over 20%.

It sounds like you are beefing up the inventories a little bit in the third quarter.

So at what point does that inventory sales growth trend start to level off a little bit.

A couple of things.

I would challenge the way you've said it.

We are not pre-predicting a tough economy.

We just think it's going to be volatile.

That's a different word.

We think it can be up and down as we go along.

What that means to us as retailers is, I think we have to be very nimble about what we do.

We are looking for a strong holiday season.

We're looking for a good Thanksgiving.

We think that we have planned carefully around the last year, September 11th.

I think our catalogues, as Pat Connally talked about are great.

We just think that it is going to be volatile.

And we're going to have to respond.

It is no different than the second quarter.

We were going through the first two months you know, on course, on stream.

July came.

We had to be responsive to that.

That's what we think that we have to do, is be nimble and responsive.

It is not a matter that we're pre-pre-predicting a bad economy.

We just think that you are going to have to be very, very good retailers as we go through the second half of the year.

In terms of inventories, I think that we uhm, we made a lot of progress in the last year and a half on inventories.

I think that you are going to see a significant flow of new product into the stores for third and fourth quarter.

And you are probably going to see inventories start to rise a bit.

But management of receipt flow is as important an issue as the overall absolute number of inventory.

As many of you know, we sell receipts.

We don't sell inventory.

We sell new goods in the store.

Our customer tells us that time and time again.

And so you're going to see an effort.

We will continue to push our businesses to improve their turnover, but only in the sense of good management.

We want to be in stock in the stores.

We don't want to have backorders in the catalogues.

And we want to make sure that customers sees new, fresh products every time that they come in the store.

Because we know that excites them.

Then they buy many other things.

Right.

Good.

Thank you.

Fair enough.

For our next question we go to David Ricci with William Blair.

A couple of questions.

First, was there anything in the business in July that was more internally related that could affect your business, like the level of clearance this year versus last year, anything else like that?

Yeah, um, it's Laura. there obviously are always internal issues, and I would say the big opportunity is that we, you know, we sold through a lot of our goods very early in the season.

We moved up our fall floor sets as much as we could in response to that.

But, you know, we also have much healthier inventories than last year.

And so the decision to not take our core product was a very important one because we did not have the stressed merchandise inventory levels that we had last year that, while they might have driven the comp, they didn't help profitability.

And a lot of retailers in the malls, you know, you saw them take the promotional actions to drive comps.

And, you know, I think that's a short-term strategy that, long term, hurts the brand integrity, especially as the customer start to wait for markdowns and only buy markdowns, it becomes a self-fulfilling issue as you do it more regularly.

That was a strategic decision that Sharon and Dale both mentioned.

And you know, we did have lower--we had lower sale inventory levels.

And we sold through our regular prices much quicker than expected.

And, David, we reflect on that decision -- you know, we were faced at a point in time, you know, coming out in June where things were very positive.

To see the slowing in consumer demands the first week of July and throughout the month of July, we felt that that was very much a point in time that market had declined dramatically.

People were trying to figure out what that meant and where it was going to go.

And we were thinking at that point we consciously made the decision that we felt it was short term and felt it was an overreaction by the consumer to all of the bad news.

Not just to mention not only the market declining, but the turmoil in the financial markets in general related to accounting and the concerns about August 14th filings and those types of things.

So we made that decision in light of the fact that this could be short-term.

One last thing I would like to add that Laura and I have spent a lot of time talking about [INAUDIBLE] related to Pottery Barn and that is we think we missed an opportunity, what we'll call summer II.

She had an unbelievable early spring/summer where it was a tremendous opportunity for the business in the first quarter, early second quarter.

We have an opportunity to drop in between that period and the time we set in fall, what I'll call summer II.

And it's a opportunity to put in a fresh set of new product.

She's already developed that.

In fact, I went through it with her design team here a few weeks ago.

And It is really an opportunity for us, as we roll against next year to give the customer that kind of second summer set that is really exciting.

I've got it.

Two other questions.

One, on the catalogue side, if you think about the drops that have taken place, I don't know, if the last six weeks or since July 1, can you provide some color on how the response of the catalogue drops have been in this time frame?

I think it's consistent with our guidance, Dave.

We've been -- we've been very pleased, really, all year, and we're very encouraged about what's going to happen in the second half.

We've got our circulation planned up significantly.

You know, our second-quarter circulation was actually planned down and executed down, and that may have had some impact a little bit on our store traffic.

But we're back in our normal circulation levels.

I'm also encouraged that we've been able to build our house file fairly significantly this year with some of the lowest advertising costs that we've seen in many years.

Our paper costs are at an all-time low, and we are taking advantage of that to do additional prospecting.

I'm very pleased with the Williams-Sonoma catalogue which, as you know, has been in issue for several years.

And look ago head to the Pottery Barn drops throughout the remainder of the year and the P.B.

Kids drop, I think that they have a newness and freshness focused around Halloween, Thanksgiving, and Christmas that we haven't seen in the past.

So --

I think you are going to be thrilled with what is to come.

I mean, we're very pleased with how the fall catalogues have been received.

The best is yet to come on that front.

I think the same thing on WS, too.

You've got the fall catalogue coming the first week of September and as Pat mentioned, and extra one in December.

We have really had some great product opportunities.

So it's a great way to send it out and let people see it.

One last thing on the Sonoma side had--just maybe to clarify something.

It sounded like each of the major events you were quite pleased with in the quarter, yet the quarter overall, you had negative same store sales.

Can you just kind of put those two together for us?

Well, you know, we had great celebrations in our Mother's Day.

Father's Day was good.

Fourth of July was a good week.

You know, and then we had lack of demand.

Traffic was down in July.

As Sharon and Dale had mentioned we seriously looked at what to do and the brand is so strong, that to take the markdowns would have been a mistake against our core product so we held on.

You don't see this.

But our margins were excellent in our core product over the month.

In August we started out, we had a drop in July catalogue, and just had some of our new product--we had some of our new product for the fall in stores, and it's taking off, and so we are very pleased that, you know, if it holds, you know, we are very good in August, back to the plan.

We are actually at plan or above.

But it is very difficult to describe.

It was a volatile period of time.

We had good holidays.

We did well on those things.

We sold through our merchandise quicker in Mother's Day and Father's Day than we wanted to, so we needed more merchandise.

And we are planning that next year.

Laura talks about summer II, and we're doing the same thing.

We had a full program a week ago on the outdoor for next summer making sure that our period of time from after the 4th of July through the end of August that we remain strong.

It is an opportunity to create and put in fresh merchandise.

So that's where we were this year and where we will be next year.

Terrific.

Thanks very much.

Can we take one more question, please?

And that question will be with Brent Ricestrom from U.S.

Bank Corp, Piper Jaffray.

Yeah, just a quick question.

You had mentioned how much Williams-Sonoma and Pottery Barn overall sales have grown.

Did you mention Pottery Barn itself?

You mentioned Pottery Barn Kids but not Pottery Barn, I believe.

No, we did mention Pottery Barn.

The Pottery Barn business was up 13% in total sales and -- let me grab my -- Sales in the Pottery Barn brand were up 13% for the third quarter.

Okay, thank you very much.

Ok, thank you, everybody.

We appreciate your time.

We are looking forward to the fall season.

I think we are well-positioned and prepared well to deliver on the guidance, both our sales guidance and also our profit guidance.

Thank you, again.

Thank you.

Thank you.

Ladies and gentlemen, this does conclude our conference call for today.

You may disconnect at this time.