Williams-Sonoma Inc (WSM) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma incorporated third 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 Ronald Lobe, Senior Vice President and General Counsel at Williams-Sonoma incorporated to discuss forward-looking statements.

Please go ahead, sir.

Good morning.

The earnings guidance, company plans and other forward-looking statements included in this 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 and business as a 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, included but not limited to reports on forms 10K, 8K and 10Q for the full text of the forward-looking statement 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 would now like to turn the conference over to Dale Hilpert, Chief Executive Officer.

Thanks, Ron.

Good morning and thank you for joining us.

With me today is Howard Lester, our Chairman.

Pat Connelly, our Executive Vice President and Chief Financial Officer.

Laura Alber, President of Pottery Barn brands.

Patrick Cowell, our President of Williams-Sonoma brands.

And Sharon McCollam, our Senior Vice President and Chief Financial Officer.

Third quarter 2002 was a quarter of many achievements for the company.

Not the least of which was delivering the strongest earnings in history of the company for the fourth consecutive quarter.

As mentioned in this morning's press release, despite a difficult economic environment, we delivered top-line sales growth of 14.2% and third quarter 2002 diluted earnings per share of 13 cents.

Which was 3 cents above First Call consensus estimates and 10 cents above last year.

Even more encouraging is that on a year to date basis, we delivered top-line sales growth of 14.8% and diluted earnings per share of 37 cents versus 5 cents last year.

Consistent with our strategy to improve profitability in our core businesses, these strong earnings and better than expected results were driven by substantial improvement in gross margin and the ongoing success of five key performance drivers.

The first key driver was the significant improvement in our net shipping profitability for merchandise delivered to customer, in Pottery Barn and Pottery Barn Kids brands.

The second key driver was a substantial reduction in customer returns, replacements and damages.

Lowering customer returns has been a long-term objective and we're gradually driving results in this area.

The third key driver was a substantial reduction in retail inventory shrinkage, due to significant improvement in physical inventory results and improved management oversight in freight to store delivery processes.

The fourth key driver was a year-over-year increase in merchandised gross margins.

This increase was primarily driven by reductions in cost of merchandise due to improved sourcing, better inventory and receipt flow management and strong merchandise assortment.

The fifth driver was distribution center performance, including labor productivity and cost reduction initiatives.

In the third quarter 2002, the total distribution center operating cost decreased by 3.8% versus the same period last year despite a 13.8% increase in total company merchandise sales.

Other achievements during the quarter included: The national rollout of our Pottery Barn and Pottery Barn Kids private label credit card program.

Which we believe will be highly effective marketing tool over the next several years.

The on-time or ahead of schedule opening of 34 new stores, including three flagship stores on Blur Street in Toronto, Canada.

The successful launch of our next generation e-commerce site for the Williams-Sonoma brand and the successful implementation of the company's supply chain contingency plan to minimize the impact of inventory delays caused by the West Coast port shut down.

Another achievement during the quarter was the continued rollout of our West Elm concept.

On a year to date circulation of 4 million catalogues, we continue to be pleased with the performance.

Assuming these trends continue through the fourth quarter, we will substantially increase our catalog circulation and launch an e-commerce site in 2003 and open retail stores in the fall of 2004.

We continue to believe that this brand has strategic potential in the middle market segment.

Also during the quarter, a decision was made to discontinue the publication of taste magazine after the fall 2002 issue.

This decision was made based on the magazine not meeting the company's long-term return objectives.

The financial impact of this decision is immaterial to the company's current and future revenue and earnings.

Finally, in furthering our brand alignment strategy, we're pleased to announce the recruitment of Randy Borne, a Senior Vice President and General Merchandise Manager of Hold Everything brand.

Prior to joining Williams-Sonoma, Randy served for 16 years as President and Founder of Exposure Catalog Company.

A premium specialty catalog company focused on storage and display of photos and keepsakes.

Randy brings to Williams-Sonoma an innate understanding of the direct to customer business and a proven track record in brand development.

Randy also brings significant experience in the home category.

As Senior Vice President of General Merchandise Manager of the Hold Everything brand, Randy will be responsible for developing a long-term, multi-channel strategy for the concept.

Randy started in September and is reporting directly to Jim Boike, our Chief Operating Officer.

As we look forward to the fourth quarter, we remain confident despite the economic uncertainties that we will be able to drive our business and deliver the EPS guidance we have provided to our shareholders.

We have been cautious all year in our economic expectations for the fourth quarter and believe our guidance is based on conservative and executable assumptions.

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

Thank you, Dale.

Good morning!

I'd like to start by outlining the agenda for the remainder of this morning's call.

First, we will review our third quarter 2002 earnings results.

Next, we will briefly talk about our 2002 guidance.

Then, Laura Alber will have a business update for the Pottery Barn and Pottery Barn Kids brand.

Then, Patrick Cowell will provide you with a business update for the Williams-Sonoma brand.

Then we will open the call for questions.

In our last conference call, we told all of you that we believed that even if the economy remained volatile in the third quarter, we were committed to delivering the earnings per share guidance we promised to our shareholders.

We are very pleased to report today that we met and exceeded this commitment.

In the third quarter of 2002, we delivered diluted earnings per share of 13 cents which was 3 cents above the high end of guidance and 10 cents above the prior year.

We also delivered pretax operating margin as a percentage of sales of 4.66%, approximately 60 basis points above the high end of guidance and 330 basis points above last year.

Net revenues for the third quarter of 2002 increased 14.2% to $527.7 million versus $462.1 million in the third quarter of 2001.

During the quarter, the company launched a new private label credit card program in the Pottery Barn brands.

To support the launch of the card, the company offered introductory discounts and a loyalty rewards program to customers who accepted the card.

The cost of these programs is accounted for as a reduction of net revenue and negatively impacts year-over-year top line sales growth.

Retail sales grew by 18.8% to $306.1 million versus $256.6 million in the third quarter of 2001.

This growth was driven by new store omgs and a 2.8% increase in comparable store sales, but partially offset by customer discount on the private label credit card.

Store counts at the end of the third quarter of 2002 totaled 477.

This was above guidance by 7 stores due to the advancing of the opening dates of 6 stores from the fourth quarter into the last two weeks of the third quarter and postponing the closure of one store.

As in other aspects of the business, we are continuing to exceed expectations in the execution of the store development calendar and are very encouraged by the financial performance of our new stores.

Comparable store sales for the third quarter of 2002 increased 2.8% versus a decrease of 1.1% in the third quarter of 2001.

As we look at the sales momentum during the quarter, we are pleased to see that the two-year comparable store sales trend by month was increasingly positive.

We believe this trend is a favorable indicator that the consumer may be regaining confidence and focusing on the upcoming holiday season.

Direct to customer sales grew by 6.5% to $187.7 million versus $176.6 million in the third quarter of 2001.

This growth was primarily driven by increased sales in the Pottery Barn, Williams-Sonoma and Pottery Barn Kids brands in addition to incremental sales from the West Elm catalog.

These increases were negatively impacted by an expected decrease in the Hold Everything brand and customer discounts on the private label credit card.

The lower than expected growth in direct to customer was driven by softness in the catalog channel.

The softness was primarily driven by a shift in catalog mailing dates into the fourth quarter, a significant increase in prospecting and lower response rates on catalogs mailed in store areas.

The Internet, however, more than offset this softness with sales growth of 35.4% in the third quarter.

Internet sales in the third quarter of 2002 were $48 million versus $35.5 million in the third quarter of 2001.

Gross margin in the third quarter of 2002 reported at 39.1% of net revenues increased 320 basis points versus the third quarter of 2001.

This increase was driven by several operational improvements, including a 160 basis point increase in net shipping profitability, a substantial improvement in customer returns due to improved merchandise quality, changes in the company's return policy for furniture in the Pottery Barn brands and new processes for handling returns in the call centers.

A substantial reduction in retail inventory shrinkage due to better than expected mid-year results, lower cost of merchandise due to improved sourcing and lower freight costs from the distribution center to the stores.

SG&A in the third quarter of 2002 reported at 34.4% of net revenues increased 20 basis points versus third quarter of 2001.

This increase was primarily due to an increase in employment costs, offset by substantial leverage in administrative expenses and lower advertising.

The year-over-year employment cost increase is a percentage of net revenues in the third quarter of 2002 was primarily driven by an increase in incentive compensation due to improved profitability during the quarter, higher retail employment due to a year-over-year increase in new store openings and higher employment costs to support information technology initiatives.

The significant leverage in administrative expenses was primarily due to a reduction in credit card exchange fees due to customers shifting from major credit cards to the private label credit card during the quarter.

A reduction in bad debt expense due to the implementation of check authorization in fourth quarter 2001.

And ongoing reductions in other general operating expenses.

Interest expense in the third quarter of 2002 was $100,000 versus $1.7 million in third 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 in the third quarter of 2002 was $23.2 million, versus $20.9 million in second quarter 2001.

The third quarter 2002 credit for the deferred lease and amortization was $4.3 million, versus $3.3 million in the third quarter of 2001.

Capital spending for the third quarter of 2002 was $52.9 million, versus $44.8 million in the third quarter of 2001.

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

Cash at the end of the third quarter of 2002 was $38.5 million and the company had no obligations under its revolving line of credit.

This compares to a $6.9 million cash balance and $155.3 million of revolving debt at the end of the third quarter of 2001.

This represents a $186.9 million improvement in the company's net debt position.

This substantial strengthening in the company's net debt position is primarily due to strong earnings and an increased focus on cash and asset management.

During the quarter, the company extended its $200 million unsecured line of credit facility.

The new agreement expires on October 22, 2005.

Year to date, there have been no borrowings under the line and we expect that to continue throughout the end of the year.

Merchandise inventories at the end of the third quarter 2002 were 358.4 million versus 334.8 million in the third quarter of 2001.

This represents an 8% increase versus the third quarter of 2001 but is substantially below the company's year-over-year sales growth of 13.8%.

This continued improvement in year-over-year inventory turns is primarily driven by the ongoing improvement inventory and receipts flow management.

Inventory turnover based on retail inventory values on a trailing 12-month basis at the end of the third quarter in 2002 increased 18.3%.

Pre-paid catalog expenses at the end of the third quarter of 2002 were 41.6 million, up 7 million from the second quarter of 2001.

This was due to the timing of expenditures for the Pottery Barn and Pottery Barn Kids catalog and increase in catalog paper inventories and the addition of skend pictures on the West Elm catalog, which was not launched until 2002.

Pre-paid expenses at the end of the third quarter 2002 were $22.5 million, up $7 million versus third quarter 2001.

This increase was primarily due to increases in pre-paid store rents, up approximately $3 million, pre-paid maintenance contracts up approximately $1.4 million.

And pre-paid insurance up approximately $2.4 million.

Current other assets at the end of the third quarter 2002 were $3.9 million, down $8.4 million versus third quarter 2001.

This decrease was due to the collection of an $8 million income tax refund that was outstanding in third quarter 2001.

Accounts payable at the end of the third quarter 2002 was $175.8 million, up $56.3 million versus the third quarter of 2001.

This increase was primarily due to higher inventory levels, significant inventory receipts late in the quarter, due to the West Coast port delays, higher payables on store construction due to an increased in store openings during the quarter.

Higher payables on pre-paid catalog expenses due to the timing of expenditures during the quarter and the timing of a vendor change in freight payment processing.

Accrued expenses at the end of the third quarter of 2002 were $59.2 million, up $12.8 million versus the third quarter of 2001.

This increase is primarily due to higher accrual balances and incentive compensation, customer returns, employee salaries and benefits and worker's compensation.

Customer deposit at the end of the third quarter of 2002 were $90.8 million, up $31.7 million versus the third quarter of 2001.

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

I would now like to briefly discuss our current guidance.

In this morning's press release, we provided detailed guidance for the fourth quarter and fiscal year 2002.

It is important to note that the fourth quarter of 2002 is a 13-week quarter versus 14 weeks in fourth quarter 2001.

As previously released, the incremental benefit of the additional week in 2001 was approximately $38 million in revenue and 2 cents in diluted earnings per share.

We are pleased to report that based current sales trends we have not changed our top line revenue guidance for the fourth quarter with the exception of the mix between retail and direct to customer.

Our retail sales have been adjusted to reflect the additional stores we have added during the year and our direct to customer sales have been reduced to reflect a more conservative assumption on catalog response rates.

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

We have also not changed our fourth quarter diluted EPS guidance.

Since February of this year, we told our shareholders we believed that the conservative guidance we provided for the fourth quarter was prudent based on uncertainties in the U.S. economy.

Clearly, we've seen the uncertainties become realities in the last three months.

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

We continue to be optimistic that our holiday assortments combined with strong execution in both our retail stores and direct to customer operations will enable us to drive the business in the fourth quarter.

With fewer shopping days this year between Thanksgiving and Christmas, we are focusing on enhancing customer convenience in both our retail and direct to customer businesses.

We have prepared for the post-thanksgiving rush by hiring and training seasonal associates on an accelerated schedule, installing registers, prerack product in the stores, implementing rapid replenishment procedures to get merchandise to the retail locations and extended our weekend schedules to accommodate direct to customer orders through December 23.

We believe that all of these initiatives will be key to driving revenue in the fourth quarter and will provide us with a marketable competitive advantage.

For the balance of the year, we will be flexible from in our decisions and remain focused as a management team on the three key initiatives we committed to at the beginning of the year.

Driving top line sales growth, improving operating margins as a percentage of sales and enhancing shareholder value.

I'd now like to turn the call over to Laura Alber.

Thank you, Sharon.

This morning I'd like to first provide you with a brief update on the launch of the private label credit card and then we will discuss the Pottery Barn and Pottery Barn Kids brands.

The Pottery Barn and Pottery Barn Kids private label credit card program was launched nationally in mid-August in all three channels.

The card is administered by a third party credit card provider and our company bears no exposure to credit risk on the card.

To drive the customer acceptance of the card, the launch was supported by the following initiatives: Prequalification of 4.2 million existing customers and introductory 10% discount on the first purchase.

A loyalty rewards program.

Employee contest in all channels.

And credit card advertising in all catalog mailings.

Since the launch, consumer acceptance of the card has substantially exceeded our expectations and we are optimistic about the long-term opportunities the card can provide as an efficient marketing tool.

It is too early in the program, however, to determine to what extent sales on the card were incremental versus a shift in payment method.

Based on our marketing strategy, which was directed heavily toward existing customers and offered a 10% discount for acceptance, we believe that the potential for shift in payment method during the initial launch was high.

At the end of the third quarter over 148,000 accounts had been opened, of which approximately 19% appear to be new customers to our file.

The total amount charged on the card during the quarter was approximately $75 million and the average transaction was significantly higher than the average transaction with other payment methods.

As we look forward to the next six to 12 months, we have four key objectives for the card.

First: To provide us with a vehicle to support a loyalty rewards program for our better customers without increasing our overall marketing costs.

Second: To provide us a new opportunity to develop a private relationship with our best customers.

Next: To have a new marketing vehicle to communicate to existing customers.

And finally: To provide us with a tool to support sales growth by increasing access to the brand for new customers, especially in tight economic times.

Based on our initial success and the strong operational support of the card, we are optimistic that all of these objectives are achievable.

I would now like to talk about the Pottery Barn brand.

The overall performance in the third quarter was very strong, despite a difficult retail environment.

Net sales for the quarter increased 10.1% and comparable store sales increased 1.5% during the quarter.

We opened 10 new stores versus 8 stores in our previous guidance.

The e-commerce business continued to drive strong growth in the direct to customer channel primarily due to the ongoing success of the wedding and gift registry.

Through the end of the third quarter, new registries created in 2002 increased 84% versus the prior year.

From a merchandising perspective, sales I mentioned during the quarter was driven by continued consumer response to our core of seasonal assortments.

Furniture and lighting were some of the categories that drove the business during the quarter.

Initial reads on the new holiday assortments have been positive.

What was particularly encouraging about the third quarter was the positive trend in retail and then some.

While the overall growth rates of the second and third quarters were similar, monthly comparable store sales were improving at the end of the third quarter and they declined at the end of the second quarter.

This positive trend clearly reflects a favorable shift in consumer spending our businesses and we are cautiously optimistic that it will continue into the holiday season.

In addition to solid sales growth during the quarter, we also saw a substantial increase in brand profitability.

This increase as a percentage of net revenues was primarily driven by improvement profitability in the customer shipping model, a reduction in customer returns and replacements and other reductions driven by extremely successful supply chain and inventory management initiatives.

Inventory turns for the Pottery Barn brand on a trailing 123-month basis improved approximately 18% versus the same period last year.

Now I would like to talk about Pottery Barn Kids.

They continued a strong performance in the third quarter.

Net sales for the quarter increased 34.4% and we opened 12 new stores, including our first flagship store in Toronto.

From a merchandising perspective, strong performance in bedding, nursery accessories and seasonal offerings drove sales during the quarter.

The Halloween and early holiday assortments exceeded our expectations.

Although our comparable store sales in the third quarter decreased 2.7%, we do not believe that this should be of significant concern.

Our primary objective for 2002 in the Pottery Barn Kids brand was to increase customer access to the brand.

To accomplish this, we said we would double our store count, increase our catalog circulation and expand the customer house file through aggressive prospecting.

We are on target to profitably achieve every one of these objectives.

With the rapid growth of the Pottery Barn Kids retail concept, however, comparable store sales will fluctuate, due to the initial inton of new store openings on initial comparable stores, grand opening events and inventory management challenges that result from store opening calanders and better than expected merchandise successes in a new retail concept.

To put it in perspective, Pottery Barn Kids ended 2001 with 27 stores.

To date in 2002, Pottery Barn Kids opened 27 stores of which 26% were opened ahead of schedule.

Of the 27 stores that were opened in 2002, 11 were in the brand's top 6 comparable store markets, thus putting significant pressure on the overall comparable store sales in the quarter.

In single store markets, however, comparable store sales for the quarter were positive.

Another significant highlight in the Pottery Barn Kids business is the ongoing success of e-commerce.

The e-commerce business was a driver of growth in the direct to consumer channel during the third quarter.

Productive Internet partnerships and significant growth in baby and gift registry sales were the primary drivers of the e-commerce increase.

Through the end of the third quarter, over 26,000 new baby and gift registries had been created versus 3800 in 2001.

This represents a year-over-year increase of over 600%.

Also in the third quarter, the brand saw continued improvements in gross margin, primarily due to improved profitability in the customer shipping model, lower inventory shrinkage and lower replacements in damages.

SG&A slightly deleveraged during the quarter due to start-up expenses related to new store openings, increased catalog circulation and acquisition and prospecting costs.

Inventory turns for the kids brand on a trailing 1212-month basis improved approximately 20% versus the same period last year.

As we look forward to the fourth quarter for both Pottery Barn and Pottery Barn Kids, we are very excited about our seasonal merchandising strategies and confident in our ability to drive the business.

We believe that our holiday assortments, our brand focus on gift giving and our peak execution capabilities are stronger than they have ever been and we are committed to delivering our results.

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

Equally important, however; that all of these initiatives support our number one most important strategic objective which is to exceed our customer's expectations.

Now I'd like to turn the call over to Patrick Cowell.

Thanks, Laura.

I'd now like to talk about the Williams-Sonoma brand.

The Williams-Sonoma brand had an excellent third quarter.

Despite a challenging economic climate, net sales for the brand increased 15.3% and performance was strong in both the retail and direct to customer channels.

Comparable store sales increased to better Chan expected 4.9% and we opened 12 new stores during the quarter.

The e-commerce business continued to drive significant growth in the direct to customer channel.

Side traffic increased 60% and conversion rates were very high compared to industry bench marks.

We also saw a significant increase in online bridal registry sales.

Our sales momentum during the quarter was across several merchandising categories, but we saw particularly strong consumer response to core product lines including bake ware, cookware, cutry, seasonal foods, electrics and house wares, what's most encouraging to us is the positive trend and retail momentum in the latter part of the quarter.

We believe that the trend clearly reflects a favorable shift in consumer spending and we're prepared to capitalize on the opportunity as we enter our peak season.

In addition to strong sales growth during the quarter, we also saw a substantial increase in brand profitability.

Primarily due to cost reductions as a percentage of net revenues driven by successful supply chain and inventory management initiatives and higher catalog productivity.

Inventory turns for the Williams-Sonoma brand on a trailing 12-month basis improved approximately 15% versus the same period last year.

As we look forward to the fourth quarter, we are very excited about our new selections in foods and electrics.

Based upon strong prior year performance, we significantly increased our holiday food SKUs and expanded our assortment in electrics to include a broader selection of coffee makers, espresso machines and mixers.

As the consumers focus on traveling less and entertaining more during the holiday season, we believe that Williams-Sonoma will continue to be a top of mind destination for gift giving and holiday entertaining.

At this point, we'd like to open the call up for questions.

Thank you.

The question and answer session will be conducted electronically.

If you would like to ask a question, you may do so by pressing the star key followed by the digit 1 on your touch-tone phone.

If you are on a speaker phone, be sure your mute function is turned off.

Once again, that is star 1 to ask a question.

And we will go first to Dana Selsky with Bear Stearns.

Good morning, everyone.

Good morning.

Congratulations on a very, very good results.

Seems like two of the themes I'm noticing is an increase in shipping profits and increases in inventory turns.

Can we talk a little bit more about if these increases in shipping profits, can it continue?

And what should we expect going forward?

Inventory turns: Is there more in each of the divisions?

Where is that coming from?

And also, more commentary on catalog productivity of any of the different catalog brands.

Thank you.

Thank you, Dana.

This is Dale.

Just a couple of quick comments on shipping.

Shipping really is improved really for two reasons.

We have taken a look at our -- our -- both the schedule of what it cost to move to the customer and better reflect that in n our catalog, but most importantly we have worked very hard to reduce the cost side of the equation.

We are -- we're continuing to work through our distribution and logistics people in Memphis to drive the cost down and we think there's continued opportunity there.

The issue that we have with shipping income is that we want to be very careful and make sure the customer shares some of the benefit of our reduced cost.

In terms of inventory turn, as many of you know, we've taken a -- an aggressive approach to try to clean our stocks, make sure we have flow of the right receipts and make sure we have both the right quantity and quality of merchandise.

As we noted at the end of the second quarter, we probably overcorrected on quantity and we adjusted that as we entered the third quarter.

We're still being a very aggressive with regard to keeping our inventories very clean and flowing as much good as possible.

As we look at the third quarter, all of you are aware of the issues that surrounded the port strike.

We had about 453 containers trapped in that mix.

We moved a lot of product around the West Coast through the east coast, especially textiles and goods from India.

But the reality is that furniture is a big issue for us and we cannot have other kinds of transportation.

So, that has to be brought to L.A.

We -- I think did as good as job and I'm very proud of the work done by our logistics and distribution people as long as w our inventory management people to handle that situation.

I think we minimized the impact on the company.

Pat, do you want to comment on the catalog issue?

Sure, Dana, catalog sales were a modest growth in Williams-Sonoma and Pottery Barn with a decrease in Pottery Barn Kids.

That was because of a rapid expansion of the store base.

We got a decrease in sales around the store area until we anniversaried that the following year.

That was offset by very high growth on the Internet side and we know that a significant part of the sales from the Internet come from people who receive the catalog and then order on the Internet.

That's fine with us because our analysis indicates that people who shop from both channels after receiving the catalog spent 15 to 20% more with us.

But we're very encouraged about the upcoming fourth quarter.

Operator: Next we go to Mark Rowen with Prudential Securities.

Thanks, good morning, everyone.

A couple of questions, first for Laura on Pottery Barn.

I'm trying to understand a little bit better how the -- the comps tie into the gross margins and I know we don't have it broken out specifically for Pottery Barn, but it seems like sales have slowed from earlier in the year and yet gross margins have held up pretty well, which suggests that the merchandise is right.

So, can you confirm that, that you're not having to take more markdowns to move the merchandise at Pottery Barn?

And kind of help me understand why the comps have slowed so much and yet the margins are good.

Our strategy continues to be to bring in new flow of merchandise regularly, to make sure that we always have freshness in the store and to take markdowns in season because they're much less costly than out of season.

So, we've been aggressive about the strategy and the results can be seen throughout the year.

We have had continued strong gross margins.

The sales increase in the third quarter for Pottery Barn comparable store sales was 1.5%, similar to our Q2 comparable store sales.

Our Q1 comparable store sales on a two-year basis, we had had a tough 2001 Q1 and really made up the difference in this 2001 comparable store results.

So, while the numbers swing dramatically this year, if you look at the two-year, it is much easier too -- to understand that it is not a slowdown, but simply a two-year look at the growth.

One other question -- one other point I would make, this is Dale, that the -- when I was talking about the furniture impact on the West Coast dock strike, the issues surrounding that are really Pottery Barn and Pottery Barn Kids.

There was very little impact in Williams-Sonoma on the West Coast strike.

So, it's primarily an impact on that -- as we've come out of that and continued to flow fresh furniture into both Pottery Barn and Pottery Barn Kids, that business continues to be very strong.

Next is Anne-Marie Peterson with Thomas Weisel Partners.

Yes, just a couple of questions.

First of all, you indicated that the private label credit card discount had unfavorably impacted sales.

Can you, perhaps, give us a little more quantification in terms of what channel did you see that most in?

And secondly, in terms of the operating margin potential as we look at 2003, can you kind of give us an idea, recap where you've seen the most improvement 2002, where you feel like you're completed and next year where we should see that coming from.

Thanks.

Anne-Marie, first I'd like to comment on your initial statement regarding private label credit card and the impact on top-line sales.

The -- on the discounts that we take on the private label credit card, accounting requires us to record those as an offset to sales.

And obviously in 2001 we did not have a private label credit card so we believe that there is no question about -- from an accounting standpoint, that you do have the offset.

It was split evenly between the retail and the direct to customer businesses during the quarter and as Laura said earlier in her comments about the private label credit card, it's very difficult for us at this time to measure the incrementality of the private label credit card.

She mentioned that the marketing programs related to the card were very much targeted toward existing customers.

So, it is uncertain -- we're uncertain at this time how much of the sales that were on the card are from the actual incrementality versus shift from other payment methods in order to obtain discounts on the merchandise.

However, saying all of that, we continued to be very excited about the private label credit card.

We think the marketing opportunity is substantial.

We think that over time that we are going to be able to develop personal relationships with our customers, with our better customers and we believe that it provides us another vehicle with which to touch our customer.

So, from a data perspective and from a relationship perspective, we think the card is substantially a great tool for us as a company and our success has absolutely exceeded our expectations.

Anne-Marie, this is Dale.

With regard to the operating margins, I think you remember about a year and a half ago we said as a management team we would shoot to get to 8 -- to 10% operating margins in two to three years.

At our meeting last April, here and in San Francisco, we got a little more aggressive with that and raised our own bar to 9 to 11%.

As we look at that, we think that's clearly where we are and clearly achievable.

In terms of how we get there, there is really, as always, about four components.

The first and most important one is to drive the top line and sales.

If we do anything in 2003 we'll put a major effort to drive our top line.

We think that there's still major improvement gross margin.

As a management team, though, we believe strongly that that comes from reduced cost elements, not increasing the retail to customers.

And you're seeing some of that come through now with many programs that we started a year and a half ago and are now paying significant dividends.

Everything from the initial cost of product, the first cost, which is a sourcing issue, all the way through damage shrink, returns, replacements, every element.

The third issue is really operating expenses.

We continue to believe there is leverageable opportunity in all elements of our operating expenses as we get organized by brand, we reduce the corporate staff impact on the cost elements.

We think there will continue to be an opportunity to leverage our operating expenses.

And no small part of this whole thing is management of our assets.

The balance sheet needs to be managed as effectively as our operating expenses, our sales and our gross margins.

So, we will be looking at all four elements and we're really encouraged that we can make major improvements across-the-board, but it will start next year with a real focus on driving sales.

Next we go to David Ricci with William Blair.

Good morning.

A couple of questions.

First on the Pottery Barn credit card, given the reduction in revenue and because of the accounting, is it fair to say that actually that would be a slight positive in terms of the operating margin?

Secondly, on Pottery Barn Kids, can you elaborate a little bit more with respect to how these stores are opening and what you're learning?

Is the grand opening there, for example, greater than that of your other concepts?

And then lastly, Laura, if you could talk at all about any key hits going into the holiday assortment here?

Going into the holiday season.

Thank you.

Okay, we will let Sharon handle the first part of that and Laura the second two pieces.

Dave, on the Pottery Barn margins and the impact of the credit card, obviously I'm not quite -- I'd like you -- perhaps we can talk about it later, to clarify your question.

If this is recorded as an offset to revenue and because it is the top -- it causes the top line to be lower and that would, of course, increase the gross margin if everything else remained equal.

So, I think that your -- you're putting those together is absolutely correct but as -- but there is more than a substantial offset in Pottery Barn and substantial improvement in the gross margins so you really don't see it.

It is not material to the Pottery Barn gross margins.

Hi, David, it's Laura.

Kids -- yes, we have a stronger grand opening program.

In each and every store that we open, we do a grand opening event in the kids store and only do it in select markets for Pottery Barn.

Also, you know, in a lot of markets it's the first store when we open one and there is a lot of excitement pent up for the store opening.

So, it is a more substantial, more exciting store opening.

From the holiday assortment perspective, we are really excited as I said earlier.

We have a lot of things that are working and if you go into our stores it is pret apparent that the customer is responding well to the holiday merchandise, both from a gift giving perspective and also in decorating their home.

We think it continues to be a real strength of ours and we increased the amount of home decor items in the Pottery Barn brands and really focused on great toys for kids through Christmas and early results on these merchandising initiatives have been very strong.

Due to time constraints, our final question is from Joan Storms with Wedbush Morgan.

Hi, two quick questions.

First of all, I wondered, Sharon, if you could share with us any preliminary read on the promotion that you're doing with the Sonoma concept in Citibank?

We have Patrick Cowell on the line, we will have Pat respond to that.

Yeah, Joan, thank you.

We initially did that with Citibank, where we printed up a lot of books to give with purchase using the Citibank card of $50 or more.

As of last weekend we had given away 12,000 books which meant that we had 12,000 transactions using that Citibank card.

In all fairness, the only thing that's come out so far has been the advertising in the magazines, the four periodicals that we did and the stuffers that go out to the Citibank holders went out effective November 15.

So, we should start to see some significantly higher lift on this over the next couple of weeks with that promotion.

But initially we're very encouraged by it.

Okay, well, we'd like to thank everybody for their time this morning.

We appreciate your support of Williams-Sonoma, Inc. and I can't tell you how proud Howard and I are of the management team and of the effort.

Obviously the third quarter was very challenging and the management team performed extremely well and both of us are very, very proud of the results that have been delivered.

Thanks for your attention.

We look forward to seeing you soon.

This does conclude today's conference call.

We thank you for your participation.

You may disconnect your line at this time.