Williams-Sonoma Inc (WSM) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Williams-Sonoma Incorporated third quarter 2003 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. Steve Nelson, Director of Investor Relations at Williams-Sonoma Incorporated to discuss forward-looking statements.

Please go ahead, Mr. Nelson.

Good morning.

Please note that information provided on this call should be considered in conjunction with this morning's press release.

The forward-looking statements included in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements address among other things, the financial condition, results of operation, 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 release and SEC filings including but not limited to reports on forms 10-K, 8-K, and 10-Q for an explanation of all the risks and uncertainties that could cause our results to differ materially from those expressed or implied in our forward-looking statements.

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 Mr. Ed Mueller, our Chief Executive Officer.

Good morning and thank you for joining us.

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

Before I begin talking about our third quarter results I would first like to comment on our newest executive level appointment.

I'm very pleased to announce that Vivian Stevenson, previously serving as our Senior Vice President and Chief Information Officer, has been appointed to the newly created position of Chief Operating Officer to lead our corporate-wide supply chain initiatives.

In the position of Executive Vice President and Chief Operating Officer, Vivian will continue to lead information technology and rapid deployment, in addition to product sourcing, distribution, logistics, and call center operations.

We believe the consolidating the leadership of these highly co-dependent organizations will allow us to more quickly advance our operational technologies and streamline our business processes.

Now I'd like to discuss our third quarter earnings results.

We're pleased to be here today to deliver our shareholders another quarter of strong financial performance.

On revenue growth of 20% we increased our earnings per share by 54% while continuing to make important investments in our new and emerging brands.

Although consumer demand was clearly stronger than previous quarters, we did see some unpredictability in both directions in our overall day to day sales trends towards the end of the quarter.

Despite this unpredictability we executed against our strategic initiatives and delivered to our shareholders the best third quarter performance in the history of the company.

We are very proud of this result and believe it reflects the tremendous consumer appeal of our brands, the power of our multichannel strategy, and the competitive advantage that we have created with our operational flexibility and improved execution.

What pleases us the most about our third quarter performance is that we once again were able to deliver on our short-term commitments to our shareholders while investing in the long-term strategic initiatives that will drive our future.

During the third quarter we delivered strong sales growth in both our core and emerging brands with momentum in both our retail and direct to customer channels.

In our three core brands, Williams-Sonoma, Pottery Barn, and Pottery Barn Kids, each delivered mid single-digit comparable store sales increases.

Direct to customer growth was also very strong.

As a matter of fact, the direct-to-customer sales growth in the third quarter of 2003 was the strongest growth we have seen in the core brands in three years.

In the emerging brands we substantially increased catalog circulation and successfully launched the Pottery Barn Teen and West Elm Web sites to a very enthusiastic customer response.

We also made several strategic senior-level hires in the Hold Everything and Williams-Sonoma Home creative and inventory management teams to support a fall 2004 launch of both catalogs.

The highlight of the emerging brands this quarter was the extremely strong performance of Pottery Barn Teen.

Although it is still very early to predict the future potential of this brand, the performance to date has been very similar to the outstanding first-year performance of Pottery Barn Kids, which is very encouraging.

As we look ahead to the fourth quarter, we will continue to focus on delivering against our three strategic initiatives.

Driving top line sales growth, improving our pre-tax operating margin, and most importantly, enhancing shareholder value.

To drive top line sales growth in the fourth quarter we will be continuing to invest in the direct marketing infrastructure of our emerging brands, including opening our first West Elm store on November 22nd, increasing catalog prospecting in our core brands to identify new customers to the brand, and implementing new visual strategies in our retail stores.

To improve our pre-tax operating margins in the fourth quarter we will be continuing to optimize transportation costs with a specific focus on furniture shipping.

Improving furniture quality, supply chain management, and catalog depiction to reduce customer returns, replacements, and damages, and continuing to focus on corporate overhead cost containment initiatives.

Consistent with our final strategic initiative to enhance shareholder value we remain committed to executing against our key business strategies while delivering the EPS guidance that we have provided to our shareholders.

Looking specifically at our fourth quarter, we are encouraged by the overall sales trends that we have seen in our retail and direct to customer businesses and are excited about the opportunity in our new and emerging brands.

At the same time we are cautioned by the fact that we are increasing our prospecting in our core brands and that 30% of our total circulation for the fourth quarter will be mailed in our new and emerging brands.

This inherently creates a higher level of uncertainty in our forecast but we believe it is extremely important for us to maintain our momentum in our direct to customer initiatives.

We will also be executing our peak season with a 21% increase in distribution square footage that was added in the third and fourth quarters to support our current growth.

Based on the lower level of forecasting certainty associated with these fourth quarter initiatives although we increased our revenue guidance for the fourth quarter in the range of 3 to 4% we are reiterating our earnings per share guidance in the range of 80 cents to 85 cents and expect to deliver our earnings within that range.

This represents an earnings per share increase of 19 to 27% on a revenue increase of 14 to 18%.

We have, however, increased our full-year guidance to the range of $1.26 to $1.31, versus previous guidance of $1.25 to $1.28, reflecting our 1 cent better than expected earnings per share achievement in the third quarter and the reiteration of our fourth quarter guidance in the range of 80 cents to 85 cents.

I will now turn it over to Sharon McCollam.

Thank you, Ed.

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 2003 earnings highlights and our fourth quarter and fiscal year 2003 earnings guidance.

Next, Pat Cowl will provide with you with a business update for the Williams-Sonoma Brand, then Laura will provide with you with a business update for the Pottery Barn, Pottery Barn Kids and Pottery Barn Teen Brands and finally we will open the call for questions.

I would now like to discuss our third quarter 2003 earnings highlights.

In our last conference call we committed to driving top line sales growth, generating positive comparable store sales in our three core brands, improving our pretax operating margin, and delivering our earnings per share.

We are very pleased today to report that we were able to deliver against all of these commitments.

And for the 13th consecutive quarter we have met or exceeded the earnings per share guidance we have provided to our shareholders.

For the third quarter 2003 we delivered diluted earnings per share of 20 cents, which was 7 cents above the third quarter of 2002, a penny above the high end of our guidance, and 50% above any other third quarter in the history of our company.

Net revenues for the third quarter of 2003 increased 19.9%, to $633 million, with strong performance in both the retail and direct to customer channels.

Retail sales for the third quarter of 2003 increased 14.8% to $351 million.

This year-over-year increase was driven by incremental sales and 39 new stores and comparable store sales growth of 5.6%.

Net sales increases in Pottery Barn Kids, Pottery Barn, and Williams-Sonoma were the primary contributors of this increase.

Retail execution during the quarter was very strong, and we saw significant sales benefits from our inventory reinstatement initiative that was substantially completed at the end of the second quarter.

Direct-to-customer sales for the third quarter of 2003 increased 27.5% to $239 million.

This increase was primarily driven by year-over-year sales growth in the Pottery Barn, Pottery Barn Teen, and Pottery Barn Kids Brands.

Internet sales for the third quarter increased 71.4% to $82 million, contributing 34.4% of total direct to customer sales.

As we have previously discussed, 50 to 60% of the sales in the Internet channel are generated by customers who have recently received a catalog.

Gross margin as a percentage of net revenues in the third quarter of 2003 was 39.3% versus 39.1% in the third quarter of 2002.

This is the highest third quarter gross margin in the history of the company.

The 20 basis point increase as a percentage of net revenues was primarily driven by favorable leveraging of fixed occupancy expenses due to year-over-year revenue growth and improved shipping profitability for merchandise delivered to customers.

This increase was partially offset by higher accruals for inventory shrinkage.

Inventory shrinkage expense increased in the third quarter of 2003 due to higher inventory levels and an unusually low level of expense in the third quarter of 2002.

This lower level of expense in the third quarter of 2002 was primarily due to a substantial reduction in the accruals for retail inventory shrinkage expense, based on a favorable mid-year physical inventory result and a significantly lower inventory level at that time.

SG&A in the third quarter of 2003 was 33.2% of net revenues versus 34.4% of net revenues in the third quarter of 2002.

This 120 basis point improvement as a percentage of net revenues was primarily driven by lower employment and other administrative costs offset by higher advertising costs.

Lower employment costs were primarily driven by reduced incentive compensation and the year-over-year elimination of restricted stock expenses.

Lower administrative costs were primarily driven by the ongoing corporate-wide initiatives to control discretionary overhead expenses.

The advertising cost increase as a percentage of net revenues was primarily driven by a greater percentage mix of total net revenues during the quarter being generated by the direct to customer channel, in addition to relatively higher costs associated with our new and emerging catalog concepts.

Depreciation and amortization in the third quarter of 2003 was $24.2 million versus $23.4 million in the third quarter of 2002.

Deferred lease amortization in the third quarter of 2003 was $5 million versus $4.3 million in third quarter of 2002.

I would now like to discuss third quarter 2003 significant year-over-year cash flow highlights and balance sheet variances.

Cash at the end of the third quarter of 2003 was $42.5 million versus $38.5 million at the end of the third quarter of 2002, an increase of $4 million.

Compared to the cash balance at the end of 2002 of $193.5 million, cash decreased $151 million.

This year-to-date decrease was primarily due to a net usage of cash in operating activities of approximately $43.4 million, capital spending of $131.9 million, and the positive impact of proceeds from the exercise of stock options of approximately $30.3 million.

Merchandise inventories at the end of the third quarter of 2003 were $466.4 million versus $358.4 million at the end of the third quarter of 2002.

This increase of $108 million was primarily due to the successful execution of our decision in late 2002 to reinstate our core merchandise inventories in the Williams-Sonoma, Pottery Barn, and Pottery Barn Kids Brands.

Pre-paid catalog expenses at the end of the third quarter of 2003 were $54.9 million, up $13.4 million, versus the third quarter of 2002.

This increase was primarily due to the timing of expenditures, increases in circulation in our core brands, higher paper inventories, and the incremental year-over-year costs for the new Pottery Barn Teen catalog launched in April 2003.

Pre-paid expenses at the end of the third quarter of 2003 were $26.8 million, up $5.3 million versus the third quarter of 2002.

This increase was primarily due to higher pre-paid maintenance costs due to entering into a long-term maintenance agreement with a strategic computer vendor and higher pre-paid store rent due to increased store counts.

Other current assets at the end of the third quarter of 2003 were $9 million, up $5.2 million versus the third quarter of 2002.

This increase was primarily due to a secured deposit of $5 million for the purchase of a corporate aircraft.

Other long-term assets were $18.6 million at the end of third quarter of 2003, up $11.9 million versus the third quarter of 2002.

This increase was primarily due to higher pre-paid maintenance cost due to entering a long-term maintenance agreement with a strategic computer vendor and an increase in the cash surrender value of life insurance policies held in conjunction with the company's non-qualified executive deferred compensation plan.

Accounts payable at the end of the third quarter of 2003 was $196.4 million, up $20.6 million versus the third quarter of 2002.

This increase was primarily due to higher inventory payables due to increased inventory levels and higher freight payables due to increased volume in the timing of expenditures.

Customer deposits at the end of the third quarter of 2003 were $115.3 million, up $24.5 million, versus the third quarter of 2002.

This increase was primarily due to an increase in the customer liability associated with recognizing revenue on a delivered basis and an increase in unredeemed gift certificates due to the strong growth in gift certificate sales.

I would now like to briefly discuss our outlook for the fourth quarter and our fourth quarter and fiscal year 2003 guidance.

Recognizing that approximately 36% of our full-year revenues and 64% of our annual earnings will be generated in the fourth quarter, we are continuing to be cautious in our outlook.

Although we are executing against a less conservative top line plan, we are remaining extremely focused on our key operational initiatives, including strong merchandising, solid supply chain execution, and continued cost control, that has enabled us to consistently deliver the earnings that we have committed to our shareholders.

For the fourth quarter as discussed in this morning's press release, although we have increased our revenue guidance we have reiterated our diluted earnings per share guidance in the range of 80 to 85 cents and expect to deliver our earnings within that range.

For the reasons Ed mentioned earlier, there is a higher level of uncertainty in our forecast, and to reflect that, we are maintaining our conservative guidance range.

For the full year, we have increased our diluted earnings per share guidance from a range of $1.25 to $1.28, to a range of $1.26 to $1.31.

This increase reflects the impact of the 1 cent better than expected earnings that we delivered in the third quarter and the reiteration of our fourth quarter guidance in the range of 80 to 85 cents.

In summary, the strength of our brands, our strong operational execution, and our proven track record in delivering on our commitments provides us with a strong confidence in our ability to deliver the earnings per share guidance we have provided you today.

I would now like to turn the call over to Pat Cowell to discuss the Williams-Sonoma Brand.

Thank you, Sharon.

Good morning.

We are very pleased that the strong sales momentum that we saw in the Williams-Sonoma Brand in the first two quarters of this year continued into the third quarter.

Third quarter net sales increased over 11% with ongoing strength in the retail channel.

Comparable store sales increased by a healthy 6.9%, and new stores exceeded sales targets.

A positive consumer response to the overall merchandise assortment and a higher in-stock position on retail inventories drove those better than expected results.

Also during the quarter we opened our new flagship store on Union Square in San Francisco.

This store serves as an icon and a billboard for the brand and represents the best of everything the brand has to offer.

The media coverage has been very strong, and we believe this store will bring tremendous long-term equity to an already powerful brand.

In the DTC channel, revenue growth was driven by ongoing success of our e-commerce initiatives.

Unique visitors to the Web site more than doubled and conversion rates continued to be very strong.

We also saw increasing momentum from our strategic Internet partnerships which we believe are going to be a significant marketing opportunity for the brand long-term.

Another key driver of our third quarter sales results in both the retail and the direct to customer channels was the success of our bridal registry business.

Bridal registries during the quarter increased over 17% and the registry value increased over 30%.

Bridal registry continues to be a strategic growth initiative within the brand due to its role as a multichannel sales driver and a source of new customers to the brand.

From a merchandising perspective during the quarter both core and seasonal food, cookware, housewares, and high-end electrics were very strong.

We were also very pleased with the initial consumer response to our new KichenAid electrics and our new maple-theme selections in the food division.

Although top line sales growth during the third quarter was very strong we saw some year-over-year gross margin rate pressure resulting from the execution of our tabletop transition initiative and the exchange impact of a weak U.S. dollar to the euro.

As we look ahead to the fourth quarter we are very excited about our seasonal merchandising strategies we are confident in our ability to drive the business.

The initial response to our new tabletop, seasonal food, and high-end electrics has been very positive and our inventory position entering the quarter is very strong.

We believe that Williams-Sonoma will continue to be the top of mind destination for gift giving and in-home entertaining during the holiday season.

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

Thank you, Pat.

Good morning.

From an overall perspective I'd like to start out by saying that the third quarter was an exceptional quarter for all the Pottery Barn brands and we are pleased with the progress that we have made in driving these businesses forward.

One of our key strategic initiatives is to drive profitable growth in all of these businesses and we are proud of the fact every business exceeded its third quarter performance targets.

Now I will talk more specifically about the individual brands beginning with Pottery Barn.

Net sales in the third quarter increased 14% and all channels performed above expectations.

This better than expected sales result was driven by a positive consumer response to both our core and seasonal assortments and a higher in stock position on merchandise inventory.

In the direct to consumer channel e-commerce is the primary growth driver.

Web site traffic increased over 60% and conversion rates remained high.

Bridal registry was also very strong.

New registries created during the quarter increased over 25%.

In the retail channel, comparable store sales increased 5.4% a significant improvement versus last year and previous quarters.

We are encouraged by this improving trend.

And we attribute our performance in Pottery Barn on our focus on improving our designs, upgrading our quality, and presenting strong visual statements.

This quarter we saw strength in furniture, flooring, decorative accessories, and core tabletops.

The customer response to Halloween and Thanksgiving was also very positive and the initial response to our holiday offering is above expectations.

I would now like to talk about Pottery Barn Kids.

Net sales for the Pottery Barn Kids brand increased over 44% in the third quarter.

This increase was primarily driven by retail store growth, positive comparable store sales, and continued momentum in the direct to consumer channel.

We executed our store opening strategy well in the retail channel.

We opened 11 new stores during the quarter and at the end of the quarter Pottery Barn Kids operated 77 stores versus 54 stores a year ago.

On a comparable store base of 45 stores at the end of the quarter, comparable store sales increased 6.3%.

This increase was primarily driven by strong performance in our single store market.

We continue to believe that comparable store sales in this brand continue to be volatile until there at least 75 stores in the comp base.

In the third quarter we concluded our in-store summer concert series.

The traffic generated by these brand-enhancing events substantially exceeded our expectations and based on the strong consumer response we are offering additional family engaging programs going forward.

We believe this strategy differentiates the Pottery Barn Kids brand from the competition and lays a foundation for long-term relationships with our customers and their children.

The direct to consumer business was also very strong, both catalog and Internet.

An expanded focus on personalization in key merchandise categories, highly productive Internet partnerships and significant growth in baby and gift registries contributed to the strong growth in this channel.

New registries created during the third quarter increased over 100%.

From a merchandising perspective, strength in our core businesses, furniture, nursery, bedding and decorative accessories and the introduction of new categories were significant contributors to our growth during the quarter.

I would now like to talk about Pottery Barn Teen.

We are absolutely thrilled with the performance of Pottery Barn Teen in the third quarter.

Net sales exceeded expectations and the launch of our Web site was a tremendous success.

The Web site has driven substantial brand awareness and appears to be a significant shopping channel of our choice for our customers.

As we go forward and continue to increase our circulation, which will be over 8 million in the fourth quarter, we are aggressively implementing strategies to attract new customers to the brand.

Since the initial launch of the brand we have developed a catalog request Web site, launched an e-catalog, established Web portal partnerships, prospected heavily with our catalog and leveraged very powerful unsolicited media covering.

The equity of the Pottery Barn name combined with the outstanding merchandising in the catalog has allowed to us secure significant press attention since our launch including a product feature on MTV and promotional tie-ins with the WB Network and various teen magazines.

Although this brand is only six months old it's initial performance indicates a significant opportunity for the future and we are very excited about its long-term potential.

In summary, we are pleased with our third quarter performance in the Pottery Barn brands and we are well positioned and committed to executing a successful fourth quarter.

Now I would like to open the call for questions.

Thank you.

Ladies and gentlemen, if you would like to ask a question, press star one on your touch-tone phone.

Again, star one for any questions or comments that you may have.

We ask that you limit yourself to one question to allow everyone a chance to ask their question.

Again, star one.

We'll go first to Mark Friedman with Merrill Lynch.

Thank you.

Good morning everybody.

Good morning, Mark.

Just a question about '04 as far as real estate plans.

I know it's early, just in the process of launching West Elm, but any thoughts about where we would see real estate growth across the board in '04 and any thoughts about, you know, experimenting with PB Teen concept next year at retail?

Mark, we will be giving 2004 guidance when we release guidance in the fourth quarter press release so we will not be talking about 2004 real estate plans until that time.

We're still cementing those plans and thinking about what those numbers will be.

So at this time we are not giving guidance on that.

We'll go next to Dana Telsey, Bear Stearns.

Good morning everybody.

I was wondering if you could comment a little bit on the 30% increase in prospecting the 21% increase in distribution square footage, which catalogs is that coming in?

What have you seen in terms of response rates lately, P B Teen, Laura, looks terrific, and on the last conference call you mentioned that Pottery Barn brand increases would be bigger in the third quarter than Williams-Sonoma.

How are you looking at the fourth quarter?

Thank you.

Laura, why don't you take the Pottery Barn Teen piece of that question, and then bring it back to me and we'll talk about where the circulation increases are.

Sure.

Hi, Dana.

The Pottery Barn Teen response rate has been consistent and growing.

Consistent with what we've seen in the initial launch of Pottery Barn Kids and also our fall catalog was successful in driving new businesses into the brand by offering some lower price point categories which tend to increase response rate, so we're pleased with specifically the response rate on -- that's, I believe, the question you asked me on Pottery Barn Teens.

As your question was, Dana, you had several, actually, the first one was where is the 30% increase, 30% of our circulation in the emerging brands coming from.

The primary piece of that is coming from both Pottery Barn Teen, which Laura gave you the circulation at 8.9 million, and then the incremental is coming from West Elm.

We have some slight increases in the other brands but the material piece of the increases is coming from the newer brands.

On the 21% increase in distribution leased square footage, we historically have taken on additional space during the fourth quarter, but as we look at our growth going forward and obviously you can see the strong growth that we're seeing now, we took on in the press release we talked about taking on an additional 11% that we took on in Q3 and then we will be taking on an additional 10% in Q4, and then we will be looking at additional space in 2004 to support the growth of the emerging brands.

With the success of those businesses we clearly are going to have to make some DC infrastructure investments.

We'll go next to Peter Benedict with CIBC.

Hi, guys.

Quick question.

Sharon, can you give us a little more color on the interplay between the merchandise margin and the shipping margin and how you see that in the fourth quarter?

I think based on the guidance it looks like we're looking for about a flat shipping margin in the fourth quarter year-over-year.

Is that correct?

What's the thought process there?

Thanks.

Well, with the shipping margin, in the fourth quarter, actually, I'm not sure that I would agree that you've got a flat shipping margin.

So I think that as to avoid, Peter, taking time in this conference call, the guidance is in the press release, and we believe that we are in a range in Q4 that you will see within a range, if you take the press release guidance we gave you, you will see an increase in the merchandise margins on the high end, and in the margins excluding shipping.

Remember that the margin excluding shipping includes occupancy and cost of merchandise, so the issues within those lines are various, and we would talk more about them in Q4, but there are improvements if you do pull out the shipping guidance out of the fourth quarter guidance, there is improvement in the margin at the high end of the guidance.

Actually at the mid and the higher ends.

We'll go next to Lauren Levitan with SG Cowen.

Thanks, good morning.

I had a couple of questions related all to Q4.

One, you did mention that you were planning to do more prospecting within the core brands, hoping you can just elaborate on the thought process that leads to you that decision and what that prospecting increase looks like.

You also -- Ed also mentioned early on that you saw some unpredictability toward the end of the quarter.

I'm wondering if you could elaborate on that, Ed, because then Laura also mentioned that you were happy at Pottery Barn with the early reads on holiday.

So if you could help us reconcile that.

And then Sharon, the new guidance for inventory year for end is it a little higher than before, could you comment on what that's associated with?

Doe that have to do with the new brands or are those timing issues that we should be prepared for?

Lastly, I'm wondering if you're going to give any thought to revising your long-term pre-tax operating margin target given it sounds like you will be achieving the lower end of that range this year.

I'm just curious how we should think about investments in the new brands versus your ability to achieve the higher end of that range over the next couple of years.

Thanks very much.

I'm going to let Pat Connolly first address the prospecting question in the brands, and then Lauren I'll come back and pick up on your other two questions.

So Pat, could you please address.

Sure.

We're going to be in the core brands, Lauren, increasing total circulation in the third and fourth quarters between 5 and 10%.

Those are the best quarters to do prospecting.

We had pulled back on prospecting a little bit in previous years, especially after 9/11, and it's important to keep your house file healthy and growing, and based on results we've seen today we're able to successfully increase our prospecting levels.

Lauren, talking about the increase in the inventory guidance, we are, in light of the success of the new and emerging brands, we are increasing our inventory levels in addition to what we need to just support the Q4 books, of course we're going to have increased circulation in Q1 as well, so that is the nature of the inventory increases.

There were no increases per se in the other brands.

The strong growth in DTC though is very promising and we've got to be in stock in order to satisfy that customer.

In question to your 9 to 11% pre-tax margins, again, we'll be giving guidance when we release fourth quarter earnings but as you point out, the guidance that we gave today puts you over the 9% range and we recognize that over the next couple of years as we continue to roll out the emerging brands we will be making decisions about the investments and the timing of the investments but we remain committed to the 9 to 11%.

We believe that the three-year period, if we make big investments to grow these businesses, which look very promising, that could potentially be a little bit over a longer timeframe but we feel very good about the fact that we are focused on profitable sales growth and we will continue to invest in businesses that drive that.

And then I'm going to let Ed now discuss the question that you had regarding the unpredictability that we saw late in October and coming into the first part of fourth quarter.

Good morning, Lauren.

What we saw was for the quarter, obviously we had a great performance, but we see the variance in some of our retail concepts both up and down that lead us to believe that, you know, we don't necessarily know how the customer is shopping right now.

We feel confident in our guidance, so we just call that out, that that was different for us, and it was different resident in the last part of the quarter, and we'll just wait and see but we still feel really good about delivering our guidance.

We'll take our next question from David Magee with SunTrust Robinson Humphrey.

Good morning.

Thank you.

My question has to do Hold Everything.

I've noticed some interesting furniture products in the catalog and I'm just curious what your thinking is about that concept at this point in time?

I'm going to let Ed take that question.

The catalog that we have today as we move to our new product will be significantly different in the future.

So I wouldn't read anything into the catalog to this day.

We've been repositioning and transitioning, so that isn't necessarily the product that will be there in the future and I just think you wait and we'll see some, we'll see several quarters out before we really see the change in the positioning.

So we called out fall of '04 and that's where we'll be.

Thank you.

We'll go next to John Baugh with Wachovia Securities.

Thank you.

Good morning.

Question on how much bedroom furniture are you currently importing from China, and what, if any strategic decisions have you made concerning the dumping petition that's been filed?

And secondly, if you could just comment on Williams-Sonoma Home, what again the timing is on that and the strategy?

Thank you.

Related to your question about how much are we importing from China, John, we don't give specific information about our sourcing locations or quantities, as you know.

We are very focused on the furniture dumping petition.

We're evaluating it like all retailers that are in the situation are evaluating it, and when we have more clarity to the issue we will definitely, of course, if it's something that significant, talk about, although we believe that it is an issue we do not believe that it is a significant issue.

At this point we're waiting to see what happens, and we are not currently planning on changing any of our strategies until there is a reason to do so.

As it relates to the timing, for Williams-Sonoma Home I will let Ed respond to that and talk a little bit about what we're doing there.

Williams-Sonoma Home, we're out there late next year, we'll be -- you'll be seeing our product, I think we'll called out fall of '04 in the catalog.

We will announce what our plans are obviously when we get to guidance in the fourth quarter.

We are, I think it's fair to say, accelerating that effort.

We have put people against it.

I mentioned early on that we've had some key hires and we're really excited about where we're going with this and believe it will be one of our emerging brands that will really do well.

We'll go next to Michael Baker with Deutsche Bank.

Hi, thanks.

My question is on the expense line.

Two questions.

First, I'm wondering, it sounds like you're doing very well here.

What's going on with the incentive expense?

Why are you cutting back on those a little bit?

Secondly, within the expenses, just curious as to, have there been any savings at the store labor level?

And then finally, one more question, just on the shrink, I guess the question is, what happened in the fourth quarter of last year with the shrink?

Was it still a very low number and so therefore it's not going to lead to higher shrink accruals in the fourth quarter of this year as well?

Thanks.

Michael, related to your first question on incentive compensation we called this out last year with our 60% EPS increase that we delivered in 2002, there was obviously higher incentive compensation associated with that.

In addition to that, we also had restricted stock for our previous CEO, and we had those expenses as well that were hitting the P&L related to that stock.

This year we no longer have the restricted stock expense and as much as I'd like to tell you that we would, we are not currently guiding to a 60% year-over-year EPS increase, so the incentive compensation calculations are lower.

As it relates to savings in store labor, one of the things we're doing -- we are pleased with our store labor, although one of the things and the reason that Ed called out this little bit of unpredictability is that especially as we come into our peak seasons, when you have unpredictability like that it's more challenging to schedule your labor, not just your stores, but your call centers and your DCs, so we are continuing to focus on that but our guidance reflects what we believe will occur in Q4.

Then as it relates to inventory shrinkage we will do, as we always do, a physical inventory in the fourth quarter.

We have projected that our inventory shrinkage would be at historical levels, excluding the 2002 level because the inventories were so low, and we -- that is how we accrue, so as we count the inventory of course we'll know whether or not the additional inventories resulted in additional shrinkage.

We feel like we're executing extremely well but this is our accounting policy so we'll see what happens in Q4 but whatever would happen is based on the historical shrinkage rates, is projected in the guidance you got today and it is a variance, by the way, in the Q4 guidance.

It's an increase.

We'll go next to Colin McGranahan at Sanford Bernstein.

Good morning.

Most of my questions have been answered by now but let me hit you with just two more.

First, if you could just give us a little bit more color on West Elm, I know the first store in Dumbo opens on Saturday, just kind of a quick update on how things are going there?

It looks like the catalogs have been transitioning a little bit more neutral.

And then secondly, Sharon, you know you aren't going to get away without a question on shipping.

It looks like the change in guidance was that the costs of shipping have gone up a little bit versus prior expectation.

I know it's just tweaking of numbers, but was there any impact on the recent trucking driver regulation change where there's fewer hours they can be on the road and things like that?

Thanks.

Okay.

I'm going to let Ed take the question on West Elm and then I will address your question on shipping.

And I'm really pleased that you brought it up it's an excellent question.

On the West Elm we're pleased with where we're going with West Elm.

I think your call-out broadening a bit and as we experiment with this brand, opening our store I think we're just -- we're being very prudent in how we go about this and our store will be our first indication where we can get in and see how we have placed the goods within the catalog themselves.

We'll just keep modifying until -- not much, but modifying and broaden so we get a bigger customer appeal but so far we're happy with the launch.

In response to your shipping question, Colin, in our shipping guidance one of the very positive highlights for Pottery Barn during the third quarter was that furniture is continuing to be very strong for them, and actually accelerating.

So in Q3 and in Q4 now we are anticipating to have a higher percentage of our shipping costs associated with furniture.

Obviously, when our mix shifts like that the cost of delivering furniture as a percentage of the sales dollar is substantially lower than shipping other merchandise, so, therefore, you end up with a higher cost associated with the shipping as a percentage of the revenue.

So we have anticipated for Q4 that we would see similar trends that we saw in Q3 related to furniture, and obviously if we didn't, then, of course, you would see a different sales mix and then you would have higher shipping profitability.

The other thing that I would point out about that is your question, next question, would probably be why, then did you guide it differently before.

The reason for that is, last year when we had launched the private label credit card, the significant piece of the sales on those cards were furniture, and we had promotions associated with those.

And this year we did not do those promotions, so we anticipated that furniture without the promotion would not be as strong.

And we've been pleasantly surprised to see that it has been not only as strong but actually stronger.

As we are talking about the rate changes in the Department of Transportation rules, this is really not an issue for us as it relates to the delivery to our customers.

It is more of an issue on freight to stores.

And in -- we had contracts that we have put into place, and, of course, those contracts will expire in 2004, and we will, in fact, see increases from those changes in 2004.

It's not a material number.

We don't think it's going to be a material number.

I think we've seen some highly exaggerated numbers in the Wall Street Journal so it's an issue but I don't think that it is nearly the issue that they're trying to make it into.

We'll go now to Mark Rowen with Prudential.

Thanks and good morning.

I have two questions my first is for Laura.

You've been talking about a mix shift towards more basics and carrying less fashion.

I was wondering if could you update us on where you're at on that and if you are comfortable with more basics in the store that down the road may cut down on the excitement that you have to draw people in.

My second question is for Pat Connolly.

I'm trying to understand the core catalog business.

You said you're doing more prospecting in the third and fourth quarters.

It's a little hard to understand with all the new catalogs and all the Internet increases, exactly what's going on in the core.

So is revenue per catalog in the core, is that stable, or is that moving in one direction or another?

Thanks.

Laura, why don't you take the first piece of Mark's question and then Pat will pick up when you're finished.

Sure.

We are very pleased with the progress we're making and really strengthening our core businesses.

Particularly in the core dinner wear, furniture, and our core basics in textiles where we've introduced higher end sheeting and towels, and then also in rugs where we really built our natural flooring business and in windows we're meeting our customers' demands for wider window panels and longer window panels in our core fabrics.

So these are all things that the customer has clearly communicated to us through sales that they expect from us at Pottery Barn.

The fashion is going to be even more exciting as we go forward because no longer will it be based solely on trend but also on timeless classics that are extraordinary.

So, for example, where you may have seen us being more trend-oriented in the past now you're going to see really overscale, beautiful glassware, hurricanes that make a statement in the room.

It is not that excitement will be decreasing, it's just that we're repositioning the fashion to stand the test of time, and also really just bolstering it up with a core base that makes Pottery Barn top of mind for the customer when they think about furnishing their home and thinking about having it be there for a lifetime.

So in total, I'm very, very pleased with the progress we've made to date, and you're going to continue to see each and every quarter enhancements to the strategy and I think the sales are showing us that the customer is responding well to this strategy.

Mark, in response to your second question, we had the strongest DTC growth here in three years in this quarter in the core brands.

So we're very pleased with that.

It is a little bit complicated because the catalog drives a lot of demand to the Internet and so we look at the demand that the catalog drives in total both to the Internet and to our care centers and we've combined the two and look at the performance of those customers when they receive the catalog.

The performance by catalog and also by page circulated has been stable and so we're very pleased with that.

We'll take our final question from Rob Wilson with Terburn Research.

Yes.

Sharon, your gross profit margin guidance is less than last year.

And I just wondering, does that relate to the shrink issue that you brought up earlier?

Also, you guys have had a year with the private label credit card.

Can you give us a sense for, something we talked about last year was the shift of payment versus new customers?

Thanks.

The first question, let me start with the private label credit card.

As we think about the private label credit card and the shift we have not seen, without promotion behind the card, we have seen substantially less sales on the card, even customers that have the card we've seen a reduction in those sales.

We believe that the strategic value of the card and, Rob this is no different than what we said last year.

We consistently in every one of these calls said it's shift, not lift.

That was our concern.

People were concerned about us comping this quarter in Pottery Barn because we had the launch last year and then we had to comp it this year, the fact that Pottery Barn comped mid single digits is just a great tribute to the brand and also confirmation that it really was shift, not lift.

It is, of course, depressing our SG&A expenses because we have higher credit card fees associated with Visa and MasterCharge.

As it relates to the gross margin, in the gross margin range in Q4 we do have the issue that relates to the shrinkage, and as far as other issues that we would be facing in Q4, we are actually feeling very good about the business overall but we are being conservative.

We've bought the new inventories in the emerging brands.

They don't have the same, currently they don't have the same level of volume that the other businesses have, so in many cases their margins are not as robust in their early launches.

So as we look at that, and we've also, of course, guided to assume that if the economy is soft you know that we always retain a level of conservatism that we would have the sales but we would have lower margins.

So we've guided to make sure that in the event that some of the uncertainty that Ed referred to occurred that we would have already built into our guidance the risk associated on the margin side.

Okay.

I'd like to just close.

We really feel good about our quarter, obviously.

We've had a great performance, we feel extremely confident that our strategic direction is correct, and we look forward to continuing delivering shareholder value to our shareholders and appreciate you attending the call.

So thank you and have a great day.

Once again ladies and gentlemen, that concludes today's call.

Thank you for your participation.

You may disconnect.