Williams-Sonoma Inc (WSM) 2004 Q1 法說會逐字稿

Good day everyone and welcome to the Williams-Sonoma Incorporated first quarter fiscal year 2004 earnings 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 today's conference is being recorded.

Now I'd like to turn the call over to Steve Nelson, Director of Investor Relations at Williams-Sonoma, Incorporated to discuss forward-looking statements.

Please go ahead, Mr. Nelson.

Good morning.

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 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 and SEC filings including but not limited to reports on forms 10-K, 8-K, and 10-Q for more information on the risks and uncertainties that could cause actual results to differ materially from these 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 call over to Mr. Ed Mueller, our Chief Executive Officer.

Good morning and thank you for joining us.

With us today is Howard Lester, our Chairman, Laura Alber, our President of the 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.

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

While continuing to invest in our long-term growth initiatives, including our emerging brands, we delivered the highest first quarter pretax operating margins and diluted earnings per share in our history.

On revenue growth of 19% we increased our earnings per share by 64% and our pretax operating margin by 135 basis points or 33%.

A strong merchandise assortment enhanced by renewed focus on core collections in Pottery Barn, higher order fulfillment rates in both our retail and direct-to-customer businesses and continuing benefits from successful supply chain and overhead cost reduction initiatives drove these strong results.

We're very proud of these results and believe they reflect a tremendous consumer appeal of our brands, the power of our multichannel strategy, and the competitive advantage we've created with our operational flexibility and improved execution.

During the quarter we were very pleased with the performance of both our core and emerging brands.

In our three core brands net sales increased 16.1%, primarily driven by high teen percentage increases in both the Pottery Barn and Pottery Barn Kids brands and a high single-digit increase in the Williams-Sonoma brand.

The positive consumer response to both core and seasonal product offerings and a higher in-stock position on core merchandise inventories in the Pottery Barn brands drove these strong results.

In our emerging brands, including PB Teen, Hold Everything, West Elm and Chambers, net sales increased 69.5% in the first quarter.

This increase was primarily driven by incremental sales generated in PB Teen and strong year-over-year sales growth in West Elm.

Net sales in the West Elm brand in the first quarter substantially exceeded expectations in both the catalog and E-commerce channels and the initial consumer response to the expanded color pallet and enhanced catalog presentation has been very favorable.

We also saw strong performance in the Hold Everything brand in the first quarter driven by a positive consumer response to the new merchandise assortment and an improved catalog presentation.

Comparable store sales were positive for the first time since 2002 and we saw significant improvements in catalog productivity.

As we look forward to the second quarter and the balance of the year we are continuing to focus on the strategic initiatives that are fueling our success;

Driving top-line sales growth, increasing pretax operating margin, and enhancing shareholder value, including delivering consistent and predictable earnings.

Consistent with our strategic effort to drive top-line sales growth we are continuing to invest in new growth opportunities in both our core and emerging brands.

In our core brands we are increasing retail leased square footage and catalog circulation, introducing new core and seasonal merchandise assortments, enhancing product quality with a particular focus on furniture, closely monitoring our in-stock positions on retail and DTC inventories and implementing new marketing initiatives that will continue to expand the reach of our brands.

In the emerging brands the growth strategies for 2004 by brand are different due to each of the brands being a different stage of growth.

We believe, however, that the long-term potential of all these brands represents a significant growth opportunity.

In PB Teen we're continuing to aggressively increase catalog circulation and expand our extremely successful on-line marketing initiatives.

In Hold Everything we're continuing to increase catalog circulation and will open our first prototype retail store at the end of the fourth quarter.

We will also be expanding the reach of the Hold Everything brand by launching an E-commerce enabled website in the fourth quarter.

We're positioning Hold Everything as an up-scale lifestyle brand offering contemporary, organizational solutions for all areas in the home.

In West Elm we'll be opening two new prototype retail stores, one in third quarter and one in the fourth quarter, and launching a new version of the E-commerce website in the fall.

E-commerce continues to be an extremely strong revenue driver for the West Elm brand.

Although West Elm has been successful in highly urban markets, we believe that with a broadening of the assortment it has the potential to appeal to a much wider market segment and become one of our larger brands over time.

In Williams-Sonoma Home we will be launching our first catalog in the third quarter.

We're positioning this new concept as a premium lifestyle brand offering classic furnishings and decorative accessories of enduring quality and casual elegance.

Upon the launch of Williams-Sonoma Home catalog the Chambers catalog will be retired.

Consistent with our second strategic initiative to improve profitability in our core businesses we are continuing to project an increase in our 2004 pretax operating margin of 20 to 40 basis points.

The key drivers of this pretax operating margin improvements are expected to include improving the supply chain cost structure in the area of transportation, customer returns, and inventory management.

And leveraging general overhead expenses as we continue our efforts to reduce our fixed and variable cost structure.

In the second quarter we will open a 781,000 square foot furniture distribution center in Cranberry, New Jersey to support our rapidly expanding furniture businesses which now represent approximately 25% of total company annual sales.

We believe this facility will enable us to improve service levels to our east coast customers and reduce furniture delivery costs.

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

While the strength of our brands and our proven track record in driving our business in difficult economic times provide us with a high level of confidence in our ability to execute against these initiatives and deliver the earnings guidance that we are providing to our shareholders today.

We remain conservative in our economic outlook for 2004 and are cautious about consumer sentiment.

We have, however, increased our full-year guidance to the range of $1.53 to $1.57 versus previous guidance of $1.52 to $1.56, reflecting within our ranges the better than expected EPS achievement in the first quarter.

I will now turn the call over to Sharon McCollam to discuss first quarter results.

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 first quarter 2004 financial results, our second quarter outlook, and our second quarter and fiscal year 2004 earnings guidance.

Second, Pat Cowl will provide you with a business update for the Williams-Sonoma brand, then Laura will provide you with a business update for the Pottery Barn, Pottery Barn Kids, and PB Teen brands.

Finally we will open the call for questions.

I would now like to discuss our first quarter of fiscal year 2004 financial results.

In our last conference call we made several commitments to our shareholders.

We committed to driving top line sales growth, improving our pretax operating margin and delivering our earnings per share guidance.

We are very pleased today to be able to report that we have delivered against all of these commitments and for the 15th consecutive quarter we have met or exceeded the earnings per share guidance we have provided to our shareholders.

In the first quarter of 2004 we delivered diluted earnings per share of 18 cents which was 7 cents or 63.6% higher than the first quarter of 2003.

Net revenues in the first quarter increased 19.4% to 640.9 million with strong performance in both the retail and direct-to-customer channels.

Retail sales in the first quarter of 2004 increased 15.3% to 349.4 million.

This increase was primarily driven by an increase in retail leased square footage of 10.9% including 33 net new stores and a comparable store sales increase of 6.8%.

Net sales generated in the Pottery Barn, Pottery Barn Kids, and Williams-Sonoma brands were the primary contributor to this year-over-year increase.

Retail execution during the quarter was also very strong and we saw significant sales benefits from our mid 2003 inventory reinstatement initiatives in the Pottery Barn brands.

Direct-to-customer sales in the first quarter of 2004 increased 24.2% to 246.6 million.

This increase was primarily driven by net sales generated in the Pottery Barn, Pottery Barn Kids, and West Elm brands in addition to incremental sales from our newest brand, PB Teen.

All of the brands in the direct-to-customer channel delivered positive growth during the quarter except Chambers which is being down-sized in preparation for the launch of Williams-Sonoma Home in the third quarter.

Internet sales in the first quarter increased 58.6% to 95.6 million.

Internet sales contributed 38.8% of total direct-to-customer sales in the first quarter versus 30.3% last year.

As we have previously discussed customers who have recently received a catalog generate 40 to 50% of the sales generated in the Internet channel.

Gross margin in the first quarter of 2004 reported at 38.3% of net revenues increased 20 basis points versus the first quarter 2003.

This increase as a percentage of net revenues was primarily driven by a rate reduction in occupancy and freight to store expenses in addition to an increase in the net shipping margins.

The rate reduction in occupancy and freight to store expenses resulted from a greater percentage of total company net revenues in the first quarter of 2004 being generated by the direct-to-customer channel which does not incur store occupancy or freight to store expenses.

These favorable contributors to the increased gross margin rate were partially offset, however, by a year-over-year increase in the cost of liquidating damaged merchandise that was returned from customers.

SG&A in the first quarter of 2004 was 210.6 million or 32.9% of net revenues.

The 120 basis point improvement as a percentage of net revenues was primarily driven by a rate reduction in employment and catalog advertising expenses partially offset by a rate increase in other general and administrative expenses.

The employment rate decrease was primarily driven by year-over-year leverage in corporate employment and store labor expenses in addition to a year-over-year reduction in employee benefit costs.

The advertising rate reduction was primarily driven by a greater percentage of total company revenues in the first quarter of 2004 being generated in the E-commerce channel which incurs advertising expense at a lower rate than the company average.

The other general and administrative expense rate increase was primarily driven by a year-over-year increase in corporate travel and consulting costs to support our supply chain information technology and product development initiatives.

In addition to costs associated with the termination of a service provider agreement.

I would now like to discuss first quarter 2004 significant year-over-year balance sheet variances.

The balance sheet at the end of the first quarter of 2004 reflects the fourth quarter 2003 implementation of FIN 46R, the consolidation of variable interest entities which required us to consolidate two of our Memphis based distribution facilities.

This consolidation resulted in year-over-year increases in our consolidated balance sheet of approximately 19.4 million in property and equipment, 18.2 million in long-term debt and approximately 1.2 million in other liabilities.

Merchandise inventories at the end of the first quarter of 2004 were 425.6 million up 53.1 million or 14.3% versus the end of the first quarter of 2003.

This increase compares to a projected increase in net revenues in the second quarter of 2004 in the range of 15 to 18%.

Pre-paid catalog expenses at end of the first quarter of 2004 were 39.1 million up 5.5 million versus the end of the first quarter of 2003.

This increase was primarily due to increased costs at the PB Teen catalog which had only limited circulation when it was initially launched in April 2003 and the timing of expenditures for the Pottery Barn catalog.

Prepaid expenses at the end of the first quarter of 2004 were 25.7 million up 1.9 million versus the end of the first quarter of 2003.

This increase was primarily due to increases in prepaid rent and prepaid maintenance agreements partially offset by a reduction in prepaid insurance.

Other long-term assets were 15.9 million at the end of the first quarter of 2004, up 7.4 million versus the end of the first quarter 2003.

This increase was primarily due to a higher prepaid maintenance cost from 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 our non-qualified executive deferred compensation plan.

Accounts payable at the end of the first quarter of 2004 was 129.9 million up 6.3 million versus the end of the first quarter of 2003.

This increase was primarily driven by higher freight payables due to increased volume in the timing of expenditures.

Accrued salaries and benefits at the end of the first quarter of 2004 were 62.6 million up 7.7 million versus the end of the first quarter of 2003.

This increase was primarily due to higher accrual balances and Workers' Compensation and employee vacation liabilities.

Customer deposits at the end of the first quarter were 131.9 million, up 32.6 million versus the end of the first quarter of 2003.

This increase was primarily due to substantial growth in unredeemed gift certificates as well as in the customer liability associated with recognizing revenue on a delivered basis.

I would now like to briefly discuss our outlook for the second quarter and our second quarter and fiscal year 2004 guidance.

As we look forward to the second quarter and the back half of the year, recognizing that approximately 80% of our full-year revenues and approximately 90% of our full-year earnings will be generate in that time frame, we are continuing to be cautious in our economic outlook.

For the second quarter, as announced in this morning's press release, we have reiterated our diluted earnings per share guidance in the range of 18 to 20 cents.

This represents a project diluted earnings per share increase of 20 to 33%.

For the full year, we have conservatively increased our diluted earnings per share guidance from $1.52 to $1.56 to $1.53 to $1.57 reflecting our better than expected earnings results in the first quarter.

This revised guidance represents a projected diluting earnings per share increase in the range of 16 to 19% for the year.

We also announced in a separate press release this morning that our board of directors has authorized the repurchase of up to 2.5 million shares of the company's outstanding common stock.

The stock repurchase program is designed to enhance shareholder value and to offset share issuances under our employee compensation plan.

Our board's action is a reflection of the company's strong cash flow which the board believes is sufficient to support our continued growth strategies in addition to share repurchases under this program.

In summary, the strength of our brands, our strong operational execution, and the consistency in which we have delivered on our commitments provides us with a very high level of guidance in our ability to deliver the earnings per share we have provided to you today.

I will now turn the call over to Pat Cowell to discuss the Williams-Sonoma brands.

Thank you, Sharon.

Good morning.

The Williams-Sonoma brand delivered a very solid first quarter performance.

Net sales for the brand increased 7.5% with a significant year-over-year improvement in the gross margin rate.

In 2003 the gross margin rate was negatively impact by a rapidly strengthening euro and higher markdowns from the beginning stages of our table-top transition.

In the retail channel comparable store sales increased 3.6% and the performance of our new and expanded stores continued to exceed our expectations.

A positive consumer response to the overall merchandise assortment with particular strength in core foods, electrics, linens and housewares, and a very strong inventory position drove those first quarter results.

Also during the quarter we opened our newest flagship store in the Time Warner Center in New York.

Like our San Francisco flagship that was opened in late 2003 the Time Warner Center flagship is continuing to outperform its sales plan but more importantly it is allowing us to introduce new customers to the brand every day due to its high-traffic location.

These flagships serve as billboards for the brand and represent the best of everything we have to offer to our customers.

Although the investment in these stores is significant we believe that the enhanced brand authority that they generate for all three of our channels adds tremendous long-term value to the equity of the brand.

In the direct-to-customer channel revenue growth was driven by the ongoing success of our E-commerce initiatives.

Unique visitors to the websites increased approximately 47% from the first quarter of 2003 and the conversion rates continue to be strong.

We also saw increasing momentum from our on-line marketing efforts which we believe are a significant growth opportunity for the brands long-term.

Another driver of our sales performance during the quarter was the continued growth of our wedding and gift registry business.

New registries created during the quarter increased 6% and the registry value increased 9%.

Bridal and gift registry continues to be a strategic multichannel growth initiative and a key source of new customers to the brand.

As we look forward to the second quarter we are launching several summer merchandising strategies, including a Mediterranean table-top and entertaining theme, new flavorful Marguerite mixes and a significantly expanded grill and outdoor program for summer holiday gatherings.

We'll also be adding one additional floor set in late July between Father's Day and Labor Day.

This additional midsummer floor set will allow us to further align the summer catalog offering with the retail channel and provide a fresh visual presentation during a time that's historically limited in new offerings.

Although we are prepared to executing against these second quarter growth initiatives recent trends have shown signs of potentially slowing sales momentum.

As previously discussed the Williams-Sonoma brand faces very difficult year-over-year sales comparisons.

In the second quarter of 2003 sales growth in the Williams-Sonoma brand was over 17% including a comparable store sales increase of 12.1%.

This prior year comparable store sales increase was driven in part by the reinstatement of our retail inventories and increased sales that resulted from a heavily promotional table-top transition.

Due to the non recurring nature of these prior year sales drivers and our cautious view of the economy overall we believe that despite the successful execution of our second quarter growth initiatives our sales growth rate for the Williams-Sonoma brand in the second quarter of 2004 will be substantially lower than the sales growth rate in the second quarter 2003.

As we look forward to the balance of the year we will continue to focus on the following strategic growth initiatives;

Enhancing our seasonal and core merchandise assortment, growing our customer database with catalog prospecting and online marketing, increasing our electronic direct marketing efforts to drive increased traffic to both our retail and direct-to-customer channels and expanding our corporate sales program.

We believe that executing against these initiatives over the balance of the year will allow us to continue to expand the reach of the brand and leverage the strength of the brand's authority as a destination for high-quality cooking accessories, gift-giving ideas and home entertaining essentials.

I'd like to now turn the call over to Laura Alber to discuss the Pottery Barn brands.

Thank you, Pat.

Good morning.

I would now like to discuss the first quarter performance of Pottery Barn, Pottery Barn Kids and Pottery Barn Teen brands.

I will begin with Pottery Barn.

We are extremely pleased with the performance of the Pottery Barn brand in the first quarter.

Net sales increased 19.9% which represented the strongest quarterly sales gain in over three years.

All channels performed above expectations.

A positive consumer response to both core and seasonal product offerings including furniture, decorative accessories and core table-tops and a higher in-stock position on core merchandise inventories drove these better than expected results.

In the retail channel comp store sales increased 10.2% and the performance of new and expanded stores substantially exceeded expectations.

What was particularly encouraging about this increase was the significant number of merchandise categories that gained momentum during the quarter.

The direct-to-customer channel also delivered impressive sales growth during the quarter.

Strong merchandising in DTC, improved editorial and decorating tips and a significant improvement in order fulfillment rates drove these better than expected results.

Traffic on the website increased over 75% and conversion rates remain high, wedding registry sales were also very strong.

Our electronic direct marketing efforts were significantly expanded and we saw extremely positive results from our online marketing initiatives.

We continue to believe that on-line marketing is a significant growth opportunity for the brand and a source of new customers for the future.

As we look forward to the second quarter we are very encouraged by the momentum that we are seeing in both our core and seasonal businesses and are confident that our improved in-stock position on core merchandise inventories will support our year-over-year growth initiatives.

The initial consumer response to our summer floor set is very positive and our overall furniture business continues to be very strong.

Now I would like to discuss Pottery Barn Kids.

Net sales in the Pottery Barn Kids brand increased 17.8% in the first quarter.

This increase was primarily driven by the addition of 18 new retail stores, positive comp store sales growth and strong momentum in the E-commerce channel.

In the retail channel we opened three new stores during the quarter.

At the end of the quarter we operated 81 stores versus 63 stores in 2003.

Comparable store sales increased 1%.

This increase is primarily driven by an improvement in the comparable store sales performance of retail market where a new store had not been opened within the last 12 months.

This includes both single store and multi-store markets that meet these criteria.

We continue to believe that comparable store sales in this brand will remain volatile until there are at least 75 stores in the comp base due to the significant pressures that our rapid store expansion strategy impose on the performance of existing comp stores.

At the end of the first quarter 61 stores were included in the comp base.

In the direct to consumer channel sales growth continues to be driven by the ongoing success of E-commerce.

Highly productive on-line marketing initiatives, including our electronic direct marketing and internet partnerships, and a significant increase in on-line gift registry sales drove the majority of this increase.

New baby and gift registries created during the quarter increased over 86% due to a significantly enhanced registry assortment and a successful registry event in March.

From a merchandising perspective strength in our core and seasonal businesses, including bedroom furniture, occasional furniture and nursery and the introduction of new categories including custom nursery seeding, core table-tops and outdoor were the significant contributors to our growth during the quarter.

Both Valentines Day and Easter exceeded our expectations and we saw great success from our expanded focus on personalization in key merchandise categories.

As we look forward to the second quarter we are encouraged by the early consumer response to both our core and seasonal assortments and continue to be excited about our summer merchandising strategies including our summer textiles, outdoor entertaining, outdoor furniture and personalized towels.

I would now like to talk about the newest addition to the Pottery Barn brands, PB Teen.

We are once again extremely pleased with the performance of PB Teen.

Net sales in the first quarter continued to exceed expectations in both the catalog and E-commerce channels and the consumer response to the overall merchandise assortment remains strong.

During the first quarter PB Teen celebrated its one-year anniversary.

In its first 12 months of operations PB Teen sales surpassed the outstanding performance of the Pottery Barn Kids brand at the same stage in its growth cycle.

Although there are differences in the way these brands were launched, Pottery Barn Kids in catalog only and PB Teen in catalog and E-commerce, we are encouraged by the success because we believe that these results are an indicator of the long-term growth potential of the brand.

As we look forward to the second quarter and the balance of the year we will continue to focus on driving top line sales growth and extending the reach of the brand.

To drive profitable top-line sales growth we will strengthen our focus on key merchandising categories, continue to refine our assortment, introduce new merchandise categories and improve order fill rates.

We will also increase catalog circulation at page counts and expand our on-line marketing initiatives in order to increase customer access to the brand.

Online marketing is extremely important to the growth of this brand as the website continues to be a significant driver of brand awareness and the shopping channel's choice for many of our teen customers.

We'll also be focusing on increasing interactions with teens through a variety of contests and campaigns that will create affinity with the brand and drive customer acquisition.

We remain very confident in the long-term potential of PB Teen.

In summary we are excited about our merchandise strategies in the Pottery Barn brands and are confident in our ability to drive our business in the second quarter and back half of the year.

Our continued strategic focus on retail execution, product design, creative merchandising and operational execution has laid the foundation for profitable growth in each of the brands and we remain committed to delivering our results.

I would now like to open the call for questions.

Thank you.

The question-and-answer session will be conduct electronically today.

If you would like to ask a question simply press the star key followed by the digit 1 on your touchtone telephone.

Once again that's star 1 on your touchtone telephone to ask a question.

Also if you're using a speakerphone please make sure your mute function is turned off to allow your signal to reach our equipment.

Due to time constraint please initially limit yourself to one question.

We'll first hear from Mark Friedman of Merrill Lynch.

Thank you.

Good morning everybody.

Nice job in the quarter.

Thank you, how are you doing?

I'm okay, Sharon.

I was wondering in some of the comments that you put out this morning about real estate it looks like at the margin, at least at the beginning of the year, some of the store growth is coming in a little bit ahead of plan, was wondering if that was true, if you were seeing any new opportunities here for additional store growth in the back half of the year.

Thanks.

Hi, mark this Ed Mueller, how are you doing?

We're delivering a little ahead of schedule but I think we're going to be on schedule.

Our guidance is what it is and we feel real comfortable about that.

We're continuing, as you noticed in our call to talk about West Elm and Hold Everything and we're aggressively now seeking places to put those two brands and I feel real comfortable that our guidance is on track and we're in good real estate position.

Great.

Mark, just to respond, on the full year guidance that we gave this morning we did increase our lead square footage guidance from 8 to 9% which was the previous guidance to 9 to 10.

That's what I thought.

Thank you.

Could you just clarify, Pat, for me, sales momentum slowing, is that just relative to the tough comparisons or are the expectations that because the numbers in the second quarter were so strong that sales could be down for the Sonoma brand in the second quarter this year?

No, Mark, I think you're right.

We were up against very strong comps from last year.

We had an increased inventory position in 2003 from 2002, so we did a very good job of being able to drive the sales in the quarter to last year and we have strong sales, had a very good Mother's Day, a little weaker building to Mother's Day than we thought but very strong Mother's Day and we've got a wonderful summer of grilling and outdoor stuff that's in the stores now and has gotten good response.

Great, thank you.

Very strong comps last year.

Our next question comes from Lauren Levitan of SG Cowen.

Thanks.

I'm wondering if you could comment about the learnings that you may have gotten on West Elm and Hold everything and possibly even Pottery Barn teen with respect to what that retail potential might look like as you just commented that you're aggressively pursuing real estate, I'm just wondering if the learnings from catalog has helped you sort out what that real estate strategy will be.

Then similarly, Ed, you had commented in your prepared comments that you remain cautious about consumer sentiment, I'm just curious if this is any shift from the caution that you had expressed earlier in the year and if you could incorporate if your thoughts on how a rising interest rate environment and higher energy costs, if they have any impact on your customer and how you think about the forward opportunity.

Thanks very much.

Good morning, Lauren.

First let me take West Elm and HE.

West Elm first.

We're very excited.

You recall last call we said we're pulling back on our search strategy in West Elm and that's been super successful and we're really happy with the new merchandise and the color pallets and the broadening of it and therefore now more aggressively seeking out West Elm locations.

So we feel really good about that and it's coming really well.

Is that primarily targeting urban or suburban locations or street or mall?

Have you refined that at all?

We are broadening from the urban and we will be looking at every one of those locations to see how it plays, so I think it's all of the above.

Okay.

On HE we are really happy with the new assortment, the catalog is performing well, as I said our comps are up for the first time since 2002 and we will be bringing out a new prototype store which we're really excited about so the HE look will be different, the product is significantly softened and colored up and I think we really have cautious optimism on that one.

Both West Elm and HE have strong E-commerce platforms and extremely proud of the way the customers respond on the Internet which helps our three-channel strategy.

PB Teen we are just now anniversaring our first catalog year and PB Teen follows a different annual cycle than our other brands.

I'm really optimistic that as we go into the second year of this that we will firm up our real estate strategy, whatever that may be.

I think this is a time to watch but the encouragement that Laura talked about in all of her brands, particularly PB Teen is continuing and I am really happy with that.

So all of our emerging brands, which we include PB Teen, are really hitting on all cylinders.

The caution that I expressed on the economy is the same as I've talked about before.

We are better, I believe, as a company running cautious against the economy than not cautious.

And that helps us with our expense control, it helps us with our inventory control, but we are not cautious to the point of pulling back.

We are expanding and want to increase our revenue growth in all directions, not only comp store sales but leased square footage, new brands, and the entire catalog performance.

So while I remain cautious we don't know how to factor in, frankly, interest rates that have not risen but are predicted to rise.

Fuel prices do impact us.

They impact everybody and so we watch that but at this point we are operating as if cautious economy is the right framework for us.

Great.

Thank you very much.

Our next question comes from Colin McGranahan of Sanford Bernstein.

Good morning.

Sharon, hoping you could give us maybe a little bit more color on the gross margin.

Looks like there was nice leverage in occupancy but the merchandise margin was down a little bit, certainly came in a little bit less than your guidance.

Can you tell us what affected that and how things played out versus your plan at the beginning of the quarter, especially given the strength in Pottery Barn?

Yes, Colin, when we gave guidance at the beginning of the quarter we did not anticipate the tremendous strength that we have seen in the furniture businesses really across all of our brands but predominantly in Pottery Barn and that comes into play in two areas.

It comes into the merchandise margin in addition to the fact that it comes into the shipping margin but we're very excited about it.

I'm going to let Laura add a little bit of color to that.

I think it will be very encouraging for all of you.

Thank you.

Our furniture strategy is really the corner stone of our product strategy at Pottery Barn.

And although short term it creates margin pressure, long-term we are confident in our ability to profitably drive and grow furniture as well as the total brand and deliver on our commitment to deliver our operating margins by investing in supply chain initiatives that will allow us to grow this business even more profitably than we run it today.

Thanks.

Next we'll hear from Peter Benedict of CIBC.

Hi, everyone.

Following up on Colin's question, you might have just answered it but just some more color on the return of damaged goods in the first quarter.

Was that a result of just furniture being so strong or was there any kind of change in the return rate that you saw?

Thanks.

No, what happened there is that, as you know we had made a decision to move forward with a furniture quality initiative.

We had returns that had come in in the first quarter and the nature of the returns and the damages that we saw we made the decision that opposed to liquidating through our outlet channels that we would use other liquidation channels and really start improving our merchandise quality even in our outlet stores so it was a, I don't want to say a one-time decision, clearly, to use liquidation channels on a recurring basis but it was a decision we made, a conscious decision that we made during the quarter.

One thing to add, you are correct in talking about the volume of the furniture but I will tell you that returns as a percent due to damages was actually down year-over-year so our continued focus on our quality improvements in furniture continue to drive and allow us to run it more profitably, but you are correct there's a higher volume coming through so even though the rate is down the volume is up.

Okay, thanks very much.

Next we'll hear from Alan Rifkin of Lehman Brothers.

My question surrounds inventory levels.

Looks like they were down less than what you had guided for.

Sharon, can you maybe be a little bit more specific as to where the inventory is a little bit lighter?

I know that Laura mentioned that your in-stocks were above expectations on the Pottery Barn side in the core division, but can you maybe provide some color?

Absolutely.

Alan, we had talked earlier in the quarter about the fact that we were very focused on improving the flow of merchandise into our distribution centers and through our distribution process.

Ed calls that the weeks of supply initiative that we are currently working on in the company.

This task force has been very successful in flowing merchandise much more efficiently than we had guided initially.

Now, we are continuing to be cautious because this is a new initiative.

We saw initial positive results and we are continuing to guide in the same range as we guided previously but we are seeing very early encouraging results from the initiative that Ed has put in place.

Okay.

But at that store level, Sharon, are you comfortable with where inventory levels are at each of the divisions?

We are totally comfortable.

Where we've seen the reductions is not in the stores, it's in the distribution center because, Alan, this is nothing but a flow issue.

Okay.

Thank you.

Next we'll hear from Rex Henderson of Raymond James.

Good morning and congratulations again.

I have a couple of questions on the SG&A line.

First of all the leverage you got on store employment costs is that sustainable and how much of that was a benefit reductions?

We haven't quantified publicly the breakout between the labor leverage and the benefit.

However, I will say that on the labor side and store labor clearly the strong comps that we ran across all of our business this quarter contributed to the leveraging of labor and as we continue to run strong comps we would expect to see similar leverage.

In the case of benefits the call-out that we will make is that our actual benefit costs were lower than they were in the prior year this is not a rate leverage issue.

Our benefit costs were actually lower.

We have done several things in the company to more strategically run our benefit programs and clearly without taking anything away from our associates we have been able to better manage our costs.

Okay.

Second question is on your direct to consumer channel, Internet seems to be driving that.

Can you give me a sense of what the kind of long-term growth rate of that channel is, how much growth do you see next year and beyond continued at this 60% rate or is it 25%?

Where do you see that over the next couple of years?

When we look at the Internet channel, we look at it in context with the total direct-to-customer business.

And you've got to keep in mind that our numbers indicate and our analyses indicate that 40 to 50% of the sales that are generated in the Internet channel are actually driven by the mailing of the catalog so you cannot look at these two channels in isolation.

As a result of that we've given top line guidance for the next three years.

We don't give channel guidance out that far but we expect to see a continued benefit and continued strong growth on the Internet side of the business and our on line marketing.

Throughout today you've heard a lot of conversation about online marketing initiatives, relationships with third parties through Yahoo, MSN, et cetera and we see great success from those, and as we said in our prepared remarks earlier, we actually have a lower advertising cost on those sales that are generated so we're motivated to continue to enhance that channel.

Our next question comes from Mark Rowen of Prudential.

Thanks, good morning.

Two quick questions.

Sharon, first on this big jump in customer deposits which you said was related to unredeemed gift certificate.

Do you expect the majority of that jump to be cashed in this quarter and if not how long are you required to carry that before you can make some sort of judgment that they're not going to be redeemed and run it through the income statement?

And then second, on the Internet channel advertising, is that primarily sponsored search that you're doing or is it brand advertising through banner ads, what kind of campaigns are you actually running on line to get the new customers?

Thanks.

Let me start with your first question which relates to the growth in our customer deposits.

Our gift certificate redemption time frames vary and since we've just launched the gift card in Q4 obviously we believe that there is possibility that the history can change.

We absolutely do not believe that you can expect that to redeem in a three-month period, but we will continue to watch that as this is new history for us as a company.

What we're very pleased with is the fact that we are seeing a strong performance from the gift cards which is encouraging, obviously, for future sales.

So we feel very good about that.

As it relates to how long can we retain them and how long can we keep them, obviously, companies don't just get to take those gift certificates, necessarily, back to income.

There are states that have (inaudible) laws.

You have to look at where you're operating.

It's a more complex question than that.

Our hope would be as a company that with the gift card and the fact that we are retiring the paper side of our business that we will see higher redemption because the one thing we know for sure is that when we have gift cards redeemed or merchandise certificates or gift certificates redeemed we see a higher sale than the face value of the certificate.

So that would be our hope, not seeing ourselves sell them and take that into income.

That isn't our objective.

As far as the question regarding the search on the Internet side I'm going to let Laura and Pat talk about their individual business.

On the Williams-Sonoma side we have used now for a couple of years portal partnerships with MSN or AOL, Yahoo and we've moved it around both on a search word purchase as well as a revenue sharing using their distribution.

Tremendously successful for us because it gets our brand on that distribution channel in a lot of different ways.

We obviously combine our e-mail campaigns of all the capture of e-mails, that is a big program for us, for all the new customers that are shopping on the Internet as well as just having their e-mail address, so we do a lot of programs there.

We use the Internet, obviously, as a sales strategy, it's very quick and (inaudible).

So we have a great series of partnerships and different ways we use it and as time goes on it expands.

A great market for us.

Strategy's very similar in Pottery Barn.

Key word search is very good as well as partnerships with key partners like Baby Center, Wedding Channel and we do a variety of teen sites.

The other thing that's been very interesting is how we interact with the magazines both in their magazines and then when they have a website and an editorial fashion.

But l will say e-mail continues to be a very strong internal marketing tool to drive sales to the website.

As a reminder if you would like to ask a question press star 1 at this time.

We'll now hear from Rob Wilson at Tiburon Research.

Yes, thank you.

Sharon, can you talk about what you're doing this year with catalog page counts and what we should expect with catalog page productivity this year?

We don't give circulation guidance on page count, as you know, but I don't think that there is any significant change in our strategy regarding page count.

Where it's appropriate to increase page count and that we believe that they are going to be productive we, of course, would increase page count.

We are seeing currently reductions in page count in the Chambers brand because of the transition, but every brand evaluates their page count on every circ, and we look at that and it changes throughout the year, so I don't think, Rob, you'd like to have a cookie cutter answer to this question There's just not a cookie cutter answer.

Every brand makes decisions as they deem appropriate and of course it comes into play too with the Internet side of the business because of the multichannel and the co-dependencies of those two channels, that also affects what we might decide to do.

Also Ed referenced fulfillment rates in direct and retail channels.

Can you give us a sense for what the improvement was in fulfillment rates in Q1?

I'll let Laura take that.

She's in a good place for that.

She'd be the one to get it.

Go ahead, Laura.

Year-over-year our fulfillment rates have dramatically improved, it's a key metric that we judge our customer service by because I know if any of you have ever stayed home and waited for a Pottery Barn delivery how annoying it can be.

It's gone up substantially over where it's been, even over the past couple of years, and we're now at levels that we really think provide excellent customer service on a regular basis.

And of course there's always going to be a few things that are out of stock because of high sales trends but the amount that we have is far less than what we had last year.

If you recall a year ago when Ed and Howard first discussed the initiative to improve the fulfillment rates across the company they said they were targeting an 85% total company fulfillment rate and we were thrilled in Q1 to have delivered 86%.

To answer a more broad question, we have put a lot of effort into the inventory, as we said last year, but more importantly it's in the bigger picture of the Pottery Barn improvement in both furniture and delivery and the whole inventory channel and that's, while it is a metric we are seeing the results of extraordinarily good execution all over the Pottery Barn delivery channel.

And we're really happy with that.

Next we'll hear from Dave Magee of SunTrust Robinson Humphrey.

Hi, good morning.

Good quarter.

Thank you.

Just a couple of clarification questions.

Number one, just to make sure, the product gross margins, it's fair to assume, have been stable, right, in the first quarter and going into the second quarter?

We are not expecting to see any major changes in the margins from Q1 to Q2.

What we said, Dave, earlier in the call is that the shift in mix that we saw in Q1, which we are forecasting for Q2, the furniture has put pressure on the margin but we also expect that as that continues to stabilize, we will see increased benefits which Laura talked about, or we'll see improvements in that over time.

Right.

So ex that mix shift things are stable, then?

Yes, absolutely.

And I want to be clear that this mix shift issue we believe is a short-term issue.

We are still committed to continuing to improve our pretax margin and delivering that 11% pretax margin out four to five years.

So we feel very, very good about the way the furniture compliments the rest of the assortment and how it can drive the business long-term.

You may have mentioned this earlier but I didn't catch it.

Did you speak to fuel costs or any impact from that?

We didn't speak to it directly.

Ed did mention in his comments about being conservative about the economy and our outlook that those were clearly factors that were playing into that.

We are seeing pressure like all companies in the area of fuel cost.

It also actually fuel cost, as many of you know, also play into the cost of raw materials and fabric and other things.

And so we are seeing pressure from that but again we are finding other ways in the company to offset those costs and, of course, our growth is always helpful because we also have the leverage.

So we're seeing them but a lot of those, I will say, Dave, we had guided them.

You and I have talked about this.

We came into this year anticipating fuel surcharges across the board, we came in to this year expecting to see container costs increase so this is not a new phenomenon.

The magnitude of some of the surcharges is an issue.

We're also contracted in a lot of the arrangements that we are currently in.

So it's an issue but obviously you've got the guidance for the year.

We looked at it, we just relooked at it and we feel very confident in the numbers we gave you today.

Your final question from Michael Novak of Frontier Capital.

Hi, good quarter.

Thank you, Michael.

I have a couple questions on furniture.

Have you ever looked at the patterns, the shopping patterns of your customers where as when you sell them furniture you get higher attachment rates of other home furnishings items?

Mike, I'm going let Laura take that question.

I think your question is when you think about the growth in the furniture business is it complimenting and driving the rest of the assortment.

I'm going let Laura take that.

We are very fortunate to have a huge database due to our direct to consumer channels and so we do and I just recently reviewed customer shopping patterns and it's always very interesting.

What we do find is that generally a new customer doesn't start with furniture they start with lower ticket and they start at retail and then they buy furniture and the greater the success with the furniture the more likely they are to repurchase from us and also we see huge amount of people who move.

People who move are often your biggest furniture purchasers because when you buy a new house you need to buy new furniture so we see a correlation with moving and our furniture sales.

But it's an important part of our business because it's really the foundation of your house and the accessories go along with it and we're really seeing the strong consumer demand for well priced great design great quality furniture and that's exactly what we're focused on.

That is all the time we have for questions today.

Mr. Ed Mueller, I'll turn the call back over to you for any additional or closing comments.

Okay, thank you.

Obviously we are very proud of our results.

You can tell by the team.

I think it's consistent, we've continued to, I think, guide in a cautious but a way we can deliver and we're delivering great results.

I said to you the last call that our team is what we're all about, and this team is really functioning and we're super excited that the core brands are doing well and the emerging brands are on track to continue to provide us the long-term growth we need and so I really am optimistic about Williams-Sonoma, Inc., in it's totality and we will continue to deliver the earnings that are expected by our shareholders.

That's it, thank you.

This concludes today's teleconference.

Thank you all for your participation.

You may now disconnect.