Williams-Sonoma Inc (WSM) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the Williams-Sonoma, Inc. second quarter 2004 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, today's conference is being recorded.

I would now like to turn the call over to Mr. Steve Nelson, Director of Investor Relations at Williams-Sonoma, Inc. to discuss forward-looking statements.

Please go ahead, sir.

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 conditions, 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 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 brand;

Pat Cowell, our President of the William-Sonoma brand;

Pat Connolly, our Executive Vice President and Chief Marketing Officer; and Sharon McCollam, our Executive Vice President and Chief Financial Officer.

We are very pleased to be here today to deliver to 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 second quarter pretax operating margin and diluted earnings per share in our history.

On revenue growth of 18.8%, we increased our earnings per share by 53.3% and our pretax operating margin by 150 basis points.

A strong consumer response to our merchandising initiatives, especially in the Pottery Barn brands, higher order fulfillment rates in both our retail and direct-to-customer businesses and continuing benefits from successful supply chain and overhead cost containment initiatives drove these strong results.

We are 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 have created with our operational flexibility and strong execution.

During the quarter, the performance of both our core and emerging brands exceeded our expectations.

In our 3 core brands, net sales increased 16.5% with Pottery Barn and Pottery Barn Kids driving impressive year-over-year sales increases.

A positive consumer response to both our core and seasonal product offerings and a higher in-stock position on core merchandise inventories drove these better than expected results.

In our emerging brands, including PB Teen, Hold Everything, West Elm, and Chambers, net sales increased 53.7% in the second quarter.

This increase was primarily driven by exceptional year-over-year sales growth in the PB Teen and West Elm brands and new momentum in the Hold Everything brand.

These increases were partially offset by a planned year-over-year decrease in the Chambers catalog as we reduced circulation in the anticipation of the transition to Williams-Sonoma Home.

Net sales in the West Elm brand in the second quarter substantially exceeded expectations in all channels and the initial consumer response to the expanded color pallet and enhanced catalog presentation has continued to be favorable.

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

Comparable store sales were positive for the second consecutive quarter and we saw significant improvements in catalog growth rates.

Operationally in the second quarter we began our first phase of operations in approximately 1/3 of our new 781,000 square foot East Coast furniture distribution center in Cranbury, New Jersey.

Upon completion of the facility this fall, we believe this center will enable us to improve service levels to our East Coast customers and over time reduce furniture delivery costs as we fine-tune inventory balancing between the coastal distribution centers.

Our rapidly expanding furniture businesses now represent approximately 25% of total Company annual revenues.

Also during the quarter we continued to make gradual progress in the first phase of our weeks of supply inventory management initiative.

As you can see from the numbers we reported this morning, we were once again able to moderate our quarterly inventory growth and improve our customer service by focusing on the flow of merchandise through the distribution network.

Although the full benefit of this project will not be realized until after the implementation of our new merchandising systems in 2006, we continue to believe that there are significant opportunities for ongoing sustainable improvement using our existing systems and non-integrated database technologies.

As we look forward to the third 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 lease 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 at a different stage of growth.

We believe, however, that the long-term potential of all these brands represent a significant growth opportunity in underserved markets for the home.

In PB Teen, which Laura will talk more about later in this call, we are continuing to increase catalog circulation and expand our extremely successful on-line marketing initiatives.

In Hold Everything we are continuing to increase catalog circulation and will be launching our E-commerce website in the fourth quarter.

Reflecting our growing confidence in the long-term potential of the brand we have also committed to opening 2 additional prototype stores this year in addition to the 1 store previously announced.

We are positioning Hold Everything as an up-scale lifestyle brand offering an expanded assortment of organizational solutions for all areas in the home in a contemporary setting.

In West Elm we're also continuing to increase catalog circulation, expanding our on-line marketing initiatives and launching a new version of the E-commerce website in the fall, as the Internet continues to be an extremely strong revenue driver in the West Elm brand.

Again, in reflection of our growing confidence in the brand, we have also committed to opening 1 additional prototype store in the third quarter for a total of 3 new stores in 2004.

We continue to believe that with a broadening of its assortment West Elm has the potential to appeal to a much wider market segment and become one of our larger brands over time.

We're extremely excited about the launch of Williams-Sonoma Home, our newest brand, which will be in home in less than 3 weeks.

This new premium brand, offering classic home furnishings and decorative accessories of enduring quality and casual elegance, will extend the Williams-Sonoma lifestyle beyond the kitchen into every room of the home.

We believe there's been a void in the market between high-end designer and contemporary home furnishings and that Williams-Sonoma Home can achieve dominance in this underserved market by pairing compelling price points with outstanding quality.

Staffed with its own design and management team, the brand will be vertically integrated and leverage the Company's scale and operational excellence in sourcing, direct marketing, creative, supply chain and distribution.

With an initial circulation of over 3 million catalogs, this launch will be our largest mailing for a new brand.

Consistent with our second strategic initiative to improve profitability in our core businesses, we are projecting an increase in our 2004 pretax operating margin of 30 to 50 basis points.

The key drivers of this pretax operating margin improvement are expected to include, improving the supply chain cost structure in the areas of transportation, customer returns, and inventory management, including the weeks of supply initiative and leveraging general overhead as we continue our efforts to consistently improve our fixed and variable cost structure.

Consistent with our 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're providing to our shareholders today, we remain conservative in our outlook for the balance of 2004, and are cautious about consumer sentiment due to the ongoing uncertainty in the macroeconomic and geopolitical environments.

We have, however, increased our full-year guidance to the range of $1.57 to $1.61 versus previous guidance of $1.53 to $1.57 reflecting within our ranges the better than expected EPS achievement in the second quarter.

I will now turn the call over to Sharon McCollam to discuss second 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 second quarter 2004 financial results, and our third quarter and fiscal-year 2004 earnings guidance.

Second, Pat Cowell will provide you with a business update for Williams-Sonoma.

Then Laura Alber will provide 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 second quarter 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 again against all of these commitments, and for the 16th consecutive quarter, we have met or exceeded the earnings per share guidance we have provided to our shareholders.

In the second quarter of 2004 we delivered diluted earnings per share of 23 cents, which was 8 cents, or 53.3% higher than the 15 cents we reported for the second quarter of 2003.

Net revenues in the second quarter of 2004 increased 18.8% to 689.6 million with strong performance in both the retail and direct-to-customer channels.

Retail sales in the second quarter increased 13.5% to 380.7 million.

This increase was primarily driven by a 12% increase in retail leased square footage, including 33 net-new stores and a comparable store sales increase of 5%.

Net sales generated in the Pottery Barn and Pottery Barn Kids brands were the primary contributors to this year-over-year increase.

Direct-to-customer sales in the second quarter of 2004 increased 27% to 262 million.

This increase was primarily driven by net sales generated in the Pottery Barn, Pottery Barn Teens, and Pottery Barn Kids brands.

All of the brands in the direct-to-customer channel delivered positive growth during the quarter except Chambers, which mailed its final transition catalog during the quarter in preparation for the launch of Williams-Sonoma Home in mid-September.

Internet sales during the quarter increased 60.2% to 111 million, contributing 42% of total direct-to-customer sales in the second quarter of 2004 versus 33.6% in the second quarter of 2003.

We estimate, however, that 60 to 65% of nonbridal Internet sales are generated by customers who have recently received a catalog.

Gross margin in the second quarter of 2004 reported at 37.6% of net revenues, increased 50 basis points versus the second quarter of 2003.

This increase as a percentage of net revenues was primarily driven by a rate reduction in occupancy expenses, partially offset by a higher percentage of furniture-driven merchandise cost of goods sold and shipping costs.

The rate reduction in occupancy expenses resulted from a greater percentage of total Company net revenues being generated in the direct-to-customer channel which does not incur store-related occupancy expenses in addition to the overall leverage and fixed occupancy expenses that resulted from strong sales growth during the quarter.

SG&A in the second quarter of 2004 was 204.6 million or 31.1% of net revenues versus 186.2 million or 32.1% of net revenues in the second quarter of fiscal-year 2003.

This 100-basis-point decrease as a percentage of net revenues was primarily driven by a rate reduction in employment expenses partially offset by a rate increase in catalog advertising expenses.

The employment rate decrease was primarily driven by year-over-year sales leverage in corporate employment, store labor, and employee benefit expenses.

The advertising rate increase was primarily driven by a greater percentage of total Company net revenues in the second quarter of 2004 being generated in the direct-to-customer channel, which incurs advertising expense at a higher rate than the retail channel.

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

The balance sheet at the end of the second quarter of 2004 reflects the fourth quarter 2003 implementation of FIN 46R, the consolidation of variable interest entities which required us at that time to consolidate 2 of our Memphis-based distribution facilities.

This consolidation resulted in year-over-year increases in our consolidated balance sheet of approximately 19.2 million in net property and equipment, 1.2 million in the current portion of long-term debt, 1.3 million in other liabilities, and 16.7 million in long-term debt.

The balance sheet at the end of the second quarter also includes the accounting impact of a $15 million debt transaction that we entered into in June 2004 to utilize state and local tax incentives that were offered to us by the State of Mississippi for expanding our distribution operations in December 2003.

All proceeds of this debt must be used for fixed infrastructure and operating equipment investments in the new leased facility.

The accounting for this debt resulted in a $9.5 million increase in other current assets, a $5.5 million increase in other long-term assets, and a $15 million increase in short-term debt.

Cash and cash equivalents at the end of the second quarter of 2004 were 119.2 million, an increase of 37.4 million, or 45.8% versus the end of second quarter of 2003.

In the second quarter of 2004, consistent with our strategy to enhance shareholder value and to offset share issuances under our employee compensation plan, we utilized 8 million of cash to repurchase 255,000 shares of our common stock.

Year to date we have utilized 14.8 million of cash to repurchase 470,000 shares of our common stock.

Accounts receivable at the end of the second quarter of 2004 were 47.7 million, an increase of 9.2 million versus the end of second quarter 2003.

This increase was due to a year-over-year increase in landlord receivables that has resulted from higher landlord participation in the cost of store construction and the timing of new store openings in 2004 versus 2003.

Merchandise inventories at the end of the second quarter of 2004 were 410 million up 33.1 million or 8.8% versus the end of the second quarter of 2003.

This lower than expected year-over-year increase was primarily driven by the ongoing success of our newly implemented weeks of supply inventory management initiative.

Prepaid catalog expenses at the end of the second quarter of 2004 were 47.1 million, up 5.8 million versus the end of the second quarter of 2003.

This increase was primarily due to the timing of expenditures for both the Pottery Barn and Williams-Sonoma catalogs and increased circulation for PB Teens.

Other current assets at the end of the second quarter were 13.9 million, an increase of 5.3 million versus the end of second quarter of 2003.

This increase was primarily driven by a $9.5 million increase in restricted cash relating to the $15 million Mississippi debt transaction, offset by a $5 million reduction in fixed asset deposits at the end of the second quarter of 2003, that were reclassified into property and equipment in the fourth quarter of 2003.

Accounts payable at the end of the second quarter of 2004 were 157.6 million, up 12.5 million, or 8.7% versus the end of the second quarter of fiscal-year 2003.

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

Accrued salaries, benefits, and other expenses at the end of the second quarter were 69.2 million, up 9.6 million versus the end of the second quarter of 2003.

This increase is primarily due to higher accrual balances for Workers' Compensation, employee vacation, incentive compensation, sales returns, and product liability.

Customer deposits at the end of the second quarter were 136.7 million, up 27.1 million or 24.7% versus the end of the second quarter of 2003.

This increase was primarily due to continued growth in our unredeemed gift certificates and gift card liabilities.

Income taxes payable at the end of the second quarter of 2004 were 1.1 million, a decrease of 18.7 million from the end of the second quarter of 2003, primarily due to a year-over-year increase in quarterly estimated tax payments which resulted from a reduction in quarterly timing differences.

The current portion of long-term debt at the end of the second quarter of 2004 was 24 million, an increase of 16.6 million versus the end of the second quarter of 2003.

This increase was primarily driven by the $15 million Mississippi debt transaction in addition to 1.2 million consolidation impact of the FIN 46 consolidation.

Long-term debt at end of the second quarter of 2004 was 27 million, an increase of 9.8 million versus the end of the second quarter of 2003.

This increase was primarily driven by the $16 million consolidation impact of FIN 46 previously discussed, offset by a $5.7 million payment on our senior notes.

I would now like to briefly discuss our third quarter and fiscal-year 2004 guidance.

As we look forward to the third quarter and the back half of the year, recognizing that approximately 58% of our full-year revenues and approximately 75% of our full-year earnings will be generated in that time frame, we are continuing to be cautious in our economic outlook.

For the third quarter, as announced in this morning's press release, we have reiterated our diluted earnings per share guidance in the range of 21 to 23 cents.

This represents a projected diluted earnings per share increase of 5% to 15%, during a quarter when we are launching a major new brand, increasing catalog prospecting in all of our brands and expecting to mail 27% of our planned circulation in our emerging brands.

For the full year we have conservatively increased our diluted earnings per share guidance from $1.53 to $1.57, to $1.57 to $1.61, reflecting our better than expected earnings results in the second quarter.

This revised guidance represents projected diluted earnings per share increases in the range of 18.9% to 22% for the year.

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 high level of confidence in our ability to deliver the earnings per share guidance 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.

We are pleased today to report that despite a very challenging year-over-year growth rate comparison, the Williams-Sonoma brand was able to deliver sales growth of 4% in the second quarter.

In our last conference call we highlighted the fact that in the second quarter of 2003 the Williams-Sonoma brand had delivered an exceptional 17.6% sales increase, which was partially driven by 2 significant sales-generating events that we did not expect or plan to recur in 2004.

These 2 events included a substantial inventory reinstatement initiative and a deeply promotional tabletop transition that we strategically did not try to comp.

Despite the absence of these 2 events in the second quarter of 2004, a strong consumer response to key merchandising categories including core and seasonal foods, high-end electrics, housewares, cooks' tools and cutlery, allowed to us drive the sales growth we delivered in the second quarter.

As the majority of the impact of the 2003 inventory reinstatement and tabletop transition initiatives benefited the retail channel, comparable store sales decreased 1.6% in the second quarter of 2004 versus a comparable store increase of 12.1% in 2003.

The performance of new and expanded stores, however, continued to exceed our expectations.

In the direct-to-customer channel, sales growth during the quarter was driven by the ongoing success of our E-commerce initiatives, including on-line bridal registry.

Unique visitors to the website increased an impressive 64% and we saw ongoing momentum from our on-line and electronic direct marketing efforts which we believe continue to be a significant growth opportunity for the brand long-term.

As we look forward to the third quarter we are excited about our new merchandising strategy.

As we discussed in the last call, we began the third quarter with an additional floor set which aligned the late summer catalog offering with the retail channel and successfully provided a fresh visual presentation in the stores during a time that had been historically limited to new offerings.

Our post-Labor Day merchandising strategies in both the retail and direct-to-customer channels will focus on inspirational back to basics, cooking and entertaining ideas with new product offerings and in-store events.

During the quarter we are launching several new high-end electric collections, including exclusive product offerings from Krups, KitchenAid and Villaware in addition to our expanded cookware assortment featuring Calphalon One nonstick.

Our new autumn cooking tabletop, entertaining themes will feature Mediterranean tabletop designs and expanded assortment of Al'Olivier olive oils and a new cookbook series that focuses on foods of the world.

While we are encouraged by our fall merchandising strategies and are confident in our ability to execute against them, we recognize that once again facing difficult year-over-year sales comparisons in the back half of the year due to the benefits derived from the continuation of the tabletop transition in the third and fourth quarters of 2003.

Based upon these difficult comparisons and a conservative economic outlook, our guidance conservatively assumes that the total brand growth in the back half of the year will continue to lag the strong growth that we delivered in the back half of 2003.

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

Thank you, Pat.

Good morning.

I would now like to discuss the second quarter performance of the 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 second quarter.

Net sales increased 23.2%, which represented the strongest quarterly sales gain in over 3 years.

All channels performed above expectations.

A positive consumer response to both our core and seasonal merchandise assortments, including indoor and outdoor furniture, decorative accessories and core tabletops and a higher in-stock position on core merchandise inventories, drove these better than expected results.

In the retail channel, comparable store sales for the second quarter increased 10.2% compared to a 2.6% increase last year and the performance of new and expanded stores substantially exceeded expectations.

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

Strong merchandising, improved editorial content, including entertaining and interior design ideas, and a significant year-over-year improvement in order fulfillment rates drove these better than expected results.

Traffic on the website increased over 75% and conversion has continued to exceed our expectations.

Wedding and gift registry sales were also very strong.

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

We continue to believe the 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 third quarter we are very encouraged by initial consumer response to our fall merchandise assortment, including furniture, textiles and decorative accessories, and are confident our emphasis on design and quality which was extremely successful in the first half of the year, will continue to support our year-over-year growth initiatives.

Now I would like to discuss Pottery Barn Kids.

Net sales in the Pottery Barn Kids brand increased 16.5% in the second quarter.

This year-over-year increase was driven by incremental sales from new stores and strong momentum in the E-commerce channel.

At the end of the second quarter we operated 82 stores versus 66 stores in 2003.

Comparable store sales for the quarter decreased 4/10's of 1% versus a 5.7% increase in 2003 due to the negative impact of new store openings in multi-store markets.

We are encouraged, however, by the fact that comparable store sales were positive in both our single-store markets and those multi-store markets where there has not been an additional store opened in the last 12 months.

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.

At the end of the second quarter, 66 stores were included in the comp base.

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

Highly productive on-line marketing programs, including electronic direct marketing and Internet initiatives and a strong increase in on-line gift registry sales contributed to the strong growth of this channel.

From a merchandising perspective, strength in our core and seasonal businesses, including bedroom furniture, nursery and bath, and the introduction of new categories including upholstered furniture, kids tabletop and outdoor were the significant contributors to our growth during the quarter.

We also saw strong consumer response to personalization across all categories.

As we look forward to the third quarter, we are encouraged by the early consumer response to both core and seasonal merchandising assortments and continue to be excited about our fall merchandising strategies, including the expansion of core furniture collections, the introduction of a back-to-school consumables program and the enhancement of our nursery presentation.

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

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

Net sales in the second quarter continued to exceed expectations in both the catalog and E-commerce channels and the consumer response to the overall merchandising assortment, including textiles, furniture, and decorative accessories was very positive.

As we look forward to the third quarter, we are continuing to focus on driving top-line sales growth.

To date, we are extremely pleased with the initial consumer response to our fall merchandising strategies, including our expanded furniture collections, our new textile assortment and our back-to-school program.

During the quarter we will increase catalog circulation, including page counts and expand our on-line marketing initiatives.

On-line marketing is extremely important to the growth of this brand as the Internet continues to be a significant driver of brand awareness and the shopping channel of choice for many of our teen customers.

We will also focus on increasing interactions with the teens through a variety of contests and campaigns that will build brand affinity and drive customer acquisitions.

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

In summary, we are excited about the merchandising strategies in all of our Pottery Barn brands and are confident in our ability to drive our businesses in the third and back half of the year.

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

I would now like to open the call for questions.

Thank you.

To ask a question today, simply press the star key followed by the digit 1 on your touch-tone telephone.

We do ask that you limit yourself to 1 question to allow everyone an opportunity.

If you are using a speakerphone, please release your mute function to allow your signal to reach our equipment.

And again, it is star 1 to ask a question.

We'll pause for just one moment.

We'll take our first question from Marni Shapiro at Merrill Lynch.

Hey, guys, congratulations on a great quarter.

Could you give us a little bit more color about the circulation plans for back half of the year by division?

PB Teen, you mentioned West Elm, you're launching Williams-Sonoma Home, and I'm guessing Hold Everything would get a little boost.

And then could you also talk about any plans to increase Internet advertising in the back half of the year as well?

Marni, I will take the question regarding the overall circulation guidance that we give.

Our guidance for the year on circulation for catalog is 12 to 14%, and what we've said is that approximately 27% of that circulation is going to be in the emerging brands, increases in the emerging brands which will cross all of the brands.

We don't give specific guidance in the individual brands for the back half.

We will have, however, circulation increases in both Q3 and Q4.

So I'll leave it at that and then we'll talk more about it when we get into Q3 and Q4 on our actual circulation strategies.

Okay.

And then the Internet advertising in the back half?

We're continuing to invest in Internet advertising.

I'm going to let Laura talk about a couple of the programs she's very excited about, then I'm going to let Pat Cowell talk about the programs that they're pursuing in the back half.

Laura?

As I said earlier that the Internet marketing programs that we're participating in continue to be very successful and we're able to look at them monthly and reevaluate our investments.

We're particularly excited about the search -- the search marketing efforts that we have employed and also some content sites that really help drive our design authority in the marketplace.

I'd just like to echo the same thing.

We have the search has been expanded dramatically on our site, which has helped.

We've expanded our put-throughs.

We've had a lot of increases in things in our website that's helped certainly boost the E-com Internet bridal, as well as our partnerships with other people, so we're excited about that.

Thank you.

And we'll go to our next question with Dana Telsey with Bear Stearns.

Good morning, everyone, and congratulations.

Inventory was very well managed.

Now you've had 2 quarters in a row of inventory growth coming in below sales growth.

I think your guidance suggests inventory growth more in line with sales growth in the third quarter.

Is that due to the investment in the Williams-Sonoma Home, or can you take us through the rational there?

Can you also tell us a little bit about Williams-Sonoma Home and the differences in that catalog launch versus other like PB Teen?

And just lastly, your shipping margins and gross margins seemed to flatten out in the back half of the year.

Can you just give us some insight into that?

Thank you.

Dana, we'll start with the inventory growth question.

We have been very pleased with the -- with the inventory growth in Q1 and Q2, as you mentioned, and as we go into Q3 and Q4 we're continuing to be conservative in our inventory guidance.

We will be building inventory for the emerging brands, and as we get into Q4 for the mailing of the spring book we will ensure that our in-stock positions are very high.

So I would tell you that I believe that our inventory guidance is cautious, and as Ed mentioned in the call earlier, these new initiatives that we are doing are obviously being done for the first time in the Company and 2 quarters is very exciting for us, but, again, it's not sustaining long-term, so we just want to make sure that we can continue this going forward.

That's how we're thinking about that.

As we -- your second question, Dana, was regarding -- the Williams-Sonoma Home catalog launch and the strategy toward the launch and I'm going to let Ed and Howard talk about that.

Ed, you want to take that?

Yeah.

We are launching, as we said, the Williams-Sonoma Home after we have shut down the Chambers catalog, and it's a big launch for us, but we feel really confident and will be promoting this through our stores, our Williams-Sonoma stores, and the inventory part of that we feel in a good position.

We'll just to have wait and see what the customer response is to that.

Howard, you may want to add something to that.

No, I think that's correct, Ed.

The only -- Dana, I don't know whether your question was that or whether it had to do with the relative mailings or not.

We are mailing, I think, about 50% more -- in the neighborhood of 50% more Williams-Sonoma Home books than we did teen in the first quarter of the mailings.

And then your last question, Dana, was regarding the margins in the third quarter and the inherent margin in the fourth quarter and the guidance that we've provided.

As we've consistently said, in the first quarter and the second quarter, we did have pressure on our margins in 2003 due to the significant volumes that we had done in the tabletop transition.

This is particularly an issue in Q2.

As we go into Q3 and Q4 we are anticipating that we are going to continue to see strong margins in the -- or strong growth in the furniture category which will, as we have said, put pressure on the gross margin going forward.

We're also launching Williams-Sonoma Home and we are being cautious in our margin guidance as we go into the launch of this new catalog, so those would be the support and justification for the margin guidance that we've given in the back half, but again we continue to be conservative in our approach to thinking about the margins as it relates to the strength in our furniture business.

Thank you.

Next we will hear from an Ann Marie Peterson at Thomas Weisel Partners.

Hi, I have 2 questions.

The first one is for Pat Cowell.

At the Williams-Sonoma brand you've done a great job over the last couple of years just through better merchandising, expanding the consumable assortment, et cetera.

If you could just speak to the opportunities that you see over the next couple of years in terms of driving the business and sort of where you are in that kind of process of improvement.

And then secondly, Sharon, if you could comment on return rates and what you've been seeing, particularly with respect to the furniture, and then your outlook this year and into next year, I'd appreciate it.

Thank you.

Okay.

Okay.

First, thank you for the question.

On the merchandising, we continue to expand our core merchandising.

We've got a launch, for example, this fall, of our new products in Krups and KitchenAid, which we have an exclusive on the accolade mixers, we have the brand-new Calphalon One nonstick that comes out on an exclusive basis, so we continue to look at the departments that carry us and expand on that.

As we move into holiday season, again, we're very strong in the holidays around Thanksgiving and Christmas with all the various cookware and the food products, and we're still strong on that.

But as we go forward next year, we're going to continue to define the departments that work very well for us on a core basis and some fashion business that continues to work, we'll do that.

Otherwise, we'll continue to focus on what made us successful, the core business.

But I don't think we'll make any significant changes because what we have works very well.

We're very happy with that.

The tabletop area is an opportunity which Ed will probably discuss in a little bit, but we've had a very good run in our core business, we've expanded, for example, our Apilco assortment, which has been with us for over 40 years.

We're continuing to run super comps in that business, so we're adding areas to that.

I go back to we're really continuing to focus on the things that have driven the business for all these years and continue to be strong.

And then, Ann Marie, your second question had to do with return rates.

We again saw gradual improvement in our return rates.

The improvements that we have made in quality in furniture across the brands is making a difference, and we think that we will continue to see that.

I would still say that we believe that we are early in our process for improving the return rates of the Company.

Again, we're not making any dramatic changes.

The furniture quality is coming in better, but we're not making any major changes because we don't want to disrupt the business while we're improving it, so it will be a gradual incremental process, as we continue to say, and we expect to see great opportunity in that area over the next couple of years as well.

Thank you.

And as a reminder, please press star 1 to ask a question.

Please limit yourself to 1 initial question and follow-up questions you may queue up for.

We'll go next to Peter Benedict at CIBC.

Hey, guys.

I have a quick question.

Obviously, it sounds like business is doing very well during the second quarter and your outlook is for continued good numbers.

Just wondering about the trends you might have been seeing during the second quarter in terms of comps.

Was there anything discernible in terms of starting strong, ending soft, or the opposite?

And then secondly, any early read on how business is going at this point so far through August?

Thanks.

Peter, we don't give monthly comps, as you know, so we're not going to comment on trends during the quarter.

But as we mentioned in all of the earlier speeches, Laura talked about her business, and the initial consumer response to her assortment, Pat discussed the consumer response in Sonoma, so those are current trends as of the time that we're giving this call this morning, so we're very pleased with the consumer response to our fall merchandising strategies.

Thank you.

Now we'll hear from Lauren Levitan of SG Cowen.

Thanks.

Good morning.

Good morning, Lauren.

Sharon, I had a question on your guidance.

You've been saying for the last, oh, couple of years, that your planning assumptions include a conservative outlook on the consumer.

I'm curious if you've got any change on that or if the commentary today is just consistent with that?

And then related to that, I'm curious if with the progress you're making in your operating margin, despite the significant investments in the new businesses, if you could comment on where you think you are relative to that long-term target of 9 to 11%.

I think that's something that might have upside potential going forward.

Thank you.

Lauren, as it relates to the comments about our conservatism in our outlook, I still believe that until we see trends in the markets and the economic trends, the geopolitical situation we also think is an issue, I believe a conservative outlook is the appropriate outlook and I would tell you that Ed and I agree on this wholeheartedly.

You know, the market is overreacting to all good news and all bad news, and clearly we're coming into some times with a lot of issues from a global point of view.

So we think executing the business from a conservative point of view is appropriate.

Now, clearly when you look at our second quarter growth, we are seeing a very strong consumer at the high end.

But in general, we're approaching the business with the same level of caution and we're -- I think that what that truly means, Lauren, is that every time we have the opportunity to make a decision about a strategy, we are remaking the decision looking at what is currently happening.

In our business we have the luxury of deciding what our circ will be at various points.

Obviously, the stores are the stores, but we have other places where we can modify and adjust our strategies and we are going to continue to consistently adjust our strategies to match what is going on in the economy.

As it relates to our progress on the 9 to 11% guidance that we had given over 3 to 4 years, we continue to stand behind that guidance over the next couple of years, we're very pleased with the improvements that we are seeing.

Obviously, they're coming faster, Lauren, than we anticipated.

However, we will say that we are very excited about the emerging brands.

We are going to continue to invest in the growth of those emerging brands, and I think at this time it's only appropriate for to us stay committed to delivering that 11% 3 years, 4 years from now, and then we'll keep looking at it as the emerging brands get bigger and we have more clarity to their future.

Thank you.

Now with SunTrust Robinson Humphrey we have David Magee.

Hi.

Good morning and great quarter.

Thank you.

Just a quick question on the Cranbury distribution center.

Was that any sort of a meaningful negative with regard to the impact on gross margin in the second quarter, and how soon would that facility begin to contribute towards, you know, a higher gross margin?

As far as being -- the distribution center opened mid-quarter and it -- as Ed had said, we only occupied 1/3 of the building.

This is only the first phase of it.

So in response to your question, David, all the cost in the second quarter, the answer is no.

However, all the costs associated with the facility are inherent in the guidance that we have given you.

I'm going to let Ed talk about when he envisions the distribution center giving us the benefit that we're hoping to derive both from a service point of view and then, of course, long term from a cost point of view.

Good morning, David.

Sharon answered the initial opening of the center.

We're going to have our furniture on the East and West Coast in our DTC business.

Cranbury is not fully open yet.

We're moving through getting it operational and that probably will conclude sometime in September.

But we don't -- I don't think it's a significant -- significant impact on our financials at the corporate level.

Over time it will improve.

We didn't do that for any other reason than improve our customer service on the East Coast, and it will improve our transportation over time as we sort out and bleed down our Memphis facility out of the furniture.

So we are cautiously moving ahead and I feel like that it's the right thing for our customer primarily, and it will give us a cost benefit, but that will come as we move out into the future.

Thank you.

Now we'll hear from Alan Rifkin from Lehman Brothers.

Yes, congratulations on a nice quarter.

A couple of questions if I may.

Sharon, first, with respect to the inventory, with it being up only 8.8%, can you maybe provide some color as to where those inventory improvements are coming from?

I know that you said that you're making strides on the weeks of supply initiative, but how much of the inventory reduction is really coming, let's say, you know, at the DC level versus the store level?

Then I have a follow-up, if I may.

Okay.

As far as the inventory goes, Alan, the majority of the reduction in -- almost 100% of it, is at the DC level, and what is extremely great news is that the weeks of supply initiative was focusing on both the fast-moving and the slow-moving merchandise and how we flow that merchandise.

And we are taking a much more aggressive strategy on both sides of that equation, which is allowing us to do nothing more than improve the flow.

We are taking our – particularly with our outlet transfers, et cetera, on inventory that is slow moving, we're moving it through our system, we're getting it out of the DC, and on the fast movers, of course, we are bringing that inventory more frequently so that we can flow it as opposed to house it.

You know, we call it -- we have a little joke for this initiative, we call it the bus stop versus parking lot initiative.

The vision is that the distribution center is a bus stop, not a parking lot.

So building homes for these larger cubes of merchandise is very, very expensive and to the extent that we can continue to do this we see this weeks of supply initiative as one of our largest opportunities because if we can truly flow the merchandise, we will be able to improve our -- the amount of distribution square footage that it requires to support the larger cube businesses that we're developing, so we're very, very pleased with where it's going, and there is no need to be concerned that any of the inventory shortfall is sitting in the stores.

Thank you.

Now we'll hear from Colin McGranahan at Sanford Bernstein.

Good morning, nice job.

Thank you, Colin.

2 quick questions here.

Sharon, you had commented on an extremely strong consumer at the high end.

Can you comment at all on what you're seeing, especially in Pottery Barn, in terms of the transaction count versus your average ticket, and obviously you've had strong furniture, so I would imagine that's impacting your ticket, but just parsing your comments at the high-end consumer versus what you're seeing in terms of the number of transactions versus the ticket you're seeing in the stores.

Colin, we don't give average ticket or transaction counts.

We don't have transaction counters in our stores.

But what I would say is this: We delivered a 19%, 18.8% growth this quarter and we are catering to the 75,000 and above customer for the most part across all of our brands.

So as I refer to, clearly it's hard to argue that this customer was shopping this quarter as it relates to our businesses.

But I would say more importantly that from our point of view, the merchandising has been so strong in the Pottery Barn brands, and as a result of that we clearly believe that we are benefitting from the consumer still being there, but we are also benefitting from taking share from our competitors.

The strength in our furniture business and the fact that we are growing so substantially in that category when every one of our competitors is releasing not better -- worse than expected numbers, there has to be a compelling argument that the assortment that Laura has put together in Pottery Barn is taking share.

Thank you.

And we'll go to Alan Rifkin.

Oh, yes, I had a follow-up, Sharon, if I may.

I know in the past that you've provided a little bit of color on the inventory levels, you know, by concept and channel.

Would you be willing to provide any color there?

You know, we've -- Alan, it's a lot of detail, and in light of the fact that we're managing our inventory so well that our fulfillment rates are higher than last year, et cetera, that is more granular guidance than we're going to continue to provide.

I assure you that we're very pleased with our inventory levels.

We have one piece of good -- I think it's good news, from one point of view, we've got a lot of run-aways in Pottery Barn which gives us higher back orders than we'd like to have, but again, this is because of run-aways, not because of inventory management initiatives are not supporting the business.

So we are truly better flowing the merchandise with a plan, with a strategy, with total buy-in from the brands.

The difference between this and a couple of years ago is we had a strategy, we had a plan, it was implemented with the brands involved and actually creating the strategy, so it's a very different time.

Thank you.

And our final question today will come from Michael Baker.

Hi.

Thanks.

Congratulations on a very good quarter.

The question I wanted to ask is on the furniture business, do you -- you talk about, you know, I think you gave the percentage of furniture this year.

Can you tell us what it was last year and then maybe get a sense of how much of the same-store sales growth is driven by furniture versus other categories?

Do you go to that level of detail?

I'm going to let Laura talk about the furniture business since the majority of our growth is coming in her business.

And, Laura, why don't you take that.

Sure.

Furniture has grown from approximately 17% of the business to 25% and that's total Company.

It's really a key strategic focus.

We've spent the last 2 years building furniture as a core competency and we examine every portion of our furniture supply chain to drive profitability and top-line sales.

We believe we have a strong competitive advantage over our competition in that we've been in the furniture business longer, we're vertically integrated, and we -- we also started our overseas ventures earlier so we're well-positioned overseas in Asia and able to provide superior design and quality at a great value to our customers.

So furniture continues to be a strong area of growth and one where we're very focused on driving profitability.

Thank you.

And that does conclude today's conference call.

Thank you all for your participation.

Have a great day.