Williams-Sonoma Inc (WSM) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Williams-Sonoma, Incorporated first-quarter 2005 earnings release conference call.

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

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

As a reminder, this conference is being recorded.

I would now like to turn the call over to 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 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, business initiatives, growth opportunities, and prospects of the Company in 2005 and beyond, and are subject to certain risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the Company's current press releases and SEC filings, including reports on Forms 10-K, 10-Q and 8-K 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 brands, 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 to deliver to our shareholders another quarter of record financial performance.

In the first quarter of 2005, we delivered the highest first-quarter pre-tax operating margin and diluted earnings per share in the history of the Company.

On revenue growth of 12.4%, we increased our diluted earnings per share by 22.2%, which represents $0.22 per share and increased our pre-tax operating margin by 70 basis points.

We are very proud of these results and believe they continue to reflect the power of our multichannel strategy, our ability to build strong brands, and the competitive advantages that we have created with our operational flexibility and supply chain execution.

A strong consumer response to key merchandising categories, including furniture, textiles, and kitchenware, combined with continuing benefits from successful supply-chain and overhead cost reduction initiatives, drove these stronger than anticipated results.

We were particularly pleased with the results of our efforts to improve our in-stock position on core furniture inventories.

At the end of the first quarter, inventories increased to better than expected 23% versus last year, of which approximately half was in furniture.

As a result, we were able to substantially improve our customer service by filling our customer back orders more quickly than we had expected.

While at the same time, improving our initial order fulfillment rates.

These two significant customer service successes allowed us to realize revenue and earnings in the first quarter, that we had not expected to realize until the second quarter.

We estimate that our first-quarter earnings benefited by approximately 1 penny per diluted share due to this earlier than expected order fulfillment.

We have accordingly adjusted our second-quarter earnings guidance downward by $0.01 to reflect the shift in timing.

In our core brands, net revenues increased 10.6% in the first quarter of 2005, primarily driven by high single-digit growth in the Pottery Barn and Williams-Sonoma brands, and mid-teen growth in the Pottery Barn Kids brand.

We are especially pleased with the execution of our Pottery Barn and Pottery Barn Kids retail strategies, as well as our Williams-Sonoma brand initiatives.

Howard and Laura will provide additional comments on these strategies later in this morning's call.

In our emerging brands, which include West Elm, PBteen, Hold Everything, and Williams-Sonoma Home, net revenues increased 33.7%, driven by strong performance in the West Elm and Williams-Sonoma Home brands.

Net revenue growth in the West Elm brand in the first quarter exceeded our expectations in both the retail and direct-to-customer channels, driven by increased catalog circulation, strong performance in e-commerce and incremental revenues from new prototype stores, including the new store that opened in San Diego last month.

All four of the new West Elm prototype stores currently rank within the top 20% volume-producing stores in the Company, and three of the four are consistently in the top 10%.

In the Hold Everything brand during the first quarter, we continued to transition the merchandise assortment, and test new retail and direct-to-customer merchandising strategies.

Although the brand delivered a mid-teen comparable store sales decrease for the quarter, it was in line with our expectations due to the gaps in the retail assortment that we discussed in the fourth quarter.

In the direct-to-customer channel, we continued to increase catalog prospecting to build a Hold Everything database and increase page counts to test new merchandising strategies.

Although the additional catalog circulation drove strong momentum in e-commerce, catalog productivity was below expectations, due to a slower than expected consumer response to the brands merchandising transitions.

Although we are disappointed we did not see a stronger catalog response, we believe, as we did in the fourth quarter, that the response was negatively impacted by the in-transition merchandise assortment.

In Williams-Sonoma Home, our newest brand, net revenues, like those in West Elm, exceeded our expectations in the first quarter.

A better than expected consumer response across merchandising categories, including furniture, textiles, and lighting, drove these strong results.

We also continued to see strong demand for custom upholstered furniture, which we believe is an important category because it speaks to the long-term competitive advantage that we can create in this brand by leveraging the strength of our superior design esthetic and our furniture supply chain capabilities.

Operationally in the first quarter, we rolled out the first phase of our daily store replenishment program to approximately 50% of our stores, and converted the remainder of our stores during the first two weeks of May.

As we said in our last call, our guidance assumes that we will incur approximately $0.01 per share in additional costs this year to implement this program.

We are optimistic, however, that the longer term benefits of this program will ultimately include improved customer service by minimizing retail store out-of-stocks, more efficient store operations due to less inventory in the back rooms, and reduced inventory damage and shrinkage, due to less handling of the merchandise.

Although it is very early in the rollout, the new operational aspects of the program are working effectively, and store feedback has been very positive.

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 profitable top-line revenue growth, increasing pre-tax operating margin, and enhancing shareholder value.

Consistent with our strategic effort to drive profitable top line revenue 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 across all brands, continuing to refine the retail and catalog merchandising strategies in the Williams-Sonoma brand, expanding our merchandise assortment in Pottery Barn Kids, to include categories that will generate repeat customer traffic, and implementing new marketing initiatives that will drive growth across channels, including expanding our gift card merchandising initiatives.

In our emerging brands we are extremely focused on building our customer databases and expanding the multichannel reach of the brands.

In PBteen, we are increasing catalog circulation and page counts, and expanding our on-line marketing initiatives.

In West Elm, we are opening six additional prototype stores later this year and will continue to increase catalog circulation, page counts, electronic direct marketing, and on-line customer acquisition efforts.

Although we continue to believe that it is too early to predict the ultimate growth potential of West Elm, the strengthening consumer response to date for this brand is confirming our belief that West Elm over time has the potential to become our largest brand.

We believe that the key success factors necessary to achieve such growth will include, increasing the breadth of the current merchandise assortment, evolving the merchandise assortment to appeal to a broader consumer base, executing an effective retail strategy, and capturing the mind share of the large consumer segment that West Elm targets by leveraging our strengths in multichannel retailing.

In Hold Everything, we are significantly refining our catalog circulation strategy, expanding our on-line marketing initiatives, and opening two additional prototype stores in the second quarter.

We are also reevaluating our new retail and direct-to-customer merchandising strategies based on the first quarter consumer response.

In Williams-Sonoma Home we are increasing catalog circulation, adding order placement functionality to the current e-catalog website, and opening our first three prototype stores in the third quarter.

We believe that the retail launch in Williams-Sonoma Home is strategic to expanding the multichannel reach of the brand, due to the customers' desire to actually see the product and fully experience the brands design authority.

Consistent with our second strategic initiative to improve profitability in our core businesses, we are projecting an increase in our 2005 pre-tax operating margin of 20 to 30 basis points.

The key drivers of this pre-tax operating margin improvement are expected to include: Ongoing expense reductions in the furniture delivery network, including the transportation cost benefits derived from the late 2004 in-sourcing of furniture line-haul management, and the strategic positioning of our Coastal furniture distribution centers in closer proximity to our customer base.

Improved inventory management processes, which are allowing us to fine tune our inventory allocations between our Coastal distribution centers and reduce our out-of-market shipping expenses, improved in-stock positions on merchandise inventory, which are enabling us to decrease our packages shipped per order, and reduce corporate overhead expenses as a percentage of net revenues driven by strong expense management initiatives.

Operationally, key initiatives for the remainder of the year include: Implementing the second phase of the daily store replenishment program, including rebalancing the inventories between the stores and the distribution center; developing operational disciplines throughout the supply chain to reduce returns, replacements and damages, particularly in furniture, improving our furniture sourcing and inventory management disciplines by implementing a long-term capacity and production planning process with key strategic vendors; expanding warehouse capacity to support higher inventory levels and emerging brands growth; and in-sourcing furniture hub management to develop a new gold standard for customer service and improve the overall operational efficiency of the furniture supply chain process.

At the end of the first quarter, furniture represented approximately 27% of total Company merchandise sales on a trailing 12-month basis.

Consistent with our strategic initiative to enhance shareholder value, we remain dedicated to delivering on the commitments we have have made to our shareholders.

Although our proven track record in driving our business in uncertain economic times, provides us with a high level of confidence in our ability to execute against our plans, we are remaining conservative in our outlook for the balance of 2005, which we believe is prudent.

Therefore, despite our strong performance in the first quarter, we are reiterating our fiscal 2005 diluted earnings per share guidance in the range of $1.84 to $1.88, representing an increase of 15% to 17.5% versus the $1.60 we achieved in fiscal 2004.

I would also like to mention this morning that our Board of Directors has approved the repurchase of up to 2 million additional shares through our share repurchase program.

This program is designed to enhance shareholder value, and to offset share issuance under our employee compensation plan.

Our Board's action is a reflection of the company's strong cash flow, which we believe is more than sufficient to support our continued growth.

I will now turn the call over to Sharon McCollam for more details on the first quarter 2005 financial 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 2005 financial results and our second-quarter and fiscal year 2005 earnings guidance.

Next, Howard will provide you with a business update on the Williams-Sonoma brand, then Laura will provide you with an update on the Pottery Barn brand, and finally we will open the call for questions.

I would now like to talk about our first-quarter earnings results.

We are extremely pleased to deliver to our shareholders another consecutive quarter of strong earnings performance.

Throughout the quarter, we remained intently focused on our operational initiatives, including furniture sourcing, and distribution and transportation management.

We also continued to maintain our disciplined cost containment initiatives in corporate overhead.

Based on our success, in all of these areas, we were once again able to deliver another quarter of record-financial performance.

And for the 19th consecutive quarter, we met or exceeded the earnings per share guidance we provided to our shareholders.

In the first quarter of 2005, we delivered diluted earnings per share of $0.22.

Net revenues in the first quarter of 2005 increased 12.4% to 720.7 million.

Retail net revenues in the first quarter of 2005 increased 13.1% to 397.2 million.

This increase was primarily driven by an 11.1% increase in retail lease square footage, and a comparable store sales increase of 5%.

Direct-to-customer net revenues in the first quarter of 2005 increased 11.6% to 323.5 million, with catalog circulation increasing approximately 7.7%, and paid circulation increasing approximately 18%.

These circulation increases compare to catalog and page count circulation increases of 25.8% and 30.8% respectively in the first quarter of 2004.

Internet revenues during the first quarter increased 36% to 153.5 million, contributing 47.4% of total direct-to-customer revenues versus 39% in the first quarter of 2004.

While all of the brands in the direct-to-customer channel delivered positive growth during the quarter.

Gross margin is expressed as a percentage of net revenues in the first quarter of fiscal year 2005 with 39.5% versus 38.3% in the first quarter of fiscal year 2004.

This 120 basis point increase was primarily driven by expense reductions in shipping costs and a rate reduction in occupancy expenses.

Partially offset by a furniture driven rate increase in merchandise cost of goods sold.

The improvement in shipping expense was primarily due to ongoing expense reductions in the furniture delivery network, including the transportation cost benefits derived from the late 2004 in-sourcing of furniture-aligned haul management, and the opening of the East Coast Distribution Center.

The rate reduction in occupancy expenses was primarily due to strong sales leverage in the retail channel, substantially offset by the higher occupancy costs associated with last year's 25% increase in distribution lease square footage.

Selling general and administrative expenses were 241.2 million or 33.5% of net revenues in the first quarter of fiscal year 2005, versus 32.9% in the first quarter of fiscal year 2004.

This 60 basis point increase was primarily driven by higher catalog advertising expenses in the direct-to-customer channel.

Increased paper costs across all brands in addition to higher costs associated with increased catalog and page circulation in the emerging brands drove the majority of this increase.

Our income tax rate in the first quarter of 2005 was 41% versus 38.3% in the first quarter of 2004, due to an increase in reserves for potential state audit exposures.

For the second quarter, we expected our income tax rate to be in the range of 37.9 to 38.1%, and our annual rate to be in the range of 38.4 to 38.8%.

Throughout the year, however, we expect that there could be ongoing variability in our quarterly tax rate, as taxable events occur and exposures are reevaluated.

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

All comparisons are versus the balances at the end of the first quarter of 2004, which are included in the financial statements attached to this morning's press release.

Cash and cash equivalents at the end of the first quarter of 2005 were 115.7 million, the highest first-quarter ending balance in the history of the Company after investing 12.4 million in share repurchases during the quarter.

Merchandise inventories at the end of the first quarter of 2005 were 522 million, an increase of 96.4 million or 22.7%.

This above sales growth year-over-year increase was primarily driven by our success in improving our in-stock positions on core furniture inventories.

Prepaid catalog expenses at the end of the first quarter of 2005 were 52.8 million, an increase of 13.7 million.

This increase was primarily due to increased circulation, higher paper costs and the timing of expenditures for the Pottery Barn and Pottery Barn Kids' catalogs, in addition to incremental costs associated with the Williams-Sonoma Home catalog which was launched in September 2004.

Prepaid expenses at the end of the first quarter of 2005 were 39.5 million, up 13.7 million.

This increase was primarily due to prepaying a portion of the Company's 2005 data center hosting fees in the fourth quarter of 2004.

Deferred income tax assets at the end of the first quarter of 2005 were $39 million, up 18.5 million.

A change in the timing of revenue recognition for income tax purposes on unredeemed gift certificates drove the majority of this increase.

Deferred income tax liabilities at the end of the first quarter of 2005 were 21.1 million, up 12.2 million.

This increase was primarily due to timing differences between book and tax depreciation.

Customer deposits at the end of the first quarter of 2005 were 153.7 million, up 21.8 million, this increase was primarily driven by year-over-year growth in unredeemed gift certificates.

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

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 90% of our full-year earnings will be generated in that timeframe.

We are continuing to be cautious in our outlook which we believe is prudent based on the ongoing uncertainty we believe exists in the current economic environment.

As announced in this morning's press release, our diluted earnings per share guidance for the second quarter is projected to be in the range of $0.24 to $0.26, versus $0.23 in the second quarter of fiscal year 2004.

This is a reduction from previous guidance of $0.01 due to the shift in backorder fulfillment from Q2 to Q1 that Ed discussed earlier in this morning's call.

For the full year, however, as this is only a timing issue between Q2 and Q1, we are reiterating our diluted earnings per share guidance in the range of $1.84 to $1.88, representing a year-over-year increase of 15 to 17.5% on revenue growth of 12% to 14%.

I would now like to turn the call over to Howard Lester, to discuss the Williams-Sonoma brand.

Thanks, Sharon and good morning.

In the first quarter, net revenues in the Williams-Sonoma brand exceeded our expectations.

Increasing 7.5% on top of a 7.4% increase in the first quarter of 2004.

We also saw a significant improvement in our year-over-year gross margin rates, driven by a substantial increase in full-price selling in both channels.

Reducing markdowns was a strategic initiative for the brand in 2005, and we're very pleased with our early results.

In the retail channel, although comparable store sales decreased by 0.5%, we were not disappointed because of the year-over-year shortfall was driven by significantly fewer markdowns in the retail stores.

We also saw very strong performance in our new and expanded stores.

In the direct-to-customer channel, our catalog redesign initiative combined with a substantial increase in on-line marketing drove better than expected results in both our catalog and e-commerce businesses.

The success of the catalog redesign was very strategic for us.

Because not only did it drive strong -- strong results in the direct-to-customer channel, it also drove increased traffic in new merchandising strategies into our retail stores, and onto our website.

In e-commerce, traffic on our website increased 13% and we continue to benefit from above-average conversion rates.

We also saw strong results from increased electronic direct marketing and expanded on-line search capabilities, as well as on-line bridal.

All of which are significant marketing opportunities for the brand long term.

From a merchandising perspective during the quarter, we saw better than expected growth across key merchandising categories, with particular strength in Cookware, Electrics, Cutlery and [core foods].

As we look forward to the second quarter and the balance of the year, we continue to be encouraged by the momentum that we are seeing from our new initiatives.

In the second quarter, we will continue to drive our full-price sales initiative, excess inventories during the quarter will be exited through our outlet stores, and by the third quarter we expect comparable store sales to return to positive levels in the brand.

We will also begin rolling out new visual presentation and merchandising strategies to our small and mid-sized stores.

Based on the success we've seen in our first test store.

Since the time we made changes to the store in early March, we have seen positive sales trends in the effective merchandising categories, and a better than brand average comparable store sales increase.

Based on these early results, we continue to believe that there is an opportunity to improve our smaller-store performance by implementing these types of strategies in additional stores.

Another highlight for the balance of the year is the ongoing national broadcast exposure, we are receiving from the new five-minute cooking school series that the CBS Early Show is taping at our Columbus Circle flagship store in New York.

These segments which will air between now and the end of the year provide significant brand exposure and demonstrate the brand's authority in home cooking and entertaining.

Let me now turn the call over to Laura Alber to discuss the Pottery Barn brand.

Thank you, Howard.

Good morning.

First I will start with the Pottery Barn brand.

We are very pleased with the performance of the Pottery Barn brand in the first quarter as net revenues for the quarter increased 9.6% on top of a robust 20.4% increase in the first quarter of 2004.

A positive consumer response to both our core and seasonal merchandise assortments, particularly in furniture, textiles and tabletops, and a higher in-stock position on core furniture inventories, drove this year-over-year revenue increase in all channels.

In the retail channel, comp store sales for the first quarter increased an impressive 6.1% on top of a 10.2% increase in the first quarter of 2004.

The direct-to-consumer channel also delivered solid growth during the quarter, on top of a very strong growth in the first quarter of last year.

This increase is primarily driven by continuing momentum in e-commerce and the ongoing success of our direct-to-consumer only merchandising initiatives.

During the quarter, traffic on our website increased approximately 12%, and we significantly expanded our electronic direct marketing efforts.

We also saw very strong results from on-line advertising initiatives.

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

As we enter the second quarter, we will continue to focus on the following brand-building initiatives: Leveraging our improved in-stock positions, particularly in furniture, to minimize lost sales and re-establish the service levels expected by our customers; expanding our on-line advertising and electronic direct marketing efforts to drive increased traffic to both our retail and direct-to-consumer businesses; increasing the retail assortment in our larger format stores to better serve the higher end Pottery Barn customer, and maximize our sales per square foot; and introducing a new retail merchandising flow at the end of May, that is synchronized with our direct to customer marketing.

While we are excited about all of these initiatives, we are cognizant of last year's very strong second quarter, when we delivered a total brand growth of 23.2% and comp store sales growth of over 10%.

Additionally, although our year-over-year sales trends continue to be positive, we are experiencing recent volatility in certain merchandising categories, including outdoor assortments where we have invested heavily this year.

Despite these difficult year-over-year comparisons, and this current uncertainty we believe exists in the retail environment overall, we remain confident in our ability to execute against the initiatives we have set for ourselves for the second quarter.

I would now like to talk about Pottery Barn Kids.

We are also very pleased with the performance of the Pottery Barn Kids brand in the first quarter, as net revenues for the quarter increased 14.1% on top of a 17.6% increase in the first quarter of 2004.

This strong performance was driven by consistently positive consumer response to key merchandising strategies throughout the quarter, particularly in retail with impressive growth in furniture and textiles.

The strong growth in both of these categories drove better than expected sales, but consequently lower order fulfillment rates in the direct-to-consumer channel.

We currently project that we will not be fully in-stock in this brand until the beginning of the third quarter.

In the retail channel, comp store sales for the quarter increased 10%, versus a 1% increase in 2004, and the performance of new stores was very strong.

What was extremely encouraging about our retail performance was the success of our new in-store design initiatives, and the overall strength of the consumer response to our newly introduced retail merchandising strategies, even given the ongoing pressure of lower in-stock and key programs.

And the direct-to-customer channel sales growth continued to be driven by the ongoing success of our direct-to-customer only merchandising initiatives, and the strength of our e-commerce business.

Highly productive on-line marketing programs including a substantial increase in electronic direct marketing, and better than expected results from on-line advertising contributed to the strength in e-commerce.

Traffic on our website increased approximately 12% and like Pottery Barn, conversion rates continued to exceed industry norms.

As we enter the second quarter, we are encouraged by the early customer response to both our core and seasonal merchandise assortments, and continue to be excited about our new merchandising strategies, including the introduction of new color pallets, and the expansion of categories that will generate repeat customer traffic.

I would now like to talk about PBteen.

The first quarter was challenging for PBteen.

Despite a significant increase in catalog circulation and page count, revenue growth was below expectations for the first time since the launch of the brand, due to a softer than expected consumer response to the spring and summer catalogs.

Although we are disappointed, we believe that the softness that we saw was the result of changes we had made to test the boundaries of the brand, that did not resonate with our customer.

We believe the spring and summer catalogues lacked the cohesion between merchandising and presentation that our customer expects.

From a product perspective, we believe that we pushed fashion trends further than our customer wanted to go.

From a visual presentation point of view, we believe that the flow of the merchandise assortment appeared disjointed and that many of the spreads were overly busy, resulting in a difficult shopping experience for the customer.

As we look forward to the second quarter and the back half of the year, we are confident that we have strategies in place to address the merchandising and visual presentation issues we saw in the first quarter, but know that many of these strategies will not be fully executable until later in the year.

In the short-term, however, there are initiatives we are implementing, including reducing catalog circulation and effecting markdowns, which we believe will partially offset the impact of the softness in response rates that we anticipate in the second quarter.

In the back half of the year, we are optimistic that the changes we will execute in the third and fourth quarters, will allow to us continue to drive strong growth in the brand.

During that time, we will be improving our catalog presentation, including new merchandise categories, and aggressively pursuing the significant opportunity we identified last year in our gift-giving assortment for the holiday season.

We will also increase our holiday catalog circulation, in addition to our electronic direct marketing contacts as we continue to leverage our database to identify new customers for the brand.

To maintain a growing teen awareness for the brand, we also plan to remain active in building our media and internet partnerships.

New on-trend marketing initiatives including contests, surveys and media tie-ins will continue to increase interaction with teens, and further enhance their affinity for the brand.

Despite the short-term challenges we are currently facing, we remain very confident in the long term growth potential of PBteen, and its role in our life-stage marketing in the Pottery Barn family of brands.

I would now like to open the call for questions .

[OPERATOR INSTRUCTIONS] For our first question, we'll go to Lauren Levitan with SG Cowen.

Go ahead.

Thanks, good morning.

I have a couple questions.

My first one I guess is for you, Sharon.

Is the conservatism that you're referring to in your planning assumptions any different than when you had entered the year?

And if so, maybe give us some thoughts as to in what elements?

And then I have another question on inventory.

Thank you.

Lauren, I don't think that our level of conservatism has changed.

We continue to see the uncertainty, the volatility, you're seeing it in the markets, and we're just continuing to be cautious.

So we can infer that any gains that you made in Q1 really are market share driven?

We believe -- we specifically said, Lauren, that we believe that the success we had in reinstating the inventories on core furniture brought back orders from Q2 to Q1 from our original guidance, but that is the only change from our guidance.

Okay.

And then my other question is related to inventories.

Given you have so many initiatives that you're getting some reads on, I'm wondering if you could give us some update as to the daily store replenishment program, and the other initiatives?

Can you give us some thoughts as to what kind of longer term inventory turn opportunities you might have and also as furniture continues to grow as a percent of business, what kinds of long-term capacity issues you might have, and where you'd see that furniture percent possibly going?

Thanks very much.

Okay.

Lauren, that's a lot of -- let me try to go through those questions each one of them.

First of all, your first question was from a longer term point of view as it relates to inventory turns, how are we thinking about that.

As we think about going forward in the future, I believe that we will grow with sales growth this year we're in a replenishing mode, of reinstatement mode, and we are determined to improve our service levels to the customer.

So from that point of view, going forward out of '05 and into future years, we would expect to see that.

Now, we do believe that from the daily store replenishment program, that there are opportunities to substantially improve our flow of merchandise but backing that all the way up to the vendor.

But initially, we have made very few changes in that, because we want to get the process rolled out to the stores, and we want to get it executing, and then we will work on re-engineering the supply chain on the back end, to focus on the turn opportunity that that initiative represents.

As it relates to our vendor sourcing and capacity issues, I'm going to ask Ed to speak to that.

He just got back from Asia and Ed, will you please speak to our capacity furniture capacity issues in Asia?

Okay.

Thanks, Sharon.

The furniture capacity, we are working very diligently, as we said in the past, on getting a production planning cycle that matches our sales cycle.

So what that -- the short-end version is we will have strategic vendors who we will place orders with, that meet their production planning and also then therefore solve our customer backorder problem, and also try not to get us overinventoried.

That's what we're trying to do with our capacity planning.

In addition, furniture is increasing, Lauren asked how much.

Well, you know, it's -- just continues to increase.

I don't think we have a prediction, but it will continue to increase.

As a percent, the cube's bigger and we are looking at how our distribution network should be configured, and that may include more DCs closer to our customers.

Thank you.

For our next question we'll go to Mark Friedman with Merrill Lynch.

Thank you.

Good morning, everybody.

Great job on the quarter.

Thanks, Mark.

Howard, Ed, I was wondering if you could talk, the success of these new West Elm stores as you look towards 2006, what's the thought process on -- you know, ramping up store growth there?

And I was also curious, the latest plans and thoughts on continued renovations and expansions within both Sonoma and Pottery Barn, where you see opportunities and -- what we might see later this year into next year?

Thank you.

Okay.

Howard, would you like to speak to the 2006 real estate strategy for West Elm, and the real estate regarding the Williams-Sonoma Pottery Barns, future renovations or remodels.

Thanks, Sharon.

Mark, with respect to the -- to the West Elm stores, you know, as Ed mentioned, we are -- we are quite pleased with the results so far.

All the stores that are open, I think there's six now, are exceeding our pro forma expectations.

So we are just very pleased with those.

We continue to see a lot of opportunity with West Elm.

We think that many of the assortments can be expanded and can grow considerably, in terms of SKU count and just authority.

We see the stores probably getting a little bit larger as we move forward, but we're cautious about that.

We have stepped up -- our efforts to find more stores sooner.

We are spending a lot of time on it.

Our real estate team is out in the market.

Ed and I have been on trips and Dave is aggressively looking for space.

We are seeing some wonderful locations around the country.

And while I can't give you an exact number now for next year, uh, we are looking at more sites than we -- we were three months ago and we are very optimistic about the real estate we are seeing, and the response we're getting from the community.

So more to come as we open the balance of the stores this year and early into next year, and continue to monitor the volumes, but we're very pleased with it.

We mentioned briefly -- the program we had on the Williams-Sonoma stores to improve our smaller stores, I commented on that -- in the earlier remarks that we made.

We are pleased so far.

We continue to tweak it.

And, also, some of the new merchandise, particularly in the tabletop area that we've designed will not be in the stores until some this fall, but the bulk of it will be completed next spring, so that's going to take a little while to get the goods in there.

We are very excited about them.

We've pretty much completed our dinnerware assortment changes, in terms of editing the assortment out, but we don't have all the new goods that we will have in there later this year.

So we continue to be pleased with -- we've really only got the results from the one store.

We've got two more under way currently.

And we are -- we are developing plans to get very aggressive, the balance of the year, with as many of the stores as we can do.

Expansions of course as you know, we just take them when we can get them.

We continue to expand our better stores, and we have a lot of opportunities left to do that.

Our average store volumes continue to increase and we are pleased with that and we will continue to expand the Sonoma stores.

Pottery Barn, the same thing is true.

We are looking for expansion opportunities there.

We are going to do one quite large Pottery Barn store in about a year and a half, we contracted for the real estate which would take us up to about 25,000 feet, maybe 27 I think.

And test much more furniture on the floor.

So we continue to expand our -- our vision about where these brands can go, and we are pleased with the results that we've had thus far.

Our next question will go to Dana Telsey with Bear Stearns.

Good morning, everyone.

Good morning, Dana.

Hi.

Can you talk a little bit more about Pottery Barn Teen.

What do you want the merchandise focus to be?

How do you see it -- how do you see it changing at all?

And then can you talk about the SG&A the second quarter is a little bit greater than what you had in the first quarter.

What's the complexion of that.

And just lastly furniture is around 27% of sales, where do you see that -- see that going? obviously it's been great, because that helps the average transaction, how do you see that evolving for the brands?

Thanks you.

Dana I'm going to let Laura discuss the merchandise in Pottery Barn teen and their strategy, and I'm also going to let Laura speak to the furniture mix in her Pottery Barn brands, and then I'll speak to the bigger company on the furniture and I'll talk to the SG&A.

Okay.

So Laura.

Sure.

On Pottery Barn Teen, we continue to refine the balance between appealing to the teen customer who is very aware of trends in the marketplace, but also realizing that these are products that go in your home, and very different from apparel.

The current myth, as I said earlier, I believe is due to too much fashion, too much apparel-based bedding, and room decor that isn't as livable as our customer expects from us, and so we've made those changes for fall.

And really balancing that these teenagers are living in their parents' house, and they have a little bit more of a rustic traditional style, but at the same time realizing that we need to appeal to the teen customer.

As it relates to furniture in the Pottery Barn brands, furniture continues to be a very important part of our strategy.

It is the foundation of the home.

So we're very focused on our quality initiatives and our in-stock customer metrics, which we've made great progress on.

We will continue to grow furniture.

However, as a percent of the mix, we believe that it will remain pretty similar to where you see it as a percent of the mix, and we have a great opportunity to balance some of the other areas and drive response rates, particularly in the mail at gift-giving time through the year.

And then as it relates to the mix in furniture for Pottery Barn.

Covered that.

Great.

The question -- the final question, Dana, that you have was the increase in SG&A?

Exactly.

And in the second quarter, we did tweak -- we took up our gross margin guidance but we also took up the SG&A by about 20 basis points.

And that's primarily due to catalog advertising, 100% due to catalog advertising.

And as you look at the direct-to-customer revenue guidance when we take that down, as we look at catalog productivity in Q2, we are being more cautious in our guidance, as a result of the issues that we talked about with Pottery Barn Teen and Hold Everything.

So that's basically what we're looking at for Q2.

Thank you very much.

You're welcome.

We'll now go to Michael Novak with Frontier Capital.

I have a couple questions.

First off, the 1% decrease in comp guidance for 2Q should be just under $4 million, yet you only decreased the retail revenue guidance by 1 million.

So I assume that has to do with what you're seeing with new-store productivity.

Is that all West Elm and can you elaborate, please?

Mike, no, it's not.

This is the question on comp store sales guidance and we reduced it to 1.5 to 3.5% in Q2.

We lowered the second-quarter comp store sales guidance due to our anticipation of fewer markdowns in the Williams-Sonoma brand, the majority of that change, Mike, was actually in Sonoma, because they're not going to have the markdowns in the store.

And then there was also the higher level of conservatism in PB to some extent.

But as it relates to why the revenue in retail is still so strong, when you think about it, the strong performance in this new store, and West Elm is a piece of that but all the stores that are not in the comp base are stores that we have remodeled, or put in great locations and these new stores across brands are continuing to exceed our expectations.

Okay.

Thank you.

My second question is can you give us your thought process behind why you thought it was more transparent, or better for us, to stop breaking out shipping gross margins?

Absolutely.

In the past, Mike, we were breaking out shipping revenues and shipping costs.

And we did that because we believed that it was -- when we first had to make the accounting change three years ago, the cost reductions that we were achieving were direct cost reductions.

It was from renegotiating our contracts and changing our processes around shipping, changing our furniture delivery network, and they were all included in that line.

Last year, we went to a new phase of reducing our shipping costs, which included opening extremely expensive distribution centers, the West Coast and the East Coast DCs.

And as a result of that, even though you were seeing an improved margin on shipping, if you just take net shipping, you weren't seeing the occupancy costs that were being funded in order to fund those savings.

So that's why we stop breaking out, because if you keep looking at that and you look at that shipping margin, it could over time become misleading.

So that's why we consolidated it and condensed it, because we don't believe that that metric any longer is -- as indicative of our performance as what it was in the past because we're spending money in other areas to get the savings we're getting today.

We'll now go to Neely Tamminga with Piper Jaffray.

Great.

Thank you and congratulations on a great quarter.

I'm just trying to figure out a little bit more with respect to your bridal businesses.

I don't know if you can have both Laura and Howard talk about how the registries are looking as we head into the summer?

I mean, is there anything different that you're seeing in those businesses?

Laura, you want to start?

Sure.

The bridal customer continues to be very important to us, and our higher in-stock levels and our improvement in core merchandise strategies across the Pottery Barn brand in both channels, is really good for that customer.

It's a focus of ours.

We also continue to refine the way we interact with our bridal customers in the store, and are trying some new things to make that experience a better one.

In the kids' business, our nursery registry continues to grow, and we are focused on bringing in new categories of merchandise that will round out the nursery registry so that the customer can come to us for more practical items,` as well as the bedding and cribs and furniture that they come to us for today.

So both continue to be very important parts of our strategies and we continue to improve the customer service that we provide.

Our next question we'll go to Charles Grom with JP Morgan.

Good morning.

Nice quarter.

Some others in your space have commented on the weakness in outdoor furniture, and I noticed that many players from grocery stores to even some home improvement outlets are entering the space.

Could you provide some details on how you expect to remain competitive on this front, and if you have in fact seen the space get more competitive recently?

Thanks.

Sure.

It's Laura.

And our outdoor furniture business is very strong actually.

We did get a lower -- slower start than we had last year, because the weather has not changed -- it hasn't been as warm as it was last year, but this is a strategy that -- that we continue to see strengthen.

We have particular strength in some of our new introductions in Pottery Barn where we're very different from our competition.

And where we will continue to be better is really in the areas of new design ideas.

You may recall seeing our wonderful outdoor sectional.

And that's an item that no one else has in the market.

So we continue to increase our quality, improve our quality, I should say, and also bring better products to market and you will see us expand this category next yea, with even more innovative products for the outdoor spaces.

Great.

And then one follow-up for Sharon.

For 1Q just to go back to the previous question on margins -- gross profit margins.

Could you give us what your margins were X shipping, so we can compare that rate to last year?

No we're not going to be breaking that out because as we said Charles, now you have all these costs of the distribution centers, and those aren't allocated into those lines so we're not going to be breaking out shipping margins.

I understand.

Good luck, thanks.

Okay.

And then I'd like -- Neely's questions, Howard did not get to speak to the Williams-Sonoma bridal business, which is very exciting.

Howard, would you speak to the Williams-Sonoma bridal question?

Many of the things that Laura are true in Williams-Sonoma, of course it's very important to us.

We are -- we are one of the big things I think we're doing is improving our merchandise assortment for the bride.

I think the changes that we're making in tabletop are going to be particularly well received, because there's much more of a guarantee that we'll be in stock over a period of time, and we'll have an assortment that the bride identifies with.

We've got some operational initiatives underway as well, -- and we are advertising -- we have stepped up our marketing some with our bridal business this year, -- so we're very excited about where it's going, and we're looking forward to a great year in our bridal business.

And then Pat, you had a couple of things you wanted to say about bridal.

Yes.

We're going to be relaunching our bridal website across our brands, in particular with Williams-Sonoma this fall.

We -- it's always been a great advantage for us, and we've been recognized as a leader but we're going to be taking it to a new level.

And then following up on what Howard said, we are going to be doing bridal advertising.

We don't -- as you know, do very much advertising but here's an area where we think we can bring new customers to the brand very effectively, and you'll see us do more of that in the future.

We'll now go to Rex Henderson with Raymond James and Associates.

Good morning.

I have a couple of questions.

First of all, I was interested in the daily replenishment program, and do you have any kind of color or information about what the sales results in those stores have been?

Have you seen any -- had enough experience with it yet to get any meaningful information about -- about sales volumes where you've implemented daily replenishment?

Ed, would you like to speak to that?

Sure.

It's really too early, Rex, to call the sales, we've been at this almost a year and a half, and we're very slow and deliberate in our first three pilots, but we were cautious and I think prudent, when we did our business case for the daily store delivery, not to get too excited about sales increases.

I think it's intuitive that they'll work and we'll get comp increases, and we will provide our customers a better experience.

But this was based on inventory, better efficiencies that we mentioned in my pre-prepared remarks, so we're very excited.

Our second phase is pretty well rolled out.

We will then evaluate primarily our in-stock positions in our -- in our stores and we want to be very -- I think diligent about -- that we don't just back it up into our DCs.

We want our DCs to then go all the way back to our manufacturers.

I think our sales lift will come, and I do think our sales lift will come when we have higher volumes, particularly in our -- in our holiday because we can wait and see which stores are producing, and over time even in summer which stores are producing longer, and we can hold back and then feed the stores that produce, as opposed to our old way of allocating to the stores.

So more to come, but we think this is just an absolute home run.

Okay.

Thank you.

Second question concerns the guidance for SG&A for the second quarter.

And -- the increase due to catalog advertising expense.

I just want to make sure that I understand that that is because you are expecting -- your sales guidance for that is down, so you're amortizing that expense over a -- over a smaller sales base.

Is there any impact from higher paper than expected, or increased catalog circ, versus the last time you provided guidance on this?

No.

There's not.

It's exactly what you just said.

And what we said earlier.

Okay.

We are in line with our paper costs, we projected our paper cost increases.

It was in our guidance originally.

It has nothing to do with higher paper costs.

Okay.

Thank you.

And then, finally, -- the -- a third question.

Does your guidance anticipate any markdowns on outdoor furniture in Pottery Barn?

Have you thought about that at all?

Is there any need for that?

All of the markdown strategies that we have planned are in the guidance for Pottery Barn.

Okay.

And are you considering any markdown strategies for that, or can you say at this point?

You know, It's highly competitive.

We are taking markdowns as need be.

And you see in our recent drop of the catalog, we have taken the one that is in home this week, you will see that we have taken some markdowns on select programs.

Okay.

The good news is due to our supply-chain initiatives, we have very healthy margins in our outdoor furniture.

Right.

Okay.

Well, thank you very much.

I haven't seen that catalog yet, but I'll take a look at it.

It's beautiful.

And for a final question, we'll go to David Magee with SunTrust Robinson Humphrey.

Hi.

Good morning.

Good quarter.

Thank you.

Two questions if I could.

One on the -- Sharon, does the assumption this year in terms of EPS guidance, does that assume a meaningful improvement in the furniture return percentage?

I know there are a lot of things that drive the EBIT margin, but do you anticipate meaningful improvement this year?

No, we did not.

We -- we anticipated some improvement, Dave, but we are being cautious with that.

You know, it takes time.

We just reinstated our inventories.

We are filling customer orders more efficiently and more quickly.

So that's great news because we think that contributes to the return rate.

Laura is running low-90s in fulfillment rates right now in Pottery Barn, which is particularly impressive.

So as a result of that, we are hopeful that that will happen, but we did not guide much in the way of improvement in that area.

And I'll let Ed speak to some of the things we're doing.

He's got an entire task force on this, and I'll let Ed speak to what we're doing to address returns, replacements and damages in furniture.

Okay.

Thanks, Sharon.

David, what -- we're very focused while we have -- as Sharon mentioned in our financials.

This is a big deal, and I don't think it's a big deal in this quarter or the entire year.

It's a big deal total we should be working on every day.

But the fluctuations and maybe a quality issue out of Asia, as we work through our daily store delivery, we've got issues to work through -- on furniture damage as we've gone to UPS.

We don't have any big issues today but we're very -- very aware of what could happen.

And, also, I think the whole return replacement damages, as we look at as a whole, and have a very I'd say targeted approach in our Company, list the first five or six big deals, work them through, see how they work, and let the patterns fall from there.

I think as time goes on we will really fine-tune this to where we can be more explicit on what it will or won't be.

Thank you.

And then secondly, Laura.

You mentioned adding categories at PB Kids to drive repeat traffic.

Could you give us an example of what some of those products might be?

In the current assortment, we've really increased our consumable strategy, so you can see in the stores that we have more gifts and more toys, and that is really working.

We also have books that I think are great, our customers have told us they want more educational items for their children in our stores, and we're focusing on that.

We are also very cognizant of the different ages of children that come into our stores, and how different their needs are for their rooms, and for their -- just as gifts for them.

And so we continue to look at what are the -- what are the rooms for the toddler versus the older child, and that represents a pretty sizeable long-term strategy for us.

And of course we always have some secrets up our sleeve about things to come, and so just a lot of excitement in the kids' business, a lot of opportunity.

Great.

Thank you.

Thank you.

And I'd now like to turn the call over to Mr. Ed Mueller for closing comments.

Thank you.

I'd like to thank you for joining us today for our Williams-Sonoma first-quarter conference call.

We are proud of our first-quarter results, and are excited about the many opportunities that lie ahead for the Company for the remainder of 2005 and beyond.

Thank you again and have a great day.

Thank you.

That does conclude today's conference.

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