Williams-Sonoma Inc (WSM) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Williams-Sonoma Inc. third 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 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.

This morning's conference call should be considered in conjunction with our third quarter 2005 earnings press release including financial statements, which we issued earlier today.

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 plans 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 call over to 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 consecutive quarter of strong financial performance, despite a number of factors that challenged the business during the quarter.

The third quarter was initially affected by the sales impacts of the hurricanes, which we estimate at approximately 3.5 million in lost revenue versus our guidance, and then continued with a level of variability in consumer response, which we believe was driven by the national focus on the hurricane relief efforts, increasing fuel prices, and overall economic uncertainty.

We also experienced other challenges during the quarter, including hurricane-related distribution disruptions, and late deliveries of our catalogs, due to subsequent ground transportation capacity constraints.

Despite these challenges our operational flexibility and strong execution allowed us to deliver the highest third quarter diluted EPS and pretax operating margin in our history.

In the third quarter of 2005 on revenue growth of 14.5% we increased our EPS by 29.2% to $0.31 per share, and our pretax operating margin by 80 basis points.

During the quarter we continued to expand the reach of the west elm and Williams-Sonoma home brands, including the opening of our first three Williams-Sonoma home stores, and successfully kicked off the first phase of our furniture hub in-sourcing strategy in our East Coast distribution operation.

We also continued to maintain our strengthened in-stock position on core merchandise inventories, resulting in our third consecutive quarter of improved direct-to-customer fulfillment rates.

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

In our core brands, net revenues increased 11.5% in the third quarter, driven by low double-digit growth in the Pottery Barn and Pottery Barn Kids brands, and mid single-digit growth in the Williams-Sonoma brand.

Laura and Howard will discuss the performance of each of these brands later in this morning's call.

In our emerging brands which include west elm, PBteen, Williams-Sonoma home, and holdeverything, third quarter net revenues increased 46%, primarily driven by strong performance in west elm, Williams-Sonoma home, and PBteen.

In the west elm brand we continue to see strong year-over-year growth, driven by incremental revenues from new stores, increased catalog circulation, and high traffic in e-commerce.

Also encouraging the growth in our west elm customer database.

Our initiatives to broaden the merchandise assortment, soften the color pallette, and enhance the life style presentation are clearly attracting new customers to the brand, which is critically important as we accelerate our growth plans in 2006.

In Williams-Sonoma home, the third quarter was an exciting time, as we opened our first three retail stores, not only did the new stores open to a positive customer response the direct-to-customer channel also saw impressive growth, as it anniversaried its 2004 launch.

In the holdeverything brand during the third quarter, the consumer response to the overall merchandise assortment continued to fall short of our expectations.

Because we anticipated a continuation of the negative impact from the merchandising transition, the weakness we saw in both the retail and direct-to-customer channel, while once again disappointing was not unexpected.

To address the inventory-related impact of these lower than planned sales as we discussed in our call at the end of the second quarter, we implemented aggressive inventory markdown and disposition strategy, which again resulted in significantly lower gross margins in the third quarter versus last year.

Operationally in the third quarter, we initiated the first phase of in-sourcing in our East Coast furniture hub operation, and continued to refine our process to capitalize on the benefits of our daily store replenishment program.

As previously discussed, we have seen a significant improvement in our retail in-stock positions, due to the shortened replenishment cycle and are optimistic that this program will provide substantially improved customer fulfillment during the upcoming holiday season.

As we look forward to the fourth quarter, we are continuing to focus on the three strategic initiatives that are fueling our success: Driving profitable top line revenue growth, increasing pretax operating margin, and enhancing shareholder value, consistent with our strategic initiative 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 catalog circulation, increasing our outlet leased square footage to continue to maximize our return on excess inventories, refining our visual merchandising in our Williams-Sonoma retail stores, and implementing new electronic direct marketing and gift card initiatives, that we believe will drive increased sales and new customers to the brand.

In our emerging brands, we are focused on building our customer databases and expanding our multichannel capabilities.

In the west elm brand, we are opening one additional store late in the fourth quarter.

We are also increasing our catalog circulation, electronic, direct marketing, and on-line customer acquisition efforts through the remainer of the year.

Although it is too early to predict the ultimate size of west elm, we believe the consumer response to our new merchandising initiatives is confirming our belief that over time, west elm has the potential to become one of our largest brands.

We also believe however, that there are key success factor inside achieving this growth, including continuing to evolve the merchandise aesthetic to appeal to a broader consumer base, expanding the merchandise assortment into new categories, executing an effective retail strategy, and effectively marketing the brand to capture increased mind share in the large consumer segment west elm targets.

In the Williams-Sonoma Home brand in the fourth quarter, we are increasing catalog circulation, promoting the order placement functionality on the current e-catalog website, and significantly expanding our holiday assortment.

We continue to believe that the retail launch will accelerate the growth in this brand, due to the customers desire to see the product, and experience the brands design authority.

In the holdeverything brand, although there is a significant amount of new merchandise in our fall and holiday assortments, we are approaching the remainder of the year very cautiously based on our year-to-date results.

Add at a minimum, we know that our margins will remain under pressure, due to the ongoing impacts of the inventory disposition strategy that we implemented in the second quarter.

Also we will be continuing our assessment of the overall positioning of the holdeverything brand within our portfolio long-term.

While we continue this assessment, we are suspending all new store opening activities, reducing catalog circulation, and reducing both current and future inventory commitments.

Consistent with our second strategic initiative to improve profitability in our core businesses, we are projecting an increase in our 2005 full year pretax operating margin of 30 to 40 basis points.

And to enhance shareholder value, we remain dedicated to delivering on the commitments we have made to our shareholders.

As we look forward to the fourth quarter, we continue to believe that it is prudent to remain conservative in our outlook, based on the higher level of uncertainty inherent in our forecast, due to our new initiatives in the emerging brands, and the volatility we are seeing in overall consumer demand.

The strength of our brands and our proven track record, however, provide us with a strong confidence in our ability to execute and deliver, against the commitments we have set for ourselves in challenging times.

Based on this, although we are narrowing our guidance range for the fourth quarter, we are pleased today to be affirming the high-end of our full year diluted EPS guidance range.

In our previous guidance our fiscal year 2005 diluted EPS guidance was in the range of $1.84 to $1.88.

Today we are increasing the low end of that range to $1.86 due to our strong third quarter results.

And affirming our full year guidance at the high-end of the range at $1.88, representing a year-over-year increase of 16.3%, to 17.5% on revenue growth of 12.3% to 13%.

I will now turn the call over to Sharon McCollam for more details on the third quarter 2005 financial results.

Thank you, Ed.

Good morning.

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

First, we will review our third quarter 2005 financial results, and our fourth 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 brands.

And finally, we will open the call for questions.

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

In the third quarter of 2005 diluted EPS increased 29.2% to $0.31 versus $0.24 in the third quarter of 2004.

Throughout the quarter, we continued to see benefits from our transportation management and overhead cost containment initiatives.

These benefits combined with a strong consumer response to key merchandising strategies, allowed to us deliver another quarter of record financial performance.

And for the 21st consecutive quarter, we met or exceeded the EPS guidance we provided to our shareholders.

Let's look at what drove these strong results.

Net revenues in the third quarter of 2005 increased 14.5% to 828 million.

Retail net revenues in the third quarter increased 12.8% to 445 million.

This increase was primarily driven by a 10.6% increase in retail lease square footage, and a comparable store sales increase of 4.4%.

Direct-to-customer net revenues in the third quarter increased 16.5% to 383 million, with catalog circulation decreasing approximately 5.3%, with page circulation increasing 0.7%.

This circulation compares to catalog and page count circulation increases of 10.3% and 15% respectively in the third quarter of 2004.

Internet revenues during the third quarter increased 42.2% to 198 million, contributing for the second consecutive quarter, more than 50% of our total direct-to-customer revenues.

Gross margin expressed as a percentage of net revenues in the third quarter was 39.4%, versus 38.9% in the third quarter of 2004.

This 50 basis point increase was primarily driven by expense reductions in customer shipping costs, and sales leverage in fixed occupancy expenses.

But was partially offset by a rate increase in merchandise Cost of Goods Sold.

The improvement in customer shipping costs was primarily driven by cost benefits derived from the third quarter 2004 opening of the East Coast distribution center, and the fourth quarter 2004 in-sourcing of our furniture line home management operations.

The rate increase in merchandise Cost of Goods Sold was primarily due to a furniture driven rate increase in merchandise costs, and increased transportation costs associated with the 2005 daily store replenishment program.

In the third quarter of 2005 year-over-year furniture sales increased 24%.

SG&A expenses were $267 million, or 32.2% of net revenues in the third quarter, versus 235 million, or 32.5% of net revenues in the third quarter of 2004.

This 30 basis point decrease as a percentage of net revenues was primarily driven by sales leverage and deployment costs, partially offset by higher catalog advertising expenses.

Increased paper costs across all brands, drove the majority of this catalog advertising expense increase.

I would now like to briefly discuss the impact of Hurricane Katrina in the third quarter.

Prior to Hurricane Katrina, we had five stores operating in the New Orleans area.

Two of these five stores were severely damaged, which resulted in both property and inventory write-offs during the quarter.

As these losses were fully insured, however, the impact of these write-offs was immaterial to our third quarter 2005 financial results.

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

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

Cash and cash equivalents at the end of the third quarter was $92 million.

This is the highest third quarter balance in the history of the Company, despite investing over $126 million in share repurchases over the past 12 months, including 1.3 million shares repurchased during the third quarter of 2005.

Merchandise inventories at the end of the third quarter increased 18.2% to 588 million.

This above sales growth increase is consistent with our strategy to reinstate our core inventory levels with the majority of the increase being in core furniture.

On a two-year basis, however, inventory growth is slightly below sales growth.

Prepaid catalog expenses at the end of the third quarter of 2005 increased 3.1% to $67 million.

This increase was primarily driven by increased paper costs.

Prepaid expenses at the end of the third quarter of 2005 were $37 million, up $8 million.

This increase was primarily driven by prepaid IT service and maintenance agreements.

Customer deposits at the end of the third quarter of 2005 increased $32 million to $168 million.

This increase was primarily driven by a sales growth-related increase in unredeemed gift certificates, and a year-over-year increase in customer orders in transit at the end of the third quarter.

I would now like to briefly discuss our fourth quarter and fiscal year 2005 EPS guidance.

As we look forward to the remainder of the year, we are mindful of the fact that approximately 35% of our full year revenues, and 60% of our full year earnings will be generated in the fourth quarter.

We are also mindful that during this time, we will be continuing to invest heavily in the growth of our emerging brands.

As these growth initiatives inherently create a higher level of uncertainty in our forecast, we believe as Ed said earlier, that it is prudent to remain conservative in our outlook.

Therefore although we are narrowing our diluted EPS range for the fourth quarter from $1.07 to $1.11, to $1.07 to $1.09, we are affirming the high-end of our full year guidance range.

In our previous guidance our full year 2005 diluted EPS was in the range of $1.84 to $1.88.

Today due to our strong results in the third quarter we are increasing the low end of that range to $1.86, and affirming our full year guidance at the high-end of our range at $1.88, representing a year-over-year increase of 16.3% to 17.5%.

We believe this guidance is appropriately conservative, based on the current trends that Ed discussed earlier, and are confident in our ability to deliver against it based on the ongoing strength of our brands, our proven track record and operational execution, and the consistency in which we have been able to deliver on our commitments.

I will now turn the call over to Howard Lester to discuss the Williams-Sonoma brand.

Thanks, Sharon, and good morning, everyone.

We were pleased with the improved sales trends that we saw in the Williams-Sonoma brand in the third quarter.

Net revenues in the brand increased to better than expected 6%, and we saw renewed momentum in the retail channel.

Focusing on retail execution continues to be a major initiative during the quarter, including an increased number of in-store events, and enhanced visual merchandising.

In the retail channel, we expensed a 1.3% comp store gain increase which brought year-to-date comparable store sales into positive territory.

Our new and expanded stores also generated better than expected results, which helped to offset the impact of lost sales due to the hurricane.

In the direct-to-customer channel revenue growth in the third quarter also exceeded our expectations.

The successful redesign of our catalog, combined with a substantial increase in on-line marketing drove these strong results.

In e-commerce, traffic to our site increased by 31%, and we continued to see strong conversion and higher average order size.

The significant increase in traffic was driven by strong results from increased electronic direct marketing and on-line search.

In addition to on-line bridal, all of which continue to be significant long-term growth opportunities for the brands.

From a merchandising perspective during the third quarter we saw positive growth in all merchandising departments except tabletop, with particular strength in electrics, cookware and cutlery.

In the tabletop category, we don't expect to see a rebound in performance until we launch our full assortment in the Fall of '06.

As we look forward to the fourth quarter we are excited about our new initiatives.

In the retail channel, we rolled out some of the visual merchandising changes that we discussed earlier this year in the perimeters of our smaller stores, a significantly additive assortment, combined with increased signage is providing greater visual clarity on the items we are selling, which we believe is resulting in an enhanced shopping experience for our customers.

We have completed six mini-remodels similar to the Stonestown project we discussed with you earlier this year, with significant improved comp store gains.

We have also enhanced our gift giving statement in the stores, including an expanded assortment of prewrapped gifts.

Training has also been a key focus for us this year.

During the fourth quarter we are completing a new training program for all of our store associates, which has been designed to enhance sales and customer service, in three of our most important holiday merchandising categories, electrics, cookware and cooks tools.

We expect that all these retail initiatives will allow us to accelerate the positive comparable store sales momentum that we saw in the third quarter.

In the direct-to-customer channel in the fourth quarter, we are optimizing our catalog circulation strategy by increasing our contacts with recent retail buyers, and expanding the use of versioning.

Both initiatives were tested in 2004, and are expected to result in significantly improved catalog driven demand.

Also in the fourth quarter we are testing a small newspaper advertising campaign, focused on cooking and entertaining for the Thanksgiving holiday.

In addition to continuing the CBS five-minute cooking school filmed at our Columbus Circle flagship store.

Both of these initiatives are targeted to promote Williams-Sonoma's brand authority in home cooking and entertaining.

Now let me turn the call over to Laura Alber to discuss the Pottery Barn brands.

Thank you, Howard.

Good morning.

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

We are very pleased with the performance of Pottery Barn in the third quarter, as net revenues increased 12.3%, versus a strong 17.3% increase in the third quarter of last year.

A positive consumer response particularly in furniture and textiles and decorative accessories, and a higher in-stock position on core furniture inventories drove this year-over-year increase cross both channels.

In the retail channel, comparable store sales for the third quarter increased 5.5% on top of a 5.7% increase in the third quarter of 2004.

A positive consumer response to our new autumn floor set, and continued strength in core furniture drove this year-over-year increase.

The direct-to-customer channel also delivered strong growth during the quarter driven by successful catalog and Internet only merchandising initiatives, and strong momentum in e-commerce.

Newness in both our marketing strategies and merchandise assortment drove strong sales across categories.

During the quarter unique visitors to our website increased 19%, and conversion rates continued to exceed industry norms.

We also saw significantly increased our e-mail campaigns focusing on seasonal messages, core product offerings, and decorating and entertaining ideas.

As we look forward to the fourth quarter, the early consumer response to our seasonal merchandise assortment, including ornaments and trim is very strong.

This is encouraging because we shifted the timing of our holiday floor set this year, moving it from mid-October to November, in order to provide an assortment more relevant to our customers buying patterns.

Although we believe it is still too early to measure the impact of the strategy, the overall consumer response appears to be positive.

Also encouraging is our strengthened holiday gift assortment, which we believe will drive increased traffic to our stores and invite new customers to the brand.

From an operational point of view, we are focusing on the following peak season initiatives: Maintaining our in-stock positions to enhance customer service and minimize lost sales, exposing the brands to a broader customer base by marketing our gift cards in prominent supermarket chains, expanding our paid search initiatives to enhance traffic in all channels, and leveraging our logistics network to meet last minute customer demand via daily store delivery and accelerated UPS delivery.

I would now like to talk about Pottery Barn Kids.

In Pottery Barn Kids third quarter net revenues increased 12.3%, versus a 15.2% increase in the third quarter of 2004.

A positive consumer response to both core and seasonal merchandise, particularly in textiles, furniture and decorative accessories, drove this year-over-year increase.

This increase was partially offset however, by lower than expected sales in nursery furniture, which resulted from the vendor quality issues in our crib assortment that we discussed last quarter.

As textiles and furniture continue to exceed our expectations again this quarter, orders fulfillment rates in these categories continue to run below targeted levels.

Although we have seen improvement and our vendors are a aggressively working to replenish our in-stock positions, we do not believe we will be at inventory levels until 2006.

In the retail channels, comparable store sales for the third quarter increased 3.8%, and the performance of new stores was very strong.

We are particularly encouraged by the success of our new bedding programs, in addition to our decorative accessories and bedroom furniture.

During the quarter we continue to build on the success of our in-store family events, and added one new floor set between Halloween and Thanksgiving, to keep the seasonal messages fresh throughout the quarter.

The direct-to-customer channel also delivered strong growth during the quarter driven by successfully direct-to-customer only merchandising initiatives, including personalization, and strong momentum in e-commerce.

E-commerce growth continued to be driven by a substantial increase in electronic direct marketing, which helped to increase traffic to the website by over 25%.

As we look forward to the fourth quarter, we are encouraged by the early consumer response to both our core and seasonal merchandising strategies.

To date fourth quarter year-over-year sales growth in key merchandising categories is positive, and we are optimistic about our seasonal and gift gifting assortments.

We have also substantially expanded our holiday gift assortment to include a greater number of gifts for all age groups.

I would now like to talk about Pottery Barn Teen.

We are very pleased with the strong performance of Pottery Barn teens during the third quarter.

Despite a year-over-year reduction both in catalog and page circulation, the performance of the brands once again exceeded our expectations and delivered impressive year-over-year sales growth.

What was particularly encouraging is that these better than expected are results were driven by new product offerings and presentation, both of which were key initiatives for the brand as we entered the back half of the year.

From a merchandising perspective, we saw strong performance in furniture and decorative accessories, a consistently on brand presentation in addition to increased newness, drove these better than expected results.

As we look forward to the fourth quarter, we are encouraged by the initial consumer response to our seasonal merchandise assortment, and are optimistic that our focus on holiday gift giving, which we identified as a significant opportunity in 2004, will draw new customers to the brand.

During the quarter we will be substantially increasing year-over-year catalog circulation including page counts, and significantly expanding our electronic direct marketing initiatives.

We continue to believe that electronic direct marketing represents a significant opportunity for this brand long-term, as over 50% of its year-to-date revenues are being generated in the e-commerce channel.

I would now like to open the call for questions.

[OPERATOR INSTRUCTIONS] First question, Mark Friedman with Merrill Lynch.

Thank you.

Good morning everybody.

Congratulations on the quarter.

Laura, I was wondering if you could elaborate, if I remember correctly it was part of the Pottery Barn collection last year that wasn't as strong as it could be.

What have you done to improve upon that, and is there anything you can say about early response to that?

Thank you.

Thanks, Mark.

Last year we felt that our Christmas assortment, it didn't really meet our customers need for sparkle and elegance at Christmas, and this year I don't know if you've been in our stores, but we have really significantly improved our trim and ornament assortments, and we also have been very cognizant of our customers buying patterns, and put together an assortment between Halloween and Thanksgiving, that really was very relevant to what that customer was doing at that time of year, and as I said in my speech, we held Christmas longer than we did last year, and we are pleased with what we are seeing, in terms of sales.

Next question, Lauren Levitan with SG Cowen.

Thanks, good morning.

Sharon, I was hoping you could elaborate on the growth margin guidance for the fourth quarter and give us some insight into what might be driving the target there, in terms of did furniture increase or decrease as a percent of sales in the fourth quarter, what should we be thinking about, in terms of any drag from holdeverything, and what potential impact is there from Pottery Barn hopefully not marking down those holiday goods as early as they did last year.

And then separately throughout the call you commented on marketing tests and experimentation, you mentioned the Williams-Sonoma testing some newspaper, and certainly all of the brands doing more in the way of paid search and on-line partnership.

I'm wondering if you could talk longer term about what the shift might mean, in terms of overall marketing and advertising costs as a percent of sales, and what they might mean overall for what your circulation plans might be able to do up or down, to drive a similar level of sales, if you are spending more on paid search and other on line initiatives?

Thank you very much.

Lauren, I will take your gross margin question, and give an initial response on your second question regarding the tests that we are doing, and then I am going to turn it over to Pat Connolly to let him elaborate on that.

Thank you.

In our gross margin guidance for Q4, if you look at what we put out this morning in the press release, our gross margin guidance for Q4 is down in the range of 70 to 100 basis points.

This unfavorability is primarily driven by year-over-year increases in fuel surcharges and higher utility costs.

The increased cost of daily store replenishment, and the impact of the markdowns and occupancy deleverage that we are seeing in holdeverything.

Lauren, there's no big mix shift issues, the question was, is there a mix shift issue.

Furniture had a greater percent of sales, those are not the issues.

The issues that I just gave you, are what are driving that margin variance.

Okay?

On your question about these tests that we are doing from a strategy, overall strategy point of view and a cost point of view, these are tests.

And therefore, I believe that it is fair to say that it is not having a material impact on our ad cost in Q4, and we are not currently guiding any benefit or change in our strategy in our longer term guidance.

But I would like Pat to elaborate on what we are doing in this area.

So, Pat, could you please responds to Lauren's question.

Sure Sharon, Hi Lauren.

I think we are going to continue to see a substantial improvement in productivity here in the Pottery Barn brands in the fourth quarter, due to stronger merchandise assortment and also due to lower lost sales, due to a better in-stock position.

We are seeing very strong performance on the Internet, the 42% growth in the prior quarter reflects that.

It's becoming a very significant contributor to overall sales.

We see three big opportunities for us in search.

Not only improving on-site search for the customer, which is part of our new IBM platform, but also improving natural search return, and paid search.

It's a big focus for us.

We see it as a very big opportunity.

It is not a very significant part of our advertising budget now, but we think we can do in the future.

We will take our next question from David Strausser with Banc of America.

Thank you.

Could you just talk a little bit about the direct business?

You brought the guidance down a little bit, despite what was a strong third quarter.

Did you allude in the call I guess, to not having enough inventory, or something to that effect regarding Pottery Barn.

Is that the biggest issue?

Are there other issues as well?

Dave, in our guidance I would say we tweaked our guidance in Q4 slightly.

It's a big number, but when we look at that the reason that we tweaked it, is based really only on our conservative outlook on the consumer, which we believe is appropriate.

And we also believe that we are being cautious about our in-home dates on our catalog, due to concerns we have with the Postal Service right now, and the associated ground transportation constraints.

Revenue recognition is a significant issue for us, and just as we look at that we are just being cautious as we approach this.

There is no underlying message or theme, as relates to the tweaking of that number.

Thank you.

We will take our next question from Dana Telsey with Bear Stearns.

Good morning everyone.

Can you talk a little bit about new store openings?

It seems like, are there delays in new store openings this year, and what is the plan for next year?

And lastly on the in-sourcing furniture strategy, how is that going so far, and what benefit do you think it brings to margins over time?

Thank you.

Dana, I am going to take the question on the store openings, as far as the current guidance.

If you notice in our current guidance, last quarter we were at 578 stores, and at the end of this quarter we are at 570.

Four of those stores are the New Orleans stores that are closed, and are not anticipated to reopen until at least early next year.

So that's four of those stores.

Then we had some opportunistic opportunities present themselves, where we had stores that the leases were expiring, and we have made the decision generally because these stores are so small, that we are not going to renew those leases.

One of them you can see is in Palo Alto for holdeverything, so they are really just tweaked in our store guidance, and would expect of course to have bigger stores that would replaced those, not in the case of holdeverything necessarily, but in the other three stores that we are closing.

That's the store issue.

We have not given guidance yet for 2005, and we will not be giving guidance for '05 until we released Q4 earnings, when we always give our detailed guidance.

On your second question, regarding the in-sourcing of the furniture hub operations, which is where we are performing some of the services Excel was doing, I am going to let Ed speak to that.

Good morning, Dana.

We are early in this test and I think we've publicly told you what we are doing before, but the big deal for us is two-fold.

One is originally getting our hands-on the customer contact , delivery, the whole cycle that Excel did for us and we have this opportunity in our East Coast hub.

So we are going to take over, in the process of taking over, and having early good results in talking to our customers, scheduling, potentially, expanding hours both in delivery, as well as daytime, how many days we deliver.

The second big thing that we are excited about, is that in the East Coast DC we may be able to hub and service New York dense areas from store delivery, as well as to help the store delivery, as well as to the customer that would buy at the store that wanted delivery service.

So we are early on, we are really excited.

We think this is really a big plus for us in how we handle our customers, and could be an additional good deal for us, as we move through our daily store delivery, particularly in dense areas like New York.

Thank you.

We will take our next question from Jack Murphy with William Blair.

Thanks.

Two quick questions.

First on the Williams-Sonoma Home as a retail concept, I know it's early days, but could you give us some sense of what you are seeing there, and secondly I wonder if Sharon could help us think a little bit about the overall profitability, or the drag on profitability from emerging brands, and help us think about how that trajectory looks over the coming quarters?

Okay, Ed, Howard, would you like to response to do question about the performance of the Williams-Sonoma Home stores?

Yes, Sharon, of course it's early, we've only had our first store which we opened in the Los Angeles area in the design district.

It's only been open about a month and a half, about 45 days.

We are very, very pleased with the first 45 days.

I think the store itself was somewhat of an experiment, the real estate location, because it's in as I mentioned sort of a design district, which is not so much of a retail area, although it's an emerging retail area, we are very proud of the store, and pleased with the way it looks.

I think it's a unique home shopping experience, and it's off to a very good start.

So we are quite pleased with that one.

We opened two others.

One in Indianapolis in the Keystone shopping mall, and one in Cincinnati at Kenwood shopping center.

They are a little bit smaller than the store in Los Angeles.

They didn't open as strong, but we wouldn't have expected them to, because those markets are not as strong.

And we did promote the Los Angeles store heavily.

So I think we are very pleased.

They are all attractive.

They look great.

Customer response is good.

Probably too early to tell how they are really going to sustain themselves.

And what's the right real estate strategy.

Then to your question regarding the profitability of the emerging brands, we had said consistently the emerging brands in no way are anywhere close on an operating contribution basis, to our core brands.

And they are a significant drain on the pretax operating margin.

We are not giving profitability by brand, but it's fair to say that they are a significant, they are causing significant reductions to the pretax operating margin.

I think how we think to think about is, that each year we will be expanding the real estate, as they grow their margins improve because they can by minimums.

The operations of the business improves with our, as we get more sophisticated in running these bigger stores, et cetera, and I think it will be gradual and incremental over time.

That's how you should think about it.

That's how we are thinking about it, and in the case of holdeverything, that we will continue to discuss clearly the improvement in holdeverything.

It will be important to the future of the overall profitability of the emerging brands, and what we do with holdeverything long-term.

We will take our next question from Neely Tamminga with Piper Jaffray.

Thank you.

First real quick clarification on the newspaper ads, Sharon, could you give me a sense if that's inserts?

And then more strategically for holiday, it would be great if we could have Laura and Howard each comment on how the brands will be transitioning for the week after Christmas with such an emphasis on gift cards, how will you be changing maybe your product flows to capture that incremental sale, that all important week after Christmas.

Thanks.

Neely, what I would like to do is let Laura and Howard respond to the gift card question, and the holiday strategy, and then Pat Connolly will respond to your question about the newspaper advertising.

So Laura, could you please discuss gift cards, and the strategy you have with gift cards this year?

Sure.

In Pottery Barn and Pottery Barn Kids, I said we are marketing our gift cards in Safeway, and a few other supermarket chains, and we are seeing a nice consumer response to that, and expect to also see a big list based on what we are hearing from the industry, of sales of our gift cards through our retail channels.

The good news is we are seeing redemption earlier than we had several years ago.

And we think it's a big opportunity for us, in particular because in January we have historically and continued to push regular priced merchandise into all channels in the beginning of January.

We have a floor set, we of course have markdowns from Christmas that will be on the floor, but we have a very significant, very exciting regular priced flow that will be marketed in the stores in that time period, which is a big difference from other retailers who are generally really very promotional in January.

So we have a great opportunity, because we know that the stores will have those, there will be a lot of customers with gift cards and our stores will look really fresh with new merchandise on January 1, as well as having the markdowns obviously that we need to clear our Christmas merchandise.

And in Williams-Sonoma with respect to the gift cards, we are not doing anything special I don't think.

We are more focused on changing our floor visuals, and the in-store marketing for goods that are available for the gift giving season.

It's a huge time for us in Williams-Sonoma.

We are a very large supplier of gifts for Christmas and the holidays, and so we are just focusing on that.

We have a very active floor visual change program, so that we have a lot of ideas on the floor.

As I mentioned in my comments we have a lot of prewrap on the floor, various things that make it easier for our customers to be a source for Christmas giving.

And Neely, on the newspaper we are testing some Thanksgiving advertising in a partnership with Gannett, Tribune and Knight Ridder, in a number of our store markets, and looking at whether that kind of marketing around very important holidays for us, we always think with Williams-Sonoma that's a, Thanksgiving is a big holiday for us, and we will be testing that, and seeing what opportunities that might have for us in the future.

Thank you.

It's a test that we do, we want from time to time to stay on top of all the various alternatives available to us.

We will take our next question from Michael Baker with Deutsche Bank.

Hi, thanks, guys.

A quick question, just on the comp guidance, Sharon, you had said that you are being appropriately conservative, and I think that makes sense, a 3 to 5% range is very healthy.

But it is on an easier comparison, and there was an increase in the customer deposits, which in my math always typically leads comps, so is it just a case of being a little bit conservative?

In that same range on an easier comparison, or is there something else, another way to ask is, how is the pace of sales through the third quarter?

Was November as strong as earlier in the quarter, or did something happen there?

Michael, actually when you look at our retail sales guidance we did take up our retail sales guidance slightly, about $3 million, and we increased it based on the consumer response that we are seeing to seasonal merchandise, particularly in the Pottery Barn brand, so we I think in the guidance it would indicate to you a little more optimism actually in retail.

Understandably we are up against a much easier comparison but this is a very big quarter.

We are coming off of a backdrop in Q3 from an overall economic point of view.

We think it was volatile, and we think it's appropriate.

So I would tell you that the retail sales guidance was up, and we are continuing to see some variability in our sales, different shopping patterns than we expected.

We think a lot of this coming from the aftermath of the hurricanes, and people with all the things we earlier talked about, consumer concerns over utility costs, and all these types of issues are out there in the background, it's all noise.

And we want to be cautious.

So we are approaching it that way, which is no different than the way we've always approached it, but we did actually increase the retail sales guidance slightly, based on the strong trends on our seasonal right now.

Thanks.

Next question from Mark Rowen with Prudential.

Thanks, good morning.

I wanted to follow up on the direct-to-customer business.

In your guidance for the fourth quarter, Sharon, if you look at the high-end of your range, and you assume that the Internet business continues to grow at somewhat similar levels that it grew this quarter, that would suggest that the catalog business is actually going to be down year-over-year.

I was wondering if that's the case and if so what's driving that, and if that's not the case then why do you expect the Internet business to slow substantially?

My second question is you've talked a few times about paper cost increases raising the price of sending out the catalogs.

Given the postage increases in 2006, coupled with paper cost increases, I know you are not giving 2006 guidance, but can you give us a sense of how much of a problem that might be for you going forward?

Thanks.

In response to the question about our DTC revenue guidance, and our outlook on Internet, I can only, I am going to speak to basically the overall perspective we have.

We are expecting to see productivity in our catalogs.

I do think you should look back on your trends however in Internet, and look at the growth that we see year-over-year in Q4, because if you go back to last year you will notice that the growth year over year in Q4 is actually lower than other quarters.

We do a very strong catalog business, as well in Q4.

Customers shop early, as well as late, but I think you should go back and look at the numbers, because I think what you will see, is that that tends to be a lower quarter for us, not a higher quarter.

We are expecting catalog productivity to be good.

Some of the testing we've done in Williams-Sonoma and Pottery Barn, the results we are seeing we are very confident, and we are confident in this DTC guidance.

That's the question regarding that.

The ad cost increases driven right now by paper, and then the postage increase that you referred to in 2006, we are obviously mindfully aware of it.

And we do expect paper costs, and all the projections we've been giving to all of you have contemplated both of those.

We are going to have to be more productive in our circulation.

That is why we are testing this paid search strategy, and learning as much as we can about that.

Remember this quarter, Mark, that more than 50% of our DTC revenues, the second consecutive quarter, have come from the Internet.

We think that is exciting.

We think it's encouraging, but don't forget that 60% of those revenues going to the Internet, are being orders placed by customers that recently received a catalog.

So the two businesses have to work in tandem, and we are not ready to announce or to say that we are going to have a sweeping change in the way that we direct market to our customers.

We are going to have to absorb those, and continue to grow our businesses, as the consumers desire for shopping occurs.

That's how we are thinking about it.

Thank you.

Next question, Colin McGranahan with Bernstein.

Three questions, Sharon, looks like CapEx came down modestly, and the Q4 guidance about $10 million.

Other than store growth reduction, what else is being trimmed there?

Second on circulation growth, also looked modest reduction in the growth rate in the fourth quarter.

Which brands is that in?

Secondly, on SG&A leverage other than the benefits of a little bit less circulation, and fewer stores, what else is contributing to very strong leverage you are expecting in the fourth quarter?

And then third and finally, if you could comment on the new west elm stores, and any experience in the off mall location?

Okay.

Let me let Ed speak to the performance of the west elm stores, and then I will address your questions regarding capital spending and SG&A.

Ed, could you speak to the performance of the west elm stores?

Yes, I would be happy to, Sharon.

Good morning, Colin.

The west elm stores continue to perform well.

We are happy with them, we will have 13 or 14 out by the end of the year, and our locations are varied, and we are really happy with them, and I think it's too soon to have a real definitive real estate strategy.

We may have multiple real estate strategies.

So in that regard, we are really happy and our performance continues to be positive for us.

Okay.

And then on your question, first, about capital spending, the areas that we reduced capital spending is actually not new stores.

It is in e-commerce and store fixtures, and corporate facilities, so those were the areas of capital spending that changed.

In the second question you had regarding catalog circulation, we did again decrease our catalog circulation as Ed mentioned, in the holdeverything brand, so as we think about that, that's in Q4 if you look at the tweak we've made in the guidance, that's basically where we made our tweak.

And remember that catalog circulation always crosses over quarters so it's hard, we always tell you guys to look at catalog circulation a little more holistically because books always cross quarters.

On the SG&A side as you look at the Q4 guidance related to SG&A, the favorability is primarily being driven by lower employment, general overhead expenses, and catalog advertising, even though we do have the cost increases associated with paper.

As I said to Mark earlier, we are expecting catalog productivity to be better because of the issues we had last year with our inventories, in addition to our stocked consumer response to the holiday merchandise assortment, so both of those are offsetting that, so that's where we expect to see the favorability coming in Q4.

Thanks, good luck.

We will take our final question from Pauline Reader with Thomas Weisel Partners.

A question for Howard on Williams-Sonoma stores.

I guess how many of the stores, or what's the timing on when all the stores will get the full upgrade or full face lift that you gave to the Stonestown and Cherry Creek stores?

When that is going to happen, and if you compare your stores now, to those completely remodeled stores, what percentage of the way are they?

The Stonestown remodel involved, I think it was a new cutlery fixture, a new linen fixture, some significant signage changes, departmental signs that we separated out coffee from electrics, and built some focal walls, and moved the books.

We closed the store for a brief period.

That's what I mentioned in my comments, that we have six additional ones completed.

And those are doing quite well.

We are very, very pleased with those.

But it takes longer.

The mini-remodels we did, was the moving of adjacencies, some elimination, editing of some SKUs, a few things, a few signage improvements.

That we have rolled out in the bulk of the stores, or will be done in the next couple of weeks, and will have touched most of the vast majority of the stores.

But the improvement of course in that is not going to be as significant, as it is in the fuller remodel.

So those are going to take a couple of three years to work our way through probably.

Because we have to close them, and it requires planning, and a lot of manpower, and vendors, and so on.

So we are trying to come at it both ways, get as much as we can out of it in what we are calling the mini-remodels.

That we are doing quickly.

As I say mostly it will be done this year, and the others are going to take a little longer.

I don't know whether that answers your question, or not but it's kind of two different strategies that are converging.

Thanks.

That does answer my question.

Thank you.

That is all the time we have for questions today.

I would like to turn the call over to Mr. Ed Mueller for closing comments.

Thank you.

I would like to thank all of you for joining us for the Williams-Sonoma third quarter conference call.

We are very proud of the results we discussed today, and excited about the many opportunities that lie ahead for the Company, for the remainder of 2005 and beyond.

We appreciate your time, and look forward to the next quarter.

Have a great day.

This does conclude today's conference call.

We appreciate your participation.

You may disconnect at this time.