Williams-Sonoma Inc (WSM) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma, Inc.

second-quarter 2010 earnings conference call.

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

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

This conference is being recorded.

I would now like to turn the call over to Steve Nelson, Director of Investor Relations, to discuss non-GAAP measures and forward-looking statements.

Good morning.

This morning's conference call should be considered in conjunction with the press release that we issued earlier today.

Our press release in this call contain non-GAAP financial measures that exclude the impact of unusual business events.

These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons.

A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful are discussed in the press release.

The forward-looking statements included in this morning's 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, guidance, growth plans, and prospects of the Company in 2010 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 release and SEC filings for more information on these risks and uncertainties.

The Company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after this call.

I will now turn the conference call over to Laura Alber, our President and Chief Executive Officer.

Good morning and thank you for joining us.

With me today are Pat Connolly, our Chief Marketing Officer, and Sharon McCollam, our Chief Operating and Chief Financial Officer.

While many retailers saw a slowdown in consumer spending in the second quarter, we continued to see ongoing strength across all of our brands.

Innovative merchandising at compelling price points, combined with highly-targeted marketing and a superior customer experience, drove these better-than-expected results.

During the second quarter, net revenues increased 15%, and we delivered the highest second-quarter non-GAAP diluted EPS in our history at $0.31.

Throughout the quarter revenue trended at or above the high end of expectations and gross margins continued to substantially improve versus last year.

Across all brands we capitalized on the competitive strengths that are driving our business today; creativity and product and presentation, service, a best-in-class multi-channel strategy, and a world-class supply chain.

In our core brands net revenues increased 15%.

Pottery Barn saw the greatest increase followed by Pottery Barn Kids and Williams-Sonoma.

In our emerging brands, including West Elm, PBteen and Williams-Sonoma Home, net revenues increased 16%.

Initiatives, including innovative products at a great value, eMarketing and our retail clienteling program, were the key drivers of our overall better-than-expected top-line performance.

In the retail channel comparable-store sales increased 13.6%.

In the DTC channel net revenues increased 20%, including a 28% increase in eCommerce.

ECommerce is our fastest growing channel and we continue to identify new opportunities to build brand awareness and customer engagement through targeted e-mail, paid search, affiliate marketing, and mobile technologies.

All of these initiatives, combined with our catalog circulation optimization strategy, have contributed to an ongoing increase in online traffic and conversion rates, while reducing the Company's overall advertising rate by 30-basis points, despite a 70-basis points investment in eMarketing expenses.

Our capabilities in this area are advancing quickly, and while the catalog remains a very effective marketing vehicle, our eMarketing activities are finding new customers and bringing them not only to the Direct-to-Customer channel, but also to our stores.

In our international business we are pleased with the performance of our first four franchise stores in Dubai and Kuwait.

While this has little immediate financial upside, it is a strategic step toward a longer-term international growth plan.

Five additional stores are already planned for 2010 -- 2011, I'm sorry.

In supply chain we successfully completed the first phase of our east coast distribution consolidation and continued to see ongoing benefits from our hub distribution strategies.

We also saw incremental savings from our newly-introduced packaging, optimization and domestic transportation initiatives.

All these initiatives, combined with strong inventory management, drove increased gross margin dollars during the quarter.

We will, however, see an increase in inventory levels in the third and fourth quarters as we replenish the better-than-expected sales from the first half of the year.

As we look forward to the third quarter and balance of the year, we are extremely encouraged by the sales and margin trends we are seeing in our business today, particularly in the Pottery Barn and West Elm brands.

As such, we are increasing our full-year guidance for the out performance we saw in the second quarter and the upside we are currently seeing in the third quarter.

That brings our fiscal-year 2010 revenue growth to a range of 9% to 11% and our non-GAAP diluted EPS to a range of $1.63 to $1.70 versus $0.95 last year.

I will now turn the call over to Sharon for more details on the quarter and the increase in our guidance.

Thank you, Laura.

Good morning.

While growth in the home furnishings industry trended downward on a two and three-year basis during the second quarter, growth in our business continued to improve on both the top and bottom lines, and our results continued to exceed our expectations.

Net revenues during the second quarter increased 15% to $776 million, with 12% growth in the retail channel and 20% growth in the Direct-to-Customer channel.

Catalog versioning drove a 1% decline in catalog pages mailed while catalog circulation increased 1%.

Non-GAAP diluted earnings per share increased $0.26 to $0.31 versus $0.05 last year and were significantly higher than our guidance.

Stronger sales growth, aggressive cost containment initiatives, and greater full-price selling drove these better-than-expected results.

GAAP diluted earnings per share of $0.28 also exceeded our expectations, including a $0.02 charge associated with under-performing retail stores and a $0.01 charge associated with CEO retirement expenses.

Non-GAAP gross margin increased 480-basis points to 37%.

This improvement was primarily driven by sales leverage of fixed occupancy expenses, reduced markdowns, and a decrease in occupancy expense dollars.

Non-GAAP SG&A expense decreased 110-basis points to 29.8%.

This decrease was primarily driven by sales leverage of fixed expenses and a 30-basis points benefit from a gain on the sale of assets, partially offset by increased incentive compensation and internet advertising expenses.

In our segments, for which financials are now included in the press release, non-GAAP earnings before tax as a percentage of net revenues improved substantially during the quarter.

In the retail segment non-GAAP earnings before tax increased from 2.3% in 2009 to 8.6% in 2010.

This 630-basis points improvement was driven by sales leverage of fixed occupancy costs, reduced promotional activity, and improved labor productivity.

In the DTC segment non-GAAP earnings before tax increased from 15.4% to 21%.

This 560-basis points improvement was driven by the optimization of advertising spend, reduced promotional activity, and sales leverage of fixed occupancy costs.

In support of both the retail and DTC segments, non-GAAP expenses in the non-allocated segment increased from 6.3% in 2009 to 6.6% in 2010.

From a balance sheet perspective, second-quarter year-over-year high highlights were as follows.

Cash and cash equivalents increased $239 million to $404 million after repurchasing $44 million of common stock.

Merchandise inventories increased only $2 million, or 1%, to $519 million due to better-than-expected sales growth.

Prepaid expenses decreased $10 million to $42 million, primarily driven by a reduction in prepaid income taxes.

This decrease was more than offset, however, by an $18 million increase in income taxes payable due to higher earnings.

And accounts payable increased $54 million to $184 million, primarily due to the timing of merchandise receipts.

I'd now like to discuss our third-quarter and fiscal-year 2010 guidance.

Based on our strong performance throughout the second quarter and the ongoing momentum we are seeing in our business today, we are increasing our third-quarter and full-year guidance.

Net revenue growth in the third quarter is now expected to be in the range of 7% to 10% versus previous guidance of 1% to 4%, and non-GAAP diluted earnings per share is expected to be in the range of $0.26 to $0.30 versus previous guidance of $0.16 to $0.20.

As for the fourth quarter, we continue to believe there is risk in the economy and that it is prudent to wait to address the fourth quarter until our November earnings release when we have more visibility to the sustainability of current trends and a read on the consumer response to our holiday merchandise assortments.

So after we include our out performance from Q2 and reflect our revised outlook for Q3, we are increasing our 2010 full-year guidance as follows; net revenue growth is now in the range of 9% to 11%, non-GAAP diluted earnings per share is now expected to be in the range of $1.63 to $1.70, including $510 million in occupancy expense, and GAAP diluted earnings per share, including $0.11 of unusual business events, is now expected to be in the range of $1.52 to $1.59 versus $0.72 last year.

From a balance sheet perspective, we are maintaining our annual capital spending guidance of $75 million while increasing our year-end inventory guidance by $20 million to a range of $490 million to $535 million.

We are also increasing our permanent store closings this year from 18 to 22, with a corresponding unusual business events charge of $0.04.

I'd now like to turn the call over to Laura to discuss the performance of our brands.

Thank you, Sharon.

In the Williams-Sonoma brand net revenues increased a better-than-expected 6%.

Comparable store sales increased 8.3%.

From a merchandising perspective, we saw strong growth across categories, with particular strength in electrics, cookware and cooks tools.

We also saw strong consumer response to our seasonal and summer holiday assortments.

As we look forward to the third quarter and the balance of the year, we will continue to execute against those initiatives that are driving the business today, including innovative marketing strategies that bring people together around food, particularly in the areas of eCommerce, social media, and in-store events; new and exclusive product introductions; marketing relationships with several top chefs; and strategic price points and targeted promotions.

Examples of these initiatives include the launch of the Williams-Sonoma Cooks network and our newly-formed relationships with the Voltaggio Brothers from Bravo's Top Chef, and Jamie Oliver, the host of the Food Revolution.

The launch of the William-Sonoma Cooks network is a collaboration of the over 60 of the top food bloggers, whereby we furnish relative content, not just advertising.

All these initiatives are significant opportunities as we create an experience that is uniquely Williams-Sonoma.

They will drive new customers to the brand and affirm our position as the most trusted source of cooking and entertaining knowledge and products in the world.

In the Williams-Sonoma Home brand our restructuring process continued and we are successful in reducing the brand's year-over-year non-GAAP operating loss from $0.01 per diluted share in the second quarter last year to break even this year.

We were also successful in negotiating the year-end closure or rebranding of eight of our 11 stand-alone stores.

As we look forward to next year we will continue to market the brand through an online and limited store-in-store strategy with the Williams-Sonoma brand.

Remaining assets on the balance sheet at the end of the second quarter were $12 million, including $8 million of inventory.

In the Pottery Barn brand, net revenues in the second quarter increased 19%, with continuing momentum in both the Retail and Direct-to-Customer channels.

Comparable-store sales increased 17.3%.

From a merchandising perspective, all key categories, particularly furniture, textiles, and decorative accessories, delivered impressive growth.

Our artisanal product assortment, distinctive clienteling services and strong value proposition drove these better-than-expected results.

From an operational perspective during the quarter gross margin also exceeded our expectations as we continued to realize benefits from our inventory management, supply chain, and occupancy cost reduction initiatives.

We are particularly encouraged by the success of our domestic logistics, and hub distribution strategies, which are continuing to reduce our transportation, packaging, quality, and inventory management costs while at the same time enhancing the overall customer experience.

This is a significant competitive advantage for us and an important barrier to entry for potential competition.

In the Direct-to-Customer channel we are continuing to optimized catalog circulation and internet marketing, which are driving incremental growth and new customer acquisitions.

Our versioning initiatives have allowed us to profitably mail a greater number of catalogs while still reducing our overall advertising rate.

In eCommerce our new website gives us significantly better visual merchandising capabilities, optimizes natural search, and allows us to more easily integrate new technologies, which we have already begun to capitalize on in both mobile and social media.

As we look forward to the third quarter and the balance of the year, we are encouraged by the positive consumer response we are currently seeing for our fall merchandising assortment and are excited about the strategies that are currently driving our business today, including a cohesive merchandising strategy in every category; a strong value proposition, including planned category promotions; a superior customer service, offering including in-store and in-home clienteling; and a greater investment in eCommerce and eMarketing to capitalize on the strength of our internet presence.

All these initiatives are driving new customers to our brand and represent a significant opportunity to gain market share despite a potentially more challenging macro environment.

I would now like to talk about Pottery Barn Kids.

During the second quarter, net revenues increased a substantially better-than-expected 20%, including an 18.9% increase in comparable store sales and a 3% benefit from the anniversarying of a product recall impact last year.

These increases were partially offset by a 7% reduction in retail leased square footage.

From a merchandising perspective we saw strong growth across all major product categories, including textiles, gear and furniture.

We were particularly pleased with the strength of our nursery business and believe we are only beginning to see the potential of that category.

In the back half of the year we will continue to expand our marketing through social media and other online venues to introduce new mothers to the brand and promote a greatly enhanced registry experience.

In the Direct-to-Customer channel, we saw exceptionally strong performance during the quarter, particularly in eCommerce.

Our highly-targeted catalog initiatives are consistently exceeding expectations and our customer acquisition initiatives are driving significant new customer growth.

From an operational perspective during the quarter, like Pottery Barn, strong inventory management, targeted promotional strategies, and ongoing improvements in the supply chain drove a substantial increase in the year-over-year gross margin.

Retail profitability also substantially improved due to strategic store closings and reductions in our store operating expense structure.

As we look forward to the third quarter and the balance of the year, our growth strategy is to provide innovative product at a great value and superior service to our customers.

In the Retail channel today the percentage of sales being driven by in-store clienteling is continuing to climb, and we expect that number to continue to grow as we expand these services into our customers' homes.

In the Direct-to-Customer channel we will continue to leverage our new database by enhancing our ability to more precisely targe presence of children.

We will also make social community and design capabilities an intrinsic part of the online experience.

All these initiatives will attract new customers to the brand and allow us to further establish Pottery Barn Kids as the upscale retailer of children's home furnishings in a way that is casual, tasteful, appealing and easy.

I would now like to talk about the Pottery Barn teen brand.

PBteen continues to be the top performing brand in the Company, as net revenues increased a better-than-expected 22% and the brand delivered its highest second-quarter operating contribution since its launch.

From a merchandising perspective, we saw strong growth across all major product categories, as new entry price point introductions continue to be both top sellers and new customer acquisition vehicles.

During the quarter we launched a new mailer, PBdorm, to an extremely enthusiastic consumer response.

We see this business as a significant growth opportunity and will be expanding our merchandise assortment to fill what we believe is white space in this category.

As we look forward to the third quarter and the balance of the year, we will continue to drive profitable growth in this brand by introducing innovative, exclusive product at a great value, coupled with an unparalleled direct-to-consumer experience.

This brand has been built to inspire and educate our customers on creative ideas for teen spaces and the online experience is critical.

As such, PBteen will continue to be the competitive leader in creativity and functionality.

Now I would like to talk about West Elm.

The second quarter was another very strong quarter for the West Elm brand, as changes in merchandising, marketing and visual presentation continued to have an exceptional impact on both the top and bottom lines.

In both channels and all key product categories new product introductions, planned promotions, and enhanced value drove better-than-expected results.

Furniture and textiles saw particularly strong growth during the quarter.

As we look forward to the third quarter and the balance of the year, there are several strategic and tactical initiatives that we believe will continue to meaningfully accelerate the growth and profitability of the brand.

Many of these initiatives are under way and include remixing our assortment and expanding the aesthetic to appeal to a wider range of customers including significantly expanding our holiday gift assortment and collaborating with emerging artists; enhancing customer engagement through worm and inviting multi-channel lifestyle marketing; increasing the penetration of opening price points to offer a compelling value proposition to the customer; and expanding the non-furniture assortment to rebalance the product mix.

We will also continue to rationalize our retail footprint by closing unprofitable stores, including three this year, and opening new stores in great opportunistic locations when we attain sustained retail performance.

All these initiatives are improving our competitive positioning and allowing us to profitably grow the West Elm brand.

I would now like to open the call for questions.

Thank you.

(Operator Instructions).

Our first question will come from Budd Bugatch with Raymond James.

Congratulations on the quarter, Sharon, Laura, Pat, excellent performance.

I guess my question relates to -- I'm just trying to make sure I understand the SG&A difference from what we were looking for and I think, Sharon, you said that there was 30-basis points less SG&A for advertising and 70-basis points for eMarketing.

Maybe if you could go over that and if I missed it perhaps you can help me elucidate where the difference is -- key difference is to original expectations in SG&A and what you came in at?

Absolutely.

From -- versus our guidance and we're talking versus guidance, Budd?

Okay.

No, that's my question to you.

Yes, that'd be fine.

Okay.

Versus the guidance on the SG&A, it was several areas.

We are continuing to see exceptional performance in labor productivity in our stores and our distribution centers, so from a labor component point of view we exceeded our guidance, or our SG&A was lower.

Secondly, the productivity of the catalogs we are mailing are also continuing to exceed our expectations and the shift in investment from catalog circulation to paid search is proving to be highly profitable for us, so that was the other area where we saw significant benefit during the quarter.

And those would be the two key drivers of the benefit.

I also just have to point out that there was also in the SG&A, and we quantified it, which was a 30-basis point benefit from the gain on the sale of assets, which was a land sale that we did, and that was 30-basis points of it, which was unanticipated at the time we gave our guidance.

Our next question will come from Colin McGranahan with Bernstein.

Good morning.

Just wanted to follow up on gross margin here.

You continue to show some pretty impressive gains in the quarter, can you give us a sense of where you were on full-price sell through and then maybe what the average markdown was in the quarter and then how that compared to maybe a year ago?

Absolutely, Colin.

From a gross margin point of view, as we've consistently said, we're not giving specific numbers on percentage of full-price selling versus markdowns, but one of the key contributors to the improvement in the markdown -- or in the margin was reduced markdown activity.

We're continuing to make progress there, but if you go back and you look at our history, even in Q2, we still have -- versus our historical numbers we still have opportunity to continue to improve in that area.

It's like Q1, where we're getting back near our historical selling margins but still there is more promotion in the business.

We recognize that.

We think it is appropriate based on the economic environment, but there's still room in the selling margin to continue to enhance going forward.

Our next question will come from Matt Nemer with Wells Fargo Securities.

Good morning, this is actually Trisha in more Matt.

Just a question on the SG&A guidance.

When you look back at the typical sequential progression from 2Q to 3Q, you typically see an uptick in revenue, gross profit, and operating income, but even at the top end of your SG&A guidance range in 3Q it implies a sequential downtick in operating income and EPS from 2Q to 3Q.

Is there anything particularly unique about this year that would cause you to stray from that historical pattern?

There's a couple things.

One would be the weighting in Q3 and Q4 of incentive compensation based on the way that our earnings play out during the year.

The second thing that we are -- it's deliberate on our part, within the guidance I think we have consistently said all year we're going to continue to be conservative and cautious, and we have put cushions in there in both the SG&A from an investment and catalog circulation.

We believe this is a market in which we can seize share, and we have some money within the guidance with which to continue to accelerate our prospecting and other activities to drive new customers to the brand.

So within the guidance we have included investment for that as we go into the back half.

We also have put additional payroll into the stores within the guidance.

We think that there is tremendous opportunity there.

Although the stores are doing a phenomenal job currently leveraging that, we -- as we go into the back half we are, again, making sure that the guidance does include what's possible, and that's what's possible.

So those are the reasons why you might be seeing that versus Q2.

That would be true, by the way, in Q3 and Q4 because you guys can back into a Q4 scenario and we know that, so those same explanations would pertain to Q4, as well.

Our next question comes from Joe Feldman with Telsey Advisory Group.

Hi, guys, congratulations on the quarter.

So I wanted to ask about the type of customer you're seeing in the store.

Are you guys seeing increased spending from existing customers?

Are you starting to see more new customers?

Anything you can share about the type of income level, like are your more affluent customers the ones that are driving the sales, or is it broad based?

Maybe just some thoughts--?

Pat, would you take that, please?

Joe, we see it as pretty broad based, and we're very pleased with the new customer acquisition that we're seeing this year.

In a few cases our average order is down slightly, and that's purposeful on the part of the merchants to drive repeat purchases and those initiatives are paying off.

Our next question comes from David Magee with SunTrust Robinson and Humphrey.

Thank you.

Good morning and congratulations.

Thank you.

As you look to 2011 seeing that 82% of your DTC business is now online, if you just could sort of boil down to the most effective way you think to grow that customer base going forward, what would it be next year, do you think?

Pat, would you like to talk about our initiatives for 2011?

David, I think it's a continuation of the same.

We have been working hard, as you know, on a whole variety of eMarketing initiatives, and coupled with the implementation of our customer data warehouse we're able to really know a lot more about our customer and send more relevant marketing messages to them.

And we think that the core eCommerce business will continue to grow and we see opportunities to enhance our merchandising strategy on the Internet and expand our offerings there.

Our next question comes from Scot Ciccarelli with RBC Capital Markets.

Hey, guys, Scot Ciccarelli.

The federal housing tax credit obviously had a pretty positive impact on housing sales and I would assume pretty much across the housing-related spectrum.

Do you guys have any color or perspective on how that tax credit may have impacted your business in the first half?

From a -- Scot, we've looked at this, and the only measure that we can really use is looking at data that we purchase to find customers who are moving, so it's our new mailer program.

And we looked at it and while it is volatile the number of new customers that we were able to identify that we could mail catalogs to and offers to was up and down on average.

We did not see any kind of robust increase in the number of customers that we were able to mail over time.

Obviously when you look at our business and the fact that on a two and three-year basis we are accelerating, clearly the loss of the credit has not seemed to affect us.

I still believe that that credit was in a demographic -- the majority of that credit was in a demographic that is likely not our customer, so I do think that that could be part of the reason why -- where you would see some other retailers -- and we all know who those would be -- that would greatly benefit from that.

We cannot correlate to our performance a direct impact of the credit on the things that we can measure, so it is hard for us to say.

Do we think it was no benefit, of course not.

Any kind of stimulus for housing has to benefit us and some people in our demographic certainly took advantage, but it wasn't something that we could consider a key driver of our business.

Our next question comes from Alan Rifkin with Banc of America-Merrill Lynch.

Yes, thank you very much.

I realize somewhat hesitancy to give greater guidance on the upcoming holiday season, but with it fast approaching it looks like on a sequential basis you're looking for comps to be in the 1% to 4% range with inventory levels up 5% to 15%.

Can you maybe just provide a little bit more color as to where you see things in the holiday season with respect to full-price sell through and how many new SKUs will there be in the assortment year over year?

I'm going to let -- Laura, would you speak to the fourth-quarter merchandising strategy?

Sure.

Remember, we had a strong holiday season last year, and we've really -- it's when last year we really started to see our customer respond to the new initiatives we had put in place, and so as we look at this year, we have built on those -- on that foundation every brand that worked last year and there's a lot of new product introductions in all of our brands.

The biggest expansion is in West Elm because they've had the smallest Christmas assortment of all the brands in the past, and we've really built amazing gifts and entertaining assortment for this Christmas.

But all of our brands have a wonderful seasonal offer, and we're really in the thick of relooking at everything and making sure that the prices are the right prices for our consumers, that we have special customer programs to really inspire our customers and help them shop in the season.

And we're very mindful that people are still extremely careful with their money and so we're not taking anything for granted.

We're looking at how do we give them a better product, a better price and the best service in the mall, and that -- so we're very excited about our strategy for Christmas.

It's really the environment that puts caution on the numbers and to say that we don't want to get ahead of ourselves.

We don't want to take anything for granted and we're just -- we're staying very focused on the customer.

You also, Alan, have to remember the timing of the introduction of entry price points into the Pottery Barn Kids and Pottery Barn Teen brands.

Last year, if you recall from the comments we made in the fourth quarter, in Pottery Barn Kids they had only rolled out approximately 50% of the strategies that they were looking for as it related to the entry price point value proposition for the Pottery Barn Kids customer.

In Teen we had not even undertaken that initiative.

So one of the things that we are very excited about while have not played into the guidance clearly -- you guys know our Q4 guidance is conservative -- but this year what we have the benefit of is in Pottery Barn Kids we have the other half of that entry price point rollout, which has been proving to drive our business, both in Q2 and as we're coming into Q3.

When Teen followed Kids and launched that, we saw an immediate consumer response to that strategy in Pottery Barn Teen, and they are also taking into that -- account that strategy in West Elm, and that would be new for West Elm coming into Q4.

While still small in West Elm, it is just beginning.

So all of those are opportunities for us in Q4 that were not there last year.

And I am going to let Pat -- because I think that it's such an important discussion, I'm going to let Pat talk about some of the things that we are doing in eMarketing and in eCommerce that we were not doing in Q4 last year that we believe are also going to be big drivers of our business.

So, Pat, could you talk a little bit about those initiatives, as well?

We continue to see strength in the growth of eCommerce from a number of things that we've worked on over the past year, and that's really much more targeted e-mailing.

We've been able to substantially increase the percentage of our e-mails that are specifically targeted on information we know about their customers and what they've done and this is also extended to what we're doing in our retail stores where we're now collecting almost 60% of our customers' e-mail addresses at the time of purchase.

We've seen great success from our versioning strategies and we'll continue to roll those out.

We've expanded our display advertising.

We do not buy run-of-site advertising anywhere.

It's all targeted and based on information that we have that would say these offers are going to respond, and so we think we're going to be very present in the consumer's mind come this holiday season.

Our next question comes from Chris Horvers with JPMorgan.

Thanks and good morning.

On the gross margin it seems like occupancy helped maybe 290-basis points here in the second quarter and maybe want to speak to the selling margins but maybe you could talk to -- on the supply chain and on returns, replacements and damages qualitatively what kind of seeing -- lift you're seeing there and where you are in that process and when you expect basically completion of the aspects that you're working on right now?

We continued to see benefit in the returns-replacements categories in Q2 and our -- as Laura mentioned in her prepared remarks, we are -- we have several initiatives, new initiatives that are on the table right now that we believe are going to drive incremental benefit.

We talked about from 2005 to 2009 the 140-basis points of benefit that we had derived from supply chain.

As you know, in Q1 we quantified another 30 to 40-basis points and again this quarter we're seeing similar performance and expect to in the back half of the year.

But I'm going to let Laura talk about some of the things that we're doing in the supply chain right now because we -- while these are all very interesting and it seems like a lot, we have significant new benefits that are coming down the pipe that, Laura, could you talk about?

Sure.

We will continue to push on damage free, and we still have areas where, whether it is a new product or a -- we -- shipping through our hub system where we see opportunity to reduce damages.

And we are looking at how do we do things differently, how do we touch furniture less, how do we ensure that as we engineer and design products we're building quality in, and not just on the first shipment but -- so that when the customer takes into their home and lives with it that they don't have any issues one year, two years from purchase.

And given the complexity of our product offer, everything from a candle to a couch, we have a lot of areas that we're not satisfied with still in terms of our damage rates on our product categories.

We are making substantial improvement, but that will continue to be a focus and you'll continue to see improved results there.

We also know how important the service into the home is on some of the large products and we continue to increase that service and are trying some new things, including doing it ourselves in some cases, to really provide a superior customer experience.

And again, from New York City to Iowa very different delivery environments.

So those are some of the key opportunities that we see and are working on.

And then, of course, there's getting profitably back to shelf, or profitably selling off anything that isn't perfect through our outlets and also through liquidation, and that is an area, too, that we are continuing to find opportunity in.

The last thing that we've consistently talked about is the fact that we have moved into the first phase of our consolidated East Coast distribution facility.

We talked about this initiative in prior quarters, and we will be moving from a -- several buildings on the East Coast into one large building, which has tremendous efficiencies associated with it, so we are doing that gradually and incrementally as our leases expire in our current facilities.

But we already have made the first move into the facility, we're up and running in the facility.

We quantified the benefit of this once we're all in at about $8 million a year, and we absolutely, based on the early reads on what we're doing today, can confirm that we believe we'll see those benefits and then some, most likely.

And so that is another initiative, while not for 2010 and only a portion of 2011 but in 2012 that's going to be another substantial opportunity for us.

And we'll continue to engineer these facilities and our distribution supply chain with those types of objectives in mind, and we do see further opportunity in that area, as well.

Thank you, Sharon.

Just last on that, less touch is less damage, so that is another -- that is in addition to the efficiency really the superior product quality that we want to get to our customers is at the forefront of this strategy.

Our next question comes from Neely Tamminga with Piper Jaffray.

Oh, great, good morning.

Just a couple -- or one main question here.

The mini mailers that have been coming out on back-to-school for kids, as well as the halloween, Laura, do you see that -- I mean, is that incremental to last year in terms of doing those little very targeted mini mailers and then maybe a read as to how those are doing and then could we see that for holiday?

Is that a new strategy?

Thanks.

Laura?

Sure.

The mailers are -- we're very excited about the mailers.

The mailers really help us create dominance in categories that we are really proud of, and they're really efficient.

They're not -- people can receive them and it's a smaller format, so obviously it's cheaper and it's easier to digest for the customer.

And so we're able to actually increase our total circulation in some cases because they're more efficient and targeted versus mailing a big book that is broader, and we just think creatively they're very inspiring, they give a lot of information to the customers.

They drive traffic to the website, they drive traffic to the stores, and you will continue to see us try them in different categories.

I would add, Neely, that it's the combination of great merchandising, well presented, plus incredible data from our customer data warehouse because that Kids mailer went to households where we know there were children three-to-seven years old.

Our next question is from Brad Thomas with KeyBanc Capital Markets.

Thanks.

Good morning, and let me add my congratulations, as well, on really another great quarter here.

Thank you.

Given some of your commentary around the macro backdrop and some of the softening that we may have seen in consumer spending over the last few months, the slightly more negative view on housing that we may have over the next year or so, could you guys just talk a little bit more about how you balance capitalizing all of the success that you really had over the last year versus maintaining some level of caution, especially in the context of inventory growth and expanded holiday assortment and increased payroll?

Absolutely.

Let me just start by reiterating something that I said earlier which is, despite the home furnishings industry trending downward, both a two-year and a three-year basis during the second quarter, our business on the other side of that did improve and accelerate and we absolutely believe that that is coming from the gaining of market share.

We believe we're gaining share from, first and foremost, the loss of competition.

There was absolutely positively during the 2008 to end of 2009 period of time a loss of competition and I don't -- I'm not going to spend time on the call so we can get more questions today on other topics.

We all know what that competition looked like, whether it was closing stores in the Smith & Hawkin businesses, completely shutting it down on both the direct and the retail sides, or it was the Gallery closing stores or it was these independents on every street that we all drive on leaving the market period, we know we're gaining share.

The other thing that we have that is an enormous benefit to us is that, just as the recession was ending, 2009 was a break-through year for us, both from our database point of view, the taradata database, and we also at the end of the year, as Laura mentioned earlier, launched an entirely new eCommerce platform that took us -- that made us leaps and bounds ahead of the competition from a capabilities point of view combined with the database.

So we believe that these are key drivers to our outperformance to the economy, yet we are absolutely cognizant of what is going on around us and it is a key topic in every meeting we have.

I'm going to turn it over now to Laura to talk about how from the brands point of view they are balancing this because it is a difficult thing to balance but we seem to be being able to do it very well.

So, Laura, could you speak to what you guys are doing from the brand point of view?

Sure.

I'll just first start by saying that the results you were seeing are a lot of work from a lot of people for the past two years.

It's the culmination of all this work that started and know we did -- and you heard those early calls where we went through and said we're looking at everything; every single piece of our product, our departments by brand and supply chain and what we were doing and our eCommerce and multi-channel marketing strategies and cutting costs that didn't affect the consumer and investing where it did.

And so the results you're seeing are the culmination of that, and certainly we are clearly taking share from people who aren't -- and I don't -- who aren't doing as well or who didn't get as focused as early as we did.

And so we set up a pretty firm foundation, we believe, to weather this storm, and have proven that we can flex our inventories.

We showed you that as we saw the drop and you're seeing it on the uptick now and this conversation of how much inventory is alive and well here because we are running quite short in a lot of cases in inventory right now.

And if you call our care centers and try to order some things you'll see that our back orders are higher than we'd like in some categories.

We're chasing some best sellers.

At the same time we're cognizant that we don't want to get too far ahead of ourselves.

So they're placing -- they're doing it in very competitive ways so that there is flexibility.

I've said before our vendors are -- we have amazing vendor partners who help us with this flexibility and such a strong sourcing team around the world that sets us up for success, and so we're investing in the core.

We know that as we start the fall season we can see some clear best sellers that will carry through Christmas, and we know how to plan the escalation, and we know then what happens in January.

So there is a large portion of our business that is core and more easy to predict.

And then on the seasonal things, we're making the investments where we love the product and where we know that the price is better than anyone else in the market.

So that is the approach we're taking because, you're right, as much as there's opportunity there is risk and we have to balance both.

Our next question comes from Kate McShane with Citi Investment Research.

Yes, good morning.

This is actually (inaudible) sitting in for Kate this morning.

I believe in previous comments you had said that you were going to do some small share buybacks to offset some of the option activity while at the same time being conservative with your cash.

Is that still the case and can you just talk a little bit about your plans for use of cash?

Absolutely.

We did during the quarter repurchase $44 million of our stock.

We had a $60 million authorization.

I think the best indication of what we're planning on doing, obviously, was the press release we put out when we launched the share repurchase program.

At a minimum it is the Board's intention to repurchase dilution.

If you go back and you look at the current share count, or you look at the current share count, you look at where we were at the end of the last year, there is still shares to be purchased if we're going to offset dilution, so we'll continue to manage that and continue to move forward with that objective in mind.

We also will consistently take a look at where the cash balance is and other vehicles of returning cash to our shareholders.

It's important that we all say that the first and foremost use of cash in the Company is going to be growth.

Obviously we're demonstrating that we can get the growth and so we'll invest there first.

But there is a limit to what we see there, so we also want to just reiterate that we do think it is important in this environment after the last question on the call, about -- or the observation about the risk in the economic environment we do want to make sure we're carrying a healthy level of cash on the balance sheet to keep any dependence off the capital markets.

That's a consistent point of view here at Williams-Sonoma.

But clearly, based on this new guidance and these new numbers, the cash flow is significant and we will continue to return cash to our shareholders as we see fit going forward.

Our next question comes from Laura Champine with Cowen and Company.

Good morning, guys.

I'm just thinking that you probably have a pretty good idea of square footage growth for next year, is there anything on that front that you'd be willing to share about your retail segment?

Actually, I would say that we haven't given guidance and we certainly are continuing to work on the plan, but I believe that square footage -- we said this when we went into all of this, I would suspect that flat would be the best case next year because we do have some store closings on the list for next year, and then, of course, those would be offset about whatever we do that's new.

When we think about new square footage, Laura, why don't you speak to that as it relates to West Elm and some of the things you're thinking about over the next couple of years?

Sure.

I said in my prepared remarks we are very pleased with our West Elm performance.

We want to see it be sustained, we want to see where it can land and be sure that we understand it.

But we do see opportunity to add stores in West Elm, and we are looking currently at where there is great real estate and opportunity to do so.

And so we found a few different opportunities now, and we'll continue to look for them, and really continue to very carefully measure the performance to be sure that we drive profitable growth in West Elm.

And then in the core brands, of course, we'll continue to look for opportunistic real estate in markets where we believe there is opportunity.

But we -- as we just had two questions now and we've had to refer to the economic environment, we are going to continue to be cautious here.

The other thing is that we are seeing such tremendous opportunity in our direct business.

As we look at our business going forward, we see a shift from the percentage of our revenue that is driven by retail and the direct channel.

This is not because as a Company we have decided that's where we need to go.

This is where the consumer is going.

If you look at any market data right now in any of the research on consumer behavior patterns, the multi-channel strategy is what is going to drive the best retailers.

So we believe that we will -- while we may not be opening stores, Laura, that we absolutely expect that we will be picking up that share and picking up the improvements that occur in the economy from a direct point of view.

So e -- I want to make sure that as we think about our business that we don't obsess on lease square footage because our -- we have some tremendous growth opportunity coming from the direct channel.

Next we'll go to Brian Nagel with Oppenheimer.

Thank you, good morning.

Congrats on a nice quarter.

Thank you.

I wanted to just dig a little bit deeper into demand trends and the question I have, clearly the market right now is quite concerned with the outlook for the consumer over the next few quarters, several quarters, as evidenced by you guys putting up a great quarter and your stock actually trading lower this morning.

The question -- so Williams-Sonoma is, as far as I'm concerned, one of the best companies that understand their consumer mining through the data as provided through your website or your catalogs.

The question I have for you is, as you look at the data -- we obviously have all the published numbers in your press release, but as you look at the real trends in your business, what are the leading indicators you see so to say (inaudible - audio difficulties)?

The leading indicators.

We've had actually external consulting done on this very topic, and basically what -- like many businesses, our business is trading on several things.

It is -- or can be correlated to several things.

It can be correlated to consumer confidence, it can be correlated to unemployment in our demographic, it can be correlated to housing.

So when you look at those three you would say, well, obviously there is definitely trepidation from an economic point of view, and we don't have to guess whether that exists or not because we all can look at the NAIC government, home furnishings -- home furniture and home furnishings numbers and see the exact thing that you're talking about.

The issue for us is that our numbers don't look like that.

Actually, on a two-year comp basis, if you want to take it progressive through the second quarter, we actually, on a two-year basis, improved every month during the quarter and when you look at the home furnishings number even on a three-year basis it was very close.

So it -- what trends they are seeing -- what we have to focus on here, and what we are focused on here is gaining market share.

Doing what we do better than anyone else does it, and the service initiatives that Laura has built into all of the brands, the creativity that is being motivated within the organization, the strategies as it relates to everything about the customer, that's Laura's philosophy.

Whatever we do it has to be benefiting the customer because that is what the customer is looking for and what's going to happen to us versus others.

So I believe that those strategies, which the entire organization is executing against, are what are making the difference for us and will continue to make the difference for us as you look at us in Q3 and Q4.

Our next question comes from Matt McGinley with ISI Group.

Good morning.

I have a quick question on your DTC segment.

I notice that in the guidance you gave you had a slight uptick in the amount of catalog shipments you have planned in the back half versus pre -- versus what you had previous in the year -- previously in the year.

I noticed your stated intention you want to move over to more Internet acquisitions so why would there be an increase in catalog spend given you want more Internet acquisition?

Laura, do you want to talk to catalog circulation, please?

Sure.

We continue to look at where we have opportunity to mail our customers profitably, and these new versions that we've been working with are giving us a new leg of opportunity in circulation, and very profitably so, that we didn't have -- if you look at last year, we didn't have that plan built out as robustly, so that, coupled with the West Elm success, is really explaining some of that that you're seeing in the numbers.

Our next question is from Michael Lasser with Barclays Capital.

Good morning, thanks a lot for taking my question.

Can you talk about how the demographic for each of the concepts -- the composition of the demographic for each concept has evolved over the last couple of years.

I imagine you lost some aspirational customers in at least a few of the brands during the downturn and is it your sense that those aspirational customers are coming back, or is it that some of the higher-end customers are spending a little bit more, and where do you think the demographic from a socioeconomic perspective stands right now?

Thanks.

We've done an extensive amount of work on this and Laura has spent an enormous amount of time and I'm going to turn this over to Laura.

Sure.

As we look at -- we study our demographics but we also are looking at psychographics and we're saying, and who don't we have and how can be include them and what are they looking for.

And we can see across because we can study our health style performance and our -- all our segment performance that we're seeing improvement with our best customers, we're seeing improvement -- we have new customers coming into the brand at a very strong rate.

So we really believe we're getting our customers back, we're inspiring them to -- even though they're not buying a new house to renovate their house or buy new towels that they didn't buy for the last two years and they're looking at those things and thinking that they need to upgrade and refresh some of the things in their homes.

So we're seeing it across the board.

I do believe that, particularly in the case of Pottery Barn, where the focus has been on aspirational artisanal products at great compelling price points that we're picking up share from the higher end, because the consumer is realizing that great design does not need to be expensive and they know that our quality is better than anyone else's.

So they're coming to us, whereas before they may not have shopped with us.

They might have gone to another higher-end retailer or they may have gone to the decorator trade.

We're seeing those people in and we're also seeing, as I said, new customers at the lower end of the spectrum and demographics in an income come into, particularly in the West Elm brand.

And just last, in Williams-Sonoma we're very cognizant of keeping the brand very relevant to both the current, very extremely loyal customers, but also raising the awareness among younger customers.

And so you'll see us work with both Thomas Keller and the Voltaggio Brothers.

What they have in common is they're great chefs, but they appeal to slightly different customer bases, and we believe that -- we want to be where the conversation is happening around food, we want to be the resource to help decorate your home, and we think that we're doing probably a better job than most out there and that's why they're coming to us.

Michael, we're seeing improved response and performance across virtually every segment of our house file, in every brand, in both our active and inactive customers and also we're seeing in some of our brands an higher average order among new customers, which we think is very encouraging.

Next we'll go to Jennifer Milan with Sterne, Agee.

Hi, thank you.

I was wondering if you could at all quantify the new customer acquisition rates as I think you have on past calls?

And also just any changes that you may notice in the way that consumers are shopping.

I know you mentioned that there's definitely a shift to online spending that we have been seeing pretty broadly across retail, but are you able to analyze at all the number of customers that are shopping online before coming into the stores, or kind of the crossover that you're seeing?

Pat, would you like to talk about what's happening in the direct channel?

Sure.

I think you raise a great question.

The number of people who research online before going offline, that -- the dollars that are influenced offline by online media is actually larger, much larger than eCommerce, and we think that's the reason the multi-channel strategy is playing so well.

And so all of our -- we've talked about eCommerce, but at the same time the Internet and our eMarketing efforts are driving sales to both channels.

At this time I would like to turn the call back over it Laura Alber for final and closing remarks.

Thank you for joining us for the Williams-Sonoma second-quarter fiscal 2010 earnings conference call.

We very much appreciate your time and continued support and we look forward to talking to you next quarter.

Have a great day.

Once again that does conclude today's call.

Thank you for your participation and have a wonderful day.