Williams-Sonoma Inc (WSM) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Williams-Sonoma Inc.

second quarter 2012 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.

(Operator Instructions)

This conference is being recorded.

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

Good afternoon.

This afternoon's call should be considered in conjunction with the press releases that we issued earlier today.

Our earnings press release and 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 Exhibit 1 and elsewhere in the earnings release.

The forward-looking statements included in this afternoon'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, trends, guidance, growth plans, and prospects of the Company in 2012 and beyond, and are subject to 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 the most recent 10-Q 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 the date of this call.

I will now turn the conference call over to Laura Alber, our President and Chief Executive Officer, to discuss our second quarter 2012 results and our outlook for Q3 and fiscal year 2012.

Thank you, Steve.

Good afternoon, and thank you all for joining us at our new time.

On the call today are Pat Connolly, our Chief Marketing Officer, and Julie Whalen, our newly appointed Chief Financial Officer.

I couldn't be more pleased to have Julie in her official role for this call.

It's such an important appointment for us, and Julie brings a wealth of internal experience and has been an incredible partner to me.

I know many of you have met her and have sent me very complimentary notes, and I look forward to all of you getting to know her better and to many years of success with her as our CFO.

Today we'll be discussing our second quarter 2012 results and our outlook for the third quarter and fiscal year.

During the quarter, we delivered strong performance in revenues, operating margins, and earnings per share.

Diluted earnings per share grew 16% on net revenue growth of 7%, with comparable brand revenue growth accelerating from 5.4% in Q1 to 7.4% in Q2.

Also during the quarter, e-commerce net revenues increased 14%.

Most importantly, we drove this growth in revenue and earnings while simultaneously investing in our long-term growth initiatives.

All brands contributed to these results.

Pottery Barn and West Elm again performed very well during the quarter.

Pottery Barn Kids and Pottery Barn Teens both posted year over year increases, and Williams-Sonoma improved its revenue trend versus the prior quarter.

This performance demonstrates to us that the strategies we are executing in each of our brands are working.

As we outlined in the beginning of the year, our growth long-term is going to come from three areas -- growing our core brands, new brands, and global expansion.

Foundational to our growth strategies are e-commerce and supply chain, and we continue to make investments in both to improve customer service and quality.

In e-commerce, we implemented enhancements that further improved the shopping experience.

We improved site navigation to accommodate our growing product assortment, making it easier for our customers to find and buy.

Data and algorithmically driven product recommendations which we began implementing last fall are having a measurable impact on increasing revenue per visitor.

In e-marketing, our focus on relevance in all of our marketing streams contributed to increases in advertising productivity.

In supply chain we continue to be focused on improving the customer experience while reducing costs, and this quarter we made progress against that initiative.

And now let's talk about our core brands.

In the Williams-Sonoma brand, comparable brand revenues decreased 0.4%.

We are pleased with the progress we are beginning to see in the Williams-Sonoma brand as we execute the transformational strategies we have previously outlined for you.

In addition to the improvement in revenue trends, we also saw substantial improvement in our selling margins on a sequential basis, and our product margins were up on a year over year.

This is a very encouraging trend.

It demonstrates that we can drive sales while at the same time improving our selling margins in this brand.

On the product front, we are meeting our internal targets for increasing our ratio of exclusive products, and we are improving our marketing and customer engagement.

In the second quarter in the areas where we have the highest percent of exclusive products, electrics, tabletop, and agrarian, we had strong increases.

As we introduce more innovative and exclusive products across all categories, we expect to see gradual and incremental improvement.

One example that we can tell you about today is the new Verismo System by Starbucks.

The first at-home, premium single-cup machine that makes espresso, brewed coffee, and lattes all in one, and meets Starbucks commitment to taste and quality.

Williams-Sonoma will be the first retailer to launch the platform and we will carry our own exclusive premium model.

We will also be selling Starbucks espresso, coffee, and milk pods in our stores and online for easy access and replenishment.

The availability of Starbucks Verismo pods combined with this versatile machine will appeal to our customers desire to create an authentic Starbucks cafe experience in their home.

This is but one example of a series of product launches that we'll be introducing during the balance of the year, and we look forward to sharing these product introductions with you.

In addition to exclusive product debuts, we are increasing our seasonal assortment.

For example, based on last year's success with Halloween, we'll be carrying 50% increase in Halloween related SKUs and giving it dominant marketing in stores and online.

On the marketing front in Q2, we made several enhancements to our catalog, website, and in-store displays, executing on our strategy to develop a differentiated and powerful voice across all channels.

We will continue to refine our marketing, maximizing the unique potential of each channel to deliver consistent and compelling narratives around our products, our categories, and our authority as the leader in cooking and entertaining.

In support of our strategic initiative to improve overall customer experience and further differentiate the brand, we are focusing at retail on our selling culture and the engagement of our retail associates.

In Q2, we made significant progress in rolling out our clienteling initiative and associate training programs designed to elevate the product and culinary expertise for all associates.

Our clienteling initiatives, underway in the Pottery Barn brand, is a significant part of our current success.

Overall, we believe that clienteling can have a similar impact in the Williams-Sonoma brand and we are just getting started.

We are pleased with the progress in the Williams-Sonoma brand and look forward to updating you on the brand's progress.

I would now like to talk about Pottery Barn.

In the Pottery Barn brand, comparable brand revenues increased 12% and accelerated from the first quarter.

The brand continues to deliver a dynamic and comprehensive assortment that inspires customers, bringing decorating and entertaining together with great value in new ways.

From a merchandising perspective, all key categories in putting furniture, textiles, accessories, and tabletop delivered strong growth during the quarter.

As we enter the third quarter, we are pleased with the response to our fall assortment.

Customers are positively responding to our new Rustic Luxe collection and our Furniture business is strong.

In Q3 and beyond, we'll continue to create new experiences for our customers to make decorating easy, fast, fun, and affordable through engaging in-store events, clienteling, and complementary in home design services.

We are also focused on enhancing our website to make it the broadest expression of the brand, blending commerce and content to deliver a rich inspirational and motivational shopping experience.

Executing on these commitments will delight existing customers, attract new customers to the brand, and allow us to capture significant additional market share.

In the Pottery Barn Kids brand, comparable brand revenues increased 4% on top of 8% last year, with all key categories including furniture, textiles, and decorative accessories contributing to this performance.

Growth was also driven by strong consumer response to our expanded baby offering and registry, which are key initiatives of Pottery Barn Kids this year.

Furniture was the strongest driver of the comparable brand revenue growth, reflecting improved in-stock positions and successful new product introductions.

We are excited about the third quarter and the launch of our fall assortment.

Demand has exceeded expectations for our new back-to-school gear collections, which include innovative products designed to support healthy eating for kids at lunch time.

Customers have also been responding well to our textiles and we expect to see continued growth in baby.

We are confident in our strategies for the remainder of the year.

Next I would like to talk about Pottery Barn Teen.

PBteen comparable brand revenues were a positive 0.8% on the quarter on top of last year's 20% growth, and PBteen demand has shown steady improvement from Q1.

We had strong consumer response to our textiles, which ran double digit comps, lead by our dorm initiative and early response to our fall collections.

The furniture category saw improvement in the latter part of the quarter, as the brand began to improve its inventory position in key collections.

These positive results in textiles and furniture were partially offset by softness in decorative accessories.

In Q3, we have a series of exciting product launches.

My favorite is our exclusive launch with Burton.

As you probably know, Burton is the world's leading snowboard company.

They own this market, and we work with Jake Burton to design the line of home furnishings exclusively for PBteen that includes textiles and decorative accessories.

It's a great collection, and we believe this collection will attract new customers to the brand and support the growth of our Business.

Lastly, I'd like to talk about West Elm.

West Elm delivered a 16% comparable brand revenue increase on top of 29% last year, driven by double-digit growth in textiles, furniture, decorative accessories, and lighting.

We continue to drive new levels of profitability in this brand.

This quarter, we refined our promotional strategy in store which lead to higher margins in our retail channel, and we are seeing strong results in the direct channel through expanded assortments and compelling marketing messages.

As we look forward to Q3 and Q4, we are going to expand our product lines and increase engagement with all of our customers in all channels with a particular emphasis on seasonal and gift giving.

We have been aggressively seeking retail expansion opportunities.

We opened one store in the second quarter and we will open an additional five stores in the third quarter.

Overall, we continue to execute on our multi-brand, multi-channel model, driven by dynamic, direct, and digital marketing and outstanding customer service that we believe is a superior platform for retailing home furnishing.

This combined with our innovative and proprietary products are all powerful differentiators.

We are focused on elevating our performance in all areas and we are investing in the future to reach our goal of growing this to a $1 billion brand.

Before I pass it to Julie, I want to spend a minute updating you on the progress we have made with our development of new brands and our global expansion strategy.

In Rejuvenation, we opened an exciting new store in Berkeley, California and continued with our integration of this brand into our Company.

In other new business development, we continue to work on new ideas, and I'm proud to announce that we will be launching a new DTC brand in early November of this year.

One of the things that differentiates Williams-Sonoma Inc.

is our ability to launch new brands that can grow into substantial businesses.

This is evidenced by Pottery Barn Kids, Pottery Barn Teen, and West Elm, all of which we incubated here in the Company and collectively account for over $1 billion in annual revenue.

We will update you with more information on this new brand and the progress we are making on other new business ideas on our next call.

Also this afternoon, we announced that we'll be opening our first Company-operated stores outside of North America.

We will be opening four stores in Sydney, Australia, a Williams-Sonoma, a West Elm, a Pottery Barn, and a Pottery Barn Kids.

We expect to open these stores in early fiscal 2013.

We are tracking ahead of our original global timeline because we are able to identify a compelling strategic retail opportunity.

Also, we opened two additional stores during the second quarter in Saudi Arabia with our franchise partner.

In addition to these stores, we'll be opening the first Williams-Sonoma, West Elm, and PBteen stores in the Middle East later this year.

Further, in our Direct business, we are shipping internationally to more than 95 countries.

Last but not least, I want to tell you about something that I'm particularly proud of.

Our recently opened Pottery Barn Kids store is the first store in Saudi Arabia that is operated by women and has women in management.

This is an example of how we can not only drive earnings and sales, but how we can help make changes to improve the communities where we do business.

Now, I will turn the conference call over to Julie for additional details on our Q2 financial performance and our Q3 and full year 2012 financial guidance.

Thank you, Laura, and good afternoon.

For the quarter, net revenues increased 7% to $874 million with 13% growth in the direct-to-customer channel and 4% comparable store sales growth in the retail channel.

Non-GAAP diluted earnings per share increased 16% to $0.43 per share, and non-GAAP operating margin at 8% matched the highest ever for the second quarter.

As a result, our revenues, operating income, and diluted earnings per share were a record for any non-holiday quarter while we simultaneously invested in our future growth.

Comparable brand revenues increased 7%, lead by strong performance in Pottery Barn and West Elm.

E-commerce revenues for the quarter increased 14% driving direct-to-customer revenues to 47% of total Company revenues versus 45% last year.

Gross margins improved 40 basis points versus last year to 38.3%.

This increase was driven by the leverage of fixed occupancy costs and was partially offset by lower selling margins including increasing our shipping value to our customers.

Selling margins on a sequential basis, however, increased 90 basis points from the first quarter, with the most significant improvement in the Williams-Sonoma brand.

Occupancy expense was $124 million during the quarter versus $123 million last year.

Non-GAAP SG&A increased 20 basis points versus last year to 30.2%, primarily driven by increased employment expenses, partially offset by greater advertising efficiency.

Included in this increase in SG&A expense were the planned incremental investments to support our e-commerce, global expansion, and business development growth strategies.

I would now like to comment on our second quarter non-GAAP operating margin in each of our business segments.

As mentioned earlier, total Company non-GAAP operating margin at 8% matched our highest ever for the second quarter.

A 30 basis point increase in the direct-to-customer segment to 23% was offset by a 30 basis point decrease in the retail segment to 8.4% and a 20 basis point increase in corporate unallocated expenses to 7.3%.

The 30 basis point improvement in the direct-to-customer segment was primarily driven by greater advertising efficiency and sales leverage of fixed occupancy costs, partially offset by lower selling margins and higher employment.

At $95 million, the direct-to-customer operating income is the highest quarterly segment operating income ever recorded in either segment for a non-holiday quarter.

The 30 basis point decrease in the retail segment was driven by higher employment, partially offset by fixed occupancy cost leverage and improved selling margins.

The 20 basis point increase in corporate unallocated segment was primarily driven by the planned incremental investments to support our global expansion and business development growth strategy.

From a balance sheet perspective, the second quarter highlights were as follows.

Cash at the end of the quarter was $337 million versus $425 million last year for a net decrease of $88 million.

So cash provided by operating activities actually increased $60 million on a trailing 12-month basis.

The increase was offset primarily by additional year over year spending on share repurchases and dividends, as well as additional capital spending to support our growth initiatives.

Merchandise inventories increased $60 million or 11% to $616 million which was consistent with our expectations and was primarily to improve our in-stock inventory positions and to drive sales in all of our brands.

I would now like to discuss our third quarter and fiscal year 2012 guidance.

We are very pleased with the progress we have made in the first half of this year and our momentum entering the third quarter remains strong.

Our third quarter guidance for net revenues is estimated to be in the range of $905 million to $925 million and our non-GAAP EPS is estimated to be in the range of $0.43 to $0.46 per share.

This assumes revenue growth of 4% to 7%, comparable brand revenue growth of 4% to 6%, and a non-GAAP operating margin of 7.5% to 8.1%.

We are again increasing our full year guidance to reflect the outperformance we saw in the second quarter.

Therefore for the year, non-GAAP diluted earnings per share are now expected to be in the range of $2.44 to $2.51 per share, which would be the highest diluted earnings per share in the history of our Company.

Net revenues are now expected to be in the range of $3.98 billion to $4.03 billion.

It is important to note that our fiscal year EPS guidance reflects both a $0.02 negative weighted share effect on the sum of the quarters and a $0.02 impact from the incremental spend associated with the unplanned early fiscal 2013 global expansion of our first retail stores in Australia.

Our capital spending guidance remains unchanged, however, as changes in the scope and timing of certain projects allow us today to absorb the additional construction costs of our four new stores in Sydney, Australia.

For all other fiscal year 2012 guidance, please see today's press release for further details.

In summary, we are pleased with our second quarter financial results, particularly because we drove these results while simultaneously investing in our future growth and we are encouraged by our momentum entering the third quarter.

Lastly, I'd like to say thank you for the warm reception I have received from so many of you as I assume my new role.

Williams-Sonoma Inc.

is entering a new and exciting period of strategic growth and I am thrilled to be in this position today to help drive the initiatives that will lead us to this growth.

I am so proud to be apart of such a strong team that is committed to driving this Company to these new levels of performance and to increasing shareholder value.

I would now like to open up the call for questions.

Thank you.

(Operator Instructions)

Matthew Fassler, Goldman Sachs.

My question relates to the shipping dynamic that you discussed.

Where are we in the evolution free shipping as an offer across your brands, and if you think about the transition but presumably offer it to greater rev offers, how far along are we towards what you expect the end game to be both in terms of penetration within the business and impact on your margin?

Thanks, Matt.

We use a variety of different promotions, as we've talked about before, to introduce our customers to our brands and drive additional purchases.

Free shipping is one of those promotions, and we have been running it as we had planned to run it this year.

We do different things in different brands based on the dynamics in those brands, and we've seen a particular good response to running threshold shipping in Williams-Sonoma.

And its really helped us increase conversion on branded goods, which tells us that, when we improve the value, they'd rather buy the products from us.

And so we've continued to run that promotion as you probably all know through this year.

And the other thing that we've been able to do is that, through the work we've done in supply chain, and I know we've talked about this a lot before, but all the costs that we've taken out and the improvements in quality and service to our customers, we've been able to reduce our cost and pass that along to our customers and reduce the income that we get from shipping.

And so we are going to continue to do that.

And our goal is to provide the finest shipping experience for our products and do so at a cost to the customer that they consider reasonable.

Thank you.

And we will take our next question from --

Did you hear me say thank you?

Yes, we did.

Thank you, Matt.

I apologize.

I was asking my associate, not you.

(laughter) Thank you.

Appreciate it.

Peter Benedict, Robert Baird.

Nice to see the progress obviously at the Williams-Sonoma concept.

Maybe, Laura, you can talk about how you envision that playing out over the balance of the year?

What's implied in the guidance, a continued improvement in the comparable brand revenue growth and how about the selling margins, are they envisioned to be up in the back half of the year through holiday?

Thank you.

In the beginning of this year, we shared with you what we believe would be the three key strategies to transform this business, and to be not just on the defensive but be on the offensive because we know that our customer loves this brand.

And every piece of research that we've done tells us that there's some things we can do, but that we fundamentally have still such a powerful brand that really resonates with the customer, particularly for gift giving.

And so we've been executing against those strategies, the first being the product innovation and exclusive products, which is the cornerstone of the whole thing.

And specifically, each quarter we bring in more and more across categories.

And last quarter, we told you that the first area we could assess would be the tabletop where the lead times are shorter.

And we're on track, as we had predicted, with the business there.

And we've also been working with our vendors, and you've seen us launch new innovative products in-store that we are launching exclusively and really being right on trend with what customers are looking for, particularly in electrics.

And so through the balance of this year, while it's very competitive to go through each and every one of them, we have substantial launches both in Q3 and Q4 that will continue to position Williams-Sonoma as the leader in cooking and entertaining in there across a variety of product categories.

The second piece of the program that we talked about was our marketing and really to help the customer understand better what we do and why the products that they're purchasing offer them a differentiated experience.

And this is hand in hand with the training work that we're doing in our stores to better instruct our selling associates about why we were so excited to introduce specific products.

For example, we right now have a Breville ice cream maker that is the only ice cream maker on the market where you can have your dinner party and the ice cream stays at the right consistency and doesn't cool down.

You don't have to put it in the freezer to make it and then it freezes and then you have to serve it, and it's very difficult.

This one holds the temperature, and then if you want it harder or softer you just push a button.

The marketing that we're talking about is how do we best explain that to the customer.

And also how do we tell the bigger story about the quality of our products because we're using so many artisanal products, and our food is so clean and free of so many of the things that aren't good for you.

And we realize we have a big opportunity to better communicate that.

And so you've seen in our recent catalog our marketing from the farm.

You see in the store the real focus on healthy living that's really resonating with our customers.

And the last thing that we're doing that we talked about a lot is our selling culture and to make sure that -- good service is selling.

People come into our stores because they want to buy something, and we have such an opportunity to do a better job.

We have great sales associates and we need to get them better tools and better training.

And that's what we've been focused on.

And using all we know from our other brands in this brand.

So we're making a lot of progress against these fronts.

I told you earlier this year we'd measure each and every bit of it.

We do that.

And it sets us up I think not just for the fourth quarter but beyond.

And you'll just continue to see gradual and incremental improvements, and it's of course assumed in our guidance for the balance of the year.

Matt McGinley, ISI Group.

I have two questions on the expense that you had in the quarter.

You said that there is some additional SG&A expense that you had, and you had originally guided $15 million to $20 million of incremental expense in the year.

Was that more heavily weighted to the second quarter or how should we think about that gating over the remainder of the year?

And then on the capital spending, you're running pretty far below the original guidance you gave and you maintain the $200 million $220 million is only spent $70 million so far.

Why are you running so far below plan right now and what does that say about where you could be by the end of the year?

I'll take that.

This is Julie.

First of all, let me frame that question strategically in terms of the power of our operating model.

In addition to looking at our business by brand and seeing sequential improvement in our brand, I think what hopefully everyone is starting to appreciate is the power of our operating model.

So as we continue to grow at a higher percent of our business in the DTC channel, we can drive higher profitability while making investments in our business.

And that is something really rare to us.

There's no one else our size that has this kind of balance and flexibility in their model because, as you know, most retailers do not close 50% of their business in the direct channel.

So through this model, we are able to both generate the improvements you're seeing today while investing in our growth strategies that provide financial returns in the future.

This model has allowed us to invest in new brands.

We have a new brand that's going to be launching in early November, new lines of business, PBdorm, Agrarian, et cetera, with more to come.

New product partnerships, we just announced Starbucks and Burton.

The development of more proprietary products in our Williams-Sonoma business.

And finally, our global expansion, which we just announced earlier today that we have accelerated.

So all of this progress is extremely exciting, and again, only possible because of the power of our operating model.

So to answer your question, what we're trying to strategically do is to double our business.

And there's going to be incremental spend ahead of the revenues to do that.

And the fact that we've been able to fund this, while still being profitable at record levels, is really exciting for us.

So what we're trying to hope is that we can get people focused less on the $15 million to $20 million and how that plays out and be more committed to looking at us delivering the full year on the operating margin line as we continue to grow this business, and again try to double it in the future in the next 10 years.

As far as capital spending, we are tracking to our range of $200 million to $220 million.

As we mentioned, we absorbed the additional construction costs associated with Australia.

So it's just the timing of when the actual spend for capital spending will occur, but we do believe that we will actually be somewhere towards the high end of that range.

Joe Feldman, Telsey Advisory Group.

We wanted to ask what is your biggest limiting factor in getting West Elm rolled out more quickly?

I know we've talked about it in the past, but I just want to get an update of what you're seeing in the real estate front?

And if I could sneak one more just housekeeping one in, just was curious how much Rejuvenation actually added?

I know you called it out in the press release as helping to drive DTC.

Thanks.

Thanks, Joe.

We feel very good about our growth in West Elm.

Last year, we told you that we are going to be very sure of our retail model before we open stores.

And so we're just now -- this is the quarter where we opened five stores.

We're just going -- you're going to see us open more now than we had in the beginning of the year and more than we had opened last year, but we really think it's the prudent thing to do.

You want to really understand how stores perform in multi-store markets and how much more you can drive in direct and how big the assortment can be.

So there's no real reason to push it, and we're growing very fast as we speak.

We feel very good about it.

And we want to do it with customer in mind, do a great job, and keep the artistic bent to the brand, and not miss a beat.

So there's nothing gating it.

I think it's, could we find a few more stores here and there that would add to it?

Yes, probably.

We are aggressively looking for stores, and we have great stores lined up for the balance of this year as I had mentioned.

And we're going to be able to see how they perform and use that to even more specifically refine the road map to more store openings.

The second question about Rejuvenation, small.

The point is that you just -- the volume goes into the DTC side, but it's a small number.

Budd Bugatch, Raymond James.

Thank you for taking my question, and Julie congratulations again on your promotion.

Thanks, Budd.

My question really relates to the guidance for the year and how to think about the mix between gross margin and SG&A, given the fact that you are investing in the new -- in the initiatives and the fact that you're also attempting to -- and developing more proprietary product.

So how do we compare -- what do we think about the comparisons of that in the third and the fourth quarter gross margin versus last year where you ran into some issues in the fourth quarter, how should we think about that numerically?

And what can you specifically tell us about the way -- what's constructed inside the guidance?

Okay, I'll take that, Budd.

Obviously, as you guys know, we don't provide guidance on the gross margin and SG&A line, but there's a couple things I think you can think about to put it all together.

One, gross margin we've been saying has been sequentially improving.

Two, I would say that from an SG&A perspective, obviously the impact of the investments that we talked to you guys about at the beginning of the year that are flowing through have less of an impact on Q3 and Q4 because our revenues are substantially higher.

And then we told you today that there's a $0.02 impact related to Australia that was completely unplanned.

But we want to make sure everyone is grounded on the fact that we're obviously very confident in the guidance we put out that we're confident in our ability -- our strategy for the back half of the year, but there's still a lot of uncertainties out there.

We've got an election in a couple of months.

We've got status of the global economy.

So we don't want to get ahead of ourselves.

So when you add that plus our investments, and again the $0.02 weighted share effect on the full year, we think we're in the right spot.

David Magee, SunTrust Robinson Humphrey.

I just had a question regarding the move into Australia.

I'm curious what your thinking was behind using Company owned stores versus franchise, and how much you go from there to other countries?

Sure, thanks, David.

Australia is -- we're so excited that it's the first place we're going.

We know a lot about Australia through our FiftyOne venture, and it ranks very high also on our affinity matrix for evaluating global opportunities.

We know that the cultural attributes are very similar to ours.

It's an entertaining, cooking, and gift giving culture.

There are large homes.

Our aesthetic is already popular there.

There's limited competition.

They love to cook.

And as I said, it's the strongest market for our DTC business outside of North America and we also, as we look at the world and where the economics are, Australia has the 14th highest GDP per capita in the world and their economy grew at an average rate of 3.6% for over 15 years.

And so we feel that there's a lot of things that came together very well.

And we found the right location.

We're opening a store across the street from a shopping center that has the second highest volume of any shopping center in the Southern Hemisphere.

So it's very exciting that we found the spot and that the math works.

It meets the same hurdle rates that we have set for ourselves domestically.

It's the same language.

I would guess that it's probably going to be easier for us to do this than even our venture into the Middle East where there was so many changes, and we've done that very successfully.

So it all added up to, it makes absolute sense we should do it ourselves.

I've made the joke, we wouldn't have franchised Texas.

And there's a lot of places out there that we can own and operate our own business and make great profits there at the same time.

So we also are just thrilled to be able to have this be our first market for all the reasons we talked about and success is going to be determined by the customer experience, but also the achievement of our financial targets that we've set for ourselves.

Kate McShane, Citi Research.

Thanks for taking my question.

I wondered, Laura, if you could comment at all about the overall pricing environment for the Williams-Sonoma banner, certainly all of the companies specific, and merchandising changes you are making is making a big difference.

But wondered if that has gotten any healthier?

And also wanted to see if you could comment at all on your response to your Halloween mini catalog, because I know you've said in the past that's always a very good response to it.

There's always a very good indication of how the Christmas holiday season will be.

Yes, I would just say you should order the costumes now if you want to get them.

On the overall promotional environment, we've been saying all along that it's clear the customers are looking for quality.

It's clear they're looking for value, and the retailers with compelling differentiated assortments are thriving.

And great in-store experience and better product is what makes the difference and building our brands is the most competitive thing that we can do.

And what makes them come back to us is the product, the value, and the experience.

And we believe this is our long-term competitive advantage.

We have a culture of continuous improvement, and we have developed a strategy that's planned, it's measured, and we're seeing good response.

And we're going to have promotions.

We learned a lot from the promotions we ran last year.

We're running much more effective promotions, both from a customer perspective, but also from a profit perspective, and you're going to see us execute that this holiday season.

And we're pleased with where we are.

In terms of I think that was the two questions.

In terms of what we're seeing in the broader competitive environment, I'm going to let Pat say a few words about the broader competitive environment and particularly the online environment.

Thanks, Laura, and thanks for the question, Kate.

I think the question you're really asking is we compete against such a broad range of companies, how do we think about competition and why do we believe that we will continue to capture market share, both in North America and around the world, as we start to expand.

What we've done is we've come to believe that we are at the intersection of lifestyle merchandising and analytics, and we'll compete against the commodity players with superior lifestyle merchandising and we'll win against other lifestyle companies with superior analytics.

As we've said before, year after year when Americans are asked what one thing says the most about you, the number one answer is the home I live in.

And this is the consumer that we're marketing to, and luckily there are a lot of them.

And this consumer aspires to enhance their home as a reflection of who they are.

They want ideas and inspiration.

They want confidence.

They're not commodity shoppers.

And we attract this customer with our lifestyle merchandising from our edited and original point of view in our products to how they're shown in the stores, in our catalogs, and online.

And I don't think anyone does it the way we do.

We combine that with superior analytics and this database built on 30 years of a direct heritage.

We have 50 million households on our database that have purchased from us.

And we -- every month, we know the name and address of the retail customers that represent 75% of our sales.

I don't think anyone else has that.

And I think that's why we're gaining market share, and why we believe that we will continue to do so.

Laura Champine, Canaccord.

This is Jason Smith.

I'm on the line for Laura today.

I just want to ask if you can maybe give us a little bit more color about how you view inventory levels for the second half of the year?

Sure, I'll take that.

This is Julie.

First of all, I think it's important to know that we're feeling very good about the health of our inventory and we are basically back in stock from our -- the issue we had from last quarter.

But you should know that our largest inventory increases are supporting our biggest growth drivers and we are going to be investing in inventory.

It's the right thing to do.

We are carrying our base inventories way too low and we are preparing our brands to be ready for Q4 in the beginning of 2013.

So the reality is there is -- what we're finding is there's no way to beat the sales unless you buy the merchandise.

So right now, given what we're seeing in our underlying business trends and our global expansion, we need more inventory and you'll see that to continue to happen throughout the year.

Brian Nagel, Oppenheimer.

Congratulations on a nice quarter.

The question I wanted to ask is on gross margins, and I know others have touched on it too, but if you look at -- you had a nice gross margin increase here in the second quarter and it showed a pretty significant reversal from what we've seen over the last couple quarters.

You mentioned the exclusive products, so I was wondering if maybe we could drill down a little further to say the various -- if you could break down for us, how should we be thinking about the gross margin gain we saw here in Q2 by components and maybe describe the magnitude of each?

Okay, this is Julie.

I'll start and then pass it to Laura to follow up on it.

But I think the couple things we want to make sure we get out is that we saw sequential improvement.

So yes, year over year the margins are down, but we saw sequential improvement even from year-end through Q1 through to Q2.

And the biggest improvement was in the Williams-Sonoma brand.

And in fact, in Williams Sonoma the product margin was up year over year.

So I think Williams-Sonoma is one of the key drivers, and in fact it's across just about every brand.

Laura, do you want to add a little more detail on that?

Just in the selling margin world, there's so many different things that we did to achieve these results.

It's everything from mix to selling through fashion to the way we handled the goods, packaging, the exclusive product that we develop, which has a higher margin, versus product that we buy.

And then a big one is having gone through the promotional environment last year, really understanding which promotions drive what and being smarter about how we run promotions.

Great.

And then if I could just follow-up with more of a broad based question.

But if we look at the environment, there's been mixed signals out there in the overall consumer environment.

You guys clearly had good results today.

How much, as you think about the sales acceleration you saw in the second quarter -- understand you have a lot going on at your Company, but how much do you think that reflects an overall improving consumer environment here lately?

We're talking about Q2, so there was a lot of mixed consumer results during that quarter, and I think you've recently gotten a few better pieces of news out there.

Our focus is on really developing strategies to fuel our growth over the long-term.

And the foundation of that is our operating model, our cultured analytics, and product innovation.

And we've been at it for a while as we have a very specific plan, and we also have the flexibility to change.

We listen to our customers.

We stay hungry.

We're humble.

And we're always looking for opportunities.

We always want to have you tell us where we can do something better and improve our customer experience.

And I think when you take all of that together, both the attitude of the management team here and the people in the financial disciplines we have and then, as I said, the cultural end of it, the analytics, the product innovation, our entrepreneurship, which is one of our core competencies, it all adds up to better results than our competition is getting.

Alan Rifkin, Barclays.

Laura, you mentioned that you'll be the first retailer to launch the Verismo platform.

I was wondering if you could give a little bit more color with respect to that product, namely how long will your exclusivity be for and how many SKUs are we talking about with respect to the machines versus the K-Cups.

And then I have a follow-up if you don't mind.

I gave you as much information as I can.

We're very excited about the launch.

Starbucks has been a great partner of ours, and the cup of coffee that it makes is fantastic.

The milk pods, all that, the convenience of it, and we're thrilled to be in partnership with them.

Okay.

And then, you also mentioned that you're happy with the internal targets that you've met on the Williams-Sonoma side of the business with continuing to develop exclusive and proprietary products.

If the development continues to hit your plan, whatever that may be, and I know that in the past you've said that branded product is slightly less than 50%, what can we expect in terms of the revenue mix at the Williams-Sonoma division between branded and proprietary product, let's say at the end of this year or the end of next year?

There's a lot of different ways to look at that.

There's how many you offer, there's how much you sell.

And the reason we've had an approach that lasts more than a quarter is to really make sure that we are doing what's right and not just doing something for the sake of change because our customer tells us that they're so pleased with the brand.

It's not a brand that has a customer satisfaction issue, it's one they love.

So we have been measured about what we're changing, and I would say that if I were to give you an answer today I think it would be -- I think we'd be ahead of ourselves.

We have a lot more to do.

We're introducing and we're happy with what we're seeing in the areas that we've talked about and we will keep you absolutely posted as we go.

We're here because people have watched our success and there's been a lot of competition.

So we have to play this one a little closer to the vest than we did in the past because we don't want to share our strategies to our competitors.

I hope you can understand that.

Brad Thomas, KeyBanc Capital Markets.

Thanks for taking my question.

Wanted to just follow up on some of the previous questions about margins, but maybe step back a little bit and look out over the next few years.

Obviously, when we look at this year, there's some specific investments that you called out, the guidance for this year, operating margin to be up slightly to down slightly.

As we look out the next few years and recognize there's still a cyclical opportunity, but by the same token the Company will have some areas it's investing.

How are you thinking about the margin opportunities over the next few years?

This is Julie.

Hi, Brad.

Obviously, the goal is to improve the margins.

Clearly, we'd like to get back to at least last year's level if not improve it further, but we do believe that there's sort of a new reality out there from the promotional environment that we're continuing to perfect.

As Laura mentioned, we're getting better and better at that, and I think that's one of the key strategies that we're going to have in place relative to our peers.

So the goal is to get back to last year's levels or higher, but full well knowing it's going to be a harder environment to make that happen.

Marni Shapiro.

Congratulations on a fantastic quarter.

Thank you, Marni.

I can tell you how you could improve my customer experience.

Stay out of stock on compost cookies, they are addicting and very fattening.

(Laughter).

Will do.

I don't -- keep them out of the tri-state area.

Okay.

I don't know if we can do that.

You talked a little bit about being more in-stock in inventory.

And I was curious if that was across the brands or --?

I'm noticing as I prowl through the stores and the internet, West Elm seems particularly back ordered in a lot of spots, and I'm just curious if it was a little bit more specific to West Elm?

And are you taking this point of view specifically at West Elm or Williams-Sonoma looking ahead to the holiday season where obviously a back order is a bigger issue because she might not have the patience to wait given the deadline of a holiday?

Hi, Marni.

This is Julie.

I'll take that.

Actually, we are investing across all of our brands.

We are really beginning to realize and, especially in light of last quarter and the trends we're seeing and the analysis that we've done, that being in-stock is critical.

And so oftentimes you can not be in-stock and it comes later, but sometimes you lose the sale.

So it's really critical for us to be in-stock across all of our brands.

So I wouldn't say there's any particular brand that we're investing in more than the others.

Fantastic.

And then if you think about the holiday season have you guys upped the ante on the gifting?

I know you've continued to do this over the last years, but I wasn't sure if you guys were happy with the mix last holiday or you'll continue to push the pedal on that?

I think there's always opportunity, and we checked it once, checked it twice.

We check it every week.

We've reviewed these buys.

We use every piece of data that we have on our current selling whether it's a halloween costume or food selling to make adjustments.

And we're good at flexing the inventory.

You've seen us do it before.

So we're changing some things, and we're reviewing photography for the holiday season and we're very pleased with what we're seeing there.

And then we make our investments, we make changes based on what we see.

And we're setting up our floor sets.

And so it's a really big focus of all of the teams right now.

And we're doing exactly what you were alluding to which is we're getting -- we're all very focused on this gifting opportunity.

And we know that our brands are top of mind for gifts, and we think we can do an even better job this year than we have in the past.

Fantastic guys, best of luck.

And that concludes our question-and-answer session for today.

I'll now turn the conference back over to Ms. Alber for additional and closing remarks.

Thank you all for joining us this afternoon.

We really appreciate your time and interest and continued support, and we will speak with you again next quarter.

Thank you.

And that does conclude our conference for today.

We thank you for your participation.

You may now disconnect.