Williams-Sonoma Ekes Out Surprise Profit

The profit was a result of significant cost containment efforts. The company reduced inventory 21% on a year-over-year basis and began shedding 1.2 million square feet of distribution space and 80,000 square feet of excess San Francisco office space, a process it said would be completed in the third quarter. Previously, the company reduced its catalog circulation, refined its product assortment and cut 1,400 positions, or 18% of its full-time staff. Looking ahead, it increased this year's planned permanent store closures to 16 from nine, and made plans to open four stores next year in the Middle East, which will mark its first stores overseas.

The 80% increase in planned store closures may reflect a failure to obtain rent reductions from some landlords. On the two previous quarterly conference calls, company executives told analysts that the company is being "aggressive" in seeking rent reductions and would close some stores if it cannot renegotiate their leases.

"We are trying to work with our landlords," chairman and CEO Howard Lester told analysts in March, at which time the company had negotiated rent reductions for 15 of its stores. "It's a difficult problem for all of us, certainly as renewals come up we are able to negotiate much better lease terms than we had before. Obviously we've got to bring our occupancy costs in line with our sales at something close to historical levels and that's our goal and there's several ways to get there. We would prefer to get there by keeping our current store base and readjusting our expense structure and if we can't, then we'll have to get there by closing some of our stores and driving those sales into the remaining stores in those markets, so we'll see how it plays out over the next few months to a year."

This week, without detailing the company's ongoing negotiations with landlords or saying how many more stores have achieved lower occupancy costs, Howard said the company continues to make "slow" progress. "Of our major half a dozen or so landlords we've got about one-third to one-half of them that are more willing than the others to work with us to try to find creative solutions that will work for both of us, both in the short term and the long term," he said. "The others are more difficult and haven't been willing to get to that point yet. So we are somewhat encouraged with one-third to one half of our major landlords but still disappointed with the other half."

With regard to the Middle East, company executives told analysts the first four stores would be opened in partnership with the Alshaya Group and would carry the Pottery Barn and Pottery Barn Kids brands. The first stores will be split evenly between Dubai and Kuwait. "Some of the greatest growth in retail is in the Middle East," one company executive told analysts. "It gives us a new revenue stream."

Howard added that they also chose the Middle East as a test ground for global expansion because from a retail perspective it's very much like America in that it is mall-based, with many malls being copies of ones here in the US, and because of the experience of its partner. "There is a lot of money there and a high shopping rate, [and] we do not have the resources to field our own [international] team from scratch," he said.

Getting back to the company's second quarter performance, revenue fell 18% and same-store sales declined 15% overall. Year-to-date, same-store sales are down 13.1% at Williams Sonoma, 19.1% at Pottery Barn, 23.7% at Pottery Barn Kids and 22.3% at its Outlet stores. Backing out lease-termination and other non-recurring items, the company said it would have posted a profit of $0.05 a share.

The performance caused the company to forecast and increase in revenue to as much as $700 million in the third quarter, and for a profit of between $0.01 and $0.05 per share excluding one-time items. It is expecting to achieve those results despite an expected 13% year-over-year decline in same-store sales. Adjusted profit in the fourth quarter is expected to be $0.27 to $0.36 per share on an 11% decline in same-store sales. Analysts had previously predicted a loss of $0.05 per share for the third quarter and a profit of $0.32 for the fourth quarter.