Welcome to the Williams-Sonoma, Inc. First Quarter 2014 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the call over to Gabrielle Rabinovitch, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you, Doris. Good afternoon. This call should be considered in conjunction with the press release 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. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why these non-GAAP financial measures are useful are discussed in our release. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which address the financial condition, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2014 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-K, 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 first quarter fiscal 2014 results.

Thank you, Gabrielle. Welcome, everyone, and thank you for joining us this afternoon. On the call with me today are Julie Whalen, our Chief Financial Officer; and Pat Connolly, our Chief Marketing Officer. I'm excited to discuss with you today our strong performance. In the first quarter, we delivered record net revenues of $974 million, with comparable brand revenue growth of 10% driven by broad-based strength across each of our brands. This resulted in a 17% increase in operating income and a 20% increase in diluted earnings per share. This double-digit revenue increase was accompanied by solid operating profitability. Innovative high-quality products, personalized service, relevant marketing and strong execution across all brands drove these better-than-expected results. With 50% of our revenue in the direct channel this quarter, we believe our multi-brand, multichannel platform is driving consistent market share gains and providing us with a competitive advantage. We are pleased that we are able to deliver these strong earnings against a challenging backdrop. The term "multichannel" has become ubiquitous. We feel that our model is different, and this difference is what is driving our performance. I thought it would be worth discussing these differences as we see them, including the following attributes. First is scale. Our direct business is 50% of total revenue. This gives us significant flexibility and leverage in our marketing spend. Second, we have more than 3 decades of experience in leveraging synergies between the channels. We know that our digital spend drives customers to our stores. We also know that retail is a major source of new customers and that many of them become direct-to-customer as well. Third, we have the catalog, which is an important component of our model. Nothing can match the productivity of an inspiring catalog delivered to the right customer. Fourth, advanced marketing…

Thank you, Laura, and good afternoon, everyone. We are very pleased with our strong start to 2014. For the first quarter, net revenues increased 9.7% to $974 million, with comparable brand revenues increasing 10% on top of 7.2% in Q1 2013. All of our brands experienced strong year-over-year growth in comparable brand revenue, with Williams-Sonoma up 6%, Pottery Barn up 9.7%, Pottery Barn Kids up 8.1%, Pottery Barn Teen up 12% and West Elm up 18.8%. Net revenues in our direct-to-customer channel grew 17.2%, including e-commerce growth of almost 20%. Our direct-to-customer channel generated 50.4% of total company net revenues for the quarter, crossing the 50% threshold for the first time in the company's history, a 320-basis-point increase over last year. Our retail channel revenues also increased 3.1% to $483 million, with West Elm and Pottery Barn the most significant contributors to the growth. Gross margin for the first quarter was 37.8% versus 37.6% last year. This 20-basis-point increase resulted primarily from higher selling margins as occupancy costs in the first quarter of 2014 as a rate were essentially flat at 15% of net revenues or $146 million in comparison to 15% of net revenues or $133 million in the first quarter of 2013. On a GAAP basis, SG&A in the first quarter improved 30 basis points to 30.2% versus 30.5% in 2013. On a non-GAAP basis, excluding the 40-basis-point impact in 2013, SG&A increased 10 basis points to 30.2% versus 30.1% in 2013, primarily driven by higher employment costs related to the vesting of long-term incentive compensation, partially offset by advertising leverage. GAAP operating income in the first quarter increased 16.5% to $74 million, resulting in an operating margin of 7.6% compared to 7.2% last year. On a non-GAAP basis, last year's operating margin was 7.5%. The improvement in…

[Operator Instructions] And we'll go first to Kate McShane with Citi.

Julie, I know you don't give guidance around gross margins, but I can't help but get a little excited about what we saw in Q1. So I was wondering if you could help us understand how you are viewing gross margin for the year. And if you could maybe give a little bit more detail on how the promotional environment shaped up in Q1 and what you expect for the rest of the year.

Sure. We're actually really excited about the gross margins. To your point, it's been a little while since we've seen the gross margins are up, and really the reason is solely due to higher selling margins. As we mentioned, occupancy is essentially flat year-over-year. And so what we're seeing, I think what's important for everyone to hear is that the pure sort of MMU product margin is what is up, and it's across both channels and across many of the brands. So we think that's a really good sign. There's various factors for that, one of which we believe is our supply chain initiatives that we're focused on, we've been talking about it for a while, such as the in-sourcing of our foreign agents and the regionalization of our distribution centers, as well as the manufacturing of our own upholstered goods. All of that is starting to slowly but surely come to fruition within the margins. We think that is a great opportunity to see those margins continue to rise. However, with the continued promotional environment and especially during Q2, for example, with the summer sales and an increase in occupancy costs, including depreciation from our ongoing capital investments in the business, there's going to be continued pressure on the gross margin. But as we always like to tell you guys, we have to remember that with a 50-50 business, 50% e-commerce and 50% retail, that we tend to manage to the operating margin line because we have different levers that we can pull throughout the P&L. But we're really happy with our results on the gross margin line. And then promotional environment, Laura, would you want to take that?

Sure, yes. We continue to see that the market is promotional, which is why we're working so hard, as Julie said, to take costs out of our supply chain and to develop inspiring and appealing products for our customer. We think one of the reasons we continue to win is that we have exclusive and innovative products. And we also have aesthetic diversification across all of our brands, which allows our customers to develop their own unique individual style but also gives them confidence to come back. And it's a tremendous advantage because if you think about it, a customer's previous purchase really weighs heavily on their future purchases. And this further isolates us from competitors, we believe, that are using heavier promotions. You're simply not going to buy something for your house that doesn't go with the rest of it just because it's cheaper.

And we'll go next to Matthew Fassler with Goldman Sachs.

I hate to use my one question on what might be kind of a banal topic, but if you could sort of talk a little bit more, Julie, to the investments that both you and Laura cited, talk about their cadence as they work their way through the year only because from the context of the numbers you just put up and an easier comparison, the guidance for second quarter margins seems a bit on the conservative side. I'm sure you have some drivers there out, so any color would be great.

Sure. We're really excited that we're seeing opportunities, particularly in e-commerce, that we're going to build on. The customer trends are strong and it's driven by our marketing strategies. And through testing over the past few quarters, we've uncovered several breakthrough developments. And so this Q2 earnings guidance reflects the fact that we see opportunities to invest more in the second quarter in these initiatives, which will set us up for the back half. Also in Q2, we're investing in our supply chain, with our new Dallas distribution center, as well as the IT infrastructure to support the supply chain. And we're putting several major IT projects into service in Q2. And of course, we always have our continuing investments in global. I think the disconnect is obviously we didn't guide to Q2. Those have always been our numbers for Q2, and so it's just a delta between what you're seeing. But that has always been an investment in Q2. And the reality is when you look to the year, we actually raised the year and added $0.02 on the year, which is exactly in line with our 3-year outlook.

And we'll go next to John Marrin with Jefferies.

So first, I'd like to hear about how sales trends were for the quarter and maybe a comment on current sales trends, if you can. And also just what you're looking at over the remainder of the year relative to what you were seeing a few months ago.

Yes, we don't provide the cadence of our sales trends throughout the quarter. Obviously, at the end of the day, Q1 was a strong quarter, and we mentioned that Easter was strong for us, and we're only 3 weeks into this quarter so it's really too early to call the card on that.

Okay. And just this incredible performance of direct, I understand that you instituted some changes there that probably drove performance. I'm just wondering if maybe you could talk about how that looked across the brand portfolio and what the growth outlook is for the rest of the year.

John, I think if you know me, you know that I'd love to get under the hood and tell you exactly what we're doing in terms of these breakthroughs in e-marketing. But clearly, it's very competitive for us. And e-commerce is so foundational to our ongoing success and our ability to harness the information we have and utilize it effectively. It's just core to the way we do business. These capabilities are -- which we are most excited about, relate to our email and our e-marketing programs, and they span a number of areas, including technology, new ways to utilize our data, our processes in the way we manage our programs. And these -- they'll build over time, but remember, we're starting from a base of over $2 billion in e-commerce. That said, we laid out our plan in March and this has been in our plan. We're very excited about what we see coming down the road here.

[Operator Instructions] We'll go next to Chris Horvers with JPMorgan.

I also wanted to follow up on the 2Q guide. Obviously, a fantastic quarter against a fantastic quarter in the fourth quarter, and really differentiated versus what's going on at so much of retail at this point. So your comparison on the brand comp is not really harder, but your maybe 100 basis points that you're guiding to a pretty sharp deceleration. So I'd love to get your thoughts on that.

Yes, I mean, the reality is we're off to a great start, but it's still early in the year, and one quarter doesn't really give us enough certainty about the trends for the rest of the year. And you have to remember, in particular, with the revenue, we're up against tough compares in Q2 with an 8.4% comp last year. And so -- and obviously, we just mentioned the investments from an earnings perspective. Again, those were in our numbers. So obviously, you guys didn't have visibility to that. But I think with all that said, the fact that we raised guidance on the full year and that is exactly in line with our 3-year outlook, we're feeling very good about this guidance.

Okay. And then on the -- the inventory growth is also -- going back to, let's say, 4Q '12, it started to pick up. A lot of that seemed to be on the global growth side. But you mentioned, for a couple of the brands, the in-stocks have improved and they've really contributed to sales. So is there a way to think about how much of that inventory growth has contributed to sales or how much of that relates to domestic? And how do you think about inventory growth through the balance of the year?

Sure, yes. We're really excited about the inventory levels, given the fact that it certainly has been one of the main drivers for driving the outperformance that we've seen. Obviously, everything else factors into that as well, you have to have the right product and the right marketing and all of that. But the reality is having an in-stock position has been strategic for us. And I think everyone needs to know that even though the inventory levels seem high, they're in the brands that are fueling our growth. So it's in Pottery Barn, it's in West Elm with a 10 and 19 comp in just this quarter alone. And we do have that additional inventory that you mentioned comping, but the reality is, for global, for example, we're adding 8 new stores this year, so we have to build inventory for those that aren't comparable. So there's a lot of things -- the new businesses, brand extensions -- that are growing. You've got more inventory this year than you had as a base last year, and so it sort of looks skewed from a growth perspective, but all investments in good things. So we think this inventory level is somewhat sustainable for a period of time. We think it's strategic. With that said, we obviously see the opportunity to reduce slow movers. We have very strong disciplines across the company. We're always focused on slow movers and also getting back in stock. So we're aggressively going after the slow movers, while at the same time aggressively going after the bestsellers. As you know, there's a delicate relationship between service levels and the inventory, and all of this inventory is what's supporting our 2014 guidance. So we think it's very strategic.

And our next question comes from Gary Balter with Crédit Suisse.

This is actually Andrew on for Gary. I've got a quick question on Williams-Sonoma. I was just wondering if you could delve into little more details on what's happening at the brand. Is it all internally driven or do you think it's just that you're seeing some more industry tailwinds? And then finally, where do you think the ceiling is on, on this improvement? For example, do you think you could outcomp the core business in the second half against easy compares?

Thank you for the question. We've been talking about our strategies in the Williams-Sonoma brand for some time. And we've been working very hard to bring back more exclusive products and also to improve our execution and to have more relevancy to the customers. And we have made some nice progress. We still have a lot more work to do, but we are happy with the consumer response. Clearly, a 6 comp is a strong number. And we have a lot of new product in the pipeline for the second quarter that builds on what we're seeing. I don't know if you've been in lately, but we had a great collaboration with Tacolicious right now. It's really innovative and uses market-fresh sustainable ingredients in every product. And together, we've developed a line of salsas and braising bases that are inspired by world-class restaurants in Mexico City. So it's an example of new product that's something I'm excited about. And we're also seeing that some of our new categories like Open Kitchen are bringing new customers to the brand. And new customer growth is an exciting trend and integral to the long-term health of the brand. And so it really has been another piece of what we're doing is to bring accessible price points back in. And lastly, the work we've done to give our great field teams better tools and training to support these great product launches is paying off. So I guess I'd summarize it by saying the teams have been working very hard to get where we are, and we still have a lot more opportunity ahead of us.

And we'll go next to Daniel Hofkin with William Blair & Company.

I apologize if this issue was addressed. I just wanted to get a little bit more color on what you feel at the Williams-Sonoma brand itself. What are the main things that are contributing to kind of the firming of trends in that business? Is it more on the merchandise side, or is it highlighting some of the -- what you feel are differentiated services like cooking classes? If you could just shed some additional light on that in particular, I would appreciate it.

Daniel, I can't resist. I just answered that question, but I'm happy to do it again because I am so excited about it. We have really been focused on our innovative product pipeline, and we've brought in some key lines that are working well and we're building on them. We are focused on execution at the retail level. And really, we've given our great field teams better tools and better training, which is really helping them to service our customers more effectively than we have before. We have better in-stock position than we had before. And we're really focused on relevant food trends. So we're not just selling the tool but we're selling the whole idea. And if you go into the stores, you'll see us doing more tastings and more events to really provide that education to our customers.

And our next question comes from Matt Nemer with Wells Fargo Securities.

I've got a question on the merchandising side. You all have introduced a number of design collaborations with outside brands like Burton and Etsy and others. And I'm just wondering what are the broader aspirations for that in some of the brands that we haven't seen that in yet? Is that something that could expand significantly from here?

Yes, thank you. We're always looking for great designs, and there are incredibly talented artists and designers out there, and we love working with them to bring new things to market. And these collaborations have really extended the aesthetic diversification in each brand. And I can't wait for you to see what we've done with Zio Ziegler that's upcoming. I think it's just a great example of what can be done together. And it really also inspires our teams here to see a new way to approach the home product.

If I could just sneak in one more, which is any early thought FedEx going to dim weight shipping, if we see some general shipping inflation, how do you think that could impact your business?

A great deal of our products that we ship would not be impacted as we have a lot of heavyweight products. The reality is UPS have not followed suit with FedEx at this point. We have long-term agreements in place with UPS, so we don't expect this to impact us.

And we'll go next to Michael Lasser with UBS Investment Bank.

I have 2 quick ones. Number 1, can you discuss the connection between Williams-Sonoma's performance and the company's overall profitability? It seems like this is the best brand comp from that segment in quite some time and maybe it was coincidental that the overall entity also had its really stellar profitability performance. But it seems like perhaps there's some connection there. And then the second quick question is on the level of in-stocks. Perhaps you can give us some sense of where in-stock levels are now versus where they were a year ago and where do you see that just leveling out over time?

Sure, it's Laura. The Williams-Sonoma brand represents about 25% of our total business. Q1 is not a big quarter for Williams-Sonoma, and we're thrilled with the trends we're seeing, but really, it would impact profitability much more in the latter half of the year. As it relates to in-stocks, we haven't given our fill rates, but I will tell you that they're materially higher than they were last year. And not only does that drive better customer satisfaction, it also reduces our cost if we can ship it once versus shipping a back order. Julie, do you want to add anything to what I said about Williams-Sonoma?

No, I mean, other than that, I would say that we did see a lot of -- whether it's Williams-Sonoma or not, the total company outperformance did drop down to the bottom line, if that's where you're headed with that question. Obviously, we had guided from an operating margin perspective to be below last year, and we came in above last year with 17% income growth and 4% above the high end of our guidance from an EPS perspective, and that's while absorbing all of our investments and also some incremental expense in Q1 related to the vesting of some long-term incentive compensation. So we feel really great about how much of the earnings dropped to the bottom.

And our next question comes from Peter Benedict with Robert W. Baird.

I have 2 quick questions, unrelated, but I'll sneak them in. First, is Williams-Sonoma Home big enough to have any impact on what you just did in Williams-Sonoma in total, the CBR [ph]? I'm just trying to understand if that brand is starting to show up in the broader numbers. And then secondly, just on the rent and occupancy trends. It looks like they accelerated here in the first quarter. Does that have to do with the Dallas DC? Or is there something else that we should be thinking about as we try to model that out forward?

Sure. Yes, Williams-Sonoma Home is obviously a part of the Williams-Sonoma brand in total, but it does have a piece of obviously the growth on it, but it's still so small that it's not meaningful relative to the total fixed comp that we saw in the Williams-Sonoma brand, so I wouldn't read too much into that. From an occupancy perspective, if there is -- we've got investments that we're making from a capital perspective, and as those continue in the last couple of years, we have sort of stepped-up capital investments, and those layer on top of each other from a depreciation perspective, and that rolls into occupancy. So that's a lot of the reason why you're seeing higher occupancy but you do see it, obviously, of course, due to rent from -- the Dallas distribution center is one key player of that, but it's also all of our store leases and all of that put together. But I would say it's the biggest piece is from the continual investment in our business.

I'd like to share one more thing on Williams-Sonoma Home. While it is not material now, we have set some very ambitious goals for ourselves, and we believe that this could be a very large brand in the future.

And our next question comes from Matt McGinley with ISI Group.

My question is on unallocated expense and how that trended in the quarter. Last year, you had a lot of investment in talent, and I think it was some higher employment expense. This year you called out longer-term comp, or long-term comp vesting as being the increase. Is that $12 million step-up you experienced in the quarter the kind of the new run rate? Or is it just kind of a one-off thing, where it would it be that high? And then my second question is on the international revenues or the franchise revenues. What drove that decrease in the revenues?

Okay, sure. It's Julie, I'll take that. From the corporate operating margin perspective, that is something that's relatively unusual. As we said in our prepared remarks that we basically deleveraged 80 basis points and it's primarily due to the vesting of long-term incentive compensation. And really what that is, is that we incurred some additional compensation expense from the vesting of more equity awards from lower employee departures and higher payroll taxes on the compensation amount associated with those equity that's vesting due to higher stock price. So that's sort of -- we had a large 4-year cliff that came in that was granted back in 2010. It hit in this quarter, and so it has a sort of a disproportionate impact, given this is our smallest quarter of the year. So I would not assume that trend going forward at all. From an international franchise perspective, I'm assuming that's what you are alluding to. Basically I wouldn't read much into that, either. Last year the franchise partner somewhat accelerated more of their purchases into Q1, which they had then evened out throughout the rest of the year, so it's more of a year-over-year timing that makes it not comparable for this quarter. We actually have a plan to open 4 more stores with our franchise partner, and our relationship is very strong.

And we'll go next to Brian Nagel with Oppenheimer.

So I wanted to ask a question on gross margins as well, and maybe more from a bigger picture philosophical standpoint. But we saw for the first time in a while a positive gross margin. I think in response to one of the questions, you talked about some of the dynamics there. But the question I have is that just given kind of the focus of the company, which has been driving market share, to the extent that now some of the investments you're paying off in helping to drive margins, as you look at the margin going forward, would you be more inclined to reinvest that to drive more market share? Or what we should expect if these investments continue to pay off, margins will actually stay higher?

Yes, it's really nice to have the flexibility, as you can imagine, and what we're doing is really working hard to be very efficient. We have a culture of high performance and continuous improvement. And we believe we still have some things we can do to take more costs out of the product life cycle. And that will give us the opportunity if we want to invest more or if the market demands it to be more promotional. So it's hard to predict, but what I want to talk about again is the power of our operating model that allows us to be flexible, which I think is key in this retail environment.

And we'll go next to Aram Rubinson with Wolfe Research.

This is actually Carol in for Aram. You guys just have an enormous amount of data on all of your customers that you've used quite well to extend your brand across customer segments. Have you guys considered any category extensions beyond kind of the furnishing realm?

We are very focused on the home and it's our area of expertise. With that said, our Mark and Graham business has introduced us to some new categories. And we have in that business a disproportionate amount of accessories and jewelry. Very well selected under the heading of gifts and monogram personalized gifts. So that has been our first foray into anything other than home, and we're very pleased with the early results and how it complements what we do in the home.

And we'll go next to Laura Champine from Canaccord.

My question, Julie, is for you. So with the full year guidance not raised as much as you beat by on sales and earnings in Q1, does that indicate a shift in timing of store launches or any shift in your investments internationally? Or is there anything more than just kind of targeting your 3-year plan in that guidance?

No, I wouldn't read anything more into that. It's really that we're just -- it's early in the year, and we had this great Q1. But that doesn't necessarily assume that we're going to have that kind of outperformance every single quarter. So we're going to continue to read our trends and we'll adjust if necessary. But with that said, we did raise $15 million on the top in revenue and $0.02 on the bottom, and that puts us right where we want to be with our 3-year outlook.

And from Piper Jaffray, we'll go next to Neely Tamminga.

I just -- I want to drill on a little bit on West Elm. I appreciate the focus on Williams-Sonoma, but it is potentially going to be $1 billion business over here at West Elm, too. Could you remind me, Laura, in terms of how you're thinking about the $1 billion market? Is it just kind of the U.S., North America, or is that kind of your whole global vision? Do you think you're just kind of still testing the waters globally? And then the other kind of more strategic question I have is it just seems like West Elm can really do no wrong right now. And so the question is, what can't they do? And I'm just wondering at what point do you guys just reevaluate the footprint around what you can offer and explore with in-store especially looking at community? You do a really good job in social media community. Do you expand it into in-store community?

Thank you for the question. We have used the $1 billion mark to represent both domestic and global. But there you could make a case that, that's maybe modest at this point, given how large our Pottery Barn brand is and the appeal of West Elm and, in particular, globally. So we are -- trust me, as I said earlier, we have very big plans for this brand, and we are testing so many things and learning from them. We are careful to open the right amount of stores and to keep measuring the ROI of our store investments, and we are also very focused on building our direct business in West Elm that is growing very quickly. We're trying some really -- some new marketing techniques in West Elm that we've learned a lot from and are now rolling to other brands. And we are continuing to push the diversification of product and to work hard to make sure that as we get bigger, it stays very relevant to the customer and that it's different, as you can imagine, from Miami to Denver in how they would expect to see their West Elm. So we're being very careful as we grow to stay very relevant and personalized in our expression.

And we have time for one last question. We'll go to Anthony Chukumba with BB&T Capital Markets.

So I just -- just a really quick question. I mean, you talked to -- you touched on the franchisees internationally and sort of what drove the revenue decline there, but I guess, I was just wondering if you could give us a little bit of a color. It maybe didn't move the needle... [Technical Difficulty]

I'm sorry. Did we lose you?

Anthony, we've lost you. I'm sorry, Anthony, we seem to have lost you, so we can't hear you. Bad connection. So we're going to move to one final question from someone else.

And currently, there are no questions remaining in the queue. That does conclude the Q&A session for today. Ms. Alber, I'll turn the call back to you.

Well, thank you, all, for joining us. We really appreciate your support, and we look forward to talking to you again next quarter.

Thank you. That does conclude our conference call for today, and we thank you for your participation. You may now disconnect.