Welcome to the Williams-Sonoma, Inc. Second Quarter 2015 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the call over to Ms. Gabrielle Rabinovitch, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead, ma'am.

Thank you, Tom. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. This call may 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 2015 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 and 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 fiscal 2015 results.

Thank you, Gabrielle. Good afternoon, everyone, and thank you for joining us today. On the call with me are Julie Whalen, our Chief Financial Officer; and Pat Connolly, our Chief Strategy and Business Development Officer. We're pleased to be discussing our second quarter 2015 results with you today. In the second quarter, net revenues grew 8.5%, with comp brand revenue growth of 6.3%. We are pleased to have delivered another quarter of solid performance, once again demonstrating the competitive advantage from our multi-brand, multichannel business model. We believe that our balanced approach, which leverages the capabilities of each channel, is differentiated and will allow us to drive continued market share growth in the future. We have an intense focus on the evolving shopping patterns of our customers and the opportunity we have to deliver an exceptional experience. As always, we are focused on disciplined execution against our long-term growth initiatives. Towards the end of the second quarter, our stock position materially improved as we received inventory in our core products as well as our early fall and back-to-school floor sets and collections. We saw significant improvement in our order fill rates as inventory levels recovered, and we are committed to providing high levels of customer service through the back half of the year. We also continued to invest in our supply chain technology infrastructure and our e-commerce capabilities in Q2. In supply chain, we continue to focus on enhancing inventory planning and allocation systems and we are upgrading our customer order visibility tools. In e-commerce, we are improving our on-site search experience, personalizing content on our websites and enhancing our mobile shopping experience. Across all these initiatives, we made meaningful progress in the second quarter. Now I'd like to update you on the developments in our brands, starting with Pottery…

Thank you, Laura, and good afternoon, everyone. We are pleased with the results we are reporting today. Our second quarter performance speaks to the strength of our portfolio of brands as we delivered a solid quarter, despite absorbing incremental shipping and fulfillment-related costs associated with the lingering effects of the West Coast port disruption and investing in our long-term strategic initiatives. Our strong Q2 performance demonstrates that we continue to take market share with our home furnishings brand, reporting another quarter of revenue growth well ahead of the industry. And heading into the second half of 2015, we believe we are well positioned for additional market share gains and to expand the reach of our brands. Before I walk you through our second quarter financial results and our third quarter and fiscal year guidance, I would like to update you on the financial impact during the second quarter from the effects of the West Coast port disruption. During the second quarter, as expected, we saw higher shipping and fulfillment-related costs from shipping inefficiencies stemming from inventory shortages and unbalanced inventory positions across our distribution centers. We entered the period with elevated back order levels as a result of delayed receipts. In order to get the goods to our customers as quickly as possible, multiple deliveries on a single order as well as out-of-market shipments were made as we got back in stock. Though the financial impact directly related to the port is hard to measure with precision, we estimate it to be $0.04 in the second quarter, primarily due to higher shipping and fulfillment-related costs or approximately 50 basis points to our gross and operating margin. Additionally, our supply chain incurred incremental labor costs. Heavy inventory inflows from both the delayed inventory as well as inventory receipts for our seasonal…

[Operator Instructions] We'll take our first question from Peter Benedict with Robert W. Baird.

Just was hoping the labor costs in the supply chain that hit SG&A, any way you can kind of quantify that? I think that was probably one of the bigger surprises in the P&L in the quarter. So anything further you can give about that and then maybe how you see that line over the back half of the year.

Sure, I'll take that. It's Julie. We have not specifically quantified these indirect costs. Of course, it's hard to disaggregate them with precision. But one way to look at it, of course, in our Q2, our operating margin declined 80 basis points, of which we said 50 basis points was primarily associated with the higher shipping and fulfillment-related costs due to the port. I think it's safe to say that the incremental indirect costs were at least the remaining 30 basis points. Going forward, we expect some additional labor and incremental shipping costs will continue, primarily in Q3, but obviously not to the degree we saw in the first half as we continue to rebalance our inventory levels especially at our West Coast DC. But we're also accelerating our investment in technology. So it's not just labor costs, it's also investment in technology. As we are growing, and particularly in furniture, it is important to make the necessary investment in technology to support this growth. So as such, we're accelerating our investment in inventory tools to allow us to better forecast our inventory flow and space capacity requirements by DC, brand and channel. And additionally, future system enhancements will give us better customer order visibility, allowing us to know every touch point where that inventory resides. This investment in technology is obviously primarily a capital investment but there is some additional expense associated with that. And all these additional costs are reflected within the guidance we have provided today. And we believe that these additional costs are an important investment in superior customer service, longer-term supply chain efficiencies and of course, maintaining our competitive supply chain advantage.

We'll take our next question from Daniel Hofkin with William Blair & Company.

I guess just to clarify quickly, and then one, I guess, more substantive follow-up. On the tax rate in the quarter, were you expecting those -- the positive resolutions within your original second quarter guidance? And then I had just a follow-up regarding -- given that your in-stocks are approaching a better position now, curious kind of about the third quarter guidance. Obviously, you have a tough comparison last year, but are you seeing any evidence of either in your second quarter results or early third quarter of slippage in the consumer environment?

Okay. Regarding the tax rate, no, we weren't aware of that when we first gave out our guidance. Obviously, there are things that change as you go through any quarter. And there's variability with your tax rate and obviously, this was a good guide for us. So that's a positive. On the flip side, we also didn't expect these incremental supply chain costs. And so thankfully, we had this and we still landed a very solid quarter at $0.58.

On the second part of your question, Dan, I'll take that, the macro. Look, we're watching the market along with everyone else. It goes without saying that a significant sustained pullback in the stock market could lead to a reduction in consumer confidence and impact the discretionary spending landscape. But that being said, our demand has been strong all year, particularly our furniture business, and recent economic reports in housing and consumer confidence are positive. And I believe our brands are well positioned to gain market share in the second half.

And we'll take our next question from Kate McShane with Citi.

If I could ask a question around the investment. Can you -- I'm sorry. Do you anticipate these costs to continue through Q4 of 2015? And could they possibly continue into the next fiscal year? And how long does it take for these type of systems to ramp up before they become beneficial to the business?

I'll take that. It's Julie. I think the labor costs we're expecting is going to be predominantly in Q3 as well as the shipping costs. Obviously, Q4 has got a lot of noise going on with it, given it's the holiday quarter, so there'll be things going both directions from that. But specific to this incremental investment, labor, we expect and shipping primarily we expect to be in Q3. The investment in the inventory tool obviously is a multiyear investment, but we'll be rolling out enhancements as we move even through this year and through the next year or 2.

I think that the big thing to remember is that shipping furniture and large cube has always been a competitive advantage of ours and a big differentiator. There's a lot of people who sell stuff and have websites. And if you can do that really hard thing well, you put yourself ahead of the pack. And it's just really crystal clear to us that customer service in this area and high touch is incredibly important. And honestly, while the port disruption was extremely difficult, the good news is that it caused us to re-examine every single element of our supply chain. And we have identified significant opportunities to improve service levels and over time, drive down costs.

We'll take our next question from Chris Horvers with JPMorgan.

Can you talk about the Williams-Sonoma brand a bit more? Where did the comp come in relative to your own expectations, assuming you would have seen some of the shift in the electric launches? And then can you talk about some of the key items that launched last year in the second quarter?

Yes, we were disappointed that we weren't able to completely offset the big launches in electrics in Q2 of last year. Last year, we had our big Nespresso and Vitamix launches in the quarter. And our cookware, as I said, a lot of our proprietary businesses were very strong, but they weren't strong enough to completely offset those releases. And why we're confident that this is going to improve is that we have more releases in electrics and across all of our businesses, as I mentioned earlier, towards the back half. Also one of the other businesses that was a disappointment further than what we planned is our outdoor business because frankly, the market has been saturated with a lot of outdoor cooking items. And we didn't see enough real innovation to invest in that. We didn't want to just drive markdowns. So we pulled that back probably a little bit too far, frankly. And that's an opportunity for us going next year, to drive more innovation in that area and also obviously, it's not a big -- as big a part of the business in Q3.

So as a follow-up to that, the Sonoma brand becomes a lot more important as you look into the back half of the year. So the launches aside, do you think the brand's positioned to get back to positive levels in the back half?

I think we have a very exciting lineup for the back half, both through Q3. Our Thanksgiving entertaining assortments and food stories, as I said on the prepared remarks, are very strong. We have a lot of key big money introductions. And then Q4, it's very competitive obviously to talk about the specific product lines. But I think we have a lot of opportunity, not just with the product line but peak season execution and providing our customers with a great experience and being more efficient, frankly, than we were last year.

We'll take our next question from Greg Melich with Evercore ISI.

I wanted to follow up a little bit on the moving pieces on the margin line. If it was 50 bps from the ports and occupancy leveraged 40, it seems like everything else, gross profit margins were down around 60 bps. Could you help us understand what drove that? Was it promotion, shipping costs, anything else in there, and how you'd expect that to trend going forward?

Sure. Yes, gross margin was actually down about 70 basis points, and 50 basis points, as we said, was due to the port with the higher shipping and fulfillment-related costs. We also have in there, which I know creates a little bit of noise, but when we have higher franchise revenues, technically, that puts pressure, so to speak, on the gross margin because it's a cost-plus model. And so it impacts the gross margin with very few costs in SG&A that drops down to a higher profitability at the op margin level. And so you're seeing about 20 basis points of impact within the gross margin level for that. We also had some higher fulfillment-related costs that were primarily offset with the 40 basis points of occupancy leverage. But I think the really great news, which is unfortunately under the covers, you guys can't see it, is that the pure merch margins are essentially flat to up. And I think you've been hearing me say that now for a few quarters. And what that tells us is that the health of the business is great and that the fact that our long-term initiatives such as the insourcing of our foreign agents is working. And so that's a really great story, I think. Unfortunately, we have the noise of these higher shipping costs that over time should improve. And as you mentioned with the occupancy leverage, these pure merch margins that are flat to slightly up and then the shipping cost going away, we should see improved margins over time.

And linked to that, the franchise revenues with all the launches coming and the Philippines getting ramped up, was that a key driver then to the retail EBIT -- EBITDA profitability improvement?

The retail profitability was about 10 basis points and that was primarily due to occupancy leverage. That was the biggest driver. But the retail revenue was both from the new West Elm stores that outperformed and the incremental acceleration of both our franchise and company-owned stores.

We'll take our next question from Matthew Fassler with Goldman Sachs.

I want to ask one quick question on the quarter for Julie and then a broader strategic one. On the quarter, just to make sure I understand the relationship between the e-commerce sales versus the retail sales, retail seemed a bit better than we expected, e-commerce a bit light. Are the inventory issues really much more focused on the e-commerce or direct-to-customer business than on retail? Were you able to overcome shipping challenges when you were distributing to stores more so than to customers?

If you're talking about the revenue line --

Yes.

I mean, we are really focused on total brand performance. And so we are actually really pleased with the results of both channels. I know there's been some focus on e-commerce only had a 9.1% but with total revenue growth of 8.5%, we had strong growth effectively of both channels. And so obviously, sometimes, the customer's going to want to shop online, sometimes, they want to shop in the store, and we want to serve them wherever they want to shop. So I really wouldn't read anything more into it than that.

Fair enough. And then taking a step back on the strategic side, as you think about this inventory initiative and the supply chain initiative, it seems like you're putting real money against capital and SG&A. Is this primarily in response to what you saw related to the ports, and how you felt you were able to handle it? Was this something that was emerging prior to that? Because it seems like it's -- certainly, the impact of investing against it will last prior to the port issue, the discrete port issue getting resolved.

Yes, I mean it's a -- what I said earlier is that whenever you have something that happens of significance, you learn a lot and you get into it. And we see opportunities to both being better in stock and then to cut overstocks, and hence our inventory optimization initiative. And as I think you all know, we've regionalized our network, and that's a big change from the way we used to run it. And so we have a lot of opportunity to understand better customer demands by region and get the product there the first time in the right place. And the supply chain is critical. Customers have a lot of choices. And the -- it's one thing to buy something. You need to have a great experience. And so as we've gotten into this, we've seen that this is a strategic investment that is so important to the core of what we do, which is to serve our customers better than anyone else.

And we'll take our next question from Michael Lasser with UBS.

Based on a comment that you made a little bit earlier, it sounds like your product costs are pretty stable. So should we interpret that to mean that the promotional activity across all the brands hasn't really increased, especially in light of the changing and very dynamic competitive landscape we're seeing that Wayfair and some of the online-only players are growing quite rapidly versus the traditional department stores, which are seeing more sluggish trends. So is that influencing the company's promotional posture?

Our promotional calendar has been strategic and competitive. We plan it in advance and assess it on an ongoing basis. Our posture is to be competitive. We expect to continue to take market share through the back half of the year, and the reality is the competitive environment is a reality. And we talked about before, we've anticipated this. We've made changes in our supply chain to allow us to be more competitive, most notably, the insourcing of our foreign agents, our in-house product development. And we're focused on giving our, most importantly, our customers inspiring and innovative products at great prices.

And we'll take our next question from Seth Sigman with Crédit Suisse.

You discussed the EPS impact from the port issue. But just wondering, did you mention the sales impact? I think you had expected a $5 million to $10 million impact. So if you could just clarify that and where maybe you saw the biggest impact. And then the second piece of that, just excluding that disruption, any color on trends you're seeing within some of the bigger-ticket categories or any color on the composition of the basket as we try to assess the health of the consumer?

From a sales impact for the port, I guess the good news is that it was less than what we anticipated. We hadn't really quantified it because as the farther out you get, just like when we said in Q4, the beginning of it and the end of it gets really murky, as to what's causing what. And so we believe that there was definitely an impact in Pottery Barn Kids, which is what we had expected. But it wasn't anywhere near where we thought it would be in the range of the $5 million to $10 million. And so it really was for us in Q2, the port story was about higher shipping and fulfillment-related costs.

The second part of your question, I'm sorry, on the macro, as I said earlier, we're 3 weeks in, we have a labor day shift. We have had a lot of market volatility. We never read too much into short-term volatility or changes that are based on volatile markets, we've seen it before. But the balance of what we're seeing is that we have a strong lineup for the balance of the year. The key aspects of our business that differentiates us haven't changed from our strong brands, our multichannel model, our superior supply chain. And we are focused on profitable growth. I think that holding yourself to a high level of profitability forces a discipline that ensures success. And so regardless of what happens in the macro, we believe that we are poised to take share.

And we have time for one final question today. It comes from Simeon Gutman with Morgan Stanley.

Just one clarification and then one strategic. Clarification, related to a lot of the questions this quarter, the 6% brand comp was fairly solid, but the cost of doing business obviously was a bit higher, and you mentioned mostly -- actually explained most of the weakness. Can you talk about how much of, I guess, generating that 6% comp or the extra fulfillment is tied to the business just this quarter? Or is that also getting yourself ready for the following, such that we won't keep some of that. My strategic question is -- Julie, you largely diffused this with the comment on merch margin. You're coming off a transition with insourcing, and of course, this hit at a similar time with some of the port issues. Is there anything related to the 1 or the 2 at all? I just want to diffuse that thought if there is any connection.

So I think -- we're trying to understand your question a little bit. But I think on the costs that were incurred in Q2, we did say earlier that, that will continue. It's not necessarily related to cost of getting a 6.3% comp if that's what you're alluding to, it's really the incremental cost associated with the port, the higher shipment and fulfilling costs but also this incremental supply chain labor cost, and those will continue to some degree into specifically Q3, maybe a little bit in Q4, but predominantly Q3, but not at the same levels that we have been trending.

So service level didn't suffer, meaning that -- to the point where you could have done a better comp? Or -- I know that, that was the last question, on how you think about that. But meaning the premise is, had you not had to spend all this incremental labor, would you have also had better sales?

Well, that's hard to disaggregate. I mean, who knows?

Okay. And then to clarify the second point. It was just you're doing the sales sourcing. This year, there's been some disruption with inventory. It all looks like it's related to the port issues. I'm just trying to disaggregate that there's anything to do with insourcing and disruptions from there at the same time.

No, no, not at all.

And that concludes our question-and-answer session today. I'd now like to turn the conference over to Ms. Alber for any closing remarks.

Well, I want to thank you all for joining us again today and asking great questions and thank you for your support. We'll talk to you next time.

Thank you, and this does conclude today's conference call. We thank you for your participation. You may now disconnect.