Welcome to the Williams-Sonoma, Inc. First Quarter 2017 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the call over to Beth Potillo-Miller, Senior Vice President, Finance, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you, Melissa. Good afternoon, everyone. This call should be considered in conjunction with the press release that we issued earlier today. Our discussion today will relate to results and guidance based on certain non-GAAP measures, including non-GAAP SG&A, operating margin, effective tax rate and diluted EPS, which exclude certain items affecting comparability. During the first quarter of 2017, we incurred severance-related charges of approximately $6 million or $0.04 per diluted share. These charges were recorded as SG&A expense within the unallocated segment. Also during the quarter, we incurred tax expense of approximately $1 million or $0.02 per diluted share associated with the adoption of new accounting rules related to stock-based compensation. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in our press 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 2017 and beyond, and are subject to risk and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current press release and SEC filings, including the most recent 10-K for more information on these risk 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.

Thank you. Good morning, and thank you all for joining us today. On the call with me are Julie Whalen, our Chief Financial Officer; and John Strain, our Chief Digital and Technology Officer. In the first quarter, we delivered total revenue growth of 1.2% and earnings per share of $0.51. In the quarter, we saw improvement in Pottery Barn, demonstrating the effectiveness of the brand strategies that we are executing against. Williams-Sonoma delivered another strong quarter with 3.2% comparable revenue growth, and we also delivered another quarter of double-digit revenue growth across West Elm; our newer businesses, Rejuvenation and Mark and Graham; and our company-owned global operations. And while the negative revenue comps in Pottery Barn Kids and Teen were disappointing, we did see sequential demand comp improvement in both brands. Strong execution against our strategic initiatives drove our Q1 results. We remain focused on delivering a superior customer experience and executing against our brand strategies, which we believe will drive growth acceleration and shareholder value. We are building upon our supply chain successes from last year and continue to invest in the customer experience. Our initiatives in the supply chain will significantly improve customer service and the delivery experience. With strategies and teams concentrating on key customer touch points, including order visibility, back order management, virtual home delivery and quality and damages, we continued to improve our customer metrics during the first quarter. Our customers are receiving their orders more quickly, and returns and replacements declined in the quarter, largely driven by supply chain efficiencies resulting from our initiatives. Key performance indicators like customer satisfaction, service metrics and Net Promoter Scores all improved significantly in the first quarter. We also continue to invest in e-commerce innovation. During Q1, we introduced the first in a suite of new digital products…

Thank you, Laura, and good afternoon, everyone. We are pleased we were able to deliver on all of our first quarter financial commitments and exceed the high end of our EPS guidance range while also investing in our long-term initiatives. Our first quarter results demonstrate our ability to execute against our growth and operational initiatives while, at the same time, maintain strong financial discipline. For the first quarter, net revenues increased 1.2% to $1,112,000,000 with comparable brand revenues increasing 0.1% on top of 4.5% last year. These results were primarily driven by double-digit growth across West Elm, our newer businesses and our company-owned international operations as well as strong year-over-year growth in Williams-Sonoma. This growth was partially offset by the Pottery Barn brands. In the Pottery Barn brand, however, we were pleased to see 270 basis points of sequential improvement in comp brand revenue from Q4, highlighting the effectiveness of the initiatives we are working on in that brand. In Pottery Barn Kids and PBteen, although their net revenue comps declined due to inventory outages across several key categories, they both saw sequential improvement in their demand comps. In our e-commerce channel, net revenues grew 0.7% to $581 million and represented 52.2% of total company net revenues for the quarter, relatively in line with last year's channel mix. This growth was driven by West Elm, Williams-Sonoma, our newer businesses and our company-owned international operations, all of which generated double-digit e-commerce growth. This growth was partially offset by the Pottery Barn brands. Our retail channels net revenues increased 1.8% to $531 million in the first quarter, primarily driven by West Elm and Pottery Barn. The improvement we saw across the Pottery Barn brand reflects the success we are seeing across our various retail initiatives, including increased density of decorative accessories and…

[Operator Instructions] And we'll take our first question from Christopher Horvers with JPMorgan.

So want to think about the advertising effort and the new merchandising introductions that you've done, particularly in the core Pottery Barn brand and understand where we are in that effort. So for advertising, do you expect the response to advertising to build momentum from here based on when you started it? And maybe, John, could you share some metrics around new customer acquisition as that's been such a big focus? And then on the merchandising side, how far are we into resetting the PB brand based on the customer research effort you did last year? I know you did a lot around giftables and decorative. But how far are we into getting to touch the rest of the assortment?

I'm going to let John start on marketing.

Great. Thanks, Chris. We've seen positive improvements in our visits and revenue derived from digital marketing, really, as a result of our Q1 investments. Overall, we're seeing our penetration of demand derived from marketing programs increase both sequentially and year-over-year. We're going to continue to optimize catalog expenses and shift that spend into our highly productive digital channels. I mean, in particular, we're seeing strength in our non-brand search terms, affiliates, remarketing and social programs. And at the same time, on the e-mail front, we're really excited about some of the continued positive results from our triggered e-mail programs and initiatives around new e-mail personalization models. So at this point, we're seeing nearly 40% of our e-mails driven from sales -- e-mail-driven sales coming from trigger programs despite representing less than 10% of our total e-mails sent. And I think these results reinforce the point. Relevance matters, hence our obsession with continuing to expand our personalization capabilities, so we remain relevant and targeted in terms of our messaging to our customers.

And just to take the question in the broader sense. Last year, early in the year, we realized that we needed to listen more carefully to our customers in what they're looking for. And as I think I mentioned in the last call, we did extensive customer research on what the customers were saying. And as a result of our brand work, we put together a quarter-by-quarter very aggressive execution plan covering both product innovation, digital operations, store remerchandising, value, and we've been executing against that successfully. I'd say that some of the really -- the strong good reads include small spaces, although it wasn't a big buy, as we received really good response and gives us confidence that it will be a meaningful contributor to the future. So that's one that we haven't even begun to maximize. Store merchandise, we've changed the merchandise strategies in our stores, restoring our tabletop and decorative accessories categories that people come to us for and that drives actually new customer acquisition. And the spring decorating and entertaining was a success. We saw substantial increase in our tabletop business and our decorating businesses and entertaining for Easter. And then, as John said, we continue to improve the online experience. We've always had a ton of content, and we have a chance to leverage that even more than we are online. So while we're pleased that our initiatives are checking, we're not by any means satisfied with the comp performance, and we will continue to drive hard with our team to improve it and to build upon what's working and then, of course, when it's not working, to pull back.

We'll take our next question. We'll go to David Magee with SunTrust Robinson Humphrey.

Just a question on the supply chain. You guys have done a great job squeezing efficiencies out of that and keeping your prices sharp. How much more do you have to do there over the next, say, 18 months?

Thanks for the question. Again, we've made a lot of progress with improvement across our customer metrics as well as lowering costs, but we see a ton more opportunity. We've been relentlessly focused on it, and we believe that service, reliability, quality and speed are keys to our long-term advantage. And as a result of the investments we've been making, our back orders are down. Our on-time shipping is up. Out-of-market shipping is down, which drives cost down, too. We've also regionalized our inventory, which is complicated to do, but because of that, we're seeing fewer out-of-market shipments, reducing our freight expense, decreasing our in-transit. I mean, the big opportunity for the future is further inventory optimization so that we're both in better stock and then have lower out of stock -- lower overstocks. And that, I think, will continue -- you'll continue to see improvements there on both sides. And at the same time, we can better communicate to our customer about where their order is through the delivery cycle. So yes, we've done well. Again, we have a lot more to do, and we are building a much more responsive, agile supply chain. And we are investing in the processes and technology to achieve the absolute best service at the lowest cost.

We'll next go to Matt Fassler with Goldman Sachs.

My primary question relates to an e-commerce line item on Pottery Barn in particular. So Pottery Barn accelerated or improved from where we were in Q4. I don't think you isolated the different brands in terms of e-com performance in Q4, but it seems like its e-commerce business was a notable laggard relative to the rest here in Q1. So how should we think about what's going on in the core furniture business online? Is this a competitive factor as the business recovers? And it sounds like PB has continued to gain momentum. Would you expect its performance in the e-commerce channel to recover as well?

Matt, this is Julie. I'll take that. So a couple things to answer that question. First, yes, we had lower e-commerce growth at 0.7%. But we still held our mix relative to last year at 52.2%, and we still held our profitability at 22.7%. The key takeaway is that all businesses, so West Elm, Williams-Sonoma, our newer businesses, our company-owned international operations, everybody had double-digit e-commerce growth, except for the Pottery Barn brands, which obviously, we've been working on and we saw the sequential improvement from Q4 to Q1 of 270 basis points. If you look at it on a 2-year basis, sequentially from Q4 to Q1, Q4 e-commerce growth was 5.1 and Q1 was 8.9, so we did see 380 basis points of improvement truly. And so with that said, obviously, the Pottery Barn brands at negative 1.4% total growth, given their size, impacts the total company e-commerce growth. So certainly, that is a big factor that we're continuing to work on. We certainly don't believe this is where e-commerce growth will stay, and as we continue to see Pottery Barn improve, you'll see this number change dramatically.

We'll next go to Michael Lasser with UBS.

I want to talk about the guidance a little bit. For the second quarter, you're expecting an acceleration across your comparable brand revenue growth. The comparisons do ease a little bit in the second quarter. So are you expecting the acceleration to occur across all the different concepts? And as part of that, I think you are still implying a 1% to 3% type growth rate for the back half of the year. Is there any reason why it should slow after an acceleration in the second quarter?

So our guidance reflects, obviously, our best estimates as the possible range of outcomes. Yes, at the high end, it assumes approximately on -- from a revenue growth perspective, about 500 basis points of sequential improvement. And obviously, given the sequential improvement that we saw on the Pottery Barn brand and the continuous double-digit growth in our growth initiatives, it gives us confidence in our ability to drive that improved growth, but, of course, it depends on the overall environment and the things that are out of our control. We are also aware that retailers are being aggressive with their liquidations and promotional stance. We believe the range of possible outcomes we have provided are appropriate at this time.

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

My question is centered around West Elm. I think you had noted on the last quarter comp that there was some distraction in November that, that was cited for the slowdown in the comp last quarter. Why didn't we see more of an uptick in that business in Q1? And what can we expect for the rest of the year?

So I mean, let's first pause and say that we still believe that West Elm will grow to be our largest brand over time. This brand has experienced, as you know, double-digit comp growth for 7 years straight, and they've reached now over $1 billion. So you can't expect that this brand will grow double digits in perpetuity. But with that said, this brand still had a really strong comp of 6 on top of a 19 last year, and they continued to experienced double-digit revenue growth. They also had stronger demand comps than net. So had we had the necessary inventory on hand to fulfill this demand, their net comp would have shown an acceleration from the fourth quarter. So at the end of the day, we continue to be very pleased with the growth in this brand, and there still remains an incredible runway for growth. And I wouldn't really read anything more into it.

We'll next go Dan Binder with Jefferies.

It's Dan Binder. I just wanted to go back to your comment about the reduced flat shipping fee for the Pottery Barn business. Can you just give us a little bit color on how that's changed, what it was before? And I think it's $99 now based on what I saw on your website. But just curious, is this a path to potentially even lower shipping fees if it does stimulate sales? I'm not sure if you've ever broken it out. But if you would eliminate shipping fees entirely, what would that do to margins?

Yes. We have not broken that out. Our goal is to be ideally break-even from a shipping fee perspective, and we want to make sure that we're giving value back to the customer. So at the end of the day, we're testing different models, and the initial response to this model is very strong. And so we're going to continue with that. But obviously, I think the way to look at it is we started this with the Pottery Barn brand back basically in Q3, we rolled it out to the other Pottery Barn brands at the beginning of this year, but if you look back, our selling margins and our operating margin in the DTC channel have remained very strong. In fact, we still have a selling margin that's the highest it's been in 2 years. So the impact of it, we're obviously getting the benefit from the top to end.

We'll next go to Greg Melich with Evercore ISI.

I wanted to follow up more specifically on 2 things. One, Pottery Barn, what are the areas, if we look of the sales, where they're not coming through, are there some things? Like a few quarters ago, you mentioned opening price point items and trying to broaden that out. You mentioned top of table. So I'd just like to maybe add a little bit as to what you really think you're missing there to get that back on the path that we're used to seeing.

Yes. I think it's always innovation, and customer recognizes value and design innovation. There's been a lot of people, obviously, who've seen our success and copied it. And the great news is that the team has put together, in a very quick time, a very compelling assortment that attracts a wider range of customers. So you can look online or in a catalog or in the stores, and you're going to see some new looks for Pottery Barn that are -- they are proving to attract the new customers, whether it's because of size or aesthetic or more urban. And it's all under the same Pottery Barn aesthetic and value proposition. So I think when brands get [ 2, 1 no ] or they become too expensive, they shorten their ability to grow. And it's clear to us that Pottery Barn, as a brand that is loved by our customers, is great when it's inspiring and friendly and decorative. And that is what you're seeing from us now and you're going to see even more improvements through fall and holiday. We're very excited about what's to come.

We'll next go to Simeon Gutman with Morgan Stanley.

Julie, a follow-up on the second quarter guidance and then in relation maybe to longer term. So the top line guidance, pretty solid, 2% to 5%, and I think at the high end, that translates to modest year-over-year EPS growth. Within it, I'm getting to flattish operating profit growth even on the high single-digit comp. So if that math is fair, what is it understating vis-à-vis the flow-through of the business? Because I would have expected it to look a little bit better. And just as a tie in, if you could touch on the digital advertising, if that's one of the causes of the holdback, what's the duration? And then the shipping investments, how long should that persist?

So basically, you kind of answered your own question. Those are the 2 reasons for why you're not seeing it necessarily flow through as you would typically. We said, even on our last call, that we are going to be making this year investments in digital advertising and reduce shipping income. We're in this to be #1. And so we need to be able to make these investments in our future growth, and so you're seeing a more significant step-up with the advertising investments in the second quarter.

We'll next go to Peter Benedict with Robert Baird.

So kind of a clarification and then a question, kind of follow-up on the last one. Just a clarification, in the first quarter, it looked like the stock-based compensation was down significantly, like 38% year-over-year. I'm just curious what drove that. I'm not sure if you mentioned that during the SG&A comments. And then the question really kind of dovetails off the last question, which, as we look to the second half of the year, the guidance certainly implies improved EBIT margins year-over-year. Is that just the effectiveness of the digital advertising starting to flow through? Or are there other factors we should think about with respect to driving margin -- operating margin expansion in the second half of the year?

So the stock-based compensation every Q1 basically, we have a significant true-up to our stock base depending on who's here, who isn't here. So I wouldn't read anything more into that; it's a normal Q1 exercise. As far as EBIT improvement throughout the rest of the year, obviously, as we make the assumption that we're going to have higher growth rate on the top line, that flows through to the EBIT.

We'll next go to Steven Forbes with Guggenheim Securities.

Maybe just regarding the in-home design services you mentioned within the prepared remarks. Can you expand on what the anticipated rollout of that program is, whether it be you're testing it on a regional basis, where it's going to be a national offering? And then how do you think about the maturation of it as far as driving new customer acquisitions or targeting your key members? Maybe just touch on how you're thinking about the maturation of the program.

Yes, a great question. Highly competitive, though, so I need to caution the -- myself against sharing too much here. So it's -- what we see is the opportunity to use our brands together to better serve our customers, and while they're very independent and have different aesthetics and value propositions, we know that we all shop and the good customers shop across them. And so we're seeing great response from The Key, and we can use our Key rewards not just in the form of dollars but in the form of services to help our customers furnish their homes because we know that different than apparel, different from other categories, furnishing your home is a more complicated decision, and we have studied and seen that customers go to store, they go online, they go back to the store. And so design services, both online and in-store, across multiple brands with different aesthetics is a very powerful, competitive advantage because while there are others who are doing only online or others who are doing it only in stores, we're one of the few that can do it in both places in synergy across these multiple areas and into the kitchen and into the hardware that Rejuvenation sells. So that is a very exciting initiative that we're going to be rolling in Q2. We're in training now and you'll start to see it throughout our fleet at the end of Q2 and throughout the balance of the year.

We'll next go to Brian Nagel with Oppenheimer.

So maybe a bigger picture question. But if you look at the sales results here and, clearly, there was some nice acceleration in a couple of core brands. You've talked in the past about the overall environment. So how would you frame the environment here or for your company in Q1? I mean a number of other retailers have discussed a choppy sales environment over the past few months or so. Some of these factors like weather and delayed tax refunds may not have had as big impact. But -- so how would you frame the overall environment, how that may or may not have helped that -- some of that sequential improvement?

Great. There's more competition coming in, particularly at the low end, and there's still the big-box retailers who have been offering furniture for a lot of years. And we've just learned that Amazon is going to come into the furniture business. We believe that actually Amazon will take more market share from the mass retailers than anyone else, and we will continue to carve out our specialty niche with our edited inspirational assortment and decorating ideas for our customers. We know that our stores are a competitive advantage because they're experiential, and they're the fullest expression of our brands. And as I just said earlier, we offer our shoppers an integrated experience across channels, and our retail stores help drive e-commerce sales. Retail traffic's down 9. We all read those numbers. Our traffic is down a lot less. And we believe there's a huge interaction between our online and our stores obviously, and we're going to continue to maximize the opportunity. So I'd say that, yes, it's definitely competitive. We don't see the promotional environment going away, and as Julie said, we see a lot of people liquidating a lot of inventory. And we believe that we are going to outperform because of our sustainable, profitable model. There's ways to grow, and there's ways to grow profitably. And there are a lot of people growing, but I guess the question is this growth sustainable. I can tell you ours is. We're disciplined. We prioritize our initiatives, and our strong cash flow generation gives us the flexibility to invest in our future.

We have time for one last question from Charles Grom with Gordon Haskett.

Just when we think about the Q2 view of up 2% to 5%, is that a function of the compare getting easier? Or was there inflection in the first quarter business as you guys progressed through the quarter? And then could you also talk about your customer base today and how much of your sales are from new customers versus existing customers by banner?

So as far as the guidance, the biggest differential is the continued improvement in Pottery Barn is what our expectations are. So we saw the sequential improvement from Q4 of 270 basis points, and we believe that Pottery Barn will continue that momentum as they move throughout the year. So that is the biggest driver of the guidance.

And as far as those new customers, where we're at, we track that customer file very closely. New to corp, new to brand are 2 of our key metrics in terms of being able to grow the brands and really be healthy over the long term. And we're happy to report we saw very solid growth in our digital new-to-corp customers in Q1, and digital market remains our #1 source of new customer acquisition across all the brands. Williams-Sonoma continued to be a large -- our large contributor in terms of new-to-corp customers, sourced from both digital and stores, which we read as a really strong sign for the health of our WS brand.

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

Well, thank you all for joining us. Have a great summer. We look forward to talking to you at the end of Q2.

Thank you. And that does conclude our conference call for today. We thank you for your participation. You may now disconnect.