Welcome to the Williams-Sonoma, Inc. Third Quarter 2018 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the call over to Ms. Elise Wang, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you. Good afternoon. 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. A reconciliation of the non-GAAP financial measures to the most comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in Exhibit 1 of 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 conditions, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2018 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 release 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.

Thank you, and good afternoon, everyone. On the call with me today are Julie Whalen, our Chief Financial Officer; Felix Carbullido, our Chief Marketing Officer; and Yasir Anwar, our Chief Technology Officer. We delivered third quarter with EPS at the high end of guidance and continued strength in demand and customer growth. This performance demonstrates our team's strong execution, the ongoing benefits of our strategic initiative and the power of our multichannel, multibrand model. Given the substantial progress we've made in our business this year and our compelling pipeline of innovative products and inspiring content, we believe we are well prepared to deliver this holiday season and remain on track to meet or beat our full year guidance. Now let me provide a summary of our third quarter financial results. Net revenues grew 4.4% with comparable revenue growth at 3.1%. Demand comp, which accounts for total customers -- total customer orders placed in the quarter was higher, accelerating sequentially to 4.6%. The difference between demand and net resulted from unexpected delay in product receipts this quarter caused by congestion out of China as many U.S. importers accelerated their shipments before the tariffs went into effect as well as a higher-than-expected amount of dropship sales that take longer to fulfill. Despite this disruption, earnings per share for the quarter grew 13.1% to $0.95 per share, at the high end of our guidance range. Our financial results this quarter were once again driven by our team's strong execution of our 4 strategic priorities: digital leadership, product innovation, retail transformation and operational excellence. Let me start with some highlights in digital leadership. Our innovation efforts are driving customer acquisition and e-commerce growth to an all-time high of 55% of total revenues. We continue to leverage the power of our multibrand portfolio, launching 2…

Thank you, Laura, and good afternoon, everyone. Our third quarter results reflect the momentum we are gaining in all of our strategic initiatives and our continued commitment to operational discipline. We are pleased that despite a delay in product receipts we experienced in the quarter, we delivered top line results within our guidance range; demand comps outpacing the second quarter and last year; e-commerce revenues growing over 8% to an all-time high of 55% of total revenues; continued strength across our gross and operating margins, including e-commerce and retail operating margin expansion; earnings per share at the high end of our guidance range with double-digit growth; and a strong balance sheet with inventory growth again substantially below revenue growth. Before I discuss our results in more detail, a reminder that our third quarter 2018 results include the financial impact from the implementation of a new accounting standard associated with revenue recognition. Similar to last quarter, the impact associated with the re-class of other income from SG&A into net revenues resulted in an approximate 100 basis point improvement to revenue and a 60 basis point swing in margin improvement from SG&A into gross margin. The remaining impact is primarily associated with the timing of our revenue recognition for certain merchandise shipped to our customers, which is dependent upon our performance during the last week of the quarter. Now let's review our third quarter financial results. Net revenues in the third quarter were $1,356,000,000 for a year-over-year growth of 4.4%, and comparable brand revenue growth was 3.1% on top of 3.3% last year. Demand comps, which include orders placed by customers that are not yet fulfilled, were higher at 4.6%, accelerating sequentially and versus last year. We are pleased to see this continued strength in customer demand. By brand, comp growth for…

[Operator Instructions] We'll take our first question from Michael Lasser with UBS.

It's going to come in 2 parts to squeeze it in under the definition. So first part is should we consider the difference between the reported comp of 3.1% and the demand comp of 4.6% due to the issues with dropship and congestion in China? So is that 150 basis point spread all due to those delays? And should we just add that to our 4Q comp estimate? And then you said you're working to aggressively mitigate potential impact from tariffs. But can you help us understand the potential impact next year given that you previously said about 15% of your sales are currently subject to the tariffs?

Okay. So on the first question -- Michael, this is Julie. Basically, yes, the complete spread of 4.6% to the 3.1%, 150 basis points, is due to fulfillment. And so there's 2 pieces to that. There's the fact that we had congestion in the China ports that caused a delay in product receipts, and we also have a shift to higher sales associated with dropship sales. So those take longer to fulfill. And so those should come in into the fourth quarter, of course, those are assumed within our guidance. As far as tariffs, just to clarify, you said 15% of sales. We actually said it's 15% of total cost of goods is the impact to us. And as we said in our prepared remarks, we are aggressively going after offsetting that impact by lowering the cost from our vendors by resourcing where we source our products from out of China and then obviously looking for every way possible to find cost savings throughout the company.

And just to clarify also for you, Michael, we're assuming that the tariffs go to 25% as they have been communicated. Of course, if that changes, that would be great. But right now, we're assuming the worst case scenario.

And if they do go to 25%, is that going to have a meaningful impact on your margin in 2019?

As I said in my prepared remarks, we have been executing against a very aggressive plan to mitigate the impact of the tariffs and stay ahead of future risks. And we're very lucky that we're vertically integrated. We have a multi-country supply chain, and we have really great relationships with our vendors. So we're moving a lot of goods out of China. We're renegotiating with our long-standing Chinese vendor partners. And then as I mentioned earlier, we're looking at every other part of our business to find other cost offsets. And we're really pleased with what we have targeted. So we are looking to mitigate every dollar next year of the possible tariff risks, that is our intention.

We'll now take our next question from Peter Benedict from Baird.

I guess just a question on the operating margin plan for the year. 8.4% to 9.0%. If we look at the midpoint of the revenue guidance maybe for the fourth quarter, it would seem to imply that the margins in 4Q would have to be up anywhere from 80 to maybe even a couple hundred basis points to kind of get into that 8.4% to 9% range for the year. Are we thinking about that correctly? And if so, just curious what would be the driver of that level of expansion in the fourth quarter?

I think you're thinking of that correctly. I think obviously the op margin is a play on the revenue. If we come in at the higher end of the revenue, we continue to have healthy selling margins, and obviously, that leverages the P&L and drops all the way down that we've seen in the beginning of the year. So it depends on your assumptions. But if you're at the high end of the revenue range, you should see that op margin expansion.

And just as a follow-up to that, Julie, did I hear you say that the EBIT margin decline in the third quarter of 90 basis points, did you say all of that was the incentive comp change or did I mishear that?

No, you heard that. So if you look at the corporate unallocated deleverage of 150 basis points, almost all of that is due to this higher compensation that we have this year from lower compensation last year. And so but for that, our operating margin total company would have expanded because if you look at the retail and e-commerce channels, they both expand. So the health of the business is incredibly strong. We just have this one moment in time where we had a difference in incentive compensation because we didn't earn it last year.

Got it. And then the fourth quarter, it's expected to be more similar year-over-year, that's the point?

Yes.

We'll now take our next question from Chuck Grom with Gordon Haskett.

This is Andrew on for Chuck. I had a question on full year sales outlook. So to get to the midpoint of the comp guidance, it implies a pretty material acceleration on the 2-year and 4Q across your biggest brands. Can you guys help us understand a little bit like what's going to drive that acceleration in the fourth quarter? And then I have a quick follow-up.

Well, I mean if you look at our year-to-date performance on a 1-year basis, we're essentially at the high end of our guidance. So I mean, yes, you can look at it at 2-year and come to your own conclusions on that. But at the end of the day, we feel confident we have no reason to believe that we can't continue to drive that top line especially given all of the strong customer counts that we have, the strong traffic we have, the momentum we're seeing in the e-commerce business. And again, our demand just accelerated from second quarter, so the health of the customer and what they want from our business is still strong. You also saw Williams-Sonoma accelerate from the second quarter, and they become a bigger piece of the pie next year. So given all of our product pipeline, the fact that our teams are ready more than ever with the increase in the hourly wages, we've been able to get them lined up, an incredible lineup of talent to be ready for this holiday season. We feel very strong that we can hit the high end.

That's great. That's helpful. And then if I could just on the gross margin line, ex revenue, add rev rec impact, I know you guys talked about the components. But can you give us a sense of the magnitude of the different components of gross margins this quarter versus second quarter?

Well, so we don't typically go through all the line items. We typically tell you selling margin was up 50 basis points. It was up 10 basis points from an occupancy perspective. For total gross margin, up 60. If you back out the accounting, it's essentially flat across the board. But I think what's important to realize is that we drove these healthy margins, and we had demand comp that was higher, and we had shipping costs that were higher because we were able to offset it again with another quarter of incredible supply chain efficiencies. So it really speaks to the fact that our initiatives to both streamline the promotions and to continue to drive efficiencies across our company enabled us to hold our selling margins and gross margin.

[Operator Instructions] We'll hear our next question from Chris Horvers with JP Morgan.

So if -- I'm just curious on the demand comp. Did Williams-Sonoma and West Elm have a demand comp versus actual comp this year? Was that mainly in Pottery Barn? And if not, for West Elm, I mean it's a pretty similar type of product mix. Why wouldn't West Elm would have that impact? And then as it relates to the fourth quarter guide, I mean you did widened out to 0% to 5% versus 3% to 5% in the first half of the year. So if you have this visibility to an incremental 150 basis points, it's already in the bag, so to speak. Why widen the guide out so much? Is that -- do you expect further demand comp issues?

So on the West Elm and the other brands -- all brands were impacted by the delays out of China. And so all brands except for one of the smaller brands had demand comps that were higher. So your question on West Elm, they would've been even higher. That's how on fire they were. So I wouldn't read anything into that. As far as the guidance range, there's a couple of things going on there. I mean first of all, we just held the fiscal year. We raised twice this year already. So given we hit our guidance, we saw the prudent thing to do was to hold our fiscal year, and that's just sort of the math, which is equal to the implied guidance that we gave you guys last quarter. There's not a big story there. I mean the only thing I could -- other -- point to on that front is the fact that we do have this China delay, and we're obviously watching that closely. We do expect that to be cleared up in the next couple of weeks. But in the event that doesn't, that could cause us to be at the lower end of the range, which by the way as was mentioned earlier, on a 2-year basis, it's still in line with our trend.

And then just a quick follow-up. So the selling margins up 50, that includes the accounting benefit?

Yes.

[Operator Instructions] We'll hear now from Simeon Gutman with Morgan Stanley.

Sorry for the noise. I'll put it all in one. Julie, on the demand comp, one more on this. I guess the history on it, I think you said assuming all of that demand gets realized, is there anything different about this quarter? Will customers back out? Like why should it flow through at that rate? And then the second question, I think you also mentioned product delays, but it looks like customer balance sheets -- customer deposits are also down on the balance sheet. So how do those reconcile?

Yes. There isn't anything unusual from a cancellation perspective or anything like that, that you're thinking about from a demand perspective. We do expect that all to come in. I mean when we look at the delta between the demand and net and we look at what is missing from a receipt perspective, it matches up. So we expect that all to come in. It's just a delay in the timing of the receipts. From a customer deposit perspective, the reason that it's down is -- from the beginning of the year, that's been down because of the accounting change. We had to run through a bunch of income through that balance sheet account. And so when you look at it now at Q3 relative to last year, it's just showing that it's down for that reason. I would not read anything into that at all. And remember, the biggest piece of that account is our gift cards.

Right. And the inventory, would that have been up more had it flipped? Say the demand and the same-stores comp was the same, the inventory would have looked different at the end of the quarter or still would have looked better than sales?

No, it should have still looked better than sales because remember, this inventory is to fulfill customer demand. So they're on back order. They're waiting for it, so we would have then flipped it around and shipped it out, so it would have been in our inventory.

We'll take our next question from Jonathan Matuszewski with Jefferies.

Just first one, last quarter you mentioned some new opening price points at West Elm. I think you've been giving that across the Pottery Barn brands too. Could you just elaborate on your progress kind of with this pricing strategy? Maybe just share some more on this introduction of the Design Crew Basics line and kind of is the conversion for these opening price points coming from more existing customers or new customers? Any color there would be helpful.

Sure. Thank you for the question. We're always testing and refining our pricing strategy. And we did some of our brand work last year in Williams-Sonoma and Pottery Barn. We had a lot of customers who said, "We love your brand, but we simply can't afford it." And so at that point, we looked to increasing our opening price point and also the scale of the products we're selling. And in all of our brands, we never set out to be the most expensive. We set out to be the best, to have the best quality for the value. And so because of our buying power, we knew that we'd be able to bring in great quality basics at a great price. And that's what we've done across all of our brands, this Design Crew Basics program that we're talking about. And then specific to each brand, they each have one of these strategies. So for example, in Williams-Sonoma, you see Open Kitchen. Fantastic growing business, and it's really attracting a younger clientele and new customers to the brand, which is awesome. In Pottery Barn, you've seen us introduce Pottery Barn Apartment, which is smaller scale, more value-oriented, a lot of knockdown furniture. And again that's driving increased incremental demand. And then West Elm continues to grow its business across not just furniture but in other categories, so that if you're not looking for a sofa yet but you want to go in and buy a vase, there's more offer. And so they're attracting younger customers and customers coming into the market with not only price point but mix.

Got it. And then just a quick follow-up on the loyalty program. It seems like the easier enrollment is probably helping expansion of the program. But what are you thinking in terms of driving that enrollment higher? Are you thinking about any new kind of member benefits there? Any color there would be helpful.

As Laura mentioned, our enrollment rates for the quarter were up close to 4x last year's rate. Buried in some of those numbers is the latter half of October, where we implemented easy enrollment online, and we actually saw the numbers go close to 20x last year's rate. So we're headed into Q4 with a platform that will encourage enrollment across not just our retail stores, which was the key driver of enrollment, but now for our online customers, to make it basically a no click alternative to join our program. And as Julie mentioned, that's 55% of our business. So we anticipate this program growing dramatically. This quarter, we're excited to introduce a number of different initiatives. I guess the most exciting one is a program in which we're encouraging customers to repeat across our brands, with an ultimate prize to win a home makeover sweeps by our Design Crew. So we have a number of programs in place that will encourage frequency across our brands for the holiday.

[Operator Instructions] We'll hear now from Cristina Fernández with Telsey Advisory Group.

I had a follow-up question on the inventory delays. Are there any categories that are more impacted? And are you seeing any meaningful change in the cost to bring product? And we've heard from other retailers that it's just more costly with the backlog, so wanted to see if that's something you're seeing as well.

Sure. We actually had a little bit more of an impact on our kids business, where the demand comp was even more sizably greater than the net comp. But as Julie said, all brands were affected. In terms of price, we have a really favorable shipping contract out of Asia. So even if we're paying a spot rate on a few containers, it's not exorbitant. It doesn't add up to as much. Depends on, I think what people's rates were and where their contract began or ended, and we're in good shape.

And a quick follow-up, if I may. On Pottery Barn Kids and Teens, are the unproductive promotions that affected this quarter just a onetime or -- and we should see revenues accelerate? Or is that something that could carry forward into the fourth quarter as well?

I'm just -- I'm thrilled that the kids and teens have reduced the amount of clearance particularly in the stores, but also online, it's a really very healthy way to run the business. And we didn't buy into that inventory, running our inventories tight, and we didn't comp it. So we saw very sizable margin improvements in those businesses. And, of course, gave up little sales in the meantime, but we're looking to drive to more profitable sales and not carry overstocks.

We'll now take our next question from Seth Basham with Wedbush.

I was hoping you can provide some more color on category strength. Is furniture still disproportionately driving the account?

We're seeing strength across a lot of categories. As I said earlier, some of these incremental businesses are very important to us and whether it's the baby business, Modern Baby, the apartment business, Open Kitchen, those are all excellent. And then we see strength where we have innovation in Williams-Sonoma and exclusives that I talked about earlier. And then we continue to see our upholstery and furniture business to be quite strong. We have an advantage because we make most of our own upholstery here in America. It's very high quality, and our customers really understand that quality difference. And it's able to get to them faster. It's all custom. And we're able to deliver a faster and higher quality than our competition.

And as a follow-up, I was hoping to get some color on how you would characterize the current promotional environment and how you fared in terms of changing your promotions around year-to-date and what you might do any differently going forward.

Sure. I would say that we have more effective promotions this year versus last. And as I said earlier, we have less clearance. As you can tell out in the environment, we're in the midst of the holiday season, and people are getting ready for Black Friday as are we. And it's been competitive. It's been competitive in years past. I don't see a material change.

We'll take our next question from Mike Baker with Deutsche Bank.

I wanted to ask about the accounting change, and you said it has to do with the timing with the last week, the strength of the last week. But if I'm understanding your Exhibit 2 in your press release, it looks like it helped -- that helped the EBIT dollars by about $4.3 million. And I think it's been a help in each of the last 3 quarters. So is that just that you just had really strong last weeks of the quarters, the last 3 weeks? And I guess the sort of related question is when does that reverse or cycle itself? And not to make everyone's head explode, but how does the extra week impact that? Because the timing of all your quarters will be off next year.

Okay. So I think the first way to think about it, especially in this quarter, is the fact that if you were to not sort of accept or account for the accounting change in the third quarter, then basically you can't account for it in the second quarter, which means the second quarter change would come into the third quarter. And if you look at the second quarter and the third quarter, they're exactly the same. I mean they're very, very similar. So from that perspective, there's absolutely no impact on our quarter. But to answer your question, yes, we have seen strength in the last week or 2 of the quarter, this quarter as well, which we're very pleased to see, given that customers reacting to the promotions and our products. Going forward, I -- you asked something about a 53rd week. I don't see that there should be any impact on the 53rd week as a result of the accounting.

Okay. Well, just the timing of when the quarters end. But so is there any way to think about a year-to-date number? Again, on that Exhibit 2, it was -- in the third quarter, it helped by $4.2 million. But I mean, so is it incorrect just to add up that Exhibit 2 number for each of the last 3 quarters?

Yes, because you would reverse it out each quarter if you think about it, right. So I mean you either get it in 1 quarter and then it comes out the other quarter. So it's a reversal that comes in and out between the quarters, so you have to take -- if you look at Q3, you have to take the Q2 and assume that would've been in Q3, and then you would have pulled Q3 out. And so you can't look at it as a sum of 3 quarters.

And we'll take our final question from Marni Shapiro with Retail Tracker.

The stores look absolutely beautiful so best of luck with the holidays if I don't remember at the end. Can we just dig in a little bit to your registry business? Can you give us an idea about the scale of your registry businesses across the brands? I guess which brand is the biggest and what it looks like and how significant the one could be? And then also do you find that your registry customers have a much higher lifetime value across the span of years?

Sure, I'll take that. Registry is a really important entry point to our brands. And they are often our best customers lifetime. We have never given the number of what it is. Of course, it's the largest in Williams-Sonoma. But we have also realized that we haven't been as competitive because we didn't offer the kitchen plus the linens and the whole house wasn't offered together. And so with this Registry One Collective that we've just launched across our brands, you can register in each of our brands and have the great experience that we offer across all of them. And that is a huge unlock. I actually, believe that it will double our registry business over time. And we just did this a couple weeks ago. So it's really too early to read for you. But I expect that we'll see both registry and total growth but also value creation over time.

Over time. And is it a significant enough part of the business to the level of one of your smaller businesses? Is it as significant as, say a Mark and Graham kind of thing?

I don't -- is...

Meaning are your registry sales, because -- are your registry sales at the level of, say Mark and Graham as a stand-alone company?

That's an interesting way to ask me how big it is.

Well, I guess without giving me the -- I mean, let me rephrase it. I guess is it as important, I guess? Without giving me exact numbers, is it very important, as important as one of the new businesses or birthing a new business?

It is very important. It's got a lot of upside because I don't think we've been as competitive as we could be because we didn't have it cross-brand, which is the obvious unlock. And so now that we have the platform, imagine taking the platform plus The Key and all the things that we know how to do with our house phone, using that against this One Registry Collective. So I think it's going to be an area where we've been strong but an area where we can be the clear leaders because we own these brands in house and we have the platform to serve our customers across them.

And it is a key driver of new customer growth for every brand, including Pottery Barn Kids. So as Laura mentioned, the lifetime value there as we start to introduce more relevant customers in that market to our other brands, we see new customer growth as a major benefit of The One.

Can I ask a follow-up to the customer growth? Is dorm also an area for new customer growth? Do you see new customers coming into your brands because of PB Dorm as well?

Yes, absolutely. And these incremental businesses that we talked about earlier are meant to focus on new customer acquisition. Yes, our existing customers participate, but they're also strategic after going -- in terms of going after white space in the market.

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

Great. I want to thank all of you for joining us on the call today. I know our thoughts all go out to those affected by the devastating fires in California. And as a company that's based here in California, we're using our headquarters here as a foundation for donations for the relief efforts, just like we did last year. And I know we're all going off to celebrate a wonderful Thanksgiving, but it's an extremely difficult time for some of our neighboring communities. And we are all doing what we can to provide assistance to those in need. And with that, happy Thanksgiving to you and yours, and I'm looking forward to talking to you after the holidays.

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