Welcome to the Williams-Sonoma Inc. Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the conference over to 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 directly 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 2019 and beyond, and are subject to risks and uncertainties that could cause certain 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. Good afternoon, everyone. On the call with me are Julie Whalen, our Chief Financial Officer; Felix Carbullido, our Chief Marketing Officer; and Yasir Anwar, our Chief Technology Officer. 2018 was a strong year for our business. We outperformed revenue and EPS expectations while making important investments in our business that sets us up for accelerated long-term growth. For 2019 and beyond, our goal is to maximize growth and maintain high profitability. And we have several substantial growth engines that we'll be aggressively prioritizing, including West Elm, our newly launched Business to Business offering; our emerging brands Williams-Sonoma Home, Rejuvenation and Mark and Graham; as well as growth in our largest brand, Pottery Barn and our namesake brand, Williams-Sonoma. We'll also continue to improve the customer experience through technology innovation and supply chain optimization. We believe superior customer service is oxygen for growth. We built over time a vertically-integrated supply chain and a unique platform to launch and scale new brands and businesses. These are unparalleled advantages, which will enable us to deliver mid- to high single-digit revenue growth and margin stability for the long term. Before I discuss our growth opportunities for the years ahead, I would like to highlight some of our accomplishments in 2018 and the powerful foundation that we will continue to build upon for future growth. In 2018, we delivered revenue growth of 7.1% and comp brand revenue growth of 3.7%, the highest in 4 years and driven by positive comp growth in all brands. Growth in Pottery Barn accelerated from last year driven by outperformance in the e-commerce business and break-out growth in new businesses, Marketplace and Pottery Barn Apartment as well as strong upholstery growth. Q4 comp was below our expectation due to a softer gift business in December. And while we…

Thank you, Laura, and good afternoon, everyone. We delivered another quarter of solid results on both the top and bottom line, once again demonstrating our ability to execute against our growth and operational initiatives while maintaining strong financial discipline. Before I discuss in more detail our fourth quarter financial results, I would like to first highlight our financial accomplishments for the full year. As a reminder, our results include the financial impact from a 53rd week that added approximately $85 million in net revenues and approximately $0.10 in earnings per share to the fourth quarter and the year. Our results also include the financial impact from a new revenue recognition standard that we adopted at the beginning of the year, which primarily reclasses other income from SG&A into net revenues and impacts the timing of our revenue recognition for certain merchandise shipped to our customers. For fiscal year 2018, we delivered net revenues of $5.7 billion, growing 7.1% over last year. Comparable brand revenues grew 3.7%, which was an acceleration of 50 basis points from fiscal year 2017, and was our highest comp in several years. Growth was driven by both channels. Retail revenues grew 3% despite a decline in nationwide retail traffic. And e-commerce revenues almost doubled their growth to 10.8%, reaching a record high of 54.3% of total revenues. By brand, we saw positive comps across all brands this year, with the Pottery Barn brand accelerating 150 basis points from the prior year. Pottery Barn maintained its momentum with a comp of 1.2%, increasing 20 basis points over last year. Our Pottery Barn Kids and Teen business return to a positive comp this year of 2.8% versus a negative 1.7% last year. The Williams-Sonoma brand drove a 1.7% comp on top of a 3.2% comp in fiscal year…

[Operator Instructions] And we'll now take our first question from Oliver Wintermantel from Evercore ISI.

Laura, you mentioned your long-term guidance, right, so the mid- to high single-digit revenue growth, but margin is stable. Can you maybe explain what needs to happen to -- that we see margin expansion? I mean we've seen over the years, your top line is growing nicely, but then we have shipping costs, we have ad costs and all of that, so that margins are not growing. So with this longer-term guidance, what would have to happen that we see a margin expansions?

Sure. Thank you for the question, and thank you for the coverage. We -- I want to remind you, you might not be aware that last year -- or I'm sorry, in 2017, we made a big move to reduce our shipping income to be competitive. And we changed from a per item charge to flat rate, and it was a substantial hit to shipping. And we don't see the need to overhaul and make another change like that. In fact, we are looking at ways to take cost out of our network so that it's less expensive to ship. So that explains one of the reasons you saw that big hit in 2017. As far as the mix of the brands and also the channels, as I think you know, the DTC channel is more profitable. And as we continue to push the growth there, from a margin perspective, you see the benefit. We're also working to close underperforming stores. Over the next 3 years, we have over 1/3 of our stores up for renewal, and so we'll either get great favorable leases, or we'll leave. And that's going to be a substantial opportunity for us to reposition at a time where our -- the mall owners and landlords really want to have great brands like ours that drive traffic. And then, of course, with our business, growth leverages everything. And we have substantial growth initiatives that we have a clear view to. And I went through some of them before but West Elm, a very profitable business that we can really maximize and leverage our great designs across multiple geographies and also pushing to grow the customer base as we have done across DTC. We continue to see the brand really resonate both in urban and suburban markets…

We will now take our next question from Jonathan Matuszewski of Jefferies.

I guess, just first off, on port congestion. I know that impacted results last quarter, contributed to the spread between reported and demand comps. What did you see on the port congestion front during fourth quarter? And do you see any issues still ingrained at this point?

This is Julie. Yes, we did receive all the delayed goods from China. They did come in, in the fourth quarter, and all the customer orders were filled. As a result, we saw that our backorder rates, of course, significantly improved compared to last quarter, and we're seeing less customer issues than we've had in the past with more on-time deliveries and less damages, returns and replacements. So that issue regarding the China port slowdown is behind us.

Great. And then just a quick follow-up for West Elm, I know you mentioned expanding some categories where you've seen historical strength and momentum and then maybe some new product introductions. Could you just elaborate there and keep us updated on what we can expect in stores in 2019 that's different from the past?

Sure, it's very exciting. They continue to really push and lead in design. And while the specifics are quite competitive, I'm really impressed with how this team is really innovating and building new products for the modern customer. So you're going to see a lot of innovation in core categories. And then also, as you just saw, we just relaunched bath to great success, and we're still just in the early stages of building out that business, as an example.

We will now take our next question from Michael Lasser of UBS. Apologies, we will now take our next question from Curt Nagle of Bank of America Merrill Lynch.

So just one. In terms of just the guide for next year, just curious if you could comment on what you guys have factored in for onetime items because I know you guys don't guide to GAAP. And then just as a follow-up, just kind of curious what your expectations are or, I guess, why the foray into Rent the Runway, it seems like at least an interesting opportunity.

Yes, this is Julie. As far as the non-GAAP items go forward, I think we've said to you in the past that the outward costs that we're backing out, particularly associated with the transaction costs that are going to be amortized over multiple years, are going to be backed out for 2019. Those are the only things that we've identified at this point.

In terms of Rent the Runway, it's another example of a very interesting way to get into the consumer's house. We've seen success in clothing. And people, different life stages, sometimes don't want to buy things. They're going to rent them anyway. They're going to go to secondhand stores. And we see this as a really high-quality way to participate in that circular economy and give the customer what they want. And we know that when we get them early on or in a certain part of their life, we usually are able to keep them better than other retailers. So that's one -- just yet another example of how we're thinking about our business differently. No different than Business to Business where we look at the world and say, "Where else aren't we?" And we launched the Workspace in West Elm, it's been very successful, and we continue to push on contract. And everywhere that you see furniture, we want to be a part of it. And we believe that we can build a really sizable business in these different kinds of channels than we have before.

We will now take our next question from Michael Lasser of UBS.

You mentioned that you're being less promotional on the Williams-Sonoma brand. Is that in response to something you're seeing in the environment? And do you expect Williams-Sonoma to comp negative in the first half of the year? And then I have a follow-up.

We don't like negative comps any time of the year. Yes, so less promotional, we're reducing the amount of SKUs, unproductive SKUs in stores and being smarter about the inventory investments. And so you may not comp those sales that were less profitable. And as we've reduced inventory -- we're going to continue to reduce it, by the way, because we know it's the right thing to do -- you're going to have less in that bucket. On the other hand, you could make the argument that when you offer too much on sale, you trade them down. And so do you actually lose the sale? Or do you trade them up to something that's at regular price? And at the regular price, in all brands, including Williams-Sonoma, we're pushing value. So Open Kitchen is a great example where you can go to Williams-Sonoma and buy great -- the best products at the best price, all exclusive in Williams-Sonoma. And that should, I hope, offset the reduction in the clearance activity in that brand. But as I said earlier, we're undertaking a pretty transformational change and improving the profitability in the Williams-Sonoma brand, improving the ROIC in the Williams-Sonoma brand, and we really are excited about that initiative. And you could see some more muted comps. But on the other hand, we have some great opportunities in that brand and an exciting product lineup for the year.

And then my second question is as we calibrate our model, you've guided to a flat margin at the midpoint of your 2% to 5% comp outlook for the year, so call it 3.5%. Does that mean if you comp at the low end, you would see some margin compression? Or because you might be giving up some unprofitable sales, we shouldn't expect to see a margin degradation at a lower end of the comp range.

Yes. I mean, what we've guided to, obviously, is to be in line with last year's op margin. So that is fully where we believe we'll come in regardless of where we land on the revenue. So yes, there'll be things that play like that, like where we might be giving up on comps to be able to have a more promotional sale -- I mean, more profitable sale, sorry, like Laura just spoke to with Williams-Sonoma. And quite honestly, across our brands, we've been doing more of that. So that's possible, but I wouldn't read anything more into the low end of the revenue range relative to op margins.

We will now take our next question from Marni Shapiro of Retail Tracker.

Hey, guys, congratulations. The stores have looked really fantastic. Can you just talk a little bit about West Elm? Specifically, you talked about accelerating the growth. I'm curious because, Laura, you have a lot of things going on with West Elm, so I'm curious if you're looking to accelerate the growth by opening more stores? Or is it things like Rent the Runway or all of the other aspects of West Elm that you're targeting right now?

I mean, it is all of the above, which is quite exciting. So it's the cross-brand initiatives that we've talked about that feed right into West Elm's strengths. They're still really early in the registry business, so that is wide open space for them to take that business away from others. And particularly now that you can finish your registry at West Elm's furniture with Williams-Sonoma Open Kitchen, we really have the product to serve the whole house. And so that's an opportunity as well as the new channels we talked about. And then as I said within just the core brand, there's product category opportunities. There's aesthetic opportunities, price point scale. In fact, we believe that sometimes the furniture is too small. West Elm was born for an urban environment, yet suburban people in larger homes love it. And so we also are doing the opposite of what we're doing in Pottery Barn, which is expanding the size of some of our products, so that they fit in larger homes. And then lastly, I don't think we've really explained well enough the operational excellence that the team at West Elm are pushing. They've really changed the course of the profitability. The inventory is in so much better condition. It's very clean. Backorder crate rate is way down, and our on-time delivery is up. And while it's hard to put an exact finger on how much that's worth, we know that's a sizable number that will continue as an opportunity through this year.

And can you just give us an update quickly? You had launched West Elm, the Baby side, And I think it was last year, or it might have been the year before, I had seen in a bunch of stores you rolled out, what I would call like a higher-end, a more exclusive West Elm. If you could just touch on those. Are those still in the works, both of them? And where are they going?

Yes. Great question. So on the Baby side, we did a collaboration. We do lots of collaborations with different outside designers. And we realized, let's do a collaboration with PB Kids and West Elm because PB Kids understands safety in building children's furniture, and West Elm has a unique aesthetic that Kids hadn't been offering. So we actually -- they designed it together in-house, and we put the product, both in the stores for West Elm and the Kids stores, and online on both, and all brands are benefiting. And the [ volume ] is kind of similar. It's actually quite distinct. Now in terms of collection, we had tried a higher-end West Elm, and it wasn't successful, and we very quickly exited that. And the great news was it was a small test. So we feed the ones that work, and we got rid of that one. And actually, we had a store in New York where we had the separate entrance, and we had collections in there. We converted that to our bedding and bath expansion. So it was a pretty easy move.

We will now take our next question from Christopher Horvers of JPMorgan.

I wanted to follow up on the demand comp commentary. So the rough math around the third quarter is 110 basis points, call it, was shifted in based on the 150 basis point headwind from the third quarter. So that was about 110 basis points in the fourth quarter. So do you look at like a low 1 is really the underlying demand comp there? But you also mentioned that you also had some late shipments, so I was trying to understand sort of the underlying trend, how much you expect could shift into the first quarter? And then bigger picture, sort of how you think about the first quarter relative to the guide for the year, do you think that 1Q could be at the low end of the range or slightly below or midpoint? How are you thinking about it?

Chris, it's Julie. I'll take that. So I think there's a couple of things you have to think about. I mean, yes, demand comps were higher than net in Q4. And yes, I said earlier that we did get the China goods in to the fourth quarter. What you have to recall is a couple of things. First of all, we had a 2.4 comp, which, of course, is the midpoint of our range relative to 5.4 last year. But we also incurred a 70 basis point negative impact on -- from an accounting perspective as a result of the new revenue recognition standard. And so that, right out of the gate, hurt the comps and brought them lower. We also, as Laura had mentioned in her prepared remarks, also had a couple other drivers that impacted the demand-to-net's conversion, primarily associated with the Pottery Barn brand and the fact that a lot of their growth is coming out of dropship sales, which -- in marketplace and upholstery, which those take longer to fulfill. And then we also were impacted, as we just spoke to with Michael about Williams-Sonoma, with the lower comps primarily associated with being less promotional in the fourth quarter. But all that to say, at the end of the day, we had really good strong comps relative to our performance to last year. As far as giving guidance to the first quarter, obviously, is one thing that you do need to remember in the first quarter. We have an Easter shift that's pretty sizable, and I alluded to this in my prepared remarks. That's going to put the Easter revenue comps towards the end of the quarter. And obviously, as Easter drives both traffic and revenue across our brands, this timing shift makes it hard to currently read the business. But this Easter shift actually further speaks to exactly why we want to get out of the business of the shorter-term business reads and to move away from quarterly guidance as it's not reflective of our more strategic long-term vision.

Understood. And then as a follow-up, on the flat EBIT margins for 2019, any color in terms of how you're thinking about the gross versus the SG&A? Closing 30 stores, rough math, seems like about a 50 basis point tailwind to occupancy. So are you expecting gross and SG&A to be relatively flat to arrive at that EBIT guide?

Well, there's obviously a lot of moving parts in there. I mean, certainly, with higher revenues, you have occupancy leverage with lower cost like we had in the fourth quarter, it was actually one of our lowest growth rates we've had at 2.2, you're starting to see some of these costs come down, both from rent and otherwise, depreciation, et cetera. So with that continuing, that should be some tailwinds for us. Also, we saw merch margins that were up in Q4 that we continue to talk about, so I think that's another opportunity to provide leverage on the gross margin. And a lot of our supply chain initiatives to help lower some of our cost that hit gross margin should also be helpful. The tailwind -- or the headwind, if you will, is the higher shipping costs that we continue to have, obviously, from both the UPS shipping rate increases but, more importantly, from the higher mix of furniture and the China tariffs, which is everybody's question mark, as to where that's going to land. We have, in fact, included that in all of our guidance for the full year. It's factored into our op margin because we're covering that 100%. But it could, short term, put pressure on our gross margin, which, of course, then as we have higher sales leverage across the P&L like we've done in the fourth quarter, we'll continue to leverage the other areas of the SG&A lines to be able to offset that and to be able to land at an operating margin that is flat to last year.

And by the way, since we have covered the China tariffs and it's in our guidance. If it's removed, it's upside.

Understood. You mean the 10% tariff.

No.

No. We actually have -- we are anticipating -- we plan to the 25%.

And that's sort of some sort of comp benefit but some sort of gross margin headwind [ down ] ultimately.

Yes, so we put the worst case scenario in, and we've prepared ourselves. We've been working on this for a while. The sourcing team has done a phenomenal job, and it speaks to, really, our vertical integration and our sourcing structure across the world. We've moved a ton out of China. We've gotten better prices. We've moved a lot of our upholstery business domestically, which also has the net impact of, unfortunately, hurting net, Chris, because it used to come in from China and sit in our DCs and be shipped. And now we've moved and opened, as you know, Tupelo, where we're moving a lot of our upholstered furniture business. But that also was because we got ready for what we thought was going to be 25% tariffs. And so in addition to all the movement of the sourcing, we have been going after indirect vendor cost around the company. We have a team that's working on consolidating every contract. So between all these moves and also some mix shifts and some selective price increases, we're prepared for the worst.

Any comments on the degree of upside? You said -- you opened up the box, so I figured I'd ask.

I know go ahead. Yes, it's a good question. I mean, I don't think you can do the straight math because a lot is yet to be seen about this. But certainly, it's a good number.

We will now take our next question from Steve Forbes of Guggenheim Securities.

I wanted to start with the footprint expectations, right? So the 30-store closings on a net basis, maybe just help us bridge the gap there, gross to net and, if you can, any color by brand. And then given your commentaries about the 1/3 of the stores up for renewal, can you talk about how these conversations for this store class the landlords went as you went to negotiate?

So as far as the numbers from a gross-to-net perspective, it's predominantly store closures that you're seeing in that number. So -- and basically, as we've gone through and we told you in the past, there was about 250 stores that were coming up for renewal, and we said we'd close 1/3 of them if the economics didn't make sense. And so having 30-store closures in this one particular year -- it's, if you look back, one of the largest store closures that we have announced. So it's clearly a sign that we are pushing back with the landlords and being very aggressive with our stance.

I do want to add, though, that we see retail as a very important part of our multichannel model because it allows our customers to touch and see our products in person, and it does drive new customer acquisition. So while we have the opportunity, and we have over 250 stores that are coming up for lease renewal in the next 3 years, we also have the opportunity to selectively open stores and invest in new stores for West Elm and drive very profitable growth. And in terms of the negotiation, these are leases that are up. It's the end of the lease. And so there's cases where we are deciding to stay due to favorable economics and other places where we are leaving. And so the 30 is our best guess, and it just depends on what kind of agreement we can get with our landlords. And we'd love to work together to really keep a very healthy fleet in the best centers in the United States.

[Audio Gap] We spent a lot of time on the call today on the growth potential for West Elm. But maybe if you can expand on Williams Sonoma Home, right, especially as it relates -- pertains to like the presentation of the brand within the store. I think you mentioned sort of small and tactical presentations. But really, how do you plan on driving brand awareness, right, of that offering over the next, say, 3 to 5 years?

Thank you. We're very excited about the opportunity for Williams-Sonoma Home, and we have not seen -- we've seen an interesting mix in our Kids and Teen businesses, which are predominantly online. In fact, in Williams-Sonoma Home, we are choosing to consolidate out of some of the stores, actually, and remove the footprints so we can make a better impact in others. And we tried a lot of things last year, we tried it in a lot of markets. And we see ourselves -- we've already taken it out of some, and we're going to take it out of some more and then really expand it in others based on where the market is. And at the same time, online, we can drive a lot of customer acquisition through our digital efforts and also because we're introducing -- we have the Room Planner that's cross-brand. So as our designers and the other retail stores help furnish their customers' full homes and maybe they go into the Pottery Barn door, the Room Planner allows them to drag and drop products from all of our brands and put together a multi-brand house, which we think is a really big competitive differentiator for us and one that we're going to continue to build upon.

Ladies and gentlemen, there are no further questions at this time. Thank you for your participation. You may now disconnect.

Thank you all. Appreciate your support and looking forward to talking to you next time.