Williams-Sonoma, Inc. (WSM) Q2 2023 Earnings Report, Transcript and Summary

Welcome to the Williams-Sonoma, Inc. Second Quarter 2023 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Jeremy Brooks, Chief Accounting Officer and Head of Investor Relations. Please go ahead.

Good morning, and thank you for joining our second quarter earnings call. I'd like to remind you that during this call, we will make forward-looking statements with respect to future events and financial performance, including guidance for fiscal '23 and our long-term outlook. We believe these statements reflect our best estimates. However, we cannot make any assurances these statements will materialize, and actual results may differ significantly from our expectations. The company undertakes no obligation to publicly update or revise any of these statements to reflect events or circumstances that may arise after today's call. Additionally, we will refer to certain non-GAAP financial measures. These measures should not be considered replacements for and should be read together with our GAAP results. A detailed reconciliation of non-GAAP measures to the most directly comparable GAAP measures appears in Exhibit 1 to the press release we issued earlier this morning. This call should also be considered in conjunction with our filings with the SEC. Finally, a replay of this call will be available on our Investor Relations website. Now I'd like to turn the call over to Laura Alber, our President and Chief Executive Officer.

Thank you, Jeremy. Good morning, everyone, and thank you for joining the call. Before we get into the details of the quarter, I'd like to take a moment to thank the incredible team at Williams-Sonoma, Inc. Without their outstanding work, creativity and relentless focus, none of the results we are reporting today would be possible. We are pleased to deliver another quarter of strong earnings. We significantly exceeded profitability estimates with an operating margin of 14.6% with earnings per share of $3.12, well above our pre-pandemic results. Our sales ran negative 11.9% in Q2, but our 2-year comp was essentially flat, and our 4-year comp to 2019 was positive 39.7%. We achieved these results against an increasingly promotional environment and softening industry metrics by leveraging our market advantages and focusing on regular price selling, driving improved customer service and controlling costs. We're in a period where consumers are buying fewer large-ticket furniture pieces than they did a year ago as they shift their spending. However, our advantage is our portfolio of brands serving a range of categories, aesthetics and life stages. Only approximately half of our business is furniture, and we are seeing relative strength in kitchen purchases, fashion tech sales, dorm, baby and seasonal holidays. And our in-house design capabilities and vertically integrated sourcing organization allows us to design and develop quality products at a great value. But we are not only innovators, we are also operators. Core to our business model is a digital-first but not digital-only channel strategy that supports our world-class shopping experience. We are pleased that due to our focus and investments in operations, we have made meaningful progress on our customer service. We've seen improvements in our key metrics, including on-time delivery and damages, both of which improve customer satisfaction and reduce costs. On the digital front, we continue to control ad costs tightly, optimizing spend with a focus on the most productive channels, leaving some flexibility to test into formats that tap into new audiences. And as one of the largest e-commerce players, we continue to enhance our proprietary e-commerce tech stack. We believe we will lead the way in retail, and our use of AI and our tech capabilities, including our homegrown recommendations engine used for enabling relevant product selection on our website and our AI-powered room design tool with intelligent design guidance. We also operate a best-in-class retail business with our stores not only serving as billboards for our brands but driving profit and customer service. I truly believe we have the best team in retail. And our stores are beautifully designed and curated with aspirational assortments, and our continued retail optimization efforts have refocused our fleet on the most profitable, inspiring and strategic locations. Additionally, we continue to enhance our omni initiatives to better serve our customers and drive profitability. We also tightly managed all the other expenses, including employment costs. In both Q1 and Q2, we made tough decisions to rightsize our organization to control costs and drive efficiency. And we closely managed our inventory levels to align with our demand trends while improving our in-stocks. Total inventory was down 15.7% versus last year. Now I'd like to tell you about our progress and our sustainability efforts. In Q2, we released our 2022 Impact Report, highlighting our commitment to our values and our progress toward achieving our science-based targets and other sustainability goals. Notable in our report, we significantly scaled renewable energy. And in our value chain, we launched a vendor engagement and preferred material strategy to reduce emissions. We also detailed progress in our worker well-being goals. Our commitment to fair trade premiums, Nest-certified Ethically Handcrafted products and other programs that impact the lives of almost 100,000 individuals globally. We are committed to action and continuous improvement, and we are making meaningful progress on the path we've laid out. Also, we launched a new home furnishings brand, GreenRow, which I'll discuss later, which uses sustainable materials and manufacturing processes and targets an emerging demographic that prioritizes sustainability in the brands they support. Now I'd like to spend a few minutes talking about our brands. Pottery Barn ran a negative 10.6% comp in Q2 but a 10.9% positive on a 2-year and a 48.7% positive on a 4-year basis. Although furniture demand has decelerated, we are seeing relative strength and easy updates in decorating, frames, pillows, throws and table linens. In late July, we launched our new and seasonal fall assortments, and we're getting a strong response to our proprietary textiles, including duvets, quilts, pillows and rugs. Halloween decorating is off to a strong start, which is a good indicator for the upcoming holiday season. In furniture, we're seeing strength in our new lighter finishes, velvets and cozy fabrications. And while it is early, the new fall assortment is up versus new fall last year. Also in Q2, we successfully opened our newly relocated store on Post Road in Westport, Connecticut with much success. Repositioned stores like this are proving to be very productive as they bring to life our broader product assortments and showcase our free design services. Westport is an example of the effectiveness of our company-wide retail optimization strategy, which includes closing smaller and older stores and repositioning it to larger stores in open-air lifestyle centers and destination street locations. The Pottery Barn Children's business ran a negative 9% comp in Q2 and was negative 3.8% on a 2-year basis and positive 19.1% on a 4-year basis. Across these life-stage brands, we are focused on delivering compelling innovation and elevating the customer experience. One key area in the quarter has been our back-to-school offering. We're proud to expand our market-leading gear to include an accessible option and to build upon our best-selling desks with accessible study solutions. Another highlight is our dorm assortment, which addresses the distinct needs of college-bound students with XL twin bedding, no nails decor and storage. The dorm opportunity is significant, given the underserved market, and we expect to continue to pick up market share and drive year-over-year double-digit growth in this category. Customers can shop online and ship product to any of our company stores that are closest to their college campus. Included in our dorm offer, we are excited to showcase our partnership with LoveShackFancy, which has gained even more traction with the dorm launch. We also continue to focus on baby, the entry point to our Pottery Barn Kids brand. Here, we are winning with our GREENGUARD Gold nursery seating, our curated selection of baby gear and the expansion of furniture and gifts in our stores. Now let's talk about West Elm. West Elm is a brand that has been most impacted by the customer pullback in furniture. In Q2, West Elm ran a negative 20.8% and was negative 14.7% on a 2-year basis but ran a 43.4% positive on a 4-year basis. West Elm is our brand with the highest percentage of its assortment in furniture, the most underdeveloped in other categories and a customer base that has been most impacted by the environment. Despite current challenging dynamics, the brand made progress on 2 key areas that we believe will drive improvement in their business in the near term: first newness, we are doubling our newness penetration in the back half, fueled by our fall and holiday launches. We are encouraged by the strong performance of the new fall product launch so far, which marks a real evolution in the brand's modern design voice. And while it is a small assortment, it is exceeding the performance of last year's fall newness. And second, given the success of recent collaborations with Colin King Studio and RHODE and the response to fall product, we see sizable opportunity in West Elm as it expands into textiles, decorative accessories, entertainment and seasonal offerings. These 2 key focus areas underpin the opportunity to improve customer count and omnichannel performance in the brand. And we continue to be very optimistic about the long-term growth trajectory of West Elm with its industry-leading design and value. The Williams-Sonoma brand ran a negative 0.7% comp in Q2. On a 2-year basis, the brand was essentially flat and positive 35.7% on a 4-year basis. The quarter was driven by our kitchen business, which ran positive comps offset by the home business. Throughout Q2, high-end electrics, particularly in coffee and espresso continued to lead the way in growth with successful new product launches. Customers also responded well to categories like storage and organization with our exclusive Hold Everything collection. And for the balance of the year, we have a strong pipeline of exciting exclusive product launches and strong collaborations. And based on early reads on Halloween and Autumnal, we expect the holiday entertaining and dining at home businesses will drive strong results for the brand. Now I'd like to update you on our other key initiatives. Business-to-Business ran down 5% in Q2. We continue to see strength in our contract business, which ran positive 23% in the quarter, sequentially improving from Q1. We won several proposals across industry segments, including with Sony in the entertainment space, the San Antonio Spurs Training Facility and multiple properties with the Montage, the Four Seasons, Westin, Hilton and Hyatt. The trade business has been more impacted by the slowed housing market. However, we see recent improvement in our trends, and we remain confident on this piece of the B2B business long term. Now I'd like to talk about our global business. Our standout performer this quarter is our Canadian business. We continue to see strength from our recently replatformed e-commerce website, and we are excited with the launch of our wedding registry service in August in Canada. The Mexico market continues to show strength due to strong execution of design services and an improved in-stock position. India also remains a key growth market in our global business with strong year-over-year performance and the opening of 3 new stores next month, including the first Pottery Barn Kids store. Lastly, I'd like to update you on our emerging brands. At Rejuvenation, we continue to see success from the replatforming of the website with improved sales, conversion and customer experience. The brand is seeing outperformance in its home project category and strength in newly entered growth categories. At Mark and Graham, our high-quality gift and personalization brand, the business drove a high single-digit comp in Q2. And at GreenRow, we are pleased with the initial reaction to the new brands and the assortment. And while it's early and the volume is small, we are ahead of plan and remain optimistic about the potential of this brand and its aesthetics. These successful and exciting emerging brands are a testament to our ability to develop new businesses that expand our portfolio of brands and address white space in our product offerings, all with minimal investment, low cost of entry and leveraging our knowledge and infrastructure. In summary, we recognize there's been a pullback in spending on high-ticket discretionary goods with relative strength in certain other categories. Despite this top line pressure, the proven strength of our operating model produced strong earnings this quarter, driven by our focus on service, cost control and regular price selling. As we put this all together, we have changed our outlook for the year. We now expect full year revenues to come in at a range of down 5% to down 10%, and we are raising our outlook on operating margin to a range of 15% to 16%. It is important to note that the reduction in our revenues outlook is offset by our raised operating margin outlook. On balance, we believe that running our business with tighter inventory, stronger merchandising and design curation with fewer promotions will continue to drive customer satisfaction and long-term growth. Thank you, and now I will turn the call over to Jeff Howie.

Thank you, Laura, and good morning, everyone. As Laura said, we're proud that once again, we've delivered a strong quarter of earnings. Our Q2 results reflect the themes we've been communicating over the past several quarters: first, our steadfast commitment to maintain price integrity and not run site-wide promotions, even if it means forgoing some revenues in the short term; second, our first half supply chain cost headwinds that will become second half tailwinds; third, our ability to control SG&A costs and manage inventory levels; and finally, how we've structurally changed our operating model, driven by our higher e-commerce mix and our retail optimization strategy. Our earnings this quarter exceeded expectations despite softer top line revenues. This illustrates the profitability of our platform and supports our long-term 15% operating margin floor. Now let's dive into our Q2 results, followed by an update on our fiscal year guidance. As I did last quarter, in addition to year-over-year results, I'll reference 2019 as it's helpful to compare our performance with pre-pandemic levels. Net revenues came in at $1.863 billion. While below our expectations, our revenues reflect the larger home furnishings backdrop and our commitment to maintain price integrity as the industry became more promotional. Our revenue growth in Q2 came in at negative 11.9% comp. Our 2-year stack was essentially flat, and our 4-year stack against 2019 grew 39.7%. Our Q2 demand at negative 11.4% was materially in line with our revenue comps, reflecting a normalized spread between demand and net comps as I mentioned last quarter. On a 2-year stack, our demand was negative 8.1%, and on a 4-year stack, our demand was a positive 37.4%. From a cadence perspective, our demand trends continued to be inconsistent and choppy and decelerated from Q1, driven by a pullback in consumer spending on high-ticket discretionary. Moving down the income statement. Gross margin at 40.7% was in line with our expectations. While 280 basis points below last year, our gross margin sequentially improved over Q1 by 210 basis points. Merchandise margins decreased year-over-year as the residual amount of the capitalized costs from higher product costs, ocean freight, detention and demerge sitting on our balance sheet flowed into our income statement. Excluding these atypical capitalized costs, our merchandise margins were in line with last year. Selling margin also continued to be impacted by higher outbound customer shipping costs although to a lesser extent than prior quarters. We incurred these higher costs to best serve our customers by shipping from out-of-market distribution centers and, in some cases, intentionally shipping multiple times for multiunit orders, which typically would have been fulfilled in a single shipment. While we still have room to elevate our customer experience, we made substantial progress in Q2 with our customer service. I'd like to congratulate and thank our supply chain organization for elevating our service experience. Altogether, our selling margins were 90 basis points lower than last year. Driven by these short-term supply chain costs and inefficiencies we've been discussing in the past several quarters. As these costs are now fully amortized, Q2 will be the last quarter we report on these headwinds. In fact, we anticipate they will become tailwinds over the next few quarters. Occupancy costs at 10.9% of net revenues were 190 basis points above last year. Occupancy dollars at $203 million grew 5.3% over last year and were essentially flat quarter over quarter. Our 200 basis points leverage versus 2019's 12.9% occupancy rate demonstrates the impact of our higher e-commerce mix and our retail optimization strategy have had on our gross margin despite Q2 '23 softer top line results. Our Q2 gross margin at 40.7% remained 530 basis points higher than 2019's 35.4%. And that includes absorbing the residual 90 basis points in supply chain-related costs and inefficiencies. Our SG&A rate once again reflects our ability to control costs in a challenging environment with Q2 coming in at 26.1%, leveraging 30 basis points to last year. We leveraged both employment and ad costs in the quarter. Employment leverage as we manage variable employment costs in accordance with our top line trends. We also benefited from a reduction-in-force actions in Q1 and Q2 as we continue to look for opportunities to improve efficiency, remove redundancy and streamline operations. Our advertising leverage reflects the competitive advantage of our agile, performance-driven marketing organization. Our in-house capabilities, first-party data and multi-brand platform allow us to drive efficient advertising spend as we see business trends evolve. Overall, SG&A came in 240 basis points lower than 2019's SG&A rate of 28.5%. Once again, these results highlight the impact our higher e-com mix and our retail optimization strategy have on our profitability. With regard to the bottom line, we are pleased with our results, especially in light of the quarter's challenging industry environment. Q2 operating income came in at $272 million and operating margin at 14.6%. While down 250 basis points below last year, 14.6% stands 770 basis points above 2019's 6.9%. These results reflect the power of our profitability initiatives and underpins our 15% operating margin long-term guidance. Our diluted earnings per share of $3.12 was $0.75 or 19% below last year's record second quarter earnings per share of $3.87 but significantly above 2019's earnings per share of only $0.87. On the balance sheet, we ended the quarter with a cash balance of $514 million with no debt outstanding. This was after investing $43 million in capital expenditures supporting our long-term growth and returning over $69 million to our shareholders through quarterly dividends and share repurchases. Merchandise inventories at $1.3 billion were down 15.7% to last year. Three important points I'd like to emphasize here: first, we are well positioned to maintain our price integrity as we proactively managed our inventory levels in line with our demand trends; second, our in-stock levels are robust and near historical highs, and our regional balance and composition has improved considerably; and finally, third, our Q2 ending inventory levels are up only 9.5% versus same period in 2019. And that's with revenue comps of 40% over the same time frame. This highlights how we've improved our efficiency and turnover. Summing up our Q2 results. We're pleased to have delivered earnings exceeding expectations. I want to pause and thank all our associates across our stores, supply chain, customer service centers, global operations and corporate offices for delivering these results in a challenging environment. Now let's turn to our outlook. We are updating our fiscal '23 guidance to reflect both the ongoing top line uncertainty and the proven strength in our operating margin. We now expect full year '23 net revenues to be in a range of down 5% comp to down 10% comp, and we are increasing our operating margin outlook to a range of 15% to 16%. It's important to note that our lower sales outlook is offset by our raised operating margin, producing materially similar implied EPS guidance. On the top line, our updated guidance is based upon the facts and trends we know today by extrapolating our 1-, 2- and 4-year trends in Q2 to full year '23 net revenues. Specifically, our Q2 1-year trend yields full year revenues at the low end of guidance. While our Q2 2-year trend yields full year revenues at the midpoint of guidance, and our Q2 4-year trend yields full year revenues at the high end of guidance. While our top line year-over-year comparison gets easier in the back half, we recognize the challenging environment for home furnishings. On the bottom line, when aligned with historical quarter-over-quarter builds, our strong Q2 operating margin produces full year operating margin within our updated range of 15% to 16%. Additionally, in the back half of the year, our headwinds from the short-term supply chain costs will become tailwinds to support our operating margin guidance. We also expect our full year income tax rate to be approximately 26%. Our 2023 capital allocation plans remain unchanged. We will continue to prioritize funding our business operations. Commensurate with our industry-leading return on invested capital, we will also invest $250 million in capital expenditures in high-return projects to support our long-term growth. As we have communicated quarterly, we are committed to returning excess cash to shareholders through dividends and opportunistic stock repurchases. We will continue to pay our quarterly dividend of $0.90 per share, and we have almost $700 million remaining under our current $1 billion share repurchase authorization to repurchase our stock opportunistically. As we look further into the future, we are reiterating our long-term guidance of mid- to high single-digit top line growth with operating margins exceeding 15%. We're confident we'll continue to outperform our peers and deliver profitable growth for these reasons. Our ability to gain market share in the fractured home furnishings industry, the strength of our in-house proprietary design, the competitive advantage of our digital-first but not digital-only channel strategy, the ongoing strength of our growth initiatives and the resiliency of our fortress balance sheet. With that, I'll open the call for questions.

[Operator Instructions] Our first question comes from Max Rakhlenko from TD Cowen.

Congrats on the nice results. So as we think about your margin profile and the long-term outlook, what do you view as structural differences today compared to pre-pandemic versus ones that have been a little bit more temporary in nature and could still potentially have risk ahead?

It's a great question. I think it all goes back to what I've been talking about over the past few quarters regarding our 15% operating margin floor. These structural changes in the business start with our higher e-commerce sales mix where we continue to drive growth in the higher contribution channel and our retail optimization strategy, where we've really repositioned our fleet to be more profitable and more productive. It also comes down to -- those are structural changes that in and of itself bridge us to a lot of our margin results we're seeing today in second quarter and in our guidance. Additionally, we have the supply chain efficiency that's coming. We've been talking for the past few quarters about the headwinds and the short-term supply chain costs that we're seeing on our balance sheet and how they flowed through our income statement. Those are now behind us, and these headwinds are going to become tailwinds in the back half of '23 and into '24. We also have the pricing power that I think we demonstrated in Q2 where our in-house design, our proprietary products command a higher price point in the market. And with the strength of our design teams and our global sourcing organization, we're able to provide the consumer with a very competitive value equation for them to consider. We've also demonstrated our ad cost optimization and our in-house capabilities with our own hands on the keyboard really make a difference in our ability to control those costs and leverage them with sales. And then finally, I'd say our cost inventory reductions, which we demonstrated in the past few quarters, we've managed our SG&A very efficiently. And as you can see, this quarter with our inventory down 16%, we're very good at managing inventory levels over time. Here's the key point. Our operating margin is sustainable and could even go higher from here with more leverage from higher revenues.

Our next question comes from Seth Basham from Wedbush Securities.

Could you help us dimensionalize the difference in performance of your business between furniture and nonfurniture categories? How much stronger were nonfurniture categories or how much of a decline did you see year-over-year in furniture-related growth?

Sure. Laura. Yes, so we are so fortunate to have a portfolio of brands serving life stages, different aesthetics and different parts of the house for that matter. And while we do have a large portion of our business in furniture, we also have business in textiles, decorating, entertaining. We have quite a robust children's business. Baby is the entry point, dorm. And these are all very different businesses. And so while we did see a generalized pullback across many categories, there's some real winners. And these winners are not just happenstance. It's because we've been working so hard to build these businesses. We've talked about our growth drivers and that there's both growth in new brands and new ways to sell to customers like B2B. But there's also growth in categories where the market is underserving the customer. And one of those is dorm, and the dorm business is a very large fractioned market. And with the exit of Bed Bath & Beyond and others struggling, we've picked up, I believe, pretty considerable market share very quickly. And we've been working both on the product assortment side of that equation but also on logistics. And there's still a lot of room to grow from here because we're still relatively small. Thus I give you that as an example of a category that's really outperforming what you see in our total average numbers. And there's a lot of other examples like that, whether it's Hold Everything and Williams-Sonoma. Williams-Sonoma itself, I think you see the performance in the kitchen business. That team has worked very hard to build new businesses and expand their branded assortments as a percent of total. Those are things that they are designing and developing that cannot be found elsewhere. That's been a very important strategy. And yes, furniture is softer. There is definitely a pullback in furniture. And we are planning the -- this will be the case until the environment strengthens. And so as you look at us to the back half of the year, the reality is these holidays, entertaining, gift-giving, those are strong points for us. And so we're going to be really leaning into them with exciting new products and really relevant marketing as we go to the holiday season.

Our next question comes from Chuck Grom from Gordon Haskett.

Laura, I was wondering if you could talk about the health of your customer today and overall demand indicators that you guys evaluate. As we've kind of progressed through earnings here, a number of retailers, some off-price names have called out the category as rebasing a little bit. I'm just wondering if you would share in that thought process. And then my follow-up is just on your overall pricing strategy. You talked about it a little bit in your prepared remarks, but I was wondering if you could elaborate a little bit more on that and how big of an advantage it is for Sonoma.

Yes. Thank you, Chuck. It's definitely an uneven macro environment. Every day, we hear different messages, right? So we have the positive indicators in the stock market and jobs, but there's still a fear of layoffs at the higher income levels. And then you also have the obvious negative indicators for businesses like ours, like interest rates and housing. So it's a mixed bag but the consumer confidence is up. They're spending a lot of money on travel and services. We all know that there's definitely a movement out of categories like ours into some of those other areas. And yet at the same time, we talked about this, we were in New York. Customers love their homes. And right now is not a time when they're buying a new one or moving as much, but they're always thinking about it and thinking about the next project. And easy updates to the home and life stage changes and gift-giving around the home are very relevant and as relevant today as they've ever been. In terms of pricing, Jeff touched on it in the beginning. But I just want to remind everybody what makes us really, really different than other people in this business. We design and source 90% of our products. And as a result, we are able to deliver a higher-quality value equation to our customers, and we have scale. And so the vendors are very happy to work with us to value engineer our products and it's a huge advantage. There are a lot of people out there buying offline. And so it's a race to the bottom on pricing because there's not a lot of differentiation. Honestly, they're selling a totally different level of quality. And then there's people who are really at the high end and substantially more expensive than we are. But honestly, we care about all of them. And so we're constantly checking our prices against the competition. And we are constantly reviewing our products in person vis-à-vis the competition. I got to tell you, I feel really good about where we sit because there are big differences, and we have a huge advantage in the design quality value equation. In some cases, yes, we have reduced prices, but we have also received cost decreases from our vendors. It's a big important point. I have to be honest, we also have increased prices still in some categories where we thought we were too low. And this is a constant testing, learning, rolling across brands. And part of our religion just like retail optimization or real estate, all of it, this is our discipline and I think we're quite good at it.

Our next question comes from Cristina Fernández from Telsey Advisory Group.

Nice profitability. I wanted to ask on the gross margin. Came better than expected or that I expected this quarter. So if you could talk about what is leading to that outperformance relative to the first quarter. And as you look at the revised operating margin for the year, maybe you can help us with what are the buckets where you're seeing better profitability that gives you confidence to raise the outlook even with the lower sales.

Yes, so gross margin at 40.7% sequentially improved 210 basis points over Q1. There were really 3 main drivers behind this: first, our lower inventory levels enabled us to maintain our promotional levels consistent, unlike others in the marketplace; second, our improved customer service resulted in lower costs. We had less out-of-market, fewer multiple shipments for an order as well as things like damages, appeasements and replacements that go along with all those things; and finally, it was the wind-down of the residual capitalized supply chain costs that have been sitting on our balance sheet that we've been talking about the past few quarters. We don't like to guide individual lines as we look towards the back half, but the important thing to remember is we've been consistently speaking about all these headwinds becoming tailwinds. And the capitalized costs are behind us. The ocean freight, as everyone knows, has come down, and we do anticipate that we'll see the benefit of that in the second half.

Our next question comes from Anthony Chukumba from Loop Capital Markets.

Congrats on the better-than-expected profitability as well. I guess my question is on the promotional environment -- competitive promotional environment. I just was wondering if you can comment on what you've seen, let's say, sequentially over the last few months and then also how it compares to pre-pandemic levels.

Sure. We do definitely see elevated levels of promotion in the market, really exacerbated by the liquidation of Bed Bath & Beyond. And we are tracking pricing decreases at key competitors, noting that they are much more promotional versus last year and versus us. We are committed, as you know, to running our business without the use of site-wide promotions. We are using markdowns to manage some reverse as we've always done. But when you look at all the other people out there as well, you'll see hidden promo tactics, including e-mail sign-up discounts, coupon matches, reductions of price in different categories, none of which we are doing at this point. And we are absolutely committed to the stance. We think it's the healthiest way to run our business for the long term, and it's a function of the high-quality sustainable products we offer. So I don't know that I can comment about versus pre-pandemic, it seems so long ago. It was quite promotional then too but we haven't done that analysis.

Our next question comes from Peter Benedict from Baird.

Jeff, maybe 1 for you. Just I don't know if you could help us maybe size the advertising cost leverage you guys have seen in the first half of the year. And maybe how do you think about the second half, given the various revenue paths that you've laid out? I understand the agility of that model, but just trying to think through how much leverage you expect to get on that. Or is it did your ad spend just come down as the sales are coming down? And so just if you can help kind of dimensionalize that for us, that would be super helpful.

Yes, sure. Peter, thank you. Look, our Q2 SG&A at 26.1% leveraged 30 basis points. This reflects our financial discipline and ability to control costs. And in the quarter, we leveraged both employment and ad costs. And as you all know, we don't like to guide individual P&L line items. But I think you can keep 3 factors in mind as you model the back half. From an employment standpoint, the majority of our employment is in our stores, distribution centers and call centers where we have the ability to flex with sales. But look, there are some fixed costs that will leverage with lower sales. Getting specifically to your question our in-house advertising. With our in-house own hands on the keyboard approach to marketing its competitive advantage, it does allow us to adjust spend as we see business trends evolve. But there's a minimum amount of advertising we'd always do. So there's a limit to the amount that we would be able to leverage that line. And third, I think this is the most important point for everyone. I just want to remind everyone that in Q4 last year, we benefited from a reduction in incentive compensation and some insurance proceeds. We do not anticipate being able to anniversary that this year, which will likely impact our Q4 SG&A rate. When you take a step back, I think the key takeaway here is our SG&A leverage shows the flexibility of our operating model, our commitment to financial discipline and our ability to control costs.

Our next question comes from Brian Nagel from Oppenheimer.

Congrats on a nice quarter here. So my question just with regard with furniture. So maybe I'll kind of wrap a few questions into one. But you talked about a more challenged backdrop there. So the question I have is, are you seeing -- as you look at the furniture category, is it getting worse? Are you seeing -- did you see weakening demand through the quarter so far in the back half? And I guess it's easy -- well, it's not -- there's a lot of reasons we can, you know -- bigger ticket. A lot of other companies have called out weakness in bigger ticket. Is it a consumer dynamic? Are you seeing something more competitively there as well? And then just a final piece of it, as we think about the back half of the year, just remind us on the seasonality, the general seasonality of furniture. I mean, does furniture become less significant as we head towards the holiday season?

Thanks, Brian. Yes. I mean, certainly, furniture becomes less significant as we head towards the holiday season and Williams-Sonoma becomes a larger part of our total. And also the Pottery Barn decorating and gift-giving business also really shines at that time of the year. We have been working hard to increase the seasonal holiday assortment in West Elm as well. And I'm excited that we have a good amount of newness for West Elm this holiday season. I think it looks great. In terms of furniture cadence, we don't really comment on cadence. I think you know that. There are some real winners in our furniture assortment. It's amazing to look at all the differences and see where the customer is going. And we're thrilled to see some of our new fall programs doing really well and seeing what the customer is looking for. And we're building on those wins, of course, and then reducing inventory on things that are not working. But it's in total, the furniture business, I said earlier, there's pullback. And it's, I think, a real function of people not moving as much right now and being scared of the high ticket. And we still continue to see the opposite in high-end electrics. So there's a lot of mixed messages out there for the consumer -- that the consumer is giving us. And what we're doing is really without giving away the farm competitively on this call, focusing on what they're telling us. And the good news is that we -- when we go to the back half of the year, the comps get easier. And we have our strength in the categories that they seem to be responding to at this point anyway.

Our next question comes from Oliver Wintermantel from Evercore ISI.

I had a question just regarding your online penetration, if that was still about mid-60s percent or if that has shifted? And then longer term, how you think about the store base. I know there were like some store closures. And what do you think your online penetration should be going forward with store closures on that?

I think we're seeing consistent performance, and my answer would be consistent with what we've been saying. From a long-term standpoint, we see the industry continuing to transition from retail to online. And with our penetration around 66%, we see it going to 70% over time. That's Williams-Sonoma's penetration of e-commerce. From a retail optimization standpoint, our strategy remains unchanged. We have about 50% of our leases come due over the next 3 years. We will very carefully go through those and look to optimize the fleet. Some of that is closing underperforming stores that don't meet our profitability thresholds. Others are repositioning stores to better locations where we see a very quick return on investment and really pick up some nice market share and good results. A good example of that is the Pottery Barn store in Westport, Connecticut, which we moved from one location where we were underperforming both on the top and bottom line. And the new location not only looks fantastic, I invite everybody to go join it, but it's way outperforming the prior location and giving us a very good return on the investment there. So we do continue to see that we'll continue to cull the fleet and optimize that. But overall, I think this is part of our key strategy and part of our key things that are going to make us really come out ahead over the long run. The fundamental dynamics in the home furnishing industry haven't really changed. It's a very fragmented market with no one player commanding sizable share. Our key differentiators, which include our in-house design, our digital-first but not digital-only channel strategy, our strong portfolio of brands, our growth initiatives and our fortress balance sheet position us well to take market share in any environment.

Our next question comes from Brad Thomas from KeyBanc Capital Markets.

Good execution here. I wanted to follow up on B2B. Still a ton of opportunity there. Hoping you could just give us a little more sense of maybe where you're thinking the revenues come in on B2B for the year in your updated guidance. And maybe any updated thoughts on what gets that business growing again?

Yes. Thank you. That's a great question. B2B continues to be one of our most exciting initiatives. And while the total business ran down 5% in Q2, which was an improvement over Q1, the contract business, which is the source of our growth and really where our focus is, grew 23% in the quarter to achieve our largest quarter-to-date in contract. And as Laura mentioned in her prepared remarks, we've seen quite a few notable wins. San Antonio Spurs training facility, Sony in the entertainment space and multiple projects with The Montage, Four Seasons, Westin, Hilton and Hyatt. Overall, we're not seeing a slowdown in the contract side of the business. There's a large backlog of projects coming out of the pandemic, and we see a steady pipeline of bids we've gone out on. And I think you have to remember, this business has 2 formats, trade and contract. Trade is currently more volume but contract is the source of our growth. And while the trade business has been more impacted by the slowed housing market, we've seen recent improvement in the trend, but our focus is on accelerating our contract growth. The key point when you think about B2B is it continues to be a winning strategy for us, and we continue to capture market share in an $80 billion fragmented market. It leverages our portfolio of brands, our in-house design team and our global sourcing capabilities, and we can really service the B2B customer in multiple ways.

Our next question comes from Steven Zaccone from Citi.

Laura, I'm curious for your perspective of the overall industry at the halfway point in the year. Do you think the industry has gotten more promotional than you've expected and you're just not willing to participate? Or is it just overall, you've seen a bigger pullback in kind of furniture spending? And then as you look to the second half of the year, if the industry stays promotional, would you not be comfortable in kind of participating in that? We should think sales are probably going to come in at the low end of the range.

The industry has always been promotional. Honestly, it was promotional before the pandemic and it's promotional now. Our stance is the same that it's been. We want to give our customers the best designs, the best quality and the best value versus running up and down pricing, which is a very short-term way to run your business and creates a lot of customer friction, honestly. Think about a customer who buys something and then sees the price get reduced. So it's not good for customer service. And when we think about what the right thing to do is, we think about our customer. And how do we always give them a better product? How do we improve the quality? How do we improve the pricing versus thinking about the short term? And so I feel very good about our product lineup. I feel that we are continually looking at where we should make small pricing adjustments. We are maniacal about inventory optimization and clearing things that are not selling. And I think that's the right way to run a retail business. You've seen us bring our inventory levels down pretty substantially. And yet, we're in better stock than we've been in for a long time. So we're pretty, I think, well set up. And as we said earlier, that's why we're confident in the guidance we gave this morning.

Our last question will come from Marni Shapiro from Retail Tracker.

And Laura, that LoveShackFancy has like taken over TikTok. Congrats on that. Can you just touch back again on the pricing and promotion? It seems from being in your stores and on your sites on a very regular basis that you've taken a very focused and consistent view on pricing on furniture and not really promoting on furniture where it's a considered purchase. Somebody is not passing your store and saying, "Oh, I think I want to update my couch today." It's a considered purchase. And you're pulling promotions where you need to in things like seasonal, holiday, even something like a throw or something like that, where a consumer might be on your site and say, "Oh, you know what, 20% off, I think I will buy that." Is that sort of the path forward? Is that how we should think about your use of promotion and pricing going forward for the brands?

It's an interesting comment, Marni, and I think you're right about considered purchases versus things that just inspire you to buy. But we're not actually actively doing it that way. We're looking at, as I said earlier, what's the best price for the product in the market and how do we win and really being self-critical to constantly improve our pricing value equation. And sometimes that means reducing a price. Sometimes that means changing the color or making something smaller or making something larger. And it's really based on the customer's reaction to the product and every day they vote with their sales, and we can see we have a lot of data, what they're interested in and what is exciting them. And as I said, I'm optimistic about not just the near term but the future of the business because we have such competitive advantages with our products -- proprietary product pipeline platform, others don't -- who don't design and endorse their own products. So thank you for the question. And yes, LoveShackFancy is fantastic.

This will conclude today's question-and-answer session. I would like to turn the call back over to Laura Alber for any closing remarks.

Well, thank you, all. I really appreciate your support and all your questions and your interest, and I look forward to seeing you all soon.

This concludes today's conference call. Thank you for your participation. You may now disconnect.