Welcome to the Williams-Sonoma Inc. Second Quarter 2016 Earnings Conference Call. [Operator Instructions] This call is being recorded. And I would now like to turn the call over to Beth Potillo-Miller, Senior Vice President, Finance and Corporate Treasurer, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you, Matt. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Our discussion will contain non-GAAP guidance, including non-GAAP EPS and operating margin, which excludes the impact of unusual business events. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in our press release. During the first quarter of 2016, we incurred a onetime reorganization charge related to the reduction of headcount, primarily in our corporate functions of approximately $13 million or $0.09 per diluted share. This charge was recorded as SG&A expense within the unallocated segment. The remainder of the discussion today will reference full year guidance related to EPS and operating margin on a non-GAAP basis, excluding this unusual item. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which address the financial condition, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2016 and beyond and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current press releases and SEC filings, including the most recent 10-K and 10-Q, for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I would now like to turn the conference call over to Laura Alber, our President and Chief Executive Officer, to discuss our second quarter 2016 results.

Thank you, Beth. Good afternoon, and thank you all for joining us. On the call with me today is Julie Whalen, our Chief Financial Officer; and John Strain, our Chief Digital and Technology officer. John joined in 2006 as Senior Vice President and Chief Information Officer and was promoted to his current position in 2014. Welcome to the call, John. Not on the call today is Pat Connolly, who most of you know after 37 years at Williams-Sonoma, retired last month. I want to reiterate my deepest thanks to Pat on behalf of our management team and all of our associates for his many contributions to the company. Our executive team isn't like that of most ides [ph] with an average of more than 10 years at the company and several of us with much more. So we've all worked together very closely for a very long time and couldn't be happier to see our colleague, Pat, begin his well-deserved retirement. Now I'll discuss the second quarter. In the second quarter, we delivered revenue growth of 2.8% and earnings per share of $0.58. These second quarter results once again reflect our competitive advantages, a portfolio of strong brands, a balanced multi-channel model, successful growth initiatives and a relentless focus on operational improvements. West Elm, Rejuvenation and Mark and Graham and our global business had strong year-over-year growth, and our improved supply chain execution contributed to our earnings results. We made substantial progress against our operational initiatives, which helps elevate our customer service levels, reduce costs and drive down merchandise inventory. We also continue to make progress across all of our brands in the area of corporate sustainability. One example of our company's commitment to responsibly sourced products is that West Elm was just recognized as one of Fortune's 7 world…

Thank you, Laura, and good afternoon, everyone. Before I walk you through the second quarter financial results in more detail, I would like to begin with a few second quarter financial and operational highlights. We are particularly pleased with the progress we have made on our long-term initiatives and the impact of these initiatives on our financial statements. First, our focus and disciplined execution against our long-term growth initiatives are driving quarter-after-quarter top and bottom line growth. West Elm, which we believe will be our largest brand over time, delivered their 26th consecutive quarter of double-digit profitable growth with comparable brand revenue growth of 15.8% on top of 15.7% last year. Our newer businesses, Rejuvenation and Mark and Graham combined, had another quarter of double-digit growth approximately 32%. In our global business, we also saw improved profitability and another quarter of double-digit revenue growth of approximately 20%, taking our global revenues to $80 million for the second quarter. Second, we have made progress on our operational initiatives. Our direct sourcing advantage continues to drive material cost reductions, allowing us to provide value to our customers and still maintain merchandise margins that are only slightly down to last year. Our focus on our supply chain initiatives has generated reduced shipping and fulfillment-related costs, resulting in improved selling margins. And our inventory initiatives have already allowed us to reduce our inventory levels and to reduce costs from our distribution network. Finally, we are a company with a culture of strong financial discipline. We continue to leverage our SG&A with strong cost control, particularly across employment and general expenses. We maintain a strong balance sheet, which in turn have allowed us to continue to invest in our business for future growth and to provide returns to our shareholders in the form of dividends…

[Operator Instructions] And we'll move to our first question. This will be from Daniel Hofkin with William Blair & Company.

Just wondering, you cited obviously the softer retail environment. Wondering how -- kind of what gives you confidence that, that's the main factor versus -- and I'm am thinking particularly about Pottery Barn here, versus internal merchandising or execution or, let's say, competitive factors. And then just a related question. How should we think about your outlook for the rest of this year in the context of your 3-year plan issued earlier this year?

Thanks, Daniel. It's mixed out there. We know mall traffic's down. Certain categories are more challenged than others. On the flip side, housing metrics appear to be strong, and we also are seeing growth in some of our smaller businesses. Our approach has always been the same. We're going to focus on things we can control, and we would prefer to be self-critical. The things we can control are our product, our value prop and our service. We're executing on our growth strategies and against our operating initiatives to drive improvements across the company, and we believe that these priorities, along with the combination of our portfolio of strong brands and our multi-channel model, will leave us well positioned amongst the competition regardless of what's going on in the external world.

And Dan, this is Julie. Regarding the outlook -- 3-year outlook. Our 3-year outlook still remains unchanged with mid- to high single-digit revenue growth and low double-digit to mid-teens EPS growth. Obviously, in the short term for 2016, our earnings growth is guided to obviously be below that outlook, and that is both due to the revised guidance on the year resulting from the softening retail environment, but it was also due to the investments we spoke to you about last time that we're making in our supply chain and inventory. But we are confident longer term, first, by the fact that West Elm is definitely clearly on their path to $2 billion with another quarter of double-digit growth. The scaling of our global businesses that I spoke to, the improvement in our newer businesses and their continued growth and all of these supply chain and inventory initiatives that we said we were doing, we're working on for a while and clearly, now they're showing that we are executing upon them and getting the benefits from them, when all of those come together plus all the strategic initiatives that Laura mentioned on the Pottery Barn brand, we are absolutely confident in our ability to grow in the longer term.

This time we'll take a question from Peter Benedict from Robert Baird.

Julie, in your remarks, you kind of mentioned the gap between revenue growth in CBR in 2Q, 220 basis points. Just curious -- and that's the way it's been for the last several quarters. What would affect that going forward? Why wouldn't that gap continue as we look out to the back half of this year?

I mean it could. In our full year guidance we do show that. We do have the revenue growth 100 basis points above the comp growth. Obviously, it just depends on the mix of revenues in any given quarter, but we've certainly reflected that in our full year. We don't -- have no belief, to answer your question, that West Elm is slowing down anytime soon, nor our global operations. So with those 2 being the big drivers of the non-comp growth, that is -- we still think that's going to continue.

At this time, we'll move to Matt Fassler with Goldman Sachs.

I want to ask one question about the guidance. You spoke about the retail environment eroding, presumably, over the course of the quarter and since you last spoke to us in May. The midpoint of your comp brand guidance for the third quarter is actually a bit better than the number that you put up for Q3. So is that a function of the environment stabilizing? Is it a function of other steps you're taking? Particularly I'd ask on the promotional front to try to shore up that revenue because even though there's some deterioration, I guess, it doesn't seem like you're modeling a much softer outcome for Q3 than you saw in Q2.

Yes. I mean, our guidance obviously, as I said, reflects our best estimate at this time, as the possible range of outcomes for the back half and for Q3. Obviously, the higher end of our range does assume improvement, and depending on the ongoing success of our growth initiatives in all the areas that we're focused on that Laura went through in detail, at the Pottery Barn brand, those should drive improvements. Obviously, we've got a range. We still have a softening retail environment. We don't know if that's 2 weeks or 2 months or what have you, so that is why we have a range of 0 to 4%. But on the upper end of that range, we do expect improvement.

And then just by way of very quick follow-up. Would you say, if you think about underlying demand, that you can detect within the e-commerce channel versus underlying demand, that you can track at retail particularly as it relates to traffic? Would you say that this is more of a footfall issue in brick-and-mortar stores or more of a consumer issue, broadly speaking?

I would say that it's both. In retail, there's reported reduced traffic from all the counter aggregate data you see. And then the customer's just more careful right now. And I'm not an economist, so I'm not going to go through all the reasons that can be. But our focus is on giving them incredible service and great value and innovative products. And we are testing a lot of things in both channels, and we have a lot of things that are working that we're building on. As I said earlier, particularly in Pottery Barn, we are very aggressively ordering what's working and canceling what's not and that it's really good to have new bestsellers that are really, really strong that you can build on even though you also are seeing some softness in other categories. So a little bit -- a little bit more color. And we're working across all of our channels, which do affect each other quite a lot to increase conversion and drive traffic and over the long haul, really build a much stronger, more loyal customer base. So we have a lot of initiatives. I went through them in probably too much detail in my script that are all focused on customer acquisition and driving traffic and conversion in both of our channels.

We'll move now to David Magee with SunTrust.

Can you give us what -- sort of an early read on what you see with the success of the seasonal merchandise thus far? Just maybe an early read on what you have for seasonal, for the fall.

Sure, great question. It's early, and we love the seasonal holidays. They provide the customer a great reason to buy new things and decorate their homes. And I know, for me, it gives me a lot of pleasure to put up those Halloween decorations every year for the kids, and our customer's telling us the same thing. Despite what I said about the caution, we're delighted to see strong results to Halloween so far. I mean, it's really early, so I hesitate to even tell you that, but it is true. And we have incredible costumes in kids and some wonderful entertaining stories in both Williams-Sonoma and Pottery Barn and so far, so good. And following that, of course, we don't know about Christmas yet. We did see a nice back to school with kids. I mentioned that earlier. And also in teen despite the softness in other categories, the seasonal merchandise has been selling. And this is important because not only is it important for sales, obviously, in the short term, those are the categories that bring the new customers in. So you want to make sure that you're getting customers in with those things because then they're more likely to buy a sofa from you or a rug in a different life stage or when they move than they would have they'd never experienced the brand.

We'll move now to Chris Horvers with JPMorgan.

So I wanted to ask a couple questions on gross margin. Can you quantify how much the inventory clearance impacted enterprise-level gross margins? And do you expect any remnant markdown pressure in the third quarter? And then I have one follow-up.

It predominately hit the retail operating margin the most. As we've said, that we did most of the clearance through our outlook stores, which hit the retail operating margin. So you can look at the delta on the retail operating margin and come to some conclusions. We haven't disclosed the exact amount, but it was material to that margin. As far as of the guidance, I think, sure, could we still have some pressure from some of our inventory initiatives? Sure. But I think the bigger story to take away from, what I'm really pleased to be able to say is if you look at our gross margin, if you look at it sequentially, it has improved from Q4 to Q1 to Q2, and we've gone from basically holding our merch margins flat to slightly down and our selling margins, taking out global, are flat. And I think it's been a long time since I have said that. So clearly, everything we are doing from a supply chain perspective is allowing us that -- trust me, we are still promotional, so -- but we're able to be able to offset that unlike other retailers because of all these initiatives we've been tirelessly working on. It is finally coming to fruition. So I think that's the great story about the gross margin going forward.

That's a perfect segue to my follow-up question. So you previously had talked about improved gross margin performance in the back half. Obviously, lower comp, you have occupancy deleverage. But can you update us on your thoughts on selling margins? Will you promote more to drive the business? Will that be -- can you offset that? And then the impact of shipping and fulfillment costs, obviously, a lot of pressure from out-of-market shipping and returns of damages last year in the back half. Do we get those back now that inventories are cleaning up?

So we're seeing all of that even today. We're getting a lot of benefits from the fulfillment-related costs that are improving as we speak. I don't expect that to change, so we should see that. To your point about occupancy, it depends on the top line, right? Occupancy, depending on where the revenues come in, can deleverage and that would affect total gross margin. Often depends on the mix of revenues from a global perspective, if you got higher franchise, all of that. So it's hard to say exactly where clearly, we don't guide it, where the margin's going to come out. But what I did say is that the op margin we expect for Q3 to be relatively in line with last year, so hopefully, that gives you some indication that we're not feeling that the gross margin's going to be changing.

We'll move now to Greg Melich with Evercore ISI.

I guess, I want to switch gears a little bit. If we think about the overall sales growth, the comp -- brand comp of 0.6%. And I think, Laura, in your comments, you mentioned more opening price point items being added at Pottery Barn, and I think PBteen. Could you help give us some examples on the quarter, the second quarter, as to whether ticket was actually up or down and if this is meant to help improve conversion and sort of gets to a price point that's more affordable for the consumer? Or what's really driving that decision?

Customers are savvy. As I said earlier, they know a value when they see one, including if it's a higher price point type of item. So a sofa that's a great value may be a lot more money than a candle. The truth of the matter though is that the candle, a lot more people can afford. So as I said earlier, we have to make sure that we are not just driving our furniture business but bringing in really innovative decorating and entertaining ideas into all of our brands. It's a very competitive area, so I hesitate to go through specific examples because, as you know, the competition is listening very carefully to our strategies. So I'm sorry not to give you more detail. I'll just say that there's no tricking those customers. They know a good price when they see them, and we are looking at our pricing both versus the competition but also where we cannot just stay status quo but where we can really win. And because we have better quality and they know it and we also offer a lot of service, I believe as we continue to give them innovation and that combination, we will outpace our competition.

That's helpful. And Julie, just to follow up the gross margin question from before. I think last year, did you, sort of, mention something like 50 or 60 bps of headwind on supply chain and related to the West Coast ports and some of that? And how should we think about cycling that in terms of the second quarter and then the back half guidance?

I don't recall that I exactly gave the amount. Probably what I did was alluded to more the fact that if the gross margin was down, it was predominantly associated with the supply chain challenges that we were -- were occurring. So we are seeing a lot of that return and come back to us as we should expect, but I think the bigger story for -- it's going to -- it's a ship you're turning around, so it takes a while. But we've seen all of it start to come back first quarter, second quarter, and it's gaining momentum. But I think the bigger story there that we have to take away is that we are now seeing opportunity to get back to even better than we've been before. And so that's what we're focused on. So we've got improvements from last year, but as we move forward, as we move through the end of the year, into subsequent years, we've got to improve it even beyond that. So that's the exciting part.

We'll move along to Michael Lasser with UBS.

Could you frame the margin benefit that you're seeing from all the supply chain initiatives that you've been putting in place? Also, how long can that last? And how are you thinking about, from a strategic perspective, letting those margin benefits fall to the bottom line versus reinvest them back in the promotions to drive the business?

Yes. We haven't disclosed it, and there's different kinds of margin benefits we're getting. So from specifically from the merch margin line item, it's a lot of the sourcing benefits that we've been talking about for years. I know I've gotten the question a lot that is it going to end next quarter. Well, no, it keeps going on. So first, we started with just the reductions in actual cost vis-a-vis versus the third party and that's still continuing. But now we're moving into that second phase where we've got our employees out there, and they're actually make a difference on the raw material and the negotiation of prices. And so that's one piece of it. The other piece of it is all the supply chain initiatives that we're working that were challenges last year. So get some improvement from that but then also to move ahead from it. So I think the way I would think about it is it's the fact that we are almost -- effectively, it's only slightly down in merch margins and flat on selling margins if you take out the global impact. We were less promotional. So if you look at other retailers and see how promotional they were, you might be able to get some idea of how much benefit we are getting. And would we ever have let it drop down? I mean, of course, but at this point, we see the opportunity to continue to be aggressive and competitive and move forward.

We'll now move to Dan Binder with Jefferies.

Just 2 items. I was wondering if, first, you can discuss a little bit more color on the cadence of the quarter from a sales perspective. And then secondly, on the promotional environment, I'm just curious with the change in the comp momentum, what you're seeing customers -- what have they stopped responding to versus maybe what they were responding to before.

On the cadence of the comps, Julie, you want to answer that?

Yes. We usually don't comment on the cadence of the comps. But as far -- I mean, I can comment, Laura can comment, but on the promotional environment and what we thought was different at least from my perspective, from a financial perspective, if you look at many retailers, we are not alone in this situation. If you look at Q1 versus Q2, it was much more broad based. You saw deceleration from Q1 to Q2. It was much more across categories that we've seen before. So I think that's where you start to step back and say, hmm, this is something a little more than we've got the wrong product category in a particular brand.

We have time for one more question. This will be from Simeon Gutman with Morgan Stanley.

I'll make it 2 parts just to get it all in. Just a follow-up on gross margin, Julie. You talked about, a few minutes ago on a response, how you think you can get back to -- or maybe better than some of, I don't know exactly what your words, but to some levels that you were before. In that context, can you talk about do you feel like the gross margins are bottoming cyclically, temporary and you should be able to move on from here? And then my follow-up question, to sneak it in, it looks like the first, I guess, through third quarter margins are roughly flattish. And so doesn't the full year guide imply that margins are going to be down in the fourth quarter? And why is that the case?

What -- for your second question, are you talking about operating margins? Are you talking about gross margins?

Operating.

Okay. So as far as gross margins, I mean, there are so many moving parts in there. That's why it's so hard for us to answer that. I mean, clearly, I am confident our supply chain and inventory initiatives, both sourcing and comping the supply chain challenges we have last year, so I'm confident in that piece of it and that piece moving forward. Obviously, it depends on the promotional environment. It depends on the mix of revenues that we have, how much is global. It depends on the level of revenue to determine where does occupancy play out. And so I can't give you a specific answer to that, but I think the fact that we've seen Q4 to Q1 to Q2, we've seen improvement and we are seeing the success of our supply chain initiatives roll through, I feel really good about the gross margin. From an op margin perspective, really, that is a revenue play. It really depends on -- obviously, we said, for Q3, we're going to be relatively in line with last year, so it was a Q4 conversation, one of our biggest quarters and where the revenue lands. At the high end of our range, we're flat to last year, and so -- and it's a range. So we could be a different level on the revenue, different level on the op margin relative to our guidance, but it does assume that we've got continued improvement in our supply chain.

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

Well, thank you all for joining us, and we look forward to catching up with you again next quarter.

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