Williams-Sonoma, Inc.
Q2 2017 Earnings Call Transcript

Published: 24 Aug 2017

[Operator:]

Welcome to this Williams-Sonoma Incorporated Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session after the presentation. This call is being recorded. I would now like to turn the call over to Beth Potillo-Miller, Senior Vice President, Finance, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

[Beth Potillo Miller:]

Thank you, Shannon. Good afternoon everyone. This call should be considered in conjunction with the press releases that we issued earlier today. During the first and first quarter of 2017, we incurred severance related charges of approximately $6 million or $0.04 per diluted share. These charges were recorded as SG&A expense within the unallocated segment. Also during the first quarter, we incurred tax expense of approximately $1 million or $0.02 per diluted share associated with the adoption of new accounting rules related to stock-based compensation. The remainder of the discussion today will reference full year guidance related to diluted EPS and operating margin on a non-GAAP basis excluding these unusual items. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in our press release. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which address the financial condition, results of operations, business initiatives, trends, guidance, growth plans, and prospects of the Company in 2017 and beyond, and are subject to 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 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.

[Laura Alber:]

Thank you. Good afternoon and thank you all for joining us today. On the call with me are Julie Whalen, our Chief Financial Officer, and John Strain, our Chief Digital and Technology Officer. Our second quarter results reflect the strength of our brands and our competitive advantages as well as our relentless focus on driving innovation and operational excellence. The acceleration of our revenue growth to 3.7% with comp growth of 2.8% demonstrates the investments and actions we are taking are driving improved top line performance. Our success with our key initiatives is centered upon delivering value, quality and full service to meet our customers changing needs. And we are aggressively building upon these initiatives to further differentiate ourselves and to drive growth. Digital leadership is one of our highest priorities. We are increasing our investments to improve the customer experience and engagement and to drive profitable top line growth. As you are aware, one of our key areas of focus this year is investment in new customer acquisitions to increase digital advertising. Year-to-date we have significantly increased our digital advertising investment and as a result we are seeing strong new customer accounts with higher traffic trends and increased orders. And our commitment to increasing our top of the funnel digital advertising spend has allowed us to reach more customers. We've also experienced strong new customer growth in the key channels of paid search, display and social advertising. In an effort to drive engagement with our customers to relevance across all our brands we are expanding our one-to-one personalization efforts. We have experienced an uplift in engagement and higher margins in our new personalization based emails and we are seeing these same results translate to our site. By the end of the fiscal year we anticipate tripling the number of personalized impressions delivered on our websites enabled by both an expansion of personalization campaigns and improved customer identification. We have several high impact ecommerce initiatives going live throughout Q3. We are re-platforming our mobile experience leveraging the latest progressive Web App technology that will feature a highly engaging task performing app like experience. We are launching a redesign of our product information pages introducing improved functionality, product information and storytelling. We are taking our key loyalty program to the next level with an improved in-store experience, customer self-service options and capabilities that will enable us to introduce new and enhanced services for our key members. We are also testing various digital innovation initiatives in specific brands and based on our findings we will implement best practices across the portfolio. For example, in PBteen we improved the ship to store experience specifically for our PBdorm customers. While the pilot is still in play early results are very positive both for the customers in terms of convenience and for our stores in terms of driving traffic. This has been a great test in advance of our [indiscernible] pick up in-store program that will be first launching in the Williams-Sonoma brand this fall. On our Pottery Barn site we introduced a new feature called Favorites that allows our customers to bookmark their favorite products across our desktop and mobile sites. We've already seen great response with over 600,000 favorites in less than six weeks and the directly attributable revenue has exceeded our expectations. We will feature out all brands this quarter. Our West Elm team launched the Pinterest Style Finder tool in July. This visual search tool is just one example of the artificial intelligence based solutions that we are working on. It is a great complement to the efforts we are driving on the augmented reality this digitalization front across our brands where we already have 130,000 skills encoded in 3D that we are using both on our sites and in conjunction with our apps. Second, our supply chain remains a primary focus for us and we are continuing to invest in those initiatives that directly improve our customers experience and value perceptions and that position us even further ahead of the competition. Order visibility is the key area of focus for us. We are working aggressively to both improve the customer experience and drive efficiencies at our stores and care centers. We want our customers to know precisely where their furniture is in the delivery process. In Q3 we will be enhancing our customer order visibility platform enabling customers to better track the status of their furniture orders and even receive text alerts when the driver isn’t around. As it relates to damage free and speedy delivery, we've seen significant improvements in our metrics and are aggressively challenging ways to find further advancements. Our speed of delivery our ongoing process optimization efforts have yielded improvements in both our furniture home delivery and our conveyable parcel delivery network. Productivity increases have not driven shorter delivery times, but have also resulted in reduction in operating expenses. And in our pottery manufacturing operations we have increased productivity to an all time high. From a cost efficiency perspective, we've realized savings in several areas as a result of our optimization efforts including order consolidation improvements, increased pieces for delivery and meaningful reductions in returns and replacements. Also in the quarter we launched a new international Direct Ship solution that combines our advantages of direct sourcing in Asia with our domestic logistics network. This also allows us the ability to strategically expand our assortments without impacting our regional distribution centers. While we have just launched the program in Q2 we are enthusiastic about the incremental opportunities that this represents. Our supply chain efforts are yielding results as indicated by our improved customer metrics and the feedback we are receiving from our customers service survey on some of the most critical customer touch points including our home delivery network and care center. In Q2 we expanded our survey capability to directly source feedback from customers on every in home delivery and every call. The insights from this research not only validate our progress today, but most importantly allow us to identify opportunities to better service our customers in the future. We will continue to prioritize these customer centric initiatives as our supply chain is a competitive advantage for us and a critical component of the customer experience. Finally in retail we know that our stores are competitive advantage and that our multichannel model especially in our industry will allow us to lead. And as a result we have been working on several opportunities to maximize this competitive advantage. Across all brands our retail presence offers customers an important source of inspiration and having experienced sales associates and in-home designers working through the complexities of an in-home design experience is a competitive advantage for us. We've recently took our leading in-home design services to the next level with the launch of Design Crew a new complementary cross brand design service. The Design Crew initiative will offer our customers personal assistance from design professionals design products and services for a variety of unique needs leveraging our portfolio of brands in an integrated way. Our efforts are specially trained to help customers with many home requests such as decorating, renovating, entertaining, cooking and gift giving. This service further reinforces our commitment to provide outstanding service to our customers and deepens our relationship with both new and returning shoppers. Additionally to enhance the customer experience in all of our stores we've been investing in point-of-sale technology and scheduling tools which will provide operational efficiencies and elevated service levels. We've also been focused on retail optimization across our brands and have driven improved financial results from both closing underperforming stores and successfully remodeling or relocating existing stores. Now, I'd like to discuss the performance of our brands and their progress on their product initiative. I would like to talk to you about progress in Pottery Barn which delivered a 1.2% revenue comp in the second quarter. The Pottery Barn team has been working very hard on the repositioning of the brand and has developed a roadmap of initiatives to implement across all areas of the business from product to value to marketing. As a result of these initiatives we're seeing positive response in customer satisfaction metrics, customer accounts and increased sales. We're driving improvements in multiple categories. Our new furniture collections are strong and most exiting is that our decorative accessories entertaining and textile categories where we are driving growth with our focus on easy decorating and seasonal ideas that convert new customers. In our fall collections we launched a broader assortment of opening price points small space solutions and a wider range of aesthetics and we are just getting started. We recently launched a collaboration with [indiscernible] after very successful partnerships with Pottery Barn Kids and Teens and the initial customer reaction has been strong. Also we announced an exclusive collaboration with designer Monique Lhuillier which will debut in the holiday season. Our brand repositioning is working, our new product introductions, opening price points, merchandising strategy, improved store experiences and fresh press to marketing are all resonating with our customers. The Pottery Barn team has made significant progress on these strategies to increase brand development and acquire new customers and we believe we will continue to see further acceleration in growth in Pottery Barn. In Pottery Barn Kids while comp revenues declined 3.9%, demand revenue was positive in the second quarter. Our customers are responding favorably to our back to school assortment, our textiles and our furniture collections. In particular nursery furniture continues to grow double digits and we continue to make progress transitioning all nursery and bedroom furniture to Green Card certification. We remain focused on expanding our baby business. We are seeing a favorable response for our baby gear launched in April which is attracting new customers to the brand and drove double-digit increase and registry creations in the quarter. During the quarter we introduced our back to school collection featuring innovative designs, new personalization options and wait three months solutions and the customer response has been excellent. We recently launched our fall and Halloween collections and are also very excited early response to those. These results along with the performance we are seeing in our back to school collection and an increased level of assortments we have built in these important seasonal categories give us the confidence and success of our Q3 and Q4 strategy. PBTeen posted a 0.2% revenue comp a significant turnaround from Q1 results of negative 14.3 with improvement across all major categories as well as in our inventory position and our ability to serve our customers. We launched our fall collection during the quarter and are encouraged by the customer response to our increased aesthetic diversity revamped offerings across many categories and are focused on value. Furniture continues to deliver positive results driven by introductions in our bedroom furniture business and expanded allowance feeding options. In the textile accessory categories we saw dramatic improvement with our fall launch giving us confidence for the upcoming seasons. And in our back to school business we are seeing breakout results in our dorm offerings which feature innovative and stylish solutions for small space living. Our collaborations remain an important strategy and we continue to see exceptional response to our new Emily and Meir [ph] collection. We will continue to build upon these successes and are joining forces with top talent and beloved brands to deliver next level products exclusively and compelling digital content. We've recently announced our license collaboration with Harry Potter. The collection is designed with iconic Harry Potter references across the range of home décor including furniture, bedding, and decorative accessories to transform any bedroom into a magical space. The collection will launch in September and we have other cutting product launches scheduled for fall and holiday including collaboration with iconic fashion designer Anna Dewey [ph]. With the recent improved trends in PBTeen we are optimistic about the quarter ahead. Our fall offering is strong. Our back-to-school businesses are delivering meaningful volume and the pipeline is full of new launches, new collaborations and a compelling holiday assortment. The Williams-Sonoma brand ended the quarter with a 1.9% comparable brand revenue growth. We continue to execute on our strategies of high quality merchandise at great value elevating the experience across all channels and acquiring new customers. From a merchandising perspective we continue to see growth by offering our customers exclusive products available only at Williams-Sonoma. We continue to expand our Williams-Sonoma branded lines while at the same time deliver exclusive innovation from our strategic vendor partners. We had a strong summer season with introductions of exclusive outdoor cookware and innovative products that capitalize on current cooking trends. We launched several key collaborations in our food business including a line of food products with New York Times best selling cookbook author TV personality and country music singer Trisha Yearwood which were among some of our most popular selling food items this season. In our marketing efforts, we continue to interact with existing and new customers with a variety of initiatives. For the third consecutive year Williams-Sonoma presented the Culinary Stage at BottleRock in Napa, California. Chefs and celebrities including Martha Stewart, Jesse Tyler Ferguson, Jose Andres, Chef Morimoto and Ayesha Curry partnered in culinary theme performances to entertain audiences throughout the entire event. We also participated in the Atlanta Food and Wine events and hosted a wide array of events and book signings across all our entire retail fleet with chefs and personalities including Jada [ph]. Also Williams-Sonoma Home continued its strong performance in the second quarter. We expanded our retail presence in Williams-Sonoma Home adding products into seven additional locations in the quarter, bringing the total to 51 store locations with Williams-Sonoma Home products. In the third quarter we will be placing Williams-Sonoma Home into 13 more stores as well as converting a Pottery Barn store in Chelsea, New York to a freestanding home location. Looking to fall, we are already seeing great consumer response to our fall seasonal line-up and we are excited about new product collaborations and a number of new exclusive launches. Additionally we will be launching a key strategic program by our line pick up and store that we believe will be transformative in driving incremental sales. Now I'd like to talk about West Elm. As we announced at the beginning of June, Alastair Dorward has returned to West Elm to lead the brand after four years of driving the Rejuvenation transformation and growth strategy. His deep experience at West Elm before moving off to Rejuvenation allowed him to drive quick results at the brand and his transition to the brand is a great demonstration of the power of our multi brand strategy and deep bench of talent across our organization. In Alastair's first quarter with West Elm growth has reaccelerated to 14.3% with comp brand revenues up 10.1%. The West Elm team has quickly worked to focus on promotional messaging, streamlined pricing strategies and to reassert the key brand differentiators of product choice, community building, and consciousness in sourcing. We drove a very successful outdoor season with additional depth in key collections and breadth across new materials and functions. The launch of our new Italian modern furniture collection in June is a great representation of our market leadership and design and the strong customer feedback to the questions builds a solid foundation for continued launches and growth throughout the year. On the sourcing front we continued our leadership of launching and scaling Fair Trade in the home industry. We certified the first Fair Trade furniture factory in Vietnam in the quarter, bringing our top selling furniture collection and over 2,500 more workers into a program that now benefits over 5,000 workers in four countries. We're also committing economic development here in the United States with a focus on local sourcing expanding our local showcase program to over 800 artisans and designers across all of our store markets. Our focus on conscious sourcing at home and abroad continues to be a major differentiator for the brand and drives benefit not only for our vendor partners, their workers and their communities but also for our overall supply chain and customers. We continue our focus on expanding the brands footprint to new geographic areas and market segments. We opened two new stores in Phoenix, Arizona and Portland, Maine within the quarter and both stores are performing above our expectations. We have seven additional store openings throughout the remainder of the year and continue to see our profitable expansion of West Elms retail fleet as a major competitive advantage to build sales and brand awareness. We also continue to build our business into new markets segments. We debuted more than 20 new products and solutions in our West Elm work space line at Yukon in Chicago including a new collaboration with a world renowned design firm Gensler and product design innovators QDesign [ph] where we won three coveted Best of NeoCon awards and Interior Design Magazine's HiP Award. We also announced two new locations for West Elm's Hotels offering us unique and powerful tool to expose new customers to the West Elm brand and to deepen our relationships with the current customers. Now I’d like to discuss our newer businesses Rejuvenation and Mark and Graham as well as our global business. Rejuvenation delivered another quarter of double digit comp growth driven by expansion online and a national store rollout that continues to be effective at driving profitable multichannel sales and customer acquisition. Greater depth in the core lighting and hardware categories are important to growth accelerated by new businesses in furniture, textiles and furniture accessories. Our [indiscernible] to our manufacturing roots in Portland as well as our partnerships with domestic manufacturers across the country is fundamental to the growth and strategic direction of this business. As previously announced in July, we welcomed Ryan Ross back to Williams-Sonoma, Inc. to lead Rejuvenation. This is a return to our company for Ryan where from 2000 to 2008, he held positions of increasing responsibility in the company’s Pottery Barn brand culminating in the role of Vice President of E-commerce. Ryan most recently served as Executive Vice President Marketing Creative and Digital Commerce at HSM. Ryan has great multichannel expertise and we're excited about his ability to lead our Rejuvenation management team and their continued efforts to drive accelerated and profitable growth in this brand. Mark and Graham continued its profitable double digit growth in the second quarter also driven by successful execution of Mother's Day and Father's Day both of which were important gifting opportunities for the brand. We also recently launched a new lifestyle marketing campaign which is contributing up to triple digit comps on core programs. We believe Mark and Graham is well positioned for Q3 and Q4 with new product innovations and exciting new creative campaign and emphasis on digital marketing and is on track for continued success as an emerging brand. In our global business, our company owned businesses in Australia and the UK continue to deliver strong performance with over 10% revenue growth. We continue to be convinced that we have a tremendous opportunity for global multichannel, multi-platform, high quality home furnishing business like we have in the United States. We have made progress towards the goals that we have set this year entering the dynamic retail market of South Korea with our franchise partner Hyundai Livart and expanding further with our existing partners in the Middle East and Mexico. In our company owned retail and e-commerce operations in Australia and the UK, our continued focus on operational excellence along with double-digit growth has resulted in further cost structure leverage and improved profitability in each of these markets and because the positive impact that retail stores have on our e-commerce business later this year we’ll be opening an additional West Elm store in the Kingston area of London. As we continue to improve our global operations to support our existing business and partnerships, we are exploring opportunities for franchise expansion into new markets and to build our e-commerce business around the globe both company owned and with our franchise partners. In summary, the acceleration in our Q2 top line performance reflects the positive customer response to our key strategic initiatives, we know that we are successful when we offer our customers differentiated high quality products at a great value and superior high touch customer service. And our focus on innovation in operational excellence is grounded in our ability to understand and adapt to the changing desires and behaviors of our customers. And we believe our relentless focus on our strategic initiatives and customer service along with our competitive advantages and opportunities for growth will enable us to drive long term industry leading profitable growth resulting in sustainable shareholder returns. I will now pass the call over to Julie to discuss our financial results and our guidance.

[Julie Whalen:]

Thank you, Laura and good afternoon everyone. During the second quarter, our results demonstrated overall sequential improvement from the first quarter and that we are able to once again deliver on all of our financial commitments including meeting the high end of our EPS guidance range while continuing to invest in our long term initiatives. On the top line, total revenues for the second quarter increased 3.7% over $1.2 billion with comp brand revenue growth of 2.8%, a 270 basis point acceleration from the first quarter, further demonstrating the continued progress we are making on our initiatives to drive positive momentum across the business. During the quarter, we saw e-commerce revenue growth reaccelerate to 5.2% growing to 52.5% of total revenues and 80 basis point increase over last year and an historical high with growth coming from Williams-Sonoma, our newer businesses Rejuvenation and Mark and Graham and our company owned international operations almost all of which had double-digit growth. The retail channel grew 2.1% driven primarily by strong growth in West Elm and Pottery Barn reflecting the continued success we are seeing across our various retail initiatives, including our in home design services and store remodels. The Pottery Barn brand returned to positive growth with a revenue comp of 1.2% a sequential improvement of 260 basis points from the first quarter. the Pottery Barn Kids comp accelerated 180 basis points from the first quarter and they also saw sequential improvement in their demand comps which turned positive in the second quarter. In PB Teen, we delivered a positive comp of 0.2% a significant turnaround from the negative 14.3% comp in the first quarter and they also saw sequentially better demand comp at a positive 1.3% versus a negative 3.7% in the first quarter. Williams Sonoma at 1.9% had its highest second quarter revenue comp in several years and has now delivered positive comps for 15 out of last 16 quarters. West Elm which we continue to believe will be our largest brand over time re-accelerated back to double digit revenue growth of 14.3% this quarter with revenue comps of 10.1% on top of 15.8% last year. Our newer businesses Rejuvenation and Mark and Graham once again delivered double digit growth of over 25% and our company owned international businesses also delivered another quarter of double-digit revenue growth, primarily driven by the strong growth we continue to see in our e-commerce businesses in Australia and the U.K. Our execution across the company drove this overall broad based improvement in our top line and given the disruption in the retail industry overall, these results give us confidence that our strategies to reaccelerate the business along with our unique competitive positioning with the best in class multichannel model, strong well known brands with high quality and proprietary products provided to our customers with superior customer service will allow us to long term outperform and maintain our leadership position in the industry. Moving down to the income statement, gross margin for the second quarter was 35.2% versus 35.4% last year. The 20 basis points of gross margin deleverage was driven by lower selling margins primarily resulting from our investment reduced shipping income to provide value to our customers. Occupancy costs were $168 million in the second quarter of 2017 as compared to $165 million in the second quarter of 2016 leveraging 20 basis points in the second quarter. And this leverage along with the ongoing benefits we are seeing from our supply chain initiatives allowed us to only incur a 20 basis point gross margin impact after investing in reduced shipping income and providing overall value to our customers. SG&A for the second quarter was 28.4% of net revenues in 2017 versus 28.2% in 2016. The 20 basis points of deleverage was primarily driven by higher digital advertising costs from our decision to invest in new customer acquisition which was partially offset by strong financial discipline across our general expenses. As a result operating margin for the second quarter was 6.8% versus 7.2% in the second quarter of 2016. By channel, the operating margin in e-commerce channel was 21.4% versus 22.1% in 2016. The 70 basis point decline in operating margin was primarily driven by lower selling margins as a result of our investments in reduced shipping income as well as higher digital advertising costs as a result of our increased focus on new customer acquisition. This decline was partially offset by strong expense management across occupancy, employment and general expenses. Our investments to reduce shipping income and higher digital advertising helped drive the improvements we are seeing in our top line performance across the company and our higher digital advertising has driven improvement in customer accounts particularly in Pottery Barn where we saw improved, active, new and reactivated customer accounts year-over-year. The operating margin in the retail channel was 6.1% versus 5.9% in 2016. This increase in operating margin primarily resulted from higher selling margins and lower general expenses partially offset by higher employment primarily to support our growth initiatives which include additional West Elm stores and our new southeast distribution center that wasn't fully up and running until the end of the second quarter last year. Corporate unallocated expenses as a percentage of net revenues were 7.3% in the second quarter compared to 7.1% in 2016 reflecting the incremental depreciation costs associated with various technology capital investments to support the future growth of our business. The effective income tax rate of the second quarter was 34.8% versus 37.7% last year. The year-over-year tax rate improvement was driven by the overall mix and level of earnings as well as the incremental benefits we continue to see from the improved profitability across our international operations which are taxed to the lower tax rate. Diluted earnings per share for the second quarter of 2017 was $0.61 versus $0.58 last year. On the balance sheet, we ended the quarter with a cash balance of $103 million versus a $111 million last year. We had $115 million outstanding under our revolving credit facility at the end of the quarter versus $125 million last year. During the second quarter we invested an additional $51 million in our business and returned $89 million to stockholders through share repurchases and dividends. Merchandise inventories of $1.73 million increased a 11.4% compared to Q2, 2016. A large portion of this inventory growth however was associated with inventory that is in transit and not yet received at our distribution centers. The biggest drivers of our inventory growth are associated with our higher growth brands particularly West Elm. We also saw higher growth in PBTeen where sales have previously been most impacted by lower in stock inventory levels. We are continuing to evaluate the balance between inventory and customer service levels and at this point we still expect our inventory levels to be relatively in line with our sales growth by the end of the year. I would now like to discuss our third quarter and fiscal year 2017 guidance. For the third quarter of 2017 we expect to grow net revenues to a range of $1.270 million to $1.310 million with comparable brand revenue growth in the range of 2% to 5%. We expect our third quarter operating margin to be relatively in-line with last year and we expect diluted earnings per share to be in the range of $0.80 to $0.87. For the full year we are reiterating all of our guidance ranges. We expect to grow net revenues 2% to 4% to a range of $5.165 million to $5.265 million with comparable brand revenue growth in the range of 1% to 3%. We expect operating margin to be 9.4% to 9.6% and our diluted earnings per share are expected to be in the range of $3.45 to $3.65. All other financial guidance within the press release remains unchanged from the previous guidance. This guidance will have us delivering at the high end of our ranges 4% growth in revenues to almost $5.3 billion with a flat year-over-year operating margin and EPS growth in the mid to high single digits despite substantial investments in the business to support our future growth. From a capital allocation perspective, we remain committed to a disciplined capital allocation strategy. We plan to utilize our strong annual operating cash flow to continue to invest approximately $200 million to $220 million in the business in support of our ongoing initiatives to improve the customer experience and to drive further operational efficiencies. We also intend to return capital to our shareholders in the form of share repurchases and dividends. By the end of the second quarter we had invested approximately $83 million in the business, paid over $68 million in dividends and bought back over 93 million in our stock leaving approximately 317 million remaining under our current share repurchase authorization. We are continuing to monitor our rate of buybacks. If lower valuation levels persist we are prepared to continue to opportunistically increase our rate of buybacks like we did in the second quarter through the back half of the year. With our strong cash flow generation, strong balance sheet and strong financial discipline along with the improved momentum we are seeing in the business, our long term growth opportunities are well known and loved portfolio brands delivering superior customer experiences and inspiration and our leading multi channel model with over 52% of our business already transacted online give us confidence in our ability to lead our industry and to deliver long term sustainable growth for our shareholders. I would now like to open up the call for questions. Thank you.

[Operator:]

Thank you. [Operator Instructions] And we first go to Kate McShane with Citi.

[Kate McShane:]

Hello, thanks for taking my question. With regards to the merchandising changes you've made at the Pottery Barn brand which sounds like they're very effective, I wondered if you could quantify at all how much of your overall offering in Pottery Barn you touched and changed with your new merchandising initiatives and by holiday how much do you think those merchandising changes will touch as a percentage of products sold?

[Laura Alber:]

The interesting way to look at it, we haven’t really measured it that way Kate. What we've tried to do is really listen to what our customer is asking for and we have a broad base of customers we want to make sure that we're both delighting our current customers but also attracting new ones. So where we were more specifically addressing from a percentage basis change was in the value offering in the small spaces and while that's a competitive number I would tell you that we've just begun in tapping into that market we think nice response already, but we think we have a lot more opportunity in that area without affecting or turning off our current customer either.

[Kate McShane:]

Thank you.

[Laura Alber:]

Welcome.

[Operator:]

We’ll go and then take our next question from David Magee with Sun Trust.

[David Magee:]

Hi good morning, good afternoon.

[Laura Alber:]

Hello.

[David Magee:]

Hi, you mentioned both business being a big opportunity and I'm curious as to what you all might be doing differently there to make it maybe more distinctive than your competition?

[Laura Alber:]

I think the big thing is that we have a wide offer. We have incredible stores and great sales associates in the stores and we've continued to look at ways to how the channels work together and it's a natural. It's not so much that it's the different execution, it’s that we have I would argue a better platform to execute it on.

[David Magee:]

Right and just one other question if I could. You mentioned that the lower shipping income this quarter I'm curious when was the last time if you also correctly reduced that?

[Laura Alber:]

So in Q3 of last year we started with the Pottery Barn brand, but the other brands all began - rest of Pottery Barn began the first quarter of this year.

[David Magee:]

Okay, and not t he Williams-Sonoma?

[Laura Alber:]

Yes, Williams-Sonoma has always had about 49 ships free and they also do have the flat rate that was on something we put into place last year as well.

[David Magee:]

Okay, great thanks and good luck.

[Laura Alber:]

Thank you.

[Operator:]

Next question comes from Matt Fassler with Goldman Sachs.

[Matt Fassler:]

Thanks a lot. Good afternoon. I also want to focus on the shipping piece. Can you describe if the elasticity you have seen the response that you've seen kind of brand by brand as you reduced shipping whether it is evident at different ticket sizes or different kinds of transactions? And I did note, I think that Pottery Barn was really highlighted from a retail perspective more so than from e-commerce perspective and I'm wondering how that dovetails with the shipping efforts there? Thank you.

[Julie Whalen:]

Sure, it is obviously really competitive to go into too many details driving the economics of our new shipping model. But I will say that the customer is responding to it and we keep measuring to make sure that we're getting return we're looking for. And also looking at the future and saying how can we really increase our average order size and most importantly better serve our customers. As you I think all know that market is filled with lots of different shipping models. Some people put in the price, some people charge restocking and what we're trying to do is make it really simple and fair for our customers. And we're not done with, we’re not landed with what the future will hold for our shipping model in terms of specifics because each brand is very differently different AURs so, they are responding slightly differently and we're going to keep measuring and then changing our model based on what we're seeing.

[Laura Alber:]

And the brand by brand channel comment Matt, I think there's a couple things you’ve to think about there. I mean first of all we did reaccelerate 5.2 is a big piece of that, it is because Pottery Barn got better from Q1 to Q2. They are obviously not back to where they were, so that's a big driver of it. We cannot say that the shipping income working in that “channel” and from a retail perspective a significant piece of what we do is in home and a lot of that is what we call RGC [ph] which we are retail the customer and a lot of that involves shipping. So the success we're seeing there doesn't mean that the shipping obviously is only working or not working in ecommerce and also working in retail.

[Matt Fassler:]

Understood. Thank you so much.

[Operator:]

Next question comes from Chris Horvers with JPMorgan.

[Christopher Horvers:]

Thanks Good evening. Just one follow up on PB again a bit of a soft brand re-launch in July, the shop by the aesthetics effort, so placing the merchandise in front would you actually step up the advertising investment year-over-year. I know you started last year in the fourth quarter about, but did the dollar are you're seeing momentum on merchandising and new customer acquisition?

[Laura Alber:]

Yes I think you beeped out a little bit, but I think I got your question. So yes, we did re-launch with the fall assortment more distinct aesthetics, testing new aesthetics, some of which are very successful and we're building on those obviously and then reducing the ones that are less successful. But we're clearly seeing a resurgence in our decorating categories. You know the things that people come in more frequently to buy which also happened to be the areas that drive new customer acquisitions. So we’re very pleased with the effect of the new merchandising strategy and customer acquisition. Also at the same time we did step up our digital marketing, we reduced some of our catalogue marketing, but the total amount of spend was higher than last year.

[Christopher Horvers:]

But does that step up take another leg up in the back half given where you are?

[Laura Alber:]

It depends on the return. We look at it every week. So if we continue to see good returns we’ll fund those brands with the best returns and we reduce those brands that have lesser returns. It is very dynamic. We assume so though, our plan is now because it's working to keep investing in that.

[Christopher Horvers:]

Thank you very much.

[Laura Alber:]

You’re welcome.

[Operator:]

The next question comes from Michael Lasser with UBS.

[Michael Lasser:]

Good evening, thanks Laura for taking my questions. I wanted to touch a little further on that, that very topic. Your sales were up about 4%, your operating income dollars were down about 2%. It seems like some of the investments that you are putting in place are working. So should we expect that operating income dollars are going to continue to hover around this level or the year-over-year change in operating income dollars are going to continue to hover around this level as long as you're seeing an effective return on those investments and I'm talking over the next couple of years?

[Laura Alber:]

Well from an operating income/operating margin perspective obviously we've guided to be directionally in line with last year for Q3 and obviously if you kind of do the math for holding on the year that means we're going to be better in Q4 and part of that is because our expectation is we're going to have higher revenues which have a higher flow through, so we expect that we're going to continue with this accelerated momentum as we move throughout the year. And also as we mentioned earlier the investments in reduced shipping income and in higher digital advertising we began last year and we did - we had to win some small piece but in Pottery Barns we had began with that in Q3 and Q4 and so that alleviates some of the year-over-year, quarterly impact relative to like Q1 and Q2. If they’re still going to be incremental it's a lowest point we're going to be best if we see the return, but you should see improvement in the op margin as we move throughout the year.

[Michael Lasser:]

Thank you.

[Operator:]

Next question comes from Simeon Gutman with Morgan Stanley.

[Simeon Gutman:]

Thanks, good afternoon. Back on advertising for a second, you mentioned digital channel is up, can you - can we put it all together can you talk about advertising dollars in the quarter, what were they and how it compares versus last year? And any commentary on ROI, I think Laura suggested you’re continually monitoring and looking at it, but curious what you could share on the ROI? Thanks.

[Laura Alber:]

So a couple of things from a financial perspective and then I'll turn it over to John to give a little more color, but from a financial perspective we have said obviously that the biggest driver for SG&A increase was our digital advertising and it was obviously even more now because we offset it with general expense improvement and so forth. So it's a significant investment, it will come down slightly relative to Q1 and Q2 to Q3 and Q4, but it’s still something that we are investing in and have an impact on in total.

[John Strain:]

And it's working. We’re really excited about the results we’re seeing from the digital investments visits revenue directly derived from digital marketing channels have improved solidly and we're going to continue to optimize catalogue spend or shipped dollars into the digital channels and numbers reflect actually planned incremental investments there, specifically we’re seeing strength in non-brand search terms, affiliates, remarketing, social programs and these are more than offsetting any declines we’re seeing in email. And then just Q2 in Pottery Barn brand alone, we saw year-over-year positive order growth and customer growth and we’re seeing both order frequency and units for order improvements. So in general these are all indications that strategy investing this top of funnel, digital marketing channels and really is working. So we’re encouraged by this and some other further top of funnel marketing tests that we're doing because we’re seeing strong incremental lists in places like Instagram, Pinterest and the new Google POAs that really are out the funnel. So strategy is working and we plan to continue to optimize this plan and take advantage of it.

[Simeon Gutman:]

Okay, thank you both.

[Operator:]

Next question comes from Peter Benedict with Robert Baird.

[Peter Benedict:]

How are you guys? Thanks. I just want to clarify on the comment on the margins Julie, I guess the fourth quarter seems to imply, the midpoint implies maybe up 50 basis points or so year-over-year, the primary drivers of that you said is that you expect revenues, revenue growth to accelerate and you get leverage off of that or are there other dynamics that would drive across the inflection in margin operating margin in the fourth quarter?

[Laura Alber:]

Well I mean there's obviously a lot of moving parts, the biggest player is revenue. So I mean if you look at the – we obviously are not giving Q4 guidance today, but I know effectively we give implied guidance and if you look at the high end of implied guidance, it’s a 4% growth versus last year. So that’s when you get to the higher level of revenue, it immediately it flows right through to the bottom, so that is the biggest driver of the increase. The second piece is the fact that we are lapping some of that investment in our reduced shipping income and higher digital advertising because we've implemented it with Pottery Barn at the back half last year, so those are the two big drivers.

[Peter Benedict:]

Okay, that’s great and just on the occupancy which grew I think about 2% year-over-year in the second quarter, that's been slowing down. I think it was up around 5% in 2015, what’s driving the lower occupancy growth rate and is that something that we should expect to persist over the balance of this year and into next? Thank you.

[Laura Alber:]

Yes, the occupancy did grow 2.2% it is one of the lowest in a while that's correct. I think there's a lot of moving parts in there. You have to remember the depreciation flows through there too. So it’s both the fact that we are getting more effective with the renegotiation of our leases and you're seeing some of that benefit come through and it's also the fact of the timing of when and what goes into service from a depreciation standpoint. So it has moved round a bit. I am really pleased to see the occupancy has returned to leverage this quarter for the first time in almost two years and I think that's also a play on the fact with higher revenues, so I should - I expect that to continue.

[Peter Benedict:]

Okay, thanks very much.

[Operator:]

Next question comes from Dan Binder with Jefferies.

[Dan Binder:]

Hi it’s Dan Binder, thanks. You talked about supply chain savings and we've been hearing about that for probably at least a couple of quarters now. I am just curious if you could sort of size that up and give us a sense of how much is still in front of us and where it's coming from?

[Laura Alber:]

Yes, we haven't disclosed the amount of the supply chain benefits. What I did say, I mean effectively with merge margins down because of the ongoing promotional environment we were able to completely offset that with the ongoing supply chain benefits we had. The lower selling margins were predominantly due to the investment in reduced shipping income, so we are once again pleased to be able to have these benefits continuing to come in to offset that in the merge margin line. We had said I think that we gotten pressure before in Q4 last year we had 100 basis point gross margin expansion, we said guys this isn't going to continue going forward. So we have those amount of benefits has come down because part of that was from lapping some of the higher cost in the prior year but we're at a pretty sizable amount that continues to move forward as we move throughout the year and we don't expect that to change. And we see significant opportunities for ongoing supply chain benefits that we're just getting started with whether it's continuing to reduce returns, damages, replacements, freight, you name it there's still a lot of opportunity to move that needle.

[Dan Binder:]

Great, thanks.

[Operator:]

Next question comes from Brad Thomas with KeyBanc Capital Markets.

[Brad Thomas:]

Good afternoon and thanks for taking my questions. A follow up on the digital advertising as it relates to Amazon, in the last few months you’re seeing more and more home furnishings companies brands listing their products on Amazon. Maybe Laura if you could give us an update on what you’re hearing from your customer in terms of how much they're looking at Amazon for a purchase like what you offer and perhaps your willingness to consider selling through them?

[Laura Alber:]

Sure, thank you. We have really been listening to our customer a lot and what they're telling us is how much they appreciate our story and the service that we offer is a huge differentiator. And while Amazon does really so many things really well, have you ever tried calling them and asking them if they could please come refurnish your living room? It’s a big thing that we do and our customers really love that service. So that is where we're focused and we may have a lot of initiatives but they’re all centered around our customer and what our customer is looking for and our service levels cannot be easily replicated and we think it’s a huge differentiator. And there's no doubt in my mind that what we're doing at retail and our relentless succession with customer service is the reason for the success that we're seeing and we’re going to continue to focus on that.

[Brad Thomas:]

Thank you so much.

[Operator:]

We’ll take our next question after from Brian Nagel with Oppenheimer.

[Brian Nagel:]

The question I have, if you look at the revenue exclusive revenue really across the business improved in Q2 to Q1, you talk about number of the internal initiatives, are you seeing overall improvement in the environment too as you look at the your various brands, the overall environment?

[Laura Alber:]

There is a lot of mix for [indiscernible] I mean and you guys quite know better than even we do, but there is housing metrics saw unemployment numbers lowest levels in July, but there's still a slight pullback in customer sentiment since its peak and retail traffic in the malls is down 9. So I mean there's a lot of mixed news out there. We’re in my mind and I think my perspective definitely outperforming those numbers. So we've always said that we think there's opportunity for us to do better regardless of the environment and to really focus on what our customer are telling us about whether there's something we’re not offering them in product or pricing or service. And as I said in my earlier comments that is our focus is just continuing to improve what we're doing, make it better for our customers but I don't think it's necessarily the success is related to any environmental improvement.

[Brian Nagel:]

Thank you.

[Laura Alber:]

Welcome.

[Operator:]

And our last question comes from Charles Grom with Gordon Haskett.

[Charles Grom:]

Hi, thanks. Good afternoon. As we think about the second half and the improvement you guys saw at PB, you mentioned further acceleration and growth in your prepared remarks. I’m just wondering if that implies better than expected rate than you did in the second quarter which I believe was up 1.2? And then my follow up is, you spoke about shorter delivery times, lower shipments and reduced damages, just could you quantify that for us to some degree so we have a sense of the opportunity that lies ahead? Thank you.

[Laura Alber:]

Yes, unfortunately we don't disclose by brand comps for the future and obviously if you look at the high end of our range it assumes the Pottery Barn continues on a trajectory and we have no reason to believe they can't and we have no reason to believe they can't return to their historical growth levels. As far as quantifying any of the supply chain benefits, we also don't disclose that except to say if you look back you've seen they've been significant and they're continuing on that path. Supply chain is one of the biggest expenses we have in our P&L and it's a huge opportunity for us to continue to fine tune it and get a lot of savings out of it and that's where we're focused on.

[Charles Grom:]

Thank you.

[Operator:]

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

[Laura Alber:]

Yes, I want to thank you all for joining us and I’d also like to thank all of our associates. Their passion and commitment and customer service and to driving our strategies is a key component of the success we are seeing and we really want to say thank you to them on this call. Talk you all next time and looking forward to continue to report on our business in the future.

[Operator:]

And thank you ladies and gentlemen. That does conclude today's conference. We thank you for your participation and you may now disconnect.