Williams-Sonoma Inc (WSM) 2014 Q2 法說會逐字稿

Welcome to the Williams-Sonoma, Incorporated second-quarter 2014 earnings conference call.

(Operator Instructions)

This call is being recorded.

I would now like to turn the call over to Gabrielle Rabinovitch, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements.

Please go ahead.

Thank you, Angela.

Good afternoon.

This call should be considered in conjunction with the press release that we issued earlier today.

Our earnings press release and this call may contain non-GAAP financial measures, that exclude the impact of unusual business events.

A reconciliation of any of these non-GAAP financial measures to the most directly-comparable GAAP financial measures, and our explanation of why these non-GAAP financial measures may be useful are discussed in our 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 and prospects of the Company in 2014 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 will now turn this conference call over to Laura Alber, our President and Chief Executive Officer, to discuss our second-quarter FY14 results.

Thank you, Gabrielle.

Good afternoon, and thank you for joining us today.

On the call with me today are Julie Whalen, our Chief Financial Officer, and Pat Connolly, our Chief Strategy and Business Development Officer.

Before we start, I'd like to comment on the executive changes we made last month.

As many of you know, we announced several strategic executive promotions, as well as the appointment of a Senior Vice President for Global.

Collectively, these organizational changes establish a new leadership structure that better positions Williams-Sonoma, Inc.

for long-term growth, and I'm pleased to have Pat with us today in his new role.

The changes we have made reflect the strength of our talented and tenured management team, and our ability to leverage this talent to continue to grow our business.

Now, I'd like to discuss our results.

Our second quarter reflects our ability to continue to deliver revenue and earnings growth, along with operating margin expansion, in a more promotional environment.

Solid revenue growth in our brands, in conjunction with operational discipline, allowed us to deliver these results while continuing to make significant investments in our growth initiatives.

Our priorities are clear for the back half of the year, and we believe we are making important progress on our objectives that will support long-term profitable growth.

In the second quarter, we delivered record net revenues of $1.039 billion, with comp brand revenue growth of 5.7%.

We generated $85 million in operating income, resulting in 20 basis points of operating margin expansion, and record second-quarter diluted earnings per share of $0.53.

We are pleased that we are able to deliver these results against a more promotional backdrop.

Our team's scale in balancing near-term market realities with a commitment to our strategic vision is a defining characteristic of the organization.

We believe our multi-brand, multi-channel platform with over 50% of our revenue generated from our direct channel, is a sustainable competitive advantage, and will allow us to continue to drive market share gains.

We believe our model provides us with the operating flexibility to generate consistent returns.

In the second quarter, we also made important progress on our long-term growth initiatives.

Our global expansion continues, and tomorrow we'll be opening four new Company-owned stores in Australia, at Chatswood Chase, a premier shopping center in suburban Sydney.

A Pottery Barn, a Pottery Barn Kids, Williams-Sonoma, and West Elm store will be opening at the same time.

The opening of additional stores in Australia is critical to building scale, and leveraging our in-country infrastructure in this market.

In July, our franchise partner in the Philippines opened a Pottery Barn and a Pottery Barn Kids store, our first franchise locations outside of the Middle East.

These stores are also off to a great start, and we are excited about growing brand awareness in Southeast Asia.

Our new businesses are also reaching important milestones.

In Mark and Graham, we continue to see the business accelerate.

We're most excited about the new customer growth and our growth potential.

Given the momentum we have seen in Mark and Graham, we believe we'll be able to drive strong growth in the back half of the year, when gift-giving is a high priority for our customers.

We continue to attract new customers, and grow the brand with new categories.

Based on our strong results, we believe Mark and Graham will become a meaningful contributor over time.

In Rejuvenation during the second quarter, we had successful new product introductions.

This season, we updated our product aesthetic and our marketing.

We're also excited to announce that we're opening new store this quarter in a great location on University Avenue, in Palo Alto, California.

We believe that Rejuvenation has a unique place in the market, and has the opportunity to grow significantly.

In addition to new business development, supply chain enhancements are an important component of our growth strategy.

We believe that speed to market, cost abatement, and quality are key to our future.

Our teams are diligent and persistent in identifying opportunities, to improve our processes and infrastructure.

In the second quarter, we completed the successful transition from working with external overseas agents to managing our vendor relationships directly.

This transition is an exciting milestone for our business.

As we continue to expand globally, we are positioned to deliver the best possible product to our customers, along with outstanding quality and service.

We are now managing approximately 95% of our direct import business.

By directly managing this critical part of our business, we believe we will gain a greater understanding of all aspects of our supply chain, from product design to pricing.

We believe we'll be able to respond faster to changing circumstances, and gain enhanced supply chain visibility.

In the second quarter, we also opened our Dallas distribution center, and are already ahead of our initial timetable for full utilization.

We also simultaneously launched our Texas upholstered manufacturing operation in the same four walls.

In the third quarter, our new Dallas DC will in-source and consolidate all third-party delivery hubs in North Texas and Oklahoma, into our new and more efficient facility.

Home and store deliveries will be made directly from our DC, and will reduce delivery times and handling for customers and stores in Texas and Oklahoma.

In addition to investing in our supply chain, continued investments in our infrastructure, technology, user experience, customer service and marketing are critical to the success of our multi-channel platform.

During the second quarter, we launched major enhancements to our on-site search experience, making improvements to the relevance of search results, as well as the search type ahead functionality.

We also made site personalization improvements tailored to customer preferences and shopping habits.

We launched a West Elm gift registry program, with a comprehensive cross-channel experience that includes a mobile registry scanning app.

On the West Elm website, we also introduced new content enhancements that already driving higher levels of engagement on the site.

In addition, in the second quarter, we launched major improvements to the communications we send to our customers, after they place an order.

Customers are now receiving communications with delivery estimates for every product in their order, as well as a clear presentation of manufacturing, shipping and delivery status.

We believe we have significantly improved our customer service levels.

Now, let me give you more detail on each of our brands.

I would like to begin with a Williams-Sonoma brand.

Comp brand revenue increased 3.4% in the second quarter, making this the fourth consecutive quarter of positive comps for the Williams-Sonoma brand.

Our proprietary and exclusive product strategy, field leadership, better visuals, and cohesive marketing strategies, are driving the improved results.

In the second quarter, performance was strong in the following categories: Cutlery, tabletop, electrics, cookware, and food.

We are thrilled to see increased new customer counts in the Williams-Sonoma brand.

Open Kitchen, a new proprietary collection of beautiful, affordable, everyday essentials is just one of the drivers bringing new customers to the brand.

Additionally, Williams-Sonoma Home continues to outperform our expectations.

We have an aggressive plan for its future.

Looking forward to the third quarter, we have a strong line-up of exclusive products, such as of the new TK line by All-Clad, designed by Thomas Keller.

It is a mixed materials line that allows home cooks to use the right pan for every technique or dish that they are creating.

Under our own Williams-Sonoma brand, early reads on two important launches of cook's tools and cutlery are also strong.

Also, we feel good about our autumn assortment and Halloween, as we help our customers decorate and entertain this fall.

While we continue to focus on the future, we are also celebrating the history of the Williams-Sonoma brand.

We are honored to be reopening Chuck Williams's original store in Sonoma, California on his 99th birthday, this October, and we are excited to be celebrating this important milestone with Chuck.

Next, I would like to discuss the Pottery Barn brand.

In the second quarter, Pottery Barn comparable brand revenues grew 4.4%, on top of 9.9% in 2013, driven by strong performance in furniture.

We had our strongest outdoor furniture season to date, which complement our expanded decorating services, for both indoor and outdoor spaces.

Also, upholstery furniture exceeded all of our expectations.

We will continue to leverage Sutter Street, our Company-owned upholstery manufacturing operations, to serve our customers with great quality, great value, and speed.

Areas that were softer included seasonal decorating, pillows, and tabletop.

We believe we have a strong line-up for the third quarter, particularly in furniture, fashion textiles, seasonal decorating, and gifting for the holidays.

We have newness across all key categories, including leather furniture, textiles and decorative accessories.

Our fall textile collections are performing well, and are highly differentiated in the marketplace.

We already have some runaways and are chasing best sellers.

Based on the trends we are seeing, we believe our holiday decorating and gifting season from Halloween to Thanksgiving to Christmas will be successful.

We are prepared to offer our customers the best quality, design, and price in our category, and continue to work diligently on operational improvements that will further differentiate us from the competition.

Next, Pottery Barn Kids.

Pottery Barn Kids delivers inspiring design, with the highest levels of quality and safety.

In the second quarter, Pottery Barn kids comparable brand revenue increased 5.6%, on top of 8.2% in 2013.

The introduction of new furniture collections was a key contributor to growth in the quarter.

In upholstered furniture, an expanded assortment of silhouettes and new fabrics are giving our customers more options, and ways to customize their perfect nursery, chair, or bed.

Across our furniture assortment, we have broadened the materials and finishes offered.

Our back to school collection launched during the quarter with a focus on backpacks, waste-free lunch solutions, and an expanded assortment of desks and accessories.

We are pleased with the initial response we have seen, as our customers start planning for the school year ahead.

We're also encouraged with early results of our new fall collection, which marks the continued evolution of the brand's aesthetic.

As we look forward to the balance of the year, we are confident that our fall and holiday assortments will deliver the innovation and delight that has led to a strong first half.

Now I would like to discuss Pottery Barn teen.

Comparable brand revenue decreased 1%, on top of 16.3% increase in 2013.

Furniture demand remains strong throughout the quarter.

However, the brand's net revenues were impacted by increased back-orders in furniture, due to issues in Vietnam, where a number of our vendor's factories were affected by the dispute over the South China Sea.

We are working hard to get back in stock, and expect to catch up late in the third quarter.

Also in the quarter, versus our expectations, we saw softness in our dorm and gear business.

While both comped positively, they did not meet our expectations.

A highlight of the second quarter was the strong response we have seen to the second collection on which we've collaborated with Emily and Meritt.

This assortment continues to exceed our expectations.

Early fall results indicate that our Pottery Barn teen customer is responding to our new textiles, featuring a bright transitional palette and artistic details.

Our collaborations continue to bring new customers to PBteen, and are an important part of our growth strategy for the brand.

In addition to Emily and Merritt, a new Burton collection launched last week, and we're also enthusiastic about our new collaboration with Junk Gypsy, featuring an eclectic assortment of home furnishing, decor, and decorative accessories, inspired by the funky and fun-loving attitude of Amie and Jolie Sikes of Junk Gypsy.

In addition, this fall we are looking forward to celebrating the holidays with a great lineup of innovative and unique gifts for our teens, supported by a strategic promotional calendar, and targeted marketing campaigns.

Now, I'd like to update you on West Elm.

West Elm once again posted strong results.

Comparable brand revenue increased 16.7%, on top of 16.5% last year, with broad-based growth across categories.

West Elm continues to focus on three key initiatives.

Choice, community, and consciousness.

As part of the brand's choice initiative, in the second quarter, West Elm saw success with a new opening price assortment, adding incremental volume across all categories.

In addition, a new expanded lighting assortment performed well, with customers at retail and DTC.

The second quarter, West Elm also opened one store in New Orleans, as well as a temporary pop-up in Water Mill, New York.

In the third quarter, the brand was scheduled to open an additional nine stores.

To further its community initiatives in August, West Elm expanded its commitment to supporting US-based emerging artists and small businesses, by launching the West Elm local small business grant.

The small business grant will award $25,000 and ongoing business support to one winner, voted on by the public, through an online voting system.

And by the end of 2014, we expect that West Elm will offer local product assortments in more stores across the country.

In the brand's own backyard, West Elm received significant attention of the end of July, when it was chosen by the current New York City Mayor to redesign the official residence of the first family, Gracie Mansion.

This partnership earned West Elm more than 1 billion media impressions in publications from the New York Times to the London Telegraph.

And finally, West Elm continues to lead with a focus on consciousness.

In June, the team was thrilled to host President Clinton at the West Elm office in Brooklyn, and announced it will be the first home retailer in the world to offer fair trade certified rugs, handcrafted in India, and available to customers this holiday season.

During the visit, he viewed West Elm's work to support artisans around the world, and heard directly from artisan vendors the impact that the brand's collaborations are having in Haiti, India, the Philippines, Guatemala, Peru and in the United States.

More and more customers want to know that their dollars are making a difference.

In this environment, West Elm's commitment to choice, community and consciousness are differentiating the brand from its competition, and we remain confident in this brand's ability to be a $1 billion plus business.

In summary, we are pleased with our year-to-date results, and believe we are well prepared to execute in the third and fourth quarters.

I'll now turn the call over to Julie, to review our financial results in detail.

Thank you, Laura, and good afternoon, everyone.

We are once again pleased with the results we are reporting today.

Despite a more promotional environment, we delivered solid top line growth and improved our operating profitability, while at the same time, continued to invest in our long-term strategic initiatives.

For the second quarter, net revenues increased 5.8% to $1.039 billion, with comparable brand revenues increasing 5.7%, on top of 8.4% in the second quarter of 2013, or 14.1% on a two-year basis, and in line with our expectations.

Net revenues in our direct-to-customer channel grew 9.4% to $523 million.

The direct-to-customer channel generated 50.3% of total Company net revenues for the quarter, 170 basis point increase over last year.

And our retail channel revenues increased 2.4% to $517 million.

Gross margin for the second quarter was 36.8% versus 37.6% last year.

This 80 basis point decrease was driven by lower selling margins from a highly promotional environment, as well as occupancy to leverage, primarily related to our global initiatives.

Occupancy costs in the second quarter of 2014 were $148 million, or 14.3% of net revenues, in comparison to $138 million, or 14.1% of net revenues in the second quarter of 2013.

SG&A in the second quarter improved 100 basis points to 28.6%, versus 29.6% in 2013, more than offsetting the decline in gross margin.

The improvement in SG&A was primarily driven by lower general expenses, and continued advertising efficiency.

Once again, the flexibility of our operating model, with advertising spend that is substantial, due to our sizable direct-to-customer business, allowed us to make operational decisions between selling margins and advertising spend.

Each season, we are able to determine our least-effective ad spend, and while it may still be profitable, it may not be as effective as the targeted promotion.

This quarter, and similar to prior quarters, we elected to reduce our least-effective ad spend, in favor of increased promotions.

This had the net result of reducing selling margins within gross margin, which was offset by reduced ad spend within SG&A.

As a result, second-quarter 2014 operating income grew 9.3% to $85 million, with an operating margin of 8.2%, a 20 basis point expansion versus the second quarter of 2013.

Higher revenues in the direct-to-customer channel, which consistently operates at a much higher margin, drove this operating margin expansion.

The direct-to-customer segment operating margin was 23.1% versus 24% in the second quarter of 2013.

The retail segment operating margin was 7.2% versus 6.9% in the second quarter of 2013, and the corporate unallocated segment was 7% versus 7.2% in the second quarter of 2013.

The 90 basis point decrease in the direct-to-customer segment was driven by lower selling margins and occupancy deleverage, partially offset by advertising efficiency.

The occupancy deleverage was primarily driven by our incremental investments from the regionalization of our distribution centers, and our global distribution operations.

The 30 basis points of retail segment operating margin expansion was driven by lower general expenses, partially offset by higher occupancy costs and employment deleverage.

The increase of occupancy in the retail segment is primarily related to our global initiatives.

The improvement in the corporate unallocated segment was driven by lower general expenses and employment leverage.

Our second-quarter income tax rate increased from 37.5% in 2013 to 40.5% this year, driven by an unfavorable state income tax matter.

As a result, second-quarter 2014 diluted earnings per share grew 8.2% to $0.53, from $0.49 last year.

Overall, we are pleased with our results.

We delivered revenue growth, earnings growth, and operating margin expansion in a highly-competitive environment, while absorbing the financial impact of our future growth initiatives.

Moving to the balance sheet, cash at the end of the quarter was $71 million.

Year-to-date, we have returned $176 million to shareholders, consisting of $112 million in share repurchases, and $64 million in dividends.

Merchandise inventories at the end of the second quarter of 2014 increased 21.4% to $895 million from $737 million at the end of the second quarter of 2013.

Towards the end of the second quarter of 2013, we began taking ownership of our inventory earlier in the supply chain.

Excluding the impact of this additional year-over-year inventory in transit, second-quarter 2014 merchandise inventories increased 17% on a comparable basis.

This increase in inventory was predominantly to support our fastest-growing brands and our growth initiatives.

I would now like to discuss our third-quarter and FY14 guidance.

We expect to deliver another record year for our shareholders, and are on track to achieve our three-year outlook.

For the third quarter of 2014, we expect to grow net revenues to a range of $1.1 billion to $1.13 billion, with comparable brand revenue growth in the range of 4% to 6%.

We expect our third-quarter operating margin to be relatively in line with last year, and we are guiding diluted earnings per share to be in the range of $0.58 to $0.63.

For the full year, we are reiterating all of our guidance ranges, except for the guidance range associated with our estimated full-year income tax rate, which we have raised 30 basis points, and now expect will be in the range of 38.3% to 38.8%.

We expect to grow net revenues to a range of $4.645 billion to $4.725 billion, with comparable brand revenue growth in the range of 5% to 7%.

We expect our operating margin to be in a range of 10.2% to 10.4%, and we expect FY14 diluted earnings per share to be in the range of $3.07 to $3.17.

Our guidance considers the competitive landscape, as well as the investments we are making to deliver on our strategic long-term objectives.

Inclusive of these investments, this fiscal year guidance at the high end of the range assumes revenue growth of 8% and diluted earnings per share growth of 12%, consistent with our three-year outlook.

Moving to our capital guidance, there are no changes to our capital allocation plans.

We expect to make capital investments in the business in the range of $200 million to $220 million, to support our strategic growth initiatives.

We also expect to continue to return cash to our shareholders by paying dividends and repurchasing shares under our existing share repurchase authorization.

In closing, we delivered another quarter of strong results, and were able to make progress on our long-term initiatives.

Our competitive advantages, including our iconic brands, our exciting proprietary product pipeline, our multi-channel excellence, and our opportunities for growth, as well as our commitment to financial discipline, including returning capital to our shareholders, allows us to be confident in our ability to deliver sustainable, long-term, profitable growth.

I would now like to open the call for questions.

Thank you.

(Operator Instructions)

Daniel Hofkin, William Blair and Company.

Just one question, and then one quick follow-up, if I may.

If you could, just talking about the competitive promotional environment, it sounds like maybe that got more intense as the quarter progressed.

Is that a fair assessment?

And is that something that affected the items that you highlighted, as a little bit softer?

And then the second question is on the gross margin.

Related to that, was that something compared to your original expectations, came in a little lower, or was the trade-off between margin and advertising as you would have expected three months ago?

Thank you.

Thanks for the question.

I think if you go to any mall today or open any e-mail, you see that promotions are persistent and deep, particularly in the apparel areas, but you also saw a step-up in promotions in our competitive set.

It's something we've been talking about for a long time, and we feel that we have a competitive advantage, because we can use our marketing or our promotions to drive sales, and because of our large direct business, we can move that investment from one to the other.

We made the decision to be more competitive on price, particularly in our seasonal assortments, to gain market share during the quarter, because we know others won't be able to do the same, and it was strategic and one of the things I think is really exciting coming out of the quarter is how high our new customer growth is, which really is a great indicator of future results.

Julie, do you want to add on the gross margin?

Sure.

Regarding the gross margins, Dan, definitely we see the lower selling margins, particularly in the DTC channel.

That was more than we thought, the promotions were deeper than we expected throughout the quarter.

But the key message I want to make sure everyone hears is the distinct advantage that we have, Laura just touch on it, I touched on it in my prepared remarks, but every day in our Company, because we are 50% effectively e-commerce and 50% retail, we have a choice we can make, an operational decision.

Do we get the sale by having a deeper promotion, do we get the sale by offering free ship, for example?

Those two hit gross margins.

Do get the sale by more e-mails, more catalogs, more paid search?

That hits SG&A, and that's a reality of where it hits in the line item.

Thankfully, we have a big enough business with a big enough ad cost bucket to be able to make those decisions, and what we learned is that the customer was reacting better to deeper promotions this quarter, and so we followed that line of action, and we have lower gross margins.

But on the flip side, we're able to offset it in the SG&A, resulting in operating margin expansion, so we're thrilled about that.

Matthew Fassler, Goldman Sachs.

If I could follow-up on the promotional question, could you talk about whether it was particularly acute in certain brands?

And also just following up on a comment that you made, was it more focused on seasonal goods than on some of the more perennial product, furniture, for example, in a way that would lead you to believe that it would fade, just with the changing of the line-up as we moved out of summer into the second half of the year?

Good question.

The promotional environment that I was referring to, I think is touching every brand in the marketplace, including all of ours.

The outdoor categories were most specifically promotional.

We saw a lot of people come out of the gate on sale and also in the kitchen, Williams-Sonoma kitchen business, the outdoor product was much more promotional then we expected, and it's interesting, because while I'm saying all of this, we had our best season ever in Pottery Barn outdoor furniture.

But the outdoor category is much bigger than just furniture, it includes pillows and towels, and entertaining, and lanterns and all of those areas.

And so, yes, it was very intense on the seasonal product, but it's also -- it's a reality of the marketplace that we have been talking about for a long time, and our long-term perspective on it is that, that is why we are so aggressive on driving operational improvements, and investing in our supply chain, because we still see great opportunity to reduce our cost and efficiencies in those areas, and mostly because those areas are the most important areas that touch the customer.

I think at the end of the day, the customer does like a sale, when you're buying furniture, you want quality, and you want to know that you got the design you wanted, and that you have incredible service.

And for me, the service please is key to why we continue to outperform.

We're obsessed with it, both online and off-line, and we have worked really diligently to create that really high-tech experience in all of our channels, and not to go on a tangent, but we just got some great information.

We use Stella Services, that rank our industry, and the goal is really transparency in what the customer sees, and they have a rigorous methodology to test the customer service performance of online businesses, and we -- our ratings are outperforming in our industry, and something we're very proud of.

And when we give great service, we also reduce our costs.

So, we're looking forward to seeing all those improvements come to light, but also realizing that we do need to offer, and we will compete on price, as well as design and quality.

Jessica Mace, Nomura Securities.

I was wondering if you could give a little bit of color on your global expansion and maybe call out any dynamics that home furnishings category is facing in these geographies?

Sure.

We're very early in our global journey, and we're excited about the next wave of stores in Australia, so that we can really try some new things and better service our customer by giving them a better in stock position with the scale of more than one store per brand.

We are seeing that in our Company-owned global operations, that we're seeing a larger percent of DTC than we initially expected, which is quite interesting, and really a good sign for the future.

And then we're also having great results with our franchise partner.

We selected the best, we believe, partners globally, and we're seen nice improvement in those businesses, and are excited about the new geographies that we're going into.

Peter Benedict, Baird.

As is actually Justin Kleber on for Pete, thanks for taking the question here.

Julie, last quarter you had mentioned the fact that the cadence of your investment spending was a bit heavier in 2Q.

Looking at your incremental margins were higher in 2Q versus 1Q, despite what was a little bit softer revenue growth environment.

So I guess two questions in one here.

Did the cadence of that investment spend take place, that you had anticipated?

And if so, can you discuss any other expense levers, just outside of advertising that you are able to pullback on, particularly in this quarter, to manage the P&L?

Thanks.

Sure.

So it did play out as we expected.

We've got several initiatives that we're working on for the future long-term growth of our Company, and that's what our three-year outlook and beyond, is predicated upon.

And one of them is our Dallas distribution center that we opened up in Q2, which is allowing us to further our regionalization of our distribution centers, which provides better customer service and lower freight costs long-term, so that's an incredibly important initiative.

Obviously those costs hit Q2 ahead of us fully being able to get the benefit from the regionalization.

Also, you have to remember that we have our global investments, and we're opening up eight company-owned stores in Australia within Q3, and all of that requires costs that are ahead of generating the revenue and the return from.

We have to pay rent even if the landlord calls it free rent, we have to book rent, back to the day we took possession of the location.

So you have rent expense, you have to hire people ahead of -- and train them, ahead of opening the store, and advertising, et cetera.

There are lots of costs that we incur before we actually open a store, and it takes a while to get scale.

So all of those were contemplated and came out as anticipated.

Neely Tamminga, Piper Jaffray.

Laura, I was wondering if you could help bridge a little bit of the comments you made earlier around the early trends in decor being positive and giving you good, positive reads for the back half, with some of the things you are seeing with the promotional landscape.

Are the business is that you're seeing that are giving you that indication is it based on that promotional activity as well, or is that actually fuller-price activity, which gives us some hope that we're not going to continue to see major declines here in the back half?

I think I understand your question, let me just talked about the trends that we're seeing.

We have really exciting product, I believe, that builds on the sales that we currently have.

For example, Williams-Sonoma we continue to expand our Williams-Sonoma branded products, and we're launching a whole new layer of seasonal food this year.

We already have some new very nice reads on some of the recent fall introductions in Williams-Sonoma that obviously will be new for us, and provide a lot of sales in the back half.

In our home furnishings brands, we have a strong lineup of decorating and gift-giving and we're seeing in our furniture assortments that the investment an additional sizes is paying off, as we offer our customers more choice.

And aesthetically, particularly in Pottery Barn we're seeing a strong reaction to our globalist aesthetic.

We think this look is very much on trend, we're excited about the texture and the layers this fall, and the expansion of our best selling bedding collections.

In addition, our new leather collections are also off to a great start, and in all brands, we are doing more customized offerings and really improving our speed on custom products to our customer.

So, we believe we have a strong lineup and we are building on the trends that we are seeing today.

Thank you.

Chris Horvers, JPMorgan.

I was curious on the PBteen commentary, can you talk about how much that hurt your comp, or how -- perhaps how much the customer deposit billed year over year?

And just to sharpen the pencil on the last question, are people coming out on fall seasonal on discount, like they did for spring-summer?

Thanks.

I'll take the first piece of that, Chris.

Laura should take the second.

So from Pottery Barn teen perspective, we haven't quantified that, except to say it was a significant piece of their comp deceleration.

The heavy period of time for their furniture business, and the fact that we basically unfortunately had that issue in Vietnam, where it literally a factory was burned down and the inventory was no longer available caused significant delays.

So I would say that it's safe to say those are significant pieces of their comp.

From a customer deposit perspective, I've seen this talked about a few times.

I think it's taken somewhat too literally.

Coincidentally it has been true that number turns out to end up being close to what our revenue growth is, but we have to remember the customer deposits not only include our undelivered goods to our customers at the end of the quarter, it also includes our unredeemed gift cards.

When those get redeemed, who knows, so I think you can't read too much into the correlation between customer deposits and future revenue.

Okay thanks for clarifying the second part of a question, Chris.

We are seeing that people are coming out with broad-based promotions.

For example, they'll say all drapes 30% off, that will include new and old drapes.

The outdoor, though, was even more significantly promotional than anything I've seen.

So would I say that the promotional environment has moderated?

Not necessarily, but it's not as targeted to one specific category.

It's more broad-based, if you will.

David Magee, SunTrust.

Just sort of broader question on the promotional environment online.

Is this sort of a structural change that maybe there are more players now that you can contend with, and maybe they're getting better at what they do over time?

I'm going to start that, and let Pat also respond to this.

We are in such a highly fragmented business, and nobody owns a large amount.

We, at the same time, take our competition very seriously, and we're always looking at what others are doing.

But I do believe that is a significant -- I don't think that was a significant change in Q2 versus Q1, for example.

Dave, I can just follow up for a minute on that.

We haven't really seen where the competitive -- the change in individual competitors has impacted us to any extend.

We track that very closely.

I think what differentiates us really is the fact that we have, first of all, proprietary goods.

If you want to buy them, you have to buy them from us, and we have 85% to 90% of what we sell is designed and manufactured under our control, which gives us incredible product selling margin.

And I think everyone has come to the conclusion that brands are even more important on the web, so I think we are very strong there.

And lastly, we have this great data-driven marketing in our DNA, and we're continuing to leverage that, so I think we're very well-positioned, I don't see the impact of individual competitors at this point.

And David, this is Julie.

If you're also alluding to the fact that you're seeing that our revenue growth in the DTC channel isn't as strong as we've been seeing, I think there's a couple things that are important call out there, that our demand actually in the second quarter was strong, and exceeded our net revenues.

Our net revenues were impacted by a number of factors, including inventory in transit at the end of the quarter, which graded several back-order positions, as well as lower customer deliveries from higher sales volume toward the end of the quarter, so that is also impacting it, and quite honestly I am sure that's the bigger player than a competitor.

Gary Balter, Credit Suisse.

Looking more long-term, you mentioned the upfront investments related to the supply chain initiatives, and building out your International operations.

When should we start to expect those investments to provide a tailwind to expense leverage, or should we just expect that these investments will be replaced by others over time, particularly on the international side?

No, you should start to see some of that, particularly in 2015, if you are alluding to the in-sourcing of our foreign agents, we just completed that this quarter, mid-quarter actually.

And those reduced costs get factored into the cost of goods that ultimately goes on the balance sheet initially, and when the goods are sold through is when you see in it the gross margin on the P&L, so it will take a little bit of time before you'll start to see that roll through, but we should expect to see some of that in 2015.

Kate McShane, Citi.

Could you go a little more into what gives you confidence to maintain guidance for you, particularly on the margin side?

How should we think about the gross margin for Q3 and Q4, if Q4 is significantly a really high promotional environment, can you be tactical in reducing advertising cost in that quarter?

Absolutely, first of all, we don't guide gross margin, and we're really focused on the operating margin, which on the year at the high-end is at a record level for us, at 10.4%.

But that, as I specifically mentioned on the call and addressing the question, that is a big deal for us.

The fact that we are the size that we are with an e-commerce business, we can absolutely make those decisions.

Quite honestly, it might be more effective to send more e-mails and more catalogs, spend more on SG&A to get the sale, versus doing more promotions.

We're just going to make that trade off as we go throughout the back half of the year, but we're probably one of the most well-positioned to do that.

Simeon Gutman, Morgan Stanley.

Thanks, a couple questions.

The first is, can you talk about the promotion side, what form they took, whether they were blanket offers versus targeted.

And I guess taking the comments you made about operating margin expansion, I take it that you were pleased with the return that you got on the promotions this quarter.

And my follow-up, just to squeeze it all in, following up on that question regarding in-sourcing, there is both short-term and longer-term benefits.

Is it as simple as on the short-term benefit, trying to figure out what percentage of goods that are touched by the change you made in Asia and eliminating that market to sort of dimensionalize what the benefits to the gross margin would be over time?

Why don't you start with that one, Julie?

Starting with the in-sourcing side of it.

Short-term, it's definitely just lower cost, so when we have the third-party that we used before, they have a higher cost structure that we paid for, a higher rate so we've in-sourced it, we can manage that cost, so it's a lower cost on the cost of goods sold.

Longer-term, of course, there's much bigger pieces at play that are more strategic.

By having our own employees in the factories managing the product, making sure we are negotiating raw material costs, getting the best cost, getting the right raw material, minimizing damages, making sure the inventory is on time, et cetera, all of that starts to play out in a much grander scale, you'll see longer-term.

And back to the promotions.

It's both.

So you see people with broad-based promotions, high-low, you see specific clearance, extra off clearance.

So I wouldn't say I would categorize it any one way.

You've got to take a walk in the mall and you will see what I'm saying, and how that has become a real way that people compete.

Brian Nagel, Oppenheimer.

So I apologize for bringing up the promotions question again.

I hear your comments.

It shouldn't be shocking, there's been a lot of promotions in your space, going through retail recently.

You made the comment that you look to maintain market share, but I guess I'm wondering, knowing future results, I would've thought if that would be the case, that the Pottery Barn brand comp would be higher, even with the more difficult comparisons?

Maybe a comment on that?

And the second follow-up question I have, is you think about the guidance, I know other people asked about guidance as well, so I apologize here too, but what type of -- I'm looking for a qualitative standpoint, what type of professional environment are you assuming in the back half of the year?

Is it something similar to what we saw in Q2?

More or less intense?

Good question.

No apologies needed.

Pottery Barn had a solid second quarter.

Demand was very healthy in the quarter, but results were impacted by a number of factors, including the inventory in transit at the end of the quarter, backorder positions, and lower customer deliveries, as Julie said earlier.

And, we also looked at what we can do better for next year, and we see some opportunity with color palette next summer, we were a little bit too neutral, and we will have more color in next year summer collection.

The great news is the response to our fall color palette is strong and the aesthetic, that globalist aesthetic that I talked about earlier, is also being met with good consumer response.

So I hope that explains better the Pottery Barn demand versus net that we talked about for the second quarter.

I think also just a caveat, to be careful not to get too obsessed with a single quarter and to look at our results over a broader timetable.

Because it's always variations that you'll find that, you just don't want to read too much into on a single quarter.

I think it's important to remember also when you look at the home furnishings data, that grew 3.2% and our comparable business grew 6%, so we're really pleased with our results in the quarter.

From a guidance perspective, yes, we have assumed that obviously the more promotional environment continues, but we've also assumed, like we have in the past, been able to cover it and continue to get operating margin expansion, so we're well-positioned for the back half.

Michael Lasser, UBS.

Do you think that you draw in a different customer when you invest in the promotion versus in advertisements?

It seems like part of what your commentary is suggesting that promotions are just going up across the board, so the entire consumer population, or most consumers are kind of expecting it.

But I'm just wondering if you're drawing in a different -- if the customer responds differently or a different type of customer responds to a promotion, rather than in advertisement?

Thank you so much.

Sometimes, yes.

In fact, one of the things we've seen, it's not just with the promotions but opening price point products we designed specifically to reach new customers are really working, so for example on Williams-Sonoma, opening kitchen as we discussed.

If you look carefully at West Elm you'll see we brought in some new opening price points across multiple categories, and that also has brought in new customers.

You're going after a broader customer base, as well as getting more from your current customer base, and higher engagement with the current population.

Because of our sophisticated modeling and information, we can see exactly where we're growing, and be very targeted about both building sales in the short term but also getting ourselves prepared for the long-term, and making sure we always have that new group of customers that come into each and every brand that will become loyalists.

I think often, maybe the first time you buy something at a new brand, it's because you like the price, or is it really catches your eye.

But once that brand is in your set of people that you think about, when you shop for that category, you more likely go back.

And recency is a big driver for future purchases.

So this is been a really interesting thing to see at play, and we're very pleased with our customer growth, and our engagement with our current customers.

Laura Champine, Canaccord.

My question, Julie, is on inventory.

So you called out some reasons that inventories were higher, but I'm sure you're taking ownership sooner in a way that reduces your cost per unit.

So, do you have what your unit growth was?

I know that the dollar growth was 21%.

I'm guessing your unit growth is actually higher?

We actually don't provide that.

But, from an inventory perspective, I think what's important to know is that on a comparable basis, we grew 17%, and that is really to support our fastest-growing brands, and our growth initiatives and a substantial portion of this inventory balance was in transit, so it's going to support future sales.

As you know, there's a delicate relationship between service levels and inventory, especially as more of our revenues are now coming from online.

If you don't have the inventory you're going to lose a sale, so we're very careful with that balance, but we have strong inventory disciplines across the Company, and we aggressively go after the slow movers, while at the same time aggressively chase the best sellers.

At the end of the day, we believe we have the right level of inventory to support the business in the guidance we are providing.

And 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.

I just want to say thank you for joining us today, and thank you for your future support, and talk to you next time.

Thank you and that does conclude our conference call for today.

We thank you for your participation.

You may now disconnect.