Welcome to the Williams-Sonoma, Inc. Second Quarter 2015 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the call over to Ms. Gabrielle Rabinovitch, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead, ma'am. .

Thank you, Tom. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. This call may contain non-GAAP financial measures that exclude the impact of unusual business events.

A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why these non-GAAP financial measures are 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 plans and prospects of the company in 2015 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 the conference call over to Laura Alber, our President and Chief Executive Officer, to discuss our second quarter fiscal 2015 results. .

Thank you, Gabrielle. Good afternoon, everyone, and thank you for joining us today. On the call with me are Julie Whalen, our Chief Financial Officer; and Pat Connolly, our Chief Strategy and Business Development Officer. We're pleased to be discussing our second quarter 2015 results with you today..

In the second quarter, net revenues grew 8.5%, with comp brand revenue growth of 6.3%. We are pleased to have delivered another quarter of solid performance, once again demonstrating the competitive advantage from our multi-brand, multichannel business model.

We believe that our balanced approach, which leverages the capabilities of each channel, is differentiated and will allow us to drive continued market share growth in the future..

We have an intense focus on the evolving shopping patterns of our customers and the opportunity we have to deliver an exceptional experience. As always, we are focused on disciplined execution against our long-term growth initiatives..

Towards the end of the second quarter, our stock position materially improved as we received inventory in our core products as well as our early fall and back-to-school floor sets and collections.

We saw significant improvement in our order fill rates as inventory levels recovered, and we are committed to providing high levels of customer service through the back half of the year..

We also continued to invest in our supply chain technology infrastructure and our e-commerce capabilities in Q2. In supply chain, we continue to focus on enhancing inventory planning and allocation systems and we are upgrading our customer order visibility tools.

In e-commerce, we are improving our on-site search experience, personalizing content on our websites and enhancing our mobile shopping experience. Across all these initiatives, we made meaningful progress in the second quarter..

Now I'd like to update you on the developments in our brands, starting with Pottery Barn. In the second quarter of 2015, Pottery Barn delivered 6.5% -- 6.4% comparable brand revenue growth. Both our indoor and outdoor furniture businesses drove this performance. A key product strategy that drove this increase is our upholstery expansion.

We offer high-quality upholstery at great prices in styles that our customers want..

Our expanded innovative offering in outdoor furniture collections also drove meaningful growth. And we had a strong response to our seasonal prints and patterns in our textile businesses, with notable strength in our early fall collection of paisleys that launched in July..

At retail, we continue to offer differentiated free interior design services and inspiring visual vignettes. And in e-commerce, our well-developed assortment allows us to both extend the offer beyond the physical space and be relevant to our customers' life stages and lifestyles.

In the second quarter, across both our retail and e-commerce channels, Pottery Barn delivered solid results..

During the quarter, we also expanded our ecofriendly assortment of furniture and home furnishings. We believe that the quality of our products goes beyond beautiful designs to include what they are made of and how they are made, including the responsible use of raw materials.

Increasingly, we are using organic cotton in our textiles, recycled and reclaimed materials and wood certified by the Forest Stewardship Council. We are especially proud to introduce our PB Comfort Eco Sofa this quarter..

In addition, we have introduced new reclaimed wood collections, rugs crafted from recycled plastic bottles and have added more sustainably sourced materials in our sheeting collections. We launched a new brand advertising campaign in the second quarter across print, digital and social media.

Our customers love their homes, and like any great campaign, this campaign is emotion-based and illustrates the comfortable, casual lifestyle for which Pottery Barn has become synonymous. New customer growth is one of our key priorities, and we continue to test ways to acquire new customers..

We believe we have a strong lineup for the second half of the year. As one example, this month, Pottery Barn launched its first collaboration with San Francisco-based interior designer and taste-maker, Ken Fulk.

Later in the quarter, we'll introduce our new merchandise layers for Halloween and Thanksgiving, which are all about decorating the home for the holidays. This is when we transition to our holiday programs, including trim, throws and seasonal bedding and tabletops.

We are looking forward to helping our customers celebrate, entertain and give gifts this holiday season..

Now I'd like to discuss Pottery Barn Kids. In the second quarter, Pottery Barn Kids' comparable brand revenue increased 3.3%, with performance strengthening through the quarter as our inventory position improved. Results were primarily driven by our furniture and back-to-school businesses..

We launched our back-to-school season late in June, and we've seen a solid response to our study furniture assortment and backpack collections. In both of these product categories, we believe Pottery Barn Kids leads the market with great quality and innovative design.

This year, we introduced our largest selection of desks and chairs across a range of price points, styles and finishes. We expanded our assortment in gear as well with newness in color palettes, prints and patterns and innovation in our waste-free lunch solutions..

In the second quarter, Pottery Barn Kids also introduced its first design collaboration with fashion designer, Jenni Kayne. This partnership is the start of an exciting strategy for Pottery Barn Kids. Brand collaborations attract new customers, test new aesthetics and broaden our social media reach.

We are pleased with the results of this first capital assortment..

Later this week, we'll be formally announcing our second Pottery Barn Kids collaboration, which is a nursery collection with Emily & Merritt launching in early 2016. We are planning a robust program of design collaborations over the next year. We believe we have an outstanding lineup in Pottery Barn Kids this holiday season.

The third quarter marks the launch of holiday collections, and the teams have outdone themselves with a combination of magical dream room plus innovative gifting for every age and stage. We plan to own decorating the family home for the holidays with our biggest-ever assortment of seasonal decor and furnishings..

Moving to Pottery Barn Teens. Pottery Barn Teens comparable brand revenues increased 3.9% in the second quarter. Improved inventory positions in furniture and back-to-school contributed to a solid quarter.

We saw strong response to our fashion programs, including our new Kelly Slater collaboration and fresh assortments in our Junk Gypsy and Emily & Merritt partnerships..

We launched our fall collection in early July, and our new furniture introductions in desks and study spaces are performing. However, we are seeing some initial softness in our bedding assortments and bedroom furniture. As we look forward to the balance of the year, we are launching new introductions from our design collaboration.

Our fourth collection from Burton launched last week, and our third Emily & Merritt collection launched online yesterday and will be in store in mid-September. Heading into the holidays, we believe we have innovative high-quality gifts for teens and tweens, with new ideas in sleepover, decorative accessories and furniture..

In order to attract new customers, PBteen continues to increase its social media reach. In July, PBteen announced a partnership with AwesomenessTV, a multi-platform media company, that is a global leader in engaging the Gen Z audience.

Together, AwesomenessTV and PBteen produced an original 6-episode do-it-yourself series titled Revved Up Rooms featuring popular YouTube star, Meg DeAngelis, MayBaby on YouTube. This is PBteen's first video series featuring a vlogger. The partnership helps us reach and engage with the large tween and teen audience in an authentic and original way..

In the second quarter, the Williams-Sonoma brand's comparable brand revenues were down 0.3%. Growth in cutlery, cookware, tabletop and our Williams-Sonoma Home collections did not offset the difficult compares in electrics, where the timing of key product launch activity did not align with last year's calendar.

In 2015, our product introductions are more weighted to the back half of the year. Nonetheless, we were pleased with the strong consumer response to many of our proprietary collections, including tabletop and entertaining..

We also continue to successfully expand Open Kitchen, our collection of beautiful, affordable essentials, and we added Shun Kanso, an exclusive cutlery line. We also introduced a partnership with American Girl on an exclusive line of bakeware and culinary classes.

The partnership was launched in June, with cooking classes at our retail locations that have been an outstanding success. The new line of premium American Grill-branded products, including baking sets, utensils, food mixes and a cookbook, will be available this fall..

During the third quarter, Williams-Sonoma will be launching more than 3x the number of new product lines than in the same period last year. Highlights include our ongoing expansion of Williams-Sonoma-branded products with the launch of Williams-Sonoma stainless steel professional and Williams-Sonoma hard-anodized dishwasher-safe cookware lines.

We'll also be launching market-exclusive products across cookware, electrics and cutlery, including the exclusive Wüsthof Legend cutlery line..

In addition, Williams-Sonoma is partnering with Fortessa Tableware Solutions on an exclusive tabletop collection that will be featured at select Fairmont hotels and sold exclusively at Williams-Sonoma..

The Williams-Sonoma team continues to be intensely focused on evolving the retail experience. We will open 4 new locations this quarter, including our Palm City Market store in Atlanta and our new store in Calabasas, California. Our new stores are in great locations and represent innovative new store designs..

2 out of 4 include an installation of Williams-Sonoma Home, and our Palm City Market store opening this Friday features inspiring architectural details, including a direct pass through to Chef Jonathan Waxman's new restaurant.

We believe this new layout will enable us to offer our customers an unprecedented integrated experience of shopping, culinary demonstration and world-class dining..

Williams-Sonoma Home also drove positive results, and we continue our aggressive strategy to grow the Williams-Sonoma Home business. We are testing the integration of Williams-Sonoma Home into our retail stores and are encouraged by the response.

Williams-Sonoma Home is posting strong results in e-commerce, and we see this as a long-term transformational strategy at retail..

This fall, we are working closely with some of our favorite culinary experts. Williams-Sonoma will be hosting tours with Bobby Flay, Ina Garten and Giada De Laurentiis across the country.

For the second year in a row, Williams-Sonoma is proud to be the official bookseller of celebrity chef Ina Garten's book tour featuring her award-winning book, Make it Ahead, with 4 stops across the country..

In addition to this, Williams-Sonoma will be the official bookseller for Giada's 13-city book tour that launches this October, featuring her newest book, Happy Cooking. These events, held in venues accommodating several thousand people, often sell out shortly after tickets become available.

Our special events allow us to increase engagement and connect more closely with our customers..

Our key strategy is to bring in more exclusive products, grow new product categories like cookware, proprietary entertaining and Williams-Sonoma Home as well as to acquire new customers are on track. We believe that we have a strong product lineup for the back half of 2015 and beyond..

Now I'd like to update you on West Elm. The West Elm brand continues to post strong results. Comparable brand revenues increased by 15.7%, on top of 16.7% last year. Growth continued to be broad-based across categories, with particular success in furniture, decorative accessories and lighting..

Milwaukee, Grand Rapids, Atlanta, Rochester and an outlet store in Asheville, and our expanded footprint in Australia with a store in Perth. We also opened our first Philippines franchise store in Manila.

It's amazing to see the positive reception from press and customers at each new store we open, with focused excitement around our commitment to local nonprofits and their hometown heroes, the artists and makers featured in our West Elm LOCAL assortments..

Third quarter to date, we have opened an additional 3 stores in Calgary, Charleston and Skokie. As previously mentioned, West Elm has plans to open a total of 18 stores this year..

Focusing on West Elm's 3 initiatives, choice, community and consciousness, we continue to grow in diversity of aesthetics and range of prices at West Elm to appeal to a broad range of customers. As we broaden our assortment, we're also working to personalize our customers' experience across channels and all devices..

In our retail stores, we're seeing positive results from the regionalization of our product mix. We work closely with our in-market teams and utilize online sales trends to develop a store assortment that speaks to the lifestyle and homes in each store area..

In June, West Elm launched West Elm Workspace, a collection of office furniture and accessories at NeoCon, America's largest design trade show. NeoCon is attended by nearly everyone in the contract industry, from architects and builders to designers and design media. And the West Elm Workspace showroom was packed the entire week..

Contract Magazine's Best of NeoCon Gold and Editor's Choice Awards as well as Metropolis Magazine's hashtag Metropolis Likes award. As a newcomer to the industry, this type of recognition is rare and is representative of the overall positive reception of the collection..

One of the main goals of attending NeoCon was to build a nationwide network of dealers who will sell West Elm Workspace.

Based on the positive response at the event, we have confirmed 14 dealers in key cities like New York, Los Angeles and Chicago, all opening this year, and we've already started to bid and scope projects for offices from start-ups to more established companies.

West Elm Workspace represents just one of the many ways we're growing the West Elm brand outside of the traditional retail model and fuels our belief that there's a long runway for growth for West Elm..

I would now like to spend a few minutes discussing our newer brands and businesses. In the second quarter, both Rejuvenation and Mark and Graham delivered strong growth domestically. And globally, our company-owned stores and franchise businesses accelerated..

We continue to be very encouraged by the solid trends we are seeing in Rejuvenation. Strong execution across the retail, e-commerce and trade channels are contributing to these results. We believe Rejuvenation's focus on quality, craftsmanship and customization uniquely positions it in the marketplace..

Our expanded outdoor assortment, including hardware, lighting and furniture, drove brand performance in the second quarter. Strategic prospecting with our catalog and e-marketing are bringing new customers to Rejuvenation..

In the third quarter, we'll be introducing a comprehensive collection of our new Northwest modern lifestyle across lighting, hardware and furniture. For our new furniture assortments, we are pleased to be partnering with a number of family-owned firms here in the United States that have a deep heritage of craftsmanship and upholstery in case goods..

Rejuvenation will also open its sixth store in September at Palm City Market, a landmark in Atlanta's old Fort Worth and the hub of our large and expanding base of sales in the Southeast..

In addition, we are seeing profitable growth in Mark and Graham's business. The Mark and Graham brand has carved out a differentiated niche of personalized luxury goods, with beautiful packaging at very accessible price points. Each month this year, we have introduced a new layer of merchandise and mail a catalog highlighting its fresh assortments..

In the second quarter, our product introductions focused on gifting for Mother's and Father's Day, new babies and graduates. Our early fall introductions included expanded assortments in our best-selling personal accessories collection and the launch of our Halloween shop.

We are introducing new copper bar and entertaining items as well as bold new fall colors for leather totes, key fobs and catchalls..

In the second quarter, we were also pleased by the acceleration in our global businesses. In Australia, we opened 3 stores in Perth in July and will have an additional 3 stores opening in Brisbane later in the third quarter. By the end of the year, we'll have 19 stores in Australia.

Our increasing scale is leading to operational wins and increasing efficiencies..

Our franchise business is also growing and we see significant opportunity here. In the Middle East, our partner, M.H. Alshaya, continues to do an outstanding job. Our stores are performing very well in that region. I recently visited the Middle East, and I'm extremely proud of their execution..

In the second quarter, Stores Specialists, our strong franchise partner in the Philippines, opened 4 stores. And in the third quarter, we are looking forward to the opening of our first Mexican franchise store.

We expect Liverpool, our franchise partner in Mexico, to open at least 10 stores across the Pottery Barn, Williams-Sonoma, West Elm, Pottery Barn Kids and Pottery Barn Teen brands before the end of the year. We look forward to updating you on our growth with this exciting new partner and our negotiations with additional franchise partners..

In addition, today, we made a formal announcement that the West Elm brand will be launching its first global wholesale partnership with John Lewis, the U.K.'s largest department store retailer.

The partnership kicks off with the launch of a West Elm-branded shop online at johnlewis.com, followed by a shop-in-shop in John Lewis' newly-renovated 94,000-square-foot home department in their Oxford Street flagship store.

John Lewis dominates the home furnishings market in London, and their new home experience on Oxford Street offers the largest assortment of home products in any store in the U.K., making it a true destination for designers and customers from around the country..

In summary, across all of our brands, we have made good progress in the first half of the year, both with our product lines and our goal to recover in stocks.

It has never been more clear that in addition to our proprietary product lines, strong brands and multichannel model, we need to continue to lead and invest in our supply chain to drive down costs and increase customer service.

We have a significant opportunity to do better and to improve our service and to further differentiate ourselves from our competition..

Now I will turn the call over to Julie for additional details on our second quarter financial performance and our third quarter and full year 2015 financial guidance. .

Thank you, Laura, and good afternoon, everyone. We are pleased with the results we are reporting today.

Our second quarter performance speaks to the strength of our portfolio of brands as we delivered a solid quarter, despite absorbing incremental shipping and fulfillment-related costs associated with the lingering effects of the West Coast port disruption and investing in our long-term strategic initiatives..

Our strong Q2 performance demonstrates that we continue to take market share with our home furnishings brand, reporting another quarter of revenue growth well ahead of the industry. And heading into the second half of 2015, we believe we are well positioned for additional market share gains and to expand the reach of our brands..

Before I walk you through our second quarter financial results and our third quarter and fiscal year guidance, I would like to update you on the financial impact during the second quarter from the effects of the West Coast port disruption..

During the second quarter, as expected, we saw higher shipping and fulfillment-related costs from shipping inefficiencies stemming from inventory shortages and unbalanced inventory positions across our distribution centers. We entered the period with elevated back order levels as a result of delayed receipts..

In order to get the goods to our customers as quickly as possible, multiple deliveries on a single order as well as out-of-market shipments were made as we got back in stock.

Though the financial impact directly related to the port is hard to measure with precision, we estimate it to be $0.04 in the second quarter, primarily due to higher shipping and fulfillment-related costs or approximately 50 basis points to our gross and operating margin..

Additionally, our supply chain incurred incremental labor costs. Heavy inventory inflows from both the delayed inventory as well as inventory receipts for our seasonal and fall layers of merchandise in advance of peak all were received at our distribution centers over a relatively short period of time towards the end of the quarter..

This higher volume of inventory receipts put additional pressure on our supply chain organization and resulted in incremental labor costs. While we did absorb these additional costs in the quarter, we believe this was an important investment in customer service.

And we are pleased that our levels of in-stock and available-for-sale inventory recovered and our customer service metrics have begun to improve..

In the second quarter, net revenues increased 8.5% to $1,127,000,000, with comparable brand revenues increasing 6.3% on top of 5.7% last year. In addition to strong comparable revenues, we saw higher-than-expected growth from our new West Elm stores as well as our international franchise and company-owned stores..

In our e-commerce channel, net revenues grew 9.1% to $570 million, with growth across all brands and represented 50.6% of total company net revenues for the quarter, a 30 basis point increase over last year..

Our retail channel net revenues increased 7.9% to $557 million in the second quarter. This acceleration in the retail segment was primarily driven by Pottery Barn and West Elm as well as our international franchise and company-owned stores..

Gross margin for the quarter was 36.1% versus 36.8% last year. The year-over-year decline primarily reflects the impact of the higher shipping and fulfillment-related costs. Occupancy costs in the second quarter of 2015 were $156 million or 13.8% of net revenues and leveraged 40 basis points year-over-year..

In the second quarter, SG&A as a percent of net revenues was 28.7% versus 28.6% in the second quarter of 2014. Advertising efficiencies were offset by employment deleverage associated with the incremental labor costs in our supply chain as a result of the heavy inventory receipts..

As a result of absorbing these incremental shipping and supply chain costs, the total company operating margin was 7.4% of net revenues versus 8.2% of net revenues last year. By channel, the operating margin in the e-commerce channel was 21.5% versus 23.1% in 2014..

Advertising efficiencies were more than offset by the incremental shipping and supply chain costs associated with our port recovery efforts. The operating margin in the retail channel leveraged 10 basis points to 7.3%, primarily driven by improved gross margins from occupancy leverage..

Corporate unallocated expenses, at 7.1% of net revenues, deleveraged 10 basis points, primarily due to employment and employment-related costs associated with our long-term initiatives. Our second quarter income tax rate decreased to 35.4% from 40.5% last year, reflecting the favorable resolution of certain income tax matters..

These results, including the $0.04 impact mentioned earlier relating to our port recovery efforts, drove second quarter 2015 diluted earnings per share of $0.58 or growth of 9.4%. Excluding this impact, our second quarter and year-to-date underlying EPS growth was approximately 17%..

Moving to the balance sheet. Cash at the end of the quarter was $120 million versus $71 million last year. In the second quarter, we returned approximately $104 million to stockholders through $72 million in share repurchases and $32 million in dividends..

Merchandise inventories increased 15.3% to $1,031,000,000 at the end of the second quarter, which includes inventory on hand and available-for-sale of 12.5%. Entering the third quarter, healthy levels of core inventory have been restored and our out-of-stocks are lower.

Our higher back order positions have been reduced, and our fill rates are significantly improved. We now are focused on rebalancing our inventory between distribution centers to reduce the costs associated with out-of-market shipping and to improve our service levels..

I would now like to discuss our third quarter and fiscal year 2015 guidance. For the third quarter of 2015, we expect to grow net revenues to a range of $1,190,000,000 to $1,220,000,000, 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 expect diluted earnings per share to be in the range of $0.68 to $0.73..

For the full year, we expect to deliver another record year for our shareholders and are reiterating all of our guidance ranges. We expect to grow net revenues to a range of $4,950,000,000 to $5,020,000,000, with comparable brand revenue growth of 4% to 6%, and our diluted earnings per share will be in the range of $3.35 to $3.45.

All other financial guidance within the press release remains unchanged from the previous guidance..

This guidance, of course, does not assume any significant deterioration in the stock market and its impact on consumer sentiment. This guidance also reflects the incremental investments in our supply chain that we have made and will continue to make through the back half of the year.

The inventory shortages and imbalances that we have recently sustained have further validated the importance of being in stock and properly allocated across regions to ensure ongoing excellent customer service..

As we discussed in the first quarter, one of our key initiatives is inventory optimization. We are investing in technology, including enhanced inventory planning and allocation systems and upgrades to our customer order visibility tools as well as incremental labor and shipping costs throughout the back half of the year..

Our mindset is one of continuous operational improvement. Our supply chain is one of our competitive advantages. And as we grow our furniture business, continuing to invest in delivering high customer service levels is strategic.

We are committed to putting the customer first, which means the right inventory in the right place with a superior customer delivery experience..

Our guidance on the year, excluding the impact from the West Coast port disruption, reflects revenue and earnings guidance that is in line with our 3-year outlook of mid- to high single-digit revenue growth and low double-digit to mid-teens EPS growth, with revenues growing 8% and earnings growing 12% at the high end of the range..

We are also reiterating our commitment to maintaining a balanced capital allocation strategy in 2015. We will continue to take a balanced approach between investing in the business to support our long-term strategic growth initiatives, which is still targeted to be in the range of $200 million to $220 million, and returning capital to shareholders. .

Our share repurchase program and dividends are key components of our capital allocation strategy. We now have $162 million remaining and available for share repurchases on our $750 million multiyear share repurchase authorization.

Year-to-date, we have repurchased $125 million, and we expect to buy back $200 million to $250 million of our shares by fiscal year-end. We're also committed to continuing to pay dividends targeted at 35% to 40% of net income and in line with the S&P 500 dividend yield..

In summary, we are pleased to deliver continued solid top line and bottom line performance despite absorbing incremental supply chain costs. We are moving forward on all of our strategic initiatives to position ourselves to win, and we made progress in the second quarter..

Given the competitive advantages that we maintain, strong brands, proprietary products, a multichannel platform, many opportunities for growth, along with a commitment to financial discipline and returning capital to shareholders, we are 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] We'll take our first question from Peter Benedict with Robert W. Baird. .

Just was hoping the labor costs in the supply chain that hit SG&A, any way you can kind of quantify that? I think that was probably one of the bigger surprises in the P&L in the quarter. So anything further you can give about that and then maybe how you see that line over the back half of the year. .

Sure, I'll take that. It's Julie. We have not specifically quantified these indirect costs. Of course, it's hard to disaggregate them with precision.

But one way to look at it, of course, in our Q2, our operating margin declined 80 basis points, of which we said 50 basis points was primarily associated with the higher shipping and fulfillment-related costs due to the port. I think it's safe to say that the incremental indirect costs were at least the remaining 30 basis points.

Going forward, we expect some additional labor and incremental shipping costs will continue, primarily in Q3, but obviously not to the degree we saw in the first half as we continue to rebalance our inventory levels especially at our West Coast DC. But we're also accelerating our investment in technology.

So it's not just labor costs, it's also investment in technology. As we are growing, and particularly in furniture, it is important to make the necessary investment in technology to support this growth.

So as such, we're accelerating our investment in inventory tools to allow us to better forecast our inventory flow and space capacity requirements by DC, brand and channel. And additionally, future system enhancements will give us better customer order visibility, allowing us to know every touch point where that inventory resides.

This investment in technology is obviously primarily a capital investment but there is some additional expense associated with that. And all these additional costs are reflected within the guidance we have provided today.

And we believe that these additional costs are an important investment in superior customer service, longer-term supply chain efficiencies and of course, maintaining our competitive supply chain advantage. .

We'll take our next question from Daniel Hofkin with William Blair & Company. .

I guess just to clarify quickly, and then one, I guess, more substantive follow-up.

On the tax rate in the quarter, were you expecting those -- the positive resolutions within your original second quarter guidance? And then I had just a follow-up regarding -- given that your in-stocks are approaching a better position now, curious kind of about the third quarter guidance.

Obviously, you have a tough comparison last year, but are you seeing any evidence of either in your second quarter results or early third quarter of slippage in the consumer environment?.

Okay. Regarding the tax rate, no, we weren't aware of that when we first gave out our guidance. Obviously, there are things that change as you go through any quarter. And there's variability with your tax rate and obviously, this was a good guide for us. So that's a positive. On the flip side, we also didn't expect these incremental supply chain costs.

And so thankfully, we had this and we still landed a very solid quarter at $0.58. .

On the second part of your question, Dan, I'll take that, the macro. Look, we're watching the market along with everyone else. It goes without saying that a significant sustained pullback in the stock market could lead to a reduction in consumer confidence and impact the discretionary spending landscape.

But that being said, our demand has been strong all year, particularly our furniture business, and recent economic reports in housing and consumer confidence are positive. And I believe our brands are well positioned to gain market share in the second half. .

And we'll take our next question from Kate McShane with Citi. .

If I could ask a question around the investment. Can you -- I'm sorry.

Do you anticipate these costs to continue through Q4 of 2015? And could they possibly continue into the next fiscal year? And how long does it take for these type of systems to ramp up before they become beneficial to the business?.

I'll take that. It's Julie. I think the labor costs we're expecting is going to be predominantly in Q3 as well as the shipping costs. Obviously, Q4 has got a lot of noise going on with it, given it's the holiday quarter, so there'll be things going both directions from that.

But specific to this incremental investment, labor, we expect and shipping primarily we expect to be in Q3. The investment in the inventory tool obviously is a multiyear investment, but we'll be rolling out enhancements as we move even through this year and through the next year or 2. .

I think that the big thing to remember is that shipping furniture and large cube has always been a competitive advantage of ours and a big differentiator. There's a lot of people who sell stuff and have websites. And if you can do that really hard thing well, you put yourself ahead of the pack.

And it's just really crystal clear to us that customer service in this area and high touch is incredibly important. And honestly, while the port disruption was extremely difficult, the good news is that it caused us to re-examine every single element of our supply chain.

And we have identified significant opportunities to improve service levels and over time, drive down costs. .

We'll take our next question from Chris Horvers with JPMorgan. .

Can you talk about the Williams-Sonoma brand a bit more? Where did the comp come in relative to your own expectations, assuming you would have seen some of the shift in the electric launches? And then can you talk about some of the key items that launched last year in the second quarter?.

Yes, we were disappointed that we weren't able to completely offset the big launches in electrics in Q2 of last year. Last year, we had our big Nespresso and Vitamix launches in the quarter. And our cookware, as I said, a lot of our proprietary businesses were very strong, but they weren't strong enough to completely offset those releases.

And why we're confident that this is going to improve is that we have more releases in electrics and across all of our businesses, as I mentioned earlier, towards the back half.

Also one of the other businesses that was a disappointment further than what we planned is our outdoor business because frankly, the market has been saturated with a lot of outdoor cooking items. And we didn't see enough real innovation to invest in that. We didn't want to just drive markdowns.

So we pulled that back probably a little bit too far, frankly. And that's an opportunity for us going next year, to drive more innovation in that area and also obviously, it's not a big -- as big a part of the business in Q3. .

So as a follow-up to that, the Sonoma brand becomes a lot more important as you look into the back half of the year.

So the launches aside, do you think the brand's positioned to get back to positive levels in the back half?.

I think we have a very exciting lineup for the back half, both through Q3. Our Thanksgiving entertaining assortments and food stories, as I said on the prepared remarks, are very strong. We have a lot of key big money introductions. And then Q4, it's very competitive obviously to talk about the specific product lines.

But I think we have a lot of opportunity, not just with the product line but peak season execution and providing our customers with a great experience and being more efficient, frankly, than we were last year. .

We'll take our next question from Greg Melich with Evercore ISI. .

I wanted to follow up a little bit on the moving pieces on the margin line. If it was 50 bps from the ports and occupancy leveraged 40, it seems like everything else, gross profit margins were down around 60 bps.

Could you help us understand what drove that? Was it promotion, shipping costs, anything else in there, and how you'd expect that to trend going forward?.

Sure. Yes, gross margin was actually down about 70 basis points, and 50 basis points, as we said, was due to the port with the higher shipping and fulfillment-related costs.

We also have in there, which I know creates a little bit of noise, but when we have higher franchise revenues, technically, that puts pressure, so to speak, on the gross margin because it's a cost-plus model. And so it impacts the gross margin with very few costs in SG&A that drops down to a higher profitability at the op margin level.

And so you're seeing about 20 basis points of impact within the gross margin level for that. We also had some higher fulfillment-related costs that were primarily offset with the 40 basis points of occupancy leverage.

But I think the really great news, which is unfortunately under the covers, you guys can't see it, is that the pure merch margins are essentially flat to up. And I think you've been hearing me say that now for a few quarters.

And what that tells us is that the health of the business is great and that the fact that our long-term initiatives such as the insourcing of our foreign agents is working. And so that's a really great story, I think. Unfortunately, we have the noise of these higher shipping costs that over time should improve.

And as you mentioned with the occupancy leverage, these pure merch margins that are flat to slightly up and then the shipping cost going away, we should see improved margins over time. .

And linked to that, the franchise revenues with all the launches coming and the Philippines getting ramped up, was that a key driver then to the retail EBIT -- EBITDA profitability improvement?.

The retail profitability was about 10 basis points and that was primarily due to occupancy leverage. That was the biggest driver. But the retail revenue was both from the new West Elm stores that outperformed and the incremental acceleration of both our franchise and company-owned stores. .

We'll take our next question from Matthew Fassler with Goldman Sachs. .

I want to ask one quick question on the quarter for Julie and then a broader strategic one. On the quarter, just to make sure I understand the relationship between the e-commerce sales versus the retail sales, retail seemed a bit better than we expected, e-commerce a bit light.

Are the inventory issues really much more focused on the e-commerce or direct-to-customer business than on retail? Were you able to overcome shipping challenges when you were distributing to stores more so than to customers?.

If you're talking about the revenue line --.

Yes. .

I mean, we are really focused on total brand performance. And so we are actually really pleased with the results of both channels. I know there's been some focus on e-commerce only had a 9.1% but with total revenue growth of 8.5%, we had strong growth effectively of both channels.

And so obviously, sometimes, the customer's going to want to shop online, sometimes, they want to shop in the store, and we want to serve them wherever they want to shop. So I really wouldn't read anything more into it than that. .

Fair enough. And then taking a step back on the strategic side, as you think about this inventory initiative and the supply chain initiative, it seems like you're putting real money against capital and SG&A.

Is this primarily in response to what you saw related to the ports, and how you felt you were able to handle it? Was this something that was emerging prior to that? Because it seems like it's -- certainly, the impact of investing against it will last prior to the port issue, the discrete port issue getting resolved. .

Yes, I mean it's a -- what I said earlier is that whenever you have something that happens of significance, you learn a lot and you get into it. And we see opportunities to both being better in stock and then to cut overstocks, and hence our inventory optimization initiative.

And as I think you all know, we've regionalized our network, and that's a big change from the way we used to run it. And so we have a lot of opportunity to understand better customer demands by region and get the product there the first time in the right place. And the supply chain is critical. Customers have a lot of choices.

And the -- it's one thing to buy something. You need to have a great experience. And so as we've gotten into this, we've seen that this is a strategic investment that is so important to the core of what we do, which is to serve our customers better than anyone else. .

And we'll take our next question from Michael Lasser with UBS. .

Based on a comment that you made a little bit earlier, it sounds like your product costs are pretty stable.

So should we interpret that to mean that the promotional activity across all the brands hasn't really increased, especially in light of the changing and very dynamic competitive landscape we're seeing that Wayfair and some of the online-only players are growing quite rapidly versus the traditional department stores, which are seeing more sluggish trends.

So is that influencing the company's promotional posture?.

Our promotional calendar has been strategic and competitive. We plan it in advance and assess it on an ongoing basis. Our posture is to be competitive. We expect to continue to take market share through the back half of the year, and the reality is the competitive environment is a reality. And we talked about before, we've anticipated this.

We've made changes in our supply chain to allow us to be more competitive, most notably, the insourcing of our foreign agents, our in-house product development. And we're focused on giving our, most importantly, our customers inspiring and innovative products at great prices. .

And we'll take our next question from Seth Sigman with Crédit Suisse. .

You discussed the EPS impact from the port issue. But just wondering, did you mention the sales impact? I think you had expected a $5 million to $10 million impact. So if you could just clarify that and where maybe you saw the biggest impact.

And then the second piece of that, just excluding that disruption, any color on trends you're seeing within some of the bigger-ticket categories or any color on the composition of the basket as we try to assess the health of the consumer?.

From a sales impact for the port, I guess the good news is that it was less than what we anticipated. We hadn't really quantified it because as the farther out you get, just like when we said in Q4, the beginning of it and the end of it gets really murky, as to what's causing what.

And so we believe that there was definitely an impact in Pottery Barn Kids, which is what we had expected. But it wasn't anywhere near where we thought it would be in the range of the $5 million to $10 million. And so it really was for us in Q2, the port story was about higher shipping and fulfillment-related costs. .

The second part of your question, I'm sorry, on the macro, as I said earlier, we're 3 weeks in, we have a labor day shift. We have had a lot of market volatility. We never read too much into short-term volatility or changes that are based on volatile markets, we've seen it before.

But the balance of what we're seeing is that we have a strong lineup for the balance of the year. The key aspects of our business that differentiates us haven't changed from our strong brands, our multichannel model, our superior supply chain. And we are focused on profitable growth.

I think that holding yourself to a high level of profitability forces a discipline that ensures success. And so regardless of what happens in the macro, we believe that we are poised to take share. .

And we have time for one final question today. It comes from Simeon Gutman with Morgan Stanley. .

Just one clarification and then one strategic. Clarification, related to a lot of the questions this quarter, the 6% brand comp was fairly solid, but the cost of doing business obviously was a bit higher, and you mentioned mostly -- actually explained most of the weakness.

Can you talk about how much of, I guess, generating that 6% comp or the extra fulfillment is tied to the business just this quarter? Or is that also getting yourself ready for the following, such that we won't keep some of that. My strategic question is -- Julie, you largely diffused this with the comment on merch margin.

You're coming off a transition with insourcing, and of course, this hit at a similar time with some of the port issues. Is there anything related to the 1 or the 2 at all? I just want to diffuse that thought if there is any connection. .

So I think -- we're trying to understand your question a little bit. But I think on the costs that were incurred in Q2, we did say earlier that, that will continue.

It's not necessarily related to cost of getting a 6.3% comp if that's what you're alluding to, it's really the incremental cost associated with the port, the higher shipment and fulfilling costs but also this incremental supply chain labor cost, and those will continue to some degree into specifically Q3, maybe a little bit in Q4, but predominantly Q3, but not at the same levels that we have been trending.

.

So service level didn't suffer, meaning that -- to the point where you could have done a better comp? Or -- I know that, that was the last question, on how you think about that.

But meaning the premise is, had you not had to spend all this incremental labor, would you have also had better sales?.

Well, that's hard to disaggregate.

I mean, who knows?.

Okay. And then to clarify the second point. It was just you're doing the sales sourcing. This year, there's been some disruption with inventory. It all looks like it's related to the port issues. I'm just trying to disaggregate that there's anything to do with insourcing and disruptions from there at the same time. .

No, no, not at all. .

And that concludes our question-and-answer session today. I'd now like to turn the conference over to Ms. Alber for any closing remarks. .

Well, I want to thank you all for joining us again today and asking great questions and thank you for your support. We'll talk to you next time. .

Thank you, and this does conclude today's conference call. We thank you for your participation. You may now disconnect..