Williams-Sonoma, Inc.

Ladies and gentlemen, welcome to the Williams-Sonoma, Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will conduct a question and answer session after the presentation. This call is being recorded. I would now like to turn the call over to Elise Wang, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Unless indicated otherwise, our discussion today will relate to results and guidance based on certain non-GAAP measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in Exhibit 1 of our press release. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which addressed the financial condition, results of operations, business initiatives, trends, growth plans, and prospects of the company in 2020 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 release and SEC filings including the most recent 10K 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. Thanks, Taliesin. Good afternoon, everyone. Thank you all for joining us. Also on the call with me today are Julie Whalen, our Chief Financial Officer, Felix Carbullido, our Chief Marketing Officer, and Yasser Anwar, our Chief Technology Officer. On today's call, I want to talk to you about our outstanding third quarter results and, more importantly, our company's distinctive positioning and long-term growth prospects. In the third quarter, sales again outperformed expectations with demand comp up nearly 31% compared to a net comp of 24%. driven by strength across all of our brands. E-commerce accelerated sequentially to a record net comp of over 49% and we were pleased to see our store performance improve throughout the quarter to a net negative 11% comp. Even more encouraging is the retail demand comp at negative four. And we delivered these sales more profitably with operating margins reaching record levels expanding to 15.7% versus last year's 7.6%. All of our grants outperformed. Potter Barn delivered a net comp of 24.1%, driven by double-digit comps in all divisions. Growth initiatives, including PB Apartment and Marketplace, continued to build in momentum, growing more than 100% again this quarter to reach nearly $200 million in sales year-to-date. Our Potter Barn kids and teen business grew at a net comp of 23.8% with accelerated growth in all areas. We also saw a longer tail in our back to school business with our gear and study at home solutions delivering a strong finish to the season. The Williams-Sonoma brand delivered another record quarter with a net comp of 30.4%. This is a business that has always had a smaller online percentage compared to our other brands, and this represents a big opportunity. Our initiatives in e-commerce and our real estate optimization strategies are driving our channel mix shift. We're also pleased to see our stores performing better than expected in the William Sonoma brand. And finally, in our West Elm brand, we saw significant pickup in net comp in Q3 to 21.8%, driven by strong growth in all major categories, as well as the traditional retail-dominant categories of textiles and decorative accessories. As we enter the fourth quarter, holiday is off to a strong start across all of our brands. We are seeing earlier sales in holiday products than in years prior, and our teams are prepared and ready to meet this demand by moving up launch dates and marketing for our holiday merchandise. And we continue to see DTC's strength in retail improving despite reductions in store occupancy. Our supply chain team is also working diligently to meet this elevated demand. Despite industry-wide capacity and shipping constraints due to COVID-19, our teams are leveraging our scale and unique business model to do everything we can to ensure the best customer experience this holiday. Our global sourcing team has been partnering with our vendors to expand capacity, leveraging our in-country presence and long-standing vendor relationships. Our transportation team worked quickly and aggressively early this year to further diversify our carrier network and we believe we have successfully secured parcel shipping capacity for the elevated volumes we expect to drive this holiday. We will also be maximizing our omni-channel capabilities such as ship from store and buy online pick up in store to supplement our supply chain fulfillment capacity. We expect our omni-services to fulfill up to 20% of our expected total DTC volume this holiday. These results demonstrate our company's ability to deliver long-term profitable growth post-pandemic. Our company's mission is to enhance the quality of people's lives at home. We have built our business with this mission at the forefront, investing in areas that matter most to our customers. These include high-quality, well-designed, sustainable products at a great value because of our scale and vertical supply chain, inspiring marketing, and the convenience of our high-touch, digital-first, omnichannel experience. And this, combined with our loved brands that serve a wide range of customers across aesthetics and price points, is our distinctive positioning and is our competitive advantage. No one else in the market is doing what we are doing. Our mission also extends to how we take care of our employees, our vendor partners, our customers and our shareholders. At Williams-Sonoma, Inc., and across our brands we are good by design from managing resources responsibly, caring for our people and leading with our values. In a year marked by social, environmental and health crises on a scale not previously seen in our lifetimes, these values are more important than ever. And we are proud to be leaders in our industry through our financial performance, our impactful ESG programs and how we've taken care of our people while increasing returns to our shareholders. As we look at our business today, there are three key accomplishments that we believe will deliver significant growth for the future. First, we've been acquiring new customers in our digital channels at a rate of over 30% year-to-date, a significant acceleration compared to previous years. While we have seen this in the past, it generally foreshadows strong business in the future. This is a particularly notable increase as stores have historically been the key driver of new customer growth. This overall increase, despite less store traffic, shows the effectiveness of our current digital marketing strategy in acquiring new customers. Second, and even more encouraging, is that we are attracting these customers while deliberately shifting away from promotion towards marketing that has inspiring content and is brand building. This should mean that we have higher retention of these customers post-pandemic. And finally, all of our brands are resonating with younger generations. Over the last three years, this cohort has driven the majority of our new customer growth. And year to date, millennials represent nearly 50% of our sales from new customers. This, of course, has not been a coincidence as our value proposition and competitive strengths are highly appealing to younger generations who have a strong affinity for design, engaging content and accessible, sustainably made products. In addition to these three internal positive indicators, industry trends also support our longer-term growth. These industry trends include the rapid shift to e-commerce, further industry consolidation, the generational shift to a younger customer, the importance of sustainability in consumer purchasing decisions, and the increase in remote work and population mobility. We believe that we are one of the few retailers best positioned to take market share in the years to come. Not only is our value proposition relevant and compelling, our multi-year growth strategies and investments are working. We will continue to prioritize e-commerce growth and push the natural shift in our channel mix. We will also expand into product white space and aggressively support the growth of new businesses and opportunities within our brand and cross-brand. For example, our business-to-business opportunity. We believe that Williams-Sonoma, Inc. business-to-business will be our next billion-dollar business within the next five years. The B2B market is large and highly fragmented with a market size of $80 billion in the U.S. alone. Our competitive advantage is that we have eight unique brands, in-house product development capabilities, and a sustainable supply chain, which allows us to simplify the customer experience for our B2B customers. Since the launch of this business in 2019, we have gained traction in all areas, with average order size and repeat purchases both growing double digits and major project wins in residential, commercial, education, healthcare and hospitality verticals. Our number of contract accounts are up 50% versus last year. We are aggressively pursuing this growth opportunity and are on track to drive over $300 million in sales this year, which represents strong double-digit growth compared to last year. Another key growth driver that we believe is underappreciated is our global opportunity. Our expansion to date has proven that we can grow profitably and with low capital investment, further supporting the viability of profitable growth in this business for us in the estimated $450 billion global home furnishings market. To reiterate, our strategy for expansion is through a franchise model, and we look forward to growing our presence in our current markets and our launch in India next year. In summary, our vision is to own the home. And with our distinctive positioning, we will only become more relevant. We have brands that serve a wide range of customers across aesthetics and price points. And unlike our competitors, with undifferentiated marketplace models, we have always been different. We design the vast majority of our products, and for those that we carry from third-party vendors, we ensure that they are high-quality, We have the strategies, the team, and the world-class platform to successfully execute on our growth opportunities. and we are confident that we will continue to drive accelerating sales growth with increasing profitability and evolve into an even more attractive business for our stakeholders during and post-pandemic. Before I turn the call over to Julie, I want to thank our team. We have been operating in this challenging environment for more than eight months now and our team has been an unwavering source of energy, creativity and determination. We are deeply appreciative of their remarkable performance. And with that, I'd like to pass the call over to Julie to discuss our financial results for Q3 and our outlook for Q4 and beyond.

Thank you, Laura, and good afternoon, everyone. We are pleased to record another quarter of record growth and profitability. It is clear our mission and value proposition are increasingly more relevant and our growth strategies are continuing to gain traction. And this, combined with our world-class platforms that we have been investing in over time, The agility and strong execution from our team and a culture of strong financial discipline has enabled us to capture market share and expand profitably. We are so proud that our ongoing financial strength has allowed us to continue to take care of our stakeholders, our associates, our customers, our communities, and our shareholders during this unprecedented time. Turning to the third quarter financial results, net revenues grew 22.4% year over year to $1,765,000,000. with net comp growth accelerating to 24.4%. This strong performance was driven by all of our brands and at a higher margin than we have seen as we have been materially shifting away from promotions. Our demand comp, which includes orders placed but not yet filled in the quarter, was again higher at almost 31% as sales continued to outpace our expectations. Our accelerated growth was driven by a 49.3% comp in e-commerce and a material improvement in our retail revenues. All brands sequentially improved to strong double digits this quarter. Williams-Sonoma delivered another record net comp of 30.4%. Pottery Barn accelerated to a net comp of 24.1%. The Pie Barn kids and teen business grew at a net comp of 23.8%. West Elm delivered a comp of 21.8% on top of 14.1% last year. And our emerging brands, Rejuvenation and Mark and Graham, delivered another quarter of strong double digit growth. Moving down the income statement, gross margin expanded 400 basis points to 40% in the third quarter. This was driven by higher merchandise margins and occupancy leverage. Higher merchandise margins resulted from reduced promotional activity as we continued to shift to a content-led marketing strategy that focuses on the overall value equation of our high-quality, sustainable products. Occupancy leverage was driven by higher sales and an almost 3% or $5 million reduction in year-over-year occupancy costs which includes the impact of reduced rent and operating costs from fewer stores. And this resulted in occupancy leverage of approximately 250 basis points at $174 million or 9.9% of revenues this year as compared to $179 million or 12.4% last year. This occupancy leverage combined with our merchandise margin expansion was partially offset by higher shipping costs year over year driven by the substantial shift to e-commerce sales in the quarter as well as shipping surcharges from our third party shippers. We were pleased to see that even with these higher shipping costs, our selling margins, which include our merchandise margins and shipping, expanded 150 base points. And this plus our occupancy leverage allowed us to deliver our highest ever third quarter gross margin rate. SG&A leveraged 410 base points to 24.3% of net revenues compared to 28.4% of net revenues last year. This is primarily driven by significant advertising leverage as we further optimize our digital spend on those initiatives that drove high returns in traffic and conversion, employment leverage, and other leverage throughout SG&A from higher top line performance, lower variable store payroll, and ongoing strong financial discipline. These results led to another quarter of record profitability with operating income growth of 152% to $277 million and operating margin expansion of 810 basis points to 15.7%. This resulted in diluted earnings per share of $2.56, which grew 151% or more than double that of last year at $1.02. We are proud to achieve these levels of profitability while continuing to take care of our associates with heightened safety protocols such as personal protective equipment, frequent cleaning and COVID testing, as well as higher employment costs from providing pandemic bonuses for our store associates and increased hourly wages for our distribution center associates. On the balance sheet, we ended the quarter with a strong cash balance of $773 million compared to $155 million last year. This reflects the strength of our cash balance as we entered 2020 as well as the resilience of our business during this pandemic generating positive operating cash flow of almost $727 million year-to-date. Our strong liquidity position allowed us to fund the operations of the business, to invest nearly $125 million in capital expenditures in support of our future growth, and to return nearly $117 million in the form of continued quarterly dividend payments to our shareholders. Additionally this quarter, as previously announced, we also repaid in full our short-term borrowings under our $500 million revolver, reinstated our share repurchase program, repurchasing $109 million this quarter alone, and we also committed to a quarterly dividend increase of 10% effective with our next dividend payment in the fourth quarter. These decisions reflect our confidence in the long-term growth and profitability trajectory of our business and our commitment to maximizing returns for our shareholders. Moving down the balance sheet, merchandise inventories were $1,125,000 for a decrease of 10.6% year-over-year versus a 12.2% decline in the second quarter. As Laura said, we have been working closely with our vendor partners to manage through the COVID disruptions and to expand capacity. But given the ongoing elevated demand and our high back orders, we do not expect to be fully back in stock until the second quarter of next year. What this means is that we have 700 basis points of demand sales from Q3 that we expect to fill in future quarters when the inventory is available and delivered to the customer. We are pleased that our customers have continued to want their orders delivered even if they have slight delays. Turning to our outlook for the rest of the fiscal year, it is clear from the latest surge in COVID infection rates across the country and globally that there is still, unfortunately, significant uncertainty related to this pandemic. As a result, we will not be providing specific sales and earnings guidance for fiscal 2020. But directionally, I can tell you our business continues to be strong across all brands three weeks into the fourth quarter. The momentum in our business is continuing. From a gross margin perspective, with lower levels of planned promotions, we expect merchandise margins to continue to expand year over year. We also expect occupancy leverage to continue, driven by the cost savings from the leases that we have already renegotiated year to date, as well as the closure of unprofitable stores and final rent abatement negotiations. This will be partially offset by higher shipping costs that will continue to be a headwind in Q4, given the anticipated elevated levels of e-commerce sales and peak surcharges that will come into effect during the holiday peak selling season. In terms of SG&A, we expect to incur incremental costs associated with keeping our people and customers safe during the pandemic as well as additional supply chain employment costs. At the same time, we will continue to exercise strong cost discipline in all areas of nonessential spend to ensure that we can remain resilient during this period of uncertainty. As a result, on the year, we remain confident in our ability to drive substantial operating margin expansion versus last year due to our strong performance to date and the likely continuation of robust e-commerce trends through the balance of the year. With regards to capital allocations, in addition to the increased quarterly dividend and reinstated share buyback program, we have increased our capital investments in high-returning initiatives that focus on digital to drive our long-term growth. We expect our total CapEx this year to be back relatively in line with historical levels. As far as our longer-term outlook, we remain confident in our ability to drive strong top-line results while continuing to deliver operating margin expansion. It was clear pre-pandemic that our strategies for growth were working with accelerated comps through 2019 and an almost 10% comp heading into March before the pandemic accelerated. And these successful growth strategies, combined with our strong new customer count and growing loyalty customer base, the fundamental shift of business online, as well as our leadership and sustainability, which has become increasingly more important to the consumer, reinforces our ability to continue to drive strong top line growth post-pandemic. And we expect to deliver this growth with further operating margin expansion. As you know, we have a highly profitable e-commerce business with an operating margin that over the last 10 years alone has averaged over 21%. Unlike many retailers who are still in the process of scaling their online business, we have already made the significant investments in our e-commerce platform over many years, which enables us to drive significant leverage throughout as we further scale our e-commerce business. This is a significant competitive advantage that speaks to the earnings power of our digital-first model. As we continue to prioritize e-commerce growth and structurally shift the channel mix of our business, we will drive material occupancy leverage as we renegotiate more favorable leases and Close Unprofitable Stores. We have half of our leases coming up for renewal in the next three years and we'll be looking at each lease and keep only those stores where the economics of the deal makes sense and where they are brand enhancing. Our plan currently is to close approximately 40 stores this year. Stores continue to be a competitive advantage as people like to see merchandise in person. However, we are anticipating a future with fewer, better, more profitable stores. We are also planning for merchandise margin expansion by not only continuing to deliver more relevant content-led marketing, but by also building more value into our product line, which will enable us to be less promotional. Our strong product line and loved brands gives us pricing power that others don't have because their products are undifferentiated. This is very important as we expect costs globally to increase over the next several years. Another important driver of long-term operating margin expansion is SG&A leverage. and while there may be some increases in some lines, our shift to digital gives us confidence that we will be able to leverage throughout SG&A and to deliver operating margin expansion post-pandemic. In summary, our third quarter results continue to demonstrate the power of our distinctive position in driving strong profitable growth. Customers come to us for our in-house design products that are high quality, sustainably made and of the best value in the market. They come to us for our brands that serve a wide range of aesthetics and price points. They come to us for our inspiring content that is engaging and speaks to their needs, and they come to us for the convenience that we offer with our omnichannel model. These competitive advantages, combined with our long-term growth strategies and proven execution, give us the confidence that we'll continue to drive long-term, strong sales and earnings growth and further returns for our shareholders both this year and post-pandemic. And now, I would also like to thank our associates. Without their unwavering commitment to all our stakeholders, none of this would be possible. I would now like to open the call for questions. Thank you.