Edited Transcript of WSM earnings conference call or presentation 30-May-19 9:00pm GMT

Thank you. Good afternoon, everyone. On the call with me are Julie Whalen, our Chief Financial Officer; Felix Carbullido, our Chief Marketing Officer; and Yasir Anwar, our Chief Technology Officer.

We had a strong start to 2019 with comp revenue growth of 3.5%, operating margin expansion of 70 basis points and EPS growth of 21%. Customer acquisition and engagement continue to grow as we delivered more compelling and differentiated experiences to our customers.

We also reached a significant milestone for our company as we were named, for the first time, to the Fortune 500 largest companies in the United States. This accomplishment speaks to the hard work and dedication of all of our associates, the ongoing support of our loyal customers and the power of our highly differentiated platform in driving long-term profitable growth.

Given our strong start to the year and the strength we are seeing early in the second quarter, we are raising our full year EPS guidance by $0.05. This raise reflects the momentum across our business and our confidence in the substantial growth engines we are executing against. Our financial performance this quarter demonstrates the exciting progress we have made across the business to accelerate growth and improve profitability.

Our cross-brand initiatives continue to build as an important source of revenue growth and customer acquisition. Our cross-brand customer spend on average 4x more than single-brand customers, but they currently account for only 30% of our total customer base. This gives us runway to drive incremental revenues as we continue to unlock the power of our unique multi-brand, multi-channel platform.

The Key Rewards is one of our most valuable and fastest-growing assets. Since the launch of this loyalty program 2 years ago, total membership has grown to 5.5 million. Key members currently spend on average 3x more than nonmembers with 2x higher purchase frequency and 3x more likely to shop across multiple brands. They also drive a significant lift in sales as Key members typically spend over 5x the value of their rewards.

We will introduce new cross-brand marketing initiatives, broad-reaching gamification, easier reward redemptions and enhanced mobile and desktop capabilities to accelerate customer enrollment and realize the full potential of this program. We will also leverage The Key to raise brand awareness and drive more personalized content to our customers.

Our Design Crew Room Planner also continues to gain traction. Total rooms created increased more than 40% over the first quarter to 60,000 as we doubled our product coverage across the Pottery Barn, West Elm and Williams-Sonoma Home brands and enhanced the user experience with more accurate and intuitive design features. Upcoming in Q2 and Q3, we’ll be launching the Room Planner in our Pottery Barn children’s businesses. We believe 3D visualization will completely redefine how our customers shop for the home and we’re excited to be at the forefront of this industry shift with these 3D-powered tools that are transforming the shopping experience for our customers.

I would now like to talk about our newest division, Williams-Sonoma, Inc. Business to Business. We are thrilled with the progress that our team has already made, including our new partnership with the Golden State Warriors. As we jointly announced earlier today with the Warriors, we’ve been named the Official Furniture and Home Design Partner of the Golden State Warriors, 6-time and hopefully 7-time back-to-back NBA Champion. This is a marquee opportunity and an unparalleled launching pad for our Business to Business division in the United States as well as internationally. We’re even more encouraged that this is just one example of the strategic relationships we are currently pursuing across industry verticals as we expand our B2B business.

Company-wide, we’ve been putting in place the organizational infrastructure to support this growth in Business to Business. We’ve built a cross-brand, cross-functional support team and are now establishing standardized processes to facilitate large-scale contract projects. We are also restructuring our customer support to a regionally focused project management model that’s tailored to the B2B client.

To raise industry awareness for this nascent business, we’re in the process of launching our WSI Business to Business brand, starting with the recent Hospitality Design Expo, which debuted our newest cross-brand contract rate product, including West Elm’s Chroma restaurant table collection. In addition to trade show participation, we’re implementing a multifaceted marketing plan that includes collaboration with top-tier industry publications and sponsorship of contract product design competitions.

Another key highlight of the quarter was the ongoing improvements in customer experience. For example, we’ve completed the launch of our machine learning search engine across all brands. Powered by algorithms, this new engine allows us to provide customers with more relevant and personalized search results, which will progressively improve with more data over time. So far, this new capability has already driven notable lift in search conversions.

To deliver a faster and more compelling mobile experience, we improved our mobile site speed within search, hits and homepage through enhancements to our new progressive web app platform. We’ve also expanded our integration of customer-generated content from Instagram to our mobile product information pages to drive more inspiration and product discovery.

Another milestone was the launch of our in-house technology, Test Lab. This is a game-changer for our innovation agenda as it will enable us to experiment with new ideas and emerging technologies at scale and quickly determine our go-forward strategy. Technology innovation is a key accelerator of our growth, and we believe that this is a foundational capability that will significantly transform our digital experience.

In the supply chain, order visibility and operational improvements remain 2 of our top priorities. This quarter, we successfully completed the migration of our order management and fulfillment capabilities to a new platform for all brands. This will enable faster and more efficient order processing and tracking as we continue to improve the customer experience. We’ve also fully redesigned our order tracking capability to give customers and our internal teams a more accurate and granular view of their orders. This capability allows us to offer order visibility of up to 13 milestones compared to the industry standard of 5 through the order placement, fulfillment shipment and delivery journey. While still early days in this, we are already seeing this increased visibility resulting in a 30% reduction in order tracking-related calls at our customer care center.

Another area of operational improvement was the productivity rates in our non-furniture operations, which increased 10% as a result of improved processes, leading to labor savings and lower returns or replacement rates. In our furniture operations, we are proud to see the accuracy of our delivery date estimates further improve and our in-home delivery service rating reached 4.86 out of 5, the highest we’ve seen since the inception of the measurement program 2 years ago.

All these improvements in supply chain have enhanced customer satisfaction and delivered cost savings that contributed to our higher operating margin this quarter. As we said at the beginning of the year, we’ve identified significant cost savings across our business to help offset the financial impact of potential tariffs.

But of course, we are not done. We have more initiatives planned to further elevate our customer experience. One of the key upcoming opportunities is the opening of our West Elm West Coast DC in the second quarter. This new DC will help us further improve our delivery times and reduce our operating costs in the western region.

The benefits of all these cross-brand technology and operational initiatives powered our brand performance this quarter. West Elm, our fastest-growing brand, continues to deliver on our aggressive road map of $3 billion with comp growth accelerating to 11.8%. This growth was driven by strong e-commerce and broad-based strength across product categories, particularly in made-to-order upholstery and key customer acquisition categories of textile and decorative accessory. Also, our new West Elm stores are outperforming our expectations.

We also saw growth from Pottery Barn where furniture continues to outperform and our outdoor business showed early momentum when we are heading into summer and now is continuing to grow as we are underway into the summer season. Pottery Barn Kids and Teen delivered another quarter of growth with particular strength in the baby business, an important entry point to the brand.

Our emerging brands, Rejuvenation and Mark and Graham, continue to expand their product offer and the new stores in Rejuvenation are also performing above our expectations. Our global business is strong as our team works towards a successful launch of our brand in India next year.

Regarding the Williams-Sonoma brand, although we knew we are up against a tough comp of 5.6% last year, we expected our performance to be better than what we delivered. Easter came late in the quarter and did not perform to our expectations. This negatively impacted both the top line and margin performance of the brand. We also continued to reduce our promotional activity, particularly in Williams-Sonoma Home.

As we look forward to the rest of the year, Williams-Sonoma will continue to undergo a transformation to balance the brand’s top line with improved profitability. We are focused on increasing exclusive product offerings and more effective content as well as reducing promotions and less productive inventory to drive incremental revenue growth and improve margins.

Before I conclude, I want to provide you also with an update on our sustainability commitments, which are becoming increasingly important to our customers and are key pillars of our growth. In Q1, we are proud to achieve the milestone of 100% GREENGUARD Gold certification for nursery furniture and seating in Pottery Barn Kids, while Rejuvenation announced a landfill diversion partnership with Habitat for Humanity as well as its commitment to offering only textiles that are sustainably sourced and made from organic fibers.

It’s important to us that we are making a difference in the world through the products that we put in people’s homes. This is a key reason why customers choose us over our competitors. I encourage you to take a deeper look at the progress we are making in areas such as worker well-being and our supply chain, GREENGUARD’s certification of our furniture and sustainable sourcing of cottons and FSC-certified wood in our upcoming annual CSR report.

As we look to the balance of the year, we believe we are uniquely positioned to capture the significant opportunities we see in the home furnishings industry. We’ll continue to build on our strong momentum to achieve our goal of maximizing growth and drive profitability across our portfolio of brands.

Before I pass it over to Julie, I’d also like to thank all of our associates for the strong start to the year. And with that, I will turn the call over to Julie for a financial review of the first quarter and an update to our fiscal year 2019 guidance.

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [4]

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Thank you, Laura, and good afternoon, everyone.

Our strong first quarter results reflect the momentum we are seeing across our key business initiatives to drive long-term growth and profitability. We were pleased to see solid top line growth, combined with product margin expansion, occupancy and overall expense leverage, resulting in operating margin expansion and EPS growth in excess of 20%.

During the first quarter, on the top line, we generated net revenues of $1.241 billion for a year-over-year growth of 3.2%. And comparable brand revenues sequentially accelerated to 3.5% on top of a strong comparison of 5.5% last year. The key drivers of this revenue growth include West Elm delivering accelerated comps of 11.8% on top of a 9% comp last year, the Pottery Barn brand returning to a positive comp at 1.5% and our emerging brands combined delivering another quarter of double-digit growth.

From a profitability standpoint, we delivered operating income of $87.1 million, which grew 15.8% over last year and resulted in 70 basis points of operating margin expansion to 7% versus a 6.3% last year. The key components of this improvement in profitability were product margin expansion and occupancy leverage within gross margin as well as overall strong SG&A leverage.

Gross margin for the first quarter was 35.9% versus 36% last year. Higher shipping costs, which was primarily driven by a larger mix of furniture sales, was almost completely offset by the benefits we saw from product margin expansion and another quarter of strong occupancy leverage. Our product margin expansion reflects our emphasis on relevancy and inspiration rather than broad-based promotions as well as the ongoing success we are seeing across our supply chain initiatives, which continue to drive efficiencies.

Occupancy costs remained flat to last year at approximately $173 million, improving 40 basis points year-over-year to 14%. This was primarily a result of our ongoing retail optimization initiatives, including the closure of unproductive stores and the corresponding benefits we see from reduced rent and other occupancy-related costs.

SG&A for the first quarter was 28.9% this year versus 29.7% last year. This 80 basis point leverage across advertising, employment and general expenses reflect the benefits of the cost savings initiatives we’ve implemented across the business and our overall expense discipline.

The effective income tax rate during the first quarter was 24%, which was relatively in line with last year’s rate of 23.8%. This resulted in bottom line diluted earnings per share of $0.81, which was $0.14 or 21% higher than last year.

On the balance sheet, we ended the quarter with a cash balance of $108 million versus $290 million last year. In the first quarter, we invested $36 million in the business and returned over $70 million to stockholders through dividend and share repurchases, comprising $37 million in dividends and $34 million in share repurchases.

Moving down the balance sheet. Merchandise inventories were $1.155 billion or an increase of 9.7% over last year. This was primarily driven by inventory in transit and not yet received at our distribution centers. Inventory on hand and available-for-sale increased 2.3%. The overall growth in inventory was primarily driven by West Elm and Pottery Barn and reflects the timing of shipments, a mix shift in customer demand for more dropship and custom-made product compared to stock inventory as well as the cost increases associated with the previously identified List 3 10% China tariffs already in place. And although total inventory growth this quarter was higher than revenue growth, it does help alleviate some pressure from the recent List 3 tariff increase from 10% to 25%.

Operationally, we are encouraged to see continued improvement from all of our inventory initiatives, driving reduced back orders and back order crate rates at all-time lows. In the short term, we expect inventory to remain at these levels as we expedite inventory to help offset the potential impact of the List 4 tariffs. However, we anticipate that inventory growth will be back in line with sales growth by the end of the year.

Additionally, as a reminder, during the quarter, we also implemented the new lease accounting standard, which requires all leases with terms greater than 12 months to be capitalized on the balance sheet. This resulted in net increase of approximately $1.2 billion to our assets and liabilities and no impact to our income statement.

Before we discuss our full year guidance, I wanted to make a couple of comments regarding the China tariffs in light of the most recent developments. As you know, we gave full year 2019 guidance with the assumption that the List 3 10% China tariffs would increase to 25%. And unfortunately, our pessimism turned out to be true. But as we told you, we have been executing on an aggressive plan to offset the financial impact of these tariffs since last year. We have moved a substantial amount of our production out of China and we are offsetting the remaining impact through cost renegotiations, selective price increases and cost reductions in other areas of our business. It’s not an easy thing to do, but given our vertically integrated, multi-country supply chain and our trusted long-standing relationships with our vendors, we believe we are better positioned to do so than most.

As a reminder, what was not contemplated in the guidance given at the beginning of the year was the potential implementation of tariffs on the expanded list of all products imported from China or List 4, proposed by the USTR in mid-May. We are underway with our initiatives to mitigate the impact of these potential additional tariffs, including expediting inventory in advance of potential implementation.

Given our strong start to the year as well as to the second quarter, we are pleased to be raising our full year diluted EPS guidance by $0.05 from the range of $4.50 to $4.70 to $4.55 to $4.75. We are reiterating all other financial guidance given at the beginning of the year.

For the fiscal year 2019, we expect net revenues to be in the range of $5.670 billion to $5.840 billion with comparable brand revenue growth in the range of 2% to 5%. Our operating income is expected to grow relatively in line with our revenue growth, resulting in an operating margin relatively in line with fiscal year 2018.

We are also reiterating our commitment to maintaining a balanced capital allocation strategy in fiscal year 2019. We plan to utilize our strong operating cash flow to first invest $200 million to $220 million in the business in those areas that will fuel our growth and provide the highest returns. And we remain committed to returning excess cash to our stockholders in the form of share repurchases and dividend payments.

In summary, we are excited about our strong start to 2019 and the momentum we are seeing from the execution of our growth and operational initiatives. This gives us the confidence that with our clear road map for accelerated growth and improved profitability that we laid out at the beginning of the year, together with our competitive strengths, including a portfolio of loved brands, a truly industry-leading, multi-channel shopping experience, a multi-country, vertically integrated supply chain that gives us flexibility on sourcing and control over quality, sustainability and cost, our strong operating cash flow and balance sheet and our proven track record of strong financial discipline, we are well-positioned to achieve our financial targets for 2019 and longer term.

I would now like to open up the call for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we’ll go first to Jonathan Matuszewski with Jefferies.

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Jonathan Richard Matuszewski, Jefferies LLC, Research Division – Equity Analyst [2]

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First one just on West Elm. Really impressive trend here, ongoing strength in the concept. And last quarter, you alluded to the brand finding more traction in more suburban areas, branching out beyond kind of urban cities. So do — would you consider this to be one of the notable kind of drivers of the comp trend lately? And how does this kind of trend you’re seeing make you think differently about the total addressable market for West Elm ahead?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [3]

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Yes. West Elm continues to outperform across channels and across geographies, including internationally, and it really is a very powerful global design brand. And the product, I think, is very relevant right now in terms of diversity of looks and also small spaces. The quality and sustainability part of the equation, I think, are very important to our customers. And we have a lot of innovation so we keep — as much as people have tried to copy what we’re doing, we’re continuing to be bold in our designs moving forward, and we’re seeing customer acquisition numbers grow and new categories of business grow. And our new collaboration with Pottery Barn Kids, the Pottery Barn Kids West Elm baby collaboration has been also very successful. So we’re well on our way to our aggressive road map to reach $3 billion and we’re starting the year off strong.

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Jonathan Richard Matuszewski, Jefferies LLC, Research Division – Equity Analyst [4]

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Great. And then just a follow-up with regards to tariffs. It sounds like you’ve had a lot of success in terms of redirecting orders with vendors and cost negotiations. Could you just update us on your thoughts on pricing philosophy? Any changes as you look to pursue a changed architecture in the face of elevated tariffs? And how do you view the pricing elasticity across your product portfolio?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [5]

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Tariffs are obviously disruptive over the short term, but we are hopeful that the trade talks between the United States and China will continue productively and something positive will come out of it over the long term. In the meantime, as you said, we are executing on an aggressive plan to help mitigate the impact of the tariffs already in effect. And we’ve also started working on this potential of even more products being tariffed in the future. We’ve already moved a substantial amount of our products out of China. And as Julie said, we’re offsetting the remaining impact across renegotiations, selective price increases and as you can see in this quarter, a lot of cost reductions across the company.

In terms of price increases, value to our customers is extremely important. And they are looking to us for great products, quality that lasts, sustainability and a very good price. So we’ve been working hard across our brands to introduce more opening price point at great quality. So for example, in Williams-Sonoma Open Kitchen, in Pottery Barn, the apartment products that we’ve introduced. And we’ve also just been looking at how do we sharpen up our prices in total. And we have enough innovation that we have new products, new bestsellers coming in all the time. So at the same time that there is pricing pressure, we’ve also done a — we’ve made a big effort to bring in a lower-priced product at the same time. So we don’t believe our value equation will be hurt by selective price increases.

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Operator [6]

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We’ll go next to Chuck Grom with Gordon Haskett.

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Andrew James Minora, Gordon Haskett Research Advisors – Research Associate of Retail [7]

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It’s Andrew on for Chuck. I had a quick question first on EBIT margin outlook for the year. You guys are keeping it at flat year-over-year for the full year. Obviously, you had a strong quarter this quarter just with some leverage on that line. I’m just wondering if there’s any puts and takes you guys could help us think about the remainder of the year where there may be some giveback or is this just staying a little bit conservative because it’s early in the year? Anything on that would be helpful.

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [8]

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Sure. I mean, at this point, to your point, it is early in the year. So we are being conservative. Obviously, as Laura mentioned as well, List 4 tariffs are looming out there. But ex either one of those, the fundamental strength of our business and the strong start to the year is what allowed us to raise the $0.05 on the year today. And if we didn’t have any of those other uncertainties out there, we’d even be higher. So I would not be concerned about where we think the margin is going to be. Obviously, it’s early in the year and we are confident in where our margin will land, at least relatively in line with last year.

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Andrew James Minora, Gordon Haskett Research Advisors – Research Associate of Retail [9]

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No, that makes a lot of sense. And then on the comp, just kind of like a 2-part question, but where was that relative to your internal expectations? Like I know you’ve mentioned that Sonoma was a little bit worse than you guys would have hoped for in the quarter, but I guess overall? And then if you could talk about it, if you could parse it out for us like some of the self-help drivers that maybe helped drive the strong comp year-over-year?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [10]

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Yes. So I mean, obviously we aren’t giving guidance on a quarterly basis, but we gave directional guidance and I’m assuming that’s what you’re alluding to at the time of our last call. And really, what happened is since the time we gave the directional guidance, the back half of the first quarter was really strong, particularly in the home furnishings brands. And so we were really pleased to get to a solid 3.5% comp. And as we said — or as we both said in our prepared remarks, with West Elm accelerating to 11.8% on top of a 9% last year and Pottery Barn returning to positive growth at a 1.5% and our emerging brands combined growing double digits along with global growing 9%, when all of that happens, it really drives a solid comp. And that, combined with the product margin expansion that we had at the same time and the fact that we had flat occupancy costs, really allowed us to leverage the entire P&L and come through with a very strong solid Q1. But it really was back half-weighted.

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Operator [11]

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(Operator Instructions) We’ll go next to Steve Forbes with Guggenheim Securities.

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Stephen Charles Kovalsky, Guggenheim Securities, LLC, Research Division – Associate [12]

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This is Stephen Kovalsky on for Steve today. So I wanted to start with the first quarter expense performance. Maybe just expand on where you’re seeing the greatest strength there? And then if you could maybe also expand on the employee-related expenses, be it severance and reorganization charges, how we should think of those moving out through the rest of the year?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [13]

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Sure, yes. As far as the leverage we saw within SG&A, we are really pleased to see that. As Laura mentioned, this is everything to do with the fact that we are delivering our cost savings initiatives. And the 80 basis point [lift], which was really honestly across the board. It was in advertising. It was employment. It was general expenses. I mean, just about every single line, we have been aggressively pursuing these cost savings initiatives and we’re really pleased to see those come in so quickly.

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Stephen Charles Kovalsky, Guggenheim Securities, LLC, Research Division – Associate [14]

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Great. And then as a follow-up, so with the Design Crew Room Planner, could you guys give us some insight maybe into the conversion rates? And then also what percentage of those are being utilized across brands?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [15]

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Yes. I’m going to pass it over to Yasir to talk about the Room Planner.

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Yasir Anwar, Williams-Sonoma, Inc. – CTO [16]

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So as Laura mentioned, we are seeing significant improvement in engagement as we continuously tune and tweak the experience to remove friction and helping the customers to design their rooms and actually entire home you can do it today, so that is happening. And 40% increase since we launched in the number of room plans that have been created by our associates and our designers. We’re trying to create a bridge between our designers and the end customer so they can design whatever they can and they can pass it on to the experts who can finish it off or give them even more better experience there.

In terms of conversion, I think there is an improvement in conversion. We are also counting on return rate reduction, but I don’t think I can share it today. I think we want to give it a little bit more runway. Maybe perhaps next time, we would have numbers for you to define actual conversion numbers.

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Operator [17]

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We’ll take our next question from Christopher Horvers with JPMorgan.

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Tami Zakaria, JP Morgan Chase & Co, Research Division – Analyst [18]

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This is Tami Zakaria on for Chris Horvers. So we had a modeling question. Can you talk about how the week shift played out in 1Q? And in the fourth quarter, you indicated you were going to compare weeks 1 to 13 this year to the weeks of 2 to 14 from last year. Is that right? And what was the revenue shift impact to reconcile the top line to comps? And similarly, how does that shift affect sales for the rest of the year?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [19]

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We haven’t provided that much detail on it except to say that all year long, there is going to be a 1-week shift. The revenue growth has not been adjusted. Comps obviously have been adjusted. So the comps are adjusted back to the same week in the prior year, but the revenue growth has not, which is why you see the revenue growth is below the comp growth this quarter. It’s at 3.2% versus 3.5%. And that is predominantly due to the shift from the 53rd week.

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Operator [20]

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We’ll take our next question from Peter Benedict with Baird.

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Justin E. Kleber, Robert W. Baird & Co. Incorporated, Research Division – Junior Analyst [21]

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It’s Justin Kleber on for Pete. Just wanted to follow-up on an earlier question as it relates to those employment-related expenses that you call out in your non-GAAP reconciliation. Like where are you in terms of these reorganization efforts because it looks like these expenses have been recurring for over a year now. And what type of positions, I guess, are you eliminating?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [22]

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So the reduction in force that you’re alluding to, as far as the severance that you’re seeing come through in the non-GAAP, was a pretty sizable reduction in force that we did. Obviously, it’s a very sensitive subject, so we’re going to be thoughtful about how we talk about it. It’s not something that we like to do, but sometimes it’s something that we have to do in order to have the cost savings necessary to run the business and mitigate things like the tariffs. Where a lot of the reductions came out of was in management, in retail management and at corporate HQs. And they haven’t been that often. This is something that’s been every other year for different categories, but this one was pretty unique in that it was really centered around management.

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Operator [23]

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(Operator Instructions) We’ll go next to Michael Lasser with UBS.

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Michael Lasser, UBS Investment Bank, Research Division – MD and Equity Research Analyst of Consumer Hardlines [24]

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It’s on the guidance. So you beat the — at least the printed expectation by $0.12. You raised the guidance for the year by $0.05 and many of the components of the guidance were the same. Can you give us a little bit more detail on it on what’s changed? And then 2, how have you factored in the tariff impact into the guidance?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [25]

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As far as your first question, the different components of the guidance stayed the same. I mean, the reality is our Q1 came in at a 3.5% comp, which is the exact center of our 2% to 5% comp in the full year. Our EPS came in at 21% growth rate with 70 basis points [above] margin expansion. So obviously, we saw more leverage from the P&L side of things and so that’s why you’re seeing it flow through to the EPS side. As I said on an earlier question, we obviously are also being thoughtful of the fact that it’s early in the year and then there is some potential impact of List 4 tariffs that was not contemplated in our original guidance. And so we’re being thoughtful about that as far as raising any further on the year, but that’s how the guidance raise was thought through.

As far as the tariffs, the List 3 — and hopefully everybody knows this, List 3 and List 4, but the List 3 tariffs going from 10% to 25% was something we contemplated and something we told you on the last call that we did have cover within our guidance, and that is still true. List 4, we do not. And so we are aggressively working on that like we have before with the prior list and are doing everything we can to help mitigate that now ahead of that even going in. For example, as I mentioned with inventory, we are accelerating the shipping of inventory to get ahead of the potential of the increase to 25%.

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Operator [26]

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And we’ll take our next question from Oliver Wintermantel with Evercore ISI.

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Oliver Wintermantel, Evercore ISI Institutional Equities, Research Division – MD & Fundamental Research Analyst [27]

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I’m going back to the tariff. Can you give us some more details on what percent of your COGS is on List 3? And if you would expand it to all Chinese imports, how much percent of COGS would be on the list?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [28]

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We haven’t disclosed that. I mean, obviously, the numbers are constantly moving and we’re working very hard to resource a lot of the product out of China. And so, in fact, we’re planning to resource almost half, bring down half of what we do today by next year. And so it’s considerably going down and that, combined with the cost renegotiations, has really brought it down, but we haven’t disclosed the actual number.

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Operator [29]

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We’ll go next to Brad Thomas with KeyBanc Capital Markets.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division – Director and Equity Research Analyst [30]

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And good quarter here. I wanted to ask about the Pottery Barn brand. As we’ve been following it during the last quarter, it appeared that you were less promotional in the brand and so encouraging to see the sales where they were with what appeared to be less promotions. I guess, for one, can you talk about the balance of promotions in that brand, the success you’re having? And then with West Elm now your second-biggest brand, can you talk a little bit about the interplay between West Elm and Pottery Barn and how you balance that?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [31]

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Sure thing. We were pleased to see the re-acceleration this quarter and also saw the net be similar to the demand, which is important to us. And as you know, Pottery Barn is a powerful, highly profitable brand and it’s been a proven platform by which to grow incremental businesses, and the latest 2 being Pottery Barn apartment and marketplace, which is — both — which are both scaling very quickly and they are both contributing incremental revenues and attracting new customers. Demand was also strong for our special order upholstery, the majority of which is made in our proprietary Sutter Street Manufacturing in Hickory, North Carolina.

And we expect these trends to continue. As I said earlier, we’re seeing nice response to our outdoor furniture. And we’ve also been working through our inventory optimization efforts to reduce the amount of clearance, which we’ve done successfully and, therefore, running less promotions in those clearance buckets, which helps margin.

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Operator [32]

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We’ll go next to Brian Nagel with Oppenheimer.

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Brian William Nagel, Oppenheimer & Co. Inc., Research Division – MD & Senior Analyst [33]

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Nice quarter. So I’ve wanted to focus on the top line. And I’ll keep it to one question and maybe slip a few parts into it.

But first off, if you could discuss a bit maybe the trend in sales through the quarter? I think you had mentioned that Williams-Sonoma tracked — that Williams-Sonoma corp tracked within your expectation. How did the overall business track through the quarter? Any further explanation on the underlying drivers of the pickup in the Pottery Barn brand?

And then also, there’s been chatter out there with some of your competitors regarding sales weakness in states where, I guess, the SALT’s tax adjustment was a factor. Are you seeing that at all in your business?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [34]

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As far as the cadence of the sale, typically we don’t comment on that. I mean, the only thing I’ll reiterate is what I said earlier. It’s that, obviously, since we gave the directional guidance, we saw more strength particularly in our home furnishings brands in the back half of the quarter.

As far as the states where we have the SALT tax, we haven’t seen any sort of disproportionate reaction to that at all.

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [35]

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Also, I want to go back. I don’t think I fully answered the question about the West Elm and Pottery Barn interaction that was asked. And it’s interesting because we’ve really studied that over and over. We’ve actually found that the 2 help each other and that we haven’t seen cannibalization either at retail or online. In fact, they both refer and drive traffic to each other. And this is a big advantage, I believe strongly, because of our portfolio of brands. And we’re using more and more the cross-brand’s power to drive business between brands. And you’ll see us do even more of that. We do that with Key. We do that with the Room Planner where you can shop across brands. And you’re even — if you’re looking very carefully, you’ll notice when you a search category, we serve products from the other brands at the end of each category. So if you don’t find the bed you’re looking for in Pottery Barn, we will say, not finding what you’re looking for? And we’ll hotlink them to West Elm. So we actually are seeing the 2 be very symbiotic and additive. And as you know, it also really helps us with our costs to have the outbound furniture going together to zip codes.

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Operator [36]

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(Operator Instructions) And we’ll go next to Scot Ciccarelli with RBC Capital Markets.

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Beth Reed Pricoli, RBC Capital Markets, LLC, Research Division – Senior Associate [37]

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This is Beth Reed on for Scot. Just wanted to ask about shipping fees. Can you just give us just an update on how you’re thinking about these fees? Perhaps some color on the number of promotional days versus last year? How that’s trended? How you kind of plan for that to trend going forward? And then lastly, if you could give any color on to what extent you’re able to cover your costs of shipping?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [38]

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There’s no material change in shipping day promotions. Shipping is different for us than a lot of others because we do white-glove and home versus door drop on our large-scale furniture. And we do cover our costs there and you see that we do charge money on shipping. And we see shipping on the same amount of products is another just part of the whole profitability. And the customer looks at total price of product with both the retail plus the shipping together when they make a purchasing decision. And our goal is to have the best product, the most sustainable product with the best price.

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Operator [39]

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And we’ll go next to Cristina Fernández will Telsey Advisory Group.

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Cristina Fernández, Telsey Advisory Group LLC – Director & Senior Research Analyst [40]

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I wanted to go back to your comment around shifting about half of the exposure from China to other countries. Can you share where you’re moving that manufacturing to? I heard some of it is coming back to the U.S. And how does that impact your cost structure going forward?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [41]

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Sure, yes. So as you’ve heard me say, I’m so proud that we’ve opened our third Sutter Street facility in Tupelo and moving a lot of production there. We also have moved production to Vietnam, to Indonesia, to Thailand and to Cambodia.

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Operator [42]

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We’ll take our next question from Curtis Nagle with Bank of America Merrill Lynch.

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Curtis Smyser Nagle, BofA Merrill Lynch, Research Division – VP [43]

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I just wanted to quickly focus again on, I guess, the expectations for some of the adjustments that have been going through. How should we think about the rest of the year? On a dollar basis, would they be kind of in line with this quarter or perhaps lower?

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [44]

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I’m assuming you’re talking about the non-GAAP adjustments. And if that’s the case, as I alluded to on our last call, the outward impact would be continuing throughout the year. Obviously, there’ll be one-off things that can happen that I’m not aware of and at this moment similar to — or that haven’t been implemented similar to the reduction in force, but from what I know of today, that would be what would continue.

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Operator [45]

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And we’ll go next to Sumit Sharma with Berenberg Capital Markets.

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Sumit Sharma, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [46]

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Related to your gross margin, I think you mentioned that the occupancy leverage kind of offset higher shipping expenses. So I’m just wondering how much of room or leverage do you have in this line? And if you could add a little more color as to the kind of discussion you are having with your landlords. Is it just lower asking rents or are there other structures that reduce the net effective rent or towards the lease? Any kind of insight you could provide would be great.

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Julie P. Whalen, Williams-Sonoma, Inc. – Executive VP & CFO [47]

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Okay. So from an occupancy perspective, yes, we’re really pleased to see how much we’re able to leverage that. As I mentioned, we are holding our occupancy costs in line with last year, which is pretty phenomenal, and obviously drives a lot of that leverage that you’re seeing, the 40 basis points. We also did have product margin expansion and the combination of those 2 are what offsets effectively the shipping costs.

From an occupancy cost perspective going forward and what are the sorts of things that we’re seeing, it’s really — it’s the reduction in rents and all the rent-related costs that are coming with it. It’s also with the fact that we’re holding our capital investments relatively flat and so the depreciation that comes in with those that hits within occupancy has not been expanding. And so that’s what enabled us to maintain that going forward.

As far as the store closures, I don’t know, Laura, you want to take that?

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [48]

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Yes, sure. I think it’s a very interesting time for all of us as we continue to see more and more store closures being announced with the potential of more tariffs putting even more pressure on retailers, but we see this as an opportunity for strong brands like ours to strengthen our partnership with landlords and great centers. And as you know, retail is a very important part of our multi-channel model. Our stores, our experience centers for our customers, they drive brand awareness and customer acquisition. And we’re going to continue to enhance our retail experience in existing stores and selectively invest in new stores for West Elm, which have been outperforming. And that said, we’re also going to be closing underproductive stores and stores that we don’t need in underperforming markets. We have 250 stores that are coming up for lease renewal in the next 3 years, and that is a lot to look at. We’re looking for the best outcome and we imagine this will continue to provide us with occupancy leverage.

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Operator [49]

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And that concludes our question-and-answer session. I’d like to turn the call back over to management for any additional or closing remarks.

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Laura J. Alber, Williams-Sonoma, Inc. – CEO, President & Director [50]

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Well, thank you so much for joining us. I hope you’re all going to watch the game tonight. And I look forward to talking to you again next quarter.

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Operator [51]

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Ladies and gentlemen, that does conclude today’s conference. Thank you for your participation. You may now disconnect.