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Williams-Sonoma, Inc. (NYSE:WSM)

Q1 2014 Results Earnings Conference Call

May 21, 2014 05:00 PM ET

Executives

Gabrielle Rabinovitch - VP of Investor Relations

Laura Alber - President and CEO

Julie Whalen - Chief Financial Officer

Pat Connolly - Chief Marketing Officer

Analysts

Kate McShane - Citi

Matthew Fassler - Goldman Sachs

John Marrin - Jefferies

Chris Horvers - JPMorgan

Daniel Hofkin - William Blair & Company

Matt Nemer - Wells Fargo Securities

Michael Lasser - UBS Investment Bank

Peter Benedict - Robert W. Baird

Matt McGinley - ISI Group

Brian Nagel - Oppenheimer

Laura Champine - Canaccord

Neely Tamminga - Piper Jaffray

Anthony Chukumba - BB&T Capital Markets

Operator

Welcome to the Williams-Sonoma, Incorporated First Quarter 2014 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 Gabrielle Rabinovitch, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Gabrielle Rabinovitch

Thank you, Dora. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Our earnings press release and this call 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 conditions, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2014 and beyond, and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements.

Please refer to the company's current press releases and SEC filings, including the most recent 10-K 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 first quarter fiscal 2014 results.

Laura Alber

Thanks, Gabrielle. Welcome everyone and thank you for joining us this afternoon. On the call with me today are Julie Whalen, our Chief Financial Officer; and Pat Connolly, our Chief Marketing Officer. I am excited to discuss with you our strong performance.

In the first quarter we delivered record net revenues of $974 million with comparable brand revenue growth of 10% driven by broad based strength across each of our brands. This resulted in a 17% increase in operating income and a 20% increase in diluted earnings per share. This double-digit revenue increase was accompanied by solid operating profitability.

Innovative high quality products, personalized service, relevant marketing and strong execution across all brands drove these better than expected results. With 50% of our revenue in the direct channel this quarter we believe our multi-brand multi-channel platform is driving consistent market share gains and providing us with a competitive advantage.

We are pleased that we are able to deliver these strong earnings against a challenging backdrop. The term multi-channel has become ubiquitous. We feel that our model is different and this difference is what is driving our performance.

I thought it would be worth discussing these differences as we see them including the following attribute. First is scale, our direct business is 50% of total revenue. This gives us significant flexibility and leverage in our marketing spend. Second, we have more than three decades of experience in leveraging synergies between the channels. We know that our digital spend drives customers to our stores. We also know that retail is a major source of new customers and that many of them become direct customers as well. Third, we have the catalog which is an important component of our model; nothing can match the productivity of an inspiring catalog delivered to the right customer. Fourth, advanced marketing techniques applied to a very large and well developed house file. This invaluable asset allows us to market relevantly and efficiently across all three channels and across all of our brands. And fifth is lifestyle merchandising. We learned a long time ago that the best way to sell home furnishing is to show them in a home, a home that our customer aspires to live in. We have perfected this technique over decades.

Our first quarter results demonstrate how the investments we began making years ago to establish our best in class multichannel model are paying off. We are deepening connections with our customers, we are bringing innovations to the market in each of our brands through our products and service offerings, increasing our relevance in every market in which we operate, and we are further distinguishing our brands from the competition. We are also making progress against the initiatives we recently outlined for you in March.

Our global expansion continues. Customer demanded is building in both Australia and UK as brand awareness grows. We are focused on optimizing our inventory position to reflect local taste and seasonality in these markets and we are looking forward to expanding the reach of our global business initiative.

We continue to make improvements to our websites in Australia and we are planning to fill out our Australian footprint with eight new stores this year. We believe this additional scale will drive brand awareness and help us leverage our in country infrastructure.

In the United Kingdom, we'll be expanding our reach. We are looking for additional retail locations for West Elm and plan to launch Pottery Barn and Pottery Barn Kids fully integrated websites later this year.

In the Middle East our business is growing and we are particularly excited about the strong customer response to West Elm. In addition, our franchise partner in the Philippines anticipates opening a Pottery Barn and Pottery Barn Kids store this summer, our first franchise location outside of the Middle East.

We're also seeing progress in our new businesses. Mark and Graham is growing quickly and acquiring new customers, with an expanded spring assortment and deeper catalog mailing.

In Rejuvenation, we recently launched a collection of kitchen LED lighting. Rejuvenation is blended past and present reproducing classic fixtures including designs that are more than 100 years old, while using the latest LED technology to maximize energy efficiency. We're also seeing strong response to Rejuvenation's new bath collection. Approximately a 1,000 new SKUs in bath hardware, lighting and furniture have been introduced and we have seen a pickup in demand across the channel.

We know that our supply chain is key to superior customer service and we continue to invest in ours. Our Dallas distribution center went live earlier this month. We will incur some additional expense in this quarter, bringing this DC online and implementing the supporting technology. However, in addition to reducing transportation cost over time, we expect the cycle times for home furniture deliveries in essential region as well as nationally to materially improve.

And on the e-commerce front, we continue to make investments. We launched enhanced capabilities on our site relating to search and personalization to improve the user experience. We have also transitioned to rolling out new releases to our site every four weeks instead of every six weeks. Agile release cycles allow us to continuously deliver improved site functionality and stay ahead.

In e-marketing we have encovered some breakthrough programs to increase new customer acquisition. We will continue to build on these opportunities that we believe will set us step to the back half. We also will implement several important IT project this quarter to strengthen our infrastructure and prepare us for peak season.

In summary, we are investing in an executing against all of our growth strategies while simultaneously improving our profitability and returning capital to our stockholders. As we look ahead, we're excited as many opportunities that we see, our brands are distinctively positioned in the housewares furniture home furnishings market.

I would now like to share a few key developments in each of our brands. I'd like to begin with Williams-Sonoma. We're extremely pleased with our comp brand revenue increase of 6% on top of an increase of 1.9% in 2013. Comparable brand strength resulted from innovative product offerings, improved executions, strong cross-channel marketing and improved field training and development. This strong performance was delivered despite the continued promotional marketplace. We believe, our strategies on innovative and exclusive product and our focus on delivering the best service are working.

In the first quarter, we saw a strong performance across key categories including electrics, cookware and cutlery. We also saw a great response to our Easter collection and our Williams-Sonoma Home business also exceeded expectations. We believe Williams-Sonoma Home is establishing a unique market position offering customers a truly differentiated high quality global shake style. All of these growth categories led to new customer acquisition trends that are very strong. And we believe we have a great product line up to the second quarter as we welcome the summer entertaining and cooking seasons we are celebrating grilling and outdoor living. We are focused on delivering inspirational summer marketing coupled with continuing new customer acquisition strategies that we believe position us well for continued growth.

I would now like to update you on Pottery Barn, our largest brand. In the first quarter Pottery Barn comparable brand revenues increased 9.7% on top of the increase of 7.6% in 2013. From inspiration to installation Pottery Barn helps with customers make their dream home a reality. We are passionate about making [decorative accessories] accessible and affordable. Performance in the first quarter was driven by our furniture categories as well as improved in stock positions. We continue to expand our best selling furniture collection to include smaller and larger sizes as well as additional finishes. And our extended range of bath consoles and bath furniture with customizable options is capitalizing on the renovation and remodeling trends in the market.

In conjunction with Earth Day we launched an online eco-shop that gathers environmentally and socially responsible products in one play. Increasingly we are using organic cotton in our textiles recycled and reclaimed materials as well as wood certified by the Forest Stewardship Council.

As we entered the second quarter we’re getting ready for summer living and entertaining and we have expanded our outdoor furniture entertaining collections. We will also introduce our early fall assortment. We are focused on providing our customers both personalized and relevant experience across all channels.

Next, Pottery Barn Kids. In the first quarter Pottery Barn Kids comparable brand revenues increased 8.1% on top of an increase of 6.9%. Pottery Barn Kids believe that creating personal, inspirational and functional spaces for kids should be easy and fun. The brand brings quality, safety, comfort and style into every family’s home. Strength in our furniture, nursery and seasonal businesses contributed to first quarter results. The customer response to our new furniture collections as well as our core programs is strong. And we will be launching a robust schedule of new furniture collections throughout the balance of the year.

In nursery our extended offerings coupled with personalized marketing are driving this business. In PB Kids our customers love to celebrate the holidays and while Easter came later this year it was a success. And in the first quarter we also introduced our new beach and outdoor service.

As we transition to our summer season we’re excited about the new statics we are featuring in our furniture collections. And beautiful new prints and fresh color palette and our textile furnace and the launch of our high quality back to school collection.

Moving PBTeen. Comparable brand revenues increased 12% in PBTeen in the first quarter on top of an increase of 16.1% in 2013. PBTeen brings quality and value to teens bedrooms, study areas and lounge spaces. First quarter strengthened furniture and textiles was driven by strong demand and improved in-stock positions. PBTeen has broaden its appeal by featuring a wider range of influences and designs, PBTeen is focused on furnishing the whole room, extending the depth and breadth of its assortment our new blog Stylehouse helps teens gather fresh ideas for their space their style and their life.

In the coming weeks, we expect to launch our collaboration with Zio Ziegler an internationally recognized artist known for his oversized murals and bold graphic lines. The Zio Ziegler for PBTeen exclusive collection designed by Zio makes the best of his signature style and reimagines it and (inaudible) backpacks and more. So teen can bring his larger than life, free style (inaudible).

Our new PB Dorm collection which builds on last year’s success launched earlier this month. In addition graduate giving is an opportunity this quarter and we have further developed the gift category. We are also excited by the new collaborations we will be introducing in the brands throughout the second quarter.

Finally, I would like to discuss West Elm. The West Elm brand continues to post outstanding results, comparable brand revenues increased 18.8% on top of 11.8% last year, of two year comp of over 30. Growth continue to be broad based across categories with success in furniture, textiles, decorative accessories in lighting. In the first quarter, we saw a strong response to our color palette and to our core and seasonal assortment across all channels.

In the second quarter, we are excited to launch our new opening price point assortments. This special collection is designed in a modern wintrical and useful style that stands alone on mix as well with the core West Elm assortment offering our customers high design at compelling value prices and attracting new customers. While this modern static can live in any type of home we have also designed a number of pieces for smallest spaces that will appeal to our urban apartment volume customers.

The collection includes a wide array of setting wrecks and pillow as well as upholstered and bedroom furniture. This new assortment will be available through our catalogs and our websites as well as in direct retail stores and will be supported with an impactful marketing campaign.

With a focus on consciousness and everything the brand does, West Elm continues to differentiate itself from its competitors through commitments to handcrafted and local products, supply chain transparency and sustainability.

West Elm is on plan to exceed its 2013 Clinton Global Initiative commitment to action with more than 35 million invested in handcrafted and artisan products. The brand is now working with more than 30 artisan groups in 16 countries to bring unique products to its customers including sourcing partnership in emerging markets such as Central and South America.

In an effort to improve the lives of artisan, they are doing business with, West Elm recently launched an adult literacy program steady in partnership with the Clinton Foundation.

West Elm is also focused on supporting artists, makers and the growing micro entrepreneur economy in the United States through West Elm local, the initiative that will bring regional assortments to more than half of West Elm stores in 2014 giving stores a stronger sense of place in connection to their community. West Elm local brings in to the ties that have artisan [build] through in-store events and partnerships.

West Elm will continue to offer choice in our products and services that will help customers express their own individual style and create a home that will connect with their story. We will build community through connection with likeminded strangers, our crafters, collaborators, customers and associates and promote consciousness in everything we do.

The successful combination of these three factors we believe is differentiating West Elm from its competition. And based on the West Elm's current growth trend and early acceptance of the brand in global markets, we remain confident in this brand’s ability to be 1 billion plus business.

In summary, our strong results this quarter reflect our multiple engines of growth supported by distinctive products presented across our portfolio of brands, a superior multi-channel platform with analytic marketing to capture the synergies and the advantages of each channel and a sophisticated supply chain engineer to address the complexity of our merchandise category. We are confident in our ability to meet our fiscal 2014 and longer term growth target.

I will now turn the call over to Julie to review our financial results in detail.

Julie Whalen

Thank you, Laura, and good afternoon, everyone. We are very pleased with our strong start to 2014. For the first quarter, net revenues increased 9.7% to $974 million with comparable brand revenues increasing 10% on top of 7.2% in Q1 2013. All of our brands experienced strong year-over-year growth in comparable brand revenue with Williams-Sonoma up 6%, Pottery Barn up 9.7%, Pottery Barn Kids up 8.1%, Pottery Barn Teen up 12% and West Elm up 18.8%.

Net revenues in our direct-to-customer channel, grew 17.2% including e-commerce growth of almost 20%. Our direct to customer channel generated 50.4% of total company net revenues for the quarter, crossing the 50% threshold for the first time in the company's history, a 320 basis point increase over last year.

Our retail channel revenues also increased 3.1% to $483 million with West Elm and Pottery Barn, the most significant contributors to the growth. Gross margin for the first quarter was 37.8% versus 37.6% last year. This 20 basis point increase resulted primarily from higher selling margins as occupancy costs in the first quarter of 2014 as a rate were essentially flat at 15% of net revenues or $146 million in comparison to 15% of net revenues or a $133 million in the first quarter of 2013.

On a GAAP basis, SG&A in the first quarter improved 30 basis points to 30.2% versus 30.5% in 2013. On a non-GAAP basis excluding the 40 basis point impact in 2013, SG&A increased 10 basis points to 30.2% versus 30.1% in 2013, primarily driven by higher employment cost related to divesting of long-term incentive compensation, partially offset by advertising leverage.

GAAP operating income in the first quarter increased 16.5% to $74 million, resulting in an operating margin of 7.6% compared to 7.2% last year. On a non-GAAP basis last year’s operating margin was 7.5%. The improvement in non-GAAP operating margin was driven by a 180 basis point increase in the direct-to-customer channel operating margin from 22.9% last year to 24.7% this year and was partially offset by a 100 basis point decrease in the retail channel to 6.3% as well as an 80 basis point increase as a percentage of net revenues in corporate unallocated expenses.

The improvement in the direct-to-customer channel operating margin was primarily driven by greater advertising leverage and the leverage of employment cost partially offset by lower selling margins. The decrease in the retail channel operating margin was primarily due to the deleverage of occupancy and employment cost and was partially offset by improved selling margins. This retail operating margin also includes the impact of our investments in our global business.

On a non-GAAP basis, corporate unallocated expenses as a percentage of net revenues increased 80 basis points to 7.9% primarily due to increased employment cost related to divesting of long-term incentive compensation. As a result, first quarter 2014 GAAP diluted earnings per share grew 20% to $0.48 from $0.40 last year. And on a non-GAAP basis, diluted earnings per share grew 17.1%.

Overall, we are very pleased with the strength in the top-line and our ability to grow operating income and earnings per share while absorbing the financial impact of our future growth initiatives.

Moving to the balance sheet, cash at the end of the quarter was $113 million versus $253 million last year. Over the past year while generating $443 million in operating cash flow, we returned $374 million to stockholders through share repurchases and dividends including $86 million in cash to our stockholders this quarter alone through $53 million in share repurchases and $33 million in dividend.

Merchandise inventories were $850 million at the end of the first quarter. Excluding the impact of additional inventory and transit due to taking ownership of our inventory earlier in the supply chain, merchandise inventories increased 17.2% on a comparable basis. This increase in inventory was predominantly to support our fastest growing brands and global growth initiatives.

I would now like to discuss our Q2 and fiscal year 2014 guidance. We are confident in our strategies and look forward to delivering another record year for our stockholders. For the second quarter of 2014 we expect to grow net revenues to a range of 1.020 billion and 1.040 billion with comparable brand revenue growth in the range of 4% to 6%.

We expect our second quarter operating margin to be in line with last year. We are guiding diluted earnings per share to be in the range of $0.49 to $0.52. Our guidance includes the impact of a number of investments we are making to position up for the back half of the year as for our future growth. For the full year as a result of our performance in the first quarter and our outlook for the remainder of the year, we are raising our guidance range.

We now expect to grow net revenues to a range of $4.645 billion to $4.725 billion with comparable brand revenue growth in the range of 5% to 7%. And we now expect fiscal 2014 diluted earnings per share to be in the range of $3.07 to $3.17. From a cash allocation perspective there are no changes to our plans. We plan to make capital investments in the range of $200 million to $220 million as we continue to invest in our strategic growth initiatives.

We also plan to continue to return capital to our stockholders by paying dividends and repurchasing shares under our existing share repurchase authorization. Given the strength of our brands and our superior e-commerce capabilities combined with our long term growth initiative a commitment to financial discipline and a commitment to returning capital to our stockholders we remained confident in our ability to deliver sustainable long term profitable growth.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we will go first to Kate McShane with Citi.

Kate McShane - Citi

Thanks, good afternoon and congratulations.

Laura Alber

Thanks Kate.

Kate McShane - Citi

Julie, I know you don’t give guidance around gross margins, but I can’t help but get a little excited about what we saw in Q1. So I was wondering if you could help us understand how you are viewing gross margins for the year. And if you could maybe give a little bit more detail on how the promotional environment shaped up in Q1 and what you expect for the rest of the year?

Julie Whalen

Sure. We're actually really excited about the gross margin, to your point it's been a little while since we’ve seen the gross margins are up and really the reason is solely due to higher selling margins, as we mentioned occupancy is essentially flat year-over-year.

And so what we're seeing, I think what's important for everyone to hear is that the true, the pure sort of MMU product margin is what is up and it's across both channels and across many of the brands. So we think that's a really good sign. There are various factors for that one of which we believe is our supply chain initiative that we're focused on, we've been talking about for a while such as the in-sourcing of our foreign agent and the regionalization of our distribution centers as well as the manufacturing of our own upholstered goods, all of that is starting to slowly but surely come to fruition within the margins.

We think that is a great opportunity to see those margins continue to rise. However with the continued promotional environment and especially during Q2 for example with the summer sale and an increase in occupancy costs including depreciation from our ongoing capital investments in the business, there is going to be continued pressure on the gross margin.

But as we always like to tell you guys, we have to remember that with the 50-50 business, 50 e-commerce and 50 retail that we tend to manage to the operating margin line, because we have different levers that we can pull throughout P&L. But we're really happy with our results on the gross margin line. And then promotional environment Laura, would you want to take the call?

Laura Alber

Sure, yes. We continue to see that the market is promotional which is why we're working so hard as Julie said to take costs out of our supply chain and to develop inspiring and appealing products for our customer. We think one of the reasons we continue to win is that we have exclusive and innovative products. And we also have aesthetic diversification across all of our brands which allows our customers to develop their own unique individual style, but also gives them confidence to come back. It is a tremendous advantage, because if you think about it, a customer’s previous purchase really weighs heavily on their future purchases. And this further isolates us from competitors we believe that are using heavier promotions. You are simply not going to buy something for your house that doesn't go with the rest of it just because it’s cheaper.

Kate McShane - Citi

Thank you.

Operator

And we'll go next to Matthew Fassler from Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot, good afternoon. I hate to use my one question and what might be kind of been out topic. But if you could sort of talk a little bit more Julie to the investments that both you and Laura cited, talk about their cadence as they worked their way through the year only because in the context of the numbers you just put up and it is your comparison, the guidance for second quarter margin seems a bit on the conservative side, I'm sure you have some drivers there, any color would be great?

Julie Whalen

Sure. We're really excited that we're seeing opportunities particularly in e-commerce that we're going to build on. The customer trends are strong and it is driven by our marketing strategies and through testing over the past few quarters, we've uncovered several breakthrough developments. And so this Q2 earnings guidance reflects the fact that we see opportunities to invest more in the second quarter in these initiatives which will set us up for the back half. Also in Q2, we're investing in our supply chain with our new Dallas distribution center as well as the IP infrastructure to support the supply chain and we're putting several major IT projects into service in Q2 and of course we always have our continuing investments in global. I think the disconnect is obviously, we didn't guide Q2, those have always been our numbers for Q2 and so it’s just a delta between what you're seeing but that has always been an investment in Q2 and the reality is when you look to the year we actually raise the year and added two pennies on the year which is exactly in line with our three year outlook.

Matthew Fassler - Goldman Sachs

Great, thank you so much.

Operator

And we’ll go next to John Marrin with Jefferies.

John Marrin - Jefferies

Hey guys, congrats on a great quarter.

Pat Connolly

Thank you, John.

Laura Alber

Hey, John, thanks.

John Marrin - Jefferies

So first I’d like to hear about how sales trends worked through the quarter and maybe a comment on current sales trends if you can. And also just what you’re looking at over the reminder of the year relative to what you were seeing a few months ago?

Julie Whalen

Yes. We don’t provide the cadence of our sales trends throughout the quarter. Obviously at the end of the day Q1 was a strong quarter and we mentioned that Easter was strong for us. And we’re only three weeks into this quarter so it’s really too early to call the card on that.

John Marrin - Jefferies

Okay. And just this incredible performance to direct, I understand that you just instituted some changes there that probably drove performance, just wondering if maybe you can talk about how that looked across the brand portfolio? And what the growth outlook is for the rest of the year? Thanks.

Pat Connolly

So John, I think if you know me, you know that I’d love to get under the hood and tell you exactly what we’re doing in terms of these breakthroughs in e-marketing, but clearly it’s very competitive for us. And e-commerce is so foundational to our ongoing success and our ability to harness the information we have and utilize it effectively, it’s just core to the way we do business.

These capabilities which we’re most excited about relate to our e-mail and our e-marketing programs and they span a number of areas including technology, new ways to utilize our data, our processes and the way we manage our programs. And these build over time, but remember we’re starting from a base of over 2 billion in ecommerce.

That said we laid out our plan in March and this has been in our plan, we’re very excited about what we see coming down the road here.

John Marrin - Jefferies

Thanks guys.

Operator

(Operator Instructions). We will go next to Chris Horvers with JP Morgan.

Chris Horvers - JPMorgan

Thanks and good evening. I also want to follow up on the 2Q guide, obviously a fantastic quarter against the fantastic fourth quarter and really differentiated versus what’s going on in so much of retail at this point. So your comparison on the brand comps not really harder but your maybe 100 basis points that you are guiding to a pretty sharp deceleration, so would love to get your thoughts on that.

Julie Whalen

Yes, I mean the reality is we are off to a great start but it’s still early in the year and one quarter doesn’t really give us enough certainty about the trend for the rest of the year. And you have to remember in particular with the revenue. We are up against tough compares in Q2 with an 8.4% comp last year. And so and obviously we just mentioned the investments from an earnings perspective again those were in our numbers, so obviously you guys didn’t have visibility to that. But I think with all that said, the fact that we raised guidance on the full year and that is exactly in line with our three year outlook, we’re feeling very good about this guidance.

Chris Horvers - JPMorgan

Okay. And then on the inventory growth is also going back to let’s say 4Q ‘12, it started to pick up, a lot of that seem to be on the global growth side. But you mentioned for a couple of the brands that in stocks have improved and they’ve contributed to sales. So is there a way to think about how much of that inventory growth has contributed to sales or how much of that relates to domestic? And how do you think about inventory growth through the balance for the year? Thanks.

Julie Whalen

Sure, yes we are really excited about the inventory levels given the fact that it certainly has been one of the main drivers for driving the outperformance that we have seen obviously, everything else factored into that as well. You have to have the right product, the right marketing and all of that. But the reality is having an in stock position has been strategic for us. And I think everyone needs to know that even though the inventory levels seems high, they are in the brands that are fueling our growth, so it’s in Pottery Barn, it’s West Elm with a 10 and 19 comp in just this quarter alone.

And we do have that additional inventory that you mentioned comping, but the reality is for global for example, we are adding eight new stores this year, so we have to build inventory for those that aren’t comparable. So there is lot of things, the new businesses brand extensions that are growing, you’ve got more inventory this year than you had as a base last year. So it sort of looks huge from a growth perspective but all investments in good things.

So we think this inventory levels is somewhat sustainable for period of time. We think it’s strategic. With that said we obviously see opportunity to reduce slow movers. We have very strong disciplines across company; we’re always focused on slow movers and also getting back in stock. So, we are aggressively going after the slow movers, while at the same time aggressively going after the best sellers. As you know, there is a [delta] relationship between service levels and inventory and all this inventories are supporting 2014 guidance, so we think it’s very strategic.

Operator

And our next question comes from Gary Balter with Credit Suisse.

Unidentified Analyst

This is actually Andrew on for Gary. Congrats on very strong Q1. Got a quick question on Williams-Sonoma. We are just wondering if you could delve into little more details on what is happening at the brand, is it all internally driven or do you think it’s just you are seeing smart industry tailwind? And then finally where do you think ceiling is on, on this improvement? For example, do you think you could outcomp the core business in the second half, easy compare?

Laura Alber

Thank you for the questions. We have been talking about our strategies in the Williams-Sonoma brand for some time, and we have been working very hard to bring back more exclusive products and also to improve our execution and to have more relevancy to the customers. And we have made some nice progress. We still have a lot more work to do, but we are happy with the consumer response, clearly a 6 comp is strong number.

And we have a lot of new products in the pipeline for the second quarter that builds on what we're seeing, I know if you've been in lately, but we have a great collaboration with [Tacolicious] right now. It's really innovative and uses market fresh sustainable ingredients in every products. And together we’ve developed sauces and braising basis that are inspired by world class restaurants in Mexico City. So, it's an example of new products that something I'm excited about.

And we're also seeing that some of our new categories like Open Kitchen are bringing new customers to the brand. And new customer growth is an exciting trend and integral to the long term health of the brand. And so it really has been another piece of what we’re doing is to bring accessible price points back in. And lastly, the work we've done to give our great field teams better tools and training to support these great product launches is paying off.

So, I guess I’d summarize by saying teams have been working very hard to get where we are and we still have a lot more opportunity ahead of us.

Operator

And we'll go next to Daniel Hofkin with William Blair & Company.

Daniel Hofkin - William Blair & Company

Hi, good afternoon. I apologize if this issue was addressed. I just wanted to get a little bit more color on what you feel at the Williams-Sonoma brand itself? What are the main things that are contributing to kind of a firming of trends in that business, is it more on the merchandise side or is it highlighting some of the -- what you feel or differentiated services like cooking classes? If you could just shed some additional light on that in particular, I would appreciate it. Thank you.

Laura Alber

Daniel, I can't resist, I just answered that question, but I'm happy to do it again because I'm so excited about it. We have really been focused on our innovative product pipeline and we brought in some key lines that are working well and we're building on them. We are focused on execution at the retail level and really we've given our great field team better tools and better training, which is really helping them to service our customers more effectively than we have before. We have better in stock position than we have before and we're really focused on relevant food trends. So we're not just selling the tool, but we're starting the whole idea. And if you go into stores, you’ll see us doing more tastings and more events to really provide that education to our customers.

Operator

And your next question comes from Matt Nemer with Wells Fargo Securities.

Matt Nemer - Wells Fargo Securities

I've got a question on the merchandising side. You all have introduced a number of design collaborations with outside brands like Bert and FC and others. And I’m just wondering what are broader aspirations for that in some of the brands that we haven't seen that in yet? Is that something that could expand significantly from here?

Laura Alber

Yes, thank you. We are always looking for great designs and incredibly talented artists and designers out there and we love working with them to bring new things to market. And these collaborations have really extended the esthetic diversification in each brand. And I can't wait for you to see what we've done with Ziegler this upcoming I think is just a great example of what can be done together and it really also inspires our teams here to see a new way to approach the home product.

Matt Nemer - Wells Fargo Securities

If I could just sneak in one more with is any early thought that FedEx going to dim weight shipping, if we see some general shipping inflation how do you think that could impact your business? Thanks so much.

Laura Alber

A great deal of our products that we ship would not be impacted as we have a lot of heavy weight product the reality is the UPS has not followed suit with FedEx at this point. We have long-term agreement in place with the UPS. So we don’t expect it to impact us.

Operator

And we’ll go next to Michael Lasser with UBS Investment Bank.

Michael Lasser- UBS Investment Bank

All right Good afternoon. Thanks a lot for taking my question. Two quick ones. Number one can you discuss the connection between Williams-Sonoma’s performance and the company’s overall profitability. It seems like this is the best for income from that segment in quite some time and it maybe was coincidental that the overall entity also had -- it’s really stellar profitability performance but it seems like perhaps there is some connection there.

And then the second quick question is on the level of in-stock, perhaps you can give us some sense of where in-stock levels are now versus where they were a year ago and where do you see that just leveling out over time? Thank you so much, I appreciate it.

Laura Alber

Sure, it’s Laura. The Williams-Sonoma brand represents about 25% of our total business. Q1 is not a big quarter for Williams-Sonoma and we’re thrilled with the trends we’re seeing but really it would impact profitability much more in the latter half of the year. As it relates to in-stocks we haven’t given our fill rate but I will tell you that they’re materially higher than they were last year and not only does that drive better customer satisfaction, also reduces our cost if we can ship it once versus shipping a back order. Julie do you want to add anything to what I said about Williams-Sonoma.

Julie Whalen

Yes. I mean other than I would say that we did see a lot of whether it’s Williams-Sonoma or not the total company outperformance did drop down to the bottom line if that’s we are headed with our question obviously we had guided from an operating margin perspective to be below last year and we came in above last year with 17% income growth and 4% above the high end of our guidance from an EPS perspective and that’s while absorbing all of our investments and also some incremental spend for Q1 related to investing of some long-term expense competition. We feel really great about how much of the earnings drops to the bottom.

Operator

And our next question comes from Peter Benedict with Robert W. Baird.

Peter Benedict - Robert W. Baird

Hi guys.

Laura Alber

Hi Peter.

Peter Benedict - Robert W. Baird

I have got a question unrelated but I will sneak it in. First is Williams-Sonoma Home big enough to have any impact on what you just did in Williams-Sonoma in [total with] CBR, just trying to understand if that brand is starting to show up in the broader numbers? And then secondly just on the rent and occupancy trends, looks like they accelerated here in the first quarter, is that (inaudible) with the Dallas CC or is there something else that we should be thinking about as we try to model that out forward? Thank you.

Julie Whalen

Sure, yes Williams-Sonoma Home is obviously a part of the Williams-Sonoma brand in total, but it does have a piece of obviously the growth on it, but it’s still so small but it’s not meaningful relative to the total six comps that we saw in the Williams-Sonoma brand. So I wouldn’t read too much into that.

From an occupancy perspective there is we’ve got investments that we are making from a capital perspective, but as those continued last couple of years we’ve had sort of stepped up capital investments and those layer on top of each other from a depreciation perspective and that rolls into occupancy. So that’s a lot of the reason you are seeing higher occupancy but you do see it obviously of course due to rent from the Dallas distribution center as one key player of that, but it’s also all of our store leases and all of that put together. But I would say the biggest piece is from the continue investments in our business.

Julie Whalen

I’d like to share one more thing on Williams-Sonoma Home. While it is not material now, we have set some very ambitious goals for ourselves and we believe that this could be a very large brand in the future.

Operator

And our next question comes from Matt McGinley with ISI Group.

Matt McGinley - ISI Group

Thanks, my question is on the unallocated expense and how that trended in the quarter. Last year you had a lot of investment in talent and I think it was higher into some extent this year. You caught out longer term comp, on long term comp vesting is being increased. Is that $12 million step up you experienced in the quarter, is that kind of the new run rate or is it that just kind of one-off thing where it would be that high?

And my second question is on the international revenues or the franchise revenues, what drove that decrease in revenues?

Laura Alber

Okay, sure. Julie, I will take that. From the corporate operating margin perspective that is something that is relatively unusual. As we said in our prepared remarks that we basically deleverage 80 basis points, and it’s primarily due to the vesting of long term incentive compensation. And really what that is, is that we incurred some additional compensation expense and investing in [four] equity awards from lower employee departures and higher payroll taxes on the compensation amount associated with those equities that’s vesting due to higher stock price. So that is -- we had large four year cliff that came in that was granted back in 2010 and hit this quarter, and so it had sort of a disproportionate impact given this is our smallest quarter of the year.

So I would not assume that trend going forward at all. From an international franchise perspective, I’m assuming that’s what you’re alluding to. Basically I wouldn’t read much into that either. Last year the franchise partners somewhat accelerated more of their purchases into Q1 which they had then evened out throughout the rest of the year, so it’s more of a year-over-year timing that makes it not comparable for this quarter. We actually have plans to open four more stores with our franchise partner and our relationship is very strong.

Operator

And we'll go next to Brian Nagel with Oppenheimer.

Brian Nagel - Oppenheimer

Hi, good afternoon.

Laura Alber

Hi.

Brian Nagel - Oppenheimer

Congratulations on a nice quarter.

Laura Alber

Thank you.

Julie Whalen

Thank you.

Brian Nagel - Oppenheimer

So I want to ask a question on gross margins as well, maybe more from a bigger picture [first half] standpoint. But we saw for the first time in a while a positive gross margin. I think in response to some of other questions you talked about some of the dynamics, but the question I have is just given kind of the focus the company which has been driving market share, to the extent that now some of your investments are paying off and helping to drive margins, if you look at the margin going forward, would you be more inclined to reinvest that to drive more market share or we should expect that as investments continue pay off, margins will have to stay higher?

Laura Alber

It's really nice to have the flexibility as you can imagine. And what we're doing is really working hard to be very efficient. We have a culture of high performance and continuous improvement. And we believe we still have some things we can do to take more cost out of the product lifecycle. And that will give us the opportunity, if we want to invest more or if the market demands it to be more promotional.

So, it's hard to predict, but what I want to talk about again is the power of our operating models that allows us to be flexible, which I think is key in this retail environment.

Operator

And we'll now go next to Aram Rubinson with Wolfe Research.

Unidentified Analyst

This is actually Carol in for Aram. You guys just have enormous amount of data on all of your customers that you've used quite well to extend your brand across customer segments. Have you guys considered any category extensions beyond kind of the furnishing realm?

Laura Alber

We are very focused on the home and its area of expertise. With that said, our Mark and Graham business has introduced us to some new categories and we have in that business a disproportionate amount of accessories and jewelry, very well so I said under the heading of gift and monogram personalized gifts. So that has been our first [story] into anything other than home and we're very pleased with the early results and how it complements what we do in the home.

Operator

And we'll go next to Laura Champine from Canaccord.

Laura Champine - Canaccord

Good afternoon. My question Julie is for you. So with the full year guidance not raised as much as you beat by on sales and earnings in Q1. Does that indicate a shift and timing of store launches or any shift in your investments internationally or is there anything more than just kind of targeting your three year plan in that guidance?

Julie Whale

No, I wouldn't read anything more into that. It’s really that we're just -- it's early in the year. And you know we had a great Q1, but that doesn't necessarily assume that we're going to have that kind of outperformance every single quarter. So we’re going to continue our trends and we'll adjust as necessary. But with that said, we did raise 15 million on the top in revenue and $0.02 on the bottom and that's put up right we want to be with our three year outlook.

Operator

And from Piper Jaffray, we'll go next to Neely Tamminga.

Neely Tamminga - Piper Jaffray

Great, good afternoon. Fantastic to have guys.

Laura Alber

Thank you.

Neely Tamminga - Piper Jaffray

I just, I wanted to drill a little bit on West Elm. I appreciate the focus on Williams-Sonoma, but it is potentially going to be $1 billion dollar business up here at West Elm too. Could you remind Laura in terms of how you’re thinking about the $1 billion market? Is it just kind of the U.S. North America or is that kind of your whole global vision? Do you think you it’s just kind of still tasting the waters globally? And then the other kind of more strategic question I have is it just seems like West Elm can really do no wrong right now. And so the question is what can’t they do and I am just wondering at what point do you guys just revaluate the footprint around what you can offer [explorers] in store especially looking at community? You did really good job for social media community, to be expanded into in-store community.

Laura Alber

Thank you for the question. We have used the $1 billion mark to represent both domestic and global but there you could make a case will that that’s maybe modest at this point given how large our Pottery Barn brand and the appeal of West Elm and in particular globally. So, we are, trust me, as I said earlier, we have very big plans for this brand and we are testing so many things and learning from them. And we are careful to open the right amount of stores and to keep measuring the ROI of our store investments and we are also very focused on building our direct business to West Elm that is growing very quickly. We’re trying some, really some new marketing techniques in West Elm that we’ve learned a lot from and are now rolling to other brands. And we are continuing to push the diversification of products and to work hard to make sure that as we get bigger, it stays very relevant to the customer and it differs as you can imagine from Miami to Denver and how they would expect to see they’re West Elm.

So we’re being very careful as we grow to stay very relevant and personalized in our expressions.

Operator

And we have time for one last question, we’ll go to Anthony Chukumba with BB&T Capital Markets.

Anthony Chukumba - BB&T Capital Markets

Thank you. And let me also add my congratulations on a great quarter. So, I just -- just a real quick question, I mean you touched on the franchisees internationally and sort of what drove the revenue decline there. But I guess I was just wondering if you could give us a little bit of color, maybe didn’t move the needle.

Laura Alber

I am sorry, did we lose you? Anthony we have lost you. I am sorry Anthony; we think we have lost you. So we can’t hear you, bad connection so we are going to move to one final question from someone else.

Operator

And certainly there are no questions remaining in the queue. That does conclude the Q&A session for today. Ms. Alber, I will turn the call back to you.

Laura Alber

Well thank you all for joining us. We really appreciate your support and we look forward to talking to you again next quarter.

Operator

Thank you. That does conclude our conference call for today. We thank you for your participation. You may now disconnect.

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Source: Williams-Sonoma's (WSM) CEO Laura Alber on Q1 2014 Results - Earnings Call Transcript
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