Good day, ladies and gentlemen, and welcome to the Williams-Sonoma, Inc. Q2 2022 Conference Call. Today's call is being recorded. I would now like to turn the call over to Jeremy Brooks, Chief Accounting Officer and Head of Investor Relations. Please go ahead.

Good afternoon, and thank you for joining our second quarter earnings call. I'd like to remind you that during this call, we will make forward-looking statements with respect to future events and financial performance, including guidance for fiscal '22 and our long-term outlook. Although we believe these statements reflect our best estimate and all available information, we cannot make any assurances that these statements will materialize, and actual results may differ significantly from our expectations. The company undertakes no obligation to publicly update or revise any of these statements to reflect events or circumstances that may arise after today's call. Additionally, we will refer to certain non-GAAP financial measures. Those measures should not be considered replacements for and should be read together with our GAAP results. A reconciliation of non-GAAP measures to the most directly comparable GAAP measure, along with an explanation of how and why we use those measures, appears in Exhibit 1 to the press release we issued earlier today. This call should also be considered in conjunction with our periodic and annual filings with the SEC. The call is being recorded, and a replay will be available on our Investor Relations website. Now I'd like to turn the call over to Laura Alber, our President and Chief Executive Officer.

Thanks, Jeremy. Good afternoon, everyone. I'm excited to share our second quarter earnings today. Q2 marked another quarter of strong performance, delivering an 11.3% comp on the top line and earnings growth of over 19% to $3.87 per share. These impressive results reflect the strength of our multi-brand portfolio, the success of our growth initiatives, and the ongoing execution of the team. We continue to demonstrate our ability to perform by offering high-quality, differentiated, and sustainable products that our customers know and love. Our performance was driven by three factors: strong order fulfillment, positive demand comps, and our successful continued elimination of site-wide promotions. I'm very proud of this performance, especially given the macroeconomic backdrop and the strong compares we are up against, all while delivering an impressive 41.1% comp on a two-year basis. And it is this continued outperformance that gives us the confidence to reiterate our 2022 guidance and longer-term outlook today. Our positioning in the industry is a competitive strength. Our industry is large and fragmented, with more than half of sales from small brick-and-mortar retailers that do not have sophisticated e-commerce capabilities. And with the arrival of the millennial generation for the household creation stage, this is a huge opportunity for ongoing market share gains for us while the rest of the players try to catch up. At the same time, our digital-first but not digital-only channel strategy provides a competitive edge in scaling the business into the future compared to both retail and marketplace-only players. All of this creates an environment that is ripe for disruption and for us to take market share. We continue to win because of our key differentiators, which include our in-house design capabilities with inspirational, exclusive, sustainable, and high-quality products at compelling price points. Our digital-first but not digital-only channel strategy and our values rooted in sustainability, diversity, equity, and inclusion, which are becoming even more fundamental to purchasing decisions for many customers. These differentiators set us apart as a leader in the industry. And now I want to highlight one of our opportunities, business to business. Our B2B business had another terrific quarter, driving a 32% increase in demand in Q2, and it is well on track to becoming a $1 billion business this year. We continue to grow in this space by focusing on diversifying our product pipeline across a range of industry verticals. In sports and entertainment, we are excited to service our first collegiate sports facility at San Diego State New Snapdragon Stadium. In hospitality, we continue to gain market share through renovations and new builds, leveraging our diverse fleet of brands. And in our commercial office pipeline, we are encouraged to see the momentum continue as companies return to the office and workspaces are reimagined. To drive B2B growth, we are focused on the continued development of our sales team and expansion of our contract-grade product assortment. We remain optimistic and excited about the potential of this business as there is no one else providing the full suite of services and offerings that we do. Moving to sustainability. We are thrilled to announce the recent publication of our 2021 impact report, highlighting the progress and fulfillment of our industry-leading ESG goals. We remain committed to prioritizing sustainability, diversity, philanthropy, and worker well-being as key differentiators for our business. In the report, we detailed progress on our long-standing commitment, including responsibly sourced cotton and wood, waste diversion, and increased fair trade premium. We are also one of the first home furnishing brands to set a science-based target for reducing our emissions across our company, and we have made progress decreasing our carbon intensity. Now I'd like to talk about our global business. We continue to believe that global expansion represents a sizable opportunity, and we are focused on a multichannel strategy in key markets. In Q2, we continued building momentum with our franchise partnerships. Our presence in Mexico continues to drive growth, and we launched the Pottery Barn and Pottery Barn Kids websites in India with stores beginning in Q3 of this year and further expansion into 2023. And in our company-owned business in Canada, we continue to expand our family of brands with the launch of our Pottery Barn Teen website and the relaunches of Williams-Sonoma, West Elm, and our Pottery Barn Kids website in the market, all with great customer response. Before we get to the strong results of the brand, I want to update you on the supply chain. Unfortunately, this is an area where we continue to see significant disruption, inefficiencies, and cost pressures. Although our in-stock position has improved, we still have room to improve our on-time shipments to customers. Also, we continue to incur higher distribution center costs to support our growth as well as higher ocean freight. And we are still incurring added costs to ship out of market and multiple shipments to service our customers. We expect this pressure will continue in the second half of this year and the first half of next. This is reflected in our guidance and our outlook. Now let's turn to the performance of our brands. Pottery Barn delivered another extremely strong quarter with a 21.5% comp or 51.1% on a two-year basis. All channels and product divisions contributed to driving incremental demand. Our high-quality proprietary furniture business continues to lead the growth. Pottery Barn continues to innovate with product and incremental growth initiatives. For example, in July, Pottery Barn launched the Accessible Home, an exciting new concept designed to enhance the quality of life at home for aging in-place communities and people living with disabilities and injuries. Our customers have responded enthusiastically to our efforts to address this underserved market, and we believe this could be a significant opportunity across our portfolio of brands. Moving to West Elm. West Elm delivered a 6.1% comp in the second quarter on top of 51.1% last year or 57.2% on a two-year basis. We're excited about our new businesses in kids and bath, which continue to drive outsized growth for the brand. And we launched our dedicated B2B e-commerce experience and expanded assortment there. Looking forward to Q3, we are focused on three key areas of growth at West Elm. One, improving furniture in-stocks and lead time reductions; two, expanding our depth in seasonal decorating, hosting, and entertainment categories; and three, launching innovative collaborations across the brand. And with the ongoing success of our strategic initiatives, we remain confident in our ability to drive West Elm to become a $3 billion brand. Now I'd like to update you on our Pottery Barn children's home furnishing business, which delivered a sequentially stronger quarter with a 5.3% comp in Q2. During the quarter, we benefited from improving inventory receipts out of Vietnam, which faced factory closures that occurred in the back half of 2021. Also, we successfully launched our biggest-ever back-to-school collection, and we enabled functionality to ship dorm products in any store in any brand in our fleet across the country. Early results also indicate the seasonal holiday business will be a success, given the early positive reaction to Halloween. In the Williams-Sonoma brand, I want to highlight our recently announced change in leadership. Felix Carbullido, previously our Chief Marketing Officer, has assumed the role of President of the Williams-Sonoma brand. Felix brings incredible talent to the position through his experience in strategy and operations in addition to a breadth of merchandising, e-commerce, and marketing expertise. Felix is only three weeks into the role, but sees clear opportunities for the brand, particularly in key areas, including: one, leaning further into the brand's heritage of inspiring those who love to cook at home with relevant and useful storytelling across all channels; two, the importance of offering the best product and ensuring customers can rely on Williams-Sonoma to be in stock across the key essentials of a great home kitchen. And finally, there are white space opportunities not only in our core offering but also in new categories that have clear adjacencies to the kitchen. In Q2, Williams-Sonoma came in at a positive 0.5% comp with accelerating comps throughout the quarter. This was driven by an improved in-stock position, newness in the assortment as well as higher conversion on the site driven by our ongoing e-commerce initiatives that improved imagery and shop path. In-stock continues to improve, and we believe we will see further recovery in the back half. As part of the Williams-Sonoma brand, our Williams-Sonoma Home business had a high double-digit comp again this quarter and continues to be an opportunity. Given the strength of the Williams-Sonoma brand name, our expertise in the furniture category, and the clear opportunity in the high-end home market, we believe that Williams-Sonoma Home is destined to be a product leader of distinctive design-led, high-quality home furnishings. In summary, we are proud of our performance, and we remain committed to executing on our growth initiatives and operational improvements to drive market share gains and strong long-term financial returns. I want to thank our customers, our employees, and our shareholders. We are committed to delivering for all of you. And with that, I'd like to turn the call to Julie to go through all the financials in more detail.

Thank you, Laura, and hello, everyone. We had another outstanding quarter with revenues, operating margin, and earnings all exceeding expectations. Our performance and execution remain strong. Our comps outperformed due to positive and healthy demand comps and accelerating order fulfillment. Our growth strategy has continued to build momentum, and our operating margin continued to grow above expectations due to running a more regularly priced business and another quarter of advertising and employment leverage. These factors enabled us to outperform on both the top and bottom line with double-digit comps and another quarter of operating margin expansion. Our results this quarter further validate that we are one of the best positioned to succeed in the short and long term with strong profitable growth. Moving to our second quarter results in more detail. Net revenues grew to $2.1 billion, with comparable brand revenue growth at 11.3% on top of 29.8% last year for a two-year stack of 41.1%. This includes double-digit growth in both channels. In retail, we delivered an 11.4% comp despite retail traffic down almost 19% in 2019. And in e-commerce, we delivered an 11.3% comp and grew our e-commerce penetration 60 basis points year-over-year to 65.4%. Moving down the income statement. Our gross margin continued to hold near historic highs at 43.5%, which was 60 basis points below last year's record Q2. Our merchandise margins remained strong with another consecutive quarter of merchandise margin expansion year-over-year as we continue to preserve our pricing integrity by remaining committed to our decision to no longer offer site-wide promotions. The gross margin decline was driven by higher freight costs from our strong furniture demand, higher backorder fulfillment, and global supply chain disruptions, driving freight rates higher for all. We also incurred incremental freight costs in order to best serve our customers, to get products to them timely by shipping from out-of-market distribution centers and in some cases, shipping multiple times for multi-unit orders, which typically would have been done in a single shipment. Occupancy costs at 9% of net revenues were flat to last year, with occupancy dollars increasing 9.6% to approximately $193 million, which includes incremental costs from our new distribution centers on both the East and West Coast. These new distribution centers will allow us to support our ongoing growth, optimize service times for our customers, and drive efficiencies in cost over time. And given our ongoing retail real estate optimization efforts, we were pleased that we were able to help mitigate these incremental costs and hold the occupancy rate flat. Our SG&A rate continues to be at a historical low at 26.4%, leveraging 90 basis points over last year, driven by advertising and employment leverage from our strong top-line performance and ongoing operational efficiency. Across the company, we continue to operate with a disciplined approach, challenging all expenditures to maximize the return from our spend. These results once again led to a record quarter of earnings with our most profitable Q2 ever, including operating income growth of 12% to $366 million, and an operating margin at 17.1%, expanding 40 basis points over last year. This resulted in diluted earnings per share of $3.87, up 19.4% from last year's record second quarter earnings per share of $3.24. On the balance sheet, we ended the quarter with a cash balance of $125 million with no debt outstanding and year-to-date operating cash flow of $384 million. This year-to-date cash flow allowed us to fund the operations of the business and to almost double our capital investments to support our growth. In addition, we returned excess cash year-to-date of almost $880 million to shareholders, through $113 million in dividends and $766 million in share repurchases, a significant increase over last year at this time. These elevated share repurchase levels reflect the confidence we have in the long-term strength of our business and demonstrate our commitment to maximizing shareholder returns. Moving down the balance sheet. Merchandise inventories, which include in-transit inventory, were $1.542 billion, increasing 32% over our reduced levels last year. Inventory on hand increased 28% over last year, but was only up 1% to 2019 versus sales up 56% over the same time frame. In the quarter, back order levels decreased. However, they continue to be too high in total. We are working hard to get these goods in to fulfill our customer orders. We believe that we will be able to return to normalized back order levels next year. Turning to our expectations for the remainder of the year and beyond. We are reiterating our fiscal year '22 and long-term financial outlook of mid- to high single-digit revenue growth, growing revenues to $10 billion by 2024 with operating margins relatively in line with fiscal year 2021. Our reiteration of our outlook simply acknowledges that the economic backdrop remains uncertain with currently unknown outcomes surrounding spending trends, inflation, interest rates, supply chain pressures, and global unrest. The fundamentals of our business remain strong, evidenced by our first half outperformance and the accelerating demand comps we are seeing as we enter the third quarter. Our confidence to achieve our revenue outlook is rooted in three tangible drivers: our year-to-date trends, which continue to outpace the industry and reflect market share gains; our continued improvement in our inventory receipts expected through the back half, which will enable us to fill prior orders and lower our elevated back order levels; and our ongoing strength in our growth initiatives, which continue to build momentum. From a profitability perspective, we expect cost pressures to continue in the back half and into the beginning of 2023, particularly across our supply chain, from the incremental distribution centers and related costs to support our growth, plus higher ocean freight and other freight-related costs resulting from the global supply chain disruptions and our efforts to best serve our customers by delivering product to them as timely as possible. Despite these pressures, we remain confident in our ability to achieve fiscal year operating margins relatively in line with our fiscal year '21 rate at 17.7%, which was an all-time high, given our strong start to the year and our culture of strong financial discipline. In summary, we are very proud of the results we continue to deliver for our customers, associates, and shareholders. These results further validate our ability to deliver sustainable strong growth and profitability. As we continue to navigate the dynamic changes in the macro environment, we are confident that our strong foundation of differentiators and our operating model, as well as the momentum of our growth initiatives, will continue to keep us ahead of the competition. And this, combined with an environment where consumers are shifting increasingly online and are prioritizing value and sustainability in their purchases now more than ever, leaves us uniquely positioned to continue to take market share and profitably. Finally, I would like to thank all our associates for their hard work and relentlessness in driving these great results.

We'll take our first question from Max Rakhlenko with Cowen and Company.

Great. Nice job in the quarter. So first, just on topline, can you share what demand was in the quarter and then just provide any more color on early 3Q trends? And then just bigger picture, what do you attribute the outperformance to and ways that you can play offense from here as the environment does get tougher?

Max, it's Julie. So as we said in our prepared remarks, our demand comps remained positive and healthy, and, in fact, accelerated as we entered into the third quarter. They are lower than our double-digit net comps. We had alluded to that in our last call that we had seen the demand comps start to moderate. But they are nothing like what we've heard others indicate or report. And so we're pleased to see that we were able to deliver accelerated comps this quarter both driven by healthy demand and our accelerating net bill, and we're seeing both of those accelerate into the third quarter.

And Max, to your question about why we're winning and how come we're outperforming. First of all, thank you for the great question. We think it's a couple of reasons. First, we've said over and over what our key differentiators are, and they're truly setting us apart. Let me just talk about the first one first in more detail than I have in the past. We talk about in-house design, which allows us to have proprietary products that are of high quality and at the best value. It also happens to be sustainable. But it also allows us to innovate and bring in collections that no one else has and see the white space. This culture of innovation that we have is driving a lot of the great wins for our business. And truly, I don't believe we have these results if we had not continued to deliver these important points. Each one is a seed that grows into very large brands. But in Pottery Barn, Example A is accessible home, really obvious and sizable business opportunity. We just got started. They also have in Pottery Barn a bunch of great collaborations that they've been launching, my favorite one with Hailey Bieber, which is really fun if you want to check that one out. On Pottery Barn Kids, we have had exciting collaborations with different licenses that kids love, from Beatrix Potter and Disney to Emily Meritt and Harry Potter, and those continue to drive relevancy for the brand and delight the trial. For West Elm, in terms of innovation, we've talked about B2B, and the kids’ and bath initiatives too. But we also had some collaborations that really are working there like just Sarah Sherman Samuel. I don't know if you've had a chance to see that that's also in Pottery Barn Kids too. And this has really set us apart and gotten us more attention on our kids' growth in our West Elm business. And we're still really low awareness that we even have a West Elm kids business. So those are just some of the examples when we say innovation; we say that it's a differentiator that we design our own products. It's this culture of innovation that really, I think, is what's making us outperform.

Got it. That's very helpful. And then just on promotions, bigger picture. Can you speak to the strategies ahead? We've seen the debt increase, but maybe not suppressed, and you obviously haven't returned site-wide promos. So just ahead, what should we expect from you? And I guess, ultimately, would you be willing to leave some topline on the table to maintain margins even if the industry does get very promotional in some of the quarters ahead?

Yes. So first of all, the industry is already very promotional, particularly with the big box retailers faltering. There's a lot that they're flushing through, and that's been going on for more than just a couple of weeks here; you've been watching this happen most of this year. I believe, Julie, you did detail the difference between our MMU and our...

Not financially, but yes, MMU has expanded. And the delta is on our gross margin is simply just the shipping cost. But the MMU still remains strong. It's another quarter of expansion that we're seeing. And so even with the promotional environment, we're still able to drive that.

I think that's the key point that I want to make sure that no one confuses when they just do the quick read of the gross margin, that you understand where it came from and where it didn't come from. We are committed to the elimination of site-wide promos. We believe this is absolutely the healthiest way to run our business for long-term success. And it's a function of the products that we sell that have great design, as I said, great quality, and are sustainable. As long as we continue to maintain that value equation in the product and the innovation, I believe we're really equipped to maintain this posture because no one else has the same product out there in the market. That said, this commitment doesn't mean that we're not going to use markdowns to manage our inventory. We are very aggressive about managing our inventories, and markdowns are part of any retail business. We will take markdowns particularly in seasonal products and slow-moving SKUs, but we have not expanded the amount of promotions that we're running.

We'll take our next question from Cristina Fernández with Telsey Advisory Group.

Congratulations on another good quarter. I wanted to ask about inventory receipts for the back half. I mean inventory has been tight, but it seems like it's improving. So do you expect better inventory flow in the second half of the year as what you've seen so far in the first half?

Yes, I would say we do expect improvement as we progress through the latter half of the year. It's important to note that our growth to date stands at 32%, but it's only 1% on a three-year basis compared to a 56% increase in sales. We are transitioning more towards larger furniture items and are managing incoming inventory to address back orders as well as meet current demand. This situation results in a considerable amount of inventory arriving simultaneously. At the same time, we need to increase our inventory levels to ensure stock availability, while also being mindful of aging inventory that needs to be moved out to free up space in the distribution center. As we advance into the second half, we anticipate our inventory levels will improve, although we will still contend with elevated backorder levels into the first half of 2023.

Yes. To add to that, the positive news is that as we have restocked, which is crucial for our customers, we have noticed a decrease in backorder crate rates. While backorder levels remain too high, they have been reduced. Our cancel rates have also improved. Additionally, we have industry-leading lead times for our domestic in-house upholstery, with no one else shipping custom upholstery faster than us. Although our on-time shipments are not where we want them to be, we are highly focused on restocking and working every day to serve our customers as best as we can in this environment. I believe that as we progress through this year and into early next year, we should find ourselves in a much better position.

And then just a quick follow-up. On the merchandise margin, it seems like promotions are relatively stable year-over-year. What are the other factors contributing to the expansion of the merchandise margin?

That's an interesting question. We have implemented some price increases, but we are being very selective and do not simply pass these costs onto our customers. We assess where we may be underpriced and where we can still provide value. Currently, we have plateaued on raising prices. Additionally, we are beginning to see a decline in the prices of certain raw materials and fuel. Over time, this could enable us to receive price reductions from our vendors, which may improve our margins and potentially allow us to reduce some prices for our customers.

We'll take our next question from Adrienne Yih with Barclays.

Congratulations again. You just keep the trend going. So Laura, there's been a lot of discussion about household income brackets and kind of the lower end, obviously, feeling much more of the pain and having that creeped into kind of the median household income in the second quarter. You guys stayed pretty high up, but I'm curious; the strength that you saw at Williams-Sonoma Home appears to really hire in. West Elm would seem to me to be maybe more median-ish in terms of household income. Can you talk about what you're seeing with regard to these different target income brackets and how they're behaving?

Sure. First of all, Williams-Sonoma Home is still quite small for us, so I wouldn't draw too many conclusions about the entire high-end industry from that. I'm constantly reviewing customer data, and we don't observe a lot of inconsistency across locations; the Southwest and Southeast are slightly better, but not by a significant margin. Gen Z and millennials remain our fastest-growing demographic, which is excellent. There isn’t much difference in spending based on income alone; rather, it depends on how much they are willing to spend. We're noticing that customers who spend over $1,000 are increasing their purchases, while those spending under $200 are declining, which isn’t surprising given that furniture significantly contributes to our growth; it indicates they are prioritizing furniture purchases. I'm sharing these insights to highlight that we're closely analyzing various factors, and while it might seem like we're better insulated due to our customer base’s income situation, I think a more significant macro trend is that even though the housing market is slowing, many of our customers have experienced substantial home value appreciation. They cherish their homes, which often represent one of their largest assets, and they are actively seeking to enhance these assets. Additionally, we all recognize that home furnishing purchases typically lag behind home sales and renovations. Thus, current metrics on home sales and interest rates don't completely reflect the home improvement journey, leading us to believe there's substantial potential for continued home furnishing sales growth. Moreover, while many analysts are forecasting a recession, we are also observing an improvement in consumer sentiment as inflation decreases. I believe there are many reasons for our market share gains, and based on multiple data sources, it's evident that we are capturing a significant share of the market.

Okay. And then for Julie, my follow-up is regarding custom orders versus in-stock items. I know that in-stock items have been difficult to maintain. So I'm curious if you've noticed any significant shift towards custom orders, which tend to be more stable than regular cancellations due to the deposit. Any insights on trends in that area would be very helpful.

I'll take that, Adrienne. So custom orders, most of our upholstery business is custom, okay? People always want to choose their own fabric and their own frame. We don't do much stock upholstery at all. So there's no dynamic there really that's changing. What's stocked is our bedroom furniture, dining furniture, all those wood pieces. But most of our upholstery business is custom.

We'll take our next question from Seth Basham with Wedbush Securities.

Congrats on a great quarter. My first question is just thinking about the outlook for the back half of the year, if 2022 operating margins are in line with 2021, that implies some modest yearly decline in the second half operating margins after a strong performance in the first half. What's driving that slight decline? Is it some of the additional supply chain pressure? Or is there anything else that might get work here?

Yes. So there's two things there. First of all, I mean, we are obviously reiterating our strong guidance giving a nod to the fact that the environment is uncertain. So we're being cautious on that, but there is definitely some pressure that we're going to feel on the operating margin line, particularly associated with these ongoing supply chain costs. So we're going to continue to have incremental distribution center costs. We've got ocean freight costs that are higher, along with dray and demurrage costs. So there's all the costs that are increased to get the goods to us. And then incrementally, we are doing the right thing by our customer to accelerate getting the goods to them. And so there'll be incremental costs for out-of-market shipments and for multiple shipments that we typically would have done in a single shipment. The one thing from a modeling perspective to make sure you're aware of, if you remember last year in Q3, we had higher spot rate charges, and so that will help us to partially offset some of that incremental cost in Q3, but Q4, we didn't have that last year. And so you'll see that the Q4 is going to be a bigger impact than the Q3. But at the end of the day, of course, we will do everything we can to mitigate it as we always do. And thankfully, with the strength that we've had in the first half of the year, we are very confident in our ability to hit our operating margin in line with '21, which, as you know, is a 17.7% and the highest we've ever had.

That's really helpful. And then relatedly, as your inventory starts to normalize, you'll have more clearance and need to mark down slow-moving SKUs. How much has that been benefiting you for the last two years? And what kind of reversion do we see an impact on margins over the next year or two?

I mean I wouldn't assume that that would go up per se. I mean we've always had inventories that age, and we've always had to clear it. We've had warehouse sales for a while now. So I don't think there's anything there that is a significant shift that should be concerning from a promotional stance or a margin perspective. Remember, most of what we sell is core. And so we're different than the apparel companies and so forth. And so as you get more inventory and you come back in stock, if it comes in late, there's a lot more pressure for them to push it out and get it out of the distribution center. For us, it's just a space play. And so we'll continue to have markdowns and things like that where we need to get rid of aged inventory, but there's no substantial shift that should occur.

We'll take our next question from Anthony Chukumba with Loop Capital Markets.

Congratulations on a great quarter, especially considering the challenging macro environment. I have a quick clarifying question. In previous calls, you discussed emerging brands and provided updates regarding their performance. I'm curious if you could share any insights on the emerging brand performance in the second quarter.

I'm sorry for not providing that information earlier, but we're focused on sharing more in our prepared remarks, leaving ample time for questions. Both brands are driving profitable growth. I can't provide a specific comparison, but I can confirm it's in the double-digit range for both brands. Rejuvenation is seeing consistent performance in both the consumer and B2B segments, with strong results in direct-to-consumer and retail. We would like to increase our store presence because they enhance brand awareness for Rejuvenation. For Mark and Graham, we're aligning with emerging post-pandemic trends such as travel, social sports, and home entertaining, which are key drivers of brand growth. We're particularly noticing a resurgence in activities like tennis, golf, and pickleball, benefiting this business. It's becoming a vibrant gift market, and we're starting to gain recognition, attracting customers to us. We are enthusiastic about the growth potential of both Mark and Graham and Rejuvenation for our company.

Got it. No, that's really helpful. And yes, I appreciate you adding your comments, but don't edit your comments just so you can hear more questions from the likes of sell-side analysts like me. Anyway, just second real brief question. I mean, obviously, very strong free cash flow in the first half of this year. I would expect to see continuous strong free cash flow in the second half. You've been very aggressive about buying back stock. Obviously, you have the dividend. But how do you think about just near-term capital allocation, particularly like in the back half of this year?

Yes. I mean, we're going to continue with buybacks and our dividends, of course, maybe not to the same degree we'll see. Certainly, we still believe our stock is undervalued. It has recovered nicely. We're pleased that we were able to buy the stock back on average for about $138; obviously, stock is much higher now, but it's still undervalued. And so we're going to continue as long as we have some really strong free cash flow and are generating this kind of earnings and cash that we are, we think the right thing to do is to return it to our shareholders. So we're still committed to doing that.

And I think also the buyback signals also the confidence we have in our guidance.

We'll take our next question from Chuck Grom with Gordon Haskett.

Nice quarter. On our math, it looks like your backlog release continues to gain steam, which is obviously a good thing for your customer. But is it possible to size up where you are today on the backlog versus maybe where you were last year? And is there a banner where the backlog levels are more severe than others?

Yes. I mean we haven't disclosed the total amount, as you guys know, but it has come down, but it's still incredibly sizable. I think we may have said before that most of the back orders are associated with furniture. So certainly, Pottery Barn and West Elm have a sizable amount of back orders, but every brand has them. And the good news is we are starting to bring that balance down, and certainly, that's a tailwind for the back half and as we move into 2023.

Okay. And is there a banner that is higher? Would you say PB is higher than maybe Sonoma or West Elm?

Well, Sonoma is obviously lower, less furniture.

Pottery Barn is our largest brand.

Okay. And then on the 9% or so increase in occupancy dollars year-over-year. It sounds like the distribution center openings are an incremental spend on that line item. I guess is there a way to think about the occupancy line over the next couple of quarters given those openings?

Yes, it will be somewhat higher, similar to current levels due to the new distribution centers. At the same time, some offsite locations should be coming off, and we have additional hubs that will eventually come off as well. However, the larger focus is our retail real estate optimization strategy, with most of the stores we plan to close scheduled to do so at the end of the year. As we move into the new year, you'll see the benefits from reduced occupancy costs related to those stores. In the short term, though, there will be pressure on that line.

We'll take our next question from Jonathan Matuszewski with Jefferies.

Nice quarter. First one was just on supply chain. Laura, you mentioned challenges still persist there. Just curious where you guys are from a diversification standpoint? I think a while ago, you mentioned reducing China exposure by half. So just curious how much there is to go on that initiative? That's my first question.

Yes, I believe that's a continuous process. We have significantly decreased our reliance on China. Our current focus is on securing several high-quality vendors capable of producing some of our high-risk children's furniture. However, finding multiple vendors that can meet both these requirements and our sustainability standards has proven to be challenging. Therefore, we are constantly seeking out additional high-quality suppliers.

That's helpful. And then my follow-up question, Laura, you mentioned millennials and Gen Z, as the fastest-growing cohorts you're seeing. So a question on marketing strategy for you. It feels like you guys are leaning in a bit deeper into brand ambassadors, influencer marketing from what we see on social media. You launched the West Elm Collective not long ago. I never really thought about Gen Z as really a core demo for your business, but it is a group that leverages some of those channels. So just your thoughts on how you've been leaning in more to that channel, how impactful it's been? You guys have always done a good job with digital marketing. But it seems like you guys are making a bit more of a pivot at least from what we see. So any thoughts there in terms of the impact?

It's interesting. Felix is just there with me, and since he's still doing two jobs, I'm going to make a few comments too. But video is very engaging. So whether it's video on TikTok, on our sites, on Insta, we're doing more video. And as much as a lot of millennials and Gen Z get credit for liking video, don’t we all like video. The stuff we're doing for that generation, I think, is appealing to all, and we're certainly always pushing to try these new channels, whether it's Pinterest or TikTok, Snapchat. Pinterest has been much better than I expected, frankly. And I think there's still a lot of room to go there. And the TikTok, Snapchat, YouTube group is also showing that their engagement is multilayered and different than just a product ad on Google. Felix, do you want to add anything to that?

I believe it’s clear that TikTok significantly influences customers of all ages, especially the demographics you mentioned. They not only broaden our brand's reach and introduce it to new customers, but also some design collaborations bring in fresh aesthetics. This is about providing a varied perspective or expression of our brands to attract more customers and expose them to new looks and influencers. You’re right; we have engaged more in this area because society has shifted, and we want to ensure we remain relevant.

We'll take our next question from Brad Thomas with KeyBanc Capital Markets.

Let me add my congratulations as well. Great first half of the year here. It's a little early probably to talk about the holiday season, but that's obviously your most important quarter of the year. So wondering, Laura, Julie, if you could just comment a little bit about maybe from a merchandising standpoint, how you plan for this year, how you're thinking about the consumer and any differences in how it may show up here for the holidays? And any nuances of how the mix is a little bit different during that quarter?

We love the holidays. And frankly, we have a great lineup, and it's always good to see Halloween off to a good start, as I alluded to, in the kids' business also off to a really good start in PD and Williams-Sonoma, I should have said that. But we built on last year's great sellers. We sold out very fast last year of a lot of our key holiday products. And so we're going to get a chance to fully leverage those ideas that barely made it before last year. And we're excited about Williams-Sonoma. The Williams-Sonoma holiday season was disrupted last year by COVID. Let's remember, Thanksgiving was not exactly easy. I had many of my family not be able to make Christmas because of COVID. So this year, it should be a much easier celebration for people to come together, and we're really looking forward to being a part of that and giving our customers great experiences and great products to celebrate the holidays with and Felix and his team are really working on holiday preparedness right now on the website. And in fact, Felix, I think you had a meeting today with our district managers?

Yes, before this meeting, I spent four hours with our district managers from around the country to discuss the holiday season, as it is a vital part of our business and crucial for retail. We reviewed our product assortment, and everyone is very enthusiastic about it. Laura mentioned several points I am excited about, and seasonal holidays are significant because there is always a reason to celebrate each month. Williams-Sonoma is the best brand for celebrations. I am very optimistic about this holiday season and the future holidays for our brand. So stay tuned.

We'll take our next question from Simeon Gutman with Morgan Stanley.

I wanted to ask about the tone of the consumer. Last quarter, there was some mentioning of, I think, some choppiness coming into this quarter. And it sounds like things have picked up, and the sentiment has gotten better, and demand comps have gotten better. I want to make sure that that's the right read and you're not seeing the tentativeness that maybe you were at the early part of the quarter?

No, that's exactly right. I mean as we said in our last call, as we started that quarter, we saw demand comps moderate. And we're really pleased and excited to see them coming back and accelerating and being strong, heading into the third quarter. And so we haven't seen, again, what others are mentioning out there. So it's really different for certain retailers. And thankfully, we're one of those that are seeing real strength in our business.

I want to remind you that we're only three weeks into the quarter, so please don't read too much into this. What we're trying to convey is exactly what Julie just mentioned.

And B2B, the growth, I'm assuming, is outpacing the house average in terms of comp. Can you share at least the spread? Is that spread widening? Is it narrowing? And is B2B concentrated among any of your brands?

Yes. It's a consistent beat to last year in growth. And we're seeing also a lot of innovation from the brands to see B2B. So as we mentioned, bringing in products that we can offer is a big part of the strategy, and more contracts means more sales for B2B because they can do even more in the project. In terms of penetration, Rejuvenation by nature is a small business but a large percent B2B. It has always been. Trade has been a big part of that as people furnish hotels with their custom-configured lighting. But West Elm and Pottery Barn are really very strong in B2B, and Williams-Sonoma has a lot of opportunities. We started. You've heard us talk about the gifts that we do with wins from the holidays, the business, and there's a lot more room particularly as we expand the assortment in Williams-Sonoma Home because right now the assortment is so small, it's hard to do large-scale projects. There is lots of opportunity across the board.

We'll take our next question from Oliver Wintermantel with Evercore ISI.

I have a follow-up question for the B2B question from Simeon. Can you maybe give us a little bit more details on what the margin is on the B2B business versus the rest of your business?

Yes, I mentioned in the past that this contributes positively to our overall company operating margin at this time. As that business continues to grow, we see additional benefits to our bottom line.

Perfect. Given the recent success in both e-commerce and new stores, have you reconsidered the decision to close 25% of your store base that you previously disclosed? Is this something you're viewing differently now, considering the success you've experienced over the last few quarters?

Great question. We continue to reassess and review our real estate strategy. And while we have been closing stores, we've also had incredible success in repositioning and relocating stores in their current market. A perfect example in our backyard, we moved our Williams-Sonoma Corte Madera storage in a small space, and they are off to a very strong start in that store. And then as I look at the other Williams-Sonoma stores that we've repositioned, they are outperforming their forecast too as customers embrace the new design that provides an improved inspirational shopping experience. So we look at this as an opportunity to improve our retail fleet, not to just think of it as a line item on the P&L. But of course, there are some stores that underperform or are in areas that are not as vibrant, and we are always going to look for the best location in town.

We'll take our next question from Marni Shapiro with Retail Tracker.

Congratulations. I do want to take again on the B2B, not to beat it up, I'm asking on the positive. Can you just talk a little bit about how the expense structure works there? I'm assuming you have a sales team. But it sounds like the products are coming from the brand. So is the design and R&D part coming from the brands? Because that feels like a really reliant way to leverage what's already done. And then could you just touch a little bit on the relaunch of Holds Everything because I thought the timing of it was interesting. And I always liked that brand? So I'm curious about that as well.

You're right, Marni. We have a dedicated sales team led by Jose, who collaborates with the brand presidents to spot opportunities in categories that attract our clients. If she identifies an area with potential, she prompts the brands to focus on it. They work together to create new products, and most of them meet contract-grade approval; some require testing, and others need modifications to enhance durability, which ultimately benefits consumers. Looking at the impressive list of client projects, including the Marriott headquarters hotel, Waldorf Astoria, Marriott Vacations, Hilton Boston, and many others, I could easily continue listing the exciting projects we're involved in. It's a new area for us, and we're eager to furnish various spaces with new furniture. This partnership between the B2B team and the brand team has been fantastic. Regarding the Hold Everything initiative, we initially had a version of it that didn’t perform well, so we paused it. However, we recognized an opportunity to revive it under the Williams-Sonoma brand, designing and offering high-quality products that have become more visible on our site. We currently feature about 50 products, including my favorite, the expandable storage organizer for drawers. It's great because similar products online tend to break, while ours helps create a custom look in kitchens. Who doesn’t want to be more organized? This initiative has been very successful and is gaining traction, generating real volume for us.

We'll take our final question from Kate McShane with Goldman Sachs.

I'm just going back to a previous question that was asked with regards to the freight cost. I just wondered if there was any way you could compare the cost between what you're experiencing in Q1 versus Q2? And how you expect that to change just because you have been dealing with backlogs and multiple deliveries for some time? I just was curious what the change was between quarters and going forward?

Yes. I think the bigger change is in the ocean freight side of things and the dray and the demurrage as we're getting these big volumes of inventory coming in; there are containers that need to be moved around, need to be stored accordingly. And ocean freight rates, as have been the case for everybody, have gone up. And so that happened sort of I think it was May or June, and then, as you know, those sort of charges get capitalized on the balance sheet as part of inventory, and so you don't recognize those until you make sales. So it's a function of turn, which is why we're starting to feel some of those more towards the back half. But that's the reason.

And ladies and gentlemen, this will conclude today's conference call. We appreciate your participation. You may now disconnect.

Thank you. Appreciate your support. Happy shopping.