Williams-Sonoma, Inc. (WSM) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Williams-Sonoma Incorporated Third Quarter 2012 Earnings Conference Call. [Operator Instructions] This conference is being recorded. I would now like to turn the call over to Steve Nelson, Vice President of Investor Relations, to discuss non-GAAP measures and forward-looking statements.

Good afternoon. This afternoon's conference 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. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparisons. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and an explanation of why these non-GAAP financial measures are useful are discussed in Exhibit 1 and elsewhere in the earnings release. The forward-looking statements included in this afternoon's call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements address the financial condition, results of operations, business initiatives, trends, guidance, growth plans and prospects for the company in 2012 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-Q, for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the conference call over to Laura Alber, our President and Chief Executive Officer, to discuss our third quarter 2012 results and our outlook for fiscal -- outlook for Q4 and fiscal year 2012.

Thanks, Steve. Good afternoon, and thank you for joining us. On the call with me today are Pat Connolly, our Chief Marketing Officer; and Julie Whalen, our Chief Financial Officer. Today, we'll be discussing our third quarter 2012 results and our outlook for the fourth quarter and fiscal year. But first, on behalf of all of us at Williams-Sonoma Inc., I would like to express my concern for the welfare of those individuals and families impacted by Hurricane Sandy. The storm created significant hardship for many of our friends, families, colleagues and customers, and we've seen an overwhelming response from associates company-wide in their efforts to provide support to the impacted communities. And while the recent storms have caused some disruptions to our business, our response has been focused on assisting our associates and customers in need. And now, let's discuss our third quarter, where we again delivered strong performance across every one of the key metrics in our business: revenues, operating margins and earnings per share. Diluted earnings per share grew 20% on net revenue growth of 9%, with comparable brand revenue growth accelerating to 8.5% from 7.4% last quarter. E-commerce net revenues grew 17%, and operating margin exceeded last year's Q3 rate by 50 basis points, growing to a third quarter record of 8.4%. All brands delivered positive comparable brand revenue growth in the third quarter. The outperformance in Pottery Barn and West Elm continues and comparable brand growth in Pottery Barn Kids accelerated as its inventory position improved. Pottery Barn Teens and Williams-Sonoma, both posted year-over-year increases and improved revenue trends versus the prior quarter. At the beginning of the year, we outlined for you our 3 key strategic initiatives for driving sustainable profitable growth and increasing shareholder value. They are: growing our existing brands, global expansion and launching new businesses. We believe that our third quarter results demonstrate the continuing opportunity in our existing brands. And since we last spoke with you, we've also made great progress on our global expansion strategies. With our partner Alshaya, we have opened 5 new stores including the first Williams-Sonoma and West Elm stores in Kuwait. Utilizing our FiftyOne platform, we continue to see a very encouraging response from our direct shipments to more than 90 countries around the world. And in Australia, we finalized the design and began construction on our 4 retail stores. We positioned our supply chain. We hired key team members in Australia, and we've started working with public -- a public relations firm to support our early fiscal 2013 launch. As we solidify our opening strategy for Australia, we are increasingly convinced about the opportunity that global represents for our company as we offer a differentiated high-touch multi-channel shopping experience. During the quarter, we also made progress in launching new businesses. In late October, we announced West Elm Market, a brand extension of West Elm that provides an exciting retail setting for an assortment inspired by the commonsense shopkeeping of the classic general store. Our early results indicate this could be another important growth initiative for us. And last week, we announced the launch of Mark and Graham, our newest brand. Mark and Graham provides the ultimate gift-giving experience. The brand offers colorful and timeless products, personalized with a choice of more than 50 custom monograms and creative type treatments. Foundational to all of our growth initiatives are supply chain and technology, and we continue to make the progress that we had previously outlined for you to take costs out of our supply chain and drive better performance for our customers. Online, we continue to further differentiate ourselves versus our competitors. And now let's talk about our brands. In the Williams-Sonoma brand, comparable brand revenues increased 1.3%. We are pleased with the progress we have made as a result of our strategic focus on product innovation, marketing and customer engagement. From a product perspective, our goal continues to be to increase our ratio of exclusive products. The strongest performance continues to be in those categories where we have the highest proportion of new, exclusive and innovative products: electrics, tabletops and agrarian. Last quarter, we announced the launch the new Verismo System by Starbucks. And to date, our results have exceeded our internal targets. In the fourth quarter, we'll be offering a significantly higher percentage of new and exclusive products, particularly in cookware, electrics and entertaining. Yesterday, we announced the first in a series of Williams-Sonoma branded products in cookware, cook's tools and new technology-driven smart tools. These product introductions draw on our over 5 decades of culinary experience and represent the next generation of technologically advanced cookware and tools for the home cook or professional chef. This introduction is an exciting strategic development for our business, and it is just the beginning. Over the next several years, we'll be introducing many more differentiated products with the Williams-Sonoma name. From a marketing perspective, we are focused on consistently providing an inspiring visual experience that powerfully communicates the Williams-Sonoma brand across all of our channels. Our holiday catalog features a new design that delivers a more impactful visual presentation and stronger marketing messages around key products and categories. We believe our holiday catalogs will inspire our customers with this new imagery, content and compelling narrative, and we are improving our website with content, personalization and functionality to enhance the shopping experience for our customers. We've made several enhancements to our website. Most notably, more closely integrating product and content into our entertaining ideas, increasing personalized product recommendations across the site and enabling access to our customer care associates by phone or by chat. In the fourth quarter, you will see site improvements that will drive conversion of the shopping path, such as faceted navigation that will allow customers to quickly find selections through advance sort and filter functions and enhancements to our on-site search functionality. In a recent study conducted by L2, a digital think tank focused on luxury and specialty retail, the Williams-Sonoma website ranked #1. It is our goal to further separate ourselves from others with these new enhancements. In retail, in our upcoming floor sets, you will see a more impactful coordination between floor features and perimeter merchandising, and a much stronger presentation of seasonal merchandise in our perimeter fixtures. In support of our strategy to improve the overall customer experience and to further differentiate the brand, we are also focused on our selling culture. New field leadership is driving the clienteling initiative that has been so successful in our other brands, and we are pleased with our progress. In the fourth quarter, we have a schedule of traffic-building events and activities designed to complement the holiday entertaining season. We believe the Williams-Sonoma brand is well positioned for this upcoming holiday season. I would now like to discuss the Pottery Barn results. Comparable brand revenues increased 11% on top of 7% last year, with strong results across both channels and all product categories. The brand continues to deliver a dynamic and comprehensive product assortment that inspires customers, bringing decorating and entertaining together with great value in new ways. Our customers are delighted by our aesthetic and the value proposition that we are providing. We have expanded our expertise as an authority in design, decorating and entertaining, and we are sharing these ideas and capabilities with our customers as part of our service offering. As part of our complimentary design service initiative, we have trained over 1,500 design studio specialists that are ready to assist our customers in our stores and in our customers' homes. The combination of our strong product offering and these services is driving our business. Our vision is to further develop these services and market them in a more powerful way. From a merchandising perspective, all key categories had strong performance during the quarter, led by furniture, textiles and decorative accessory. Strong revenue growth and a focus on operational discipline drove profitability for the brand. Our Pottery Barn customers love to decorate and entertain, and our seasonal businesses continue to be strong. We always introduce our holiday assortment in our direct channel in advance of the store, and early reads are exceeding our expectations. Our customers are getting their homes ready for the holidays, and we are part of their lifestyle through our content online, in-store events and elevated service in the home. Finally, in anticipation of the housing recovery, we began working over a year ago on an expanded home renovation assortment in conjunction with complimentary design services. We have seen strength driven by this new category growth and expanded assortment, specifically in lighting, bathroom consoles, hardware fixtures and window treatments. We are feeling good about the fourth quarter in the Pottery Barn brand. In the Pottery Barn Kids brand, comparable brand revenues increased 10% on top of last year's 5%, showing strong results across all channels and all product categories. Textiles and decorative accessories posted strong growth reflecting a very successful back-to-school season. Additionally, our baby business was very strong, led by consumer response to our expanded nursery offerings, gift-giving and registry experience. This initiative will lead to further growth for the brand. Pottery Barn Kids' initiative to celebrate the holidays and create childhood memories is on track as we saw a great consumer response to our Halloween assortment and Thanksgiving. We are excited about the fourth quarter for Pottery Barn Kids and the launch of our seasonal and holiday assortments. We are confident in our strategy for the remainder of the year, and we will continue with our efforts to drive customer acquisition, customer engagement and strong multi-channel growth. In PBteen, comparable brand revenues increased 2% on top of last year's 6% growth. This growth was led by the furniture and textiles divisions, with great strength coming out of our textiles, led by our dorm initiative in the back-to-school time period, and our strategic launch of Burton home furnishing. To date, our results in both Burton and dorm have exceeded our internal targets, and we are excited about the growth of both initiatives. PBteen has shown improvement throughout the year, but it is still not where it could be, with furniture in-stock positions remaining our biggest challenge. We believe we will be in stock at the end of the fourth quarter. Decorative accessory also continue to be a soft spot in PBteen driven by room decor. However, the gift-giving season has not yet started, and we are introducing a very exciting group of gifts that we believe will drive our fourth quarter decorative accessories business. In Q4, you will see an enhanced gift assortment with over 500 gifts to give, ranging from personalized jewelry and beauty products to monogrammed towels, sheets and blankets, to great electronic accessories to compliment the teen's digital life. During the holiday season, we will continue our strategy of new customer acquisitions by popping up 5 new PBteen retail locations, which will allow us to understand consumer demand in different markets and give the customer a chance to experience the brand in a new way. We believe our seasonal collections, our new product introductions and the integrated marketing and shopping approach will attract new customers to the brand and allow us to further engage the teen customer in new ways in order to drive growth. Finally, I would like to discuss West Elm. West Elm delivered its 11th quarter of double-digit increases in comparable brand revenue, growing 13% on top of 27% last year. Growth continues to be driven out of all categories, led by double-digit comp growth in furniture and textile. Key seasonal and category promotions drove strong incremental sales and margin, and the continued expansion of the assortment into new areas, including kitchen, contributed to the growth. As we look forward to the balance of the year and beyond, our strategy is to continue to profitably grow the West Elm brand by engaging with a broader base of customers, while maintaining a compelling value proposition. We are executing on an expanded product assortment and customer engagement strategies, and we are aggressively looking for retail expansion opportunity. We opened 5 new stores in the third quarter and have plans to open an additional 4 stores in the fourth quarter. We are pleased that by the end of the year, we will have a total of 47 stores. As part of both our product and real estate expansion strategies, we launched the West Elm Market brand extension with the opening of our first dedicated West Elm Market store in Brooklyn, New York in October to great consumer feedback. Focused on tools for everyday living in kitchen and housewares, West Elm Market is a neighborhood store offering exclusive uniquely designed products in an environment that encourages social engagement and a sense of community. Complementing existing West Elm stores with a shop-in-shop strategy and with a robust online assortment to match, West Elm Market will help us to grow and gain relevance with core and new customers. We will open one additional standalone West Elm Market store in Vancouver this quarter, and we will add select assortments in 8 West Elm stores. We believe all these initiatives will uniquely position West Elm in the marketplace and allow us to capture additional share and drive growth in this brand. We're excited about our progress on our path towards building this into another $1 billion brand. And now, I will turn the call over to Julie for additional details on our Q3 performance and our Q4 and full year 2012 financial guidance.

Thank you, Laura, and good afternoon. For the quarter, net revenues increased 9% to $945 million, with 15% growth in the direct-to-customer channel and 3% comparable-stores sales growth in the retail channel. Diluted earnings per share increased 20% to $0.49 per share, with an operating margin of 8.4%, establishing a new high for any third quarter. As a result, our revenues, operating income and diluted earnings per share were again a record for any non-holiday quarter, all while simultaneously investing in our future growth. Comparable brand revenues increased 8.5%, with all brands contributing positive comparable brand growth, including the Williams-Sonoma brand, which achieved both sequential and year-over-year improvement. This growth was led by continued strong performance in Pottery Barn and West Elm, with renewed strength in Pottery Barn Kids. E-commerce revenues for the quarter increased 17%, driving direct-to-customer revenues to 47% of total company revenues versus 45% last year. Gross margin improved 70 basis points versus last year to 39% and was primarily driven by the leverage of occupancy cost. Most importantly, year-over-year selling margins increased on a sequential basis from the second quarter with improvements in nearly every brand. Product margins were up year-over-year and have continued to improve from the beginning of the year across all brands. Occupancy cost leveraged over 60 basis points, including an increase in occupancy expense to $130 million during the quarter versus $125 million last year, primarily driven by increased store lease obligations and new infrastructure to support our information technology initiatives. SG&A increased 20 basis points versus last year to 30.6%, primarily driven by higher employment and other expenses, including the planned incremental investments to support our e-commerce, global expansion and business development growth strategies. I would now like to comment on our third quarter operating margin in each of our business segments. As mentioned earlier, total company operating margin at 8.4% established a new high for the third quarter, with a 50 basis point improvement over last year. A 90 basis point increase in the direct-to-customer segment to 22.5% and a 20 basis point reduction in corporate unallocated expenses to 6.9% were partially offset by a 90 basis point decrease in the retail segment to 8.8%. The 90 basis point improvement in the direct-to-customer segment was primarily driven by sales leverage of occupancy and employment costs and greater advertising efficiency, partially offset by lower selling margins due to shipping reductions. This speaks again to the power of our operating model, allowing us to drive sales by using advertising dollars to give value back to the customer through free shipping. At $101 million, the direct-to-customer operating income is again the highest quarterly segment operating income ever recorded in either segment for a non-holiday quarter. The 90 basis point decrease in the retail segment was primarily driven by increased employment and other expenses to support service and growth initiatives, including new store openings, partially offset by occupancy cost leverage and improved selling margins. The 20 basis point improvement in the corporate unallocated segment was primarily driven by reductions in general expenses and further sales leverage of increased employment expense. From a balance sheet perspective, the third quarter highlights were as follows: Cash at the end of the quarter was $262 million versus $379 million last year for a net decrease of $117 million. Though cash provided by operating activities actually increased $44 million on a trailing 12-month basis, the increase was offset primarily by additional year-over-year spending on share repurchases and dividends and additional capital spending to support our growth initiatives. Merchandise inventories increased $62 million or 10% to $688 million, which was consistent with our expectations and materially in line with our revenue growth. This inventory level is to improve our in-stock inventory positions and to drive sales. I would now like to discuss our fourth quarter and fiscal year 2012 guidance. We are pleased with the progress we have made and are confident in delivering the full year. Our fourth quarter guidance for net revenues is estimated to be in the range of $1,360,000,000 to $1,400,000,000, and our EPS is estimated to be in the range of $1.21 to $1.28 per share, with operating margin of 14.5% to 15.1%. Our fourth quarter guidance includes the impact from our incremental SG&A spend to support our strategic growth initiatives, the impact of the acceleration of our global expansion into Australia in early fiscal 2013 and the estimated impact from Hurricane Sandy. Turning to our full year guidance, while the recent storms have made it harder to forecast our business in the short term, we are raising our fiscal year outlook by $0.01 to a non-GAAP EPS range of $2.45 to $2.52 due to our strong results throughout the year. This now represents fiscal year EPS guidance that is $0.05 over the high end of our original fiscal year guidance and would be the highest diluted earnings per share in the history of our company. It is important to note, this fiscal year EPS guidance also reflects the estimated $0.02 negative weighted share impact on the sum of the quarters. Additionally, fiscal year net revenues are now expected to be in the range of $3,995,000,000 to $4,035,000,000, which would represent record revenues. For all other fiscal year 2012 guidance, please see today's press release. In conclusion, we are particularly pleased with our results this quarter because they demonstrate our ability to consistently deliver against both our near- and longer-term objectives. Throughout the year, we have communicated how energized and excited we are about our future. This excitement exists from our associates in our stores, our care centers and our corporate staff, to our supply chain associates around the world. This quarter also demonstrates the commitment of our executive team to deliver value to our shareholders through consistent and predicable performance, while building the foundation to investments in our future that will yield further returns. While the events of the past 2 weeks may have hampered our ability to forecast the very near term with total accuracy, we are confident that the strategy and discipline that have driven our performance in the first 3 quarters of the year are firmly in place to achieve excellent results for our shareholders this year. Q3 represents another record quarter for Williams-Sonoma Inc. and illustrates our commitment to profitable growth. We are committed to delivering our full year guidance. I would now like to open up the call for questions. Thank you.

[Operator Instructions] We'll go first to Matthew Fassler with Goldman Sachs.

Two quick questions. You alluded to the challenge in predicting the business or incremental challenge predicting the business in the wake of the storms. Assuming that there's some volatility in the business, you might clarify that a bit. Is the geographic nature of the location of the volatility suggesting that it is in fact due primarily to the storms because they're happening mostly in the Northeast? Or are you seeing it happen or transpire more broadly across the chain?

Thanks for the question, Matthew. We're at 2.5 weeks, I think, into the quarter. And of course, the storm happened in the first week. So it's been a very short period of time, but we see strength in our business. And as we get further away from the storm, we see improvement. The whole country doesn't even have power still, as you probably know very well because you're there, and there's still a lot of people just kind of getting back to normal. But with that said, of course, we measure everything affected, non-affected areas. And it's clear to us that we have strong business performance. And we don't see any difference going into Q4 and our ability to run our business and deliver results than we have throughout the year. And in fact, on a relative basis, we feel more prepared going into the fourth quarter than we have any other time this year. But there is uncertainty out there, and we are recovering from one of the biggest storms we've had in recent memory, and we love what our associates have done. If that's any indication of their commitment, we know they're going to be there for our customers throughout the quarter. And I just -- I think on that point, so much has been done by our associates during this time that I just -- I'd like to have just a minute for Pat just sort of share some of those stories because it really speaks to the kind of ownership that we have in this company.

Thanks, Laura. Matt, our West Elm team had a special event over in Dumbo around their West Elm Market opening and several hundred people came, right? Almost right after -- right in the storm, and it was a real gathering point for them. The team did a public service day and went to one of the affected communities and worked. We had to cancel an artisan market in Williams-Sonoma. We knew those vendors were counting on that money, and so we rescheduled it right away and had it to great success up in our Columbus Circle store, and we just -- as I know you've heard from some of your associates there, some of our people walked the entire length of Manhattan to get to the stores when they couldn't get gas. I mean, the stories go on and on, but we're just so pleased with the commitment of our associates and their commitment to really deliver and serve the customer.

Well, having had dinner across the street from your Dumbo store on Saturday, I'm happy to say it's in good shape, but...

Yes, it's amazing, what -- and Pat didn't mention, but we had so little damage because in advance of the storm, everybody just spent the whole couple of days before moving product out of low-lying areas. Some people didn't really think it would hit as hard as it did, but everybody just took it on their own to make sure that the product was out of harm's way and Westport, of course, was hurt, but that's it. We had a store that was being constructed, and we boarded it up, and we've been very fortunate. But it really is because our associates care so much, and we care about them. We've been generous with them as well.

One quick follow-up question. Your merchandise margins have kind of come all the way back. And it's happened quickly, relatively quickly given the hit that you took last year. Your fourth quarter margin compare, as you all know, is the easiest of the year given the challenges that you had in the fourth quarter of last year. Within your guidance, what's your thought process on the merch margin dynamic? Are you giving yourself some leeway for an unpredictable environment? Do you feel like the trajectory that you're on can continue here?

Sure. In Q3, we saw a competitive environment, and we outperformed, and we expect to do the same this holiday season. But it's very promotional out there, and it might get more so as we move further into the season. We said all year long that we are ready to be promotional. We are confident of our lineup of product, and we have a plan to be competitive. Competitive pricing is a key part of our strategy. We know the customer expects, responds to promotions, and we don't think this is going to change. And we are so pleased in Q3 that we were able to drive higher merchandise margins while executing on these strategies. And we're going to be competitive this holiday, and we're well poised for this fourth quarter.

We'll go next to Daniel Hofkin with William Blair.

So if I could just maybe amplify a little bit on the gross margin. Did I conclude correctly that you saw overall -- not just some of them, but overall gross margin improvement in both the retail and direct channel?

So in the direct channel, we saw that selling margins were actually down, but in the retail channel, selling margins were up. But overall, I think the big story, I think similar to our conversation last quarter is that gross margin in total year-over-year is up primarily due to occupancy. But when you dig into that, the big story is that the selling margins again sequentially are improving across nearly all brands. And when you look at the product margins, they are up year-over-year. And from the beginning of the year, they've improved across all brands. So we see strong momentum in our margin throughout the company.

Okay. And then within the direct, you said selling margin is down. What was the primary factor there?

Yes. That's again speaking to our favorite words, the power of our operating model. Remember that in the DTC channel that when we give free shipping, that hits our gross margin line, but we offset that with the efficiencies in our advertising, which hits SG&A. So when you look at that -- when you look at each of those separately, you're going to see a disconnect there. But again, when you look at the operating margin in total for the DTC channel, it's substantially improved and is one of the highest margins we've had, so we feel very strong about that.

Great. And if I could just expand a little bit on Matt's question, I recognize the visibility at this early stage is very limited. If you could just maybe give us some sense for how much incremental conservatism you built in, in terms of sales and profits based on Sandy-related impact, that might be helpful.

Yes. We're obviously not quantifying that. What we have said is that in Q4, there are 3 things that are impacting our number. The first is, as you know, we've been talking about all year, our incremental SG&A investment to support our strategic growth initiatives. That's reflected in Q4. We also have the exciting opportunity regarding our global expansion for Australia. That's happening in early fiscal 2013, but we're incurring some of those costs. We've told you before, that's $0.02. That actually is being incurred in 2012 for benefits that are happening in the future and then we have the near-term impact of Hurricane Sandy, which obviously as we've said in our prepared remarks, is really hard to forecast, but that is reflected in our Q4 guidance. But keep in mind, I want to make sure everyone's focus on the bigger picture that at the end of the day, when you look at the full year -- and again, we're working towards a longer-term vision. When you look at the full year, we are still raising our guidance. We still have the highest revenue and the highest earnings in the history of the company.

[Operator Instructions] We'll move next to Peter Benedict with Robert W. Baird.

It's actually Justin on for Pete. Julie, just regarding the $20 million in incremental expense that you've talked about throughout the year, can you just help us understand the timing of how that has flowed through the P&L? Is it fair to assume that the bulk of spend -- or the spend is more heavy here in the fourth quarter versus the other quarters of this year?

Yes. I figured it wouldn't be long before I get that question. As we have said throughout the year, we're not providing you exactly how that spend is flowing through. But we've said it's relatively ratable. But as you know, as we're growing a business to $10 billion, we're going to have to spend some money upfront before future returns. And so that is just a small piece of a much bigger picture that we're excited about.

We'll take our next question from Laura Champine with Canaccord.

Julie, so once again, we're trying to reconcile the Q4 guidance with what was implied when you gave Q3 guidance, which obviously -- how much is the expense or the drag from the Australian stores, which I don't think was in that guidance at the time?

Yes. We quantified that for you before, it was $0.02 impact.

And that $0.02 hits in Q4?

Predominantly, yes.

Our next question comes from Joe Feldman with Telsey Advisory Group.

I wanted to ask, you mentioned that we've seen the inventory issues at the Pottery Barn Teen brand. Just wondering, are there any other areas where you feel you were maybe a little light that you need to get more, you would have had higher sales? Or if conversely, where you are a little heavy, and where you might have to promote for the holiday season?

All of the above. It's always that way in retail. But the great news is, in total, our inventory is really well poised for the fourth quarter. We're clean. We have -- Halloween was a success, and we're in good shape. We're also in better stock than we were last year. We learned a lot about how late in the season people shop and how important it is to have the goods when they want them. And so we think that'll be a real benefit as we get into the high gift-giving time of year.

We'll move on to David Magee with SunTrust.

Just thinking some more about the fourth quarter. I know last year was pretty promotional, and you've alluded to the fact that this year might be promotional as well. I'm just, on a relative basis, can you compare the 2? And how might you deal with it better this year than last year?

Yes. I mean, it was competitive in Q3, and you saw the results there. Our planned promotional strategy is working. We also learned from some of the things that didn't work as well last year. And so we know what was incremental and what wasn't, what the customer responds to. And we have a lot of different ways to market to our customers. We try different things, and we roll them out across different brands based on how they work in one brand, and that's a great benefit of having a multi-brand company. I'd say that it is as promotional as it was last year. The storm, I think, caused some short-term gluts in some products that people thought they would clear before Christmas, and you're seeing that. I mean, if you go to the mall, you can see a lot of events going on in-store, and we're prepared for that. We said, we thought that would happen, and we have a very, very competitive strategy for the rest of the year, and it's a state of mind. We're not going to let people take business from us.

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

I want to just focus on the real estate portfolio a little bit. When we look at the Williams-Sonoma brand and the Pottery Barn brand, in both cases did at similar levels to openings as closings. I was hoping you could just talk a little bit about where those 2 concepts stand in terms of stores that you're pleased with, stores that you'd like to remodel, stores maybe that you'd like to relocate as we think about the opportunity over the next few years?

Sure. Company-wide, we have a very disciplined approach to real estate, and we look at it regularly. We set high profitability levels for each store, and we conduct market-by-market reviews of our fleet, and it's resulted in a very profitable real estate portfolio. And we have closed stores that are underperforming or where the rent doesn't make sense relative to our hurdle rate. And we've opened other stores based on opportunity we see in the market, and we'll continue to do that. And so we have areas, stores, I should say, that we are planning to prune over the next 3 to 5 years. In Sonoma, we have some; and in Kids, we have some. But relative to other retailers, we have a very profitable retail fleet. We don't have unprofitable stores to the extent that other people have because of this high hurdle rate that we've always lived with.

We'll go next to Neely Tamminga with Piper Jaffray.

This is Neely Tamminga. A question for you guys on actually Mark and Graham. Well, I think it is actually fantastic done with respect to launching this in terms of where we are going with personalization. But when I'm on Mark and Graham, I kind of feel like there are logical categories that you guys have not yet maybe launched, and so it's a two-part question. One, what's been some of your early learnings? And candidly, what's keeping you from kind of doing even more with personalization even beyond monograms, whether it be photo uploads from Instagram or even they can do some stationary-type categories what-have-you. Could you speak a little bit more about what your longer-term vision is for this?

Sure. Great question. We are so pleased with Mark and Graham's launch as it represents really the entrepreneurial spirit of our company, and it really is everybody's mindset to look for white space and to say, how do we do a better job? And while we have monogramming in each of our brands, many of our brands you think about buying for yourself first. And I think when you look at the presentation of Mark and Graham and also the website, it is really -- it makes you think about gifts, and it's such a wonderful experience. The shopping path to the monogram personalized item is very simple. The box, I don't know if you've ordered anything, but when you do send something, I think you'll be absolutely delighted by the out-of-box experience and how beautiful it is. And there's such value in that to the customer. We have a lot more to go in terms of product expansion. It's a very edited assortment. We literally took as much time to identify the right monograms on products so that we had great combinations as we did in identifying the products. So that nobody can make a mistake and order something that doesn't look good together. So scale and color combinations were all really carefully chosen as was, as I said earlier, the packaging, and we're going to learn a lot. It's been in home what, 2 days. Monday was a postal holiday, so it just got in home on Tuesday. We mailed a very select group of customers. So far; so good. I can't tell you what the bestseller is because we've kept it a secret even from our associates because we're doing a contest to see who picks it. But we're very pleased, and we believe it will be absolutely incremental to our other brands. We also like it because it inspires all the brands to think about what else they can do. And it's an interesting story in Williams-Sonoma, we launched Verismo, and we wondered what would happen to the rest of our coffee machines. And the most fascinating thing happened when we launched it, which is, that espresso sales went up because the launch of Verismo brought attention to the category. And we think we have the same opportunity with Mark and Graham with our other brands' monogram selection.

We'll take the next question from Christopher Horvers with JPMorgan.

Could you give us a flavor of the dialogue with some of the branded manufacturers ahead of the holiday season? It seems like perhaps Le Creuset is no longer at Bloomingdale's. Curious if that's representative of the mood out there? And related to that, you've seen some of the big-box guys come in and say, hey, you know what, we'll match prices on Amazon. Do you have a policy in that? And how are you thinking about that?

We're looking for exclusive products with our vendors, and we want the best. And so we do have things others carry. What I will tell you is that versus last year, there's less of a gap. We decided to be more competitive, and we also reduced our shipping, and that's made a big difference because that was in the way of the value equation for some of our customers. And also, Amazon is having to collect tax in more states and that also helps us.

And Greg Melich with ISI Group has the next question.

I want to get into the fourth quarter outlook and the 3 things you listed that would pressure EBIT margins. Can you just confirm that gross margins, that you do expect them in the fourth quarter to continue to improve product margins? Or is that also likely to roll over just given the mix and the promotions?

Unfortunately, we don't provide guidance on the gross margin line level. But the guidance we provided is at the operating margin level. And so I don't know if you still have the question about the 3 items that are impacting it, but again, it's the $0.02 impact from Australia, it's our SG&A investments we've been talking about all year and the estimated impact from Hurricane Sandy.

Well, then, maybe on the 3 things that you did list, is it -- how do those things match up today versus 3 months ago when you were planning them? I know there was a question before on that a little bit, but if you were to say today versus 3 months ago, how has the planning changed just given what's worked and what hasn't worked?

There isn't any change. The only thing we didn't obviously know about was the storm that happened a week ago. But everything else is the same in our guidance.

The next question will come from Dave Gober with Morgan Stanley.

Just had a bigger-picture question, for the last several years, the company's been focused absolutely on what you can control and not on the macro environment. You mentioned a little bit that you've invested in the home renovation category, but I'm just curious if you see any changes as we started to hear some improvement in the broader housing market, and we've heard that from a number of different companies. Are you seeing that in your results? Are you seeing more furniture sales because of that? Or are you expecting to see a change in the mix of the business over the next 6 to 9 months or so because of that dynamic?

Yes. It's a really good question. We look at a lot of different parts of our business to try to discern what's going on. I do think there's a positive uptick there because when you move, you update a lot of things in your house that are core, whether it's bath towels or bath mats. Curtains are often -- you don't change your curtains unless you move. And some of those categories are doing better now than they were before. It's early in the cycle. We know that a housing recovery would be very good for us obviously and particularly for our Kids and Teen business. Because oftentimes, the reason you move is to have another bedroom for a child and then that bedroom requires furniture, and it's fun to redecorate, and it's -- I know it too well. I've been in the same house for a while that you don't change much when you don't move. You buy decorative accessories. You buy pillows, unless you're doing a room over. And so I do think that we are seeing the benefit from a slight housing uptick. And I expect that we're going to see more, and we are building strategies to capitalize on it. Pat?

Yes, just a little bit to add on to that, Dave. The beauty of that we have here with the e-commerce site is that we can test these categories very quickly online, decide which of these, of the classifications are working the best before we roll them out to the stores. And that's what we did in Pottery Barn and if you go to the site and look at the bed and bath renovation area, we, in anticipation of the housing recovery, we started working on that a year ago. And really, we're able to fine tune that and build it up to be a pretty substantial business, and then we can extend that out to the stores once we know exactly what is going to be responsive to the customer.

We'll hear next from Michael Baker with Deutsche Bank.

So understanding that you're already planning for a more promotional fourth quarter, are you seeing it now be more promotional than you had originally planned? Is that something that's leading to the little bit of a downtick in the fourth quarter guidance versus where it previously was? And does Sandy make it be more promotional because you've lost some sales and you got to win it back? While I have you, related to margins and promotion, can you tell us the thought process behind eliminating the Williams-Sonoma Reserve? One big question.

Good job. I am not surprised by the level of promotions, and we are well prepared to handle it. So that's the first thing. Sandy, of course, for us the thing that would be impacted is Thanksgiving, right? Because elections, Sandy, you have 1 week left, and that's an example of a product category that are we little more promotional on? Yes, you could go to our stores and see it, then we were. But we're not -- it's not drastic promotion. But we're not going to sit on those goods post-Thanksgiving. We're on it. So it's -- that’s a time-sensitive holiday. Obviously, that it doesn't surprise you, it would be impacted. I think a lot of people, they've had a lot on their minds lately and you're going to see big shopping this weekend, big shopping next week as people remember, we got to get Thanksgiving together. So that's the first thing. Williams-Sonoma Reserve, we got more competitive on our shipping. So we're doing our $49 threshold shipping. We gave -- go ahead and answer it Pat.

And Michael, on the people who were Reserve members, we extended a full year of free shipping to them at no charge because. Because we did go with the $49, and we studied that for quite a while. And because we’ve continued it, and we did it, you know what the impact is. We're very pleased with the results.

And we have time for one last question from Marni Shapiro with The Retail Tracker.

Could we just stick on Williams-Sonoma for 2 more seconds here. If you can just talk about credit cardholder penetration there? And could you also talk about 2 things, I notice you still have the home assortment on there. Not something you’re moving forward store-wise it sounds like, but it looks good online. It's obviously not doing poorly, it's still there, and it looks nice. So if you could just touch on it a little bit. And if you can also touch on the food because it looks like you guys have really branched out in the food. For a while, you guys led the pack and everyone followed you. So I guess, are you feeling good about your assortment going into the holidays? And are you able to really keep a step ahead of everybody, you feeling good about that?

Yes, thank you for the question. So on the credit cards, we're pleased with the results. It's a great way for us to build loyalty with our customer and communicate with them through another means. We haven't given the percentage. We still have a lot of opportunity with it, honestly. So in sports innings, maybe third inning. Williams-Sonoma home, we see it as a strategic opportunity over the long haul because there's still space in the marketplace for higher-end home. You'll start to see us in the fourth quarter bring in some new great gifts, and we are continually testing new things so that we can drive some more sales in Williams-Sonoma home. We are now -- last year, about this time was when we put it on the same site as Williams-Sonoma, and so we're full year on that, and it makes it easier for us to read the business. The things we're excited about food, yes. We have an extended assortment of perishable food that's excellent for the fourth quarter, and we love our new imagery. I don't know if you've been able to look through the holiday catalog, but the imagery online and in the catalog is really fresh and inspiring. I don't think the croissants have ever looked better. We're also -- you didn't ask, but I can't help but take advantage of the question on Williams-Sonoma and what else we're looking forward to. I think you probably saw yesterday the launch of our cookware and our smart tools. The cookware is just amazing. We've all been using it. It heats up 25% faster, which is -- than anything in the marketplace by the way, which allows you to cook more evenly. But also when you're done cooking, it doesn't overcook because it also then releases the heat more quickly. And we have so many qualities to the cookware to brag about. Pat, you want to talk about a few of them?

Well, thanks, Laura. I've using it here for about 6 to 8 months. I think that the handles in particular, you're going to love them. They're very nice in the hand. As Laura pointed out, the even temperature is a big thing. The pans, like the sauté and frying pans, so much thought went into them. They're each a little bit higher, and so it makes a very significant difference. You don't get as much splatter. It's just a much better cooking experience. It's the first of what is going to be a very extensive launch in this area. The lids are double walled. No one else uses double-walled lids, and so it provides very even temperature, keeps the food warm when you take it off the pan. It's all those little things that both the home chef and the professional chef will enjoy.

And also, my favorite product for the holidays, I'm going to be giving to a lot of people here is the iPad speaker and stand that we just launched, and it's not even in our stores yet. It's online, you can look at it there. It's also on the Apple Store website, and it will be in their stores upcoming. They were so impressed with the product that they wanted to run it. And it's the first time we've ever let anyone run one of our products outside of our brands before, and we think it's a wonderful opportunity to extend our product to new customers. And the reason why it's so great, first of all, it looks great in the kitchen, it's simple. You can look at the screen from close-up and far away. The quality of sound -- I'm not a big speaker person, but you can hear the difference. It is significant versus what else is on the market even at higher prices, which is the other impressive piece about it, which is how good the sound quality is on it. And so that is a great gift for someone so that they can download recipes, listen to videos, YouTube, as they cook in their kitchen.

And that concludes our question-and-answer session for today. I'll now turn the conference call back over to Ms. Alber for any additional or closing remarks.

Well, I want to thank you all for joining us again this afternoon. We appreciate your time very much and your continued support, and we'll speak with you again next quarter.

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