Williams-Sonoma, Inc. (WSM) Q3 2013 Earnings Report, Transcript and Summary

Welcome to the Williams-Sonoma, Inc. Third Quarter Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the call over to Gabrielle Rabinovitch, Director of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you, Ann. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Our press release and this call contain non-GAAP financial measures that exclude the impact of unusual business events. A reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why these non-GAAP financial measures are useful are discussed in our release. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which address the financial condition, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2013 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 2013 results and our outlook for the remainder of fiscal 2013.

Thank you, Gabrielle. Good afternoon, and thank you all for joining us. With me today are Julie Whalen, our Chief Financial Officer; and Pat Connolly, our Chief Marketing Officer. Our strong third quarter and our performance year-to-date illustrates the power of our business model and the relevancy of our brands. We delivered an 11% increase in revenue and EPS growth in excess of 18%. Importantly, we delivered this revenue growth and accompanying operating margin expansion while simultaneously investing in our multifaceted growth initiatives. We believe we are well positioned headed into the holiday season, and will continue to execute our key strategies to deliver an exceptional experience for our customers. We are focused on generating top line results in conjunction with operational and capital discipline to deliver long-term shareholder value. In the beginning of the year, we outlined to you our key strategic initiatives for delivering sustainable, profitable growth and increasing shareholder value. They are: growing our existing brands, launching new businesses and expanding the reach of our brands globally. We believe that the results we've reported today demonstrate disciplined execution across each of these initiatives. Our existing brands grew, and we made progress in our new businesses and in our global expansion. At the same time, we returned $115 million to our shareholders in the form of stock repurchases and dividends. All year, we have been making investments in our business to drive long-term, sustainable growth, as well as to prepare us for the fourth quarter. We believe we are well positioned as the destination for cooking, entertaining, decorating and furnishing your home this holiday season. We have a strong holiday product lineup and the widest assortment of personalized goods that we have ever offered. We've also made substantial investments in our supply chain and our information technology infrastructure, 2 of our core competencies, to deliver an elevated experience to our customers in whichever channel they choose to shop. In our supply chain, we have made upgrades to better serve our customers. We opened a new distribution center in New Jersey that is dedicated to retail store fulfillment in the Northeast. This facility has increased our flexibility in how we service these stores while reducing our inventory replenishment cycle time. In the past 2 weeks, we have completed the in-sourcing of 2 major furniture hubs as we continue to increase our control over and improve the customer experience of furniture home delivery. In addition, the regionalization of our Sutter Street upholstered furniture manufacturing capacity allows us to handle more volume while reducing transportation cost and delivery times. Another supply chain enhancement we have made is in personalization. We have invested in additional personalization equipment, including a new material handling system that improves throughput. And we have trained seasonal associates in personalization techniques. Personalization helps make gifts more meaningful, and we are leveraging our state-of-the-art monogramming, etching and embossing capabilities this holiday to grow the gift businesses in all of our brands. Also, we have upgraded our information technology infrastructure in advance of our peak selling season. Finally, our multi-year e-commerce investments are also yielding returns. This year, we've launched more than 50 products -- projects, with over 400 customer-facing enhancements across all of our websites. The combination of our open platform, agile development processes and an aligned organizational structure is a competitive advantage that allows us to deliver new functionality every 6 weeks. Here are some examples of key improvements we have made. We've improved our on-site personalization, as we believe relevancy is crucial to driving engagement. We have substantially enhanced order tracking visibility for our customers. Our new AB testing platform is allowing us to optimize the customer experience across virtually every section of our site through a robust test versus control and rollout strategy. Mobile devices are becoming a very important tool for connected customers at every stage of the purchase decision, and we are testing enhancements to our mobile sites to be more user-friendly, more image-driven, easy to search and shop, and more useful for finding a local store. The first site where we have deployed upgrades is Pottery Barn, where changes are being met with great response. And also, our e-marketing strategies encompass many different programs which continue to evolve and become more sophisticated, with the result that we are driving more revenue from existing customers and acquiring new ones at lower cost. I would now like to update you on our new business initiatives. We continue to see opportunity, both domestically and internationally, to help our customers decorate, furnish, cook and entertain at home, across demographics and life stages. Our global footprint is expanding and, in the third quarter, our revenue from foreign operations increased 31% to $51 million. In addition to the stores in Bondi Junction, we opened a West Elm store in Melbourne in September. In Australia, the response to our fully-integrated, direct-to-customer business has exceeded our expectations. We are excited to be opening our first store, a West Elm, in the United Kingdom next month, and we are looking forward to scaling our operations in both Australia and the United Kingdom. Our franchise operations also continue to grow. Our partner in the Middle East opened 2 stores in Saudi Arabia this quarter, bringing the total number of franchise stores to 27. I would like to spend a few minutes discussing our newest brands, Mark and Graham and Rejuvenation. Mark and Graham recently celebrated its 1-year anniversary. Demand is increasing as brand awareness grows. As an example, Mark and Graham's classic leather gloves are being featured this holiday season as one of Oprah's Favorite Things for 2013, and the typographer's napkins were on the O List in the November issue as the lead-in to the entertaining section. In addition, the brand will also have editorial placement in several other national publications in the coming weeks. The brand's assortment now encompasses 10 discrete categories including personal accessories, jewelry, apparel, tabletop, linens and seasonal products. Mark and Graham has a social media presence that is an excellent expression of the brand and is taking the gift-giving experience to a new level with innovative personalization techniques, sophisticated merchandise and beautiful gift packaging. We acquired Rejuvenation 2 years ago and while the business is still small, we continue to see an opportunity to materially grow this brand. This year, we introduced portable lighting, which extends the brand's relevance beyond hardwired products. We have been working on our product strategy to broaden the aesthetic. The next wave of product introductions will occur in 2014 and will offer more SKU depth to the bath and kitchen. In addition, Rejuvenation is leveraging our sourcing and supply chain for new product development and utilizing our database marketing expertise for targeting and customer acquisition efforts. Now I'd like to discuss the performance of our 3 Pottery Barn brands. In all 3 businesses, we will drive growth by delivering a synergistic cross-brand experience for our customers. We are leveraging our channels and extensive customer data to better serve our customers' needs in all of the rooms of their homes. The e-commerce improvements I mentioned earlier are improving the shopping experience across channels and devices, helping our customers shop with ease anywhere at any time. A comprehensive suite of services complements our innovative and well-priced product offerings. Our in-home services are differentiating us in the marketplace. Our team of designers meet with our customers in their homes and make the decorating process fun, fast and affordable; and our design services are offered free of charge. From decorating your trees for the holidays to helping you set up a breathtaking bar for that holiday party, we'll do it for you. And we will also be there to offer a concierge gift service to help our customers tackle their gift list with ease. In the third quarter, Pottery Barn comparable brand revenues increased 8% on top of 11% last year, with strong results across channels and all key categories. From a merchandising perspective, performance was led by the dining and leather furniture collections and bedding assortments. The strength of our outdoor collections continued through the third quarter. Entering fall, our dining chair and upholstery businesses gained momentum. As our upholstery business grows, we are leveraging Sutter Street, our in-house manufacturing facility, to produce our merchandise faster and at better prices. And we are returning this value to our customers. As we enter the fourth quarter, we are focused on extending the reach of clienteling to decorate both outside and inside the house for the holidays. We have broadened our seasonal decorating collections and are featuring both an elevated lodge and a classic, nostalgic aesthetic. We've also expanded our dining and entertaining assortments to help our customers host parties at home. This holiday, we are most excited about our faux fur collection, which is the biggest and broadest offering we've ever featured in the plush and luxurious materials. The collection includes throws, pillows, bean bags, neck rolls, duffle bags and more. Our exclusive ornament assortment features whimsical and nostalgic themes. And this year, we've extended our gift collections across price points and categories. From jewelry boxes and frames to stocking stuffers, we are offering personalized gifts for every price point and every gift recipient. For the third quarter, Pottery Barn Kids' comparable brand revenues increased 4% on top of 10% last year. In the quarter, our seasonal business drove strength in the brand. Our Baby business brought new customers to Pottery Barn Kids, and we saw growth across decorative accessories, furniture and textiles. We've expanded our crib offering across aesthetics, functions and finishes, and we have introduced additional nursery chair and bedding options. We are well positioned for holiday with our expanded seasonal decor, quilted stockings, nursery rockers and irresistible gift collections. In addition, this year, our enhanced personalization capabilities continue to expand customization options. As Pottery Barn Kids has the highest penetration of mobile shoppers among our businesses, the improvements we discussed relating to the simplification and optimization of our mobile user experience are particularly significant for this brand. We're helping our customers celebrate with their families and delight their children. Creating memories and traditions, our holiday assortment is inspirational and authentic, and we are pleased with the initial reception of these holiday collections. In PBteen, comparable brand revenue increased 17%. Performance this year has been driven by strength in furniture and textiles. In addition, our PB Dorm business grew significantly as a result of a broader assortment and improved marketing. In the third quarter, we debuted our Emily & Merritt collaboration, which has been met with a strong response. And we also launched our second collection with Burton and introduced our licensed Manchester United textiles and wall accessories. Successful collaborations and exclusive designs continue to drive newness and innovation in PBteen. We are excited about our more comprehensive gift offerings this holiday season for PBteen, and we are discovering additional synergies with our Pottery Barn Kids businesses as we focus on life-stage marketing across the Pottery Barn family of brands. Next I would like to discuss the Williams-Sonoma brand. In the third quarter, comparable brand revenue grew 1.4%, which accelerated sequentially from the second quarter and year-over-year. Our autumnal and Halloween assortments contributed to this growth. In addition, exclusive products from key vendors and our branded products drove positive results. All year, we have been preparing for the fourth quarter, and we believe there are 5 areas that will give us a competitive advantage. First, our stores. Our stores are a competitive advantage and essential part of connecting with our customers. As a result, we have invested in and increased and improved training in key categories, and our field teams are better trained and more engaged than ever. Second, we have increased levels of newness in our stores and online. We have more exclusive and branded product introductions this quarter. New product introductions include hard-anodized copper core cookware, Williams-Sonoma's stemware, prep and serve tools, roasters and a high-performance rapid boil top. We've also increased innovation in our foods and perishables business. This year, we are celebrating the 15th anniversary of our nostalgic peppermint bark with an expanded collection, and our gifting assortment is stronger and more relevant to a broader customer demographic than in past years. We have an increased selection of high-quality gifts, including relevant gift sets, and a new hamper collection that helps make gifting effortless. And we will inspire our customers and help them prepare for the holidays with our new entertaining and tabletop collections. Third, we have improved in-stock positions on our key holiday items and core assortments to ensure better service levels for our customers. In fact, in the last few weeks, our out-of-stock levels at retail on top items have decreased by double digits year-over-year. Fourth, we have made high-impact changes to our visual presentation. In our catalogs, we are featuring strong narratives complete with recipes. The content, imagery and value equation are more compelling. In our stores, we have new visual displays, boutique shops and an increased interactive experience. And online, easy-to-find gift shops. Supporting all of this is the Williams-Sonoma, Inc. foundation of e-commerce and supply chain excellence. And last, Williams-Sonoma Home continues to be an opportunity. Our sales and assortment continues to grow, and we continue to identify more highly responsive segments in our database and are seeing success in the stores offering the Williams-Sonoma Home collection. Given the fragmented high-end home market, we believe Williams-Sonoma Home represents a material opportunity for us, particularly online. Finally, I would like to discuss West Elm. West Elm continues to post record revenue growth with an increase of more than 30% in the quarter. The brand delivered comparable brand revenue growth of 22% on top of 13% last year. West Elm opened 4 stores in the third quarter, including locations in Melbourne, Australia; Tampa, Florida; Oak Brook, Illinois; and Birmingham, Alabama. We will open an additional 3 stores in Q4, including our company's first location in Europe on Tottenham Court Road in London. West Elm brand growth was broad-based across categories, including furnitures, textiles, decorative accessories and lighting. Handcrafted products and limited-edition collections, created in collaboration with independent artists, continue to be a key differentiator among competitors. This quarter, in support of artisanal communities in the United States and around the world, West Elm made a Clinton Global Initiative commitment to action, a 2-year, $35-million handcrafted purchasing plan and a transparency pledge around the making and sourcing of those products. The brand's commitment highlights our company's efforts, overall, to achieve our business goals while improving our social and environmental performance. West Elm continued its positive partnership with Etsy and announced it would be rolling out local assortments in many of its 50-plus stores, investing in crafts in the communities where we do business and abroad. Test assortments were celebrated in our Brooklyn and Atlanta stores in October. West Elm continues to be a leader in social media, growing awareness and credibility through global and store area communities. Each West Elm store manages its own Facebook and Instagram pages, connecting our customers with our associates in authentic and highly visible ways. All stores are hosting a regular schedule of classes and events, many in partnership with local artists, bloggers and influencers. In-store activities add another dimension to the brand's cross-channel customer experience, bringing promotional activities to life. As we look forward to the fourth quarter and beyond, West Elm has an exciting future ahead. Our strategy remains to profitably grow the brand and attract a broad base of customers by offering choice in our products and services that will help customers express their own individual style and create a home that will connect with their story: community through connections with like-minded strangers, our crafters, collaborators, customers and associates, and consciousness in everything we do, from handcrafted and local products to supply chain transparency and sustainability. The successful combination of these 3 factors is differentiating West Elm from its competition. With revenues expected to exceed $0.5 billion this year, we are confident in this brand's ability to be a $1 billion-plus business. Now I will turn the call over to Julie for additional details on our third quarter financial performance and our fourth quarter and full year 2013 financial guidance.

Thanks, Laura, and good afternoon, everyone. Our third quarter results exceeded our expectations and demonstrated the advantages of our multichannel, multibrand platform, as well as our ability to continue to drive market share gains and profitability while simultaneously investing in the business. For the third quarter, net revenues increased 11.3% to $1,052,000,000, with comparable brand revenues increasing 8.2%. Net revenues in our direct-to-customer channel grew 14.5% to 49% of total company net revenues versus 47% last year. Net revenues in our retail channel grew 8.5%. Pottery Barn and West Elm were the most significant contributors to revenue growth. Total company operating margin for the third quarter was 8.8%, a 40 basis point improvement over last year, and includes continued investments in our global expansion. The direct-to-customer channel operating margin increased 40 basis points to 22.9%, driven by advertising leverage, which was partially offset by lower selling margins. The retail channel operating margin increased 30 basis points to 9.1%, primarily driven by the leverage of employment costs and was partially offset by lower selling margins. Corporate unallocated expenses increased 10 basis points to 7% of net revenues, partially due to the incremental cost to support our growth initiatives. Gross margin during the third quarter was 38.6% versus 39% last year. The 40-basis-point decrease in gross margin resulted from lower selling margins from competitive pricing strategies across all of our brands, partially offset by occupancy leverage. Occupancy leveraged 30 basis points, with occupancy costs at $142 million in the third quarter of 2013. SG&A improved 80 basis points to 29.8% in the third quarter of 2013 versus 30.6% in the third quarter last year. This improvement in SG&A was primarily driven by the leverage of advertising and employment costs. As we have said before, the high penetration of our direct business allows us to flex between margin and advertising cost to deliver revenue and operating profit growth while generating operating margin expansion. This revenue growth and operating margin expansion drove an 18% increase in third quarter 2013 diluted earnings per share to $0.58 from $0.49 last year. These results demonstrate our continued focus on generating meaningful shareholder returns while investing in our future growth. Merchandise inventories grew 18.5% on a comparable basis. The biggest drivers of the inventory increase are in those brands fueling our growth: Pottery Barn and West Elm. We also had additional inventory this year that we didn't have last year to support our global expansion and new brands. Across our brands, the inventory increase is in our top-selling core programs. Additionally, inventory in transit on a comparable basis has grown substantially, as we are improving our in-stock levels in time for the holidays. As a reminder, as a result of the 53rd week last year, our inventory growth is also impacted by the 1-week calendar shift. Our third quarter ended on November 3 as opposed to October 28 last year, causing a higher level of holiday receipts to occur in the third quarter this year as opposed to the fourth quarter of last year. From a balance sheet perspective, merchandise inventories increased 30.5% to $899 million. As we mentioned last time, as part of our expanded Asia sourcing initiatives, which include directly procuring our inventory for our global operations through our Asian entity, we are taking ownership of our in-transit inventory earlier in the supply chain. Excluding the impact of this additional in-transit inventory, which is not in our prior year numbers, merchandise inventories increased 18.5% on a comparable basis. Cash at the end of the third quarter was $129 million. Over the past year, while generating $450 million in operating cash flow, we have returned $351 million to shareholders. During the quarter, we returned $115 million to shareholders through share repurchases and dividends and invested in the business with $47 million in capital expenditures. I would now like to discuss our fourth quarter and fiscal year 2013 guidance. For the fourth quarter of 2013, we expect to grow net revenues to a range of $1,370,000,000 to $1,430,000,000, with comparable brand revenue growth in the range of 3% to 6%. Diluted earnings per share are expected to be in the range of $1.30 to $1.37, and we expect our operating margin to be in line with last year's rate. For the full year, as a result of the outperformance in the third quarter, we are raising our revenue and earnings per share guidance. We now expect to grow net revenues to a range of $4,290,000,000 to $4,350,000,000, with comparable brand revenue growth in the range of 5% to 7%. And we now expect fiscal 2013 non-GAAP diluted earnings per share in the range of $2.76 to $2.83, representing a year-over-year growth rate in the range of 10% to 13% after adjusting for the 53rd week in 2012. It is important to note that fiscal year EPS guidance also reflects the estimated $0.02 negative weighted share impact on the sum of the quarters. Additionally, our fourth quarter and full year guidance contemplates several factors. First, the fourth quarter of 2012 included an additional week, worth approximately $70 million in revenue and $0.07 of earnings per share. On a comparable basis, due to the 53rd week in 2012, there is a 1-week calendar shift this year between the third and fourth quarter. This shift resulted in a preholiday selling week moving from Q4 to Q3. Second, the holiday shopping season during the fourth quarter will be a week shorter due to the date on which Thanksgiving falls. Third, our fourth quarter and full year guidance contemplates the closure of significantly more Williams-Sonoma stores in the fourth quarter as compared to last year. We plan to close approximately 11 stores this fourth quarter versus 8 last year. These closures represent stores that are underperforming and predominantly at the end of their lease lives. In summary, we are pleased with our results and believe that we are well positioned for this holiday season and beyond. Our customer is at the center of everything we do and the investments that we are making. We are confident in our innovative product, great value and outstanding services. We are looking forward to helping you and your family shop this holiday season. I would now like to open the call for questions. But before I do, I want to wish you and your families a happy holiday season.

[Operator Instructions] We'll take our first question from Budd Bugatch from Raymond James.

I'm wondering, and I hope you can hear me -- I wonder -- just 2 questions if I can, and I'll phrase them together. One, you gave us international revenues this year. I wonder if you could give us what the comparison was against that for last year. And maybe a little bit more color on the SG&A leverage between segments or -- you said advertising, and I think occupancy -- not occupancy, advertising and leverage in payroll. Can you give us kind of a feeling on how that was between the segments?

The international, we don't have the growth over the prior year because there wasn't really a substantial amount of growth. If you go 2 years back, we really didn't have as much international operations. All we would have had was the franchise. You can look back in the Q or I can get that for you offline. But as far as the SG&A, it really was significantly driven by advertising and employment leverage. Obviously, the more sales we have -- when we have higher sales than we expected, that leverages all of the costs.

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

Just -- I guess maybe a follow-up on the Williams-Sonoma evolution. I would like to know kind of where -- you talked about some of the increased exclusivity, where that is right now versus where you think it might be in a couple of years? And then the other question relates to operating margins. You had a nice kind of balance between the 2 segments this quarter in terms of improvement. In the fourth quarter, it looks like the top end of your guidance assumes flattish margin, maybe some decline in margin at the lower end. Just curious what the dynamic is. Is it just the holiday-related competitive environment? Or is there something sequentially that would cause the margin to potentially be down a little bit year-over-year in the fourth quarter?

Sure. Thanks, Daniel. It's Laura. I hate to use a sports analogy, but I guess I would say we're in the third inning, that we're just getting started. Janet has been in her role for 6 months. And while we started evolving our product strategy prior to Janet, the durables product development life cycle takes a while. We also want to make sure that before we change any strategy, we want to make sure that we know it's going to work. And as a result, we've been very thoughtful about testing changes in the Williams-Sonoma brand. As I've told you before, our primary focus is on product exclusives and innovation, retail execution and exciting visual presentation. And we believe there's still more growth to be had in every category, and we're looking for bigger and more broad-based growth. We know the brand is widely loved and revered, but we want to make it more accessible to more people. In the future, you're going to see us bring in a wider range of products, the best quality for what they are but aren't necessarily the most expensive. We also know that we can work more closely with our key vendor partners to develop more exclusives that will further differentiate us from the competition. And we're also seeing emerging trends that we'll be building on in new categories like the Williams-Sonoma Home business, and we are still in the very early stages of developing that.

And, Dan, regarding the operating margin, a few things going on there. Definitely, this is the first time, I think all year, that we've had operating margin expansion in the retail channel. So that's really exciting. And obviously, the higher the revenues we have, it leverages all the way through and drops to the bottom line. So we had the margin expansion this quarter. For next quarter, we've guided to be in line with last year. And one thing to remember there is that we do lose some leverage from the transition to a 13-week -- transition away from a 14-week to a 13-week, and so some of that does impact the bottom line. But with that said on the year, we basically raised the year on the bottom. It used to be at 10.0% to 10.3%. It's now 10.1% to 10.3%. And at 10.3%, as you guys know, it's equal to the highest rate we've had and will generate the highest level of operating income we've ever had. So -- all while investing in our strategies for the future. So we feel very confident about that.

We'll go next to David Magee from SunTrust Robinson Humphrey.

We're hearing from some retailers about their promotions earlier in the season. Just generally speaking, it seemed to be more severe than expected. And I'm just curious what you think about sort of the environment here relative to what you may have thought a few months ago.

Yes, we continue to recognize the promotional environment. We've been talking about it for over a year, that we embrace it and don't think it's going to change. We know our customers would rather buy from us than our competition, and so we are focused not just on price but also on all the other things that makes you buy something from a retailer. And we believe we have the competitive advantage in many of those areas. But on price, specifically, we have a very exciting line up of great value for the holiday season, and we're going to vary it from last year so that we can keep everybody on their toes and drive excitement for the customer. So you're going to see us have planned promotions, as we have all year. And it's hard to get a read on the macro and consumer sentiment, given the multitude of conflicting data points. I don't know what's going to happen with the macro, but I do believe that people are enthusiastic about decorating, cooking and entertaining. And thankfully, that is the business that we are in.

Great. On the Williams-Sonoma brand specifically, could you tell us sort of what the proprietary product percentage is this year versus last year?

It's higher.

So it's meaningfully higher year-to-year?

It's higher. And what I think is most important versus SKU counting is the quality of the exclusives.

And last question, the distribution changes that you're making now, is that going to be meaningful to next year's EBIT number? Is there a chance to really leverage that nicely into next year?

You have to remember that the most important thing about our supply chain enhancements is that we're able to give our customer better service. And in many cases, we have passed along the savings to our customers.

We'll go next to Peter Benedict from Robert Baird.

Just curious, your business has been pretty consistent across the year here, but just the cadence across -- during the quarter, was there any choppiness that you saw? Just trying to understand that. And as it relates to Pottery Barn, the complexion of the business, I mean, is there anything in that -- in the mix there that you are seeing that starts to show you evidence that the remodeling boom is starting? I mean, I know the business has been strong, we can see that, but just trying to pull back the covers a little bit on a category standpoint. Are you seeing anything that's been changing over the course of this year that can speak to that?

Yes. From a cadence perspective, we don't comment on that as it's playing out throughout the quarter. But I'll let Laura talk about Pottery Barn.

Sure. It's clear to us that the customer is very focused on their home and that, while we can't see a correlation one-for-one with housing starts or anything specifically in the macro, we do believe that people feel better about spending money on their home because the value of their homes are no longer dropping. And so at the same time, it's difficult to decorate and we're seeing market share gains, we believe, because we not only offer a wide array of well-priced products that are high quality, but also we help the customer put it together in the home. And I think it's probably early innings of a housing recovery, but we believe that because we are making it easier and offering great assortment to our customers, that we're gaining share and we will continue to do so. And so you'll see us increase newness. And also, we're also seeing uptick because we're offering more dimensional size options for our customers in terms of furniture. I mean, so many times, when you go to buy a new sofa, not only are you looking for style and the right price, but you're also looking for something that fits in your family room. And so we're very cognizant of where those holes are in our assortment and where we're adding new SKUs to gain more customers in the future.

We'll take our next question from Greg Melich from ISI Group.

Want to talk about the retail margins international, how they link. If I understand it right, your international revenue falls into the retail segment. And if that's right, how much of the sales growth is really coming from international? Or what was the trend in retail? And then second is how do we think about the retail margins in terms of -- we had a nice improvement this quarter but clearly, the calendar shift helped some there. How much of the margin improvement there would be driven by that week shift, international?

Okay. So from a retail perspective, really, last time, we specifically called out that one of the biggest drivers was international. This time, it was primarily just across the Pottery Barn and West Elm brands, not specific to international. So that wasn't one of the biggest drivers. With that said, the growth there was 31%. And year-to-date, it is 48%. International is almost 100% in the retail channel. So when I talk about it, it's because of the effective drag on earnings, by the fact that we have costs ahead of revenues. So from a margin -- from a Q3 margin perspective, obviously, if we didn't have those, for example, with the U.K. store, and we're incurring costs ahead of it actually opening later in Q4, our margins in the retail operating margin would be higher. As far as guidance, we don't provide guidance by channel, but we know that the retail channel does drive sales, of course, to our direct channel. So depending on where the customer is shopping at any particular time, you'll see fluctuation in our retail operating margin. And so obviously, you're going to see this change. We're very pleased with the results that we have this quarter and the fact that we did see that operating margin expansion. But that will fluctuate.

Got it. And on inventory, I just want to make sure I got that right. The in-transit, when you're thinking about [ph] -- you're up 18%. How much did the week shift? Is that included in that adjustment? Or would there be another adjustment, given that the quarter ended a week later?

No. There would be another adjustment. The adjustment from the balance sheet to the comparable basis is simply taking out that additional inventory that wasn't in the base last year associated with our Asian sourcing initiatives. And that would take you to the 18.5%. And then when we speak about all of these other things that are driving the inventory increase in my prepared remarks, that's in particular to the 18.5%. So there would be an additional adjustment if you backed that out.

So how much is it if it wasn't calendar shift?

We're not -- it's hard to tell. We're not quantifying it. It's really hard to actually come up with the exact amount that's representative of that.

We'll go next to Brian Nagel from Oppenheimer.

So my question is on gross margins, maybe somewhat of -- I guess maybe a little of a follow-up to the prior question. But the gross margins in the quarter were still down, but the trend was improving, particularly if you look kind of on a multiyear basis. Now we spent a lot of time over the last several quarters talking about the Williams-Sonoma strategy of using select price promotions as an advertising vehicle, and then essentially trading SG&A dollars after[ph] cost of sales. Is there something that -- was there some shift or something to drive sort of, say, the improving trend in gross margins this quarter that maybe we should expect to continue to happen as we look over the next several quarters?

I wouldn't read too much into that. I think at the end of the day, we said in our prepared markets, the main driver was lower selling margins, which was partially offset by occupancy leverage. We have said even last quarter that occupancy costs in Q4 could be higher, which obviously impacts your gross margin. But I think the positive here is a few things. First of all, when you take the puts and takes form the gross margin, it's actually across all brands and all channels, which reflects our competitive pricing strategy across-the-board, it's not particular to one brand, and the fact, to your point, that we can offset it with the SG&A improvements and still have operating margin expansion is phenomenal. So yes, we say it again and again, but our focus is on operating margin.

Okay. And then a follow-up, if I could. You gave us a lot of color on some of the merchandising initiatives. I look at my model and it was pretty clear that the Williams-Sonoma brand comps improved here in Q3, again on a kind of a multiyear basis. Was there something that was shifted there for the pause in the Williams-Sonoma brand? Or is that maybe just a culmination of some of the efforts you've been putting forth lately?

As I said in the prepared remarks, we saw a great response to our Wine Country theme, our autumnal theme. And that was stronger than our summer themes of outdoor entertaining.

We'll take our next question from Mike Baker with Deutsche Bank.

So I want to focus on the margins as well. Just on the merchandise margins, which looks like it's down about 70 basis points, so it's similar to last quarter. Is there an impact there? Is that just lower pricing? Or is there an impact from more free shipping, which I think you include in that selling margin. That's the first question. Then the second question is related, but more longer term. How do we think about -- you said you're focused on operating margins. How do we think about the long-term operating margins? Remind us what's in your 3-year plan? I think [indiscernible] is about 10.3% roughly over the last 3 years. Will that start to expand, or do we just expect more top line growth, or flat margins [indiscernible] earnings growth going forward?

Okay. So as far as the gross margin, it is -- definitely, lower selling margins is what we indicated, which, to your point, does include free shipping. At the end of the day, we were intentionally competitive across all of our brands, all channels. And clearly, it worked. As I said earlier, we can afford to do that because our strategies allow us to do that and still have operating margin expansion. So it's just a choice we make between whether we do a free ship, a pricing promotion that hits gross margin, and we pull off from doing e-marketing, which the benefit hits SG&A, to still generate the top line sales and the bottom line growth in the operating margin. So that's going to continue. I don't see that changing at all. We think that's very healthy. And clearly, it's working for our brand. As far as operating margin expansion, for the year, on the high end, we're at 10.3%, and we have said that over our 3-year outlook, that we do plan on operating margin expansion. It goes from low double digits to mid-teens in our 3-year outlook.

And so the margin expansion then starts to accelerate at some point in the next couple of years?

Yes.

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

Laura, I'd love to talk a little bit more about the theme that I heard over and over again. I haven't counted exactly how many times you said personalization, but clearly, that is a theme for you guys this holiday. And I was just wondering if we could get a little bit into what personalization actually means for you. Is it higher-margin goods? From a financial perspective, is it margin accretive? It would seem to me that it would be lower returns and maybe an additional average price point that would be a little bit higher, but what sort of penetration are you looking at for Q4 for the holiday season? How do you look at that last year versus this year for personalization?

Thanks, Neely. I see personalization as really a key differentiator and a great gift more than anything. I mean, you can give someone a beautiful glass paperweight from Mark and Graham for $35, and it may be the most thoughtful gift they receive during the holiday season. And I think that's rare these days. We spent a lot of time talking about what kind of gifts we like to receive and to give, and have developed our category that way. It's great that it happens to be high-margin and oftentimes lower queued [ph], and the -- of course, we stand behind any damages we have. We allow our customers to return if there's damage. But you're right, they don't return if there's no damaged so it is very profitable business. We have made investments to make sure that we can ship as much as we possibly can ship this year because we expect, based on last year's results, to see very, very strong growth in this category. It's not an easy thing to execute, and so we are very fortunate we've been working on this for many years and making investments every year in how we do this, how we bring all this together across multiple categories and multiple techniques. It's not just embroidery, it's so many new techniques this year. And we do it all ourselves.

Do you have a sense of how much of the penetration of your holiday products will be offered with personalization this year?

Of course, I do, and it's been so competitive. And I'd prefer not to quantify any of the growth numbers or the SKU count increase.

And we have time for one last question, which will come from Marni Shapiro with The Retail Tracker analyst.

So my question circles around -- centers around food. You guys have historically had an outstanding assortment of food at Williams-Sonoma through the year, but particularly in the holiday season. And it looks great this year. And I see -- as the market has continued to do well and expand, I've seen a few food items. So I guess it begs the question, is there an opportunity to expand a little bit more into the food there? And, Laura, you've talked over and over about whether it's getting closer to the table, farm to table, or the focus around cooking and entertaining at home, and I was curious if you guys have looked into some of these subscription things. I'm sure you've seen them, most of them are coming out of your own backyard, where people receive a box to sample things. And is that something that, either through West Elm Market or Williams-Sonoma, that would be interesting to you guys?

Yes, thank you. It sure is. So many of the food products that we carry are from local and artisanal food people, and we have a lot more continuity programs this year that, if you go online, you'll see make excellent gifts. We look for very high quality in our foods, as you know. And I'm very excited personally this year about the expansion of -- particularly our peppermint bark. We have a lot more this year because it's our 15th year anniversary in peppermint bark. And when you go into the store, there's so much irresistible product in that category.

I saw that, by the way. I thought it looked fantastic this year.

Thank you. We also spent a lot of time on making packaging changes to our Thanksgiving product that I think is much more appealing. So while it's the same great quality that it's always been, updated the graphic layer and that's being met with good response. So, so far, so good. We're just early here in the fourth quarter, but we're seeing a nice response to the food offering that we have. It's a small business for market, but you're right in that we can even be more localized and smaller there because the scale is so much smaller. So we just are very selective about the great products that we carry and offer differentiated products to the customers who come into our stores.

And would it be okay if I took this all kind of one step further? You said at Williams-Sonoma the Wine Country was a very strong theme for you. Is it out of the question to think that Williams-Sonoma could be pairing with local vineyards to do some kind of wine, I don't know, club or offering or something along those lines? Or is that just something you're not going to get involved with?

We do have a wine club already online.

Oh, I missed that.

Yes. We do have it. And so you can look at that, and we carry -- and we select all of the line ourselves and taste it here and carry wine from small growers and then some larger ones, too.

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

Well, I just want to thank all of you for joining us this afternoon. We appreciate your time and your continued support. And we'll speak with you again in the new year. In the meantime, I hope you have a wonderful holiday season.

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